2011-11008

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

[Proposed Rules]

[Pages 29818-29900]

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

[FR Doc No: 2011-11008]

[[Page 29817]]

Vol. 76

Monday,

No. 99

May 23, 2011

Part II

Commodity Futures Trading Commission

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17 CFR Part 1

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Securities and Exchange Commission

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17 CFR Part 240

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

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

Agreement Recordkeeping; Proposed Rule

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

Rules

[[Page 29818]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AD46

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

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

RIN 3235-AL14

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

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

Agreement Recordkeeping

AGENCIES: Commodity Futures Trading Commission; Securities and Exchange

Commission.

ACTION: Joint proposed rules; proposed interpretations.

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

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

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

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

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

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

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

issuing proposed rules and proposed interpretive guidance under the

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

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

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

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

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

agreements.''

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

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

by any of the following methods:

CFTC:

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

through the Web site.

Mail: David A. Stawick, Secretary, Commodity Futures

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

Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

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

Follow the instructions for submitting comments.

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

Definitions'' must be in the subject field of responses submitted via

e-mail, and clearly indicated on written submissions. All comments must

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

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

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

you believe is exempt from disclosure under the Freedom of Information

Act, a petition for confidential treatment of the exempt information

may be submitted according to the procedures established in section

145.9 of the CFTC's regulations.\1\

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\1\ 17 CFR 145.9.

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

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

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

publication, including obscene language. All submissions that have been

redacted or removed that contain comments on the merits of the

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

considered as required under the Administrative Procedure Act and other

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

Act.

SEC

Electronic Comments

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

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

File Number S7-16-11 on the subject line; or

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

Paper Comments

Send paper comments in triplicate to Elizabeth M. Murphy,

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

Washington, DC 20549-1090. All submissions should refer to File Number

S7-16-11. This file number should be included on the subject line if e-

mail is used. To help us process and review your comments more

efficiently, please use only one method. The SEC will post all comments

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

printing in the SEC's Public Reference Room, 100 F Street, NE.,

Washington, DC 20549, on official business days between the hours of 10

a.m. and 3 p.m. All comments received will be posted without change;

the SEC does not edit personal identifying information from

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

available publicly.

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

General Counsel, at 202-418-5118, [email protected], Mark Fajfar,

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

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

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

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

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

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

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

SUPPLEMENTARY INFORMATION: The Commissions jointly are proposing new

rules and interpretive guidance under the CEA and the Exchange Act

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

swap agreements.

Table of Contents

I. Background

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

A. Introduction

B. Proposed Rules and Interpretive Guidance Regarding Certain

Transactions Outside the Scope of the Definitions of the Terms

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

1. Insurance Products

(a) Types of Insurance Products

(b) Providers of Insurance Products

2. The Forward Contract Exclusion

(a) Forward Contracts in Nonfinancial Commodities

(b) Commodity Options and Commodity Options Embedded in Forward

Contracts

(c) Security Forwards

3. Consumer and Commercial Agreements, Contracts, and

Transactions

4. Loan Participations

C. Proposed Rules and Interpretive Guidance Regarding Certain

Transactions Within the Scope of the Definitions of the Terms

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

1. In General

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2. Foreign Exchange Products

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

Determination: Foreign Exchange Forwards and Foreign Exchange Swaps

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

Swap Determination

(i) Foreign Currency Options

(ii) Non-Deliverable Forward Contracts Involving Foreign

Exchange

(iii) Currency Swaps and Cross-Currency Swaps

3. Forward Rate Agreements

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

Security-Based Swaps

5. Contracts for Differences

D. Certain Interpretive Issues

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

Documented Using Form Contracts Typically Used for, Swaps or

Security-Based Swaps

2. Transactions in Regional Transmission Organizations and

Independent System Operators

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

Based Swap Definition

A. Introduction

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

Rates, and Yields

1. Title VII Instruments Based on Interest Rates or Other

Monetary Rates That Are Swaps

2. Title VII Instruments Based on Yields

3. Title VII Instruments Based on Government Debt Obligations

C. Total Return Swaps

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

Single-Name Credit Default Swaps

E. Title VII Instruments Based on Futures Contracts

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

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

Based Swap Definition

1. Introduction

2. Applicability of the Statutory Narrow-Based Security Index

Definition and Past Guidance of the Commissions to Title VII

Instruments

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

Swaps

(a) In General

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

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

Security Index'' for Index Credit Default Swaps

(i) Number and Concentration Percentages of Reference Entities

or Securities

(ii) Public Information Availability Regarding Reference

Entities and Securities

(iii) Treatment of Indexes Including Reference Entities That Are

Issuers of Exempted Securities or Including Exempted Securities

4. Security Indexes

5. Evaluation of Title VII Instruments on Security Indexes That

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

(a) In General

(b) Title VII Instruments on Security Indexes Traded on

Designated Contract Markets, Swap Execution Facilities, Foreign

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

National Securities Exchanges

H. Method of Settlement of Index CDS

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

Securities Act

IV. Mixed Swaps

A. Scope of the Category of Mixed Swap

B. Regulation of Mixed Swaps

1. Introduction

2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-

Registered Dealers or Major Participants

3. Regulatory Treatment for Other Mixed Swaps

V. Security-Based Swap Agreements

A. Introduction

B. Swaps That Are Security-Based Swap Agreements

C. Books and Records Requirements for Security-Based Swap

Agreements

VI. Process for Requesting Interpretations of the Characterization

of a Title VII Instrument

VII. Anti-Evasion

A. CFTC Proposed Anti-Evasion Rules

B. SEC Request for Comment Regarding Anti-Evasion

VIII. Administrative Law Matters--CEA Revisions

IX. Administrative Law Matters--Exchange Act Revisions

X. Statutory Basis and Rule Text

I. Background

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

law.\2\ Title VII of the Dodd-Frank Act \3\ (``Title VII'') established

a comprehensive new regulatory framework for swaps and security-based

swaps. The legislation was enacted, among other reasons, to reduce

risk, increase transparency, and promote market integrity within the

financial system, including by: (i) Providing for the registration and

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

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

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

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

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

enhancing the rulemaking and enforcement authorities of the Commissions

with respect to, among others, all registered entities and

intermediaries subject to the Commissions' oversight.

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

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

Dodd-Frank Act is available at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

\3\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may

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

2010.''

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

Commissions, in consultation with the Board, shall jointly further

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

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

Frank Act provides further that the Commissions shall jointly prescribe

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

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

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

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

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

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

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

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

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

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

B, respectively, of Title VII.

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

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

of enactment, to determine whether stable value contracts, as

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

by the swap definition. If the Commissions determine that stable

value contracts are encompassed by the swap definition, section

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

to determine whether an exemption for those contracts from the swap

definition is appropriate and in the public interest. Section

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

implementing the determinations made under the required study. Until

the effective date of such regulations, the requirements under Title

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

contracts in effect prior to the effective date of such regulations

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

The Commissions currently are conducting the required joint study

and will consider whether to propose any implementing regulations

(including, if appropriate, regulations determining that stable

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

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

the swap definition) at the conclusion of that study.

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

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

governing books and records requirements for SBSAs by persons

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

including uniform rules that specify the data elements that shall be

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

[[Page 29820]]

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

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

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

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

based swap participants.\7\

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

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

separately, swap data recordkeeping and reporting. See Regulations

Establishing and Governing the Duties of Swap Dealers and Major Swap

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

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

also issued proposed rules regarding security-based swap data

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

collection and maintenance standards for SBSDRs, as well as rules

regarding security-based swap data recordkeeping and reporting. See

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

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

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

Dec. 2, 2010.

\7\ The CFTC has issued proposed rules regarding recordkeeping

requirements for swap dealers and major swap participants. See

Reporting, Recordkeeping, and Daily Trading Records Requirements for

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

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Under the comprehensive framework for regulating swaps and

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

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

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

jointly prescribe such regulations regarding mixed swaps as may be

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

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

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

swap related to securities over which the CFTC is given regulatory

authority.\11\

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

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

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

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

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

release refer to the numbering of those provisions after the

effective date of Title VII, except as indicated.

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

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

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

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

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

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

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

seq.

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

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

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

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

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

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

or more interest or other rates, currencies, commodities,

instruments of indebtedness, indices, quantitative measures, other

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

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

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

event or contingency associated with a potential financial,

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

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

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

narrow-based security index, provided that such event directly

affects the financial statements, financial condition, or financial

obligations of the issuer).

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

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

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

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

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

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

definition of SBSA in the Exchange Act specifically excludes

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

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

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

exclusion for security-based swaps is placed in the general

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

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

structurally, the Commissions interpret them to have consistent

meaning that the category of security-based swap agreements excludes

security-based swaps.

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To assist the Commissions in further defining the Product

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

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

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

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

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

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

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

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

from a wide range of commenters.

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

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

2010. The ANPR also solicited comment regarding the definitions of

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

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

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

of a separate joint proposed rulemaking by the Commissions. See

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

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

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

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

provided the public with the ability to present their views more

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

sites, dedicated electronic mailboxes, and meetings with interested

parties. See Public Comments on SEC Regulatory Initiatives Under the

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

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

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

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

available for Web site viewing and printing in the SEC's Public

Reference Room, 100 F Street, NE., Washington, DC 20549, on official

business days between the hours of 10 a.m. and 3 p.m. Copies of all

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

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

\14\ See supra note 12.

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The Commissions have reviewed the comments received, and the staffs

of the Commissions have met with many market participants and other

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

Commissions' staffs have consulted extensively with each other as

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

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

Dodd-Frank Act.

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

outside organizations regarding the implementation of the Dodd-Frank

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

staff have had with outside organizations regarding the product

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

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

solicitations, and at such meetings are collectively referred to as

the views of ``commenters.''

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Based on this review and consultation, the Commissions are

proposing interpretive guidance, and in some instances also proposing

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

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

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

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

regulatory treatment of certain foreign-exchange related and other

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

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

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

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

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

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

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

proposing rules: (i) establishing books and records requirements

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

Commissions to interpret whether a particular type of agreement,

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

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

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

of certain regulatory requirements to particular mixed swaps. Finally,

the CFTC is proposing rules to

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

The Commissions believe that the proposed rules and interpretive

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

believe that these proposals, if adopted, would appropriately effect

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

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

and, if not, how to improve these proposals.

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

A. Introduction

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

agreements, contracts, and transactions classified as swaps or

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

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

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

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

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

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

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

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

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

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

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

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

swaps.

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

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

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

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

(x).

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

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

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

78c(a)(68).

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

are detailed and comprehensive, and the Commissions believe that

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

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

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

agreements, contracts, and transactions that previously have not been

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

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

Congress intended such agreements, contracts, and transactions to be

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

Commissions thus believe that it is important to clarify the treatment

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

transactions, such as insurance products and certain consumer and

commercial contracts.

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

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

from Robert Pickel, Executive Vice President, International Swaps

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

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In addition, commenters also raised questions regarding, and the

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

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

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

related products (including various foreign exchange products and

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

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

providing guidance regarding certain interpretive issues related to the

definitions.\22\

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\22\ Some commenters raised concerns regarding the treatment of

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

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

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

Vice President and Corporate Counsel, Prudential Financial Inc.,

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

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

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

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

Cleary Letter; CDEU Letter. The Commissions are considering whether

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

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

of the Commissions' other Title VII rulemakings.

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B. Proposed Rules and Interpretive Guidance Regarding Certain

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

and ``Security-Based Swap''

1. Insurance Products

A number of commenters expressed concern that the definitions of

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

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

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

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

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

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

occurrence of an event or contingency associated with a potential

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

do not interpret this clause to mean that products historically treated

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

based swap definition.\25\

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

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

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

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

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

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

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

Zielezienski, Senior Vice President & General Counsel, American

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

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

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

Accounting and Investment Policy, Property Casualty Insurers

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

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

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

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

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

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

Wilkerson, Vice President and Chief Counsel, Securities &

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

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

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

Annuity Insurers, Dec. 3, 2010.

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

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

Congress through the swap and security-based swap definitions to

preclude the provision of insurance to individual homeowners and

small businesses that purchase property and casualty insurance. See

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

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

that do not meet specified financial thresholds or other conditions

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

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

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

Congress intended for insurance products to be regulated as swaps or

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

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

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

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

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

\26\

[[Page 29822]]

Accordingly, the Commissions believe that state or Federally regulated

insurance products that are provided by state or Federally regulated

insurance companies \27\ that otherwise could fall within the

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

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

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

Commissions are concerned that agreements, contracts, or transactions

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

insurance products to evade the regulatory regime under Title VII of

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

and interpretive guidance that would clarify that agreements,

contracts, or transactions meeting certain requirements would be

considered insurance and not swaps or security-based swaps.

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

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

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

Act requires the newly established Federal Insurance Office to

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

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

including the consideration of Federal insurance regulation.

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

extends primarily to monitoring and information gathering; its

ability to promulgate Federal insurance regulation that preempts

state insurance regulation is significantly restricted. See section

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

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

the business of insurance from regulation by the Bureau of Consumer

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

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

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

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

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

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

are engaged in the offering or provision of consumer financial

products or services or otherwise subject to certain consumer laws

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

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

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

Federal insurance law could be established in the future. The

Commissions believe that the proposed rules should, therefore,

include a specific reference to Federal insurance law.

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

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

satisfy the requirements under the proposed rules in order to avoid

being considered a swap or security-based swap.

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The proposed rules contain two subparts; the first subpart

addresses the agreement, contract, or transaction and the second

subpart addresses the entity providing that agreement, contract, or

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

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

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

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

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

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

Requires the beneficiary of the agreement, contract, or

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

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

with respect to that interest continuously throughout the duration of

the agreement, contract, or transaction;

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

payment or indemnification therefor be limited to the value of the

insurable interest;

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

organized market or over-the-counter; and

With respect to financial guaranty insurance only, in the

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

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

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

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

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

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

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

be provided:

By a company that is organized as an insurance company

whose primary and predominant business activity is the writing of

insurance or the reinsuring of risks underwritten by insurance

companies and that is subject to supervision by the insurance

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

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

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

laws of such state or the United States;

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

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

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

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

proposing to incorporate this definition into proposed rule

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

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

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By the United States or any of its agencies or

instrumentalities, or pursuant to a statutorily authorized program

thereof; or

In the case of reinsurance only, by a person located

outside the United States to an insurance company that is eligible

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

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

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

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

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

amount reimbursable by all reinsurers for such insurance product cannot

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

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

or transferred to such person located outside the United States.

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

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

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

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

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

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

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

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

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

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

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

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

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

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\31\ The Commissions note that certain variable life insurance

and annuity products are securities and would not be swaps or

security-based swaps regardless of whether they met the requirements

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

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

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

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

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

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

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

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

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

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

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

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

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

address the facts and circumstances of new products that may be

marketed or sold as insurance, for the purpose of determining

whether they satisfy the requirements of the proposed rules, through

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

Frank Act.

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In addition, the Commissions are proposing interpretive guidance to

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

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

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

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

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

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

(a) Types of Insurance Products \33\

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

this criterion.

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

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

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

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

beneficiary have an ``insurable interest'' underlying the

[[Page 29823]]

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

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

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

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

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

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

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

transaction would ensure that an insurance contract beneficiary has a

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

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

would require the beneficiary to have the insurable interest

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

is designed to ensure that payment on the insurance product is

inextricably connected to both the beneficiary and the interest on

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

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

require the purchaser of protection to hold any underlying obligation

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

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

stake in the interest traditionally has been justified on public

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

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

arson.

\35\ Standard CDS documentation stipulates that the incurrence

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

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

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

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

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

irrespective of the existence or amount of the parties' credit

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

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

Credit Event.'').

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

under the proposed rules similarly would ensure that the beneficiary

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

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

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

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

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

limiting any payment or indemnification to the value of the insurable

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

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

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

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

subject of an automobile insurance policy is being repaired, the

Commissions would consider such items as constituting part of the

value of the insurable interest.

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Third, the proposed rules would require that the insurance product

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

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

products traditionally have been neither entered into on or subject to

the rules of an organized exchange nor traded in secondary market

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

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

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

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

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

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

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

the Commissions believe that lack of trading separately from the

insured interest is a feature of insurance that is useful in

distinguishing insurance from swaps and security-based swaps.

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

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

effort to help make the bidding process more efficient and to

facilitate trading of policies after the initial settlement occurs,

some intermediaries have considered or instituted a trading platform

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

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

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

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

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

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

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

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Fourth, the proposed rules would address financial guarantee

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

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

certain key characteristics that distinguish them from swaps and

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

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

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

underlying guaranteed obligation. Also, for particular bonds that are

covered by a financial guarantee policy, the indenture, related

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

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

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

make payment of the full amount of principal on the underlying

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

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

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

protection seller frequently is required to make payment of the

relevant settlement amount to the protection buyer upon demand by the

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

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\39\ Several commenters expressed concern that the swap and

security-based swap definitions could encompass financial guarantee

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

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

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

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

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

municipalities to provide greater assurances to potential purchasers

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

the United States Securities and Exchange Commission on the

Financial Guarantee Market: The Use of the Exemption in section

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

Banks and the Use of Insurance Policies to Guarantee Debt

Securities'' (Aug. 28, 1987).

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

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

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

Financial Accounting Standards Board has issued separate guidance on

accounting for financial guaranty insurance and CDS); Deutsche Bank

Letter (noting that financial guaranty policies require the

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

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

credit event, the Commissions recognize that there are other

financial instruments, such as corporate guarantees of commercial

loans and letters of credit supporting payments on loans or debt

securities, that allow for acceleration of payment obligations

without such guarantees or letters of credit being swaps or

security-based swaps.

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The Commissions do not believe that financial guarantee policies,

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

However, because of the close economic similarity of financial

guarantee insurance policies guaranteeing payment on debt securities to

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

criteria noted above with respect to insurance generally, financial

guarantee policies also would have to satisfy the requirement that they

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

any principal due on the debt securities. This requirement would

further distinguish financial guarantee policies from CDS because, as

discussed above, the latter generally requires payment of the relevant

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

[[Page 29824]]

The Commissions believe that requiring all of the criteria in

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

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

application of the proposed rules to products appropriately regulated

as insurance and provide that products appropriately subject to the

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

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

that these requirements would help prevent the proposed rules from

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

based swap regulatory regimes under Title VII.

However, the Commissions are considering an additional criterion as

well. One ANPR commenter suggested that the proposed rules require

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

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

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

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

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

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

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

is used for speculative purposes or to influence prices in derivatives

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

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

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

variable annuity products, which deliver insurance guarantees that do

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

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\42\ See Cleary Letter.

\43\ See ACLI Letter.

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The Commissions request comment on whether, in order for an

agreement, contract, or transaction to be considered insurance pursuant

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

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

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

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

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

variable annuity contracts (where the income is subject to tax

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

universal life insurance should be excepted from such a

requirement.\44\

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

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

Although the proposed criteria should appropriately identify

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

insurance, the Commissions also are proposing interpretive guidance

that certain enumerated types of insurance products are outside the

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

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

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

property and casualty insurance, and annuity products the income on

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

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

insurance products do not bear the characteristics of the transactions

that Congress subjected to the regulatory regime for swaps and

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

excluding these enumerated insurance products should appropriately

place traditional insurance products outside the scope of the swap and

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

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

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

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

products would need to be regulated as insurance.

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\45\ Id.

\46\ The list of enumerated insurance products is generally

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

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

insurance underwriting in national banks.

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(b) Providers of Insurance Products

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

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

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

meeting the product requirements discussed above (or being subject to

the interpretive guidance regarding enumerated insurance products

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

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

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

insurance company whose primary and predominant business activity is

the writing of insurance or the reinsuring of risks underwritten by

companies whose insurance business is subject to supervision by the

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

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

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

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

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

contained in the proposed rules.

\48\ This paragraph of the proposed rules is substantially

similar to the definition of an insurance company under the Federal

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

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

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

reinsurance companies. In order to ensure regulatory consistency,

the Commissions believe that it is appropriate to include

substantially the same definition of an insurance company as

currently exists elsewhere in the Federal securities laws, but the

Commissions are requesting comment regarding the role played by a

receiver or similar official or any liquidating agent for such

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

this provision of the insurance company definition.

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The requirement that the agreement, contract, or transaction be

provided by a state or Federally regulated insurance company would help

ensure that entities that are not regulated under insurance laws are

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

well. The Commissions believe that this requirement also should help

prevent regulatory gaps that otherwise might exist between insurance

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

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

or transaction provided by the insurance company be regulated as

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

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

agreement, contract, or transaction that satisfies the other conditions

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

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

regulator must have determined that the agreement, contract, or

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

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

Commissions believe that this condition would help prevent products

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

insurance products in order to evade the regulatory regime under Title

VII of the Dodd-Frank Act.

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

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The Commissions also believe that it is appropriate to exclude

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

instrumentalities, or pursuant to a statutorily authorized program

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

[[Page 29825]]

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

banks, savings associations, and credit unions; catastrophic crop

insurance; flood insurance; Federal insurance of certain pension

obligations; and terrorism risk insurance. Accordingly, the proposed

rules would provide that products meeting the criteria discussed above

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

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

definitions if they are provided by the Federal government or pursuant

to a statutorily authorized program thereof.

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

or transaction qualifies as insurance excluded from the swap and

security-based swap definitions, the lawful reinsurance of that

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

reinsurance would be excluded from the definitions even if the

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

Accordingly, the proposed rules would provide that an agreement,

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

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

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

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

reinsurance to a state or Federally regulated insurance company, so

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

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

reimbursable by all reinsurers for such insurance product cannot exceed

the claims or losses paid by the cedant.

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

transaction by an insurance company and would not affect the

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

agreement, contract, or transaction insures or guarantees the payment

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

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

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

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

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

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

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

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

guarantee of a security).

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One commenter has stated that monoline insurance companies (also

called financial guarantors) continue to guarantee payments under

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

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

from the underlying swap to suggest that Congress intended the former

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

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

Financial Guaranty Insurers Government Affairs Committee, Feb. 18,

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

through the issuance of a financial guaranty insurance policy, the

obligations of unaffiliated parties under swaps with other

unaffiliated parties. These insurance policies typically cover

obligations of municipalities under interest rate or basis swaps

relating to bonds issued by municipalities or in connection with

asset backed securities.'').

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

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

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

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

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\52\ See supra note 32.

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The Commissions request comment on this issue generally, and also

on the particular questions set forth in the Request for Comment

section below.

The Commissions also are considering whether the issuer of such

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

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

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

Commissions have requested comment in the proposing release for the

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

security-based swap participant''.\53\

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

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Request for Comment

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

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

Act and the interpretive guidance in this section.

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

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

swap definitions appropriately encompass insurance and reinsurance

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

not encompassed, and why?

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

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

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

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

the Exchange Act?

4. Is the proposed requirement that the beneficiary of an

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

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

carry the risk of loss with respect to that interest continuously

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

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

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

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

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

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

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

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

definition, an effective criterion in determining whether a product is

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

indemnification for proved loss be limited to the value of the

insurable interest consistent with conventional insurance analysis

across a broad range of products (including traditional property and

casualty products)? Are there particular products where such a

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

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

appropriate.

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

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

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

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

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

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

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

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

commodity? Would such a requirement be an effective criterion in

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

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

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

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

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

requirement help preclude the use of the proposed rules for products

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

requirement preclude the use of the proposed rules for products that

currently are insurance? If so, what

[[Page 29826]]

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

How are insurance payments determined today?

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

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

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

sole discretion of the insurer an effective criterion in determining

whether a financial guaranty policy is insurance that does not fall

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

9. Does the interpretive guidance proposed in this section

appropriately identify certain enumerated insurance products as

traditional insurance products that would not fall within the swap or

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

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

interpretive guidance proposed in this section sufficient? Why or why

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

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

any of the enumerated insurance products serve to exclude products that

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

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

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

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

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

explanation of the insurance products that should not be subject to

these requirements. Are there insurance products currently offered that

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

such products and their providers.

10. The Commissions are proposing guidance that certain enumerated

types of insurance products, including property and casualty insurance,

are outside the scope of the statutory definitions of the terms

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

Commissions request comment generally as to the proposed guidance

regarding property and casualty insurance. The CFTC also requests

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

GLBA, which names certain insurance products, including private

passenger or commercial automobile, homeowners, mortgage, commercial

multiperil, general liability, professional liability, workers'

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

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

boiler and machinery insurance, should be considered traditional

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

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

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

The SEC also requests comment on whether the products specified in

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

proposed guidance regarding property and casualty insurance as outside

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

other categories of traditional property and casualty insurance that

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

description of such other categories of property and casualty insurance

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

types of property and casualty insurance that fall within the swap

definition, will that affect the ability of persons, including

consumers and businesses, to protect their properties against losses?

If so, please provide a detailed explanation.

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

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

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

the Exchange Act? Is additional clarification necessary to address such

situations? If so, what clarification?

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

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

company whose primary and predominant business activity is the writing

of insurance or the reinsuring of risks underwritten by insurance

companies and that is subject to supervision by the insurance

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

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

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

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

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

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

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

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

sufficiently prevent evasion of the requirements of Title VII with

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

security-based swaps? Why or why not?

13. Are there circumstances under which a receiver or similar

official or any liquidating agency for a state or Federally regulated

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

insurance rather than administering an insurance product that is

provided by an insurance company? Please provide a detailed explanation

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

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

transaction that satisfies the criteria of insurance but that is

provided by a receiver or similar official or any liquidating agency

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

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

security-based swap definition? Why or why not?

14. Do the proposed rules appropriately treat an agreement,

contract, or transaction that satisfies the criteria of insurance but

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

instrumentalities, or pursuant to a statutorily authorized program

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

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

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

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

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

instrumentalities provide insurance products? Should the proposed

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

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

instrumentalities, or pursuant to a statutorily authorized program

thereof? Why or why not?

15. Do the proposed rules appropriately treat reinsurance by a

person located outside the United States of a product meeting the

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

total amount reimbursable by all of the reinsurers for such insurance

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

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

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

States from offering such reinsurance to a state or Federally regulated

insurance company? Do these provisions of the proposed rules

sufficiently prevent evasion of the requirements of Title VII with

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

security-based swaps? Why or why not?

[[Page 29827]]

16. Are there additional criteria for identifying contracts,

agreements, or transactions that are insurance and not swaps or

security-based swaps that the Commissions should consider? Please

provide detailed information and empirical data, to the extent

possible, supporting any suggested criteria.

17. Should the proposed rules relating to insurance include a

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

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

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

challenges may be encountered in light of the proposed Accounting

Standards Update ``Accounting for Financial Instruments and Revisions

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

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

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

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

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

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

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

accepted accounting principles.

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

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

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

the insurance wrap of a swap sufficiently different (economically or

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

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

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

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

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

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

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

empirical data and analysis to the extent possible.

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

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

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

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

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

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

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

to the extent possible. Would regulating such products as insurance

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

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

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

the extent possible.

20. Should the proposed rules include a provision similar to

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

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

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

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

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

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

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

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

should apply.

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

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21. The Commissions understand that swap guarantees may be offered

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

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

guarantees or insurance policies offered by insurance companies

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

Why or why not?

2. The Forward Contract Exclusion

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

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

nonfinancial commodity or security for deferred shipment or delivery,

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

Commenters have requested guidance from the Commissions regarding the

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

provide guidance to market participants regarding the applicability of

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

forward contracts with respect to nonfinancial commodities \56\ and

securities.

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

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

applies solely to the exclusion of nonfinancial commodity forwards

from the swap definition in the Dodd-Frank Act.

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(a) Forward Contracts in Nonfinancial Commodities

The wording of the forward contract exclusion from the swap

definition with respect to nonfinancial commodities is similar, but not

identical, to the forward contract exclusion from the definition of

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

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

commenters expressed the view that, with respect to nonfinancial

commodities, the forward contract exclusion from the swap definition

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

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

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

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

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

clarification of the scope of the forward contract exclusion from the

swap definition with respect to nonfinancial commodities is

appropriate.\60\

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

contract.

\58\ Statutory Interpretation Concerning Forward Transactions,

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

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

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

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

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

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

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

Letter''); Letter from Eric Dennison, Sr. Vice President and General

Counsel, Stephanie Miller, Assistant General Counsel--Commodities,

and Bill Hellinghausen, Director of Regulatory Affairs, EDF Trading

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

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

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

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

Letter from Richard Ostrander, Managing Director and Counsel, Morgan

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

Michael Greenberger, JD, Law School Professor, University of

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

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

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

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

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

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

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

documentation used by the parties are not dispositive of whether a

particular agreement, contract, or transaction is a swap or

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

agreement, contract, or transaction with respect to a nonfinancial

commodity qualifies for the forward exclusion from the swap

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

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

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

contract, or transaction that does not qualify for the forward

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

parties refer to it as a forward contract.

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[[Page 29828]]

Forward contracts with respect to nonfinancial commodities are

commercial merchandising transactions. The primary purpose of the

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

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solely its price risk. The CFTC has noted:

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

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

apply to private commercial merchandising transactions which create

enforceable obligations to deliver but in which delivery is deferred

for reasons of commercial convenience or necessity.\61\

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

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

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

Rep. (CCH) ] 29,636 (CFTC Nov. 25, 2003); In re Competitive

Strategies for Agric., Ltd., [2003-2004 Transfer Binder] Comm. Fut.

L. Rep. (CCH) ] 29,635 (CFTC Nov. 25, 2003). Courts have expressed

this view as well. See, e.g., Salomon Forex, Inc. v. Tauber, 8 F.3d

966, 971 (4th Cir. 1993) (``[C]ash forwards are generally

individually negotiated sales * * * in which actual delivery of the

commodity is anticipated, but is deferred for reasons of commercial

convenience or necessity.''); CFTC v. Int'l Fin. Serv. (N.Y.), 323

F. Supp. 2d 482, 495 (S.D.N.Y. 2004). See also CFTC v. Co Petro

Mktg. Grp., Inc., 680 F.2d 573, 579-580 (9th Cir. 1982); CFTC v.

Noble Metals Int'l, Inc., 67 F.3d 766, 772-773 (9th Cir. 1995; CFTC

v. Am. Metal Exch. Corp., 693 F. Supp. 168, 192 (D.N.J. 1988); CFTC

v. Morgan, Harris & Scott, Ltd., 484 F. Supp. 669, 675 (S.D.N.Y.

1979) (forward contract exclusion does not apply to speculative

transactions in which delivery obligations can be extinguished under

the terms of the contract or avoided for reasons other than

commercial convenience or necessity).

The CFTC believes that the forward contract exclusion in the Dodd-

Frank Act with respect to nonfinancial commodities should be read

consistently with this established, historical understanding that a

forward contract is a commercial merchandising transaction.

Many commenters discussed the issue of whether the requirement in

the Dodd-Frank Act that a transaction be ``intended to be physically

settled'' in order to qualify for the forward exclusion from the swap

definition with respect to nonfinancial commodities reflects a change

in the standard for determining whether a transaction is a forward

contract.\62\ Because a forward contract is a commercial merchandising

transaction, intent to deliver historically has been an element of the

CFTC's analysis of whether a particular contract is a forward

contract.\63\ In assessing the parties' expectations or intent

regarding delivery, the CFTC consistently has applied a ``facts and

circumstances'' test.\64\ Therefore, the CFTC reads the ``intended to

be physically settled'' language in the swap definition with respect to

nonfinancial commodities to reflect a directive that intent to deliver

a physical commodity be a part of the analysis of whether a given

contract is a forward contract or a swap, just as it is a part of the

CFTC's analysis of whether a given contract is a forward contract or a

futures contract.

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\62\ See, e.g., BG Letter (forward exclusion for swaps should be

consistent with the forward exclusion from futures); BlackRock

Letter (the CFTC should interpret ``intended to be physically

settled'' consistently with existing CFTC principles, including book

outs); DFA Letter (forward exclusion for swaps should be interpreted

consistently with the CFTC's prior forward contract interpretations

and precedent, including forwards requiring delivery but including

embedded options); EDF Letter (forward exclusion from the definition

of swap should be construed in a consistent manner with the forward

exclusion under the CEA); EEI Letter (forward exclusion from swap

definition should be interpreted consistently with the forward

exclusion from futures); FIA Letter (the Commissions should, through

rulemaking or interpretation, provide that the ``intent'' standard

in the forward exclusion with respect to swaps will be interpreted

the same as the existing forward exclusion with respect to futures);

Morgan Stanley Letter (the forward exclusion from the swap

definition should be interpreted consistently with the forward

exclusion from futures); University of Maryland Letter (forward

exclusion from swap definition intended to be consistent with the

forward exclusion from futures); WGCEF Letter (physical delivery

forwards should be distinguished from swaps under standards

identical to those used in forwards vs. futures); World Fuel Letter

(forward exclusion for swaps should be interpreted in a manner

consistent with the forward exclusion from futures).

\63\ As recently as October 25, 2010, the CFTC observed in In re

Wright that ``it is well-established that the intent to make or take

delivery is the critical factor in determining whether a contract

qualifies as a forward.'' In re Wright, CFTC Docket No. 97-02, 2010

WL 4388247 at *3 (CFTC Oct. 25, 2010) (citing In re Stovall, et al.,

[1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,941 (CFTC

Dec. 6, 1979); Brent Interpretation, supra note 58). In Wright, the

CFTC noted that ``[i]n distinguishing futures from forwards, the

[CFTC] and the courts have assessed the transaction as a whole with

a critical eye toward its underlying purpose. Such an assessment

entails a review of the overall effect of the transaction as well as

a determination as to what the parties intended.'' Id. at *3

(quoting Policy Statement Concerning Swap Transactions, 54 FR 30694,

July 21, 1989 (``Swap Policy Statement'') (citations and internal

quotations omitted).

\64\ In its recent decision in In re Wright, the CFTC applied

its facts and circumstances test in an administrative enforcement

action involving hedge-to-arrive contracts for corn, and observed

that ``[o]ur views of the appropriateness of a multi-factor analysis

remain unchanged.'' Wright, supra note 63, n.13. The CFTC let stand

the administrative law judge's conclusion that the hedge-to-arrive

contracts at issue in the case were forward contracts. Id. at **5-6.

See also Grain Land, supra note 61; Competitive Strategies for

Agric., supra note 61.

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Commenters also requested clarification of the treatment of one

type of forward contract--``book-out'' transactions--in the context of

the forward exclusion from the swap definition with respect to

nonfinancial commodities. The issue of book-outs first arose in 1990 in

the Brent Interpretation\65\ because the parties to the crude oil

contracts in that case could individually negotiate cancellation

agreements, or ``book-outs,'' with other parties.\66\ In describing

these transactions, the CFTC stated:

\65\ See Brent Interpretation, supra note 58. The CFTC issued

the Brent Interpretation in response to a Federal court decision

that held that certain 15-day Brent system crude oil contracts were

illegal off-exchange futures contracts. See Transnor (Bermuda) Ltd.

v. BP N. Am. Petroleum, 738 F. Supp. 1472 (S.D.N.Y. 1990). The Brent

Interpretation provided clarification that the 15-day Brent system

crude oil contracts were forward contracts that were excluded from

the CEA definition of ``future delivery,'' and thus were not futures

contracts. See Brent Interpretation, supra note 58.

\66\ The Brent Interpretation described these ``book-outs'' as

follows: ``In the course of entering into 15-day contracts for

delivery of a cargo during a particular month, situations often

arise in which two counterparties have multiple, offsetting

positions with each other. These situations arise as a result of the

effectuation of multiple, independent commercial transactions. In

such circumstances, rather than requiring the effectuation of

redundant deliveries and the assumption of the credit, delivery and

related risks attendant thereto, the parties may, but are not

obligated to and may elect not to, terminate their contracts and

forego such deliveries and instead negotiate payment-of-differences

pursuant to a separate, individually negotiated cancellation

agreement referred to as a `book-out.' Similarly, situations

regularly arise when participants find themselves selling and

purchasing oil more than once in the delivery chain for a particular

cargo. The participants comprising these `circles' or `loops' will

frequently attempt to negotiate separate cancellation agreements

among themselves for the same reasons and with the same effect

described above.'' Brent Interpretation, supra note 58, at 39190.

It is noteworthy that while such [book-out] agreements may

extinguish a party's delivery obligation, they are separate,

individually negotiated, new agreements, there is no obligation or

arrangement to enter into such agreements, they are not provided for

by the terms of the contracts as initially entered into, and any

party that is in a position in a distribution chain that provides

for the opportunity to book-out with another party or parties in the

chain is nevertheless entitled to require delivery of the commodity

to be made through it, as required under the contracts.\67\

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\67\ Id. at 39192.

Thus, in the scenario at issue in the Brent Interpretation, the

contracts created a binding obligation to make or take delivery without

providing any right to offset, cancel, or settle on a payment-of-

differences basis. The ``parties enter[ed] into such contracts with the

recognition that they may be required to make or take delivery.'' \68\

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\68\ Id. at 39189.

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On these facts, the Brent Interpretation concluded that the

[[Page 29829]]

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contracts were forward contracts, not futures contracts:

Under these circumstances, the [CFTC] is of the view that

transactions of this type which are entered into between commercial

participants in connection with their business, which create

specific delivery obligations that impose substantial economic risks

of a commercial nature to these participants, but which may involve,

in certain circumstances, string or chain deliveries of the type

described * * * are within the scope of the [forward contract]

exclusion from the [CFTC's] regulatory jurisdiction.\69\

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\69\ Id. at 39192.

Although the CFTC did not expressly discuss intent to deliver, the

Brent Interpretation concluded that transactions retained their

character as commercial merchandising transactions, notwithstanding the

practice of terminating commercial parties' delivery obligations

through ``book-outs'' as described. At any point in the chain, one of

the parties could refuse to enter into a new contract to book-out the

transaction and, instead, insist upon delivery pursuant to the parties'

obligations under their contract.

The CFTC believes that the principles underlying the Brent

Interpretation similarly should apply to the forward exclusion from the

swap definition with respect to nonfinancial commodities. To summarize,

then, the CFTC believes that: (i) The forward contract exclusion from

the swap definition with respect to nonfinancial commodities should be

interpreted in a manner that is consistent with the CFTC's historical

interpretation of the forward contract exclusion from the definition of

the term ``future delivery''; (ii) intent to deliver is an essential

element of a forward contract excluded from both the swap and future

delivery definitions, and such intent in both instances should be

evaluated based on the CFTC's established multi-factor approach; and

(iii) book-out transactions in nonfinancial commodities that meet the

requirements specified in the Brent Interpretation, and that are

effectuated through a subsequent, separately-negotiated agreement,

should qualify for the forward exclusion from the swap definition.\70\

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\70\ This interpretive guidance is consistent with legislative

history. See 156 Cong. Rec. H5247 (June 30, 2010) (colloquy between

U.S. House Committee on Agriculture Chairman Collin Peterson and

Representative Leonard Boswell during the debate on the Conference

Report for the Dodd-Frank Act, in which Chairman Peterson stated:

``Excluding physical forward contracts, including book-outs, is

consistent with the CFTC's longstanding view that physical forward

contracts in which the parties later agree to book-out their

delivery obligations for commercial convenience are excluded from

its jurisdiction. Nothing in this legislation changes that result

with respect to commercial forward contracts.''). See also 156 Cong.

Rec. H5248-49 (June 30, 2010) (introducing into the record a letter

authored by Senator Blanche Lincoln, Chairman of the U.S. Senate

Committee on Agriculture, Nutrition and Forestry, and Christopher

Dodd, Chairman U.S. Senate Committee on Banking, Housing, and Urban

Affairs, stating that the CFTC is encouraged ``to clarify through

rulemaking that the exclusion from the definition of swap for `any

sale of a nonfinancial commodity or security for deferred shipment

or delivery, so long as the transaction is intended to be physically

settled' is intended to be consistent with the forward contract

exclusion that is currently in the [CEA] and the CFTC's established

policy and orders on this subject, including situations where

commercial parties agree to `book-out' their physical delivery

obligations under a forward contract.'').

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As noted above, the Brent Interpretation applies to ``commercial

participants in connection with their business.'' \71\ Market

participants that regularly make or take delivery of the referenced

commodity (in the case of the Brent Interpretation, a tanker full of

Brent oil) in the ordinary course of their business meet that standard.

Such entities qualify for the forward exclusion from both the future

delivery and swap definitions for their forward transactions under the

Brent Interpretation even if they enter a subsequent transaction to

``book out'' the forward contract rather than make or take delivery.

Intent to make or take delivery can be inferred from the binding

delivery obligation for the referenced commodity in the contract and

the fact that the parties to the contract do, in fact, regularly make

or take delivery of the referenced commodity in the contract in the

ordinary course of their business.

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\71\ See Brent Interpretation, supra note 58, at 39192.

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Some commenters to the ANPR requested clarification with regard to

the application of the CFTC's 1993 order exempting certain energy

contracts from regulation under the CEA (the ``Energy Exemption'') \72\

after enactment of the Dodd-Frank Act.\73\ The Energy Exemption

extended the Brent Interpretation regarding the forward contract

exclusion from the term ``future delivery'' to energy commodities other

than oil. The CFTC believes that the book-out provisions of the Brent

Interpretation similarly should apply to the forward contract exclusion

from the swap definition for nonfinancial commodities besides oil.

Further, the CFTC also is proposing interpretive guidance herein that

the Brent Interpretation with respect to the application of the forward

contract exclusion from the term ``future delivery'' in the context of

book-out transactions applies not just to oil, but to all nonfinancial

commodities. The CFTC, therefore, is proposing to withdraw the Energy

Exemption, while retaining and extending through this interpretive

guidance the Brent Interpretation regarding book-outs under the forward

contract exclusion with respect to nonfinancial commodities.\74\

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\72\ Exemption for Certain Contracts Involving Energy Products,

58 FR 21286, Apr. 20, 1993. The Energy Exemption generally applies

to certain energy contracts: (i) Entered into by persons reasonably

believed to be within a specified class of commercial and

governmental entities; (ii) that are bilateral contracts between two

parties acting as principals; (iii) the material economic terms of

which are subject to individual negotiation by the parties; and (iv)

that impose binding obligations on the parties to make and receive

delivery of the underlying commodity, with no right of either party

to effect a cash settlement of their obligations without the consent

of the other party (except pursuant to a bona fide termination right

such as default). Like the Brent Interpretation, the Energy

Exemption provides that the parties can enter into a subsequent

book-out settlement of the obligation in a manner other than by

physical delivery of the commodity specified in the contract. Id. at

21294.

\73\ See, e.g., WGCEF letter. The CFTC issued the Energy

Exemption shortly after Congress had provided the CFTC with

exemptive authority pursuant to CEA section 4(c), 7 U.S.C. 6(c), in

section 502 of the Futures Trading Practices Act of 1992, Public Law

102-546, 106 Stat. 3590 (1993).

\74\ To avoid any uncertainty, the CFTC also notes that the

Dodd-Frank Act supersedes the Swap Policy Statement. The CFTC is

aware that some commenters have suggested that the Commissions

should exercise their authority to further define the term

``eligible contract participant'' to encompass the ``line of

business'' provision of the Swap Policy Statement. See Swap Policy

Statement, supra note 63, at 30696-30697. The Commissions will

address these comments in their joint final rulemaking with respect

to the Entity Definitions. See supra note 12.

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(b) Commodity Options and Commodity Options Embedded in Forward

Contracts

Some commenters responding to the ANPR requested clarification

regarding the status of commodity options under the swap

definition.\75\ Questions also were raised regarding options embedded

in forward contracts, i.e., whether a forward contract with respect to

a nonfinancial commodity that contains an embedded option can still

qualify for the forward contract exclusion from the swap

definition.\76\

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\75\ See, e.g., World Fuel Letter (exclusion for commercial

options set forth in CFTC Regulation 32.4 should also be an

exclusion from the swap definition).

\76\ See, e.g., Letter from Patrick Kelly, Policy Advisor, API,

Sept. 20, 2010 (``API Letter''), EEI Letter; Letter from Daniel S.M.

Dolan, VP, Policy Research & Communications, Electric Power Supply

Association, Sept. 20, 2010 (``EPSA Letter'') (physically settled

options should be included in the forward exclusion from the swap

definition); DFA Letter; ISDA Letter. One commenter suggested that

the CFTC should apply to each contract with an enforceable delivery

obligation a rebuttable presumption of intent to deliver, even if an

option to cash settle is included in that contract. See WGCEF

Letter.

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The statutory swap definition explicitly provides that commodity

[[Page 29830]]

options are swaps.\77\ Accordingly, the CFTC recently proposed

revisions to its existing options rules in parts 32 and 33 of its

regulations with respect to the treatment of commodity options under

the Dodd-Frank Act, and requested public comment on those proposed

revisions.\78\ The question of the application of the forward exclusion

from the swap definition with respect to nonfinancial commodities,

where commodity options are embedded in forward contracts (including

embedded options to cash settle such contracts), is similar to that

arising under the CEA's existing forward contract exclusion from the

definition of the term ``future delivery.'' The CFTC's Office of

General Counsel addressed forward contracts that contained embedded

options in a 1985 interpretive statement (``1985 Interpretation''),\79\

which the CFTC recently adhered to in its adjudicatory Order in the

Wright case.\80\ While both were issued prior to the effective date of

the Dodd-Frank Act, the CFTC believes that it would be appropriate to

apply this guidance to the treatment of forward contracts in

nonfinancial commodities that contain embedded options under the Dodd-

Frank Act.

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\77\ 7 U.S.C. 1a(47)(A)(i). Options on securities and certain

options on foreign currency are excluded from the swap definition by

CEA sections 1a(47)(B)(iii) and (iv), respectively. 7 U.S.C.

1a(47)(B)(iii) and (iv). These options are not subject to the

Commissions' proposed guidance in this section.

\78\ See Commodity Options and Agricultural Swaps, 76 FR 6095,

Feb. 3, 2011.

\79\ See Characteristics Distinguishing Cash and Forward

Contracts and ``Trade'' Options, 50 FR 39656, Sept. 30, 1985.

\80\ Wright, supra note 63.

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In Wright, the CFTC described the 1985 Interpretation and stated

that the CFTC traditionally has engaged in a two-step analysis of

``embedded options'' in which the first step focuses on whether the

option operates on the price or the delivery term of the forward

contract and the second step focuses on secondary trading.\81\ The CFTC

believes that these same principles can be applied with respect to the

forward contract exclusion from the swap definition for nonfinancial

commodities in the Dodd-Frank Act, too. That is, a forward contract

that contains an embedded commodity option or options \82\ would be

considered an excluded nonfinancial commodity forward contract (and not

a swap) if the embedded option(s): (i) May be used to adjust the

forward contract price, but do not undermine the overall nature of the

contract as a forward contract; (ii) do not target the delivery term,

so that the predominant feature of the contract is actual delivery; and

(iii) cannot be severed and marketed separately from the overall

forward contract in which they are embedded.\83\ Conversely, where the

embedded commodity option(s) render delivery optional, the predominant

feature of the contract cannot be actual delivery and, therefore, the

embedded option(s) to not deliver preclude treatment of the contract as

a forward contract for a nonfinancial commodity. The CFTC would look to

the specific facts and circumstances of the transaction as a whole to

evaluate whether any embedded optionality operates on the price or

delivery term of the contract, and whether an embedded commodity option

is marketed or traded separately from the underlying contract, to

determine whether that transaction qualifies for the forward contract

exclusion from the swap definition for nonfinancial commodities.\84\

The CFTC believes that such an approach would help prevent commodity

options that should fall within the swap definition from qualifying for

the forward contract exclusion for nonfinancial commodities instead.

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\81\ Id. at n.5. In Wright, the CFTC affirmed the Administrative

Law Judge's holding that an option embedded in a hedge-to-arrive

contract did not violate CFTC rules regarding the sale of

agricultural trade options. The CFTC first concluded that the puts

at issue operated to adjust the forward price and did not render the

farmer's overall obligation to make delivery optional. Then, turning

to the next step of the analysis, the CFTC explained that ``the put

and [hedge-to-arrive contract] operated as a single contract, and in

most cases were issued simultaneously * * *. We do not find that any

put was severed from its forward or that either of [the put or the

hedge-to-arrive contract] was traded separately from the other. We

hold that in these circumstances, no freestanding option came into

being. * * *'' Id. at *7.

\82\ The CFTC believes that ``options'' in the plural would

include, for example, a situation in which the embedded optionality

involves option combinations, such as costless collars, that operate

on the price term of the agreement, contract, or transaction.

\83\ See Wright, supra note 63, at **6-7.

\84\ This facts and circumstances approach to determining

whether a particular embedded option takes a transaction out of the

forward contract exclusion for nonfinancial commodities is

consistent with the CFTC's historical approach to determining

whether a particular embedded option takes a transaction out of the

forward contract exclusion from the CEA definition of the term

``future delivery.'' See Wright, supra note 63, at *5 (``As we have

held since Stovall, the nature of a contract involves a multi-factor

analysis . * * *'').

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(c) Security Forwards \85\

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\85\ The discussion above regarding the exclusion from the swap

definition for forward contracts on nonfinancial commodities does

not apply to the exclusion from the swap and security-based swap

definitions for security forwards or to the distinction between

security forwards and security futures products.

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No commenters sought clarification of the exclusion from the swap

and security-based swap definitions for the ``sale of a nonfinancial

commodity or security for deferred shipment or delivery, so long as the

transaction is intended to be physically settled,'' in the context of

most sales of securities for deferred shipment or delivery; however,

some commenters sought clarification of this exclusion in the context

of mortgage securitizations.\86\ The Commissions believe it is

appropriate to address how the exclusions from the definitions of swap

and security-based swap apply to security forwards and other purchases

and sales of securities.

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\86\ Specifically, commenters requested clarification that the

swap and security-based swap definitions do not include buying and

selling mortgages and forward trading of agency (i.e., Federal Home

Loan Mortgage Corporation (``Freddie Mac''), Federal National

Mortgage Association (``Fannie Mae''), and Government National

Mortgage Association (``Ginnie Mae'') mortgage-backed securities

(``MBS'') in the ``To-Be-Announced'' (``TBA'') market in order to

provide the certainty needed to avoid unnecessary disruption of the

securitization market. See Letter from Stephen H. McElhennon, Vice

President & Deputy General Counsel, Fannie Mae, Sept. 20, 2010

(``Fannie Mae Letter''); Letter from Lisa M. Ledbetter, Freddie Mac,

Sept. 20, 2010.

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The Dodd-Frank Act excludes purchases and sales of securities from

the definitions of swap and security-based swap in a number of

different clauses.\87\ Under these exclusions, purchases and sales of

securities on a fixed or contingent basis \88\ and sales of securities

for deferred shipment or delivery that are intended to be physically

delivered \89\ are explicitly excluded from the definitions of swap and

security-based swap.\90\ The exclusion from the definitions of swap and

security-based swap of a sale of a security for deferred shipment or

delivery involves an agreement to purchase securities, or groups or

indexes of securities, at a future date at a certain price.

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\87\ See CEA sections 1a(47)(B)(ii), (v), and (vi), 7 U.S.C.

1a(47)(B)(ii), (v), and (vi).

\88\ See CEA section 1a(47)(B)(v), 7 U.S.C. 1a(47)(B)(v)

(excluding from the swap and security-based swap definitions ``any

agreement, contract, or transaction providing for the purchase or

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

[the Securities Act and Exchange Act]''); CEA section 1a(47)(B)(vi),

7 U.S.C. 1a(47)(B)(vi) (excluding from the swap and security-based

swap definitions ``any agreement, contract, or transaction providing

for the purchase or sale of 1 or more securities on a contingent

basis that is subject to [the Securities Act and Exchange Act],

unless the agreement, contract, or transaction predicates the

purchase or sale on the occurrence of a bona fide contingency that

might reasonably be expected to affect or be affected by the

creditworthiness of a party other than a party to the agreement,

contract, or transaction'').

\89\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

\90\ The Commissions note that calling an agreement, contract,

or transaction a swap or security-based swap does not determine its

status. See discussion supra part II.D.1.

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[[Page 29831]]

As with other purchases and sales of securities, security forwards

are excluded from the definitions of swap and security-based swap. The

sale of the security in this case occurs at the time the forward

contract is entered into with the performance of the contract deferred

or delayed. If such agreement, contract, or transaction is intended to

be physically settled, the Commissions believe it would be within the

security forward exclusion and therefore outside the swap and security-

based swap definitions.\91\ Moreover, as a purchase or sale of a

security, the Commissions believe it also would be within the

exclusions for the purchase or sale of one or more securities on a

fixed basis (or, depending on its terms, a contingent basis) and,

therefore, outside the swap and security-based swap definitions.\92\

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\91\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

\92\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

1a(47)(B)(v) and (vi).

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As noted above, commenters requested specific guidance in the

context of forward sales of MBS that are guaranteed or sold by Fannie

Mae, Freddie Mac, and Ginnie Mae and the mortgages underlying such MBS.

MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae

are eligible to be sold in the TBA market, which is essentially a

forward or delayed delivery market.\93\ The TBA market has been

described as one that ``allows mortgage lenders essentially to sell the

loans they intend to fund even before the loans are closed.'' \94\ In

the TBA market, the lender enters into a forward contract to sell MBS

and agrees to deliver MBS on the settlement date in the future. The

specific MBS that will be delivered in the future may not yet be

created at the time the forward contract is entered into.\95\ The

Commissions believe that such forward sales of MBS in the TBA market

would fall within the exclusion for sales of securities on a deferred

settlement or delivery basis even though the precise MBS are not in

existence at the time the forward MBS sale is entered into.\96\

Moreover, as the purchase or sale of a security, the Commissions

believe such forward sales of MBS in the TBA market would fall within

the exclusions for the purchase or sale of one or more securities on a

fixed basis (or, depending on its terms, a contingent basis) and

therefore outside the swap and security-based swap definitions.\97\

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\93\ Task Force on Mortgage-Backed Securities Disclosure,

``Staff Report: Enhancing Disclosure in the Mortgage-Backed

Securities Markets,'' part II.E.2 (Jan. 2003).

\94\ Id.

\95\ Id.

\96\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

\97\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

1a(47)(B)(v) and (vi).

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Request for Comment

22. The Commissions request comment on all aspects of the proposed

interpretive guidance set forth in this section regarding the forward

contract exclusion from the swap and security-based swap definitions

with respect to nonfinancial commodities and securities.

23. Is the proposed interpretive guidance set forth in this section

sufficient with respect to the application of the forward contract

exclusion from the swap definition with respect to nonfinancial

commodities? If not, what changes should be made? Commenters also are

invited to comment on whether the application of the Brent

Interpretation generally, and its conclusions regarding book-outs in

particular, is appropriate to the forward exclusion from the swap

definition with respect to nonfinancial commodities. Would it permit

transactions that should be subject to the swap regulatory regime to

fall outside of the Dodd-Frank Act?

24. Is it appropriate, in light of the Dodd-Frank Act, for the CFTC

to withdraw the Energy Exemption while concurrently retaining the Brent

Interpretation, and extending it to the forward contract exclusion from

the definition of ``future delivery'' and the swap definition, for

book-out transactions in all nonfinancial commodities? Why or why not?

Is the conclusion that the Dodd-Frank Act supersedes the Swap Policy

Statement appropriate? Why or why not?

25. Are there any provisions of the Energy Exemption or Swap Policy

Statement that the Commissions should consider incorporating into the

definitions rulemakings (other than the request already submitted by

some commenters in response to the proposed Entity Definitions that the

``line of business'' provision of the Swap Policy Statement be

incorporated into the definition of the term ``eligible contract

participant'' (``ECP''))? If so, please explain in detail how such

provisions are consistent with the requirements of the Dodd-Frank Act

and would not permit transactions that should be subject to the swap

regulatory regime to fall outside of the Dodd-Frank Act.

26. How frequently do book-out transactions of the type described

in the Brent Interpretation occur with respect to nonfinancial

commodities? Please provide descriptions of any such transactions, and

data with respect to their frequency. Are there any nonfinancial

commodities or transactions to which the Brent Interpretation should

not apply, either with respect to the forward contract exclusion from

the definition of ``future delivery'' or the forward contract exclusion

from the swap definition, or both? Why or why not?

27. Should a minimum contract size for a transaction in a

nonfinancial commodity (e.g., a tanker full of Brent oil) be required

in order for the transaction to qualify as a forward contract under the

Brent Interpretation with respect to the future delivery and swap

definitions? Why or why not? If so, what standards should apply to

determine such a minimum contract size? Should the Brent Interpretation

for nonfinancial commodities with respect to the future delivery and

swap definitions be limited to market participants that meet certain

requirements? Why or why not? If so, does the ``eligible commercial

entity'' definition in CEA section 1a(17) \98\ provide an appropriate

requirement? Why or why not? What other requirements, if any, should be

imposed?

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\98\ 7 U.S.C. 1a(17).

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28. How often, and to what extent, do entities that do not

regularly make or take delivery of the commodity in the ordinary course

of their business engage in transactions that should qualify as forward

contracts? Should such contracts qualify for the safe harbor provided

by the Brent Interpretation? Why or why not? If so, how can it be

demonstrated that the primary purpose of such transaction is to acquire

or sell the physical commodity? Would including these transactions in

the scope of the Brent Interpretation permit transactions that should

be subject to the swap regulatory regime to fall outside of the Dodd-

Frank Act? If so, could this concern be addressed by imposing

conditions in order to qualify for the forward exclusion? What

conditions, if any, would be appropriate?

29. Are ``ring'' or ``daisy chain'' markets for forward contracts,

such as the 15-day Brent market, primarily used for commercial

merchandising, or do they serve other purposes such as price discovery

or risk management? Please explain in detail.

30. Should contracts in nonfinancial commodities that may qualify

as forward contracts be permitted to trade on registered trading

platforms such as DCMs or swap execution facilities (``SEFs'')? If so,

are additional guidance

[[Page 29832]]

or rules necessary to determine whether contracts traded on such

platforms are excluded from the CEA definition of ``future delivery''

and/or the swap definition? If so, please describe in detail such

markets and explain what further guidance or rules would be

appropriate? Should conditions be imposed with respect to the nature of

the market participants or the percentage of transactions that must

result in delivery over a specified measurement period, or both? If so,

what conditions would be appropriate?

31. Should the Commissions provide guidance regarding the scope of

the term ``nonfinancial commodity'' in the forward contract exclusion

from the swap definition? If so, how and where should the Commissions

draw the line between financial and nonfinancial commodities?

32. Should the forward contract exclusion from the swap definition

apply to environmental commodities such as emissions allowances, carbon

offsets/credits, or renewable energy certificates? If so, please

describe these commodities, and explain how transactions can be

physically settled where the commodity lacks a physical existence (or

lacks a physical existence other than on paper)? Would application of

the forward contract exclusion to such environmental commodities permit

transactions that should be subject to the swap regulatory regime to

fall outside the Dodd-Frank Act?

33. Are there other factors that should be considered in

determining how to characterize forward contracts with embedded options

with respect to nonfinancial commodities? If so, what factors should be

considered? Do provisions in forward contracts with respect to

nonfinancial commodities other than delivery and price contain embedded

optionality? How do such provisions operate? Please provide a detailed

analysis regarding how such provisions should be analyzed under the

Dodd-Frank Act.

34. Is the analysis of forward contracts with embedded options in

the 1985 Interpretation and the CFTC's Wright decision appropriately

applied to transactions entered into after the effective date of the

Dodd-Frank Act? Why or why not? If not, how should the analysis be

modified?

35. How would the proposed interpretive guidance set forth in this

section affect full requirements contracts, capacity contracts, reserve

sharing agreements, tolling agreements, energy management agreements,

and ancillary services? Do these agreements, contracts, or transactions

have optionality as to delivery? If so, should they--or any other

agreement, contract, or transaction in a nonfinancial commodity that

has optionality as to delivery--be excluded from the swap definition?

If so, please provide a detailed analysis of such agreements,

contracts, or transactions and how they can be distinguished from

options that are to be regulated as swaps pursuant to the Dodd-Frank

Act. To what extent are any such agreements, contracts, or transactions

in the electric industry regulated by the Federal Energy Regulatory

Commission (``FERC''), State regulatory authorities, regional

transmission organizations (``RTOs''), independent system operators

(``ISOs'') or market monitoring units associated with RTOs or ISOs?

36. Is there any issue with respect to the treatment of commodity

options that the Commissions have not addressed and that should be

addressed as a definitional matter in this rulemaking?

37. Should the Commissions provide more detailed guidance regarding

what constitutes a security forward? For instance, should the

Commissions provide more guidance on what it means for a security

forward to be ``intended to be physically settled''? If so, what

further guidance would be appropriate?

38. Should the Commissions provide more guidance regarding when

forward sales of MBS in the TBA market would fall within the exclusion

for sales of securities on a deferred settlement or delivery basis? Is

there any more guidance the Commissions should provide regarding types

of transactions that occur in the TBA market?

3. Consumer and Commercial Agreements, Contracts, and Transactions

Commenters on the ANPR pointed out a number of areas in which a

broad reading of the swap and security-based swap definitions could

cover certain consumer and commercial arrangements that historically

have not been considered swaps or security-based swaps. Examples of

such instruments cited by commenters include evidences of indebtedness

with a variable rate of interest; \99\ commercial contracts containing

acceleration, escalation, or indexation clauses; \100\ agreements to

acquire personal property or real property, or to obtain mortgages;

\101\ employment, lease, and service agreements, including those that

contain contingent payment arrangements; \102\ and consumer mortgage

and utility rate caps.\103\

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\99\ See Cleary Letter; Letter from Kenneth E. Auer, President

and CEO, The Farm Credit Council, Sept. 20, 2010 (``Farm Credit

Council Letter'').

\100\ See Cleary Letter; White & Case Letter.

\101\ See White & Case Letter; Fannie Mae Letter.

\102\ See BlackRock Letter.

\103\ See White & Case Letter; Deutsche Bank Letter.

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Consumers enter into various types of agreements, contracts, and

transactions as part of their household and personal lives that may

have attributes that could be viewed as falling within the swap or

security-based swap definition. Similarly, businesses and other

entities, whether or not for profit, also enter into agreements,

contracts, and transactions as part of their operations relating to,

among other things, acquisitions or sales of property (tangible and

intangible), provisions of services, employment of individuals, and

other matters that could be viewed as falling within the definitions.

The Commissions do not believe that Congress intended to include

these types of customary consumer and commercial agreements, contracts,

or transactions in the swap or security-based swap definition, to limit

the types of persons that can enter into or engage in them, or to

otherwise to subject these agreements, contracts, or transactions to

the regulatory scheme for swaps and security-based swaps. The

Commissions, therefore, are proposing the following interpretive

guidance to assist consumers and businesses in understanding whether

certain agreements, contracts, or transactions that they enter into

would be regulated as swaps or security-based swaps.

With respect to consumers, the Commissions believe that the types

of agreements, contracts, or transactions that should not be considered

swaps or security-based swaps when entered into by consumers (natural

persons or their agents) as principals primarily for personal, family,

or household purposes, include:

Agreements, contracts, or transactions to acquire or lease

real or personal property, to obtain a mortgage, to provide personal

services, or to sell or assign rights owned by such consumer (such as

intellectual property rights);

Agreements, contracts, or transactions to purchase

products or services at a fixed price or a capped or collared price, at

a future date or over a certain time period (such as agreements to

purchase home heating fuel);\104\

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\104\ These agreements, contracts, or transactions involve

physical delivery which is deferred for convenience or necessity and

thus can be viewed as being akin to forward purchase agreements

(sometimes with embedded options, in the case of those with price

caps), which were discussed above in the context of the exclusion

from the swap definition for forward contracts in nonfinancial

commodities. While the CFTC traditionally has viewed forward

contracts in nonfinancial commodities as limited to commercial

merchandising transactions, the Commissions view consumer

agreements, contracts, and transactions involving periodic or future

purchases of consumer products and services, such as agreements to

purchase energy commodities to heat or cool consumers' homes, as

transactions that are not swaps.

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[[Page 29833]]

Agreements, contracts, or transactions that provide for an

interest rate cap or lock on a consumer loan or mortgage, where the

benefit of the rate cap or lock is realized only if the loan or

mortgage is made to the consumer; and

Consumer loans or mortgages with variable rates of

interest or embedded interest rate options, including such loans with

provisions for the rates to change upon certain events related to the

consumer, such as a higher rate of interest following a default.

The types of commercial agreements, contracts, or transactions that

involve customary business arrangements (whether or not involving a

for-profit entity) and would not be considered swaps or security-based

swaps under this proposed interpretive guidance include:

Employment contracts and retirement benefit arrangements;

Sales, servicing, or distribution arrangements;

Agreements, contracts, or transactions for the purpose of

effecting a business combination transaction; \105\

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\105\ These business combination transactions include, for

example, a reclassification, merger, consolidation, or transfer of

assets as defined under the Federal securities laws or any tender

offer subject to section 13(e) and/or section 14(d) or (e) of the

Exchange Act, 15 U.S.C. 78m(e) and/or 78n(d) or (e). These business

combination agreements, contracts, or transactions can be contingent

on the continued validity of representations and warranties and can

contain earn-out provisions and contingent value rights.

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The purchase, sale, lease, or transfer of real property,

intellectual property, equipment, or inventory;

Warehouse lending arrangements in connection with building

an inventory of assets in anticipation of a securitization of such

assets (such as in a securitization of mortgages, student loans, or

receivables); \106\

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\106\ The Commissions believe that such lending arrangements

included in this category are traditional borrower/lender

arrangements documented using, for example, a loan agreement or

indenture, as opposed to a synthetic lending arrangement documented

in the form of, for example, a TRS. The Commissions also note that

securitization transaction agreements also may contain contingent

obligations if the representations and warranties about the

underlying assets are not satisfied.

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Mortgage or mortgage purchase commitments, or sales of

installment loan agreements or contracts or receivables;

Fixed or variable interest rate commercial loans entered

into by non-banks \107\; and

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\107\ See infra note 115 regarding identified banking products.

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Commercial agreements, contracts, and transactions

(including, but not limited to, leases, service contracts, and

employment agreements) containing escalation clauses linked to an

underlying commodity such as an interest rate or consumer price index.

The Commissions intend this proposed interpretive guidance to allow

consumers to engage in customary transactions relating to their

households and personal or family activities without concern that such

arrangements would be considered swaps or security-based swaps.

Similarly, applying this guidance to customary commercial arrangements

should allow commercial and non-profit entities to continue to operate

their businesses and operations without significant disruption and

ensure that the swap and security-based swap definitions are not read

to include commercial and non-profit operations that historically have

not been considered to involve swaps or security-based swaps.

The types of agreements, contracts, and transactions discussed

above are not intended to be exhaustive of the customary consumer or

commercial arrangements that should not be considered to be swaps or

security-based swaps. There may be other, similar types of agreements,

contracts, and transactions that also should not be considered to be

swaps or security-based swaps. In determining whether similar types of

agreements, contracts, and transactions entered into by consumers or

commercial entities are swaps or security-based swaps, the Commissions

intend to consider the characteristics and factors that are common to

the consumer and commercial transactions listed above:

They do not contain payment obligations, whether or not

contingent, that are severable from the agreement, contract, or

transaction;

They are not traded on an organized market or over-the-

counter; and

In the case of consumer arrangements, they:

--Involve an asset of which the consumer is the owner or beneficiary,

or that the consumer is purchasing, or they involve a service provided,

or to be provided, by or to the consumer, or

In the case of commercial arrangements, they are entered

into:

--By commercial or non-profit entities as principals (or by their

agents) to serve an independent commercial, business, or non-profit

purpose, and

--Other than for speculative, hedging, or investment purposes.

Two of the key components reflected in these characteristics that

distinguish these agreements, contracts, and transactions from swaps

and security-based swaps are that: (i) The payment provisions of the

arrangements are not severable; and (ii) the agreement, contract, or

transaction is not traded on an organized market or over-the-counter--

so that such arrangements would not involve risk-shifting arrangements

with financial entities, as would be the case for swaps and security-

based swaps.\108\

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\108\ There also are alternative regulatory regimes that have

been enacted as part of the Dodd-Frank Act specifically to provide

enhanced protections to consumers relating to various consumer

transactions. See, e.g., the Consumer Financial Protection Act of

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

(establishing the Bureau of Consumer Financial Protection to

regulate a broad category of consumer products and amending certain

laws under the jurisdiction of the Federal Trade Commission); the

Mortgage Reform and Anti-Predatory Lending Act, Public Law 111-203,

title XIV, 124 Stat. 1376 (July 21, 2010) (amending existing laws,

and adding new provisions, related to certain mortgages). Some of

these agreements, contracts, or transactions are subject to

regulation by the Federal Trade Commission and other Federal

financial regulators and state regulators.

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This proposed interpretive guidance is not intended to be the

exclusive means for consumers and commercial or non-profit entities to

determine whether their agreements, contracts, or transactions fall

within the swap or security-based swap definition. If there is a type

of agreement, contract, or transaction that is not enumerated above, or

does not have all the characteristics and factors that are listed above

(including new types of arrangements that may be developed in the

future), but that a party to the agreement, contract, or transaction

believes is not a swap or security-based swap, the Commissions invite

such party to seek an interpretation from the Commissions as to whether

the agreement, contract, or transaction is a swap or security-based

swap.

Request for Comment

39. Is interpretive guidance of the type proposed in this section

necessary with respect to the application of the swap and security-

based swap definitions to certain consumer and commercial agreements,

contracts, or transactions?

40. Is the interpretive guidance proposed in this section useful,

[[Page 29834]]

appropriate, and sufficient for persons to consider when evaluating

whether agreements, contracts, or transactions of the types described

in this section fall within the swap or security-based swap definition?

41. In particular, are the listed characteristics and factors for

consumer transactions and for commercial transactions appropriate for

purposes of evaluating whether agreements, contracts, or transactions

fall within the swap or security-based swap definition? If not, what

characteristics or factors should be included or excluded, and why? Are

any of the characteristics or factors too narrow or too broad? If so,

how should the listed characteristics and factors be modified, and why?

42. Is a joint interpretation as provided for in section 712(d)(4)

of the Dodd-Frank Act, pursuant to the proposed process discussed in

part VI below, an appropriate means of addressing any further

interpretive questions?

43. Does the interpretive guidance proposed in this section

sufficiently enumerate the types of consumer and commercial agreements,

contracts, or transactions that should not be considered swaps or

security-based swaps? If not, please provide details of other types of

such agreements, contracts, or transactions and an explanation of the

reasons why the definitions should not apply to them.

44. Is the treatment of consumer or commercial contracts containing

payment arrangements sufficiently clear? For example, should the

interpretive guidance expressly address any other specific types of

contracts, such as installment sales contracts, financings used in

normal business operations (such as receivables financings), pensions

and other post-retirement benefits, contracts relating to the

performance of a service, standby liquidity agreements, indemnification

agreements, reimbursement agreements, or affiliate guarantees? Why or

why not?

45. Is the treatment of purchases, sales, leases, or transfers of

equipment and inventory sufficiently flexible to not interfere with

ordinary business operations? As an alternative, should the guidance

expressly cover the purchase, sale, lease, or transfer of assets

(excluding financial assets) that are anticipated to be owned, leased,

licensed, produced, manufactured, processed, or merchandized by one of

the parties or an affiliate? Why or why not?

4. Loan Participations

Two commenters inquired whether loan participations fall within the

scope of the swap and security-based swap definitions.\109\ According

to these commenters, loan participations arise when a lender transfers

the economic risks and benefits of all or a portion of a loan it has

entered into with a borrower to another party as an alternative or

precursor to assigning to such person the loan or an interest in the

loan.\110\ Two types of loan participations are offered in the market

today according to these commenters: LSTA-style participations and LMA-

style participations.\111\ An LSTA-style participation ``specifically

provides that the participation is intended by the parties to be

treated as a sale by the grantor and a purchase by the participant''

and ``is intended to effect a `true sale' of the loan from the grantor

to the participant and put the participant's beneficial ownership

interest in the loan beyond the reach of the grantor's bankruptcy

estate.'' \112\ By contrast, an LMA-style participation, while not

effecting a sale, ``creates a current debtor-creditor relationship

between the grantor and the participant under which a future ownership

interest is conveyed.'' \113\ Neither type of loan participation is a

``synthetic'' transaction according to the March LSTA letter because

``they are merely transfers of cash loan positions'' and ``[t]he ratio

of underlying loan to participation is always one-to-one.''

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\109\ See Letter from R. Bram Smith, Executive Director, The

Loan Syndications and Trading Association, Jan. 25, 2011 (``January

LSTA Letter'') and letter from Elliot Ganz, General Counsel, The

Loan Syndications and Trading Association, Mar. 1, 2011 (``March

LSTA Letter, and collectively with the January LSTA Letter, ``LSTA

Letters''); Letter from Clare Dawson, Managing Director, Loan Market

Association, Feb. 23, 2011.

\110\ See Loan Market Association, ``Guide to Syndicated

Loans,'' section 6.2.5 (``Risk participation may be provided by a

new lender as an interim measure before it takes full transfer of a

loan.''), available at http://www.lma.eu.com/uploads/files/Introductory_Guides/Guide_to_Par_Syndicated_Loans.pdf.

\111\ The LSTA is The Loan Syndications and Trading Association.

The LMA is the Loan Market Association.

\112\ See January LSTA Letter (citation omitted).

\113\ See LSTA Letters. But see Jon Kibbe, Julia Lu and Carl

Winkworth, Richards Kibbe & Orbe, LLP, ``Dodd-Frank Crosses the

Pond: Unintended Consequences for LMA-Style Loan Participations?,''

3 (Nov. 12, 2010) (``The grantor of an LMA-style participation does

not grant an ownership interest in the loan to the participant.'')

(``LMA-Style LP Memo''), available at http://www.rkollp.com/assets/attachments/Dodd-Frank%20Crosses%20the%20Pond%20-%20Unintended%20Consequences%20for%20LMA-Style%20Loan%20Participations.pdf.

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Depending on the facts and circumstances, a loan participation may

be a security under the Federal securities laws and, as such, the loan

participation would be excluded from the definition of swap as the

purchase and sale of a security on a fixed or contingent basis.\114\ In

addition, depending on the facts and circumstances, a loan

participation may be an identified banking product and, as such, would

be excluded from CFTC jurisdiction and from the ``security-based swap''

and ``security-based swap agreement'' definitions.\115\

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\114\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

1a(47)(b)(v) and (vi), as amended by section 721(a)(21) of the Dodd-

Frank Act (excluding purchases and sales of a security on a fixed or

contingent basis, respectively from the swap definition).

\115\ See section 403(a) of the Legal Certainty for Bank

Products Act of 2000, 7 U.S.C. 27a(a), as amended by section

725(g)(2) of the Dodd-Frank Act (providing that, under certain

circumstances, the CEA shall not apply to, and the CFTC shall not

exercise regulatory authority over, identified banking products, and

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

based swap agreement'' shall not include identified banking

products).

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The Commissions do not interpret the swap and security-based swap

definitions to include loan participations in which the purchaser is

acquiring a current or future direct or indirect ownership interest in

the related loan and the loan participations are ``true

participations'' (the participant acquires a beneficial ownership

interest in the underlying loans).\116\

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\116\ See generally Richard M. Gray and Suhrud Mehta, Milbank

Tweed Hadley & McCloy LLP, ``US and UK compared Fundamental

differences remain between the markets. But is it worth considering

using a New York participation agreement in an English deal?,''

International Financial Law Review (Oct. 1, 2009) (discussing

differences between New York and English participation markets and

features distinguishing true participations from financings),

available at http://www.milbank.com/NR/rdonlyres/B95C06AD-C3CA-44C9-8433-B6021C4455C9/0/102009_IFLR_USandUKcompared_RGray_SMehta.pdf; Cleary, Gottlieb, Steen & Hamilton, Memorandum for the

Financial Accounting Standards Board, Re: Participations (June 14,

2004) (discussing, among other things, what a ``good'' or ``true''

participation is under the Uniform Commercial Code, the Bankruptcy

Code, case law, and other authority), available at http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175817895286&blobheader=application%2Fpdf.

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Request for Comment

46. Should any of the enumerated agreements, contracts, or

transactions be considered swaps or security-based swaps whether in

general or in certain narrow circumstances? If so, which ones and why?

In particular, how are loan participations similar to and different

from loan TRS? Does the proposed guidance adequately distinguish

between loan participations similar to and different from loan TRS?

47. Does the Commissions' proposed interpretive guidance regarding

loan participations exclude from the swap or security-based swap

definitions agreements, contracts, or transactions

[[Page 29835]]

that are swaps or security-based swaps? If so, please describe such

agreements, contracts, or transactions and suggested adjustments to the

proposed guidance to capture such agreements, contracts, or

transactions as swaps or security-based swaps.

48. Is the Commissions' proposed interpretive guidance regarding

loan participations as not falling within the swap and security-based

swap definitions appropriate? Why or why not? Should the Commissions

provide further guidance on what constitutes an ``ownership interest''

in the loan underlying a loan participation? If so, what should such

guidance provide?

49. Do all loan participations convey a current or future direct or

indirect ownership interest from the grantor to the participant or sub-

participant? If so, what indicia of ownership are conveyed and when,

particularly in LMA-style loan participations? Do loan participations

use leverage? If so, how?

50. Are any swaps or security-based swaps partly or fully defeased?

51. Should the Commissions provide further guidance regarding the

scope of ``true participation?'' If so, how should the Commissions

delineate the scope thereof?

C. Proposed Rules and Interpretive Guidance Regarding Certain

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

and ``Security-Based Swap''

1. In General

In light of provisions in the Dodd-Frank Act that specifically

address certain foreign exchange products, the Commissions are

proposing rules to clarify the status of products such as foreign

exchange forwards, foreign exchange swaps, foreign exchange options,

non-deliverable forwards involving foreign exchange (``NDFs''), and

cross-currency swaps. The Commissions also are proposing a rule to

clarify the status of FRAs and providing interpretive guidance

regarding: (i) Combinations and permutations of, or options on, swaps

or security-based swaps; and (ii) contracts for differences (``CFDs'').

Proposed rule 1.3(xxx)(2) under the CEA and proposed rule 3a69-2

under the Exchange Act would explicitly define the term ``swap'' to

include certain foreign exchange-related products and FRAs unless such

products would be excluded by the list of exclusions in subparagraph

(B) of the swap definition.\117\ In proposing these rules, the

Commissions do not mean to suggest that any other agreement, contract,

or transaction not mentioned in the proposed rules or specifically

enumerated in the statutory definition would not be covered by the swap

or security-based swap definitions in the Dodd-Frank Act.

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\117\ See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B).

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2. Foreign Exchange Products

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

Determination: Foreign Exchange Forwards and Foreign Exchange Swaps

The Dodd-Frank Act provides that ``foreign exchange forwards'' and

``foreign exchange swaps'' shall be considered swaps under the swap

definition unless the Secretary of the Treasury (``Secretary'') issues

a written determination that either foreign exchange swaps, foreign

exchange forwards, or both: (i) Should not be regulated as swaps; and

(ii) are not structured to evade the Dodd-Frank Act in violation of any

rule promulgated by the CFTC pursuant to section 721(c) of the Dodd-

Frank Act.\118\ A foreign exchange forward is defined as ``a

transaction that solely involves the exchange of 2 different currencies

on a specific future date at a fixed rate agreed upon on the inception

of the contract covering the exchange.'' \119\ A foreign exchange swap,

in turn, is defined as ``a transaction that solely involves--(A) An

exchange of 2 different currencies on a specific date at a fixed rate

that is agreed upon on the inception of the contract covering the

exchange; and (B) a reverse exchange of the 2 currencies described in

subparagraph (A) at a later date and at a fixed rate that is agreed

upon on the inception of the contract covering the exchange.'' \120\

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\118\ See CEA section 1a(47)(E)(i), 7 U.S.C. 1a(47)(E)(i). The

Secretary has issued a request for comment about whether an

exclusion from the swap definition for foreign exchange swaps,

foreign exchange forwards, or both, is warranted, and on the

application of the statutory factors that the Secretary must

consider in making a determination regarding whether to exclude

these products. See Determinations of Foreign Exchange Swaps and

Forwards, 75 FR 66829, Oct. 29, 2010.

\119\ See CEA section 1a(24), 7 U.S.C. 1a(24).

\120\ See CEA section 1a(25), 7 U.S.C. 1a(25).

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Under the Dodd-Frank Act, if foreign exchange forwards or foreign

exchange swaps are no longer considered swaps due to a determination by

the Secretary, nevertheless, certain provisions of the CEA added by the

Dodd-Frank Act would continue to apply to such transactions.

Specifically, those transactions still would be subject to certain

requirements for reporting swaps, and swap dealers and major swap

participants engaging in such transactions still would be subject to

certain business conduct standards.\121\

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\121\ See, e.g., CEA sections 1a(47)(E)(iii) and (iv), 7 U.S.C.

1a(47)(E)(iii) and (iv) (reporting and business conduct standards,

respectively).

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The Commissions are proposing to provide greater clarity by

explicitly defining by rule the term ``swap'' to include foreign

exchange forwards and foreign exchange swaps (as those terms are

defined in the CEA).\122\ The proposed rules would incorporate the

provision of the Dodd-Frank Act that, if the Secretary issues the

written determination described above, foreign exchange forwards and

foreign exchange swaps would no longer be considered swaps. The

proposed rules also would reflect the continuing applicability of

certain reporting requirements and business conduct standards in the

event that the Secretary makes such a determination.\123\

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\122\ As noted above, the proposed rules provide that foreign

exchange forwards and forward exchange swaps would not be swaps if

they fall within one of the exclusions set forth in subparagraph (B)

of the swap definition.

\123\ The exclusion of foreign exchange forwards and foreign

exchange swaps would become effective upon the Secretary's

submission of the determination to the appropriate Congressional

Committees. See CEA section 1a(47)(E)(ii), 7 U.S.C. 1a(46)(E)(ii).

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

Determination

The Commissions also are proposing rules to provide clarity that a

determination by the Secretary that foreign exchange forwards or

foreign exchange swaps, or both, should not be regulated as swaps would

not affect other products involving foreign currency, such as foreign

currency options, NDFs, and cross-currency swaps. The Commissions are

proposing rules to explicitly define the term ``swap'' to include such

products, irrespective of whether the Secretary makes a determination

to exempt foreign exchange forwards or foreign exchange swaps.\124\

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\124\ As discussed above, however, the proposed rules provide

that none of the products discussed in this section (b) would be

swaps if they fall within one of the exclusions set forth in

subparagraph (B) of the swap definition.

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(i) Foreign Currency Options \125\

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\125\ This discussion is not intended to address, and has no

bearing on, the CFTC's jurisdiction over foreign currency options in

other contexts. See, e.g., CEA sections 2(c)(2)(A)(iii) and

2(c)(2)(B)-(C), 7 U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)-(C) (off-

exchange options in foreign currency offered or entered into with

retail customers).

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As discussed above, the statutory swap definition includes options,

and it expressly enumerates foreign currency options. It encompasses

any agreement, contract, or transaction: '' (i) that is a

[[Page 29836]]

put, call, cap, floor, collar, or similar option of any kind that is

for the purchase or sale, or based on the value, of 1 or more interest

or other rates, currencies, commodities, securities, instruments of

indebtedness, indices, quantitative measures, or other financial or

economic interests or property of any kind.'' \126\

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\126\ See CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i)

(emphasis added).

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Foreign exchange options traded on a national securities exchange

(``NSE''), however, are securities under the Federal securities laws

and not swaps or security-based swaps.\127\

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\127\ See CEA section 1a(47)(B)(iv), 7 U.S.C. 1a(47)(B)(iv).

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Any determination by the Secretary, discussed above, that foreign

exchange forwards or foreign exchange swaps should not be regulated as

swaps would not impact foreign currency options because a foreign

currency option is neither a foreign exchange swap nor a foreign

exchange forward, as those terms are defined in the CEA. Consequently,

the Commissions are proposing rules to provide clarity by explicitly

defining the term ``swap'' to include foreign currency options (other

than foreign currency options traded on an NSE).\128\ The proposed

rules also would clarify that foreign currency options are not foreign

exchange forwards or foreign exchange swaps under the CEA.

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\128\ The proposed rules would treat the terms foreign currency

options, currency options, foreign exchange options, and foreign

exchange rate options as synonymous. Moreover, for purposes of the

proposed rules, foreign currency options include options to enter

into or terminate, or that otherwise operate on, a foreign exchange

swap or foreign exchange forward or on the terms thereof. As

discussed above, foreign exchange options traded on an NSE are

securities and therefore not addressed in the proposed rules.

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(ii) Non-Deliverable Forward Contracts Involving Foreign Exchange

An NDF generally is similar to a forward foreign exchange

contract,\129\ except that at maturity, the NDF does not require

physical delivery of currencies and is typically settled in U.S.

dollars. The other currency, usually an emerging market currency

subject to capital controls, is therefore said to be

``nondeliverable.'' \130\ If the spot market exchange rate on the

settlement date is greater (in foreign currency per dollar terms) than

the previously agreed forward exchange rate, the party to the contract

that is long the emerging market currency must pay its counterparty the

difference between the contracted forward price and the spot market

rate, multiplied by the notional amount.\131\

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\129\ A deliverable forward foreign exchange contract is an

obligation to buy or sell a specific currency on a future settlement

date at a fixed price set on the trade date. See Laura Lipscomb,

``Federal Reserve Bank of New York, An Overview of Non-Deliverable

Foreign Exchange Forward Markets,'' 1 (May 2005) (citation omitted)

(``Fed NDF Overview'').

\130\ See id. at 1-2 (citation omitted).

\131\ See id. at 2. Being long the emerging market currency

means that the holder of the NDF contract is the ``buyer'' of the

emerging market currency and the ``seller'' of dollars. Conversely,

if the emerging market currency appreciates relative to the

previously agreed forward rate, the holder of the contract that is

short the emerging market currency must pay its counterparty the

difference between the spot market rate and the contracted forward

price, multiplied by the notional amount. See id. at 2, n.4.

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NDFs are not expressly enumerated in the swap definition, but they

satisfy clause (A)(iii) of the definition because they provide for a

future (executory) payment based on an exchange rate, which is an

``interest or other rate[]'' within the meaning of clause (A)(iii) of

the swap definition.\132\ Each party to an NDF transfers to its

counterparty the risk of the exchange rate moving against the

counterparty, thus satisfying the requirement that there be a transfer

of financial risk associated with a future change in rate. This

financial risk transfer in the context of an NDF is not accompanied by

a transfer of an ownership interest in any asset or liability. Thus, an

NDF is a swap under clause (A)(iii) of the swap definition.\133\

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\132\ See CEA section 1a(47)(A)(iii), 7 U.S.C. 1a(47)(A)(iii)

(providing that a swap is an agreement, contract, or transaction

``that provides on an executory basis for the exchange, on a fixed

or contingent basis, of 1 or more payments based on the value or

level of 1 or more interest or other rates, currencies, commodities,

securities, instruments of indebtedness, indices, quantitative

measures, or other financial or economic interests or property of

any kind, or any interest therein or based on the value thereof, and

that transfers, as between the parties to the transaction, in whole

or in part, the financial risk associated with a future change in

any such value or level without also conveying a current or future

direct or indirect ownership interest in an asset (including any

enterprise or investment pool) or liability that incorporates the

financial risk so transferred * * *.'').

\133\ It appears that at least some market participants view

NDFs as swaps today. See, e.g., Credit Suisse, ``Non-Deliverable

Forwards,'' at 1 (characterizing NDFs as ``a derivative instrument

for hedging * * * exchange-rate risk'' in the absence of a forwards

market), available at https://www.credit-suisse.com/ch/unternehmen/kmugrossunternehmen/doc/nondeliverable_forward_en.pdf; Association

of Corporate Treasurers, ``Glossary of Terms'' (defining an NDF as

``[a] foreign currency financial derivative contract''), available

at http://www.treasurers.org/glossary/N#Non-deliverableforward.

Thus, NDFs also may fall within clause (A)(iv) of the swap

definition as ``an agreement, contract, or transaction that is, or

in the future becomes, commonly known to the trade as a swap.'' See

CEA section 1a(47)(A)(iv), 7 U.S.C. 1a(47)(A)(iv). Cf. CFTC rule

35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i) (providing that the definition

of ``swap agreement'' includes a ``forward foreign exchange

agreement,'' without reference to convertibility or delivery).

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As discussed above, the Secretary may determine that foreign

exchange swaps or foreign exchange forwards should not be regulated as

swaps. The outcome of the Secretary's determination would not impact

NDFs, however, because NDFs (like foreign currency options) do not meet

the definitions of the terms foreign exchange forward or foreign

exchange swap set forth in the CEA. NDFs do not involve an ``exchange''

of two different currencies (an element of the definition of both a

foreign exchange forward and a foreign exchange swap); instead, they

are settled by payment in one currency (usually U.S. dollars).

Notwithstanding their ``forward'' label, NDFs do not fall within

the forward contract exclusion of the swap definition. Currency is

outside the scope of the forward contract exclusion for nonfinancial

commodities. Nor have NDFs traditionally been considered commercial

merchandising transactions. Rather, the NDF markets appear to be driven

in large part by speculation \134\ and hedging,\135\ which features are

more characteristic of swap markets than forward markets.

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\134\ See ``Fed NDF Overview,'' supra note 129, at 5

(``[E]stimates vary but many major market participants estimate as

much as 60 to 80 percent of NDF volume is generated by speculative

interest, noting growing participation from international hedge

funds.'') and 4 (``[D]ealers note that much of the volume in Chinese

yuan NDFs is generated by speculative positioning based on

expectations for an alteration in China's current, basically fixed

exchange rate.'') (italics in original).

\135\ See id. at 4 (noting that ``[much of the] Korean won NDF

volume[,] * * * estimated to be the largest of any currency, * * *

is estimated to originate with international investment portfolio

managers hedging the currency risk associated with their onshore

investments'').

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Based on the foregoing considerations, the Commissions are

proposing to provide greater clarity by explicitly defining the term

``swap'' to include NDFs. The proposed rules also would clarify that

NDFs are not foreign exchange forwards or foreign exchange swaps as

those terms are defined in the CEA.

(iii) Currency Swaps and Cross-Currency Swaps

A currency swap \136\ and a cross-currency swap \137\ each

generally can be

[[Page 29837]]

described as a swap in which the fixed legs or floating legs based on

various interest rates are exchanged in different currencies. Such

swaps can be used to reduce borrowing costs, to hedge currency

exposure, and to create synthetic assets \138\ and are viewed as an

important tool, given that they can be used to hedge currency and

interest rate risk in a single transaction.

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\136\ A swap that exchanges a fixed rate against a fixed rate is

known as a currency swap. See Federal Reserve System, ``Trading and

Capital-Markets Activities Manual,'' section 4335.1 (Jan. 2009).

\137\ Cross-currency swaps with a fixed leg based on one rate

and a floating leg based on another rate, where the two rates are

denominated in different currencies, are generally referred to as

cross-currency coupon swaps, while those with a floating leg based

on one rate and another floating leg based on a different rate are

known as cross-currency basis swaps. Id. Cross-currency swaps also

include annuity swaps and amortizing swaps. In cross-currency

annuity swaps, level cash flows in different currencies are

exchanged with no exchange of principal; annuity swaps are priced

such that the level payment cash flows in each currency have the

same net present value at the inception of the transaction. An

amortizing cross-currency swap is structured with a declining

principal schedule, usually designed to match that of an amortizing

asset or liability. Id. See also Derivatives ONE, ``Cross Currency

Swap Valuation'' (``A cross currency swap is swap of an interest

rate in one currency for an interest rate payment in another

currency. * * * This could be considered an interest rate swap with

a currency component.''), available at http://www.derivativesone.com/cross-currency-swap-valuation/; Financial

Accounting Standards Board, ``Examples Illustrating Application of

FASB Statement No. 138,'' Accounting for Certain Derivative

Instruments and Certain Hedging Activities, section 2, Example 1, at

3 (``The company designates the cross-currency swap as a fair value

hedge of the changes in the fair value of the loan due to both

interest and exchange rates.''), available at http://www.fasb.org/derivatives/examples.pdf.

\138\ BMO Capital Markets, ``Cross Currency Swaps,'' available

at http://www.bmocm.com/products/marketrisk/intrderiv/cross/default.aspx.

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Currency swaps and cross-currency swaps are not foreign exchange

swaps as defined in the CEA because, although they may involve an

exchange of foreign currencies, they also require contingent or

variable payments in different currencies. Because the CEA defines a

foreign exchange swap as a swap that ``solely'' involves an initial

exchange of currencies and a reversal thereof at a later date, subject

to certain parameters, currency swaps and cross-currency swaps would

not be foreign exchange swaps. Similarly, currency swaps and cross-

currency swaps are not foreign exchange forwards because foreign

exchange forwards ``solely'' involve an initial exchange of currencies,

subject to certain parameters, while currency swaps and cross-currency

swaps contain additional elements, as discussed above.

Currency swaps are expressly enumerated in the statutory definition

of the term ``swap.'' \139\ Cross-currency swaps, however, are

not.\140\ Accordingly, based on the foregoing considerations, the

Commissions are proposing rules to provide greater clarity by

explicitly defining the term ``swap'' to include cross-currency swaps.

The proposed rules also would clarify that neither currency swaps nor

cross-currency swaps are foreign exchange forwards or foreign exchange

swaps as those terms are defined in the CEA.

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\139\ See CEA section 1a(47)(A)(iii)(VII), 7 U.S.C.

1a(47)(A)(iii)(VII).

\140\ Clause (A)(iii) of the swap definition expressly refers to

a cross-currency rate swap. See CEA section 1a(47)(A)(iii)(V), 7

U.S.C. 1a(47)(A)(iii)(V). Although the swap industry appears to use

the term ``cross-currency swap,'' rather than ``cross-currency rate

swap'' (the term used in CEA section 1a(47)(A)(iii)(V)), the

Commissions interpret these terms as synonymous.

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Request for Comment

52. Should the proposed rules explicitly define the term ``swap''

to include foreign exchange forwards and foreign exchange swaps, unless

the Secretary determines to exempt them? Should the proposed rules

clarify that, if the Secretary determines to exempt foreign exchange

swaps or foreign exchange forwards, those transactions remain subject

to certain reporting requirements, and swap dealers and major swap

participants entering into such transactions remain subject to certain

business conduct standards, imposed by Title VII and CFTC regulations

promulgated thereunder? Why or why not?

53. Should the proposed rules explicitly define the term ``swap''

to include foreign currency options and clarify that foreign currency

options are not foreign exchange forwards or foreign exchange swaps?

Why or why not? Should the terms foreign currency options, currency

options, foreign exchange options, and foreign exchange rate options be

interpreted as synonymous? Why or why not?

54. Should the proposed rules explicitly define the term ``swap''

to include NDFs and clarify that NDFs are not foreign exchange forwards

or foreign exchange swaps? Why or why not?

55. Should the proposed rules explicitly define the term ``swap''

to include cross-currency swaps as swaps and clarify that currency

swaps and cross-currency swaps are not foreign exchange forwards or

foreign exchange swaps? Why or why not? Should the terms cross-currency

swap and cross-currency rate swap be interpreted as synonymous? Why or

why not?

56. Is additional detail needed within the proposed rules regarding

foreign exchange-related products to provide greater clarity regarding

the specific products listed in the proposed rules? If so, what

additional detail would be necessary?

3. Forward Rate Agreements

In general, the Commissions understand an FRA to be an over-the-

counter contract for a single cash payment, due on the settlement date

of a trade, based on a spot rate (determined pursuant to a method

agreed upon by the parties) and a prespecified forward rate. The single

cash payment is equal to the product of the present value (discounted

from a specified future date to the settlement date of the trade) of

the difference between the forward rate and the spot rate on the

settlement date multiplied by the notional amount. The notional amount

itself is not exchanged.\141\

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\141\ See generally ``Trading and Capital-Markets Activities

Manual,'' supra note 136, section 4315.1 (``For example, in a six-

against-nine-month (6x9) FRA, the parties agree to a three-month

rate that is to be netted in six months' time against the prevailing

three-month reference rate, typically LIBOR. At settlement (after

six months), the present value of the net interest rate (the

difference between the spot and the contracted rate) is multiplied

by the notional principal amount to determine the amount of the cash

exchanged between the parties * * *. If the spot rate is higher than

the contracted rate, the seller agrees to pay the buyer the

differences between the prespecified forward rate and the spot rate

prevailing at maturity, multiplied by a notional principal amount.

If the spot rate is lower than the forward rate, the buyer pays the

seller.'').

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An FRA provides for the future (executory) payment based on the

transfer of interest rate risk between the parties as opposed to

transferring an ownership interest in any asset or liability.\142\

Thus, the Commissions believe that an FRA satisfies clause (A)(iii) of

the swap definition.\143\

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\142\ It appears that at least some in the trade view FRAs as

swaps today. See, e.g., The Globecon Group, Ltd., ``Derivatives

Engineering: A Guide to Structuring, Pricing and Marketing

Derivatives,'' 45 (McGraw-Hill 1995) (``An FRA is simply a one-

period interest-rate swap.''); DerivActiv, Glossary of Financial

Derivatives Terms (``A swap is * * * a strip of FRAs.''), available

at http://www.derivactiv.com/

definitions.aspx?search=forward+rate+agreements. Cf. Don M. Chance,

et. al, ``Derivatives in Portfolio Management,'' 29 (AIMR 1998)

(``[An FRA] involves one specific payment and is basically a one-

date swap (in the sense that a swap is a combination of FRAs[,] with

some variations).''). Thus, FRAs also may fall within clause (A)(iv)

of the swap definition, as ``an agreement, contract, or transaction

that is, or in the future becomes, commonly known to the trade as a

swap.'' See CEA section 1a(47)(a)(iv), 7 U.S.C. 1a(47)(a)(iv).

\143\ See CEA section 1a(47)(A)(iii); 7 U.S.C. 1a(47)(A)(iii).

CFTC regulations have defined FRAs as swap agreements. See CFTC rule

35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i); Exemption for Certain Swap

Agreements, 58 FR 5587, Jan. 22, 1993. The CFTC recently has

proposed to repeal that rule in light of the enactment of Title VII

of the Dodd-Frank Act. See Commodity Options and Agricultural Swaps,

supra note 78.

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Notwithstanding their ``forward'' label, FRAs do not fall within

the forward contract exclusion from the swap definition. FRAs do not

involve nonfinancial commodities and thus are outside the scope of the

forward contract exclusion. Nor is an FRA a commercial merchandising

transaction, as there is no physical product to be delivered in an

FRA.\144\ Accordingly,

[[Page 29838]]

the Commissions believe that the forward contract exclusion from the

swap definition for nonfinancial commodities does not apply to

FRAs.\145\

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\144\ See Regulation of Hybrid and Related Instruments, 52 FR

47022, 47028, Dec. 11, 1987 (stating ``[FRAs] do not possess all of

the characteristics of forward contracts heretofore delineated by

the [CFTC]'').

\145\ Current European Union law includes FRAs in the definition

of ``financial instruments.'' See Markets in Financial Instruments

Directive (MiFID), ``Directive 2004/39/EC of the European Parliament

and of the Council,'' Annex I(C), 4, 5, 10 (Apr. 21, 2004),

available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2004L0039:20070921:EN:PDF. A European

Commission legislative proposal on derivatives, central clearing,

and trade repositories applies to FRAs that are traded over-the-

counter and, thus, would subject such transactions to mandatory

clearing, reporting and other regulatory requirements. See Proposal

for a Regulation of the European Parliament and of the Council on

OTC derivatives, central counterparties and trade repositories,

title I, art. 1(1), COM(2010) 484/5 (Sept. 15, 2010), available at

http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_proposal_en.pdf.

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Based on the foregoing considerations, the Commissions are

proposing rules to provide greater clarity by explicitly defining the

term ``swap'' to include FRAs. As with the foreign exchange-related

products discussed above, the proposed rules provide that FRAs would

not be swaps if they fall within one of the exclusions set forth in

subparagraph (B) of the swap definition.

Request for Comment

57. Is the description of FRAs accurate? If not, please provide a

detailed description of FRAs. Are there various types of FRAs? If so,

please provide an explanation of their characteristics and how they

differ.

58. What types of market participants use FRAs, and for what

purposes? What market (spot) and fixed rates are used in FRAs, and how

are those rates determined, or on what are those rates based?

59. Should the proposed rules explicitly define the term ``swap''

to include FRAs? Why or why not?

60. Should the proposed rules provide a more detailed description

of what FRAs are? Why or why not? If so, please explain what additional

language regarding FRAs should be included in the proposed rules.

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

Based Swaps

Clause (A)(vi) of the swap definition provides that ``any

combination or permutation of, or option on, any agreement, contract,

or transaction described in any of clauses (i) through (v)'' of the

definition is a swap or security-based swap.\146\ As a result, clause

(A)(vi) means, for example, that an option on a swap or security-based

swap (commonly known as a ``swaption'') would itself be a swap or

security-based swap, respectively. The Commissions also interpret

clause (A)(vi) to mean that a ``forward swap'' would itself be a swap

or security-based swap, respectively.\147\

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\146\ See CEA section 1a(47)(vi), 7 U.S.C. 1a(47)(vi).

\147\ Forward swaps are also commonly known as forward start

swaps, or deferred or delayed start swaps. A forward swap can

involve two offsetting swaps that both start immediately, but one of

which ends on the deferred start date of the forward swap itself.

For example, if a counterparty wants to hedge its risk for four

years, starting one year from today, it could enter into a one-year

swap and a five-year swap, which would partially offset to create a

four-year swap, starting one year forward. A forward swap also can

involve a contract to enter into a swap or security-based swap at a

future date or with a deferred start date. A forward swap is not a

nonfinancial commodity forward contract or security forward, both of

which are excluded from the swap definition and discussed elsewhere

in this release.

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Request for Comment

61. Is additional guidance regarding swaptions, necessary? Why or

why not? If so, please provide a detailed explanation of what

additional guidance would be necessary.

62. Is the Commissions' description of forward swaps accurate? Why

or why not? If not, please provide a detailed explanation of why the

description is inaccurate. Is additional guidance regarding forward

swaps necessary? Why or why not? If so, please provide a detailed

explanation of what additional guidance would be necessary.

63. Is additional guidance regarding other combinations or

permutations of swaps or security-based swaps necessary? Why or why

not? If so, please provide a detailed description of any particular

agreement, contract, or transaction, including the purposes for which

it is used and the market participants that use it, and what additional

guidance would be necessary.

5. Contracts for Differences

The Commissions have received inquiries over the years regarding

the treatment of CFDs under the CEA and the Federal securities laws. A

CFD generally is an agreement to exchange the difference in value of an

underlying asset between the time at which a CFD position is

established and the time at which it is terminated.\148\ If the value

increases, the seller pays the buyer the difference; if the value

decreases, the buyer pays the seller the difference. CFDs can be traded

on a number of products, including treasuries, foreign exchange rates,

commodities, equities, and stock indexes. Equity CFDs closely mimic the

purchase of actual shares. The buyer of an equity CFD receives cash

dividends and participates in stock splits.\149\ In the case of a long

position, a dividend adjustment is credited to the client's account. In

the case of a short position, a dividend adjustment is debited from the

client's account. CFDs generally are traded over-the-counter (though

they also are traded on the Australian Securities Exchange) in a number

of countries outside the United States.

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\148\ See Ontario Securities Commission, Staff Notice 91-702,

``Offerings of Contracts for Difference and Foreign Exchange

Contracts to Investors in Ontario,'' at part IV.1 (defining a CFD as

``a derivative product that allows an investor to obtain economic

exposure (for speculative, investment or hedging purposes) to an

underlying asset * * * such as a share, index, market sector,

currency or commodity, without acquiring ownership of the underlying

asset''), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/sn_20091030_91-702_cdf.pdf (Oct. 30, 2009);

Financial Services Authority, Consultation Paper 7/20, ``Disclosure

of Contracts for Difference--Consultation and draft Handbook text,''

at part 2.2 (defining a CFD on a share as ``a derivative product

that gives the holder an economic exposure, which can be long or

short, to the change in price of a specific share over the life of

the contract''), available at http://www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007).

\149\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2002 ISDA

Equity Derivatives Definitions,'' art. 10 (Dividends) and 11

(Adjustments and Modifications Affecting Indices, Shares and

Transactions).

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CFDs, unless otherwise excluded, may fall within the scope of the

swap and security-based swap definitions.\150\ Whether a CFD is a swap

or security-based swap will depend on the underlying product of that

particular CFD transaction. Because CFDs are highly variable and a CFD

can contain a variety of elements that would affect its

characterization, the Commissions believe that market participants will

need to analyze the characteristics of any particular CFD in order to

determine whether it is a swap or a security-based swap. Therefore, the

Commissions are not proposing rules or additional interpretive guidance

at this time regarding CFDs.

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\150\ In some cases, depending on the facts and circumstances,

the SEC may determine that a particular CFD on an equity security,

for example, should be characterized as constituting a purchase or

sale of the underlying equity security and, therefore, be subject to

the requirements of the Federal securities laws applicable to such

purchases or sales.

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Request for Comment

64. Should the Commissions provide additional guidance regarding

CFDs? Why or why not? If so, please provide a detailed description of

any particular CFD and what additional guidance would be necessary.

[[Page 29839]]

D. Certain Interpretive Issues

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

Documented Using Form Contracts Typically Used for, Swaps or Security-

Based Swaps

The Commissions are aware that individuals and companies may

generally use the term ``swap'' to refer to certain of their

agreements, contracts, or transactions. For example, the term ``swap''

may be used to refer to an agreement to exchange real or personal

property between the parties. Or, two companies that produce fungible

products may use the term ``swap'' to refer to an agreement to perform

each other's delivery obligations--for example, if one company must

deliver the product in California and the other must deliver the same

product in New York, they may use the term ``swap'' to refer to an

agreement that each company will perform the other's delivery

obligation.

The name or label that the parties use to refer to a particular

agreement, contract, or transaction is not determinative of whether it

is a swap or security-based swap.\151\ Also, it may not be relevant

whether the agreement, contract, or transaction is documented using an

industry standard form agreement that is typically used for swaps and

security-based swaps.\152\ Instead, the relevant question is whether

the agreement, contract, or transaction falls within the definition of

the terms ``swap'' or ``security-based swap'' (as further interpreted

pursuant to the guidance proposed herein) based on its terms and other

characteristics. Even if one effect of an agreement is to reduce the

risk faced by the parties (e.g., the ``swap'' of physical delivery

obligations described above may reduce the risk of non-delivery), the

agreement is not a swap or security-based swap unless it otherwise

meets one of the statutory definitions, as further defined by the

Commissions. Similarly, the fact that the parties use another name to

refer to a swap or security-based swap would not be relevant in

determining whether the agreement, contract, or transaction is a swap

or security-based swap as those terms are defined in the CEA and the

Exchange Act and the rules and regulations thereunder.

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\151\ See, e.g., Haekel v. Refco, 2000 WL 1460078, at * 4 (CFTC

Sept. 29, 2000) (``[T]he labels that parties apply to their

transactions are not necessarily controlling''); Reves v. Ernst &

Young, 494 U.S. 56, 61 (1990) (stating that the purpose of the

securities laws is ``to regulate investments, in whatever form they

are made and by whatever name they are called'') (emphasis in

original).

\152\ The CFTC consistently has found that the form of a

transaction is not dispositive in determining its nature. See, e.g.,

Grain Land, supra note 61, at *16 (CFTC Nov. 25, 2003) (holding that

contract substance is entitled to at least as much weight as form);

In the Matter of First Nat'l Monetary Corp., [1984-1986 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 22,698 at 30,974 (CFTC Aug. 7,

1985) (``When instruments have been determined to constitute the

functional equivalent of futures contracts neither we nor the courts

have hesitated to look behind whatever self-serving labels the

instruments might bear.''); Stovall, supra note 63 (holding that the

CFTC ``will not hesitate to look behind whatever label the parties

may give to the instrument''). Likewise, the form of a transaction

is not dispositive in determining whether an agreement, contract, or

transaction falls within the regulatory regime for securities. See

SEC v. Merch. Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007)

(``The Supreme Court has repeatedly emphasized that economic reality

is to govern over form and that the definitions of the various types

of securities should not hinge on exact and literal tests.'')

(quoting Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981));

Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003) (``What matters

more than the form of an investment scheme is the `economic reality'

that it represents * * * .'') (internal citation omitted); Caiola v.

Citibank, N.A., New York, 295 F.3d 312, 325 (2d Cir. 2002) (quoting

United Housing Foundation v. Foreman, 421 U.S. 837, 848 (1975) (``In

searching for the meaning and scope of the word `security' * * * the

emphasis should be on economic reality'')).

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Request for Comment

65. What agreements, contracts, or transactions that are not swaps

or security-based swaps are documented using industry standard form

agreements that are typically used for swaps and security-based swaps?

Please provide examples of such agreements, contracts, or transactions

and details regarding their documentation, including why industry

standard form agreements typically used for swaps and security-based

swaps are used.

2. Transactions in Regional Transmission Organizations and Independent

System Operators

The Commissions received a comment letter in response to the ANPR

requesting clarification regarding the status of transactions in RTOs

and ISOs, including financial transmission rights (``FTRs''), under the

swap and security-based swap definitions.\153\ Section 722 of the Dodd-

Frank Act, though, specifically addresses how the CFTC should approach

products regulated by FERC that also may be subject to CFTC

jurisdiction. Section 722 of the Dodd-Frank Act amended CEA section

4(c) \154\ to provide that, if the CFTC determines that an exemption

for FERC-regulated instruments or other specified electricity

transactions would be in accordance with the public interest, then it

shall exempt such instruments or transactions from the requirements of

the CEA. Given this specific provision regarding these FERC-related

products, the CFTC believes the treatment of these products should be

considered under the standards and procedures specified in section 722

of the Dodd-Frank Act for a public interest waiver, rather than through

this joint rulemaking to further define the terms ``swap'' and

``security-based swap.''

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\153\ See WGCEF Letter.

\154\ 7 U.S.C. 6(c).

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Consequently, the Commissions are not addressing FTRs or other

transactions in RTOs or ISOs within this joint definitional rulemaking.

Instead, persons with concerns about whether FERC-regulated products

may be considered swaps (or futures) should request an exemption

pursuant to section 722 of the Dodd Frank Act.\155\

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\155\ This approach, however, should not be taken to suggest any

findings by the Commissions as to whether or not FTRs or any other

FERC-regulated products are swaps (or futures contracts).

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

Based Swap Definition

A. Introduction

Title VII of the Dodd-Frank Act defines the term ``swap'' under the

CEA,\156\ and also defines the term ``security-based swap'' under the

Exchange Act.\157\ Pursuant to the regulatory framework established in

Title VII, the CFTC has regulatory authority over swaps and the SEC has

regulatory authority over security-based swaps. The Commissions are

proposing to further define the terms ``swap'' and ``security-based

swap'' to clarify whether particular agreements, contracts, or

transactions are swaps or security-based swaps based on characteristics

including the specific terms and conditions of the instrument and the

nature of, among other things, the prices, rates, securities, indexes,

or commodities upon which the instrument is based.

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\156\ See CEA section 1a(47), 7 U.S.C. 1a(47).

\157\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.

78c(a)(68).

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Because the discussion below is focused on whether particular

agreements, contracts, or transactions are swaps or security-based

swaps, the Commissions use the term ``Title VII instrument'' in this

release to refer to any agreement, contract, or transaction that is

included in either the definition of the term ``swap'' or the

definition of the term ``security-based swap.'' Thus, the term ``Title

VII instrument'' is synonymous with ``swap or security-based swap.''

\158\

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\158\ In some cases, the Title VII instrument may be a mixed

swap. Mixed swaps are discussed further in part IV below.

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The determination of whether a Title VII instrument is a swap or

security-

[[Page 29840]]

based swap should be made based on the facts and circumstances relating

to the Title VII instrument at the time that the parties enter into it.

If the Title VII instrument itself is not amended, modified, or

otherwise adjusted during its term by the parties, its characterization

as a swap or security-based swap should not change during its duration

because of any changes that may occur to the factors affecting its

character as a swap or security-based swap.\159\

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\159\ See discussion infra part III.G.3(a) regarding Title VII

instruments based on indexes.

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Classifying a Title VII instrument as a swap or security-based swap

is straightforward for most instruments. The Commissions, however, are

proposing guidance to clarify the classification of swaps and security-

based swaps in certain areas and to provide guidance regarding the use

of certain terms and conditions in Title VII instruments.

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

and Yields

Parties frequently use Title VII instruments to manage risks

related to, or to speculate on, changes in interest rates, other

monetary rates or amounts, or the return on various types of assets.

Broadly speaking, Title VII instruments based on interest or other

monetary rates would be swaps, whereas Title VII instruments based on

the yield or value of a single security, loan, or narrow-based security

index would be security-based swaps. However, market participants and

financial professionals sometimes use the terms ``rate'' and ``yield''

in different ways. The Commissions are proposing guidance regarding

whether Title VII instruments that are based on interest rates, other

monetary rates, or yields would be swaps or security-based swaps and

requesting comment as to whether additional clarification in this area

would be appropriate.\160\

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\160\ Commenters did not address these instruments specifically.

A number of commenters urged clarification that various transactions

or obligations, such as commercial loans, are not Title VII

instruments solely because they reference an interest rate. See

BlackRock Letter; Cleary Letter; Farm Credit Council Letter; White &

Case Letter. The Commissions have proposed guidance to address such

customary commercial transactions in part II.B.3 above.

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1. Title VII Instruments Based on Interest Rates or Other Monetary

Rates That Are Swaps

The Commissions believe that when payments exchanged under a Title

VII instrument are based solely on the levels of certain interest rates

or other monetary rates that are not themselves based on one or more

securities, the instrument would be a swap and not a security-based

swap.\161\ Often swaps on interest rates or other monetary rates

require the parties to make payments based on the comparison of a

specified floating rate (such as the London Interbank Offered Rate

(``LIBOR'')) to a fixed rate of interest agreed upon by the parties. A

rate swap also may require payments based on the differences between

two floating rates, or it may require that the parties make such

payments when any agreed-upon events with respect to interest rates or

other monetary rates occur (such as when a specified interest rate

crosses a threshold, or when the spread between two such rates reaches

a certain point). The rates referenced for the parties' obligations are

varied, and examples of such rates include the following:

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\161\ See discussion supra part III.F regarding the use of

certain terms and conditions.

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Interbank Offered Rates: An average of rates charged by a

group of banks for lending money to each other or other banks over

various periods of time, and other similar interbank rates,\162\

including, but not limited to, LIBOR (regardless of currency); \163\

the Euro Interbank Offered Rate (``Euribor''); the Canadian Dealer

Offered Rate (``CDOR''); and the Tokyo Interbank Offered Rate

(``TIBOR''); \164\

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\162\ Interbank lending rates are measured by surveys of the

loan rates that banks offer other banks, or by other mechanisms. The

periods of time for such loans may range from overnight to 12 months

or longer.

The interbank offered rates listed here are frequently called

either a ``reference rate,'' the rate of ``reference banks,'' or by

a designation that is specific to the service that quotes the rate.

For some of the interbank offered rates listed here, there is a

similar rate that is stated as an interbank bid rate, which is the

average rate at which a group of banks bid to borrow money from

other banks. For example, the bid rate similar to LIBOR is called

LIBID.

\163\ Today, LIBOR is used as a rate of reference for the

following currencies: Australian Dollar, Canadian Dollar, Danish

Krone, Euro, Japanese Yen, New Zealand Dollar, Pound Sterling,

Swedish Krona, Swiss Franc, and U.S. Dollar.

\164\ Other interbank offered rates include the following (with

the country or city component of the acronym listed in parentheses):

AIDIBOR (Abu Dhabi); BAIBOR (Buenos Aires); BKIBOR (Bangkok);

BRAZIBOR (Brazil); BRIBOR/BRIBID (Bratislava); BUBOR (Budapest);

CHIBOR (China); CHILIBOR (Chile); CIBOR (Copenhagen); COLIBOR

(Colombia); HIBOR (Hong Kong); JIBAR (Johannesburg); JIBOR

(Jakarta); KAIBOR (Kazakhstan); KIBOR (Karachi); KLIBOR (Kuala

Lumpur); KORIBOR ((South) Korea); MEXIBOR (Mexico); MIBOR (Mumbai);

MOSIBOR (Moscow); NIBOR (Norway); PHIBOR (Philippines); PRIBOR

(Prague); REIBOR/REIBID (Reykjavik); RIGIBOR/RIGIBID (Riga); SHIBOR

(Shanghai); SIBOR (Singapore); SOFIBOR (Sofia); STIBOR (Stockholm);

TAIBOR (Taiwan); TELBOR (Tel Aviv); TRLIBOR and TURKIBOR (Turkey);

VILIBOR (Vilnius); VNIBOR (Vietnam); and WIBOR (Warsaw).

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Money Market Rates: A rate established or determined based

on actual lending or money market transactions, including, but not

limited to, the Federal Funds Effective Rate; the Euro Overnight Index

Average (``EONIA'' or ``EURONIA'') (which is the weighted average of

overnight unsecured lending transactions in the Euro-area interbank

market); the EONIA Swap Index; the Australian dollar RBA 30 Interbank

Overnight Cash Rate; the Canadian Overnight Repo Rate Average

(``CORRA''); the Mexican interbank equilibrium interest rate

(``TIIE''); the NZD Official Cash Rate; the Sterling Overnight

Interbank Average Rate (``SONIA'') (which is the weighted average of

unsecured overnight cash transactions brokered in London by the

Wholesale Markets Brokers' Association); the Swiss Average Rate

Overnight (``SARON''); and the Tokyo Overnight Average Rate (``TONAR'')

(which is based on uncollateralized overnight average call rates for

interbank lending);

Government Target Rates: A rate established or determined

based on guidance established by a central bank including, but not

limited to, the Federal Reserve discount rate, the Bank of England base

rate and policy rate, the Canada Bank rate, and the Bank of Japan

policy rate (also known as the Mutan rate);

General Lending Rates: A general rate used for lending

money, including, but not limited to, a prime rate, rate in the

commercial paper market, or any similar rate provided that it is not

based on any security, loan, or group or index of securities;

Indexes: A rate derived from an index of any of the

foregoing or following rates, averages, or indexes, including but not

limited to a constant maturity rate (U.S. Treasury and certain other

rates),\165\ the interest rate swap rates published by the Federal

Reserve in its ``H.15 Selected Interest Rates'' publication, the

ISDAFIX rates, the ICAP Fixings, a constant maturity swap, or a rate

generated as an average (geometric, arithmetic, or otherwise) of any of

the foregoing, such as overnight index swaps (``OIS'')--provided that

such rates are not based on a specific

[[Page 29841]]

security, loan, or narrow-based group or index of securities;

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\165\ A Title VII instrument based solely on the level of a

constant maturity U.S. Treasury rate would be a swap because U.S.

Treasuries are exempted securities that are excluded from the

security-based swap definition. Conversely, a Title VII instrument

based solely on the level of a constant maturity rate on a narrow-

based index of non-exempted securities under the security-based swap

definition would be a security-based swap.

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Other Monetary Rates: A monetary rate including, but not

limited to, the Consumer Price Index (``CPI''), the rate of change in

the money supply, or an economic rate such as a payroll index; and

Other: The volatility, variance, rate of change of (or the

spread, correlation or difference between), or index based on any of

the foregoing rates or averages of such rates, such as forward spread

agreements, references used to calculate the variable payments in index

amortizing swaps (whereby the notional principal amount of the

agreement is amortized according to the movement of an underlying

rate), or correlation swaps and basis swaps, including but not limited

to, the ``TED spread'' \166\ and the spread or correlation between

LIBOR and an OIS.

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\166\ The TED spread is the difference between the interest

rates on interbank loans and short-term U.S. government debt

(Treasury bills or ``T-bills''). The latter are exempted securities

that are excluded from the statutory definition of the term

``security-based swap.'' Thus, neither any aspect of U.S. Treasuries

nor interest rates on interbank loans, can form the basis of a

security-based swap. For this reason, a Title VII instrument on a

spread between interbank loan rates and T-bill rates also would not

be a security-based swap.

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As discussed above, the Commissions believe that when payments

under a Title VII instrument are based solely on any of the foregoing,

such Title VII instrument would be a swap.

Request for Comment

66. The Commissions request comment generally on the foregoing

proposed guidance regarding Title VII instruments where the underlying

reference is an interest rate or other monetary rate.

67. Does the proposed guidance in this section accurately describe

the types of interest rates and other monetary rates that are used as

an underlying reference of a Title VII instrument, and that should

cause the instrument to be considered a swap? Are any of the rates

identified in this list not used in this manner? Are there any

significant interest or monetary rates that should be added to this

list in order to provide additional guidance?

68. As discussed above, a Title VII instrument would be considered

a security-based swap if the instrument is based on constant maturity

rates that are derived from the market prices and yields of a non-

exempted debt security or a narrow-based security index of debt

securities (depending on the other terms of the Title VII instrument,

such instrument may be a mixed swap). The Commissions request comment

on this guidance. Are there certain constant maturity rates that should

not be considered to be security-based, such that a Title VII

instrument based on those rates would instead be a swap and not a

security-based swap or mixed swap? If so, are there objective criteria

to distinguish between different types of constant maturity rates in

the determination of whether a Title VII instrument is a swap or

security-based swap? If so, please describe any such criteria in

detail.

2. Title VII Instruments Based on Yields

The Commissions also propose guidance to clarify the status of

Title VII instruments in which one of the underlying references of the

instrument is a ``yield.'' In cases when a ``yield'' is calculated

based on the price or changes in price of a debt security, loan, or

narrow-based security index, it is another way of expressing the price

or value of a debt security, loan, or narrow-based security index. For

example, debt securities often are quoted and traded on a yield basis

rather than on a dollar price, where the yield relates to a specific

date, such as the date of maturity of the debt security (i.e., yield to

maturity) or the date upon which the debt security may be redeemed or

called by the issuer (e.g., yield to first whole issue call).\167\

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\167\ See, e.g., Securities Confirmations, 47 FR 37920, Aug. 27,

1982.

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Except in the case of certain exempted securities, when one of the

underlying references of the Title VII instrument is the ``yield'' of a

debt security, loan, or narrow-based security index in the sense where

the term ``yield'' is used as a proxy for the price or value of the

debt security loan, or narrow-based security index, the Title VII

instrument would be a security-based swap. And, as a result, in cases

where the underlying reference is a point on a ``yield curve''

generated from the different ``yields'' on debt securities in a narrow-

based security index (e.g., a constant maturity yield or rate), the

Title VII instrument would be a security-based swap. In either case,

however, where certain exempted securities, such as U.S. Treasury

securities, are the only underlying reference of a Title VII instrument

involving securities, the Title VII instrument would be a swap. Title

VII instruments based on exempted securities are discussed further

below.

The above interpretation would not apply in cases where the

``yield'' referenced in a Title VII instrument is not based on a debt

security, loan, or narrow-based security index of debt securities but

rather is being used to reference an interest rate or monetary rate as

outlined above in subsection one of this section. In these cases, this

``yield'' reference would be considered equivalent to a reference to an

interest rate or monetary rate and the Title VII instrument would be,

under the guidance in this section, a swap (or mixed swap depending on

other references in the instrument).

Request for Comment

69. The Commissions request comment generally on the foregoing

proposed guidance regarding Title VII instruments where the underlying

reference is a ``yield.'' Please provide a detailed explanation of any

uncertainty regarding the Commissions' proposed use of the terms

``yield'' and ``yield curve'' and what additional guidance would be

necessary.

70. Does the proposed guidance in this section appropriately

describe instruments based on the ``yield'' of a debt security that

should be considered security-based swaps? Is additional guidance

necessary regarding when the term ``yield'' is used as a proxy for

price or value? If so, please provide a detailed explanation of any

uncertainty regarding how the term ``yield'' is used and what

additional guidance would be necessary.

71. Are there instruments where the underlying reference is a

``yield'' of a debt security that should be considered a swap as

opposed to a security-based swap? If so, what are they, and how often

are they traded? How are such instruments distinguished from

instruments based on ``yield'' that should be considered security-based

swaps?

3. Title VII Instruments Based on Government Debt Obligations

The Commissions also are providing guidance regarding instances in

which the underlying reference of the Title VII instrument is a

government debt obligation. The security-based swap definition

specifically excludes any agreement, contract, or transaction that

meets the definition of a security-based swap only because it

``references, is based upon, or settles through the transfer, delivery,

or receipt of an exempted security under [section 3(a)(12) of the

Exchange Act], as in effect on the date of enactment of the Futures

Trading Act of 1982 (other than any municipal security as defined in

[section 3(a)(29) of the Exchange Act] * * *), unless such agreement,

contract, or transaction is of the character of, or

[[Page 29842]]

is commonly known in the trade as, a put, call, or other option.''

\168\

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\168\ Section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.

76c(a)(68)(C).

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As a result of this exclusion in the security-based swap definition

for ``exempted securities,'' \169\ if the only underlying reference of

a Title VII instrument involving securities is, for example, the price

of a U.S. Treasury security and does not have any other underlying

reference involving securities, then the instrument would be a swap.

Similarly, if the Title VII instrument is based on the ``yield'' of a

U.S. Treasury security and does not have any other underlying reference

involving securities, then the instrument also would be a swap,

regardless of whether the term ``yield'' is a proxy for the price of

the security.

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\169\ As of January 11, 1983, the date of enactment of the

Futures Trading Act of 1982, Public Law 97-444, 96 Stat. 2294,

section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), provided

that, among other securities, ``exempted securities'' include: (i)

``securities which are direct obligations of, or obligations

guaranteed as to principal or interest by, the United States;'' (ii)

certain securities issued or guaranteed by corporations in which the

United States has a direct or indirect interest as designated by the

Secretary of the Treasury; and (iii) certain other securities as

designated by the SEC in rules and regulations.

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Foreign government securities, by contrast, were not ``exempted

securities'' as of the date of enactment of the Futures Trading Act of

1982 \170\ and thus do not explicitly fall within this exclusion from

the security-based swap definition. Therefore, if the underlying

reference of the Title VII instrument is the price, value, or ``yield''

(where ``yield'' is a proxy for price or value) of a foreign government

security, or a point on a yield curve derived from a narrow-based

security index composed of foreign government securities, then the

instrument would be a security-based swap.

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\170\ Public Law 97-444, 96 Stat. 2294 (1983).

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Request for Comment

72. The Commissions request comment generally on the foregoing

proposed guidance regarding the treatment of Title VII instruments in

which the underlying reference is a government debt obligation.

General Request for Comment: In addition to the particular requests

for comment set forth on the issues discussed above, the Commissions

also request comment generally on the following:

73. Does the proposed guidance in this part III.B accurately

describe market practices and terminology? Will the proposed guidance

be useful in determining whether Title VII instruments are swaps or

security-based swaps?

C. Total Return Swaps

A TRS is a Title VII instrument in which one counterparty, the

seller of the TRS, makes a payment that is based on the price

appreciation and income from an underlying security or security

index.\171\ The other counterparty, the buyer of the TRS, makes a

financing payment that is often based on a variable interest rate, such

as LIBOR (or other interbank offered rate or money market rate, as

described above), as well as a payment based on the price depreciation

of the underlying reference. The ``total return'' consists of the price

appreciation or depreciation, plus any interest or income

payments.\172\ Accordingly, where a TRS is based on a single security

or loan, or a narrow-based security index, the TRS would be a security-

based swap.\173\

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\171\ Where the underlying security is an equity, a TRS is also

known as an ``equity swap.''

\172\ If the total return is negative, the seller receives this

amount from the buyer. TRS can be used to synthetically reproduce

the payoffs of a position. For example, two counterparties may enter

into a 3-year TRS where the buyer of the TRS receives the positive

total return on XYZ security, if any, and the seller of the TRS

receives LIBOR plus 30 basis points and the absolute value of the

negative total return on XYZ security, if any.

\173\ If the underlying reference of the TRS is a broad-based

equity security index, however, the Commissions believe that it

would be a swap (and an SBSA) and not a security-based swap. In

addition, a TRS on an exempted security, such as a U.S. Treasury,

under section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as

in effect on the date of enactment of the Futures Trading Act of

1982 (other than any municipal security as defined in section

3(a)(29) of the Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on

the date of enactment of the Futures Trading Act of 1982) would be a

swap (and an SBSA) and not a security-based swap.

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Generally, the use of a variable interest rate in the TRS buyer's

payment obligations to the seller is incidental to the purpose of, and

the risk that the counterparties assume in, entering into the TRS.

These payments are a form of financing that reflects the security-based

swap dealer's cost of financing the position or a related hedge,

allowing the TRS buyer to receive payments based on the price

appreciation and income of a security or security index without

purchasing the security or security index. The Commissions believe that

when such interest rate payments act merely as a financing component in

a TRS, or in any other security-based swap, the inclusion of such

interest rate terms would not cause the security-based swap to be

characterized as a mixed swap.\174\ Financing terms may also involve

adding or subtracting a spread to or from the financing rate,\175\ or

calculating the financing rate in a currency other than that of the

underlying reference security or security index.\176\ However, the

Commissions note that where such payments incorporate additional

elements that create additional interest rate or currency exposures

that are unrelated to the financing of the security-based swap, or

otherwise shift or limit risks that are related to the financing of the

security-based swap, those additional elements may cause the security-

based swap to be a mixed swap.

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\174\ Several commenters noted that such instruments should not

be characterized as mixed swaps. See Cleary Letter (expressing the

view that such Title VII instruments should not be characterized as

mixed swaps because ``the floating rate payment obligation is not

the principal driver of the security-based swap and, in that sense,

the security-based swap is not `based on' the level of an interest

rate within the meaning of [the Dodd-Frank Act]''); Deutsche Bank

Letter (explaining that such Title VII instruments in which the

party that is ``synthetically short'' the underlying security makes

payments based on the value of the underlying security to the party

that is ``synthetically long,'' and the synthetically long party

pays the synthetically short party an amount that may be based on

LIBOR or another interest rate, should not be treated as mixed swaps

because the payments to the synthetically short party are generally

intended only for financing costs incurred in establishing or

maintaining the transaction or its hedge); ISDA Letter (noting that

variable interest rate-based payments in connection with a typical

Title VII instrument of this type are ``incidental to what is

essentially a security-based transaction and should not yield mixed

swap status''); Morgan Stanley Letter (noting that the interest

rate-based payments in such Title VII instruments ``reflect

compensation for the financing costs associated'' with the

instrument and ``are not at the core of what is being `swapped'

under the contract''); Letter from Timothy W. Cameron, Esq.,

Managing Director, Asset Management Group, Securities Industry and

Financial Markets Association, Sept. 20, 2010 (expressing the view

that such a financing component is incidental to the Title VII

instrument and should not cause it to be viewed as a mixed swap).

\175\ See, e.g., Moorad Chowdry, ``Total Return Swaps: Credit

Derivatives and Synthetic Funding Instruments,'' at 3-4 (noting that

the spread to the TRS financing rate is a function of: the credit

rating of the counterparty paying the financing rate; the amount,

value, and credit quality of the reference asset; the dealer's

funding costs; a profit margin; and the capital charge associated

with the TRS), available at http://www.yieldcurve.com/Mktresearch/LearningCurve/TRS.pdf.

\176\ For example, a security-based swap on an equity security

priced in U.S. dollars in which payments are made in Euros based on

the U.S. dollar/Euro spot rate at the time the payment is made would

not be a mixed swap. Under these circumstances, the currency is

merely referenced in connection with the method of payment, and the

counterparties are not hedging the risk of changes in currency

exchange rates during the term of the security-based swap.

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For example, where the counterparties embed interest-rate

optionality (e.g., a cap, collar, call, or put) into the terms of a

security-based swap in a manner designed to shift or limit interest

rate exposure, the inclusion of these terms would cause

[[Page 29843]]

the TRS to be both be a swap and a security-based swap (i.e., a mixed

swap). Similarly, if a TRS is also based on non-security-based

components (such as the price of oil, or a currency), the security-

based swap would also be a swap.\177\

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\177\ See Mixed Swaps, infra part IV.

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Request for Comment

74. Is the proposed guidance regarding TRS and other security-based

swaps for which the use of a variable interest rate in a counterparty's

payment obligations is incidental to the risk that counterparties

assume in entering into a TRS or other security-based swap appropriate?

Why or why not? If not, please provide a detailed explanation of what

guidance would be appropriate.

75. How often do market participants use rates, other than

interbank offered rates or money market rates, in TRS to recoup their

financing costs? If so, which rates and what portion of the market

(broken down by product, country, counterparty type, and/or whatever

data are available to commenters), in percentage and/or dollar terms do

TRS with such financing rates constitute? What factors influence the

financing rates that market participants incorporate into their

security-based swaps?

76. Do market participants embed optionality, such a cap, collar,

put, or call, into the payment component of a TRS? If so, how

frequently and for what purpose?

77. Do market participants embed nonfinancial commodity components

into the payment component that directly affect the payments on a TRS

rather than operating as a mere financing component? If so, how

frequently and for what purpose?

78. Do market participants embed foreign currency swaps into a

foreign currency payment component of a TRS? If so, how frequently and

for what purpose?

79. Are there other circumstances under which a TRS should be

treated as a mixed swap rather than a security-based swap or swap? If

so, please provide a detailed description of such circumstances and

explain why.

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

Name Credit Default Swaps

The second prong of the security-based swap definition includes a

swap that is based on ``a single security or loan, including any

interest therein or on the value thereof.'' \178\ The Commissions

believe that, under this prong of the definition of security-based

swap, a single-name CDS that is based on a single reference obligation

would be a security-based swap because it would be based on a single

security or loan (or any interest therein or on the value thereof).

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\178\ Section 3(a)(68)(A)(ii)(II) of the Exchange Act, 15 U.S.C.

78c(a)(68)(A)(ii)(II). The first prong of the security-based swap

definition is discussed below.

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In addition, the third prong of the security-based swap definition

includes a swap that is based on the occurrence of an event relating to

a ``single issuer of a security,'' provided that such event ``directly

affects the financial statements, financial condition, or financial

obligations of the issuer.'' \179\ This provision applies generally to

event-triggered swap contracts. With respect to a CDS, such events

could include the bankruptcy of an issuer, a default on one of an

issuer's debt securities, or the default on a non-security loan of an

issuer.\180\ Therefore, the Commissions believe that if the payout on a

CDS on a single issuer of a security is triggered by the occurrence of

an event relating to that issuer, the CDS would be a security-based

swap under the third prong.\181\

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\179\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

U.S.C. 78c(a)(68)(A)(ii)(III).

\180\ The Commissions understand that in the context of credit

derivatives on asset-backed securities or MBS, the events include

principal writedowns, failure to pay principal and interest

shortfalls.

\181\ The Commissions understand that some single-name CDS now

trade with fixed coupon payments expressed as a percentage of the

notional amount of the transaction and payable on a periodic basis

during the term of the transaction. See Markit, ``The CDS Big Bang:

Understanding the Changes to the Global CDS Contract and North

American Conventions,'' 3, available at http://www.markit.com/cds/announcements/resource/cds_big_bang.pdf. The Commissions believe

the existence of such single-name CDS does not change their

interpretation.

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In this regard, the Commissions note that each transaction under an

ISDA Master Agreement would need to be analyzed to determine whether it

is a swap or security-based swap. For example, the Commissions believe

that a number of single-name CDS that are executed at the same time and

that are documented under one ISDA Master Agreement, but in which a

separate confirmation is sent for each CDS, should be treated as an

aggregation of security-based swaps. As a practical and economic

matter, the Commissions believe that each such CDS would be a separate

and independent transaction. Thus, such an aggregation of single-name

CDS would not constitute a ``group or index'' under the security-based

swap definition but instead would constitute multiple single-name CDS.

E. Title VII Instruments Based on Futures Contracts

A Title VII instrument that is based on a futures contract will

either be a swap or a security-based swap, or both (i.e., a mixed

swap), depending on the nature of the futures contract, including the

underlying reference of the futures contract. The Commissions believe

that a Title VII instrument where the underlying reference is a

security future would be a security-based swap.\182\ The Commissions

believe that, except with respect to certain futures on foreign

government debt securities discussed below, a Title VII instrument

where the underlying reference is a futures contract that is not a

security future would be a swap.\183\

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\182\ A security future is specifically defined in both the CEA

and the Exchange Act as a futures contract on a single security or a

narrow-based security index, including any interest therein or based

on the value thereof, except an exempted security under section

3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on

the date of enactment of the Futures Trading Act of 1982 (other than

any municipal security as defined in section 3(a)(29) of the

Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on the date of

enactment of the Futures Trading Act of 1982).

The term security future does not include any agreement,

contract, or transaction excluded from the CEA under CEA sections

2(c), 2(d), 2(f), or 2(g), 7 U.S.C. 2(c), 2(d), 2(f), or 2(g), (as

in effect on the date of enactment of the Commodity Futures

Modernization Act of 2000 (``CFMA'') or Title IV of the CFMA). See

CEA section 1a(44), 7 U.S.C. 1a(44); section 3(a)(55) of the

Exchange Act, 15 U.S.C. 78c(a)(55).

\183\ Depending on the underlying reference of the futures

contract, though, such swaps could be security-based swap

agreements. For example, a swap on a future on the S&P 500 index

would be a security-based swap agreement.

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Title VII instruments involving futures contracts on foreign

government debt securities present a unique circumstance. Rule 3a12-8

under the Exchange Act exempts certain foreign government debt

securities, for purposes only of the offer, sale, or confirmation of

sale of futures contracts on such foreign government debt securities,

from all provisions of the Exchange Act which by their terms do not

apply to an ``exempted security,'' subject to certain conditions.\184\

To date, the SEC has

[[Page 29844]]

enumerated within rule 3a12-8 debt securities of 21 identified foreign

governments solely for purposes of futures trading.\185\

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\184\ Specifically, rule 3a12-8 under the Exchange Act requires

as a condition to the exemption that the foreign government debt

securities not be registered under the Securities Act (or the

subject of any American depositary receipt registered under the

Securities Act) and that futures contracts on such foreign

government debt securities ``require delivery outside the United

States, [and] any of its possessions or territories, and are traded

on or through a board of trade, as defined in [CEA section 2, 7

U.S.C. 2].'' See rules 3a12-8(b), 3a12-8(a)(2) under the Exchange

Act, 17 CFR 240.3a12-8(b) and 240.3a12-8(a)(2).These conditions were

``designed to minimize the impact of the exemption on securities

distribution and trading in the United States . . . .'' See

Exemption for Certain Foreign Government Securities for Purposes of

Futures Trading, 49 FR 8595, 8596-97, Mar. 8, 1984 (citing Futures

Trading Act of 1982).

\185\ See rule 3a12-8(a)(1) under the Exchange Act (designating

the debt securities of the governments of the United Kingdom,

Canada, Japan, Australia, France, New Zealand, Austria, Denmark,

Finland, the Netherlands, Switzerland, Germany, Ireland, Italy,

Spain, Mexico, Brazil, Argentina, Venezuela, Belgium, and Sweden).

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The Commissions are evaluating the appropriate characterization of

Title VII instruments based on futures on such foreign government debt

securities that are traded in reliance on rule 3a12-8. The Commissions

recognize that as a result of the rule 3a12-8 exemption, futures on

foreign government debt securities of 21 foreign countries trade

pursuant to the CFTC's exclusive jurisdiction and without the futures

being considered security futures. Because futures contracts on the 21

foreign government debt securities designated in rule 3a12-8 are not

security futures, applying the above interpretive guidance to a Title

VII instrument on a futures contract on these foreign government debt

securities would mean that such Title VII instrument would be a

swap.\186\ The Commissions note, however, that the conditions in the

rule 3a12-8 exemption were established specifically for trading futures

contracts on these foreign sovereign debt obligations, not Title VII

instruments based on futures contracts on foreign government debt

securities. Furthermore, the Commissions note that the Dodd-Frank Act

did not exclude debt securities of foreign governments from the

definition of security-based swap. Therefore, a Title VII instrument

based on such debt securities would be a security-based swap. Relying

on rule 3a12-8 for the treatment of Title VII instruments on such

futures would therefore result in different treatments depending on

whether the Title VII instrument is based on a foreign government debt

security or on a future that is in turn based on a foreign government

debt security.\187\ On the other hand, to do otherwise would create

different regulators for a future and Title VII instruments based on

that future.

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\186\ The Commissions note, by contrast, that a Title VII

instrument that is based on the price or value of, or settlement

into, a futures contract on one of the 21 foreign government debt

securities designated in rule 3a12-8 and that is also based on the

price or value of, or had the potential to settle directly into, the

foreign debt security, would be a security-based swap and, depending

on other features of the Title VII instrument, possibly a mixed

swap.

\187\ This is the case today (i.e., different treatments) with

respect to, for example, options on broad-based security indexes and

options on futures on broad-based security indexes.

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The SEC believes that the characterization of a Title VII

instrument involving a foreign government debt security may affect

Federal securities law provisions relating to the distribution of the

underlying foreign debt security. Specifically, the Dodd-Frank Act

included provisions that would not permit issuers, affiliates of

issuers, or underwriters to use security-based swaps to offer or sell

the issuers' securities underlying a security-based swap without

complying with the requirements of the Securities Act.\188\ In

addition, the Dodd-Frank Act provided that any offer and sale of

security-based swaps to non-ECPs would have to be registered under the

Securities Act.\189\ Thus, for example, if a Title VII instrument on a

future on foreign government debt security is characterized as a swap,

and not a security-based swap, then the provisions of the Dodd-Frank

Act enacted to ensure that there could not be offers and sales of

securities made without compliance with the Securities Act, either by

issuers, their affiliates, or underwriters or to non-ECPs, would not

apply to such swap transactions.

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\188\ See section 2(a)(3) of the Securities Act as amended by

the Dodd-Frank Act, 15 U.S.C. 77b(a)(3). This provision applies

regardless of whether the Title VII instrument allows the parties to

physically settle any such security-based swap.

\189\ See section 5 of the Securities Act as amended by the

Dodd-Frank Act. 15 U.S.C. 77e.

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On the other hand, the CFTC believes that characterizing Title VII

instruments based on a future on a foreign government debt security

designated in rule 3a12-8 as security-based swaps could undermine the

regulatory scheme that Congress established in the CEA. As noted above,

the Commissions generally would treat Title VII instruments based on

futures that are not security futures as swaps. Many of the futures on

the 21 foreign government debt securities designated in rule 3a12-8

trade with substantial volume. Section 753 of the Dodd-Frank Act

provided the CFTC with additional antifraud and anti-manipulation

authorities patterned on those provided to the SEC in the Federal

securities laws. The CFTC believes that treating Title VII instruments

based on these futures as security-based swaps, while the underlying

futures come under the CEA, may undermine those authorities.

In sum, depending on how a Title VII instrument on such a future on

a foreign government debt security is characterized, there is potential

for such an instrument: (i) to be used to avoid the application of the

Federal securities laws, including the Dodd-Frank Act provisions, that

otherwise would apply if the Title VII instrument was instead based on

the foreign government debt security directly; or (ii) to be used to

avoid the application of the CEA, including the Dodd-Frank Act

provisions, that otherwise would apply if the Title VII instrument was

instead based on any other futures contract that is not a security

future. Accordingly, the Commissions also are evaluating whether a

Title VII instrument on such a futures contract on a foreign government

debt security should be characterized as a mixed swap.

Request for Comment

80. The Commissions request comment generally on the foregoing

discussion regarding Title VII instruments based on futures contracts

and security futures.

81. What types of such products are traded in the market today? How

often, and where are such products traded?

82. The Commissions are requesting comment on how to characterize a

Title VII instrument where the underlying reference is a futures

contract on one of the 21 foreign government debt securities that have

been designated as ``exempted securities'' under rule 3a12-8 only for

the offer, sale, or confirmation of sale of futures contracts on such

securities and only where the conditions of such exemption are

satisfied. When should a Title VII instrument on a futures contract on

a foreign government debt security being traded in reliance on the

exemption under rule 3a12-8 be treated as a swap, a security-based swap

or a mixed swap? Is there any economic reason why the treatment of a

Title VII instrument on a future on a foreign government debt security

should be different than the treatment of a Title VII instrument on the

foreign government debt security directly? Is there any economic reason

why the treatment of a Title VII instrument on a future on a designated

foreign government debt security should be different than the treatment

of a Title VII instrument on any other futures contract that is not a

security future? If the answer to either of the two preceding questions

is yes, please explain and provide empirical analysis. If the Title VII

instrument is able to be entered into by the issuer, affiliate of the

issuer, or an underwriter, or if the Title VII instrument is being

offered and sold to non-ECPs, should the Title VII instrument be viewed

as a security-based swap or a mixed swap so that market participants

cannot chose

[[Page 29845]]

whether to comply with the registration requirements of the Securities

Act with respect to the foreign government debt securities? Should such

an instrument be viewed as a swap or a mixed swap so that market

participants cannot choose whether to comply with the requirements of

the Dodd-Frank Act concerning clearing, trade execution, reporting, and

standards applicable to dealers and major participants that apply to

Title VII instruments on futures contracts that are not security

futures? Are there other suggested approaches to the treatment of Title

VII instruments on futures on foreign government debt securities that

would preserve the application of the Securities Act as contemplated by

the Dodd-Frank Act to Title VII instruments involving foreign

government debt securities? Are there other suggested approaches to the

treatment of Title VII instruments on futures on foreign government

debt securities that would preserve the application of the CEA as

contemplated by the Dodd-Frank Act to Title VII instruments involving

futures contracts that are not security futures? If the answer to

either of the two preceding questions is yes, please provide detail and

analysis.

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

The Commissions are aware that market participants' setting of

certain fixed terms or conditions of Title VII instruments may be

informed by the value or level of a security, rate, or other commodity

at the time of the execution of the instrument. The Commissions believe

that, in evaluating whether such a Title VII instrument is a swap or

security-based swap, the nature of the security, rate, or other

commodity that informed the setting of such fixed term or condition

should not itself impact the determination of whether the Title VII

instrument is a swap or a security-based swap, provided that the fixed

term or condition is set at the time of execution of the Title VII

instrument and the value or level of that fixed term or condition may

not vary over the life of the Title VII instrument.

For example, a Title VII instrument, such as an interest rate swap,

in which floating payments based on 3-month LIBOR are exchanged for

fixed rate payments of 5% would be a swap, and not a security-based

swap, even if the 5% fixed rate was informed by, or quoted based on,

the yield of a security, provided that the 5% fixed rate was set at the

time of execution and may not vary over the life of the Title VII

instrument.\190\ Another example would be where a private sector or

government borrower that issues a 5-year, amortizing $100 million debt

security with a semi-annual coupon of LIBOR plus 250 basis points also,

at the same time, chooses to enter into a 5-year interest rate swap on

$100 million notional in which this same borrower, using the same

amortization schedule as the debt security, receives semi-annual

payments of LIBOR plus 250 basis points in exchange for 5% fixed rate

payments. The fact that the specific terms of the interest rate swap

(e.g., 5-year, LIBOR plus 250 basis point, $100 million notional, fixed

amortization schedule) were set at the time of execution to match

related terms of a debt security does not cause the interest rate swap

to become a security-based swap. However, if the interest rate swap

contained additional terms that were in fact contingent on a

characteristic of the debt security that may change in the future, such

as an adjustment to future interest rate swap payments based on the

future price or yield of the debt security, then this Title VII

instrument would be a security-based swap that would be a mixed swap.

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\190\ However, to the extent the fixed term or condition is set

at a future date or at a future value or level of a security, rate,

or other commodity rather than the value or level of such security,

rate, or other commodity at the time of execution of the Title VII

instrument, the discussion above would not apply, and the nature of

the security, rate, or other commodity used in determining the terms

or conditions would be considered in evaluating whether the Title

VII instrument is a swap or security-based swap.

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Request for Comment

83. Is the guidance provided by the Commissions regarding the

relevance of the nature of a security, rate, or other commodity that

informs the determination of a fixed term or condition of a Title VII

instrument appropriate? Why or why not? If not, what guidance would be

appropriate?

84. The Commissions are aware that quoting conventions are used in

the context of setting the fixed terms of certain Title VII

instruments, such as interest rate swaps that exchange LIBOR for a

fixed rate that is set at the time of execution by reference to U.S.

Treasury securities.\191\ Are there other Title VII instruments that

use such quoting conventions? If so, please provide a detailed

explanation of such Title VII instruments and the references they use.

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\191\ The Commissions note that such Title VII instruments would

be swaps in any event because U.S. Treasury securities are exempted

securities that are excluded from the security-based swap definition

in Title VII but understand that such swaps use the reference or

quoting convention described above in setting the terms or

conditions of the Title VII instrument at the time of execution.

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

Definition

1. Introduction\192\

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\192\ Four commenters referred to the definition of the term

``narrow-based security index,'' each in the context of CDS. See

infra notes 209 and 211.

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As noted above, a Title VII instrument in which the underlying

reference of the instrument is a ``narrow-based security index'' is

considered a security-based swap subject to regulation by the SEC,

whereas a Title VII instrument in which the underlying reference of the

instrument is a security index that is not a narrow-based security

index (i.e., the index is broad-based), the instrument is considered a

swap subject to regulation by the CFTC. In this section, the

Commissions propose rules and guidance regarding several issues

regarding the term ``narrow-based security index'' in the security-

based swap definition, including: (i) The existing criteria for

determining whether a security index is a narrow-based security index

and the applicability of past guidance of the Commissions regarding

those criteria to Title VII instruments; (ii) new criteria for

determining whether a CDS where the underlying reference is a group or

index of entities or obligations of entities (typically referred to as

an ``index CDS'') is based on an index that is a narrow-based security

index; (iii) the meaning of the term ``index''; (iv) a rule governing

the tolerance period for Title VII instruments on security indexes

traded on DCMs, SEFs, foreign boards of trade (``FBOTs''), security-

based SEFs, or NSEs, where the security index temporarily moves from

broad-based to narrow-based or from narrow-based to broad-based; and

(v) a rule governing the grace period for Title VII instruments on

security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or

NSEs, where the security index moves from broad-based to narrow-based

or from narrow-based to broad-based and the move is not temporary.

2. Applicability of the Statutory Narrow-Based Security Index

Definition and Past Guidance of the Commissions to Title VII

Instruments

As defined in the CEA and Exchange Act,\193\ an index is a

``narrow-based

[[Page 29846]]

security index'' if, among other things, it meets any one of the

following four criteria:

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\193\ Sections 3(a)(55)(B) and (C) of the Exchange Act, 15

U.S.C. 78c(a)(55)(B) and (C), include a definition of ``narrow-based

security index'' in the same paragraph as the definition of security

future. See also CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A)

and (B). A security future is a contract for future delivery on a

single security or narrow-based security index (including any

interest therein or based on the value thereof). See section

3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55), and CEA section

1a(44), 7 U.S.C. 1a(44).

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It has nine or fewer component securities;

A component security comprises more than 30% of the

index's weighting;

The five highest weighted component securities in the

aggregate comprise more than 60% of the index's weighting; or

The lowest weighted component securities comprising, in

aggregate, 25% of the index's weighting have an aggregate dollar value

of average daily trading volume of less than $50,000,000 (or in the

case of an index with more than 15 component securities, $30,000,000),

except that if there are two or more securities with equal weighting

that could be included in the calculation of the lowest weighted

component securities comprising, in the aggregate, 25 percent of the

index's weighting, such securities shall be ranked from lowest to

highest dollar value of average daily trading volume and shall be

included in the calculation based on their ranking starting with the

lowest ranked security.\194\

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\194\ See section 3(a)(55)(B) of the Exchange Act, 15 U.S.C.

78c(a)(55)(B). See also CEA sections 1a(35)(A) and (B), 7 U.S.C.

1a(35)(A) and (B).

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The first three criteria apply to the number and concentration of

the ``component securities'' in the index; the fourth criterion applies

to the average daily trading volume of an index's ``component

securities.'' \195\

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\195\ The narrow-based security index definition in the CEA and

Exchange Act also excludes from its scope security indexes that

satisfy certain specified criteria. See sections 3(a)(55)(C)(i)--

(vi) of the Exchange Act, 15 U.S.C. 78c(a)(55)(C)(i)--(vi), and CEA

sections 1a(35)(B)(i)--(vi), 7 U.S.C. 1a(35)(B)(i)--(vi).

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This statutory narrow-based security index definition focuses on

indexes composed of equity securities and certain aspects of the

definition, in particular the evaluation of average daily trading

volume, are designed to take into account the trading patterns of

individual stocks.\196\ However, the Commissions, pursuant to authority

granted in the CEA and the Exchange Act, previously have extended the

definition to other categories of indexes but modified the definition

to take into account the characteristics of those other

categories.\197\ Specifically, the Commissions have provided guidance

regarding the application of the narrow-based security index definition

to futures contracts on volatility indexes \198\ and debt security

indexes.\199\ Today, then, there exists additional guidance for

determining what constitutes a narrow-based security index.

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\196\ See Joint Order Excluding Indexes Comprised of Certain

Index Options From the Definition of Narrow-Based Security Index, 69

FR 16900, Mar. 31, 2004 (``March 2004 Joint Order'').

\197\ See CEA section 1a(35)(B)(vi), 7 U.S.C. 1a(35)(B)(vi), and

section 3(a)(55)(C)(vi) of the Exchange Act, 15 U.S.C.

78c(a)(55)(C)(vi).

\198\ See March 2004 Joint Order, supra note 196.

\199\ See Joint Final Rules: Application of the Definition of

Narrow-Based Security Index to Debt Securities Indexes and Security

Futures on Debt Securities, 71 FR 39434, July 13, 2006 (``July 2006

Rules'').

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Volatility indexes are indexes composed of index options. The

Commissions issued a joint order in 2004 to define when a volatility

index is not a narrow-based security index. Under this joint order, a

volatility index is not a narrow-based security index if the index

meets all of the following criteria:

The index measures the magnitude of changes (as calculated

in accordance with the order) in the level of an underlying index that

is not a narrow-based security index pursuant to the statutory criteria

for equity indexes discussed above;

The index has more than nine component securities, all of

which are options on the underlying index;

No component security of the index comprises more than 30

percent of the index's weighting;

The five highest weighted component securities of the

index in the aggregate do not comprise more than 60 percent of the

index's weighting;

The average daily trading volume of the lowest weighted

component securities in the underlying index (those comprising, in the

aggregate, 25 percent of the underlying index's weighting) have a

dollar value of more than $50,000,000 (or $30,000,000 in the case of an

underlying index with 15 or more component securities), except if there

are 2 or more securities with equal weighting that could be included in

the calculation of the lowest weighted component securities comprising,

in the aggregate, 25 percent of the underlying index's weighting, such

securities shall be ranked from lowest to highest dollar value of

average daily trading volume and shall be included in the calculation

based on their ranking starting with the lowest ranked security;

Options on the underlying index are listed and traded on

an NSE registered under section 6(a) of the Exchange Act; \200\ and

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\200\ 15 U.S.C. 78f(a).

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The aggregate average daily trading volume in options on

the underlying index is at least 10,000 contracts calculated as of the

preceding 6 full calendar months.\201\

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\201\ See March 2004 Joint Order, supra note 196. In 2009, the

Commissions issued a joint order that provided that, instead of the

index options having to be listed on an NSE, the index options must

be listed on an exchange and pricing information for the index

options, and the underlying index, must be computed and disseminated

in real time through major market data vendors. See Joint Order To

Exclude Indexes Composed of Certain Index Options From the

Definition of Narrow-Based Security Index, 74 FR 61116, Nov. 23,

2009 (expanding the criteria necessary for exclusion under the March

2004 Joint Order to apply to volatility indexes for which pricing

information for the underlying broad-based security index, and the

options that compose such index, is current, accurate, and publicly

available).

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With regard to debt security indexes, the Commissions issued joint

rules in 2006 (``July 2006 Rules'') to define when an index of debt

securities \202\ is not a narrow-based security index. The first three

criteria of that definition were similar to the statutory definition

for equities and the order regarding volatility indexes in that a debt

security index would not be narrow based if: (i) It had more than 9

debt securities issued by more than 9 non-affiliated issuers; (ii) the

securities of any issuer included in the index did not comprise more

than 30 percent of the index's weighting; and (iii) the securities of

any five non-affiliated issuers in the index did not comprise more than

60 percent of the index's weighting.

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\202\ Under the rules, debt securities include notes, bonds,

debentures or evidence of indebtedness. See CFTC rule

41.15(a)(1)(i), 17 CFR 41.15(a)(1)(i) and rule 3a55-4(a)(1)(i) under

the Exchange Act, 17 CFR 240.3a55-4(a)(1)(i).

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In the July 2006 Rules, instead of the statutory average daily

trading volume test, however, the Commissions adopted a public

information availability requirement. Under this requirement, assuming

the aforementioned number and concentration limits were satisfied, a

debt security index would not be a narrow-based security index if the

debt securities or the issuers of debt securities in the index met any

one of the following criteria:

The issuer of the debt security is required to file

reports pursuant to section 13 or section 15(d) of the Securities

Exchange Act of 1934; \203\

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\203\ 15 U.S.C. 78m or 78o(d).

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The issuer of the debt security has a worldwide market

value of its outstanding common equity held by non-affiliates of $700

million or more;

The issuer of the debt security has outstanding securities

that are notes, bonds, debentures, or evidence of indebtedness having a

total remaining principal amount of at least $1 billion;

[[Page 29847]]

The security is an exempted security as defined in section

3(a)(12) of the Securities Exchange Act of 1934 \204\ and the rules

promulgated thereunder; or

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\204\ 15 U.S.C. 78c(a)(12).

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The issuer of the security is a government of a foreign

country or a political subdivision of a foreign country.\205\

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\205\ The July 2006 Rules also provided that debt securities in

the index must satisfy certain minimum outstanding principal balance

criteria, established certain exceptions to these criteria and the

public information availability requirement, and provided for the

treatment of indexes that include exempted securities (other than

municipal securities).

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The statutory definition of the term ``narrow-based security

index'' for equities, and the Commissions' subsequent guidance as to

what constitutes a narrow-based security index with respect to

volatility and debt indexes, is applicable in the context of

distinguishing between futures contracts and security futures products.

In the Dodd-Frank Act, Congress included the term ``narrow-based

security index'' in the security-based swap definition, and thus the

statutory definition of the term ``narrow-based security index'' also

applies in distinguishing swaps (on security indexes that are not

narrow-based, also known as ``broad-based'') and security-based swaps

(on narrow-based security indexes). Further, the Commissions believe

that their prior guidance with respect to what constitutes a narrow-

based security index in the context of volatility and debt security

indexes should apply in determining whether a Title VII instrument is a

swap or a security-based swap.

To clarify that the Commissions are applying the prior guidance and

rules to Title VII instruments, the Commissions are proposing rules to

further define the term ``narrow-based security index'' in the

security-based swap definition. Under paragraph (1) of proposed rule

1.3(yyy) under the CEA and paragraph (a) of proposed rule 3a68-3 under

the Exchange Act, for purposes of the security-based swap definition,

the term ``narrow-based security index'' would have the same meaning as

the statutory definition set forth in section 1a(35) of the CEA and

section 3(a)(55) of the Exchange Act,\206\ and the rules, regulations,

and orders issued by the Commissions relating to such definition. As a

result, except as the new rules the Commissions are proposing provide

for other treatment, market participants generally will be able to use

the Commissions' past guidance in determining whether certain Title VII

instruments based on a security index are swaps or security-based

swaps.

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\206\ 7 U.S.C. 1a(35) and 15 U.S.C. 78c(a)(55).

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However, the Commissions are proposing interpretive guidance and

additional rules regarding Title VII instruments based on a security

index. The additional rules and interpretive guidance set forth new

narrow-based security index criteria with respect to indexes composed

of securities, loans, or issuers of securities referenced by an index

CDS. The proposed interpretive guidance and rules also address the

definition of an ``index'' and the treatment of broad-based security

indexes that become narrow-based and narrow-based indexes that become

broad-based, including rule provisions regarding tolerance and grace

periods for swaps on security indexes that are traded on CFTC-regulated

trading platforms and security-based swaps on security indexes that are

traded on SEC-regulated trading platforms. These rules and interpretive

guidance are discussed in turn below.

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

(a) In General

A CDS is a Title VII instrument in which the ``protection buyer''

makes a series of payments to the ``protection seller'' and, in return,

the ``protection seller'' is obligated to make a payment to the

``protection buyer'' if an obligation or obligations (typically bonds,

but in some cases loans) of an entity or entities referenced in the

contract, or the entity or entities themselves, experience a ``credit

event.'' \207\ While the Commissions understand that the underlying

reference for most cleared CDS is a single entity or an index of

entities rather than a single security or an index of securities, the

underlying reference for CDS also could be a single security or an

index of securities.\208\ A CDS where the underlying reference is a

single entity (i.e., a single-name CDS), a single obligation of a

single entity (e.g., a CDS on a specific bond, loan, or asset-backed

security, or any tranche or series of any bond, loan, or asset-backed

security), or an index CDS where the underlying reference is a narrow-

based security index or the issuers of securities in a narrow-based

security index would be a security-based swap.\209\ An index CDS where

the underlying reference is not a narrow-based security index or the

issuers of securities in a narrow-based security index (i.e., a broad-

based index) would be a swap.\210\

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\207\ See supra note 180 and accompanying text.

\208\ See, e.g., Markit, ``Markit CDX'' (describing the Markit

CDX indexes and the number of ``names'' included in each index),

available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/cdx/cdx.page?; Markit, ``Markit iTraxx Indices,''

(stating that the ``Markit iTraxx indices are comprised of the most

liquid names in the European and Asian markets'') (emphasis added),

available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/itraxx/itraxx.page?]. Examples of indexes based on

securities include the Markit ABX.HE and CMBX indexes. See Markit,

``Markit ABX.HE,'' (describing the Markit ABX.HE index as ``a

synthetic tradeable index referencing a basket of 20 subprime

mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/abx/abx.page;

Markit, ``Markit CMBX,'' (describing the Markit CMBX index as ``a

synthetic tradeable index referencing a basket of 25 commercial

mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/cmbx/cmbx.page.

\209\ Two commenters made suggestions relating to the effect of

the jurisdictional consequences of the definition of the term

``narrow-based security index,'' but neither commented on the

meaning of the term itself. One of the two commenters, recognizing

that a jurisdictional line would exist for CDS, stressed the need

for ``substantially identical'' regulations applicable to CDS. See

Deutsche Bank Letter. The other commenter also noted that a line for

CDS would exist and urged the Commissions to adopt a regulation

stating that a derivatives clearing organization (``DCO'') may be a

clearing agency and a clearing agency may be a DCO, in order to

facilitate portfolio margining and cross-margining. See White & Case

Letter. The Commissions are sensitive to the requirement in section

712(a)(7) of the Dodd-Frank Act to treat functionally or

economically similar products or entities in a similar manner.

\210\ Similarly, an option to enter into a single-name CDS or a

CDS referencing a narrow-based security index as described above

would be a security-based swap, while an option to enter into a CDS

on a broad-based security index or the issuers of securities in a

broad-based security index would be a swap. Index CDS where the

underlying reference is a broad-based security index would be SBSAs.

The SEC has enforcement authority with respect to swaps that are

SBSAs, as discussed further in part V below.

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The statutory definition of the term ``narrow-based security

index,'' as explained above, was designed with the U.S. equity markets

in mind. Thus, the statutory definition is not appropriate for

determining whether an index underlying an index CDS is broad or

narrow-based. Nor is the further guidance that the Commissions have

previously issued with respect to the narrow-based security index

definition discussed above necessarily appropriate, because that

guidance was designed to address and was uniquely tailored to the

characteristics of volatility indexes and debt security indexes in the

context of futures. Accordingly, the Commissions are proposing rules

that would adopt criteria for determining whether an index is a narrow-

based security index within the context of index CDS.\211\

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\211\ Two commenters urged clarification of the definition of

the term ``narrow-based security index'' in the context of CDS to

ensure that it reflects ``the letter and the spirit'' of the

existing definition. See Letter from Thomas W. Jasper, Chief

Executive Officer, Primus Guaranty Ltd., and Gene Park, Chief

Executive Officer, Quadrant Structured Investment Advisers, LLC,

Sept. 20, 2010 (``Primus and Quadrant Letter'').

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[[Page 29848]]

The Commissions are further defining the term ``security-based

swap,'' and the use of the term ``narrow-based security index'' within

that definition to modify the criteria applied in the context of index

CDS in assessing whether the index is a narrow-based security index.

The third prong of the security-based swap definition includes a Title

VII instrument based on the occurrence of an event relating to the

``issuers of securities in a narrow-based security index,'' provided

that such event directly affects the ``financial statements, financial

condition, or financial obligations of the issuer.'' \212\ The first

prong of the security-based swap definition includes a Title VII

instrument that is based on a ``narrow-based security-index.'' \213\

Because the third prong of the security-based swap definition relates

to issuers of securities, while the first prong of such definition

relates to securities, the Commissions are proposing to further define

both the term ``narrow-based security index'' and the term ``issuers of

securities in a narrow-based security index'' in the context of the

definition of security-based swap as applied to index CDS. The

Commissions believe it is important to further define both terms in

order to ensure consistent analysis of index CDS.\214\ While the

wording of the two proposed definitions differs slightly, the

Commissions expect that they would yield the same substantive results

in distinguishing narrow-based and broad-based index CDS.

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\212\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

U.S.C. 78c(a)(68)(A)(ii)(III).

\213\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.

78c(a)(68)(A)(ii)(I).

\214\ Because it applies only with respect to index CDS, the

proposed definitions of ``issuers of securities in a narrow-based

security index'' and ``narrow-based security index'' would not apply

with respect to other types of event contracts, whether analyzed

under the first or third prong.

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

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

for Index Credit Default Swaps

The Commissions are considering how to further define the terms

``issuers of securities in a narrow-based security index'' and

``narrow-based security index'' in order to provide for appropriate

criteria for determining whether an index composed of issuers of

securities referenced by an index CDS and an index composed of

securities referenced by an index CDS are narrow-based security

indexes. In formulating these criteria, and consistent with the

guidance and rules the Commissions have previously issued and adopted

regarding narrow-based security indexes in the context of security

futures, the Commissions believe that there should be public

information available about a predominant percentage of the reference

entities underlying the index, or, in the case of an index CDS, on an

index of securities, about the issuers of the securities or the

securities underlying the index, in order to reduce the likelihood that

non-narrow-based indexes referenced in index CDS or the component

securities or issuers of securities in that index would be readily

susceptible to manipulation, as well as to help prevent the misuse of

material non-public information through the use of CDS based on such

indexes.

To satisfy these objectives, the Commissions intend to use the

criteria developed for debt indexes discussed above \215\ but tailor

the criteria specifically to address index CDS.\216\ These criteria

would be used solely for the purpose of defining the terms ``narrow-

based security index'' and ``issuers of securities in a narrow-based

security index'' in the first and third prongs of the security-based

swap definition with respect to index CDS and would not be interpreted

to affect any other interpretation or use of the term ``narrow-based

security index'' or any other provision of the Dodd-Frank Act, CEA, or

Exchange Act.

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\215\ See discussion of July 2006 Rules, supra note 199.

\216\ The Commissions note that the language of the proposed

rules is intended, in general, to track the criteria developed for

debt indexes discussed above. Certain changes from the criteria

developed for debt indexes are necessary to address differences

between futures on debt indexes and index CDS. Certain other changes

are necessary because the rules for debt indexes define under what

conditions an index is not a narrow-based security index, whereas

the proposed rules define what is a narrow-based security index. For

example, an index is not a narrow-based security index under the

rule for debt indexes if it is not a narrow-based security index

under either subparagraph (a)(1) or paragraph (a)(2) of the rule.

Under the proposed rules for index CDS, however, an index is a

narrow-based security index if it meets the requirements of both of

the counterpart paragraphs in the proposed rules regarding index CDS

(paragraphs (1)(i) and (1)(ii) of proposed rules 1.3(xxx) and

1.3(aaaa) under the CEA and paragraphs (a)(1) and paragraph (a)(2)

of proposed rules 3a68-1a and 3a68-1b under the Exchange Act), even

though the criteria in the debt index rules and the proposed rules

for index CDS include generally the same criteria and structure.

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(i) Number and Concentration Percentages of Reference Entities or

Securities

The Commissions believe that the first three criteria of the debt

security index test discussed above (i.e., the number and concentration

weighting requirements) are appropriate to apply to index CDS, whether

CDS on indexes of securities or indexes of issuers of securities.

Accordingly, proposed rules 1.3(zzz) under the CEA and proposed

rule 3a68-1a under the Exchange Act would provide that, for purposes of

determining whether an index CDS is a security-based swap under section

3(a)(68)(A)(ii)(III) of the Exchange Act,\217\ the term ``issuers of

securities in a narrow-based security index'' would include issuers of

securities identified in an index in which:

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\217\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).

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Number: There are 9 or fewer non-affiliated issuers of

securities that are reference entities \218\ in the index, provided

that an issuer of securities shall not be deemed a reference entity in

the index unless (i) a credit event with respect to such reference

entity would result in a payment by the credit protection seller to the

credit protection buyer under the CDS based on the related notional

amount allocated to such reference entity, or (ii) the fact of such

credit event or the calculation in accordance with clause (i) above of

the amount owed with respect to such credit event is taken into account

in determining whether to make any future payments under the CDS with

respect to any future credit events;

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\218\ For purposes of proposed rules 1.3(zzz) and 3a68-1a: (i) A

reference entity would be affiliated with another entity if it

controls, is controlled by, or is under common control with, that

entity; (ii) control would mean ownership of 20 percent or more of

an entity's equity, or the ability to direct the voting of 20

percent or more of the entity's voting equity; and (iii) the term

``reference entity'' would include an issuer of securities, an

issuing entity of asset-backed securities, and a single reference

entity or group of affiliated entities; provided that an issuing

entity of an asset-backed security shall not be affiliated with any

other issuing entity or issuer under this proposed definition.

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Single Component Concentration: The effective notional

amount allocated to any reference entity included in the index

comprises more than 30 percent of the index's weighting; or

Largest Five Component Concentration: The effective

notional amount allocated to any 5 non-affiliated reference entities

included in the index comprises more than 60 percent of the index's

weighting.\219\

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\219\ These proposed rules refer to the ``effective notional

amount'' allocated to reference entities or securities in order to

address potential situations in which the means of calculating

payout across the reference entities or securities is not uniform.

Thus, if one or more payouts is leveraged or enhanced by the

structure of the transaction (i.e., 2x recovery rate), that amount

would be the ``effective notional amount'' for purposes of the 30%

and 60% tests in paragraphs (1)(i)(B) and (1)(i)(C) of proposed

rules 1.3(zzz) and 1.3(aaaa) and paragraphs (a)(1)(ii) and

(a)(1)(iii) of proposed rules 3a68-1a and 3a68-1b. Similarly, if the

aggregate notional amount under a CDS is not uniformly allocated to

each reference entity or security, then the portion of the notional

amount allocated to each reference entity or security (which may be

by reference to the product of the aggregate notional amount and an

applicable percentage) would be the ``effective notional amount.''

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[[Page 29849]]

Similarly, proposed rules 1.3(aaaa) under the CEA and proposed rule

3a68-1b under the Exchange Act would provide that, for purposes of

determining whether an index CDS is a security-based swap under section

3(a)(68)(A)(ii)(I) of the Exchange Act,\220\ the term ``narrow-based

security index'' would include an index in which essentially the same

criteria apply, substituting securities for issuers. Under these

proposed criteria, the term ``narrow-based security index'' would mean

an index in which:

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\220\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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Number: There are 9 or fewer securities, or securities

that are issued by 9 or fewer non-affiliated issuers,\221\ in the

index, provided that a security shall not be deemed a component of the

index unless (i) a credit event with respect to the issuer of such

security or a credit event with respect to such security would result

in a payment by the credit protection seller to the credit protection

buyer under the CDS based on the related notional amount allocated to

such security, or (ii) the fact of such credit event or the calculation

in accordance with clause (i) above of the amount owed with respect to

such credit event is taken into account in determining whether to make

any future payments under the CDS with respect to any future credit

events;

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\221\ This language is intended to be consistent with the

language in the rule for debt indexes but the specific language is

different to deal with the differences in structure between the rule

for debt indexes and proposed rules 1.3(aaaa) and 3a68-1b. See

discussion supra note 216.

For purposes of proposed rules 1.3(aaaa) and 3a68-1b: (i) An

issuer would be affiliated with another issuer if it controls, is

controlled by, or is under common control with, that issuer; (ii)

control would mean ownership of 20 percent or more of an issuer's

equity, or the ability to direct the voting of 20 percent or more of

the issuer's voting equity; and (iii) the term ``issuer'' would

include an issuer of securities, an issuing entity of asset-backed

securities, and a single issuer or group of affiliated issuers;

provided that an issuing entity of an asset-backed security shall

not be deemed affiliated with any other issuing entity or issuer

under this proposed definition.

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

Single Component Concentration: The effective notional

amount allocated to the securities of any issuer included in the index

comprises more than 30 percent of the index's weighting; or

Largest Five Component Concentration: The effective

notional amount allocated to the securities of any 5 non-affiliated

issuers included in the index comprises more than 60 percent of the

index's weighting.

Thus, the applicability of the proposed rules would depend on

conditions relating to the number of non-affiliated reference entities,

issuers of securities, or securities, as applicable, included in an

index and the weighting of notional amounts allocated to the reference

entities or securities in the index, as applicable. These first three

criteria of the proposed rules would evaluate the number and

concentration of the issuers or securities in the index, as applicable,

and ensure that an index with a small number of issuers or securities

or concentrated in only a few issuers or securities would be narrow-

based, and thus where such index is the underlying reference of an

index CDS, the index CDS would be a security-based swap.

Specifically, the proposed rules would provide that an index

meeting any one of certain identified conditions would be a narrow-

based security index. The first condition in paragraph (1)(i)(A) of

proposed rule 1.3(zzz) under the CEA and paragraph (a)(1)(i) of

proposed rule 3a68-1a under the Exchange Act is that there are 9 or

fewer non-affiliated issuers of securities that are reference entities

in the index. An issuer of securities would count toward this total

only if a credit event with respect to such entity would result in a

payment by the credit protection seller to the credit protection buyer

under the CDS based on the notional amount allocated to such entity, or

if the fact of such a credit event or the calculation of the payment

with respect to such credit event is taken into account when

determining whether to make any future payments under the CDS with

respect to any future credit events.

Similarly, the first condition in paragraph (1)(i)(A) of proposed

rules 1.3(aaaa) under the CEA and paragraph (a)(1)(i) of proposed rule

3a68-1b under the Exchange Act would provide that a security would

count toward the total number of securities in the index only if a

credit event with respect to such security, or the issuer of such

security, would result in a payment by the credit protection seller to

the credit protection buyer under the CDS based on the notional amount

allocated to such security, or if the fact of such a credit event or

the calculation of the payment with respect to such credit event is

taken into account when determining whether to make any future payments

under the CDS with respect to any future credit events. These

provisions are intended to ensure that an index concentrated in a few

reference entities or securities, or a few reference entities that are

affiliated or a few securities issued by a few issuers that are

affiliated, are within the ``narrow-based'' definition and that an

entity is not counted as a reference entity in the index, and a

security is not counted as a security in the index, unless a credit

event with respect to the entity, issuer, or security affects payout

under a CDS on the index.\222\

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\222\ This requirement is generally consistent with the

definition of ``narrow-based security index'' in CEA section

1a(35)(A), 7 U.S.C. 1a(35)(A), and section 3(a)(55)(B) of the

Exchange Act, 15 U.S.C. 78c(a)(55)(B), and the July 2006 Rules,

supra note 199.

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In addition, the proposed rules would provide that a reference

entity or issuer of a security in an index and any of that reference

entity's or issuer's affiliated entities are deemed to be a single

reference entity or issuer in the index.\223\ For purposes of the

narrow-based security index definition for index CDS under the third

prong and first prong, a reference entity or issuer would be affiliated

with another entity if it controls, is controlled by, or is under

common control with, that other entity or issuer. The proposed rules

would define control, solely for purposes of this provision, to mean

ownership of 20% or more of an entity's or issuer's equity or the

ability to direct the voting of 20% or more of an entity's or issuer's

voting equity.\224\ This definition of control is designed to provide a

clear standard for determining affiliation for purposes of the narrow-

based security index criteria with respect to index CDS. Determining

whether a reference entity or issuer is affiliated with another entity

or issuer is important in assessing whether an index meets the criteria

in the proposed rules because the notional amounts allocated to all

affiliated reference entities, or all securities issued by affiliated

issuers, included in an index must be aggregated in order to prevent a

concentration of the index in reference entities or securities issued

by issuers that are affiliated and because a reference entity's and

issuer's affiliates must be considered when determining whether the

reference entity or security meets the public information availability

test discussed below. In addition, in order to ensure application of

the criteria regarding index CDS to indexes of

[[Page 29850]]

reference entities that have issued asset-backed securities as defined

in section 3(a)(77) of the Exchange Act,\225\ as well as indexes of

such asset-backed securities, the term reference entity and the term

issuer under the proposed rules includes issuing entities of asset-

backed securities. The proposed rules also would provide that each

issuing entity of an asset-backed security is considered a separate

reference entity or issuer, as applicable.

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\223\ See proposed rule 1.3(zzz)(4) under the CEA and proposed

rule 3a68-1a(d) under the Exchange Act.

\224\ The affiliate issue under the Federal securities laws is

generally a facts and circumstances determination based on the

definition of the term ``affiliate'' contained in such laws. See,

e.g., rule 405 under the Securities Act, 17 CFR 230.405; rule 12b-2

under the Exchange Act, 17 CFR 240.12b-2.

\225\ 15 U.S.C. 78c(a)(77). The Commissions note that section

941 of the Dodd-Frank Act added the definition of the term ``asset-

backed security'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.

78c(a)(77). However, section 761(a)(6) of the Dodd-Frank Act also

added the definition of the term ``security-based swap execution

facility'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.

78c(a)(77). References to the definition of the term ``asset-backed

security'' in this release are to the definition added by section

941 of the Dodd-Frank Act.

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The second condition, in paragraphs (1)(i)(B) of proposed rules

1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(ii) of

proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the

effective notional amount allocated to any reference entity or security

included in the index comprises more than 30 percent of the index's

weighting.

The third condition, in paragraphs (1)(i)(C) of proposed rules

1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(iii) of

proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the

effective notional amount allocated to any 5 non-affiliated reference

entities, or to the securities of any 5 non-affiliated issuers,

included in the index that are the underlying reference entities or

securities, respectively, comprises more than 60 percent of the index's

weighting.

Given that Congress determined that these concentration percentages

are appropriate to characterize an index as a narrow-based security

index, and the Commissions have determined they are appropriate for

debt security indexes in the security futures context, the Commissions

believe that these concentration percentages are appropriate to apply

to the notional amount allocated to reference entities and securities

in order to apply similar standards to indexes that are the underlying

references of index CDS. Moreover, with respect to both the numerical

and concentration percentage criteria, the markets have had experience

with these criteria with respect to futures on equity indexes,

volatility indexes, and debt security indexes.

(ii) Public Information Availability Regarding Reference Entities and

Securities

In addition to the numerical and concentration percentage criteria,

the debt security index test also included, as discussed above, a

public information availability test. This test was designed to reduce

the likelihood that broad-based debt security indexes or the component

securities or issuers of securities in that index would be readily

susceptible to manipulation. The fourth condition in the proposed rules

includes a similar public information availability test that is

intended solely for purposes of determining whether an index underlying

a CDS is narrow-based. Except as discussed below, under the proposed

rules, an index CDS would be considered narrow-based if a reference

entity or security included in the index does not meet any one of the

following criteria:

The reference entity or the issuer of the security is

required to file reports pursuant to the Exchange Act or the

regulations thereunder;

The reference entity or the issuer of the security is

eligible to rely on the exemption provided in rule 12g3-2(b) under the

Exchange Act; \226\

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\226\ 17 CFR 240.12g3-2(b).

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

The reference entity or the issuer of the security has a

worldwide market value of its outstanding common equity held by non-

affiliates of $700 million or more; \227\

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

\227\ See July 2006 Rules, supra note 199, at 39537 (noting that

issuers having worldwide equity market capitalization of $700

million are likely to have public information available about them).

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

The reference entity or the issuer of the security (other

than an issuing entity of an asset-backed security as defined in

section 3(a)(77) of the Exchange Act \228\) has outstanding securities

that are notes, bonds, debentures, or evidences of indebtedness having

a total remaining principal amount of at least $1 billion;

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

\228\ 15 U.S.C. 78c(a)(77).

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The reference entity is an issuer of an exempted security,

or the security is an exempted security, each as defined in section

3(a)(12) of the Exchange Act \229\ and the rules promulgated thereunder

(except a municipal security);

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\229\ 15 U.S.C. 78c(a)12.

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

The reference entity or the issuer of the security is a

government of a foreign country or a political subdivision of a foreign

country; or

If the reference entity or the issuer of the security is

an issuing entity of asset-backed securities as defined in section

3(a)(77) of the Exchange Act,\230\ such asset-backed securities were

issued in a transaction registered under the Securities Act and have

publicly available distribution reports.

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

\230\ 15 U.S.C. 78c(a)(77).

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However, so long as the effective notional amounts allocated to

reference entities or securities that satisfy the public information

availability test comprise at least 80 percent of the index's

weighting, failure by a reference entity or security included in the

index to satisfy the public information availability test would be

disregarded if the effective notional amounts allocated to that

reference entity or security comprise less than 5 percent of the

index's weighting.

These issuer eligibility criteria are intended to condition the

characterization of an index as ``narrow-based'' on the likelihood that

information about a predominant percentage of the reference entities or

securities included in the index is publicly available.\231\ For

example, a reference entity or issuer of securities that is required to

file reports pursuant to the Exchange Act or the regulations thereunder

makes regular and public disclosure through those filings. Moreover,

reference entities and issuers of securities that do not file reports

with the SEC but that are eligible to rely on the exemption in rule

12g3-2(b) under the Exchange Act (i.e., foreign private issuers) are

required to make certain types of financial information publicly

available in English on their Web sites or through an electronic

information delivery system generally available to the public in their

primary trading markets.\232\ The Commissions believe that other

reference entities or issuers of securities that do not file reports

with the SEC, but that have worldwide equity market capitalization of

$700 million, have $1 billion in outstanding debt (other than in the

case of issuing entities of asset-backed securities), issue exempted

securities (other than municipal securities), or are foreign

[[Page 29851]]

sovereign entities either are required to or are otherwise sufficiently

likely, solely for purposes of the proposed ``narrow-based security-

index'' and ``issuers of securities in a narrow-based security index''

definitions, to have public information available about them.\233\

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\231\ See discussion supra part III.G.3(b). Most of the

thresholds in the public information availability test are similar

to those the Commissions adopted in their joint rules regarding the

application of the definition of the term ``narrow-based security

index'' to debt security indexes and security futures on debt

securities. See July 2006 Rules, supra note 199. The July 2006 Rules

also included an additional requirement regarding the minimum

principal amount outstanding for each security in the index. The

Commissions have not included this requirement in proposed rule

1.3(zzz) under the CEA and proposed rule 3a68-1a under the Exchange

Act. The numerical thresholds also are similar to those the SEC

adopted in its securities offering reform rules, which were based on

data analysis conducted by the SEC's Office of Economic Analysis.

See Securities Offering Reform, 70 FR 44722, Aug. 3, 2005.

\232\ 17 CFR 240.12g3-2(b).

\233\ It is important to note that the public information

availability test is designed solely for purposes of distinguishing

between index CDS that are swaps and index CDS that are security-

based swaps. The proposed criteria are not intended to provide any

assurance that there is any particular level of information actually

available regarding a particular reference entity or issuer of

securities. Meeting one or more of the proposed criteria for the

limited purpose here--defining the terms ``narrow-based security

index'' and ``issuers of securities in a narrow-based security

index'' in the first and third prongs of the security-based swap

definition with respect to index CDS--would not substitute for or

satisfy any other requirement for public disclosure of information

or public availability of information for purposes of the Federal

securities laws.

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In the case of indexes including asset-backed securities, or

reference entities that are issuing entities of asset-backed

securities, information about the reference entity or issuing entity of

the asset-backed security would not alone be sufficient and,

consequently, the proposed rules provide that the public information

availability test would be satisfied only if certain information also

is available about the asset-backed securities. An issuing entity

(whether or not a reference entity) of asset-backed securities may meet

the public information availability test if such asset-backed

securities were issued in a transaction registered under the Securities

Act and distribution reports about such asset-backed securities are

publicly available. In addition, because of the lack of public

information regarding many asset-backed securities, despite the size of

the outstanding amount of securities,\234\ the proposed rules would not

permit such reference entities and issuers to satisfy the public

information availability test by having $1 billion in outstanding debt.

Characterizing an index with reference entities or securities for which

public information is not likely to be available as ``narrow-based,''

and thus index CDS where the underlying references or securities are

such indexes as security-based swaps, should help to ensure the

transparency of the index components.

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\234\ See generally Asset-Backed Securities, 75 FR 23328, May 3,

2010.

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In sum, an index that is not narrow-based under the number and

weighting requirements would be characterized as broad-based (and thus

an index CDS, where the underlying reference is that index, would be

characterized as a swap and not a security-based swap) unless one of

the reference entities or securities in the index fails to meet one of

the criteria in the public information availability test set forth in

the proposed rules. Yet, even if one or more of the reference entities

or securities included in the index fail the public information

availability test, the proposed rules would provide that the terms

``issuers of securities in a narrow-based security index'' and

``narrow-based security index'' would not include such an index, so

long as the applicable reference entity or security that failed the

test represents less than 5 percent of the index's weighting, and so

long as reference entities or securities comprising at least 80 percent

of the index's weighting do satisfy the public information availability

test.

An index that includes a very small proportion of reference

entities or securities that do not satisfy this public information

availability test should nevertheless be treated as a broad-based

security index. This would be achieved where the index satisfies both

of the requirements at the time the parties enter into the index CDS.

The 5-percent weighting threshold is designed to provide that reference

entities or securities not satisfying the public information

availability test comprise only a very small portion of the index, and

the 80-percent weighting threshold is designed to provide that a

predominant percentage of the reference entities or securities in the

index satisfy the public information availability test. As a result,

these thresholds would provide market participants with flexibility in

constructing an index. The Commissions believe that this provision is

appropriate and that providing such flexibility is not likely to

increase the likelihood that an index that satisfies these provisions

would be readily susceptible to manipulation or the likelihood that the

component securities or issuers of securities in that index also would

be subject to manipulation or that there would be misuse of material

non-public information about them through the use of CDS based on such

indexes.

The Commissions also are proposing that, for index CDS entered into

solely between ECPs, the public information availability test may

instead be satisfied other than in the manner discussed above.

Accordingly, solely for index CDS entered into between ECPs, an index

would be considered narrow-based if a reference entity or security

included in the index does not meet any one of the criteria enumerated

above or any one of the following criteria:

The reference entity or the issuer of the security (other

than issuing entities of asset-backed securities) provides to the

public or to such eligible contract participant information about such

reference entity or issuer pursuant to rule 144A(d)(4) under the

Securities Act; \235\

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\235\ 17 CFR 230.144A(d)(4).

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Financial information about the reference entity (other

than an issuing entity of asset-backed securities) is otherwise

publicly available; or

In the case of an asset-backed security, or a reference

entity that is an issuing entity of asset-backed securities,

information of the type and level included in public distribution

reports for similar asset-backed securities is publicly available about

both the reference entity or issuing entity as well as such asset-

backed securities.

Reference entities or reference securities that meet alternative

public information criteria currently may underlie CDS that are entered

into by ECPs and that are cleared by central counterparties operating

pursuant to exemptive orders granted by the SEC.\236\ In addition,

solely with respect to index CDS entered into by ECPs, so long as the

effective notional amounts allocated to reference entities or

securities that satisfy this expanded public information availability

test comprise at least 80 percent of the index's weighting, a reference

entity or security included in the index that fails to satisfy this

expanded public information availability test would be disregarded if

the effective notional amounts allocated to that reference entity or

security comprise less than 5 percent of the index's weighting.

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\236\ See, e.g., Order Granting Temporary Exemptions Under the

Securities Exchange Act of 1934 in Connection With Request of

Chicago Mercantile Exchange Inc. and Citadel Investment Group,

L.L.C. Related to Central Clearing of Credit Default Swaps, and

Request for Comments, Exchange Act Release No. 34-59578 (Mar. 13,

2009). This order has been extended a number of times, most recently

on November 29, 2010. See Order Extending Temporary Conditional

Exemptions Under the Securities Exchange Act of 1934 in Connection

With Request of Chicago Mercantile Exchange Inc. Related to Central

Clearing of Credit Default Swaps and Request for Comment, Exchange

Act Release No. 34-63388 (Nov. 29, 2010).

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The Commissions are also seeking comment as to whether the public

information availability test should apply to the extent that an index

is compiled by an index provider that is not a party to an index CDS

(``third-party index provider'') and makes publicly available general

information about the construction of the index, index rules, identity

of components, and predetermined adjustments, and which index is

referenced by an index CDS that is offered on or subject to the rules

of a DCM or SEF, or by direct access in

[[Page 29852]]

the U.S. from an FBOT that is registered with the CFTC.

The CFTC believes that the requirement that the index be compiled

by a third-party index provider may help to ensure that information is

publicly available because such index providers generally employ a

variety of selection criteria for inclusion of reference entities or

securities in the indexes for index CDS, including liquidity

thresholds. The CFTC believes that requiring that such index providers

make publicly available general information about the construction of

the index, index rules, components, and predetermined adjustments may

help ensure transparency regarding the index and its components. In

addition, the CFTC believes that the requirement that the index be the

underlying reference of an index CDS that is offered for trading on or

subject to the rules of a DCM or SEF, or by direct access in the U.S.

from a registered FBOT, helps to ensure that information about the

index is publicly available and that the index is not readily

susceptible to manipulation. The CEA prohibits DCMs and SEFs from

offering for trading contracts that are readily susceptible to

manipulation.\237\ Similarly, under rules recently proposed by the

CFTC, FBOTs only may offer contracts by direct access from the U.S.

that are not readily susceptible to manipulation.\238\ The CFTC

believes that CFTC oversight of DCMs, SEFs and registered FBOTs for

compliance with these requirements \239\ will help ensure that

information about an index that is the underlying reference of an index

CDS traded on these platforms is publicly available and is not readily

susceptible to manipulation.\240\

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\237\ See CEA sections 5(d)(3), 7 U.S.C. 7(d)(3) (a DCM ``shall

list on the contract market only contracts that are not readily

susceptible to manipulation.''); 5h(f)(3), 7 U.S.C. 7b-3(f)(3) (same

requirement for SEFs).

\238\ See Registration of Foreign Boards of Trade, 75 FR 70973,

Nov. 19, 2010.

\239\ CFTC oversight in evaluating compliance with the

requirement that a swap not be readily susceptible to manipulation

for cash settled contracts includes consideration of whether cash

settlement is at a price reflecting the underlying cash market, will

not be subject to manipulation or distortion, and is based on a cash

price series that is reliable, acceptable, publicly available, and

timely. See 17 CFR Part 40, Appendix A--Guideline No. 1.

\240\ Such indexes also would be SBSAs, providing the SEC with

antifraud and anti-manipulation authority.

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The SEC believes that a third-party index provider that simply

provides general information about the construction of an index, index

rules, components, and predetermined adjustments is not a substitute

for the public availability of information about the issuers of the

securities or the securities in the index; nor does such a third-party

index provider indicate a likelihood that such public information is

available, which the SEC believes, for purposes of index CDS, is

important to market integrity and to investors in engaging in

transactions based on such indexes. If a third-party index provider

does not require, as a condition of inclusion in an index it compiles,

that information likely is publicly available regarding the component

issuers or securities in the index, the SEC does not believe investors

will have adequate information regarding such component issuers or

securities. In addition, the SEC notes that, absent specified standards

regarding what persons constitute a third-party index provider for

purposes of the proposed rules, any person that compiles an index at

the behest of another person could constitute a ``third-party index

provider.'' Moreover, the SEC does not believe that requiring an index

CDS to be offered on or subject to the rules of a DCM or SEF, or by an

FBOT, addresses whether public information likely is available about

the issuers of securities or securities in an index compiled by a

third-party index provider. As a result, the SEC does not believe that

an index compiled by a third-party index provider that makes publicly

available general information about the construction of the index,

index rules, components, and index adjustments, and that is referenced

by an index CDS that is offered for trading on or subject to the rules

of a DCM or SEF, or by direct access in the U.S. from a registered

FBOT, should substitute for the public information availability test

under the proposed rules for index CDS.

Accordingly, the Commissions seek comment as to whether the public

information availability test should apply to indexes compiled by a

third-party index provider that makes publicly available general

information about the construction of the index, index rules, identity

of components, and predetermined adjustments, and which index is

referenced by an index CDS that is offered on or subject to the rules

of a DCM or SEF, or by direct access in the U.S. from an FBOT that is

registered with the CFTC.

(iii) Treatment of Indexes Including Reference Entities That Are

Issuers of Exempted Securities or Including Exempted Securities

In addition, the proposed rules provide for alternative treatment

of indexes that include exempted securities or reference entities that

are issuers of exempted securities.\241\ The Commissions believe such

treatment is consistent with the objective and intent of the definition

of the term ``security-based swap,'' as well as the approach taken in

the context of security futures.\242\ Accordingly, paragraph (1)(ii) of

proposed rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraph

(a)(2) of proposed rules 3a68-1a and 3a68-1b under the Exchange Act

would provide that, in the case of an index that includes exempted

securities, or reference entities that are issuers of exempted

securities, in each case as defined as of the date of enactment of the

Futures Trading Act of 1982 (other than municipal securities), such

securities or reference entities are excluded from the index when

determining whether the securities or reference entities in the index

constitute a ``narrow-based security index'' or ``issuers of securities

in a narrow-based security index'' under the proposed rules.

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\241\ See proposed rules 1.3(zzz)(1)(i) and 1.3(aaaa)(1)(i)

under the CEA and proposed rules 3a68-1a(a)(2) and 3a68-1b(a)(2)

under the Exchange Act; July 2006 Rules, supra note 199.

\242\ See section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.

78c(a)(68)(C) (providing that ``[t]he term `security-based swap'

does not include any agreement, contract, or transaction that meets

the definition of a security-based swap only because such agreement,

contract, or transaction references, is based upon, or settles

through the transfer, delivery, or receipt of an exempted security

under paragraph (12) [of the Exchange Act], as in effect on the date

of enactment of the Futures Trading Act of 1982 (other than any

municipal security as defined in paragraph (29) [of the Exchange

Act] as in effect on the date of enactment of the Futures Trading

Act of 1982), unless such agreement, contract, or transaction is of

the character of, or is commonly known in the trade as, a put, call,

or other option'').

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Under paragraph (1)(ii) of proposed rules 1.3(zzz) and 1.3(aaaa)

under the CEA and paragraph (a)(2) of proposed rules 3a68-1a and 3a68-

1b under the Exchange Act, an index composed solely of securities that

are, or reference entities that are issuers of, exempted securities

(other than municipal securities) would not be a ``narrow-based

security index'' or an index composed of ``issuers of securities in a

narrow-based security index.'' In the case of an index where some, but

not all, of the securities or reference entities are exempted

securities (other than municipal securities) or issuers of exempted

securities (other than municipal securities), the index would be a

``narrow-based security index'' or an index composed of ``issuers of

securities in a narrow-based security index'' only if the index is

narrow-based when the securities that are, or reference entities that

are issuers of, exempted securities (other than municipal securities)

are

[[Page 29853]]

disregarded. The Commissions believe this approach would result in

consistent treatment for indexes regardless of whether they include

securities that are, or issuers of securities that are, exempted

securities (other than municipal securities) while ensuring that

exempted securities (other than municipal securities) and issuers of

exempted securities (other than municipal securities) are not included

in an index merely to make the index either broad-based or narrow-based

under the proposed rules.

Request for Comment

The Commissions request comment on all aspects of proposed rules

1.3(zzz) and 1.3(aaaa) under the CEA and proposed rules 3a68-1a and

3a68-1b under the Exchange Act, as applied to CDS, including the

following:

85. Do the proposed criteria for identifying when an index of

reference entities constitutes ``issuers of securities in a narrow-

based security index'' and when an index of securities constitutes a

``narrow-based security index'' effectively encompass the key elements

of a narrow-based security index as it pertains to paragraph

(A)(ii)(III) (i.e., the third prong) and paragraph (A)(ii)(I) (i.e.,

the first prong) of the security-based swap definition? Why or why not?

86. Should an index with 9 or fewer non-affiliated issuers of

securities or 9 or fewer securities be ``narrow-based?'' Why or why

not?

87. Should an index in which the effective notional amounts

allocated to any reference entity or security included in the index

comprise more than 30 percent of the index's weighting be ``narrow-

based''? Why or why not?

88. Should an index in which the effective notional amounts

allocated to any 5 non-affiliated reference entities or securities

included in the index comprise more than 60 percent of the index's

weighting be ``narrow-based''? Why or why not?

89. Should an index in which publicly available information is not

available for a predominant percentage of reference entities or

securities included in the index be ``narrow-based'' for purposes of

index CDS? Why or why not? The Commissions note that the criteria for

the public information availability test do not necessarily ensure that

there is in fact public information available regarding the relevant

entities or securities, or that the criteria act in any way as a

substitute for the actual availability of public information; instead,

the criteria, taken as a whole, are intended to capture, for purposes

of the definition of the term ``narrow-based security index'' for index

CDS, those entities or securities, that on average, are likely to have

public information available, and that the relevant index would

therefore not be treated as ``narrow-based.'' Do the proposed criteria

appropriately achieve this objective? Are the criteria for the public

information availability test under the proposed rules appropriate to

result in a sufficient likelihood that public information about the

component securities or issuers of securities in an index CDS would be

available to properly address the regulatory interests of the Federal

securities laws? Are the $700 million and $1 billion thresholds

discussed above appropriate tests for the likelihood of publicly

available information in this context? These thresholds are similar to

those in the SEC securities offering reform rules used to determine, in

part, whether a particular issuer was a ``well-known seasoned issuer,''

in order to streamline registration requirements under the Securities

Act.\243\ Are there companies that have less than $700 million in

worldwide equity capitalization, or less than $1 billion in outstanding

debt (other than asset-backed securities), and that do not otherwise

satisfy the public information availability test, that have public

information available about them for purposes of determining whether an

index CDS that includes such a company as a reference entity or such a

security is broad or narrow-based? The Commissions request comment on

the appropriate thresholds for determining whether there likely is

public information available for purposes of the proposed definition of

narrow-based security index and issuers of securities in a narrow-based

security index for purposes of index CDS, in particular whether these

thresholds should be modified higher or lower, and request empirical

data to support the response.

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\243\ See supra note 231.

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90. Is it appropriate to treat an issuer eligible to rely on rule

12g3-2(b) under the Exchange Act as meeting the public information

availability test under the proposed rules? Why or why not? Would such

a provision include issuers that otherwise would not satisfy the

information condition in the proposed rules? Why or why not? Please

provide a detailed explanation and include empirical data to support

any suggested modification.

91. With respect to asset-backed securities, is the proposed

criterion for meeting the public information availability test, that

the asset-backed securities were issued in a transaction registered

under the Securities Act and have publicly available distribution

reports, the correct approach? Why or why not? Should such a provision

explicitly also apply to include asset-backed securities issued by

Fannie Mae and Freddie Mac? Why or why not? Please provide a detailed

explanation of whether and why such a condition is necessary and

include empirical data to support any suggested modification.

92. Should the proposed rules exclude a reference entity or

security in the index from the public information availability test, so

long as the reference entity or security included in the index

represents less than five percent of the index's weighting? Why or why

not?

93. Should the proposed rules exclude a reference entity or

security in the index from the public information availability test, so

long as the reference entities or securities comprising at least 80

percent of the index's weighting satisfy the provisions of those

paragraphs? Why or why not?

94. The Commissions are considering whether the public information

availability test in proposed rules 1.3(zzz) and 1.3(aaaa) under the

CEA and proposed rules 3a68-1a and 3a68-1b under the Exchange Act

should apply to an index of issuers of securities or securities that is

created and published by a third-party index provider that is not a

party to an index CDS and makes publicly available general information

about the construction of the index, index rules, components, and

predetermined adjustments, and which index is referenced by an index

CDS that is offered on or subject to the rules of a DCM or SEF, or by

direct access in the U.S. from an FBOT that is registered with the

CFTC. How are indexes created by such a third-party index provider and

what type of compensation do they receive? What role do parties to a

swap or security-based swap play in determining the constituents or

index criteria? What type of information does a third-party index

provider ensure is publicly available on an ongoing basis about each of

the constituent issuers of securities or securities identified in the

index and what actions does the third-party index provider take to

ensure the accuracy of information about the issuers of securities or

securities in any index compiled by such third-party index provider?

How would a third-party index provider take steps to ensure that the

indexes it creates are composed of issuers of securities or securities

for which there likely is public information available? Please provide

detailed examples.

95. If the Commissions determine to use, as an alternative to the

public

[[Page 29854]]

information availability test in the proposed rules relating to index

CDS, the existence of a third-party index provider that is not a party

to an index CDS and makes publicly available general information about

the construction of the index, index rules, components, and

predetermined adjustments, and which index is referenced by an index

CDS that is offered on or subject to the rules of a DCM or SEF, or by

direct access in the U.S. from an FBOT that is registered with the

CFTC, what requirements, if any, should the Commissions impose on the

DCM, SEF, or FBOT to ensure that public information likely will be

available in this context regarding the issuers of securities or

securities in the index? What specified standards, if any, should the

Commissions require the DCM, SEF, or FBOT to meet for purposes of the

proposed rules?

96. Should index CDS based on an index compiled by a third-party

index provider as described in this section be considered a ``mixed

swap'' rather than a swap in order to ensure that the protections of

the Federal securities laws apply with respect to index constituents

about which public information about the constituent issuers of

securities or securities in the index (subject to the de minimis

provisions of the proposed rules) may not be available?

97. Are there other criteria that the Commissions should adopt as

alternative means of satisfying the public information availability

test in the proposed rules? If so, please explain what they are and

what requirements the Commissions should impose to ensure the public

availability of information regarding issuers of securities or

securities in index CDS.

98. Should the proposed rules provide, solely with respect to CDS

that may be entered into only between eligible contract participants,

that the information availability test could be satisfied if the

reference entity or the issuer of the security (i) except in the case

of issuing entities of asset-backed securities, provides information to

the public or to such eligible contract participant pursuant to rule

144A(d)(4) of the Securities Act; (ii) except in the case of issuing

entities of asset-backed securities, financial information is otherwise

publicly available about the reference entity or the issuer of the

security; or (iii) in the case of asset-backed securities and issuing

entities of asset-backed securities, financial information of the type

and level included in public distribution reports for similar asset-

backed securities about both the issuing entity and such asset-backed

securities is publicly available? Why or why not? Please provide a

detailed explanation and empirical data, to the extent feasible.

99. Should the proposed rules include additional or other criteria

to determine whether an index is ``narrow-based'' with respect to index

CDS? If so, what criteria should be included, and why?

100. Does the proposed treatment of index CDS whereby a payment is

contemplated based on the default of a particular entity in the index

rather than solely on the value of the index adequately address the

Federal regulatory interests under the Federal securities laws and the

Commodity Exchange Act?

101. Does the definition of ``control'' for purposes of identifying

whether a reference entity or issuer is affiliated with another entity

(ownership of 20 percent or more of an entity's or issuer's equity, or

the ability to direct the voting of 20 percent or more of the entity's

or issuer's voting equity) appropriately identify when affiliates are

in a control relationship for these purposes? Why or why not? Should

these thresholds be higher or lower? Please provide supporting data

and/or analysis. Should issuing entities of asset-backed securities be

considered separate reference entities or issuers for purposes of the

proposed criteria? If not, why not? Are there circumstances under which

issuing entities of asset-backed securities should not be considered

separate reference entities or issuers for purposes of the proposed

criteria? Why or why not?

102. Are there other categories or types of CDS that proposed rules

1.3(zzz) and (aaaa) and proposed rules 3a68-1a and 3a68-1b do not

address or that require additional clarification regarding their

treatment under the Dodd-Frank Act? If so, please provide a detailed

description of any such categories or types of CDS, as well as any

analysis, supported by empirical data to the extent feasible, of what

clarification is necessary.

103. Are there other categories of event-type contracts relating to

issuers of securities that require additional clarification regarding

their treatment under the Dodd-Frank Act? If so, please provide a

detailed explanation of the types of contracts and why the proposed

rules should apply to such other event-type contracts.

4. Security Indexes

The Dodd-Frank Act defines the term ``index'' as ``an index or

group of securities, including any interest therein or based on the

value thereof.'' \244\ The Commissions are proposing guidance as to how

to determine when a portfolio of securities is a narrow-based or broad-

based security index and the circumstances in which changes to the

composition of a security index (including a portfolio of securities)

\245\ underlying a Title VII instrument would affect the

characterization of such Title VII instrument.\246\

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\244\ See section 3(a)(68)(E) of the Exchange Act, 15 U.S.C.

78c(a)(68)(E).

\245\ A ``portfolio'' of securities could be a group of

securities and therefore an ``index'' for purposes of the Dodd-Frank

Act. To the extent that changes are made to the securities

underlying the Title VII instrument and each such change is

individually confirmed, then those substituted securities would not

be part of a security index as defined in the Dodd-Frank Act, and

therefore a Title VII instrument on each of those substituted

securities would be a security-based swap.

\246\ Solely for purposes of the discussion in this section, the

terms ``security index'' and ``security portfolio'' are intended to

include either securities or the issuers of securities.

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In most cases, a security index is designed to reflect the

performance of a market or sector by reference to representative

securities or interests in securities. There are a number of well-known

security indexes established and maintained by recognized index

providers currently in the market.\247\ The Commissions understand,

however, that instead of using these established indexes, market

participants may enter into a Title VII instrument where the underlying

reference of the Title VII instrument is a portfolio of securities

selected by the counterparties or created by a third-party index

provider at the behest of one or both counterparties. In some cases,

the Title VII instrument may give one or both of the counterparties,

either directly or indirectly (e.g., through an investment adviser or

through the third-party index provider), discretionary authority to

change the composition of the security portfolio, including, for

example, by adding or removing securities in the security portfolio on

an ``at-will'' basis during the term of the Title VII instrument.\248\

The Commissions believe that where the counterparties, either directly

or indirectly (e.g., through an investment adviser or through the

third-party index provider), have this discretionary authority to

change the

[[Page 29855]]

composition or weighting of securities in a security portfolio, that

security portfolio should be treated as a narrow-based security index,

and that therefore a Title VII instrument on that security portfolio

would be a security-based swap.\249\

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\247\ For instance, the S&P 500[reg] is an index that gauges the

large cap U.S. equities market.

\248\ Alternatively, counterparties may enter into Title VII

instruments where a third-party investment manager selects an

initial portfolio of securities and has discretionary authority to

change the composition of the security portfolio in accordance with

guidelines agreed upon with the counterparties. Such security

portfolios would be treated as narrow-based security indexes with

Title VII instruments on those security portfolios being security-

based swaps.

\249\ The Commissions understand that a security portfolio could

be labeled as such or could just be an aggregate of individual Title

VII instruments documented, for example, under a master agreement or

by amending an annex of securities attached to a master trade

confirmation. If the security portfolio were created by aggregating

individual Title VII instruments, each Title VII instrument would

need to be evaluated in accordance with the proposed guidance to

determine whether it is a swap or a security-based swap. For the

avoidance of doubt, if the counterparties to a Title VII instrument

exchanged payments under that Title VII instrument based on a

security index that was itself created by aggregating individual

security-based swaps, such Title VII instrument would be a security-

based swap. See discussion supra part III.D.

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The Commissions believe, however, that not all changes that occur

to the composition or weighting of a security index underlying a Title

VII instrument will always result in that security index being treated

as a narrow-based security index. Many security indexes are constructed

and maintained by an index provider pursuant to a published

methodology.\250\ For instance, the various Standard & Poor's security

indexes are reconstituted and rebalanced as needed and on a periodic

basis pursuant to published index criteria.\251\

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\250\ See, e.g., NASDAQ, ``NASDAQ-100 Index'' (``The NASDAQ-100

Index is calculated under a modified capitalization-weighted

methodology. The methodology is expected to retain in general the

economic attributes of capitalization-weighting while providing

enhanced diversification. To accomplish this, NASDAQ will review the

composition of the NASDAQ-100 Index on a quarterly basis and adjust

the weightings of Index components using a proprietary algorithm, if

certain pre-established weight distribution requirements are not

met.''), available at http://dynamic.nasdaq.com/dynamic/nasdaq100_activity.stm

\251\ Information regarding security indexes and their related

methodologies may be widely available to the general public or

restricted to licensees in the case of proprietary or ``private

label'' security indexes. Both public and private label security

indexes are frequently subject to intellectual property protection.

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In addition, counterparties to a Title VII instrument frequently

agree to use as the underlying reference of a Title VII instrument a

security index based on predetermined criteria where the security index

composition or weighting may change as a result of the occurrence of

certain events specified in the Title VII instrument at execution, such

as ``succession events.'' Counterparties to a Title VII instrument also

may use a predetermined self-executing formula to make other changes to

the composition or weighting of a security index underlying a Title VII

instrument. In either of these situations, the composition of a

security index may change pursuant to predetermined criteria or

predetermined self-executing formulas without the Title VII instrument

counterparties, their agents, or third-party index providers having any

direct or indirect discretionary authority to change the security

index.

In general, and by contrast to Title VII instruments in which the

counterparties, either directly or indirectly (e.g., through an

investment adviser or through the third-party index provider), have the

discretion to change the composition or weighting of the referenced

security index, where there is an underlying security index for which

there are predetermined criteria or a predetermined self-executing

formula for adjusting the security index that are not subject to change

or modification through the life of the Title VII instrument and that

are set forth in the Title VII instrument at execution (regardless of

who establishes the criteria or formula), a Title VII instrument on

such underlying security index would be on a broad-based or narrow-

based security index, depending on the composition and weighting of the

underlying security index. Subject to the interpretation discussed

below regarding security indexes that may shift from being a narrow-

based security index or broad-based security index during the life of

an existing Title VII instrument,\252\ the characterization of a Title

VII instrument based on a security index as either a swap or a

security-based swap would depend on the characterization of the

security index using the above interpretation.\253\

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\252\ As discussed further below, the Commissions are concerned

about the potential use of security indexes to game the narrow-based

security index definition.

\253\ See supra note 249 regarding the aggregation of separate

trades.

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Request for Comment

104. The Commissions request comment on whether there are

additional or other criteria that would be appropriate in determining

whether a security index or security portfolio would constitute a

narrow-based security index for purposes of the definitions of the

terms ``swap'' and ``security-based swap.'' Please discuss any criteria

in detail and provide any supporting data where relevant.

105. What are the ways in which Title VII instruments involving

security portfolios are structured, including changes in security

portfolio composition?

106. Should ``discretionary authority to change'' by the

counterparties, either directly or indirectly (e.g., through an

investment adviser or through the third-party index provider), be a

determinative factor for whether a security portfolio should be treated

as a narrow-based security index? Why or why not? Are there Title VII

instruments where the underlying reference is a security portfolio

where counterparties may directly or indirectly (e.g., through an

investment manager or the third-party provider) exercise discretionary

authority to change the composition of the security portfolio that

should not be considered security-based swaps? Why or why not? Please

provide a detailed explanation of such Title VII instruments, the means

by which, and why, the composition of the underlying security portfolio

are established and subsequently changed, and for what purpose such

Title VII instruments are used.

107. Should a security index, where changes to the composition are

not subject to discretionary authority but instead may be made pursuant

to predetermined criteria or a predetermined self-executing formula set

forth in the Title VII instrument at execution, be considered either a

broad-based security index or a narrow-based security index, depending

on its constitution? Why or why not? Are changes pursuant to such

predetermined criteria or formulas common? How frequently do such

changes occur? What sorts of events trigger such changes? Please

provide a detailed explanation and empirical data, to the extent

feasible.

108. Are the terms ``predetermined criteria'' and ``predetermined

self-executing formula'' clear? Why or why not? If not, what

alternative or additional guidance should be provided to clarify under

what circumstances changes to the composition of a security index

underlying a Title VII instrument may be made without being considered

``at will'' or discretionary changes by the counterparties, either

directly or indirectly (e.g., through an investment adviser or through

the third-party index provider), that would result in the security

index being treated as a narrow-based security index and the Title VII

instrument being a security-based swap? Are there specific additional

criteria, restrictions, or parameters that should be considered? If so,

please provide a detailed explanation regarding such criteria,

restrictions, or parameters, including the types of changes that should

or should not be permitted.

109. Are there specific methodologies or criteria, agreed to at or

prior to the

[[Page 29856]]

execution of a Title VII instrument, for changing the composition of an

underlying security index, that should be explicitly addressed by the

Commissions in providing the proposed guidance regarding security

indexes? If so, please provide a detailed explanation of those

methodologies or criteria and what additional guidance is necessary.

110. Would restrictions on the frequency of changes to the

composition of a security index underlying a Title VII instrument be

useful in determining whether the underlying security index should be

treated as a narrow-based security index? If so, please provide a

detailed explanation of what restrictions should apply and why, as well

as empirical data to the extent feasible.

5. Evaluation of Title VII Instruments on Security Indexes That Move

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

(a) In General

As discussed above, the determination of whether a Title VII

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

swap), is made at the execution of the Title VII instrument.\254\ If

the security index underlying a Title VII instrument migrates from

being broad-based to being narrow-based, or vice versa, during the life

of a Title VII instrument, the characterization of that Title VII

instrument would not change from its initial characterization

regardless of whether the Title VII instrument was entered into

bilaterally or was executed through a trade on or subject to the rules

of a DCM, SEF, FBOT, security-based SEF, or NSE. For example, if two

counterparties enter into a swap based on a broad-based security index,

and three months into the life of the swap the security index

underlying that Title VII instrument migrates from being broad-based to

being narrow-based, the Title VII instrument would remain a swap for

the duration of its life and would not be recharacterized as a

security-based swap.

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\254\ See discussion supra part III.A.

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If the material terms of a Title VII instrument are amended or

modified during its life, the Commissions would view the amended or

modified Title VII instrument as a new Title VII instrument.\255\ As a

result, the characteristics of the underlying security index must be

reassessed at the time of such an amendment or modification to

determine whether the security index has migrated from broad-based to

narrow-based or vice versa. If the security index has migrated, then

the characterization of the amended or modified Title VII instrument

would be determined by evaluating the characterization of the

underlying security index at the time the Title VII instrument is

amended or modified. Similarly, if a security index has migrated from

broad-based to narrow-based or vice versa, any new Title VII instrument

based on that security index would be characterized pursuant to an

evaluation of the underlying security index at the execution of that

new Title VII instrument.

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\255\ For example, if, on its effective date, a Title VII

instrument tracks the performance of an index of 12 securities but

is amended during its term to track the performance of only 8 of

those 12 securities, the Commissions would view the amended or

modified Title VII instrument as a new Title VII instrument.

Conversely, if, on its effective date, a Title VII instrument tracks

the performance of an index of 12 securities but is amended during

its term to reflect the replacement of a departing ``key person'' of

a hedge fund that is a counterparty to the Title VII instrument with

a new ``key person,'' the Commissions would not view the amended or

modified Title VII instrument as a new Title VII instrument because

the amendment or modification is not to a material term of the Title

VII instrument. Because it would be a new Title VII instrument, any

regulatory requirements regarding new Title VII instruments would

apply.

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The Commissions are proposing guidance regarding circumstances in

which the character of a security index on which a Title VII instrument

is based changes according to predetermined criteria or a predetermined

self-executing formula set forth in the Title VII instrument (or in a

related or other agreement entered into by the counterparties or a

third-party index provider to the Title VII instrument) at execution.

Where at the time of execution such criteria or such formula would

cause the underlying broad-based security index to become or assume the

characteristics of a narrow-based security index or vice versa during

the duration of the instrument,\256\ then the characterization of the

Title VII instrument based on such security index would be a mixed swap

during the entire life of the Title VII instrument.\257\ Although at

certain points during the life of the Title VII instrument the

underlying security index would be broad-based and at other points the

underlying security index would be narrow-based, the Commissions

believe that regulating such a Title VII instrument as a mixed swap

from the execution of the Title VII instrument and throughout its life

reflects the appropriate characterization of a Title VII instrument

based on a security index that migrates pursuant to predetermined

criteria or a predetermined self-executing formula.

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\256\ Thus, for example, if a predetermined self-executing

formula agreed to by the counterparties of a Title VII instrument at

or prior to the execution of the Title VII instrument provided that

the security index underlying the Title VII instrument would

decrease from 20 to 5 securities after six months, such that the

security index would become narrow-based as a result of the reduced

number of securities, then the Title VII instrument would be a mixed

swap at its execution. The characterization of the Title VII

instrument as a mixed swap would not change during the life of the

Title VII instrument.

\257\ As discussed above in part III.G.4, to the extent a Title

VII instrument permits ``at will'' substitution of an underlying

security index, however, as opposed to the use of predetermined

criteria or a predetermined self-executing formula, the Title VII

instrument would be a security-based swap at its execution and

throughout its life regardless of whether the underlying security

index was narrow-based at the execution of the Title VII instrument.

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The Commissions believe that this guidance regarding the use of

predetermined criteria or a predetermined self-executing formula would

prevent potential gaming of the Commissions' guidance regarding

security indexes and prevent potential regulatory arbitrage based on

the migration of a security index from broad-based to narrow-based or

vice versa. In particular, the Commissions note that predetermined

criteria and predetermined self-executing formulas can be constructed

in ways that take into account the characteristics of a narrow-based

security index and prevent a narrow-based security index from becoming

broad-based and vice versa.

(b) Title VII Instruments on Security Indexes Traded on Designated

Contract Markets, Swap Execution Facilities, Foreign Boards of Trade,

Security-Based Swap Execution Facilities, and National Securities

Exchanges

The Commissions recognize that security indexes underlying Title

VII instruments that are traded on DCMs, SEFs, FBOTs, security-based

SEFs, or NSEs raise particular issues if an underlying security index

migrates from broad-based to narrow-based or vice versa. The

characterization of an exchange-traded Title VII instrument at its

execution, as explained above, would not change through the life of the

Title VII instrument, regardless of whether the underlying security

index migrates from broad-based to narrow-based or vice versa.

Accordingly, a market participant who enters into a swap on a broad-

based security index traded on or subject to the rules of a DCM, SEF or

FBOT that migrates from broad-based to narrow-based may hold that

position until the swap's expiration without any change in regulatory

responsibilities, requirements, or obligations, and

[[Page 29857]]

similarly a market participant who enters into a security-based swap on

a narrow-based security index traded on a security-based SEF or NSE may

hold that position until the security-based swap's expiration without

any change in regulatory responsibilities, requirements, or

obligations.

However, in the absence of any action by the Commissions, if the

market participant wants to offset the swap or enter into a new swap on

the DCM, SEF or FBOT where the underlying security index has migrated

from broad-based to narrow-based, or to offset the security-based swap

or enter into a new security-based swap on a security-based SEF or NSE

where the underlying security index has migrated from narrow-based to

broad-based, the participant would be prohibited from doing so. That is

because swaps may trade only on DCMs, SEFs, and FBOTs, and security-

based swaps may trade only on registered NSEs and security-based

SEFs.\258\ The Commissions believe it is important to address how to

treat Title VII instruments traded on trading platforms where the

underlying security index migrates from broad-based to narrow-based or

narrow-based to broad-based so that market participants will know where

such Title VII instruments may be traded and can avoid potential

disruption of their ability to offset or enter into new Title VII

instruments on trading platforms when such migration occurs. The

Commissions are proposing rules accordingly.\259\

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\258\ If a swap were based on a security index that migrated

from broad-based to narrow-based, a DCM, SEF, or FBOT could no

longer offer the Title VII instrument because it would be a

security-based swap. Similarly, if a security-based swap were based

on a security index that migrated from narrow-based to broad-based,

a security-based SEF or NSE could no longer offer the Title VII

instrument because it would be a swap.

\259\ The proposed rules apply only to the particular Title VII

instrument that is traded on or subject to the rules of a DCM, SEF,

FBOT, security-based SEF, or NSE. To the extent that a particular

Title VII instrument is not traded on such a trading platform (even

if another Title VII instrument of the same class or type is traded

on such a trading platform) the proposed rules would not apply to

that particular Title VII instrument.

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Congress and the Commissions addressed a similar issue in the

context of security futures, where the security index on which a future

is based may migrate from broad-based to narrow-based or vice versa.

Congress provided in the definition of ``narrow-based security index''

in both the CEA and the Exchange Act \260\ for a tolerance period

ensuring that, under certain conditions, a futures contract on a broad-

based security index traded on a DCM may continue to trade, even when

the index temporarily assumes characteristics that would render it a

narrow-based security index under the statutory definition.\261\ In

general, an index is subject to this tolerance period, and therefore is

not a narrow-based security index, if: (i) a futures contract on the

index traded on a DCM for at least 30 days as a futures contract on a

broad-based security index before the index assumed the characteristics

of a narrow-based security index and (ii) the index does not retain the

characteristics of a narrow-based security index for more than 45

business days over 3 consecutive calendar months. Pursuant to these

statutory provisions, if the index becomes narrow-based for more than

45 business days over 3 consecutive calendar months, the index is

excluded from the definition of the term ``narrow-based security

index'' for the following 3 calendar months as a grace period.

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\260\ CEA section 1a(35)(B)(iii), 7 U.S.C. 1a(35)(B)(iii);

section 3(a)(55)(C)(iii) of the Exchange Act, 15 U.S.C.

78c(a)(55)(C)(iii).

\261\ By joint rules, the Commissions have provided that

``[w]hen a contract of sale for future delivery on a security index

is traded on or subject to the rules of a foreign board of trade,

such index shall not be a narrow-based security index if it would

not be a narrow-based security index if a futures contract on such

index were traded on a designated contract market * * * .'' See CFTC

rule 41.13, 17 CFR 41.13, and rule 3a55-3 under the Exchange Act, 17

CFR 240.3a55-3. Accordingly, the statutory tolerance period rules

applicable to futures on security indexes traded on DCMs apply to

futures traded on FBOTs as well.

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The Commissions believe a similar tolerance period should apply to

swaps traded on DCMs, SEFs, and FBOTs and security-based swaps traded

on security-based SEFs and NSEs. Accordingly, the Commissions are

proposing rules providing for tolerance periods for swaps that are

traded on DCMs, SEFs, or FBOTs and for security-based swaps traded on

security-based SEFs and NSEs.

Under paragraph (2)(i)(A) of proposed rule 1.3(yyy) under the CEA

and paragraph (b)(1)(i) of proposed rule 3a68-3 under the Exchange Act,

to be subject to the tolerance period, a security index underlying a

swap executed on or subject to the rules of a DCM, SEF, or FBOT must

not have been a narrow-based security index \262\ during the first 30

days of trading.\263\ If the index becomes narrow-based during the

first 30 days of trading, paragraph (2)(i)(B) of proposed rule 1.3(yyy)

under the CEA and paragraph (b)(1)(ii) of proposed rule 3a68-3 under

the Exchange Act provide that the index must not have been a narrow-

based security index during every trading day of the 6 full calendar

months preceding a date no earlier than 30 days prior to the

commencement of trading of a swap on such index.\264\ If either of

these alternatives are met, paragraph (2)(ii) of proposed rule 1.3(yyy)

under the CEA and paragraph (b)(2) of proposed rule 3a68-3 under the

Exchange Act provide that the index will not be a narrow-based security

index if it has been a narrow-based security index for no more than 45

business days over 3 consecutive calendar months. Paragraph (2) of

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

3a68-3 under the Exchange Act apply solely for purposes of swaps traded

on or subject to the rules of a DCM, SEF, or FBOT.

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\262\ For purposes of the proposed rules, the term ``narrow-

based security index'' shall also mean ``issuers of securities in a

narrow-based security index.'' See supra part III.G.3(b) (discussing

the proposed rules defining ``issuers of securities in a narrow-

based security index'').

\263\ This provision is consistent with the provisions of the

CEA and the Exchange Act applicable to futures contracts on security

indexes. CEA section 1a(35)(B)(iii)(I), 7 U.S.C. 1a(35)(B)(iii)(I);

section 3(a)(55)(C)(iii)(I) of the Exchange Act, 15 U.S.C.

78c(a)(55)(C)(iii)(I).

\264\ This alternative test is the same as the alternative test

applicable to futures contracts in CEA rule 41.12, 17 CFR 41.12 and

rule 3a55-2 under the Exchange Act, 17 CFR 240.3a55-2.

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Similarly, paragraph (3) of proposed rule 1.3(yyy) under the CEA

and paragraph (c) of proposed rule 3a68-3 under the Exchange Act

provide a tolerance period for security-based swaps traded on security-

based SEFs or NSEs. Under paragraph (3)(i)(A) of proposed rule 1.3(yyy)

under the CEA and paragraph (c)(1)(i) of proposed rule 3a68-3 under the

Exchange Act, to be subject to the tolerance period, a security index

underlying a security-based swap executed on a security-based SEF or

NSE must have been a narrow-based security index during the first 30

days of trading. If the index becomes broad-based during the first 30

days of trading, paragraph (3)(i)(B) of proposed rule 1.3(yyy) under

the CEA and paragraph (c)(1)(ii) of proposed rule 3a68-3 under the

Exchange Act provide that the index must have been a non-narrow-based

security index during every trading day of the 6 full calendar months

preceding a date no earlier than 30 days prior to the commencement of

trading of a security-based swap on such index. If either of these

alternatives are met, paragraph (3)(ii) of proposed rule 1.3(yyy) under

the CEA and paragraph (c)(2) of proposed rule 3a68-3 under the Exchange

Act provide that the index will be a narrow-based security index if it

has been a security index that is not narrow-based for no more than 45

business days over 3 consecutive

[[Page 29858]]

calendar months.\265\ Paragraph (3) of proposed rule 1.3(yyy) under the

CEA and paragraph (c) of proposed rule 3a68-3 under the Exchange Act

apply solely for purposes of security-based swaps traded on security-

based SEFs or NSEs.

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\265\ These provisions are consistent with the parallel

provisions in the CEA and the Exchange Act applicable to futures

contracts on security indexes traded on DCMs. CEA section

1a(35)(B)(iii)(II), 7 U.S.C. 1a(35)(B)(iii)(II); section

3(a)(55)(C)(iii)(II) of the Exchange Act, 15 U.S.C.

78c(a)(55)(C)(iii)(II).

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The Commissions are proposing that, once the tolerance period under

the proposed rules has ended, there would be a grace period during

which a Title VII instrument based on a security index that has

migrated from broad-based to narrow-based or vice versa would be able

to trade on the platform on which Title VII instruments based on such

security index were trading before the security index migrated and can

also, during such period, be cleared. Paragraph (4)(i) of proposed rule

1.3(yyy) under the CEA and paragraph (d)(1) of proposed rule3a68-3

under the Exchange Act would provide for an additional 3-month grace

period applicable to a security index that becomes narrow-based for

more than 45 business days over 3 consecutive calendar months, solely

with respect to swaps that are traded on or subject to the rules of

DCMs, SEFs, or FBOTs. During the grace period, such an index would not

be considered a narrow-based security index. Paragraph (4)(ii) of

proposed rule 1.3(yyy) under the CEA and paragraph (d)(2) of proposed

rule3a68-3 under the Exchange Act would apply the same grace period to

a security-based swap on a security index that becomes broad-based for

more than 45 business days over 3 consecutive calendar months, solely

with respect to security-based swaps that are traded on a security-

based SEF or NSE. During the grace period, such an index would not be

considered a broad-based security index.\266\ As a result, this

proposed rule would provide sufficient time for the migrated Title VII

instrument to satisfy listing and clearing requirements applicable to

swaps or security-based swaps, as appropriate.

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\266\ These provisions are consistent with the parallel

provisions in the CEA and the Exchange Act applicable to futures

contracts on security indexes traded on DCMs. See CEA section

1a(35)(D), 7 U.S.C. 1a(35)(D); section 3(a)(55)(E) of the Exchange

Act, 15 U.S.C. 78c(a)(55)(E).

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There would be no overlap between the tolerance and the grace

periods under the proposed rules and no ``re-triggering'' of the

tolerance period. For example, if a security index becomes narrow-based

for more than 45 business days over 3 consecutive calendar months,

solely with respect to swaps that are traded on or subject to the rules

of DCMs, SEFs, or FBOTs, but as a result of the proposed rules is not

considered a narrow-based security index during the grace period, the

tolerance period provisions would not apply, even if the security-index

migrated temporarily during the grace period. After the grace period

has ended, a security index would need to satisfy anew the requirements

under the proposed rules regarding the tolerance period in order to

trigger a new tolerance period.

The Commissions note that the proposed rules would not result in

the recharacterization of any outstanding Title VII instruments. In

addition, the proposed tolerance and grace periods would apply only to

Title VII instruments that are traded on or subject to the rules of

DCMs, SEFs, FBOTs, security-based SEFs, and NSEs.

Request for Comment

The Commissions request comment on all aspects of proposed rules

1.3(yyy) under the CEA and proposed rule 3a68-3 under the Exchange Act,

including the following:

111. The Commissions request comment regarding whether the term

``narrow-based security index'' as defined in the CEA and the Exchange

Act \267\ requires further definition solely in the context of Title

VII instruments.

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\267\ CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A) and

(B); section 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C.

78c(a)(55)(B) and (C).

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112. Are there particular types of Title VII instruments that

require additional guidance as to how the narrow-based security index

definition applies? If so, which types of Title VII instruments? How

should the definition apply to them? Please provide a detailed

explanation of such Title VII instruments and the additional guidance

that would be appropriate.

113. Does the proposed guidance effectively address security

indexes that migrate from broad-based to narrow-based and vice versa?

Why or why not? If not, what additional or alternative requirements

would be appropriate, and why?

114. Will the proposed limitations regarding the use of

predetermined criteria or predetermined self-executing formulas for

Title VII instruments effectively prevent gaming of the proposed rules

and potential regulatory arbitrage based on the migration of a security

index or security portfolio from broad-based to narrow-based or vice

versa? Why or why not? If not, please provide a detailed explanation of

why not, and what additional or alternative limitations would do so.

115. Should the standard pursuant to which a Title VII instrument

would be a mixed swap during the entire life of the Title VII

instrument require instead that the predetermined criteria or

predetermined self-executing formula be constructed in such a manner

that a broad-based security index or security portfolio would be

reasonably likely to become or assume the characteristics of a narrow-

based security index or security portfolio, or vice versa? Why or why

not? Are there additional or alternative standards that should be used

in determining when a Title VII instrument would be a mixed swap during

the entire life of the Title VII instrument? If so, please provide a

detailed explanation of such standards and why they would be effective.

116. Do the proposed tolerance period rules appropriately address

security indexes that temporarily change from broad-based to narrow-

based, and from narrow-based to broad-based, in the context of Title

VII instruments that are executed on or subject to the rules of a DCM,

SEF, FBOT, security-based SEF, or NSE? Why or why not? If not, how

should the proposed tolerance period rules be modified?

117. Should the ``grace period'' applicable to Title VII

instruments executed on or subject to the rules of a DCM, SEF, FBOT,

security-based SEF, or NSE regarding a security index that becomes

narrow-based or broad-based, respectively, for more than 45 business

days over 3 consecutive calendar months be modified? Why or why not? If

so, what modifications should be made?

118. What would be the impact of the proposed rules on market

participants with open swap or security-based swap positions if the

security index underlying a swap were to become narrow-based or if the

security index underlying a security-based swap were to become broad-

based? Should market participants be allowed to liquidate their swaps

or security-based swaps prior to expiration but after the grace period?

If so, how would the listing market restrict trading for liquidation

only?

H. Method of Settlement of Index CDS

The method that the parties have chosen or use to settle an index

CDS following the occurrence of a credit event under such index CDS

also can affect whether such index CDS would be a swap, a security-

based swap, or both (i.e., a mixed swap). The Commissions believe that

if an index CDS that is not based on a narrow-based

[[Page 29859]]

security index under the Commissions' proposed rules includes a

mandatory physical settlement provision that would require the delivery

of, and therefore the purchase and sale of, a non-exempted security

\268\ or a loan in the event of a credit event, such an index CDS would

be a mixed swap.\269\ Conversely, the Commissions believe that if an

index CDS that is not based on a narrow-based security index under the

Commissions' proposed rules includes a mandatory cash settlement \270\

provision, such index CDS would be a swap, and not a security-based

swap or a mixed swap, even if the cash settlement were based on the

value of a non-exempted security or a loan.

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\268\ The Commissions note that section 3(a)(68)(C) of the

Exchange Act, 15 U.S.C. 78c(a)(68)(C), provides that ``[t]he term

``security-based swap'' does not include any agreement, contract, or

transaction that meets the definition of a security-based swap only

because such agreement, contract, or transaction references, is

based upon, or settles through the transfer, delivery, or receipt of

an exempted security under paragraph (12) [of the Exchange Act], as

in effect on the date of enactment of the Futures Trading Act of

1982 (other than any municipal security as defined in paragraph (29)

[of the Exchange Act] as in effect on the date of enactment of the

Futures Trading Act of 1982), unless such agreement, contract, or

transaction is of the character of, or is commonly known in the

trade as, a put, call, or other option.''

\269\ The Commissions' views as to the legal basis for such a

conclusion differ. The SEC also notes that there must either be an

effective registration statement covering the transaction or an

exemption under the Securities Act would need to be available for

such physical delivery of securities and compliance issues under the

Exchange Act would also need to be considered.

\270\ The Commissions are aware that the 2003 Definitions supra

note 35, include ``Cash Settlement'' as a defined term and that such

``Settlement Method'' (also a defined term in the 2003 Definitions)

works differently than auction settlement pursuant to the ``Big Bang

Protocol'' or ``Auction Supplement'' (each as defined below). The

Commissions' use of the term ``cash settlement'' in this section

includes ``Cash Settlement,'' as defined in the 2003 Definitions,

and auction settlement, as described in the ``Big Bang Protocol'' or

``Auction Supplement.''

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The Commissions believe that an index CDS that is not based on a

narrow-based security index under the Commissions' proposed rules and

that provides for cash settlement in accordance with the 2009 ISDA

Credit Derivatives Determinations Committees and Auction Settlement

Supplement to the 2003 Definitions (the ``Auction Supplement'') or with

the 2009 ISDA Credit Derivatives Determinations Committees and Auction

Settlement CDS Protocol (``Big Bang Protocol'') \271\ would be a swap,

and would not be considered a security-based swap or a mixed swap

solely because the determination of the cash price to be paid is

established through a securities or loan auction.\272\ In 2009, auction

settlement, rather than physical settlement, became the default method

of settlement for, among other types of CDS, index CDS on corporate

issuers of securities.\273\ The amount of the cash settlement is

determined through an auction triggered by the occurrence of a credit

event.\274\ The Auction Supplement ``hard wired'' the mechanics of

credit event auctions into the 2003 Definitions.\275\ The Commissions

understand that the credit event auction process that is part of the

ISDA terms works as follows:

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\271\ See Int'l Swaps and Derivatives Ass'n, Inc., ``2009 ISDA

Credit Derivatives Determinations Committees and Auction Settlement

CDS Protocol,'' available at http://www.isda.org/bigbangprot/docs/Big-Bang-Protocol.pdf.

\272\ The possibility that such index CDS may, in fact, be

physically settled if an auction is not held or if the auction fails

would not affect the characterization of the index CDS.

\273\ The Commissions understand that the Big Bang Protocol is

followed for index CDS involving corporate debt obligations but is

not followed for index CDS based on asset-backed securities, loan-

only CDS, and certain other types of CDS contracts. To the extent

that such other index CDS contain auction procedures similar to the

auction procedures for corporate debt to establish the cash price to

be paid, the Commissions also would not consider such other index

CDS that are not based on narrow-based security indexes under the

Commissions' proposed rules to be mixed swaps.

\274\ The Commissions understand that other conditions may need

to be satisfied as well for an auction to be held.

\275\ See supra note 35.

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Following the occurrence of a credit event under a CDS, a

determinations committee (``DC'') established by ISDA, following a

request by any party to a credit derivatives transaction that is

subject to the Big Bang Protocol or Auction Supplement, will determine,

among other matters: (i) Whether and when a credit event occurred; (ii)

whether or not to hold an auction to enable market participants to

settle those of their credit derivatives transactions covered by the

auction; (iii) the list of deliverable obligations of the relevant

reference entity; and (iv) the necessary auction specific terms. The

credit event auction takes place in two parts. In the first part of the

auction, dealers submit physical settlement requests, which are

requests to buy or sell any of the deliverable obligations (based on

the dealer's needs and those of its counterparties), and an initial

market midpoint price is created based on dealers' initial bids and

offers. Following the establishment of the initial market midpoint, the

physical settlement requests are then calculated to determine the

amount of open interest.

The aggregate amount of open interest is the basis for the second

part of the auction. In the second part of the auction, dealers and

investors can determine whether to submit limit orders and the levels

of such limit orders. The limit orders, which are irrevocable, have a

firm price in addition to size and whether it is a buy or sell order.

The auction is conducted as a ``dutch'' auction, in which the open buy

interests and open sell interests are matched.\276\ The final price of

the auction is the last limit order used to match against the open

interest. The final price in the auction is the cash price used for

purposes of calculating the settlement payments in respect of the

orders to buy and sell the deliverable obligations and it is also used

to determine the cash settlement payment under the CDS.

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\276\ The second part of the credit event auction process

involves offers and sales of securities that must be made in

compliance with the provisions of the Securities Act and the

Exchange Act. First, the submission of a physical settlement request

constitutes an offer by the counterparty to either buy or sell any

one of the deliverable obligations in the auction. Second, the

submission of the irrevocable limit orders by dealers or investors

are sales or purchases by such persons at the time of submission of

the irrevocable limit order. Through the auction mechanism, where

the open interest (which represents physical settlement requests) is

matched with limit orders, buyers and sellers are matched. Finally,

following the auction and determination of the final price, the

counterparty who has submitted the physical delivery request decides

which of the deliverable obligations will be delivered to satisfy

the limit order in exchange for the final price. The sale of the

securities in the auction occurs at the time the limit order is

submitted, even though the identification of the specific

deliverable obligation does not occur until the auction is

completed.

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

Securities Act

Pursuant to the Dodd-Frank Act, a security-based swap is defined as

a ``security'' under the Exchange Act \277\ and Securities Act.\278\ As

a result, security-based swaps are subject to the Exchange Act and the

Securities Act and the rules and regulations promulgated

thereunder.\279\ To the

[[Page 29860]]

extent that security-based swaps differ from more traditional

securities products, however, the SEC is soliciting comment on whether

additional guidance may be necessary regarding the application of

certain provisions of the Exchange Act and the Securities Act, and the

rules and regulations promulgated thereunder, to security-based swaps.

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\277\ See section 761(a)(2) of the Dodd-Frank Act (inserting the

term ``security-based swap'' into the definition of ``security'' in

section 3a(10) of the Exchange Act, 15 U.S.C. 78c(a)(10)).

\278\ See section 768(a)(1) of the Dodd-Frank Act (inserting the

term ``security-based swap'' into the definition of ``security'' in

section 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1)).

\279\ Sections 761(a)(3) and (4) of the Dodd-Frank Act amend

sections 3(a)(13) and (14) of the Exchange Act, 15 U.S.C. 78c(a)(13)

and (14), and section 768(a)(3) of the Dodd-Frank Act adds section

2(a)(18) to the Securities Act, 15 U.S.C. 77b(a)(18), to provide

that the terms ``purchase'' and ``sale'' of a security-based swap

shall mean the ``the execution, termination (prior to its scheduled

maturity date), assignment, exchange, or similar transfer or

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

security-based swap, as the context may require.''

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Request for Comment

119. Are there Exchange Act or Securities Act provisions, or rules

and regulations promulgated thereunder, that contemplate application to

cash market securities products or other securities products for which

additional guidance may be necessary when applied to security-based

swaps? If so, which provisions, and why? Please provide detailed

analysis and empirical data, to the extent feasible.

120. What additional guidance or modifications would be necessary

to any such provisions in order to address the application of these

provisions to security-based swaps while still achieving the regulatory

purposes of those provisions?

IV. Mixed Swaps

A. Scope of the Category of Mixed Swap

The category of mixed swap is described, in both the definition of

the term ``security-based swap'' in the Exchange Act and the definition

of the term ``swap'' in the CEA, as a security-based swap that is also:

based on the value of 1 or more interest or other rates, currencies,

commodities, instruments of indebtedness, indices, quantitative

measures, other financial or economic interest or property of any kind

(other than a single security or a narrow-based security index), or the

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

or contingency associated with a potential financial, economic, or

commercial consequence (other than an event described in subparagraph

(A)(ii)(III) [of section 3(a)(68) of the Exchange Act]).\280\

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\280\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.

78c(a)(68)(D); CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D).

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A mixed swap, therefore, is both a security-based swap and a

swap.\281\

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\281\ Id. The exclusion from the definition of the term ``swap''

for security-based swaps does not include security-based swaps that

are mixed swaps. See CEA section 1a(47)(B)(x), 7 U.S.C.

1a(47)(B)(x).

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The Commissions believe that the scope of mixed swaps is, and is

intended to be, narrow. Title VII establishes robust and largely

parallel regulatory regimes for both swaps and security-based swaps and

directs the Commissions to jointly prescribe such regulations regarding

mixed swaps as may be necessary to carry out the purposes of the Dodd-

Frank Act.\282\ More generally, the Commissions believe the category of

mixed swap was designed so that there would be no gaps in the

regulation of swaps and security-based swaps. Therefore, in light of

the statutory scheme created by the Dodd-Frank Act for swaps and

security-based swaps, the Commissions believe the category of mixed

swap covers only a small subset of Title VII instruments.\283\

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\282\ See section 712(a)(8) of the Dodd-Frank Act.

\283\ See Morgan Stanley Letter (expressing the view that ``the

universe of mixed swaps should be relatively small''); Letter from

Timothy W. Cameron, Esq., Managing Director, Asset Management Group,

Securities Industry and Financial Markets Association (``SIFMA

Letter'') (suggesting that the scope of products included in the

mixed swap category should be limited to ``avoid unnecessary and

duplicative regulation'').

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For example, a Title VII instrument in which the underlying

references are the value of an oil corporation stock and the price of

oil would be a mixed swap. Similarly, a Title VII instrument in which

the underlying reference is a portfolio of both securities (assuming

the portfolio is not an index or, if it is an index, that the index is

narrow-based) and commodities would be a mixed swap. Mixed swaps also

would include certain Title VII instruments called ``best of'' or ``out

performance'' swaps that require a payment based on the higher of the

performance of a security and a commodity (other than a security).\284\

As discussed elsewhere in this release, the Commissions also believe

that certain Title VII instruments may be mixed swaps if they meet

specified conditions.

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\284\ See Cleary Letter (providing as examples of mixed swaps,

``a swap based on the out-performance of gold, oil or another

commodity relative to a security or narrow-based security index,''

``a security-based swap with knock-out/knock-in events tied to the

value of gold, oil or another commodity,'' and ``[s]waps on indices

or baskets that include narrow-based security index and physical

commodity components''); Deutsche Bank Letter (indicating that

``best-of'' swaps should be treated as mixed swaps); Morgan Stanley

Letter (``An example of a mixed swap might be a contract under which

one party takes long exposure to the common stock of a U.S.

corporation while simultaneously taking short exposure to the price

of gold.'').

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The Commissions also believe that the use of certain market

standard agreements in the documentation of Title VII instruments

should not in and of itself transform a Title VII instrument into a

mixed swap. For example, many instruments are documented by

incorporating by reference market standard agreements. Such agreements

typically set out the basis of establishing a trading relationship with

another party but are not, taken separately, a swap or security-based

swap. These agreements also include termination and default events

relating to one or both of the counterparties; such counterparties may

or may not be entities that issue securities.\285\ The Commissions

believe that the term ``any agreement * * * based on * * * the

occurrence of an event relating to a single issuer of a security,'' as

provided in the definition of the term ``security-based swap,'' was not

intended to include such termination and default events relating to

counterparties included in standard agreements that are incorporated by

reference into a Title VII instrument.\286\ Therefore, an instrument

would not be simultaneously a swap and a security-based swap (and thus

not a mixed swap) simply by virtue of having incorporated by reference

a standard agreement, including default and termination events relating

to counterparties to the Title VII instrument.

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\285\ Those standard events include inter alia bankruptcy,

breach of agreement, cross default to other indebtedness, and

misrepresentations.

\286\ See section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

U.S.C. 78c(a)(68)(A)(ii)(III).

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Request for Comment

The Commissions request comment on the following:

121. Are there other examples of Title VII instruments that should,

or should not, be included within the mixed swap category?

122. How frequently, and for what purposes, do market participants

use mixed swaps?

123. Can, and should, the economic goals of mixed swaps be

accomplished using a combination of separate Title VII instruments,

none of which would need to constitute a mixed swap? What problems, if

any, would arise from the ``disaggregation'' of mixed swaps?

B. Regulation of Mixed Swaps

1. Introduction

Paragraph (a) of proposed rule 1.9 under the CEA and proposed rule

3a68-4 under the Exchange Act would define a ``mixed swap'' in the same

manner as the term is defined in both the CEA and the Exchange Act. The

Commissions are proposing two rules to address the regulation of mixed

swaps. First, paragraph (b) of proposed rule 1.9 under the CEA and

proposed rule 3a68-4 under the Exchange Act would provide a regulatory

framework with which parties to bilateral uncleared mixed swaps (i.e.,

mixed swaps that are neither executed on or subject to the rules of a

DCM, NSE, SEF, security-based SEF, or FBOT nor cleared through a DCO or

clearing agency), as to which at least

[[Page 29861]]

one of the parties is dually registered with both Commissions, would

need to comply. Second, paragraph (c) of the proposed rules would

establish a process for persons to request that the Commissions issue a

joint order permitting such persons (and any other person or persons

that subsequently lists, trades, or clears that class of mixed swap)

\287\ to comply, as to parallel provisions \288\ only, with specified

parallel provisions of either the CEA or the Exchange Act, and related

rules and regulations (collectively ``specified parallel provisions''),

instead of being required to comply with parallel provisions of both

the CEA and the Exchange Act.

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\287\ All references to Title VII instruments in this part IV

and in part VI shall include a class of such Title VII instruments

as well. For example, a ``class'' of Title VII instrument would

include instruments that are of similar character and provide

substantially similar rights and privileges.

\288\ For purposes of paragraph (c) of proposed rule 1.9 under

the CEA and rule 3a68-4 under the Exchange Act, ``parallel

provisions'' means comparable provisions of the CEA and the Exchange

Act that were added or amended by Title VII with respect to

security-based swaps and swaps, and the rules and regulations

thereunder.

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2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-Registered

Dealers or Major Participants

Swap dealers and major swap participants will be comprehensively

regulated by the CFTC and security-based swap dealers and major

security-based swap participants will be comprehensively regulated by

the SEC.\289\ The Commissions recognize that there may be differences

in the requirements applicable to swap dealers and security-based swap

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

participants, such that dually-registered market participants may be

subject to potentially conflicting or duplicative regulatory

requirements when they engage in mixed swap transactions. In order to

assist market participants in addressing such potentially conflicting

or duplicative requirements, the Commissions are proposing rules that

would permit dually-registered swap dealers and security-based swap

dealers and dually-registered major swap participants and major

security-based swap participants to comply with an alternative

regulatory regime when they enter into certain mixed swaps under

specified circumstances.

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\289\ Section 712(a)(7)(A) of the Dodd-Frank Act requires the

Commissions to treat functionally or economically similar entities

in a similar manner.

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Accordingly, paragraph (b) of proposed rule 1.9 under the CEA and

rule 3a68-4 under the Exchange Act would provide that a bilateral

uncleared mixed swap,\290\ where at least one party is dually-

registered with the CFTC as a swap dealer or major swap participant and

with the SEC as a security-based swap dealer or major security-based

swap participant, would be subject to all applicable provisions of the

Federal securities laws (and SEC rules and regulations promulgated

thereunder). The proposed rules also would provide that such mixed

swaps would be subject to only the following provisions of the CEA (and

CFTC rules and regulations promulgated thereunder):

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\290\ For purposes of the proposed rules, a ``bilateral

uncleared mixed swap'' would be a mixed swap that: (i) Is neither

executed on nor subject to the rules of a DCM, NSE, SEF, security-

based SEF, or FBOT; and (ii) will not be submitted to a DCO or

registered or exempt clearing agency to be cleared. To the extent

that a mixed swap is subject to the mandatory clearing requirement

(see CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A), and section

3C(a)(1) of the Exchange Act) (and where a counterparty is not

eligible to rely on the end-user exclusion from mandatory clearing

requirement (see CEA section 2(h)(7), 7 U.S.C. 2(h)(7), and section

3C(g) of the Exchange Act)), this alternative regulatory treatment

would not be available.

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Examinations and information sharing: CEA sections 4s(f)

and 8; \291\

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\291\ 7 U.S.C. 6s(f) and 12, respectively.

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Enforcement: CEA sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c),

6(d), 6c, 6d, 9, 13(a), 13(b) and 23; \292\

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\292\ 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9 and 15, 13b, 13a-1,

13a-2, 13, 13c(a), 13c(b), and 26, respectively.

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Reporting to an SDR: CEA section 4r; \293\

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\293\ 7 U.S.C. 6r.

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Real-time reporting: CEA section 2(a)(13); \294\

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\294\ 7 U.S.C. 2(a)(13).

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Capital: CEA section 4s(e); \295\ and

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\295\ 7 U.S.C. 6s(e).

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Position Limits: CEA section 4a.\296\

\296\ 7 U.S.C. 6a.

The Commissions believe that paragraph (b) of the proposed rules would

address potentially conflicting or duplicative regulatory requirements

for dually-registered dealers and major participants that are subject

to regulation by both the CFTC and the SEC, while requiring dual

registrants to comply with the regulatory requirements the Commissions

believe are necessary to provide sufficient regulatory oversight for

mixed swaps transactions entered into by such dual registrants. The

CFTC also believes that paragraph (b) of the proposed rules would

provide clarity to dually-registered dealers and major participants,

who are subject to regulation by both the CFTC and the SEC, as to the

requirements of each Commission that will apply to their bilateral

uncleared mixed swaps.

Request for Comment

124. The Commissions request comment generally on the foregoing

proposed rules regarding the regulation of mixed swaps entered into by

dually-registered swap or security-based swap dealers and major swap or

security-based swap participants.

125. Does paragraph (b) of proposed rule 1.9 under the CEA and

proposed rule 3a68-4 under the Exchange Act provide effective

regulatory treatment for bilateral uncleared mixed swaps entered into

by persons that are dually registered both as swap dealers or major

swap participants with the CFTC and security-based swap dealers or

major security-based swap participants with the SEC? If not, how should

the proposed regulatory treatment be modified?

126. Are the enumerated sections of the CEA (and the regulations

promulgated thereunder) that are reserved in paragraph (b) appropriate?

Are there sections that should be withdrawn? Why or why not? Are there

sections that should be added? Why or why not?

3. Regulatory Treatment for Other Mixed Swaps

Because mixed swaps are both security-based swaps and swaps,\297\

absent a joint rule or order by the Commissions permitting an

alternative regulatory approach, persons who desire or intend to list,

trade, or clear a mixed swap (or class thereof) would be required to

comply with all the statutory provisions in the CEA and the Exchange

Act (including all the rules and regulations thereunder) that were

added or amended by Title VII with respect to swaps or security-based

swaps.\298\ Such dual regulation may not be appropriate in every

instance and may result in potentially conflicting or duplicative

regulatory requirements. However, before the Commissions can determine

the appropriate regulatory treatment for mixed swaps (other than the

treatment discussed above), the Commissions would need to understand

better the nature of the mixed swaps that parties want to trade.

Paragraph (c) of proposed rule 1.9 under the CEA and proposed

[[Page 29862]]

rule 3a68-4 under the Exchange Act would establish a process pursuant

to which any person who desires or intends to list, trade, or clear a

mixed swap (or class thereof) that is not subject to the provisions of

paragraph (b) (i.e., bilateral uncleared mixed swaps entered into by at

least one dual registrant) may request the Commissions to publicly

issue a joint order permitting such person (and any other person or

persons that subsequently lists, trades, or clears that class of mixed

swap) to comply, as to parallel provisions only, with the specified

parallel provisions, instead of being required to comply with parallel

provisions of both the CEA and the Exchange Act.\299\

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\297\ See supra note 10.

\298\ Because security-based swaps are also securities,

compliance with the Federal securities laws and rules and

regulations thereunder (in addition to the provisions of the Dodd-

Frank Act and the rules and regulations thereunder) would also be

required. To the extent one of the Commissions has exemptive

authority with respect to other provisions of the CEA or the Federal

securities laws and the rules and regulations thereunder, persons

may submit separate exemptive requests or rulemaking petitions

regarding those provisions to the relevant Commission.

\299\ Other than with respect to the specified parallel

provisions with which such persons may be permitted to comply

instead of complying with parallel provisions of both the CEA and

the Exchange Act, any other provision of either the CEA or the

Federal securities laws that applies to swaps or security-based

swaps will continue to apply.

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Paragraph (c) of the proposed rules would further provide that a

person submitting such a request to the Commissions must provide the

Commissions with:

(i) All material information regarding the terms of the specified,

or specified class of, mixed swap;

(ii) the economic characteristics and purpose of the specified, or

specified class of, mixed swap;

(iii) the specified parallel provisions, and the reasons the person

believes such specified parallel provisions would be appropriate for

the mixed swap (or class thereof);

(iv) an analysis of (1) the nature and purposes of the parallel

provisions that are the subject of the request; (2) the comparability

of such parallel provisions; and (3) the extent of any conflicts or

differences between such parallel provisions; and

(v) such other information as may be requested by either of the

Commissions.

This provision is intended to provide the Commissions with

sufficient information regarding the mixed swap (or class thereof) and

the proposed regulatory approach to make an informed determination

regarding the appropriate regulatory treatment of the mixed swap (or

class thereof).

Paragraph (c) of the proposed rules also would allow a person to

withdraw a request regarding the regulation of a mixed swap at any time

prior to the issuance of a joint order by the Commissions. This

provision is intended to permit persons to withdraw requests that they

no longer need. This, in turn, would save the Commissions time and

staff resources.

Paragraph (c) would further provide that in response to a request

pursuant to the proposed rules, the Commissions may jointly issue an

order, after public notice and opportunity for comment, permitting the

requesting person (and any other person or persons that subsequently

lists, trades, or clears that class of mixed swap) to comply, as to

parallel provisions only, with the specified parallel provisions (or

another subset of the parallel provisions that are the subject of the

request, as the Commissions determine is appropriate), instead of being

required to comply with parallel provisions of both the CEA and the

Exchange Act. In determining the contents of such a joint order, the

Commissions could consider, among other things, (i) the nature and

purposes of the parallel provisions that are the subject of the

request; (ii) the comparability of such parallel provisions; and (iii)

the extent of any conflicts or differences between such parallel

provisions.

Finally, paragraph (c) of the proposed rules would require the

Commissions, if they determine to issue a joint order pursuant to these

rules, to do so within 120 days of receipt of a complete request (with

such 120-day period being tolled during the pendency of a request for

public comment on the proposed interpretation). If the Commissions do

not issue a joint order within the prescribed time period, the proposed

rules require that each Commission publicly provide the reasons for not

having done so. Paragraph (c) makes clear that nothing in the proposed

rules requires either Commission to issue a requested joint order

regarding the regulation of a particular mixed swap (or class thereof).

These provisions are intended to provide market participants with a

prompt review of requests for a joint order regarding the regulation of

a particular mixed swap (or class thereof). The proposed rules also

would provide transparency and accountability by requiring that at the

end of the review period, the Commissions issue the requested order or

publicly state the reasons for not doing so.

Request for Comment

127. Is the proposed procedure set forth in paragraph (c)

appropriate? Should paragraph (c) of the proposed rules include a more

detailed process for persons to request that the Commissions issue a

joint order permitting such persons to comply, as to parallel

provisions only, with specified parallel provisions, instead of being

required to comply with parallel provisions of both the CEA and the

Exchange Act? If so, please provide a detailed explanation of what that

process should include.

128. Is the information required by paragraph (c) in support of a

request for a joint order appropriate? Are there specific economic

characteristics that should be required? In particular, should

requesting persons be required to provide the specified parallel

provisions, and the reasons the person believes it would be appropriate

to request that regulatory treatment, as well as an analysis of (i) the

nature and purposes of the parallel provisions that are the subject of

the request; (ii) the comparability of such parallel provisions; and

(iii) the extent of any conflicts or differences between such parallel

provisions? Why or why not? If not, please provide a detailed

explanation, including what information requesting persons should be

required to provide.

129. Is there additional or alternative information that the

Commissions should require persons to submit in connection with a

request regarding the regulation of particular mixed swaps (or class

thereof)? If so, what additional or alternative information should be

required?

130. Should persons be able to withdraw a request for a joint order

regarding the regulation of a particular mixed swap (or class thereof)?

Why or why not? Should there be additional requirements regarding such

withdrawals? If so, what should they be?

131. Is the 120-day timeframe for issuance of a requested joint

order provided for in paragraph (c) of proposed rule 1.9 under the CEA

and proposed rule 3a68-4 under the Exchange Act appropriate? Is it too

short or too long? Are the provisions for tolling this timeframe during

a public comment period appropriate? Why or why not? Where the

Commissions do not issue a joint order, is it appropriate that they

each publicly provide the reasons for not doing so within the

applicable timeframe? Why or why not?

V. Security-Based Swap Agreements

A. Introduction

SBSAs are swaps over which the CFTC has regulatory and enforcement

authority but for which the SEC also has antifraud and certain other

authority.\300\

[[Page 29863]]

The term ``security-based swap agreement'' is defined as a ``swap

agreement'' (as defined in section 206A of the GLBA \301\) of which ``a

material term is based on the price, yield, value, or volatility of any

security or any group or index of securities, including any interest

therein'' but does not include a security-based swap.\302\ The Dodd-

Frank Act amended the definition of ``swap agreement'' in section 206A

of the GLBA \303\ to eliminate the requirements that a swap agreement

be between ECPs, as defined in 1a(12)(C) of the CEA,\304\ and subject

to individual negotiation.\305\

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\300\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v). The

Dodd-Frank Act provides that certain CFTC registrants, such as DCOs

and SEFs, will keep records regarding SBSAs open to inspection and

examination by the SEC upon request. See, e.g., sections 725(e) and

733 of the Dodd-Frank Act. The Commissions are committed to working

cooperatively together regarding their dual enforcement authority

over SBSAs.

\301\ 15 U.S.C. 78c note.

\302\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

78c(a)(78). The CFMA amended the Exchange Act and the Securities Act

to exclude swap agreements from the definitions of security in those

Acts but subjected ``security-based swap agreements,'' as defined in

section 206B of the GLBA, 15 U.S.C. 78c note, to the antifraud,

anti-manipulation, and anti-insider trading provisions of the

Exchange Act and Securities Act. See CFMA, supra note 182, title

III.

The CEA does not contain a stand-alone definition of

``security-based swap agreement'' but includes the definition

instead in subparagraph (A)(v) of the swap definition in CEA section

1a(47), 7 U.S.C. 1a(47). The only difference between these

definitions is that the definition of SBSA in the Exchange Act

specifically excludes security-based swaps (see section 3(a)(78)(B)

of the Exchange Act, 15 U.S.C. 78c(a)(78)(B)), while the definition

of SBSA in the CEA does not contain a similar exclusion. Instead,

the exclusion for security-based swaps is placed in the general

exclusions from the definition of swap in the CEA (see CEA section

1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)).

\303\ 15 U.S.C. 78c note.

\304\ 7 U.S.C. 1a(12)(C).

\305\ See section 762(b) of the Dodd-Frank Act. Sections 762(c)

and (d) of the Dodd-Frank Act also made conforming amendments to the

Exchange Act and the Securities Act to reflect the changes to the

regulation of ``swap agreements'' that are either ``security-based

swaps'' or ``security-based swap agreements'' under the Dodd-Frank

Act.

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B. Swaps That Are Security-Based Swap Agreements

Although the Commissions believe it is not possible to provide a

bright line test to define an SBSA, the Commissions believe that it is

possible to clarify that certain types of swaps clearly fall within the

definition of SBSA. For example, a swap based on an index of securities

that is not a narrow-based security index (i.e., a broad-based security

index) would fall within the definition of an SBSA under the Dodd-Frank

Act.\306\ Similarly, an index CDS that is not based on a narrow-based

security index or on the ``issuers of securities in a narrow-based

security index,'' as defined in proposed rule 1.3(zzz) under the CEA

and proposed rule 3a68-1a under the Exchange Act, would be an SBSA. In

addition, a swap based on a U.S. Treasury security or on certain other

exempted securities other than municipal securities would fall within

the definition of an SBSA under the Dodd-Frank Act.\307\ The

Commissions have received no comments regarding the definition of SBSA

in the Dodd-Frank Act in response to the ANPR, and have not been made

aware of any significant market confusion regarding what constitutes an

SBSA since the definition of SBSA was enacted as part of the CFMA in

2000. Accordingly, the Commissions are not proposing to further define

SBSA at this time beyond providing the examples above.\308\

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\306\ Swaps based on indexes that are not narrow-based security

indexes are not included within the definition of the term security-

based swap under the Dodd-Frank Act. See section 3(a)(68)(A)(ii)(I)

of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(I), and discussion

supra part III.G. However, such swaps have a material term that is

``based on the price, yield, value, or volatility of any security or

any group or index of securities, or any interest therein,'' and

therefore such swaps fall within the SBSA definition.

\307\ Swaps on U.S. Treasury securities that do not have any

other underlying references involving securities are expressly

excluded from the definition of the term ``security-based swap''

under the Dodd-Frank Act. See section 3(a)(68)(C) of the Exchange

Act, 15 U.S.C. 78c(a)(68)(C) (providing that an agreement, contract,

or transaction that would be a security-based swap solely because it

references, is based on, or settles through the delivery of one or

more U.S. Treasury securities (or certain other exempted securities)

is excluded from the security-based swap definition). However, swaps

on U.S. Treasury securities or on other exempted securities covered

by subparagraph (C) of the security-based swap definition have a

material term that is ``based on the price, yield, value, or

volatility of any security or any group or index of securities, or

any interest therein,'' and therefore they fall within the SBSA

definition.

\308\ The Commissions note that certain transactions that were

not ``security-based swap agreements'' under the CFMA are

nevertheless included in the definition of security-based swap under

the Dodd-Frank Act--including, for example, a CDS on a single loan.

Accordingly, although such transactions were not subject to insider

trading restrictions under the CFMA, under the Dodd-Frank Act they

are subject to the Federal securities laws, including insider

trading restrictions.

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Request for Comment

132. The Commissions request comment on whether further

clarification of the definition of SBSA is necessary or appropriate.

Commenters should provide a detailed analysis regarding what further

guidance should be provided and how that guidance would affect what

constitutes an SBSA.

133. The Commissions also request comment on whether there are

other examples of swap transactions that the Commissions should clarify

meet the definition of SBSA.

C. Books and Records Requirements for Security-Based Swap Agreements

The Dodd-Frank Act requires the Commissions to adopt rules

regarding the books and records required to be kept for SBSAs.

Specifically, section 712(d)(2)(B) of the Dodd-Frank Act requires the

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

governing books and records requirements for SBSAs by persons

registered as SDRs under the CEA, including uniform rules that specify

the data elements that shall be collected and maintained by each SDR.

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

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

governing books and records for SBSAs, including daily trading records,

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

and major security-based swap participants.

As discussed above, SBSAs are swaps over which the CFTC has primary

regulatory authority, but for which the SEC has antifraud, anti-

manipulation, and certain other authority. The CFTC has proposed rules

governing books and records for swaps, which would apply to swaps that

also are SBSAs.\309\ The Commissions believe that the proposed rules

would provide sufficient books and records regarding SBSAs and do not

believe that additional books and records requirements are necessary

for SBSAs. The Commissions therefore are proposing rules to clarify

that there would not be additional books and records requirements

regarding SBSAs other than those proposed for swaps. Specifically,

proposed rule 1.7 under the CEA and proposed rule 3a69-3 under the

Exchange Act would not require persons registered as SDRs under the CEA

and the rules and regulations thereunder to (i) keep and maintain

additional books and records regarding SBSAs other than the books and

records regarding swaps that SDRs would be required to keep and

maintain pursuant to the CEA and rules and regulations thereunder; and

(ii) collect and maintain additional data regarding SBSAs other than

the data regarding swaps that SDRs would be required to collect and

maintain pursuant to the CEA and rules and regulations thereunder.

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\309\ See Swap Data Recordkeeping and Reporting Requirements,

supra note 6 (proposed rules regarding swap data recordkeeping and

reporting requirements for SDRs, DCOs, DCMs, SEFs, swap dealers,

major swap participants, and swap counterparties who are neither

swap dealers nor major swap participants); Reporting, Recordkeeping,

and Daily Trading Records Requirements for Swap Dealers and Major

Swap Participants, supra note 7 (proposed rules regarding reporting

and recordkeeping requirements and daily trading records

requirements for swap dealers and major swap participants).

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[[Page 29864]]

In addition, the proposed rules would not require persons

registered as swap dealers or major swap participants under the CEA and

rules and regulations thereunder, or registered as security-based swap

dealers or major security-based swap participants under the Exchange

Act and rules and regulations thereunder, to keep and maintain

additional books and records, including daily trading records,

regarding SBSAs other than the books and records regarding swaps those

persons would be required to keep and maintain pursuant to the CEA and

the rules and regulations thereunder.\310\

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\310\ Proposed rule 1.7 under the CEA and proposed rule 3a69-3

under the Exchange Act would provide that the term ``security-based

swap agreement'' has the meaning set forth in CEA section

1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v), and section 3(a)(78) of the

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

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Request for Comment

134. The Commissions request comment on the proposed rules

regarding books and records requirements for SBSAs. Will requiring the

same recordkeeping information for SBSAs that will be required for

swaps under the CFTC's recordkeeping rules be sufficient? Should the

Commissions impose additional recordkeeping requirements for SBSAs? If

so, why, and what additional recordkeeping should be required?

VI. Process for Requesting Interpretations of the Characterization of a

Title VII Instrument

As discussed above, there may be Title VII instruments (or classes

of Title VII instruments) that may be difficult to categorize

definitively as swaps or security-based swaps. Further, because mixed

swaps are both swaps and security-based swaps, identifying a mixed swap

may not always be straightforward.

Section 712(d)(4) of the Dodd-Frank Act provides that any

interpretation of, or guidance by, either the CFTC or SEC regarding a

provision of Title VII shall be effective only if issued jointly by the

Commissions (after consultation with the Board) on issues where Title

VII requires the CFTC and SEC to issue joint regulations to implement

the provision. The Commissions believe that any interpretation or

guidance regarding whether a Title VII instrument is a swap, a

security-based swap, or both (i.e., a mixed swap), must be issued

jointly pursuant to this requirement. Consequently, the Commissions are

proposing a process for interested persons to request a joint

interpretation by the Commissions regarding whether a particular Title

VII instrument (or class of Title VII instruments) is a swap, a

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

Section 718 of the Dodd-Frank Act establishes a process for

determining the status of ``novel derivative products'' that may have

elements of both securities and futures contracts. Section 718 of the

Dodd-Frank Act provides a useful model for a joint Commission review

process to appropriately categorize Title VII instruments. As a result,

the Commissions' proposed process rules regarding swaps, security-based

swaps, and mixed swaps include various attributes of the process

established in section 718 of the Dodd-Frank Act. In particular, to

permit an appropriate review period that provides sufficient time to

ensure Federal regulatory interests are satisfied that also does not

unduly delay the introduction of new financial products, the proposed

process, like the process established in section 718, would include a

deadline for responding to a request for a joint interpretation.\311\

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\311\ The Commissions note that section 718 of the Dodd-Frank

Act is a separate process from the process the Commissions are

proposing, and that any future interpretation involving the process

under section 718 would not affect the process being proposed here,

nor would any future interpretation involving the process proposed

here affect the process under section 718.

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Proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the

Exchange Act would establish a process for parties to request a joint

interpretation regarding the characterization of a particular Title VII

instrument (or class thereof). Specifically, paragraph (a) of the

proposed rules would provide that any person may submit a request to

the Commissions to provide a public joint interpretation of whether a

particular Title VII instrument is a swap, a security-based swap, or

both (i.e., a mixed swap).

Paragraph (a) of the proposed rules is intended to afford market

participants with the opportunity to obtain greater certainty from the

Commissions regarding the regulatory status of particular Title VII

instruments under the Dodd-Frank Act. This provision should decrease

the possibility that market participants inadvertently might violate

the regulatory requirements applicable to a particular Title VII

instrument.

Paragraph (b) of proposed rules 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act would provide that a person requesting an

interpretation as to the characterization of a Title VII instrument as

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

provide the Commissions with the person's determination of the

characterization of the instrument and supporting analysis, along with

certain other documentation. Specifically, the person must provide the

Commissions with the following information:

All material information regarding the terms of the Title

VII instrument;

A statement of the economic characteristics and purpose of

the Title VII instrument;

The requesting person's determination as to whether the

Title VII instrument should be characterized as a swap, a security-

based swap, or both (i.e., a mixed swap), including the basis for such

determination; and

Such other information as may be requested by either

Commission.

This provision is intended to provide the Commissions with

sufficient information regarding the Title VII instrument at issue so

that the Commissions can appropriately evaluate whether it is a swap, a

security-based swap, or both (i.e., a mixed swap). By requiring that

requesting persons furnish a determination regarding whether they

believe the Title VII instrument is a swap, a security-based swap, or

both (i.e., a mixed swap), including the basis for such determination,

this provision also would assist the Commissions in more quickly

identifying and addressing the relevant issues involved in arriving at

a joint interpretation of the characterization of the instrument.

Paragraph (c) of proposed rule 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act would provide that a person may withdraw

a request made pursuant to paragraph (a) at any time prior to the

issuance of a joint interpretation or joint notice of proposed

rulemaking by the Commissions. Notwithstanding any such withdrawal, the

Commissions may provide an interpretation regarding the

characterization of the Title VII instrument that was the subject of a

withdrawn request.

This provision is intended to permit parties to withdraw requests

for which the party no longer needs an interpretation. This, in turn,

would save the Commissions time and staff resources. If the Commissions

believe such an interpretation is necessary regardless of a particular

request for interpretation, however, the Commissions may provide such a

joint interpretation of their own accord.

Paragraph (d) of proposed rule 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act would

[[Page 29865]]

provide that if either Commission receives a proposal to list, trade,

or clear an agreement, contract, or transaction (or class thereof) that

raises questions as to the appropriate characterization of such

agreement, contract, or transaction (or class thereof) as a swap,

security-based swap, or both (i.e., a mixed swap), the receiving

Commission promptly shall notify the other. This provision of the

proposed rules would further provide that either Commission, or their

Chairmen jointly, may submit a request for a joint interpretation as to

the characterization of the Title VII instrument where no external

request has been received.

This provision is intended to ensure that Title VII instruments do

not fall into regulatory gaps and will help the Commissions to fulfill

their responsibility to oversee the regulatory regime established by

Title VII of the Dodd-Frank Act by making sure that Title VII

instruments are appropriately characterized, and thus appropriately

regulated. An agency, or their Chairmen jointly, submitting a request

for an interpretation as to the characterization of a Title VII

instrument under this paragraph would be required to submit the same

information as, and could withdraw a request in the same manner as, a

person submitting a request to the Commissions. The bases for these

provisions are set forth above with respect to paragraphs (b) and (c)

of these proposed rules.

Paragraph (e) of proposed rule 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act would require the Commissions, if they

determine to issue a joint interpretation as to the characterization of

a Title VII instrument, to do so within 120 days of receipt of the

complete external or agency submission (unless such 120-day period is

tolled during the pendency of a request for public comment on the

proposed interpretation).\312\ If the Commissions do not issue a joint

interpretation within the prescribed time period, the proposed rules

require that each Commission publicly provide the reasons for not

having done so. This provision of the proposed rules also incorporates

the mandate of the Dodd-Frank Act that any joint interpretation by the

Commissions be issued only after consultation with the Board of

Governors of the Federal Reserve System.\313\ Finally, paragraph (e)

makes clear that nothing in the proposed rules requires either

Commission to issue a requested joint interpretation regarding the

characterization of a particular instrument.

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\312\ This 120-day period is based on the timeframe set forth in

section 718(a)(3) of the Dodd-Frank Act.

\313\ See section 712(d)(4) of the Dodd-Frank Act.

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These provisions are intended to guarantee market participants a

prompt review of submissions requesting a joint interpretation of

whether a Title VII instrument is a swap, a security-based swap, or

both (i.e., a mixed swap). The proposed rules also would provide

transparency and accountability by requiring that at the end of the

review period, the Commissions issue the requested interpretation or

publicly state the reasons for not doing so.

Paragraph (f) of proposed rule 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act would permit the Commissions, in lieu of

issuing a requested interpretation, to issue (within the timeframe for

issuing a joint interpretation) a joint notice of proposed rulemaking

to further define one or more of the terms ``swap,'' ``security-based

swap,'' or ``mixed swap.'' Such a rulemaking, as required by Title VII,

would be required to be done in consultation with the Board of

Governors of the Federal Reserve System. This paragraph is intended to

provide the Commissions with needed flexibility to address issues that

may be of broader applicability than the particular Title VII

instrument that is the subject of a request for a joint interpretation.

Request for Comment

135. The Commissions request comment generally on all aspects of

proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the

Exchange Act.

136. Should proposed rule 1.8(a) under the CEA and proposed rule

3a68-2(a) under the Exchange Act include a more specific process for

persons to request a joint interpretation of whether a Title VII

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

swap)? If so, what additional specificity would be appropriate?

137. Would the information required by paragraph (b) of the

proposed rules be sufficient for the Commissions to consider a request?

Should requesting persons have to provide a statement regarding the

economic characteristics and purpose of the Title VII instrument?

Should requesting persons have to provide a determination regarding

whether such instrument should be characterized as a swap, a security-

based swap, or both (i.e., a mixed swap), along with reasons therefor?

138. Is there additional or alternative information that the

Commissions should require persons to submit in connection with a

request for an interpretation regarding whether a Title VII instrument

is a swap, a security-based swap, or both (i.e., a mixed swap)? If so,

what additional or alternative information should be required?

139. Should persons be able to withdraw a request for an

interpretation pursuant to paragraph (c) of proposed rule 1.8 under the

CEA and proposed rule 3a68-2 under the Exchange Act? Why or why not?

Should there be additional parameters around or requirements regarding

such withdrawals? If so, what should they be?

140. Is the 120-day timeframe for issuance of a requested joint

interpretation provided for in paragraph (e) of proposed rule 1.8 under

the CEA and proposed rule 3a68-2 under the Exchange Act appropriate? Is

it too short or too long? Are the provisions for tolling this timeframe

during a public comment period, and for permitting the Commissions to

proceed with a joint notice of proposed rulemaking instead of issuing a

joint interpretation, appropriate? Why or why not? Where the

Commissions do not issue a joint interpretation, is it helpful that

they each publicly provide the reasons for not doing so within the

applicable timeframe? Why or why not?

141. Title VII requires that certain persons that are registered

with the CFTC keep books and records relating to SBSAs open to

inspection and examination by the SEC. As discussed in part V above,

the Commissions are not proposing additional recordkeeping or other

regulatory requirements for SBSAs that would require pre-transaction

identification of a swap as an SBSA by market participants. Under these

circumstances, is it appropriate to include SBSAs in the interpretation

process set forth in proposed rule 1.8 under the CEA and proposed rule

3a68-2 under the Exchange Act? Why or why not?

142. Would it be appropriate to include SBSAs in the interpretation

process, if their inclusion required the Commissions to extend the 120-

day timeframe for issuance of a requested joint interpretation to, for

example, 180 days for all products in order to address a potential

increase in requests? Why or why not?

VII. Anti-Evasion

A. CFTC Proposed Anti-Evasion Rules

Section 721(c) of the Dodd-Frank Act requires the CFTC to adopt a

rule to further define the terms ``swap,'' ``swap dealer,'' ``major

swap participant,'' and ``eligible contract participant,'' in order

``[t]o include transactions and entities

[[Page 29866]]

that have been structured to evade'' subtitle A of Title VII (or an

amendment made by subtitle A). Section 761(b)(3) of the Dodd-Frank Act,

in turn, grants discretionary authority to the SEC to define the terms

``security-based swap,'' ``security-based swap dealer,'' ``security-

based major swap participant,'' and ``eligible contract participant,''

with regard to security-based swaps, ``for the purpose of including

transactions and entities that have been structured to evade subtitle B

of Title VII (or amendments made by subtitle B). The CFTC notes that

several provisions of Title VII reference the promulgation of anti-

evasion rules:

Subparagraph (E) of the definition of ``swap'' provides

that foreign exchange swaps and foreign exchange forwards shall be

considered swaps unless the Secretary of the Treasury makes a written

determination that either foreign exchange swaps or foreign exchange

forwards, or both, among other things, ``are not structured to evade

the [Dodd-Frank Act] in violation of any rule promulgated by the [CFTC]

pursuant to section 721(c) of that Act;'' \314\

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\314\ CEA section 1a(47)(E), 7 U.S.C. 1a(47)(E).

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Section 722(d) of the Dodd-Frank Act provides that the

provisions of the CEA relating to swaps shall not apply to activities

outside the United States unless those activities, among other things,

``contravene such rules or regulations as the [CFTC] may prescribe or

promulgate as are necessary or appropriate to prevent the evasion of

any provision of [the CEA] that was enacted by the [Title VII];'' \315\

and

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\315\ CEA section 2(i), 7 U.S.C. 2(i). New CEA section 2(i), as

added by section 722(d) of the Dodd-Frank Act, also provides that

the provisions of Title VII relating to swaps shall not apply to

activities outside the United State unless those activities ``have a

direct and significant connection with activities in, or effect on,

commerce of the United States.''

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Section 725(g) of the Dodd-Frank Act amends the Legal

Certainty for Bank Products Act of 2000 to provide that, although

identified banking products generally are excluded from the CEA, that

exclusion shall not apply to an identified banking product that is a

product of a bank that is not under the regulatory jurisdiction of an

appropriate Federal banking agency,\316\ meets the definition of

``swap'' or ``security-based swap,'' and ``has been structured as an

identified banking product for the purpose of evading the provisions of

the [CEA], the [Securities Act], or the [Exchange Act].'' \317\

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\316\ The term ``identified banking product'' is defined in

section 402 of the Legal Certainty for Bank Products Act of 2000, 7

U.S.C. 27. The term ``appropriate Federal banking agency'' is

defined in CEA section 1a(2), 7 U.S.C. 1a(2), and section 3(a)(72)

of the Exchange Act, 15 U.S.C. 78c(a)(72), which were added by

sections 721(a) and 761(a) of the Dodd-Frank Act, respectively.

\317\ Section 741(b) of the Dodd-Frank Act amends section 6(e)

of the CEA, 7 U.S.C. 9a, to provide that any DCO, swap dealer, or

major swap participant ``that knowingly or recklessly evades or

participates in or facilitates an evasion of the requirements of

section 2(h) [of the CEA] shall be liable for a civil monetary

penalty in twice the amount otherwise available for a violation of

section 2(h) [of the CEA].'' This anti-evasion provision is not

dependent upon the promulgation of a rule under section 721(c) of

the Dodd-Frank Act, and hence this release does not apply to the

anti-evasion authority regarding CEA section 2(h), 7 U.S.C. 2(h).

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The CFTC has determined to exercise its anti-evasion rulemaking

authority under the Dodd-Frank Act.\318\

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\318\ No comments were received in response to the ANPR that

specifically addressed anti-evasion authority. One commenter,

however, noted that evasion is a concern. See Letter from David A.

Berg, Esq., Vice President & General Counsel, Air Transport

Association (Sept. 20, 1010).

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Structuring transactions and entities to evade the requirements of

the Dodd-Frank Act could take any number of forms. As with the law of

manipulation, the ``methods and techniques'' of evasion are ``limited

only by the ingenuity of man.'' \319\ In light of the myriad methods of

potential evasion, any attempt to comprehensively determine what

constitutes evasion, or to provide a bright-line test of evasion by

rule, would likely not be effective as would-be evaders could simply

restructure their transactions or entities to fall outside any rigid

boundary. Accordingly, proposed rule 1.3(xxx)(6) under the CEA

generally would define as swaps those transactions that are willfully

structured to evade the provisions of Title VII governing the

regulation of swaps. Specific provisions would apply in similar fashion

to currency and interest rate swaps that are willfully structured as

foreign exchange forwards or foreign exchange swaps, and to

transactions of a bank that is not under the regulatory jurisdiction of

an appropriate Federal banking agency where the transactions are

willfully structured as identified banking products to evade the new

regulatory regime for swaps that was enacted in Title VII. These

proposed rules would not apply to any agreement, contract, or

transaction structured as a security (including a security-based swap)

under the securities laws (as defined in section 3(a)(47) of the

Exchange Act).

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\319\ Cargill v. Hardin, 452 F.2d 1154, 1163 (8th Cir. 1971).

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The Dodd-Frank Act also gives the CFTC general authority to prevent

evasion of Title VII that occurs outside of the United States.

Specifically, as noted above, section 722(d) of the Dodd-Frank Act

states that the provisions of the CEA relating to swaps that were

enacted by Title VII (including any rule prescribed or regulation

promulgated thereunder) shall not apply to activities outside the

United States unless, among other things, those activities ``contravene

such rules or regulations as the [CFTC] may prescribe or promulgate as

are necessary or appropriate to prevent the evasion of any provision of

[the CEA] that was enacted by [Title VII].'' The CFTC is proposing

rules to address potential evasion of Title VII under this provision of

the Dodd-Frank Act.

Proposed rule 1.6 under the CEA would prohibit activities conducted

outside the United States, including entering into transactions and

structuring entities, to willfully evade or attempt to evade any

provision of the CEA as enacted under Title VII or the rules and

regulations promulgated thereunder. No activity, however, conducted

outside of the United States with respect to a security (including a

security-based swap) under the securities laws (as defined in section

3(a)(47) of the Exchange Act) and that is subject to the jurisdiction

of the SEC would be prohibited pursuant to proposed rule 1.6.

The CFTC's proposed rule 1.3(xxx)(6) further defining the term

``swap'' would further provide that transactions, other than

transactions structured as securities, willfully structured to evade

shall be considered in determining whether a person is a swap dealer or

major swap participant. Proposed rule 1.6 would further provide that an

activity conducted outside the United States, other than an activity

with respect to a security (including a security-based swap), to

willfully evade or attempt to evade, shall be subject to the swap

provisions of the CEA enacted under Title VII of the Dodd-Frank Act.

The CFTC believes that these provisions are necessary to fully prevent

those who seek to willfully evade the regulatory requirements

established by Congress in Title VII relating to swaps from enjoying

any benefits from their efforts to evade.

Finally, the CFTC's proposed rules would provide that in

determining whether a transaction has been willfully structured to

evade, neither the form, label, nor written documentation of the

transaction shall be dispositive. The CFTC believes that looking beyond

the form of the transaction to examine its actual substance is

necessary to prevent evasion through clever draftsmanship. Such an

approach is consistent with the CFTC's case law in the context of

determining whether a contract is a futures contract.\320\

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\320\ See, e.g., Grain Land, supra note 61, at 55748 (holding

that contract substance is entitled to at least as much weight as

form); First Nat'l Monetary Corp., supra note 152, at 30974;

Stovall, supra note 152, at 23779 (holding that the CFTC ``will not

hesitate to look behind whatever label the parties may give to the

instrument'').

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[[Page 29867]]

In order to provide clarity concerning the anti-evasion rules, the

CFTC also proposes to provide interpretive guidance as to certain types

of circumstances that may constitute an evasion of the requirements of

Title VII, while at the same time preserving the CFTC's ability to

determine, on a case-by-case basis, that particular or other types of

transactions or actions constitute an evasion of the requirements of

the statute or the regulations promulgate thereunder. In developing

this guidance, the CFTC has considered legislative, administrative, and

judicial precedent with respect to the anti-evasion provisions in other

Federal statutes. For example, the CFTC has examined the anti-evasion

provisions in the Truth in Lending Act,\321\ the Bank Secrecy Act,\322\

and the Internal Revenue Code.\323\ Based on these other statutory

anti-evasion provisions, as well as the CFTC's authority under the

Dodd-Frank Act to define terms and promulgate rules and regulations to

prevent evasion, the CFTC is proposing this interpretive guidance as to

what may constitute evasion of the requirements of the Dodd-Frank Act

with respect to swaps. The CFTC emphasizes, however, that it would

examine each individual case on a case-by-case basis, and additional

practices or circumstances may warrant a finding that particular

conduct or transactions constitute an evasion of the requirements of

the Dodd-Frank Act with respect to swaps.

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\321\ 15 U.S.C. 1604(a) provides, in relevant part, that the

Federal Reserve Board:

Shall prescribe regulations to carry out the purposes of this

subchapter * * *. [T]hese regulations may contain such

classifications, differentiations, or other provisions, and may

provide for such adjustments and exceptions for any class of

transactions, as in the judgment of the Board are necessary or

proper to effectuate the purposes of this subchapter, to prevent

circumvention or evasion thereof, or to facilitate compliance

therewith.

In affirming the Board's promulgation of Regulation Z, the

Supreme Court noted that anti-evasion provisions such as section

1604(a) evince Congress's intent to ``stress[] the agency's power to

counteract attempts to evade the purposes of a statute.'' Mourning

v. Family Publ'ns Serv., Inc., 411 U.S. 356, 370 (1973) (citing

Gemsco v. Walling, 324 U.S. 244 (1945) (giving great deference to a

regulation promulgated under similar prevention-of-evasion

rulemaking authority in the Fair Labor Standards Act)).

\322\ 31 U.S.C. 5324 (stating, in pertinent part, that ``[n]o

person shall, for the purpose of evading the reporting requirements

of [the Bank Secrecy Act (BSA) or any regulation prescribed

thereunder].* * * structure or assist in structuring, or attempt to

structure or assist in structuring, any transaction with one or more

domestic financial institutions''). The Federal Deposit Insurance

Corporation regulations implementing the BSA require banks to report

transactions that ``''the bank knows, suspects, or has reason to

suspect'' are ``designed to evade any regulations promulgated under

the Bank Secrecy Act.'' 12 CFR 353.3 (2010).

\323\ The Internal Revenue Code makes it unlawful for any person

willfully to attempt ``in any manner to evade or defeat any tax * *

*.'' 26 U.S.C. 7201. While a considerable body of case law has

developed under the tax evasion provision, the statute itself does

not define the term, but generally prohibits willful attempts to

evade tax.

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Business Purpose. The CFTC recognizes that transactions may be

structured, and entities may be formed, in particular ways for

legitimate business purposes, without any intention of circumventing

the requirements of the Dodd-Frank Act with respect to swaps. In

evaluating whether a person is evading or attempting to evade the

requirements with respect to a particular instrument, entity, or

transaction, the CFTC would consider the extent to which a person has a

legitimate business purpose for structuring the instrument or entity or

entering into the transaction in that particular manner. Although

different means of structuring a transaction or entity may have

differing regulatory implications and attendant requirements, absent

other indicia of evasion, the CFTC would not consider transactions,

entities, or instruments structured in a manner solely motivated by a

legitimate business purpose to constitute evasion. However, to the

extent a purpose in structuring an entity or instrument or entering

into a transaction is to evade the requirements of Title VII with

respect to swaps, the structuring of such instrument, entity, or

transaction may be found to constitute evasion.\324\

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\324\ A similar concept applies with respect to tax evasion. A

transaction that is structured to avoid the payment of taxes but

that lacks a valid business purpose may be found to constitute tax

evasion. See, e.g., Gregory v. Helvering, 293 U.S. 465, 469 (1935)

(favorable tax treatment disallowed because transaction lacked any

business or corporate purpose). Under the ``sham-transaction''

doctrine, ``a transaction is not entitled to tax respect if it lacks

economic effects or substance other than the generation of tax

benefits, or if the transaction serves no business purpose.'' Winn-

Dixie Stores, Inc. v. Comm'r, 254 F.3d 1313, 1316 (11th Cir. 2001)

(citing Knetsch v. United States, 364 U.S. 361 (1960)). ``The

doctrine has few bright lines, but `it is clear that transactions

whose sole function is to produce tax deductions are substantive

shams.''' Id. (quoting United Parcel Serv. of Am., Inc. v. Comm'r,

254 F.3d 1014, 1018 (11th Cir 2001)).

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Fraud, deceit, or unlawful activity. The CFTC believes that the

Internal Revenue Service's delineation of what constitutes tax evasion,

as elaborated upon by the courts, provides a useful guidepost for

determining which types of activities should be considered to

constitute an evasion of the Dodd-Frank Act. The Internal Revenue

Service distinguished between tax evasion and legitimate means for

citizens to minimize, reduce, avoid or alleviate the tax that they pay

under the Internal Revenue Code. Whereas permissible means of reducing

tax (or ``tax avoidance,'' as the Internal Revenue Service refers to

the practice) is associated with full disclosure and explanation of why

the tax should be reduced under law, tax evasion consists of the

willful attempt to evade tax liability, and generally involves

``deceit, subterfuge, camouflage, concealment, or some attempt to color

or obscure events or to make things seem other than they are.'' \325\

Similarly, persons that craft derivative transactions, structure

entities, or conduct themselves in a deceptive or other illegitimate

manner in order to avoid regulatory requirements should not be

permitted to enjoy the fruits of their deceptive or illegitimate

conduct. In determining whether particular conduct is an evasion of the

Dodd-Frank Act, the CFTC will consider the extent to which the conduct

involves deceit, deception, or other unlawful or illegitimate

activity.\326\

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\325\ The Internal Revenue Service explains:

Avoidance of taxes is not a criminal offense. Any attempt to

reduce, avoid, minimize, or alleviate taxes by legitimate means is

permissible. The distinction between avoidance and evasion is fine,

yet definite. One who avoids tax does not conceal or misrepresent.

He/she shapes events to reduce or eliminate tax liability and, upon

the happening of the events, makes a complete disclosure. Evasion,

on the other hand, involves deceit, subterfuge, camouflage,

concealment, some attempt to color or obscure events or to make

things seem other than they are. For example, the creation of a bona

fide partnership to reduce the tax liability of a business by

dividing the income among several individual partners is tax

avoidance. However, the facts of a particular investigation may show

that an alleged partnership was not, in fact, established and that

one or more of the alleged partners secretly returned his/her share

of the profits to the real owner of the business, who, in turn, did

not report this income. This would be an instance of attempted

evasion.

Internal Revenue Service, Internal Revenue Manual, part

9.1.3.3.2.1, available at http://www.irs.gov/irm/part9/irm_09-001-003.html#d0e169.

\326\ Although deceitful, deceptive, or illegitimate conduct may

be sufficient to find that evasion has occurred, such conduct is not

a prerequisite for a finding of evasion, particularly when other

indicia of evasion are present, such as, for example, when the

transaction lacks any business purpose.

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Request for Comment

The CFTC requests comment on all aspects of the proposed anti-

evasion rules, including the following:

143. Are the CFTC's proposed rules and interpretive guidance set

forth in this section sufficient to address the evasion concerns in

Title VII? Is further guidance necessary? If so, what further guidance

would be appropriate?

[[Page 29868]]

144. Is further definition of the term ``swap'' necessary to

address transactions that have been structured to evade subtitle A of

Title VII? If so, what further definition is appropriate, and why?

Please provide specific examples or scenarios, and a detailed analysis

of any such transactions and the guidance that would be appropriate.

145. In addition to defining the term ``swap'' to address evasion

generally, and with respect to certain foreign exchange products and

identified banking products in particular, are CFTC rules prohibiting

transactions from being willfully structured to evade or attempt to

evade (similar to the proposed rules regarding activities conducted

outside the United States) subtitle A of Title VII appropriate?

B. SEC Request for Comment Regarding Anti-Evasion

Section 761(b)(3) of the Dodd-Frank Act grants discretionary

authority to the SEC to define the terms ``security-based swap,''

``security-based swap dealer,'' ``security-based major swap

participant,'' and ``eligible contract participant,'' with regard to

security-based swaps, ``for the purpose of including transactions and

entities that have been structured to evade subtitle B of Title VII (or

amendments made by subtitle B). Section 772(b) of the Dodd-Frank Act

states that the provisions of the Exchange Act that were added by Title

VII (including any rule or regulation thereunder) shall not apply to

any person insofar as that person transacts a business in security-

based swaps outside the jurisdiction of the United States, unless such

person transacts such business ``in contravention of such rules and

regulations as the [SEC] may prescribe as necessary or appropriate to

prevent evasion of any provision of [the Exchange Act] that was added

by [Title VII].'' \327\

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\327\ See section 30(c) of the Exchange Act, 15 U.S.C. 78dd(c).

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The SEC is not proposing specific rules regarding anti-evasion at

this time. The SEC may consider whether to propose anti-evasion rules

based on comments received or after having experience with the new

regulatory regime under subtitle B of Title VII.

Request for Comment

146. The SEC requests comment on whether SEC rules or interpretive

guidance addressing anti-evasion regarding security-based swaps,

security-based swap dealers, major security-based swap participants, or

ECPs are necessary. Why or why not? Should the SEC adopt rules and

interpretive guidance modeled on the CFTC's proposals? If other rules

or interpretive guidance are necessary, please provide a detailed

description of what rules or interpretative guidance would be

necessary.

147. Are SEC rules or interpretive guidance addressing evasion in

the context of activities conducted outside the United States

necessary? Why or why not? Should the SEC adopt rules and interpretive

guidance modeled on the CFTC's proposals? If other rules or

interpretive guidance are necessary, please provide a detailed

description of what rules or interpretative guidance would be

necessary.

VIII. Administrative Law Matters--CEA Revisions

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') requires that agencies

consider whether the rules they propose will have a significant

economic impact on a substantial number of small entities and, if so,

provide a regulatory flexibility analysis respecting the impact.\328\

Most of the entities that will be impacted by this proposed rulemaking

have previously been determined to not be small entities. In addition,

this proposed rulemaking, which provides interpretive guidance, general

rules of construction and definitions that will largely be used in

other rulemakings will, by itself, not impose a significant economic

impact on market participants or entities.

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\328\ 5 U.S.C. 601 et seq.

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1. Effect of the Proposed Rulemaking

The proposed rulemaking in this release further defines, and

clarifies, the statutory terms ``swap,'' ``security-based swap,''

``security-based swap agreement,'' and ``mixed swap.'' It also provides

a process for requesting joint interpretations from the Commissions as

to whether agreements, contracts, and transactions are swaps, security-

based swaps, or mixed swaps, as well as a process for requesting

alternative regulatory treatment for certain mixed swaps. This proposed

rulemaking also includes books and records, and data, requirements for

SDRs, swap dealers, and major swap participants with respect to SBSAs,

and implements the anti-evasion rulemaking authority granted to the

CFTC under several provisions of the Dodd-Frank Act.

Additionally, this release proposes interpretive guidance that the

forward contract exclusion from the swap definition in the Dodd-Frank

Act with respect to nonfinancial commodities should be read

consistently with the forward contract exclusion from the CEA

definition of the term ``future delivery.'' In that regard, the CFTC is

proposing to retain the Brent Interpretation and extend it to apply to

all nonfinancial commodities, and as a result, to withdraw the Energy

Exemption,\329\ which had extended the Brent Interpretation regarding

the forward contract exclusion from the term ``future delivery'' to

energy commodities other than oil. The Energy Exemption listed certain

``appropriate persons'' that could rely on the exemption.

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\329\ Energy Exemption, supra note 72.

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The CFTC anticipates that this proposed rulemaking will affect

primarily the following entities: DCMs, DCOs, ECPs, swap dealers, major

swap participants, SEFs, SDRs, FBOTs, and those ``appropriate persons''

who previously relied on the Energy Exemption.

2. Specific Entities That Are Not Small Entities

The vast majority of entities impacted by this proposed rulemaking

previously have been determined to not be small entities by the CFTC.

Prior to the enactment of the Dodd-Frank Act, the following entities

had been determined by the CFTC to not be small entities for purposes

of the RFA: DCMs, DCOs, and ECPs. Other entities that will be affected

by this rulemaking, including swap dealers, major swap participants,

SEFs, SDRs, and FBOTs, have been certified by the CFTC not to be small

entities in other proposed recent CFTC rulemaking implementing

requirements of the Dodd-Frank Act. Specifically:

i. Swap Dealers, Major Swap Participants, SEFs, SDRs, and FBOTs.

The CFTC previously has certified that swap dealers, major swap

participants, SEFs, SDRs, and FBOTs are not small entities for purposes

of the RFA.\330\ Nevertheless, because these are new categories of

registrants under the Dodd-Frank Act, the CFTC is, again, hereby

determining that these entities are not small entities.

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\330\ See respectively, Registration of Swap Dealers and Major

Swap Participants, 75 FR 71379, 71385, Nov. 23, 2010 (swap dealers

and major swap participants); Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR

63732, 63745, Oct. 18, 2010 (SEFs); Swap Data Repositories, 75 FR

80898, 80926, Dec. 23, 2010 (SDRs); Registration of Foreign Boards

of Trade, 75 FR 70974, 70987, Nov. 19, 2010 (FBOTs).

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a. Swap Dealers: As noted above, the CFTC previously has determined

that FCMs are not small entities for the purpose of the RFA based upon,

among

[[Page 29869]]

other things, the requirements that FCMs must meet, including certain

minimum financial requirements that enhance the protection of

customers' segregated funds and protect the financial condition of FCMs

generally. Swap dealers similarly will be subject to minimum capital

and margin requirements, and are expected to comprise the largest

global financial firms. Entities that engage in a de minimis quantity

of swap dealing in connection with transactions with or on behalf of

customers will be exempt from designation as a swap dealer. For

purposes of the RFA, the CFTC is hereby determining that swap dealers

not be considered to be ``small entities'' for essentially the same

reasons that FCMs previously have been determined not to be small

entities.

b. Major Swap Participants: The CFTC also previously has determined

that large traders are not small entities for the purpose of the RFA.

Major swap participants, among other things, maintain substantial

positions in swaps, creating substantial counterparty exposure that

could have serious adverse effects on the financial stability of the

U.S. banking system or financial markets. For purposes of the RFA, the

CFTC is hereby determining that major swap participants not be

considered to be ``small entities'' for essentially the same reasons

that large traders previously have been determined not to be small

entities.

c. SEFs: The Dodd-Frank Act defines a SEF to mean a trading system

or platform in which multiple participants have the ability to accept

bids and offers made by multiple participants in the facility or

system, through any means of interstate commerce, including any trading

facility that facilitates the execution of swaps between persons and is

not a DCM. The CFTC previously has determined that DCMs are not small

entities because, among other things, they may be designated only when

they meet specific criteria, including expenditure of sufficient

resources to establish and maintain adequate self-regulatory programs.

Likewise, the CFTC will register an entity as a SEF only after it has

met specific criteria, including the expenditure of sufficient

resources to establish and maintain an adequate self-regulatory

program. For purposes of the RFA, the CFTC is hereby determining that

SEFs not be considered to be ``small entities'' for essentially the

same reasons that DCMs previously have been determined to be small

entities.

d. SDRs: The CFTC previously has determined that DCMs and DCOs are

not small entities because, among other things, of ``the central role''

they play in ``the regulatory scheme concerning futures trading.''

\331\ Because of the ``importance of futures trading in the national

economy,'' to be designated as a contract market or registered as a

DCO, the respective entity must meet stringent requirements set forth

in the CEA. Similarly, swap positions that are recorded, reported and

disseminated by SDRs will be an important part of the national economy.

SDRs will receive data from market participants and will be obligated

to facilitate swap execution by reporting real-time data. Similar to

DCMs and DCOs, SDRs will play a central role both in the regulatory

scheme concerning swap trading. Additionally, the Dodd-Frank Act

permits DCOs to register as SDRs. For purposes of the RFA, the CFTC is

hereby determining that SDRs not be considered to be ``small entities''

for essentially the same reasons that DCMs and DCOs previously have

been determined not to be small entities.

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\331\ Policy Statement and Establishment of Definitions of

``Small Entities'' for Purposes of the Regulatory Flexibility Act,

47 FR 18618, Apr. 30, 1982.

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e. FBOTs. The term ``foreign board of trade'' has been used in the

CEA and in the CFTC's Regulations to refer to a board of trade

``located outside the U.S.'' \332\ The term ``board of trade'' is

defined in the CEA as ``any organized exchange or trading facility.''

\333\ An ``organized exchange,'' in turn, includes designated or

registered exchanges, such as DCMs.\334\ The CFTC previously has

determined that DCMs are not ``small entities.'' As noted above,

because of DCMs' importance to the economy, they must meet stringent

requirements set forth in the CEA. Similarly, the CFTC will register an

FBOT only after it has met criteria similar to those required of a DCM.

Critically, an FBOT will be registered only after demonstrating, among

other things, that it possesses the attributes of an organized

exchange, adheres to appropriate rules prohibiting abusive trading

practices, and enforces appropriate rules to maintain market and

financial integrity. Because FBOTs and DCMs are functionally equivalent

entities, for purposes of the RFA, the CFTC hereby is determining that

FBOTs not be considered to be small entities for essentially the same

reasons that DCMs previously have been determined not to be small

entities.

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\332\ See CEA section 4(a), 7 U.S.C. 6(a); CFTC rule 1.33(ss),

17 C.F.R. 1.33(ss).

\333\ CEA section 1a(2), 7 U.S.C. 1a(2).

\334\ CEA section 1a(27), 7 U.S.C. 1a(27).

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ii. DCMs, DCOs, and ECPs. The CFTC previously has determined that

DCMs, DCOs, and ECPs, are not small entities for purposes of the

Regulatory Flexibility Act.\335\ The Dodd-Frank Act requires that

counterparties to swaps that are traded on a bilateral basis not on or

subject to the rules of a DCM be ECPs. Prior to the enactment of the

Dodd-Frank Act, ECPs trading swaps were generally outside the scope of

CFTC oversight under the CEA. The CFTC cannot estimate with precision

the number of non-ECPs that will, as permitted by the Dodd-Frank Act,

trade swaps on DCMs. Nevertheless, this proposed rulemaking by the CFTC

provides proposed further definitions of the terms ``swap,''

``security-based swap,'' ``mixed swap'' and ``security-based swap

agreement,'' and proposes rules of construction and interpretive

guidance (including guidance as to agreements, contracts, and

transactions that are not included within the scope of the swap

definition), that will largely be used in other rulemakings and which,

by themselves, do not impose significant new regulatory requirements on

market participants.

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\335\ See respectively, Policy Statement and Establishment of

Definitions of ``Small Entities'' for Purposes of the Regulatory

Flexibility Act, supra note 331, at 18619 (DCMs); A New Regulatory

Framework for Clearing Organizations, 66 FR 45604, 45609, Aug. 29,

2001 (DCOs); Opting Out of Segregation. 66 FR 20740, 20743, Apr. 25,

2001 (ECPs).

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iii. ``Appropriate Persons'' who relied on the Energy Exemption.

The Energy Exemption listed certain ``appropriate persons'' that could

rely on the exemption and also required that, to be eligible for this

exemption, an ``appropriate person'' must have a demonstrable capacity

or ability to make or take delivery. The Energy Exemption stated: ``in

light of the general nature of the current participants in the market,

the CFTC believes that smaller commercial firms, which cannot meet

[certain] financial criteria, should not be included.'' \336\

Therefore, the CFTC does not believe that the ``appropriate persons''

eligible for the Energy Exemption, and who may be affected by its

withdrawal, are ``small entities'' for purposes of RFA.

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\336\ Energy Exemption, supra note 72.

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Accordingly, the Chairman, on behalf of the CFTC, hereby certifies

pursuant to 5 U.S.C. 605(b) that the proposed rules will not have a

significant impact on a substantial number of small entities.

Nonetheless, the CFTC specifically requests comment on the impact that

this proposed rulemaking may have on small entities.

[[Page 29870]]

B. Paperwork Reduction Act

1. Introduction

Proposed CFTC rules 1.8 and 1.9 would result in new ``collection of

information'' requirements within the meaning of the Paperwork

Reduction Act of 1995 (``PRA''). An agency may not conduct or sponsor,

and a person is not required to respond to, a collection of information

unless it displays a currently valid Office of Management and Budget

(OMB) control number.

2. Summary of the Proposed Requirements

Proposed rule 1.8 of the CEA would allow persons to submit a

request for a joint interpretation from the Commissions regarding

whether an agreement, contract or transaction (or a class thereof) is a

swap, security-based swap, or mixed swap. Proposed rule 1.8 provides

that a person requesting an interpretation as to the nature of an

agreement, contract, or transaction as a swap, security-based swap, or

mixed swap must provide the Commissions with the person's determination

of the nature of the instrument and supporting analysis, along with

certain other documentation, including a statement of the economic

purpose for, and a copy of all material information regarding the terms

of, each relevant agreement, contract, or transaction (or class

thereof). The Commissions also may request the submitting person to

provide additional information. In response to the submission, the

Commissions may issue a joint interpretation regarding the status of

that agreement, contract, or transaction (or class of agreements,

contracts, or transactions) as a swap, security-based swap, or mixed

swap.

Proposed rule 1.9 enables persons to submit requests to the

Commissions for joint orders providing an alternative regulatory

treatment for particular mixed swaps. Under proposed rule 1.9, a person

would provide to the Commissions a statement of the economic purpose

for, and a copy of all material information regarding, the relevant

mixed swap. In addition, the person would provide the specific

alternative provisions that the person believes should apply to the

mixed swap, the reasons the person believes it would be appropriate to

request an alternative regulatory treatment, and an analysis of: (i)

The nature and purposes of the specified provisions; (ii) the

comparability of the specified provisions to other statutory provisions

of Title VII of the Dodd-Frank Act and the rules and regulations

thereunder; and (iii) the extent of any conflicting or incompatible

requirements of the specified provisions and other statutory provisions

of Title VII and the rules and regulations thereunder. The Commissions

also may request the submitting person to provide additional

information.

3. Information Provided by Reporting Entities

The burdens imposed by proposed CFTC rules 1.8 and 1.9 are the same

as the burdens imposed by the SEC's proposed rules 3a68-2 and 3a68-4.

Therefore, the burdens that would be imposed on market participants

under CFTC rules 1.8 and 1.9 already have been accounted for within the

SEC's calculations regarding the impact of this collection of

information under the PRA and the request for a control number that

will be submitted by the SEC to OMB.\337\

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\337\ 44 U.S.C. 3501-3521. See also 44 U.S.C. 3509 and 3510.

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4. Information Collection Comments

The CFTC invites public comment on any aspect of the reporting and

recordkeeping burdens discussed above. Pursuant to 44 U.S.C.

3506(c)(2)(B), the CFTC solicits comments in order to: (i) Evaluate

whether the proposed collections of information are necessary for the

proper performance of the functions of the CFTC, including whether the

information will have practical utility; (ii) evaluate the accuracy of

the CFTC's estimate of the burden of the proposed collections of

information; (iii) determine whether there are ways to enhance the

quality, utility, and clarity of the information to be collected; and

(iv) minimize the burden of the collections of information on those who

are to respond, including through the use of automated collection

techniques or other forms of information technology.

Comments may be submitted directly to the OMB's Office of

Information and Regulatory Affairs, by fax at (202) 395-6566 or by e-

mail at [email protected] Please provide the CFTC with a

copy of submitted comments so that all comments can be summarized and

addressed in the preamble to the final rulemaking. Please refer to the

Addresses section of this notice of proposed rulemaking for comment

submission instructions to the CFTC. A copy of the supporting

statements for the collections of information discussed above may be

obtained by visiting RegInfo.gov. OMB is required to make a decision

concerning the collections of information between 30 and 60 days after

publication of this release in the Federal Register. Consequently, a

comment to OMB is most ensured of being fully effective if received by

OMB (and the CFTC) within 30 days after publication of this release.

Nothing in the foregoing affects the deadline enumerated above for

public comment to the CFTC on the rules and interpretive guidance

proposed herein.

C. Cost-Benefit Analysis

CEA section 15(a) \338\ requires the CFTC to consider the costs and

benefits of its actions before issuing a rulemaking under the CEA. By

its terms, section 15(a) does not require the CFTC to quantify the

costs and benefits of a rule or to determine whether the benefits of

the rulemaking outweigh its costs; rather, it requires that the CFTC

``consider'' the costs and benefits of its actions. Section 15(a)

further specifies that the costs and benefits shall be evaluated in

light of five broad areas of market and public concern: (i) Protection

of market participants and the public; (ii) efficiency,

competitiveness, and financial integrity of futures markets; (iii)

price discovery; (iv) sound risk management practices; and (v) other

public interest considerations. The CFTC may in its discretion give

greater weight to any one of the five enumerated areas and could in its

discretion determine that, notwithstanding its costs, a particular rule

is necessary or appropriate to protect the public interest or to

effectuate any of the provisions or accomplish any of the purposes of

the CEA.

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\338\ 7 U.S.C. 19(a).

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1. Costs and Benefits of the Proposed Definitions

The proposed rulemaking and interpretive guidance would further

define the terms ``swap,'' ``security-based swap,'' ``security-based

swap agreement,'' and ``mixed swap.'' The scope of the definitions of

the terms ``swap,'' ``security-based swap,'' ``security-based swap

agreement,'' and ``mixed swap'' will be an important factor in

determining the scope of activities and entities that will be subject

to various requirements set forth in the Dodd-Frank Act, such as

reporting, registration, business conduct, and capital requirements.

Those requirements, which will be implemented in rules proposed or to

be proposed by the CFTC, will likely lead to compliance costs, capital

holding costs, and other costs, which have been or will be addressed in

the CFTC's proposals to implement those requirements.

[[Page 29871]]

Yet, the CFTC believes that the proposal to further define the

terms ``swap,'' ``security-based swap,'' ``security-based swap

agreement,'' and ``mixed swap'' is, for the most part, in line with the

expectations of market participants and does not depart significantly

from how market participants would interpret the statutory definitions

of these terms set forth in Title VII of the Dodd-Frank Act. Thus, the

CFTC does not believe that the proposed rules and interpretive guidance

further defining these terms impose any significant incremental costs

beyond the costs associated with the statutory definitions.

The CFTC also believes that the proposed rules and guidance

regarding the definitions will lead to benefits in the form of

increased market transparency, reduced systemic risk, and a lower

incidence of market-wide crises and other market failures. Further, the

proposed rules and guidance can be consistently applied by

substantially all market participants to determine which agreements,

contracts, or transactions are, and which are not, swaps, security-

based swaps, security-based swap agreements, or mixed swaps. Thus, the

proposed rules and interpretive guidance will help to create a level

playing field. Market participants will be able to use Title VII

instruments more efficiently and the swap markets will operate more

effectively because all market participants will be relying on

consistent and clear definitions. The clarity provided by the proposed

rules and interpretive guidance relating to the definitions is in the

public interest because this clarity will permit the public to better

evaluate information about Title VII instruments made available under

the Dodd-Frank Act. In particular, they will allow market participants

to better understand publicly-available price data. The clarity of the

definitions also has the potential to ease the negotiation of Title VII

instruments and reduce other transaction costs. These factors are

expected to permit the public to make a more extensive use of Title VII

instruments for risk management and other purposes.

The CFTC requests comment as to the costs and benefits of the

proposed rules and interpretive guidance regarding the definitions for

market participants, markets, and the public. In particular, comment is

requested as to whether there are any aspects of the proposed rules and

interpretive guidance regarding the definitions that are both

burdensome to apply and not helpful to achieving clarity as to the

scope of the defined terms. In addition, are there less burdensome

means of providing clarity as to the scope of the defined terms?

2. Costs and Benefits of Proposed Rules and Interpretive Guidance

Regarding Insurance

Proposed CFTC rule 1.3(xxx)(4) under the CEA would clarify that

insurance products that meet certain requirements, that are provided by

state or Federally regulated insurance companies, and that are

regulated as insurance products, would not be swaps. Specifically,

proposed rule 1.3(xxx)(4) would define the term ``swap'' so that it

would not include an agreement, contract, or transaction that, by its

terms or by law, as a condition of performance on the agreement,

contract, or transaction: (i) Requires the beneficiary to have an

insurable interest that is the subject of the agreement, contract, or

transaction and thereby carry the risk of loss with respect to that

interest continuously throughout the duration of the agreement,

contract, or transaction; (ii) requires that loss to occur and to be

proved, and that any payment or indemnification therefore be limited to

the value of the insurable interest, separately from the insured

interest; (iii) is not traded, separately from the insured interest, on

an organized market or over-the-counter; and (iv) with respect to

financial guarantee insurance only, in the event of payment default or

insolvency of the obligor, any acceleration of payments under the

policy is at the sole discretion of the insurer.

Proposed rule 1.3(xxx)(4) also would require that the agreement,

contract, or transaction: (i) Be provided by a person or entity that is

organized as an insurance company whose primary and predominant

business activity is the writing of insurance or the reinsuring of

risks underwritten by insurance companies and that is subject to

supervision by the insurance commissioner, or similar official or

agency, of a state (as defined under section 3(a)(16) of the Exchange

Act \339\) or by the United States or an agency or instrumentality

thereof, and be regulated as insurance under the laws of such state or

the United States; (ii) be provided by the United States or any of its

agents or instrumentalities, or pursuant to a statutorily authorized

program thereof; or (iii) in the case of reinsurance only, be provided

by a person located outside the United States to an insurance company

that meets the above requirements, provided that such person is not

prohibited by the law of any state or the United States from offering

such agreement, contract, or transaction to such insurance company, the

product to be reinsured meets the requirements above for insurance

products, and the total amount reimbursable by all reinsurers for such

insurance product cannot exceed the claims or losses paid by the

cedant.

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\339\ 15 U.S.C. 78c(a)(16).

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An agreement, contract, or transaction would have to meet all of

these criteria in order to qualify as an insurance product that falls

outside of the swap and security-based swap definitions pursuant to the

proposed rules. The Commissions also are proposing interpretative

guidance to clarify that certain enumerated types of traditional

insurance products, such as life insurance, health insurance, and

property and casualty insurance, are outside the scope of the statutory

swap and security-based swap definitions.

(a) Costs

In complying with proposed rule 1.3(xxx)(4), a market participant

will need to ascertain whether an agreement, contract, or transaction

is an insurance product according to the criteria set forth in the

definition. This analysis will have to be performed upon entering into

the agreement, contract, or transaction to ensure compliance with the

proposed rule. Absent this analysis, however, the cost associated with

the uncertainty cited by commenters as to whether an agreement,

contract, or transaction that the participants consider to be insurance

could instead be regulated as a swap is expected to be greater than the

cost of the analysis proposed herein.

To the extent that the criteria under proposed rule 1.3(xxx)(4)

inadvertently fail to exclude certain types of insurance products from

the proposed definitions, these failures could lead to costs for market

participants entering into agreements, contracts, or transactions that

might be improperly regulated as swaps and not as insurance products.

Similarly, to the extent that the criteria under the proposed rule lead

to the inadvertent treatment of certain types of swaps as insurance,

costs for market participants entering into agreements, contracts, or

transactions that are improperly regulated as insurance products and

not as swaps may increase.

(b) Benefits

The proposed rule and interpretative guidance regarding insurance

will help to assure that traditional insurance products remain subject

to the current regulatory scheme for insurance and not to the

regulatory regime established by the Dodd-Frank Act for swaps. Market

[[Page 29872]]

participants, therefore, will be able to continue to rely on their

previous understanding of insurance regulations without any additional

burden that may have resulted if they had to instead comply with

regulations under the Dodd-Frank Act.

Without the proposed rule and interpretative guidance herein,

market participants may be uncertain about whether an agreement,

contract, or transaction is an insurance product that is subject to

regulation as a swap. Proposed rule 1.3(xxx)(4) is intended to

eliminate the potential uncertainty of what constitutes an insurance

product by setting forth clear and objective criteria for determining

that an agreement, contract, or transaction is an insurance product

that is not subject to regulation as a swap. Providing such an

objective rule and guidance alleviates additional costs of inquiring

with the Commissions, or obtaining an opinion of counsel, about whether

an agreement, contract, or transaction is an insurance product or a

swap. The added clarity provided by the rule and guidance proposed

herein will enhance the efficiency of the swaps market and also allow

market participants to engage in sound risk management practices

because they will be readily able to consider whether a particular

agreement, contract, or transaction is insurance or a swap at the

outset.

The CFTC requests comment as to the costs and benefits of proposed

rule 1.3(xxx)(4) and interpretive guidance contained herein to

distinguish between insurance products and swaps for market

participants, markets, and the public.

3. Costs and Benefits of Proposed Rule Regarding Foreign Exchange

Products and Forward Rate Agreements

Proposed CFTC rule 1.3(xxx)(2) under the CEA would explicitly

define the term ``swap'' to include an agreement, contract, or

transaction that is a cross-currency swap, currency option, foreign

currency option, foreign exchange option, foreign exchange rate option,

foreign exchange forward, foreign exchange swap, forward rate

agreement, and non-deliverable forward involving foreign exchange,

unless such agreement, contract, or transaction is otherwise excluded

by section 1a(47)(B) of the CEA. Proposed rule 1.3(xxx)(2) also

provides that: (i) A foreign exchange forward or a foreign exchange

swap shall not be considered a swap if the Secretary of the Treasury

makes the determination described in CEA section 1a(47)(E)(i); and (ii)

notwithstanding any such determination, certain provisions of the CEA

will apply to such foreign exchange forward or foreign exchange swap

(specifically, the reporting requirements in section 4r of the CEA and

regulations thereunder and, in the case of a swap dealer or major swap

participant that is a party to a foreign exchange swap or foreign

exchange forward, the business conduct standards in section 4s of the

CEA and regulations thereunder). Proposed rule 1.3(xxx)(2) further

clarifies that a currency swap, cross-currency swap, currency option,

foreign currency option, foreign exchange option, foreign exchange rate

option, or non-deliverable forward involving foreign exchange is not a

foreign exchange forward or foreign exchange swap subject to a

determination by the Secretary of the Treasury as described above.

(a) Costs

In complying with proposed rule 1.3(xxx)(2), a market participant

will need to ascertain whether an agreement, contract, or transaction

is a swap under the definition. This analysis will have to be performed

upon entering into the agreement, contract, or transaction to ensure

compliance with the proposed rule. However, any costs associated with

this analysis are expected to be less than the costs of doing the same

analysis absent the proposed rule, particularly given potential

confusion in the event of a determination by the Secretary of the

Treasury that foreign exchange forwards and/or foreign exchange swaps

not be considered swaps. To the extent that proposed rule 1.3(xxx)(2)

leads to the improper inclusion of certain types of agreements,

contracts, and transactions in the swap definition, and therefore the

imposition of additional requirements and obligations, these

requirements and obligations could lead to costs for market

participants entering into such agreements, contracts, or transactions.

(b) Benefits

Because the statutory definition of the term ``swap'' includes a

process by which the Secretary of the Treasury may determine that

certain agreements, contracts, and transactions that meet the statutory

definition of a ``foreign exchange forward'' or ``foreign exchange

swap,'' respectively,\340\ shall not be considered a swap, the CFTC is

concerned that application of the definition, without further

clarification, may cause uncertainty about whether, if the Secretary of

the Treasury makes such a determination, certain agreements, contracts,

or transactions would be swaps. Proposed rule 1.3(xxx)(2) would clarify

that a currency swap, cross-currency swap, currency option, foreign

currency option, foreign exchange option, foreign exchange rate option,

or non-deliverable forward involving foreign exchange is a swap (unless

it is otherwise excluded by the statutory definition of the term

``swap''). The proposed rule also would clarify that reporting

requirements, and business conduct requirements for swap dealers and

major swap participants, are applicable to foreign exchange forwards

and foreign exchange swaps even if the Secretary of the Treasury

determines that they should not be considered swaps. The CFTC also is

concerned that confusion could be generated by the ``forward'' label of

non-deliverable forwards involving foreign exchange, and forward rate

agreements. Proposed rule 1.3(xxx)(2) would clarify that these types of

agreements, contracts, and transactions are swaps.

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\340\ CEA section 1a(24), 7 U.S.C. 1a(24)(definition of a

``foreign exchange forward''); CEA section 1a(25), 7 U.S.C.

1a(25)(definition of a ``foreign exchange swap'').

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Providing a clarifying rule to market participants to determine

whether certain types of agreements, contracts, or transactions are

swaps alleviates additional costs to persons of inquiring with the

Commissions, or obtaining an opinion of counsel, about whether such

agreements, contracts, or transactions are swaps. In addition, a

clarifying rule regarding the requirements that apply to foreign

exchange forwards and foreign exchange swaps that are subject to a

determination by the Secretary of the Treasury similarly alleviates

additional costs to persons of inquiring with the Commissions, or

obtaining an opinion of counsel, to determine the requirements that are

applicable to such foreign exchange forwards and foreign exchange

swaps. As with the other rules related to product definitions, added

clarity will increase the efficiency of the swaps market and also will

enable market participants to engage in sound risk management

practices, which will benefit both market participants and the public.

The CFTC requests comment as to the costs and benefits of proposed

rule 1.3(xxx)(2) for market participants, markets, and the public.

4. Costs and Benefits of Proposed Rules and Interpretive Guidance

Regarding Title VII Instruments Where the Underlying Reference Is a

Security Index

Proposed CFTC rule 1.3(yyy)(1) provides that, for purposes of the

security-based swap definition, the term ``narrow-based security

index'' would have the same meaning as the statutory definition set

forth in CEA section

[[Page 29873]]

1a(35), and the rules, regulations, and orders issued by the

Commissions relating to such definition. As a result, except as the new

rules the Commissions are proposing provide for other treatment, market

participants generally will be able to use the Commissions' past

guidance in determining whether certain Title VII instruments based on

a security index are swaps or security-based swaps.

The Commissions also are proposing interpretive guidance and

additional rules regarding Title VII instruments based on a security

index. The interpretive guidance and additional rules set forth new

narrow-based security index criteria with respect to indexes composed

of securities, loans, or issuers of securities referenced by an index

CDS. The proposed interpretive guidance and rules also address the

definition of an ``index'' and the treatment of broad-based security

indexes that become narrow-based and narrow-based indexes that become

broad-based, including rule provisions regarding tolerance and grace

periods for swaps on security indexes that are traded on CFTC-regulated

trading platforms.

(a) Costs

In complying with the proposed rules, a market participant will

need to ascertain whether an index CDS is a swap or a security-based

swap according to the criteria set forth in the definitions of the

terms ``issuers of securities in a narrow-based security index'' and

``narrow-based security index'' as used in the security-based swap

definition. This analysis will have to be performed upon entering into

an index CDS, and when the material terms of an index CDS are amended

or modified, to ensure compliance with proposed rules 1.3(zzz) or

1.3(aaaa). However, any such costs are expected to be less than the

costs of doing the same analysis absent the proposed rules, which the

CFTC believes would be more difficult and lead to greater uncertainty.

Proposed rules 1.3(zzz) and 1.3(aaaa) allow market participants to

minimize the costs of determining whether an index CDS is a swap or a

security-based swap by providing a test with objective criteria that is

similar to a test with which they already are familiar in the security

futures context, yet tailored to index CDS in particular.

Additionally, absent proposed rule 1.3(yyy), which applies the

tolerance period rules, if a security index underlying a Title VII

instrument traded on a trading platform migrated from being broad-based

to being narrow-based, market participants may suffer disruption of

their ability to offset or enter into new Title VII instruments, and

incur additional costs as a result.

(b) Benefits

Proposed rules 1.3(zzz) and 1.3(aaaa) would clarify the treatment

of an index CDS as either a swap or a security-based swap by setting

forth objective criteria for meeting the definition of the terms

``issuers of securities in a narrow-based security index'' and

``narrow-based security index,'' respectively. These objective rules

will alleviate additional costs to persons trading index CDS of

inquiring with the Commissions, or obtaining an opinion of counsel, to

make complex determinations regarding whether an index is broad- or

narrow-based, and whether an index CDS based on such an underlying

index is a swap or security-based swap.

Also, proposed rules 1.3(zzz) and 1.3(aaaa) should reduce the

potential for market participants to use an index CDS to evade

regulations, because they set objective requirements relating to the

concentration of the notional amount allocated to each reference entity

or security included in the index, as well as the eligibility

conditions for reference entities and securities. Finally, these

proposed rules benefit the public by requiring that the providers of

index CDS make publicly available sufficient information regarding the

reference entities in an index underlying the index CDS. By requiring

that such information be made publicly available, proposed rules

1.3(zzz) and 1.3(aaaa) seek to assure the transparency of the index

components that will be beneficial to market participants who trade

such instruments and to the public.

Separately, proposed rule 1.3(yyy) addresses exchange-traded swaps

based on security indexes where the underlying index migrates from

broad-based to narrow-based. The proposed rule includes provisions that

many market participants are familiar with from security futures

trading. The CFTC believes that by using a familiar regulatory scheme,

market participants will be able to more readily understand the

proposed rule as compared to a wholly new regulatory scheme. Also, the

proposal of a ``tolerance period'' for swaps on security indexes that

migrate from broad-based to narrow-based also creates greater clarity

by establishing a 45-day timeframe (and subsequent grace period) on

which market participants may rely. This tolerance period results in

cost savings when compared to the alternative scenario where no

tolerance period is provided and a migration of an index from broad-

based to narrow-based would result in potential impediments to the

ability of market participants to offset their swap positions.

Finally, the Commissions are proposing interpretive guidance that

the determination of whether a Title VII instrument is a swap, a

security-based swap, or both (i.e., a mixed swap), is made at the

execution of the Title VII instrument. If the security index underlying

a Title VII instrument migrates from being broad-based to being narrow-

based, or vice versa, during the life of a Title VII instrument, the

characterization of that Title VII instrument would not change from its

initial characterization regardless of whether the Title VII instrument

was entered into bilaterally or was executed through a trade on or

subject to the rules of a DCM, SEF, FBOT, security-based SEF, or NSE.

Absent this guidance, market participants may need to expend additional

resources to continually monitor their swaps to see if the indexes on

which they are based have migrated from broad-based to narrow-based.

Since the proposal provides that the initial determination prevails

regardless of whether the underlying index migrates from broad-based to

narrow-based, market participants do not need to expend these

monitoring costs.

The CFTC requests comment as to the costs and benefits of proposed

rules 1.3(yyy), 1.3(zzz), and 1.3(aaaa), and the proposed guidance

contained herein, regarding Title VII instruments where the underlying

reference is a security index, and regarding index CDS, for market

participants, markets, and the public.

5. Costs and Benefits of Processes To Determine Whether a Title VII

Instrument Is a Swap, Security-Based Swap, or Mixed Swap, and To

Determine Regulatory Treatment for Mixed Swaps

(a) Costs

Proposed rule 1.8 under the CEA would allow persons to submit a

request for a joint interpretation from the Commissions regarding

whether an agreement, contract or transaction (or a class of

agreements, contracts, or transactions) is a swap, security-based swap,

or mixed swap. The CFTC estimates the cost of submitting a request for

a joint interpretation pursuant to rule 1.8 would be approximately 20

hours of internal company or individual time and a cost of $9,480 for

the services of outside professionals. Once such a joint interpretation

is made, however, other market participants that seek to transact in

the same agreement, contract, or

[[Page 29874]]

transaction (or class thereof) would have regulatory clarity about

whether it is a swap, security-based swap, or mixed swap.

Separately, proposed CFTC rule 1.9 under the CEA allows persons to

submit a request for a joint order from the Commissions regarding an

alternative regulatory treatment for particular mixed swaps. This

process applies except with respect to bilateral, uncleared mixed swaps

where one of the parties to the mixed swap is dually registered with

the CFTC as a swap dealer or major swap participant and with the SEC as

a security-based swap dealer or major security-based swap participant.

With respect to bilateral uncleared mixed swaps where one of the

parties is a dual registrant, the proposed rule provides that such

mixed swaps would be subject to a regulatory scheme set forth in rule

1.9 in order to provide clarity as to the regulatory treatment of such

mixed swaps.

The CFTC estimates that the cost of submitting a request for a

joint order seeking an alternative regulatory treatment for a

particular mixed swap would be approximately 30 hours of internal

company or individual time and a cost of approximately $15,800 for the

services of outside professionals. Absent such a process, though,

market participants that desire or intend to enter into such a mixed

swap (or class thereof) would be required pursuant to Title VII of the

Dodd-Frank Act to comply with all regulatory requirements applicable to

both swaps and security-based swaps. The CFTC believes that the cost of

such dual regulation would likely be at least as great, if not greater,

than the costs of the process set forth in proposed rule 1.9 to request

an alternative regulatory treatment for such the mixed swap. The

proposed rule regarding bilateral uncleared mixed swaps where at least

one party is a dual registrant does not entail any additional costs,

and may reduce costs for dual registrants that enter into such mixed

swaps by eliminating potentially duplicative or inconsistent

regulation.

(b) Benefits

The CFTC believes that the proposed rules that enable market

participants to submit requests for joint interpretations regarding the

nature of various agreements, contracts, or transactions, and requests

for joint orders regarding the regulatory treatment of mixed swaps,

will help to create a level playing field (since the joint

interpretations and joint orders will be available to all market

participants) regarding which agreements, contracts, or transactions

constitute swaps, security-based swaps, or mixed swaps, and the

regulatory treatment applicable to particular mixed swaps. The

availability of such joint interpretations and joint orders regarding

the scope of the definitions and the regulatory treatment of mixed

swaps will reduce transaction costs and thereby promote the use of

Title VII instruments and the efficient operation of the swap markets.

This, in turn, is expected to encourage the use of Title VII

instruments for risk management and other purposes. The separate

proposed rule for bilateral uncleared mixed swaps where at least one

party is dually registered should eliminate potentially duplicative and

inconsistent regulation.

The CFTC requests comment as to the costs and benefits of the

processes for seeking joint interpretations and joint orders in

proposed rules 1.8 and 1.9, respectively, for market participants,

markets, and the public.

6. Costs and Benefits of SBSA Books and Records, and Data, Requirements

Proposed CFTC rule 1.7 under the CEA would clarify that there would

not be books and records, or data, requirements regarding SBSAs other

than those that would exist for swaps. The proposed rule alleviates any

additional books and records or information costs to persons who are

required to keep and maintain books and records regarding, or collect

and maintain data regarding, SBSAs because the proposed rule does not

require such persons to keep or maintain any books and records, or

collect and maintain any data, regarding, SBSAs that differs from the

books, records, and data required regarding swaps.

Specifically, proposed rule 1.7 would require persons registered as

SDRs to: (i) keep and maintain books and records regarding SBSAs only

to the extent that SDRs are required to keep and maintain books and

records regarding swaps; and (ii) collect and maintain data regarding

SBSAs only to the extent that SDRs are required to collect and maintain

data regarding swaps. In addition, proposed rule 1.7 would require

persons registered as swap dealers or major swap participants to keep

and maintain books and records, including daily trading records,

regarding SBSAs only to the extent that those persons would be required

to keep and maintain books and records regarding swaps.

Because proposed rule 1.7 imposes no requirements with respect to

SBSAs other than those that exist for swaps, proposed rule 1.7 would

impose no costs other than those that are required with respect to

swaps in the absence of proposed rule 1.7. Proposed rule 1.7 provides

clarity by establishing uniform requirements regarding books and

records, and data collection, requirements for swaps and for SBSAs.

The CFTC requests comment as to the costs and benefits of proposed

rule 1.7 for market participants, markets, and the public.

7. Costs and Benefits of the Proposed Interpretive Guidance Regarding

the Forward Contract Exclusion From the Swap Definition

The CFTC is proposing interpretive guidance that the forward

contract exclusion from the swap definition for nonfinancial

commodities should be read consistently with the forward contract

exclusion from the CEA definition of the term ``future delivery.'' In

that regard, the CFTC is proposing to retain the Brent Interpretation

and extend it to apply to all nonfinancial commodities, and to withdraw

the Energy Exemption which had extended the Brent Interpretation

regarding the forward contract exclusion from the term ``future

delivery'' to energy commodities other than oil. The CFTC also is

proposing that its prior guidance regarding commodity options embedded

in forward contracts should be applied as well to the treatment of

forward contracts in nonfinancial commodities that contain embedded

options under the Dodd-Frank Act.

The CFTC anticipates that its proposed interpretive guidance

construing the forward contract exclusion consistently with respect to

the definitions of the terms ``swap'' and ``future delivery'' in this

manner will not impose any material costs on market participants. It

also will establish a uniform interpretation of the forward contract

exclusion for the definitions of both statutory terms, which will avoid

the significant costs that some commenters stated would result if the

forward contract exclusion were construed differently in these two

contexts.\341\

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\341\ See EEI Letter (``Without legal certainty as to the

regulatory treatment of their forward contracts, EEI's members and

other end users who rely on the forward contract exclusion likely

will face higher transaction costs due to greater uncertainty. These

increased transaction costs may include: (i) More volatile or higher

commodity prices; and (ii) increased credit costs, in each case

caused by changes in market liquidity as end users change the way

they transact in the commodity markets. A single regulatory approach

that uses the same criteria to confirm that a forward contract is

excluded from the Commission's jurisdiction over swaps and futures

will reduce this uncertainty and the associated costs to end

users.'' (footnote omitted)).

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The CFTC requests comment as to the costs and benefits of the

proposed interpretative guidance regarding the

[[Page 29875]]

forward contract exclusion from the swap definition, including the

retention of the Brent Interpretation and its extension to all

nonfinancial commodities and the withdrawal of the Energy Exemption,

for market participant, markets, and the public.

8. Costs and Benefits of the Proposed Anti-Evasion Rules and

Interpretive Guidance

The CFTC is proposing to exercise the anti-evasion rulemaking

authority granted to it by the Dodd-Frank Act. Generally, proposed CFTC

rule 1.3(xxx)(6) under the CEA would define as a swap any agreement,

contract, or transaction that is willfully structured to evade (or as

an attempt to evade) the provisions of Title VII governing the

regulation of swaps. Further, proposed CFTC rule 1.6 under the CEA

would prohibit activities conducted outside the United States,

including entering into agreements, contracts, and transactions and

structuring entities, to willfully evade any provision of the CEA as

enacted by Title VII or the rules and regulations promulgated

thereunder.

As opposed to providing a bright-line test, proposed rule

1.3(xxx)(6) would apply to agreements, contracts, and transactions, and

proposed rule 1.6 would apply to agreements, contracts, transactions

and entities, that are willfully structured to evade (or as an attempt

to evade) the provisions of Title VII governing the regulation of

swaps. Although this test does not provide a bright line, it helps

ensure that would-be evaders cannot intentionally structure their

transactions or entities for the sole purpose of evading the

requirements of Title VII. The CFTC also is proposing interpretive

guidance as to certain types of circumstances that may constitute an

evasion of the requirements of Title VII, while at the same time

preserving the CFTC's ability to determine, on a case-by-case basis,

that other types of transactions or actions constitute an evasion of

the requirements of the statute or the regulations promulgated

thereunder. This will promote the enforcement of the anti-evasion rules

in a manner that does not inappropriately interfere with activities

undertaken for legitimate business purposes.

Absent the proposed anti-evasion rules and interpretive guidance,

price discovery would be impaired because markets would not be informed

about those transactions. Additionally, systemic risk could increase in

a manner that the CFTC would not be able to measure accurately. The

proposed anti-evasion rules and interpretive guidance will bring the

appropriate scope of transactions and entities within the regulatory

framework established by the Dodd-Frank Act, which will better allow

the CFTC to assure transparency and address systemic risk.

Request for Comment

148. After considering the costs and benefits of the proposed rules

and interpretive guidance as discussed in this section, the CFTC has

determined to issue the proposal. The CFTC invites public comment on

all of its cost-benefit considerations. Commenters are requested to

submit empirical data or other factual information quantifying or

qualifying the costs and benefits of the proposed rules and

interpretive guidance with their comments, to the extent possible.

D. Consideration of Impact on the Economy

For purposes of the Small Business Regulatory Enforcement Fairness

Act of 1996 (``SBREFA'') \342\ the CFTC must advise the Office of

Management and Budget as to whether the proposed rules constitute a

``major'' rule. Under SBREFA, a rule is considered ``major'' where, if

adopted, it results or is likely to result in: (i) An annual effect on

the economy of $100 million or more (either in the form of an increase

or a decrease); (ii) a major increase in costs or prices for consumers

or individual industries; or (iii) significant adverse effect on

competition, investment or innovation. If a rule is ``major,'' its

effectiveness will generally be delayed for 60 days pending

Congressional review. The CFTC does not believe that any of the

proposed rules in this release, in their current form, would constitute

a major rule.

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\342\ Public Law 104-121, Title II, 110 Stat. 857 (1996)

(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note

to 5 U.S.C. 601).

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The CFTC requests comment on the potential impact of the proposed

rules on the economy on an annual basis, on the costs or prices for

consumers or individual industries, and on competition, investment or

innovation. Commenters are requested to provide empirical data and

other factual support for their views to the extent possible.

IX. Administrative Law Matters--Exchange Act Revisions

A. Paperwork Reduction Act

1. Background

Proposed rules 3a68-2 and 3a68-4(c) would contain new ``collection

of information'' requirements within the meaning of the Paperwork

Reduction Act of 1995.\343\ The SEC is submitting them to the Office of

Management and Budget (``OMB'') for review in accordance with the

PRA.\344\ An agency may not conduct or sponsor, and a person is not

required to respond to, a collection of information unless it displays

a currently valid OMB control number. OMB has not yet assigned a

control number to the new collection of information.

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\343\ 44 U.S.C. 3501 et seq.

\344\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.

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These proposed rules contain collections and are being proposed

pursuant to the Exchange Act. The proposed rules would establish a

process through which a person could submit a request to the

Commissions that the Commissions provide a joint interpretation of

whether an agreement, contract, or transaction (or class thereof) is a

swap, security-based swap, or both (i.e., a mixed swap). The rules also

would establish a process with respect to mixed swaps through which a

person could submit a request to the Commissions that the Commissions

issue a joint order permitting the requesting person (and any other

person or persons that subsequently lists, trades, or clears that class

of mixed swap) to comply, as to parallel provisions only, with the

specified parallel provisions, instead of being required to comply with

parallel provisions of both the CEA and the Exchange Act. The hours and

costs associated with preparing and sending these requests would

constitute reporting and cost burdens imposed by each collection of

information.

2. Summary of Collection of Information Under Proposed Rules 3a68-2 and

3a68-4(c)

The SEC is proposing new rules that would allow persons to submit

requests to the Commissions for joint interpretations regarding whether

a particular agreement, contract, or transaction (or class thereof) is

a swap, security-based swap, or both (i.e., a mixed swap), and for

joint orders permitting alternative regulatory treatment for particular

mixed swaps.

First, the SEC is proposing new rule 3a68-2, which would allow

persons to submit a request for a joint interpretation from the

Commissions regarding whether an agreement, contract, or transaction

(or a class thereof) is a swap, security-based swap, or both (i.e., a

mixed swap). Under proposed rule 3a68-2, a person would provide to the

Commissions a copy of all material information regarding the terms of,

and a statement of the economic characteristics and purpose of, each

relevant agreement, contract, or

[[Page 29876]]

transaction (or class thereof), along with that person's determination

as to whether each such agreement, contract, or transaction (or class

thereof) should be characterized as a swap, security-based swap, or

both (i.e., a mixed swap). The Commissions also may request the

submitting person to provide additional information.

The Commissions may issue in response a joint interpretation or

joint notice of proposed rulemaking regarding the status of that

agreement, contract, or transaction (or class thereof) as a swap,

security-based swap, or both (i.e., a mixed swap). Any joint

interpretation, like any joint notice of proposed rulemaking, will be

public and may discuss the material information regarding the terms of

the relevant agreement, contract, or transaction (or class thereof), as

well as any other information the Commissions deem material to the

interpretation.

Requesting persons also would be permitted to withdraw a request

made pursuant to proposed rule 3a68-2 at any time before the

Commissions have issued a joint interpretation or joint notice of

proposed rulemaking in response to the request. Regardless of a

particular request for interpretation, however, the Commissions could

provide such a joint interpretation or joint notice of proposed

rulemaking of their own accord.

Persons would submit requests pursuant to proposed rule 3a68-2 on a

voluntary basis. However, if a person submits a request, all of the

information required under the proposed rule, including any additional

information requested by the Commissions, must be submitted to the

Commission, except to the extent a person withdraws the request

pursuant to the proposed rule.

For purposes of the PRA, the SEC estimates that the total annual

paperwork burden resulting from proposed rule 3a68-2 would be

approximately 20 hours of internal company or individual time and a

cost of approximately $9,480 for the services of outside professionals

that the SEC believes would consist of services provided by

attorneys.\345\ As discussed further below, these total costs include

all collection burdens associated with the proposed rules, including

burdens related to the initial determination requirements.

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\345\ For convenience, the estimated PRA hour burdens have been

rounded to the nearest whole dollar. Data from SIFMA's ``Management

& Professional Earnings in the Securities Industry 2009,'' modified

by SEC staff to account for an 1800-hour work-year and multiplied by

5.35 to account for bonuses, firm size, employee benefits, and

overhead, suggest that that the cost of an attorney is $316 per

hour.

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Second, the SEC is proposing new rule 3a68-4(c), which would allow

persons to submit requests to the Commissions for joint orders

regarding the regulation of a particular mixed swap (or class thereof).

Under proposed rule 3a68-4(c), a person would provide to the

Commissions a copy of all material information regarding the terms of,

and the economic characteristics and purpose of, the specified (or

specified class of) mixed swap. In addition, a person would provide the

specified parallel provisions, and the reasons the person believes such

specified parallel provisions would be appropriate for relevant mixed

swap (or class thereof), and an analysis of: (i) The nature and

purposes of the parallel provisions that are the subject of the

request; (ii) the comparability of such parallel provision; and (iii)

the extent of any conflicts or differences between such parallel

provisions. The Commissions also may request the submitting person to

provide additional information.

The Commissions may issue in response a joint order, after public

notice and opportunity for comment, providing that the requesting

person (and any other person or persons that subsequently lists,

trades, or clears that mixed swap (or class thereof)) is permitted to

comply, as to parallel provisions only, with the specified parallel

provisions (or another subset of the parallel provisions that are the

subject of the request, as the Commissions determine is appropriate),

instead of being required to comply with parallel provisions of both

the CEA and the Exchange Act. Any joint order will be public and may

discuss the material information regarding the terms of the mixed swap

(or class thereof), as well as any other information the Commissions

deem material to the order. Requesting persons also would be permitted

to withdraw a request made pursuant to proposed rule 3a68-4(c) at any

time before the Commissions have issued a joint order in response to

the request.

Persons would submit requests pursuant to proposed rule 3a68-4(c)

on a voluntary basis. However, if a person submits a request, all of

the information required under the proposed rule, including any

additional information requested by the Commissions, must be submitted

to the Commission, except to the extent a person withdraws the request

pursuant to the proposed rule.

For purposes of the PRA, the SEC estimates that the total annual

incremental paperwork burden resulting from proposed rule 3a68-4(c)

would be approximately 30 hours of internal company or individual time

and a cost of approximately $15,800 for the services of outside

professionals, which the SEC believes would consist of services

provided by attorneys.\346\ As discussed further below, these total

costs include all collection burdens associated with the proposed

rules, including burdens related to the initial determination

requirements.

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\346\ See supra note 345.

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3. Proposed Use of Information

The SEC would use the information collected pursuant to proposed

rule 3a68-2 to evaluate an agreement, contract, or transaction (or

class thereof) in order to provide joint interpretations or joint

notices of proposed rulemaking with the CFTC regarding whether these

agreements, contracts, or transactions (or classes thereof) are swaps,

security-based swaps, or both (i.e., mixed swaps) as defined in the

Dodd-Frank Act. The SEC would use the information collected pursuant to

proposed rule 3a68-4(c) to evaluate a specified, or a specified class

of, mixed swaps in order to provide joint orders or joint notices of

proposed rulemaking with the CFTC regarding the regulation of that

particular mixed swap or class of mixed swap. The information provided

to the SEC pursuant to proposed rules 3a68-2 and 3a68-4(c) also would

allow the SEC to monitor the development of new OTC derivatives

products in the marketplace and determine whether additional rulemaking

or interpretive guidance is necessary or appropriate.

4. Respondents

It is difficult to calculate the precise number of requests that

would be submitted to the Commissions under proposed rules 3a68-2 and

3a68-4(c), given the historical unregulated state of the OTC

derivatives market. Although any person could submit a request under

proposed rule 3a68-2, the SEC believes as a practical matter that the

relevant categories of such persons would be swap dealers and security-

based swap dealers, major swap participants and major security-based

swap participants, SEFs, security-based SEFs, DCOs clearing swaps, DCMs

trading swaps, SDRs, SBSDRs, and clearing agencies clearing security-

based swaps, and the total number of persons could be 475.\347\

Similarly, although any

[[Page 29877]]

person could submit a request under proposed rule 3a68-4(c), the SEC

believes as a practical matter that the relevant categories of such

persons would be SEFs, security-based SEFs, and DCMs trading swaps, and

the total number of persons could be 72.\348\

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\347\ This total number includes an estimated 250 swap dealers,

50 major swap participants, 50 security-based swap dealers, 10 major

security-based swap participants, 35 SEFs, 20 security-based SEFs,

12 DCOs, 17 DCMs, 15 SDRs, 10 SBSDRs, and 6 clearing agencies, as

set forth by the CFTC and SEC, respectively, in their other Dodd-

Frank Act rulemaking proposals. See Entity Definitions, supra note

12 (regarding security-based swap dealers and major security-based

swap participants); Registration of Swap Dealers and Major Swap

Participants, supra note 330 (regarding swap dealers and major

security-based swap participants); Security-Based Swap Data

Repository Registration, Duties, and Core Principles, supra note 6

(regarding SBSDRs); Swap Data Repositories, supra note 330

(regarding SDRs); Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR 1214, Jan. 7, 2011 (regarding SEFs);

Registration and Regulation of Security-Based Swap Execution

Facilities, 76 FR 10948, Feb. 28, 2011 (regarding security-based

SEFs); Financial Resources Requirements for Derivatives Clearing

Organizations, 75 FR 63113, Oct. 14, 2010 (regarding DCOs);

Information Management Requirements for Derivatives Clearing

Organizations, 75 FR 78185, Dec. 15, 2010 (regarding DCOs); Risk

Management Requirements for Derivatives Clearing Organizations, 76

FR 3698, Jan. 20, 2011 (regarding DCOs); Core Principles and Other

Requirements for Designated Contract Markets, 75 FR 80572, Dec. 22,

2010 (regarding DCMs); Clearing Agency Standards for Operation and

Governance, 76 FR 14472, Mar. 16, 2011 (regarding clearing

agencies).

\348\ Id.

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However, based on the SEC's experience and information received

from commenters to the ANPR \349\ and during meetings with the public

to discuss the Product Definitions generally, including the

interpretation of whether a transaction is a swap, security-based swap,

or both (i.e., a mixed swap), and taking into consideration the

certainty provided by the proposed rules and interpretive guidance in

this release, the SEC believes that the number of requests that would

be submitted by such persons to the Commissions to provide joint

interpretations as to whether a given agreement, contract, or

transaction is a swap, security-based swap, or both (i.e., a mixed

swap), would be small, and therefore expects that only a small number

of requests would be submitted pursuant to proposed rule 3a68-2. With

respect to proposed rule 3a68-4(c), the SEC also estimates the number

of requests for joint orders would be small.\350\ Pursuant to the

Commissions' proposed rules and interpretive guidance, a number of

persons that engage in agreements, contracts, or transactions that are

swaps, security-based swaps, or both (i.e., a mixed swap) would be

certain that their transactions are, indeed, swaps, security-based

swaps, or both, (i.e., a mixed swap) and would not request an

interpretation pursuant to proposed rule 3a68-2. Also, as the

Commissions provide joint interpretations regarding whether agreements,

contracts, or transactions (or classes thereof) are or are not swaps,

security-based swaps, or both (i.e., mixed swaps), the SEC expects that

the number of requests for interpretation will decrease over time. The

SEC believes that the rules and interpretive regarding swaps, security-

based swaps, and mixed swaps the Commissions are proposing, as well as

the additional guidance issues pursuant to joint interpretations and

orders under proposed rules 3a68-2 and 3a68-4 will result in a narrow

pool of potential respondents, approximately 50,\351\ to the collection

of information requirements of proposed rule 3a68-2.

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\349\ See supra note 283 and accompanying text.

\350\ See discussion supra part IV.A.

\351\ The SEC believes that there would be approximately 50

requests in the first year. See discussion infra part IX.A.5. The

SEC recognizes that one person might submit more than one request,

but for purposes of the PRA is considering each such request as one

person in order to provide a more conservative estimate of the

number of persons that would be subject to paperwork burdens.

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Similarly, because the SEC believes that both the category of mixed

swap transactions and the number of market participants that engage in

mixed swap transactions are small, the SEC believes that the pool of

potential persons requesting a joint order regarding the regulation of

a specified, or specified class of, mixed swap pursuant to proposed

rule 3a68-4(c) would be small (approximately 10 \352\). Also, those

requests submitted pursuant to proposed rule 3a68-2 that result in an

interpretation that the agreement, contract, or transaction (or class

thereof) is not a mixed swap would reduce the pool of possible persons

submitting a request regarding the regulation of particular mixed swaps

(or class thereof) pursuant to proposed rule 3a68-4(c). In addition,

not only the requesting party, but also any other person or persons

that subsequently lists, trades, or clears that mixed swap, would be

subject to, and must comply with, the joint order regarding the

regulation of the specified, or specified class of, mixed swap, as

issued by the Commissions. Therefore, the SEC believes that the number

of requests for a joint order regarding the regulation of mixed swaps,

particularly involving specified classes of mixed would decrease over

time.

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\352\ See id.

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The SEC seeks comment on the number of persons that potentially

would submit requests pursuant to rules 3a68-2 and 3a68-4(c).

5. Paperwork Reduction Act Burden Estimates

Proposed rules 3a68-2 and 3a68-4(c) would, if adopted, require

submission of certain information to the Commissions to the extent

persons elect to request an interpretation and/or alternative

regulatory treatment. Proposed rules 3a68-2 and 3a68-4(c) each require

the information that a requesting party must include in its request to

the Commissions in order to receive a joint interpretation or order, as

applicable.

(a) Proposed Rule 3a68-2

Proposed rule 3a68-2 would require any party requesting a joint

interpretation under the rule to include disclosures about the

agreement, contract, or transaction (or class thereof) in question as

well as a statement of economic purpose and the requesting party's

initial determination regarding whether the agreement, contract, or

transaction (or class thereof) is a swap, security-based swap, or both

(i.e., a mixed swap). The proposed rule would apply only to requests

made by persons that desire an interpretation from the Commissions. For

each agreement, contract, or transaction (or class thereof) for which a

person requests the Commissions' joint interpretation, the requesting

person would be required to provide a copy of all material information

regarding the applicable terms; a statement of the economic

characteristics and purpose; and the requesting person's determination

as to whether such agreement, contract, or transaction (or class

thereof) is a swap, security-based swap, or both (i.e., a mixed swap),

including the basis for the requesting person's determination. The

requesting person also would be required to provide such other

information as the Commissions may request.

As discussed above, the SEC believes the number of persons that

would submit requests pursuant to proposed rule 3a68-2 is quite small

given the proposed rules and interpretive guidance regarding swaps,

security-based swaps, and mixed swaps the Commissions are

providing.\353\ Although the SEC does not have precise figures for the

number of requests that persons would submit, the SEC believes it is

reasonable to estimate that it likely

[[Page 29878]]

would be fewer than 50 requests in the first year. For purposes of the

PRA, the SEC estimates the total paperwork burden associated with

preparing and submitting a person's request to the Commissions pursuant

to proposed rule 3a68-2 would be 20 hours per request and associated

costs of $9,480.\354\ Assuming 50 requests in the first year, the SEC

estimates that this would result in an aggregate burden for the first

year of 1000 hours of company time (50 requests x 20 hours/request) and

$474,000 for the services of outside professionals (e.g., attorneys)

(50 requests x 30 hours/request x $316).

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\353\ This estimate is based on comments from and discussions

with market participants regarding uncertainty concerning whether

certain contracts might be considered swaps, security-based swaps,

or both, i.e., mixed swaps, and the size of the mixed swaps

category, although the SEC has not received data regarding the

specific number of potential transaction types for which there is

uncertainty or that are mixed swaps.

\354\ This estimate is based on information indicating that the

average burden associated with preparing and submitting a no-action

request to the SEC staff in connection with the identification of

whether certain products were securities, which the SEC believes is

a process similar to the process under proposed rule 3a68-2, was

approximately 20 hours and associated costs of $9,480. Assuming

these costs correspond to legal fees, which we estimate at an hourly

cost of $316, we estimate that this cost is equivalent to

approximately 30 hours ($9,480/$316).

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As discussed above, the SEC believes that as the Commissions

provide joint interpretations or joint notices of proposed rulemaking,

the number of requests received will decrease over time. Although the

SEC does not have precise figures for the number of requests that

persons would submit after the first year, the SEC believes it is

reasonable to estimate that it likely would be fewer than 10 requests

on average in ensuing years. Assuming 10 requests in ensuing years, the

SEC estimates that this would result in an aggregate burden in each

ensuing year of 200 hours of company time (10 requests x 20 hours/

request) and $94,800 for the services of outside professionals (e.g.,

attorneys) (10 requests x 30 hours/request x $316).

(b) Proposed Rule 3a68-4(c)

Proposed rule 3a68-4(c) would require any party requesting a joint

order regarding the regulation of a specified, or specified class of,

mixed swap under the rule to include disclosure about the agreement,

contract, or transaction (or class thereof) that is a mixed swap as

well as a statement of economic purpose for the mixed swap (class

thereof). In addition, a person would provide the specified parallel

provisions that the person believes should apply to the mixed swap (or

class thereof), the reasons the person believes the specified parallel

provisions would be appropriate for the mixed swap, and an analysis of:

(i) The nature and purposes of the parallel provisions that are the

subject of the request; (ii) the comparability of such parallel

provisions; and (iii) the extent of any conflicts or differences

between such parallel provisions. The requesting person also would be

required to provide such other information as the Commissions may

request.

As discussed above, the SEC believes the number of requests that

persons would submit pursuant to proposed rule 3a68-4(c) is quite small

given the limited types of agreements, contracts, or transactions (or

class thereof) the Commissions believe would constitute mixed

swaps.\355\ In addition, depending on the characteristics of a mixed

swap (or class thereof), a person may choose not to submit a request

pursuant to proposed rule 3a68-4(c). The SEC also notes that any joint

order issued by the Commissions would apply to any person that

subsequently lists, trades, or clears that specified, or specified

class of, mixed swap, so that requests for joint orders could diminish

over time. Also, persons may submit requests for an interpretation

under proposed rule 3a68-4(c) that do not result in an interpretation

that the agreement, contract, or transaction (or class thereof) is a

mixed swap. Therefore, although the SEC does not have precise figures

for the number of requests that persons would submit, the SEC believes

it is reasonable to estimate that it likely would be fewer than 20

requests in the first year. For purposes of the PRA, the SEC estimates

the total paperwork burden associated with preparing and submitting a

party's request to the Commissions pursuant to proposed rule 3a68-4(c)

would be 30 hours and associated costs of $15,800 per request for mixed

swaps for which a request for a joint interpretation pursuant to

proposed rule 3a68-4(c) was not previously made.\356\ Assuming 20

requests in the first year, the SEC estimates that this would result in

an aggregate burden for the first year of 600 hours of company time (20

requests x 30 hours/request) and $316,000 for the services of outside

professionals (20 requests x 50 hours/request x $316).

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\355\ See supra note 283 and accompanying text.

\356\ This estimate is based on information indicating that the

average burden associated with preparing and submitting a no-action

request to the SEC staff in connection with the regulatory treatment

of certain securities products which the SEC believes is a process

similar to the process under proposed rule 3a68-4(c), was

approximately 30 hours and associated costs of $15,800. Assuming

these costs correspond to legal fees, which we estimate at an hourly

cost of $316, we estimate that this cost is equivalent to

approximately 50 hours ($15,800/$316).

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For mixed swaps for which a request for a joint interpretation

pursuant to proposed rule 3a68-2 was previously made, the SEC estimates

the total paperwork burden under the PRA associated with preparing and

submitting a party's request to the Commissions pursuant to proposed

rule 3a68-4(c) would be 10 hours fewer and $4,740 less per request than

for mixed swaps for which a request for a joint interpretation pursuant

to proposed rule 3a68-2 was not previously made because certain,

although not all, of the information required to be submitted and

necessary to prepare pursuant to proposed rule 3a68-4(c) would have

been required to be submitted and necessary to prepare pursuant to

proposed rule 3a68-2.\357\ Although certain requests made pursuant to

proposed rule 3a68-4(c) may be made without a previous request for a

joint interpretation pursuant to proposed rule 3a68-2, the SEC believes

that most requests under proposed rule 3a68-2 that result in the

interpretation that an agreement, contract, or transaction (or class

thereof) is a mixed swap will result in a subsequent request for

alternative regulatory treatment pursuant to proposed rule 3a68-4(c).

Assuming, therefore, that 90 percent, or 18 of the estimated 20

requests pursuant to proposed rule 3a68-4(c) in the first year, as

discussed above, would be such ``follow-on'' requests, the SEC

estimates that this would result in an aggregate burden in the first

year of 360 hours of company time (18 requests x 20 hours/request) and

$199,080 for the services of outside professionals (18 requests x 35

hours/request x $316).

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\357\ This estimate takes into account that certain information

regarding the mixed swap (or class thereof), namely the material

terms and the economic purpose, will have already been gathered and

prepared as part of the request submitted pursuant to proposed rule

3a68-2. The SEC estimates that these items constitute approximately

10 hours fewer and a reduction in associated costs of $4,740.

Assuming these costs correspond to legal fees, which we estimate at

an hourly cost of $316, we estimate that this cost is equivalent to

approximately 15 hours ($4,740/$316).

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As discussed above, the SEC believes that as the Commissions

provide joint orders regarding alternative regulatory treatment, the

number of requests received will decrease over time. The SEC believes

it is reasonable to estimate that it likely would be fewer than 5

requests on average in ensuing years. Assuming 5 requests in ensuing

years, the SEC estimates that this would result in an aggregate burden

in each ensuing year of 150 hours of company time (5 requests x 30

hours/request) and $79,000 for the services of outside professionals (5

requests x 50 hours/request x $316). As discussed above, assuming that

approximately 90 percent, or 4 of the estimated 5 requests pursuant to

proposed rule 3a68-4(c) in

[[Page 29879]]

ensuing years would be ``follow-on'' requests to requests for joint

interpretation from the Commissions under proposed rule 3a68-4(c), the

SEC estimates that this would result in an aggregate burden in each

ensuing year of 80 hours of company time (4 requests x 20 hours/

request) and $44,240 for the services of outside professionals (4

requests x 35 hours/request x $316).

Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B), the SEC solicits comments to:

(i) Evaluate whether the proposed collection of information is

necessary for the proper performance of the functions of the agency,

including whether the information will have practical utility; (ii)

evaluate the accuracy of the SEC's estimate of burden of the proposed

collection of information; (iii) determine whether there are ways to

enhance the quality, utility, and clarity of the information to be

collected; and (iv) evaluate whether there are ways to minimize the

burden of the collection of information on those that are to respond,

including through the use of automated collection techniques or other

forms of information technology. In addition, the SEC requests comment

on the accuracy of the estimates regarding the total paperwork burden.

In particular, the SEC requests comment for purposes of the PRA on

the following:

149. How many requests for a joint interpretation from the

Commissions would be submitted pursuant to rule 3a68-2?

150. How many requests for a joint order from the Commissions would

be submitted pursuant to rule 3a68-4(c)?

151. How many requests for a joint order from the Commissions would

be submitted pursuant to rule 3a68-4(c) regarding the same agreement,

contract, or transaction (or class thereof) that was the subject of a

request for a joint interpretation from the Commissions submitted

pursuant to rule 3a68-2?

152. Are the paperwork burden estimates, for both company time and

outside services, as discussed above accurate? Do these estimates

reflect the paperwork burdens and costs associated with requests made

pursuant to proposed rules 3a68-2 and 3a68-4(c)?

Commenters should, when possible, provide empirical data to support

their views.

Any member of the public may direct to us or to OMB any comments

concerning the accuracy of these burden estimates and any suggestions

for reducing these burdens. Persons submitting comments on the

collection of information requirements should direct the comments to

the Office of Management and Budget, Attention Desk Officer for the

Securities and Exchange Commission, Office of Information and

Regulatory Affairs, Washington, DC 20503, and should send a copy to

Secretary, Securities and Exchange Commission, 100 F Street NE.,

Washington, DC 20549-1090, with reference to File No. S7-16-11.

Requests for materials submitted to OMB by the SEC with regard to these

collections of information should be in writing, refer to File No. S7-

16-11, and be submitted to the Securities and Exchange Commission,

Office of Investor Education and Advocacy, 100 F Street NE.,

Washington, DC 20549-0213. OMB is required to make a decision

concerning the collection of information between 30 and 60 days after

publication of this release. Consequently, a comment to OMB is best

ensured of having its full effect if OMB receives it within 30 days of

publication.

B. Cost-Benefit Analysis

1. Background

Title VII establishes a regulatory framework for OTC derivatives.

As part of that framework, Title VII amends the CEA and the Exchange

Act to broadly categorize covered derivative products as swaps,

security-based swaps, SBSAs, and/or mixed swaps. In particular, section

712(d)(1) of the Dodd-Frank Act provides that the Commissions, in

consultation with the Board, shall jointly further define, among other

things, the terms ``swap,'' ``security-based swap,'' and ``security-

based swap agreement.'' Section 712(a)(8) of the Dodd-Frank Act

provides further that the Commissions shall jointly prescribe such

regulations regarding ``mixed swaps'' as may be necessary to carry out

the purposes of Title VII. In addition, sections 712(d)(2)(B) and (C)

of the Dodd-Frank Act require the Commissions, in consultation with the

Board, to jointly adopt rules governing books and records for SBSAs for

SDRs that are registered under the CEA, swap dealers, major swap

participants, security-based swap dealers, and major security-based

swap participants.

The Product Definitions and the regulation of mixed swaps are part

of the Dodd-Frank Act's comprehensive framework for regulating the

swaps markets whereby the CFTC is given regulatory authority over

``swaps,'' \358\ the SEC is given regulatory authority over ``security-

based swaps,'' \359\ and the Commissions shall jointly prescribe such

regulations regarding mixed swaps as may be necessary to carry out the

purposes of Title VII.\360\ In addition, the SEC is given antifraud

authority over, and access to information from certain CFTC-regulated

entities (e.g., DCOs, SEFs, and swap dealers) regarding, SBSAs.\361\

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\358\ See CEA section 1a(47), 7 U.S.C. 1a(47) (cross-referenced

in section 3(a)(69) of the Exchange Act, 15 U.S.C. 78c(a)(69)).

\359\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.

78c(a)(68) (cross-referenced in CEA section 1a(42), 7 U.S.C.

1a(42)).

\360\ See CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D); section

3(a)(68)(D) of the Exchange Act, 15 U.S.C. 78c(68)(D).

\361\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v).

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In most instances, the Commissions' proposed rules and guidance

merely clarify the application of the Product Definitions to specific

products as is required by the relevant provisions of the CEA and

Exchange Act, as modified by the Dodd-Frank Act and the regulation of

mixed swaps. However, for some of the rules the Commissions are

proposing, the Commissions are exercising their discretion to further

define the Product Definitions and to regulate mixed swaps, which would

generate costs and benefits to market participants. The Commissions

also are fulfilling the requirement in Dodd-Frank that they establish

requirements regarding books and records with respect to SBSAs, which

also would generate costs and benefits to market participants. The

costs and benefits regarding these rules are discussed below.

2. Proposed Rule 3a68-1a

(a) Benefits

A security-based swap includes a swap that is based on the

``occurrence, nonoccurrence, or extent of the occurrence of an event

relating to a single issuer of a security or the issuers of securities

in a narrow-based security index, provided that such event directly

affects the financial statements, financial condition, or financial

obligations of the issuer'' (the ``Event Provision'').\362\ Proposed

rule 3a68-1a would provide that, solely for purposes of determining

whether a CDS is a security-based swap under the Event Provision, the

term ``issuers of securities in a narrow-based security index'' would

have the meaning as set forth in proposed rule 3a68-1a.

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\362\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

U.S.C. 78c(a)(68)(A)(ii)(III).

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Because index CDS typically are written on indexes of entity names,

not on indexes of the specific securities of those entities, the

Commissions are

[[Page 29880]]

concerned that the application of the Event Provision, without further

clarification, may cause uncertainty about whether certain index CDS

would be security-based swaps or swaps. Therefore, proposed rule 3a68-

1a would eliminate the potential uncertainty of the treatment of index

CDS as either security-based swaps or swaps by setting forth clear and

objective criteria for meeting the definition of ``issuers of

securities in a narrow-based security index'' and therefore being a

security-based swap.

The SEC requests comments, data, and estimates regarding the

benefits associated with proposed rule 3a68-1a. The SEC also requests

comments, data, and estimates regarding any additional benefits that

could be realized with proposed rule 3a68-1a.

(b) Costs

In complying with proposed rule 3a68-1a, a market participant will

need to ascertain whether an index CDS is a security-based swap or swap

according to the criteria set forth for meeting the definition of

``issuers of securities in a narrow-based security index.'' This

analysis will have to be performed by market participants upon entering

into an index CDS to determine whether the index CDS is subject to the

SEC's regulatory regime for security-based swaps or the CFTC's

regulatory regime for swaps. The SEC notes, however, that any such

costs would be in lieu of the costs of doing the same analysis under

the statutory security-based swap definition. Because the statutory

security-based swap definition lacks the specificity provided by

proposed rule 3a68-1a, the SEC believes analysis of an index CDS would

under proposed rule 3a68-1a would lead to less uncertainty than would

the same analysis under the statutory security-based swap definition.

Providing a clear rule to persons to determine whether an index CDS is

a security-based swap under section 3(a)(68)(A)(ii)(III) of the

Exchange Act \363\ could alleviate additional costs to persons of

inquiring with the Commissions about whether an index CDS is a swap or

security-based swap under that provision, as well as costs of obtaining

an opinion of counsel regarding the applicability of that provision to

a particular index CDS.

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\363\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).

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In addition, proposed rule 3a68-1a is generally consistent with the

definition of ``narrow-based security index'' that exists in section

3(a)(55)(B) of the Exchange Act, as modified to address debt securities

in the context of security futures.\364\ Because some market

participants are familiar with this definition, as well as with

performing analyses of products in the security futures context based

on this definition, the SEC believes that the proposed definition of

``issuers of securities in a narrow-based security index'' will

mitigate uncertainty for those market participants regarding the

treatment of index CDS. In addition, because such market participants

would be familiar with many of the criteria in proposed rule 3a68-1a,

such market participants would require less time and effort, and thus

incur less cost, in determining the scope and applicability of such

criteria to the determination of whether an index CDS is a swap or

security-based swap.

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\364\ See July 2006 Rules, supra note 199.

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The SEC requests comment as to the costs that determinations under

proposed rule 3a68-1a would impose on market participants, as well as

estimates and empirical data to support these costs. In addition, the

SEC requests comment on any other costs associated with proposed rule

3a68-1a that have not been considered and what the extent of those

costs would be.

3. Proposed Rule 3a68-1b

(a) Benefits

A security-based swap includes a swap that is based on ``an index

that is a narrow-based security index, including any interest therein

or on the value thereof.'' \365\ Proposed rule 3a68-1b would provide

that, solely for purposes of determining whether a CDS is a security-

based swap under section 3(a)(68)(A)(ii)(I) of the Exchange Act,\366\

the term ``narrow-based security index'' would have the meaning as set

forth in proposed rule 3a68-1b.

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\365\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.

78c(a)(68)(A)(ii)(I).

\366\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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Because index CDS may be written in indexes of the specific

securities of entities as well as on indexes of entity names, the

Commissions are concerned that the application of section

3(a)(68)(A)(ii)(I) of the Exchange Act,\367\ without further

clarification, may cause uncertainty about whether certain index CDS

would be security-based swaps or swaps. Therefore, proposed rule 3a68-

1b would eliminate the potential uncertainty of the treatment of index

CDS as either security-based swaps or swaps by setting forth clear and

objective criteria for meeting the definition of ``narrow-based

security index'' and therefore being a security-based swap.

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\367\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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The SEC requests comments, data, and estimates regarding the

benefits associated with proposed rule 3a68-1b. The SEC also requests

comments, data, and estimates regarding any additional benefits that

could be realized with proposed rule 3a68-1b.

(b) Costs

In complying with proposed rule 3a68-1b, a market participant will

need to ascertain whether an index CDS is a security-based swap or swap

according to the criteria set forth for meeting the definition of

``narrow-based security index.'' This analysis will have to be

performed by market participants upon entering into an index CDS to

determine whether the index CDS is subject to the SEC's regulatory

regime for security-based swaps or the CFTC's regulatory regime for

swaps. The SEC notes, however, that any such costs would be in lieu of

the costs of doing the same analysis under the statutory security-based

swap definition. Because the statutory security-based swap definition

lacks the specificity provided by proposed rule 3a68-1b, the SEC

believes analysis of an index CDS would under proposed rule 3a68-1b

lead to less uncertainty than would the same analysis under the

statutory security-based swap definition. Providing a clear rule to

persons to determine whether an index CDS is a security-based swap

under section 3(a)(68)(A)(ii)(I) of the Exchange Act \368\ could

alleviate additional costs to persons of inquiring with the Commissions

about whether an index CDS is a swap or security-based swap under that

provision, as well as costs of obtaining an opinion of counsel

regarding the applicability of that provision to a particular index

CDS.

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\368\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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In addition, proposed rule 3a68-1b is generally consistent with the

definition of ``narrow-based security index'' that exists in section

3(a)(55)(B) of the Exchange Act, as modified to address debt securities

in the context of security futures.\369\ Because some market

participants are familiar with this definition, as well as with

performing analyses of products in the security futures context based

on this definition, the SEC believes that the proposed definition of

``narrow-based security index'' will mitigate uncertainty for those

market participants regarding the treatment of index CDS. In addition,

because such market participants would be familiar with many of the

criteria in proposed rule 3a68-1b, such market

[[Page 29881]]

participants would require less time and effort, and thus incur less

cost, in determining the scope and applicability of such criteria to

the determination of whether an index CDS is a swap or security-based

swap.

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\369\ See July 2006 Rules, supra note 199.

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The SEC requests comment as to the costs that determinations under

proposed rule 3a68-1a would impose on market participants, as well as

estimates and empirical data to support these costs. In addition, the

SEC requests comment on any other costs associated with proposed rule

3a68-1a that have not been considered and what the extent of those

costs would be.

4. Proposed Rule 3a68-2

(a) Benefits

Proposed rule 3a68-2 would establish a process for persons to

request an interpretation of whether an agreement, contract, or

transaction (or class of agreements, contracts, or transactions) is a

swap, security-based swap, or both (i.e., a mixed swap).

Proposed rule 3a68-2 would afford persons with the opportunity to

obtain greater certainty from the Commissions regarding whether certain

products are swaps, security-based swaps, or both, i.e., mixed swaps.

The SEC believes that this provision would decrease the possibility

that market participants inadvertently might violate regulatory

requirements regarding products that may constitute swaps, security-

based swaps, or mixed swaps, which could lead to enforcement action. It

also would decrease the likelihood that products might fall into

regulatory gaps by providing a method for market participants to seek

interpretations regarding the status of products for which the

applicable regulatory regime might otherwise remain uncertain. In

addition, the SEC believes the proposed rule will provide the

opportunity for financial innovation by providing a flexible structure

that will allow for the development of new products that otherwise

might be hindered by the lack of regulatory certainty.

(b) Costs

Under proposed rule 3a68-2, a person could request the Commissions

to provide an interpretation of whether an agreement, contract, or

transaction (or class thereof) is a swap, security-based swap, or mixed

swap. The SEC estimates that the cost of requesting this interpretation

for a particular agreement, contract, or transaction (or class thereof)

would be approximately 20 hours of internal company or individual time

and a cost of approximately $9,480 for the services of outside

professionals.\370\ The SEC notes, however, that any such costs are in

lieu of the costs of doing the same analysis without requesting the

Commissions to provide an interpretation. In addition, as noted above,

if the Commissions provide an interpretation pursuant to a request

under proposed rule 3a68-2, a market participant, and other market

participants that desire to transact in the same (or same class of)

agreement, contract, or transaction, would have regulatory certainty

about whether that agreement, contract, or transaction (or class

thereof) is a swap, security-based swap, or both (i.e., a mixed swap).

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\370\ See discussion supra part VIII.

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Also, the SEC believes that as persons make requests for

interpretations about whether agreements, contracts, or transactions

(or classes thereof agreements) are swaps, security-based swaps, or

both, i.e., mixed swaps, pursuant to proposed rule 3a68-2, the

subsequent costs for persons transacting in those products for which

the Commissions have provided interpretations should be reduced.

The SEC requests comment as to the costs that proposed rule 3a68-2

would impose on market participants, as well as estimates and empirical

data to support these costs. In addition, the SEC requests comment on

any other costs associated with proposed rule 3a68-2 that have not been

considered herein and what the extent of those costs would be.

5. Proposed Rule 3a68-3

(a) Benefits

Proposed rule 3a68-3 would provide that, except as otherwise

provided in proposed rule 3a68-3, for purposes of section 3(a)(68) of

the Exchange Act,\371\ the term ``narrow-based security index'' has the

meaning set forth in section 3(a)(55) of the Exchange Act,\372\ and the

rules, regulations, and orders of the SEC thereunder. This definition

would eliminate potential uncertainty regarding the treatment of a

narrow-based security index to which section 3(a)(55) of the Exchange

Act also applies.\373\

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\371\ 15 U.S.C. 78c(a)(68).

\372\ 15 U.S.C. 78c(a)(55).

\373\ 15 U.S.C. 78c(a)(55).

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Proposed rule 3a68-3 also would provide a tolerance period for the

definition of ``narrow-based security index'' to ensure that, under

certain conditions, a security index underlying a swap will not be

considered a narrow-based security index and a security index

underlying a security-based swap will be considered a narrow-based

security index, even when the security index underlying the swap or

security-based swap temporarily assumes characteristics that would

render it a narrow-based security index or not a narrow-based security

index, respectively. In addition, proposed rule 3a68-3 would provide

for an additional 3-month grace period applicable to a security index

that becomes narrow-based, or broad-based, as applicable, for more than

45 business days over 3 consecutive calendar months.

Because security indexes underlying Title VII instruments may

migrate from narrow-based to broad-based, or vice versa, the

Commissions are concerned that application of the narrow-based security

index definition, without further clarification, may cause uncertainty

regarding treatment of Title VII instruments traded on trading

platforms when such migration has occurred. Therefore, proposed rule

3a68-3 would eliminate the potential uncertainty of the treatment of

such Title VII instruments by setting forth clear and objective

criteria regarding the application of the narrow-based security index

definition to security indexes that have migrated from narrow-based to

broad-based or from broad-based to narrow-based.

The SEC requests comments, data, and estimates regarding the

benefits associated with proposed rule 3a68-3. The SEC also requests

comments, data, and estimates regarding any additional benefits that

could be realized with proposed rule 3a68-3.

(b) Costs

In complying with proposed rule 3a68-3, a market participant will

need to ascertain whether a security index underlying a Title VII

instrument is narrow-based or broad-based according to the criteria set

forth for the tolerance periods and grace periods in the proposed rule.

This analysis would be performed upon entering into Title VII

instrument on a security index to ensure compliance with proposed rule

3a68-3. The SEC notes, however, that any such costs would be in lieu of

the costs of doing the same analysis under the narrow-based security

index definition, which the SEC believes would be more difficult and

lead to greater uncertainty, rather than the clarity provided under

proposed rule 3a68-3. Providing a clear rule to market participants to

determine whether a Title VII instrument traded on a trading platform

where the underlying security index has so migrated could alleviate

additional costs to persons of inquiring with the Commissions about

whether a Title VII instrument is a swap or a security-based swap, as

well as costs of obtaining an opinion of counsel

[[Page 29882]]

regarding a particular Title VII instrument.

In addition, proposed rule 3a68-3 is generally consistent with the

tolerance period and grace period that exist in section 3(a)(55) of the

Exchange Act for futures contracts.\374\ Because market participants

are familiar with such tolerance period and grace period as well as

with performing analyses of products in the futures context based on

these provisions, the SEC believes that the proposed tolerance period

and grace period in proposed rule 3a68-3 will mitigate uncertainty for

market participants regarding the treatment of these Title VII

instruments. Proposed rule 3a68-3 also would allow market participants

to minimize the costs of determining whether a security index

underlying a Title VII instrument is considered narrow-based or not by

providing a test that is substantially similar to a test with which

they are familiar in the futures context. In addition, the tolerance

period under proposed rule 3a68-3 mitigates uncertainty for market

participants trading Title VII instruments on trading platforms by

allowing temporary migration of an underlying security index within

certain specifications without disrupting the status of Title VII

instruments based on that security index. Similarly, the grace period

under proposed rule 3a68-3 mitigates uncertainty for market

participants trading Title VII instruments on trading platforms by

allowing time for any necessary actions to be made to accommodate the

non-temporary migration of a security index underlying Title VII

instruments.

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\374\ See supra note 261 and accompanying text.

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The SEC requests comment as to the costs that determinations under

proposed rule 3a68-3 would impose on market participants, as well as

estimates and empirical data to support these costs. In addition, the

SEC requests comment on any other costs associated with proposed rule

3a68-3 that have not been considered, and what the extent of those

costs would be.

6. Proposed Rule 3a68-4

(a) Benefits

A mixed swap is both a security-based swap and a swap, subject to

dual regulation by the Commissions, and proposed rule 3a68-4 would

define the term ``mixed swap'' in the same manner as the term is

defined in both the Exchange Act.\375\ Proposed rule 3a68-4 would also

provide that a mixed swap that is not executed on or subject to the

rules of a DCM, SEF, FBOT, NSE, or security-based SEF and that will not

be submitted to a DCO or registered or exempt clearing agency to be

cleared (``bilateral uncleared mixed swap''), and where at least one

party to the mixed swap is registered with the SEC as a security-based

swap dealer or major security-based swap participant and also with the

CFTC as a swap dealer or major swap participant, shall be subject to

the provisions of the Securities Act and the rules and regulations

promulgated thereunder and only to certain provisions of the CEA and

the rules and regulations promulgated thereunder. In addition, proposed

rule 3a68-4 would establish a process for persons to request that such

persons be permitted to comply, as to parallel provisions only, with

the specified parallel provisions, instead of being required to comply

with parallel provisions of both the CEA and the Exchange Act.

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\375\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.

78c(a)(68)(D); CEA section 1(a)(47)(D), 7 U.S.C. 1(a)(47)(D).

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Because, as noted above, mixed swaps are both swaps and security-

based swaps, and thus are subject to regulation as both swaps and

security-based swaps, the Commissions are concerned that, without

further clarification, there may be uncertainty as to the scope of, and

the requirements applicable to, transactions that fall within the

definition of the term ``mixed swap.''

Proposed rule 3a68-4(a) would define the term ``mixed swap'' in the

same manner as the term is defined in the Exchange Act. This rule,

coupled with guidance regarding mixed swaps provided by the

Commissions, further clarifies whether a security-based swap is a mixed

swap and could eliminate the need to obtain an opinion of counsel

regarding a particular security-based swap.

The Commissions are proposing rule 3a68-4(b) to eliminate

potentially duplicative and conflicting regulation in the context of

mixed swaps by providing that a bilateral uncleared mixed swap, where

at least one party to the mixed swap is dually-registered with the SEC

as a security-based swap dealer or major security-based swap

participant and also with the CFTC as a swap dealer or major swap

participant, would be subject to all applicable provisions of the

securities laws (and SEC rules and regulations promulgated thereunder)

but would be subject only to certain CEA provisions (and CFTC rules and

regulations promulgated thereunder). Therefore, proposed rule 3a68-4(a)

would reduce both the number of and potential uncertainty regarding

which requirements of each Commission will apply to bilateral uncleared

mixed swaps entered into by dually-registered dealers and major

participants.

Proposed rule 3a68-4(c) also would afford persons with an

opportunity to seek alternative regulatory treatment of a specified, or

specified class of, mixed swap. Absent such alternative regulatory

treatment, a person that desires or intends to list, trade, or clear a

mixed swap would be required to comply with all the statutory

provisions of Title VII, including all the rules and regulations

thereunder, that are applicable to both security-based swaps and swaps.

The SEC believes that such a requirement could pose practical

difficulties for mixed swap transactions \376\ and that permitting

persons to request alternative regulatory treatment of a specified, or

specified class of, mixed swaps would allow the Commissions to address

the potential for duplicative or contradictory regulatory requirements

regarding a particular mixed swap.

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\376\ See discussion supra part IV.

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The information submitted by persons pursuant to proposed rule

3a68-4(c) would assist the Commissions in more quickly identifying and

addressing the relevant issues involved in providing alternative

regulatory treatment.

The SEC requests comments, data, and estimates regarding the

benefits associated with proposed rule 3a68-4. The SEC also requests

comments, data, and estimates regarding any additional benefits that

could be realized with proposed rule 3a68-4.

(b) Costs

Providing a clear rule for persons who engage in bilateral

uncleared mixed swaps would reduce the potential for duplicative or

contradictory regulatory requirements that apply to such bilateral

uncleared mixed swaps.

Under proposed rule 3a68-4(c), a person also could request the

Commissions to provide alternative regulatory treatment of a specified,

or specified class of, mixed swap. The SEC estimates that the cost of

requesting alternative regulatory treatment for a particular mixed swap

(or class thereof) would be approximately 30 hours of internal company

or individual time and a cost of approximately $15,800 for the services

of outside professionals.\377\ The SEC notes, however, that any such

costs are in lieu of the costs of complying with all the statutory

provisions in Title VII, including all the rules and regulations

thereunder, that are applicable to both security-based swaps and swaps,

which the SEC

[[Page 29883]]

believes would be more costly than requesting alternative regulatory

treatment, and which potentially could pose practical

difficulties.\378\

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\377\ See discussion supra part VIII.

\378\ See discussion supra part IV.B.

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Also, the SEC believes that as persons make requests for

alternative regulatory treatment of specified, or specified classes of,

mixed swaps pursuant to proposed rule 3a68-4, the subsequent costs for

persons transacting in those products for which the Commissions have

provided for alternative regulatory treatment should be reduced.

The SEC requests comment as to the costs that proposed rule 3a68-4

would impose on market participants, as well as estimates and empirical

data to support these costs. In addition, the SEC requests comment on

any other costs associated with proposed rule 3a68-4 that have not been

considered herein, and what the extent of those costs would be.

7. Proposed Rule 3a69-1

(a) Benefits

Proposed rule 3a69-1 would clarify that state or Federally

regulated insurance products provided by state or Federally regulated

insurance companies, or by certain reinsurers, provided such insurance

products meet certain other requirements, would not be swaps.

Specifically, proposed rule 3a69-1 would define the term ``swap'' so

that it would not include an agreement, contract, or transaction that,

by its terms or by law, as a condition of performance on the agreement,

contract, or transaction: (i) Requires the beneficiary of the

agreement, contract, or transaction to have an insurable interest that

is the subject of the agreement, contract, or transaction and thereby

carry the risk of loss with respect to that interest continuously

throughout the duration of the agreement, contract, or transaction;

(ii) requires that loss to occur and to be proved, and that any payment

or indemnification therefor be limited to the value of the insurable

interest; (iii) is not traded, separately from the insured interest, on

an organized market or over-the-counter; and (iv) with respect to

financial guarantee insurance only, in the event of payment default or

insolvency of the obligor, any acceleration of payments under the

policy is at the sole discretion of the insurer. Proposed rule 3a69-1

also would require that the agreement, contract, or transaction: (i) Be

provided by a company that is organized as an insurance company whose

primary and predominant business activity is the writing of insurance

or the reinsuring of risks underwritten by insurance companies and that

is subject to supervision by the insurance commissioner, or similar

official or agency, of a state, as defined under section 3(a)(16) of

the Exchange Act,\379\ or by the United States or an agency or

instrumentality thereof, and be regulated as insurance under the laws

of such state or the United States; (ii) be provided by the United

States or any of its agents or instrumentalities, or pursuant to a

statutorily authorized program thereof; or (iii) in the case of

reinsurance only, be provided by a person located outside the United

States to an insurance company that meets the above requirements,

provided that such person is not prohibited by the law of any state or

the United States from offering such agreement, contract, or

transaction to such insurance company, the product to be reinsured

meets the requirements above for insurance products, and the total

amount reimbursable by all reinsurers for such insurance product cannot

exceed the claims or losses paid by the cedant. An agreement, contract,

or transaction would have to meet all of these criteria in order to

qualify as an insurance product that falls outside of the swap and

security-based swap definitions pursuant to the proposed rules.

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\379\ 15 U.S.C. 78c(a)(16).

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The SEC is concerned that, without further clarification, market

participants may be uncertain about whether an agreement, contract, or

transaction is an insurance product that is not subject to regulation

as a swap or security-based swap. Therefore, proposed rule 3a69-1 would

eliminate the potential uncertainty of what constitutes an insurance

product by setting forth clear and objective criteria for meeting the

definition of an insurance product that is not subject to regulation as

a swap or security-based swap.

The SEC requests comments, data, and estimates regarding the

benefits associated with proposed rule 3a69-1. The SEC also requests

comments, data, and estimates regarding any additional benefits that

could be realized with proposed rule 3a69-1.

(b) Costs

In complying with proposed rule 3a69-1, a market participant will

need to analyze its agreements, contracts, and transactions that are

insurance products under the provisions of the proposed rule to

determine whether such insurance products fall outside the definitions

of the terms ``swaps'' and ``security-based swap.'' This analysis will

have to be performed upon entering into the agreement, contract, or

transaction to ensure compliance with proposed rule 3a69-1. The SEC

notes, however, that any such costs would be in lieu of the costs of

doing the same analysis absent proposed rule 3a69-1, which the SEC

believes would be more difficult and lead to greater uncertainty than

if the analysis were done under proposed rule 3a69-1. Providing an

objective rule to determine whether an agreement, contract, or

transaction is an insurance product could alleviate additional costs of

inquiring with the Commissions about whether an agreement, contract, or

transaction is an insurance product or a swap, or costs of obtaining an

opinion of counsel regarding a particular agreement, contract, or

transaction.

To the extent that the criteria under proposed rule 3a69-1 lead to

the inadvertent omission of certain types of insurance products, these

omissions could lead to costs for market participants entering into

agreements, contracts, or transactions that might be omitted because

these agreements, contracts, or transactions would be regulated as

swaps and not as insurance products. Similarly, to the extent that the

criteria under proposed rule 3a69-1 lead to the inadvertent inclusion

of certain types of swaps or security-based swaps, these inclusions

could lead to costs for market participants entering into agreements,

contracts, or transactions that are regulated as insurance products and

not as swaps or security-based swaps. The SEC has requested comment on

whether the criteria under proposed rule 3a69-1 inadvertently omits

certain types of insurance products or includes certain types of swaps

in order to minimize these potential costs. The SEC believes that,

pursuant to comments on the proposed criteria, any subsequent

modifications the Commissions make to proposed rule 3a69-1 would

significantly curtail the potential for inadvertent omissions or

inclusions.

The SEC requests comment as to the costs that determinations under

proposed rule 3a69-1 would impose on market participants, as well as

estimates and empirical data to support these costs. In addition, the

SEC requests comment on any other costs associated with proposed rule

3a69-1 that have not been considered, and what the extent of those

costs would be.

8. Proposed Rule 3a69-2

(a) Benefits

Proposed rule 3a69-2 provides that the term ``swap'' has the

meaning set forth in section 3(a)(69) of the Exchange

[[Page 29884]]

Act and that, without limiting the definition of ``swap'' in section

3(a)(69) of the Exchange Act, an agreement, contract, or transaction

that is a cross-currency swap, currency option, foreign currency

option, foreign exchange option, foreign exchange rate option, foreign

exchange forward, foreign exchange swap, FRA, or NDF would fall within

the meaning of the term ``swap'', unless such agreement, contract, or

transaction is otherwise excluded by section 1a(47)(B) of the CEA.\380\

Proposed rule 3a69-2 also provides that a foreign exchange forward or a

foreign exchange swap shall not be considered a swap if the Secretary

of the Treasury makes a determination described in section 1a(47)(E)(i)

of the CEA\381\ and that, notwithstanding such provision, certain

provisions of the CEA will apply to such foreign exchange forward or

foreign exchange swap, namely the reporting requirements in section 4r

of the CEA,\382\ and regulations thereunder, and, in the case of a swap

dealer or major swap participant that is a party to a foreign exchange

swap or foreign exchange forward, the business conduct standards in

section 4s of the CEA,\383\ and regulations thereunder. In addition,

proposed rule 3a69-2 provides that the terms ``foreign exchange

forward'' and ``foreign exchange swap'' have the meanings set forth in

the CEA and that a currency swap, cross-currency swap, currency option,

foreign currency option, foreign exchange option, foreign exchange rate

option, and NDF is not a foreign exchange forward or foreign exchange

swap for purposes of sections 1a(24) and 1a(25) of the CEA.\384\

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\380\ 15 U.S.C. 78c(a)(69); 7 U.S.C. 1a(47)(B).

\381\ 7 U.S.C. 1a(47)(E)(i).

\382\ 7 U.S.C. 6r.

\383\ 7 U.S.C. 6s.

\384\ 7 U.S.C. 1a(24) and 1a(25).

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Proposed rule 3a69-2 would restate portions of the statutory

definition of ``swap'' and enumerate certain types of agreements,

contracts, and transactions that are swaps in order to consolidate

parts of the definition and related interpretations for ease of

reference. Proposed rule 3a69-2 would also specify certain reporting

and business conduct requirements that are applicable to foreign

exchange forwards and foreign exchange swaps, and provide definitions

for such terms.

Because the statutory definition of the term ``swap,'' though

broadly worded and specific regarding the status of certain agreements,

contracts, and transactions, does not explicitly mention every

agreement, contract, or transaction that would fall within the

definition, the Commissions are concerned that application of the

definition, without further clarification, may cause uncertainty about

whether certain agreements, contracts, or transactions would be swaps.

Proposed rule 3a69-2 would eliminate the potential uncertainty of the

treatment of such agreements, contracts, and transactions as swaps by

setting forth clear and objective criteria for certain agreements,

contracts, and transactions without limiting the scope of the statutory

definition of the term ``swap.'' Proposed rule 3a69-2 also would

eliminate the potential uncertainty regarding the reporting and

business conduct requirements applicable to foreign exchange forwards

and foreign exchange swaps by specifying the provisions for which

compliance is required.

(b) Costs

In complying with proposed rule 3a69-2, a market participant will

need to analyze its agreements, contracts, and transactions under the

provisions of the proposed rule to determine whether such agreements,

contracts, and transactions are swaps according to the criteria set

forth in the proposed rule. This analysis will have to be performed

upon entering into the agreement, contract, or transaction to ensure

compliance with proposed rule 3a69-2. The SEC notes, however, that any

such costs would be in lieu of the costs of doing the same analysis

absent proposed rule 3a69-2, which the SEC believes would be more

difficult and lead to greater uncertainty than if the analysis were

done under proposed rule 3a69-2.

Providing an objective rule to market participants to determine

whether certain types of agreements, contracts, or transactions are

swaps could alleviate additional costs to persons of inquiring with the

Commissions about whether such agreements, contracts, or transactions

are swaps, as well as costs of obtaining an opinion of counsel

regarding a particular agreement, contract, or transaction. In

addition, an objective rule regarding reporting and business conduct

requirements could alleviate additional costs to persons of inquiring

with the Commissions about which reporting and business conduct

requirements are applicable to foreign exchange forwards and foreign

exchange swaps, and could reduce the costs of obtaining an opinion of

counsel regarding a particular foreign exchange forward or foreign

exchange swap.

To the extent that the criteria under proposed rule 3a69-2 lead to

the inadvertent inclusion of certain types of agreements, contracts,

and transactions or additional reporting or business conduct

obligations for certain swaps, these inclusions and additional

requirements could lead to costs for market participants entering into

agreements, contracts, or transactions to which proposed rule 3a69-2

applies. The SEC has requested comment on whether the criteria under

proposed rule 3a69-2 provide sufficient clarity regarding the specific

products included in the rule and whether the criteria should clarify

the applicability of reporting and business conduct requirements in

order to minimize these potential costs. The SEC believes that,

pursuant to comments on the proposed criteria, any subsequent

modifications the Commissions make to proposed rule 3a69-2 would

significantly curtail the potential for inadvertent inclusions or

additional reporting or business conduct requirements.

The SEC requests comment as to the costs that determinations under

and compliance with proposed rule 3a69-2 would impose on market

participants, as well as estimates and empirical data to support these

costs. In addition, the SEC requests comment on any other costs

associated with proposed rule 3a69-2 that have not been considered, and

what the extent of those costs would be.

9. Proposed Rule 3a69-3

(a) Benefits

Proposed rule 3a69-3 would provide that the term ``security-based

swap agreement'' has the meaning set forth in section 3(a)(78) of the

Exchange Act.\385\ Proposed rule 3a69-3 also would provide that

registered SDRs, swap dealers, major swap participants, security-based

swap dealers, and major security-based swap participants are not

required to maintain additional books and records, or, in the case of

registered SDRs, collect and maintain additional information regarding,

SBSAs other than the books and records (and, in the case of registered

SDRs, information) required to be kept (or collected) and maintained

regarding swaps pursuant to the CEA and the CFTC rules and regulations

promulgated thereunder.

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\385\ 15 U.S.C. 78c(a)(78).

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Because, as noted above, security-based swap agreements are subject

the CFTC's regulatory and enforcement authority and the SEC's antifraud

and certain other authority, the Commissions are concerned that,

without further clarification, there may be uncertainty as to the scope

of transactions that fall within the definition of the term ``security-

based

[[Page 29885]]

swap agreement.'' Proposed rule 3a69-3(c) would define the term

``security-based swap agreement'' in the same manner as the term is

defined in the Exchange Act. This rule, coupled with guidance regarding

security-based swap agreements provided by the Commissions, further

clarifies whether a swap is a security-based swap agreement and could

eliminate the need to obtain an opinion of counsel regarding a

particular security-based swap agreement.

Section 712(d)(2)(B) and (C) of the Dodd-Frank Act requires the

Commissions to engage in joint rulemaking regarding books and records

requirements for SBSAs. Providing that persons required to keep and

maintain books and records regarding, or collect and maintain data

regarding, swaps are not required to keep or maintain additional books

and records regarding, or collect and maintain additional data

regarding, SBSAs alleviates any additional books and records or

information costs to such persons.

(b) Costs

The SEC believes that, because proposed rule 3a69-3 includes within

the definition of SBSA no agreements, contracts, or transactions that

would not be an SBSA in the absence of the proposed rule, proposed rule

3a69-3 would impose no costs other than those that are required with

respect to swaps in the absence of proposed rule 3a69-3. In addition,

the SEC believes that, because proposed rule 3a69-3 imposes no

requirements with respect to SBSAs other than those that exist for

swaps, proposed rule 3a69-3 would impose no costs other than those that

are required with respect to swaps in the absence of proposed rule

3a69-3.

To the extent that the criteria under proposed rule 3a69-3

inadvertently lead to additional requirements with respect to SBSAs,

these additional requirements could lead to costs for market

participants entering into the SBSAs to which proposed rule 3a69-3

applies. The SEC has requested comment regarding whether the

requirements under proposed rule 3a69-3 are sufficient. The SEC

believes that, pursuant to comments on the proposed rule, any

subsequent modifications the Commissions make to proposed rule 3a69-3

would significantly curtail the potential for inadvertent additional

requirements.

The SEC requests comment as to the costs that compliance with

proposed rule 3a69-3 would impose on market participants, as well as

estimates and empirical data to support these costs. In addition, the

SEC requests comment on any other costs associated with proposed rule

3a69-3 that have not been considered, and what the extent of those

costs would be.

Request for Comment

153. The SEC has considered the costs and benefits of the proposed

rules and clarifications regarding the Product Definitions, the

regulation of mixed swaps, and the books and records requirements for

SBSAs. The SEC is sensitive to these costs and benefits, and encourages

commenters to discuss any additional costs or benefits beyond those

discussed here, as well as any reductions in costs. In particular, the

SEC requests comment on the potential costs, as well as any potential

benefits, resulting from the proposed rules and clarifications

regarding the Product Definitions, the regulation of mixed swaps, and

the books and records requirements for SBSAs for issuers, investors,

broker-dealers, security-based swap dealers, major security-based swap

participants, persons associated with a security-based swap dealer or a

major security-based swap participant, other security-based swap

industry professionals, regulators, and other market participants. The

SEC also seeks comment on the accuracy of any of the benefits

identified and also welcomes comment on any of the costs identified

here. In addition, the SEC encourages commenters to identify, discuss,

analyze, and supply relevant data, information, or statistics regarding

any such costs or benefits, including estimates and views regarding

these costs and benefits for particular types of market participants,

as well as any other costs or benefits that may result from the

adoption of the proposed rules, as well as the clarifications provided.

C. Consideration of Burden on Competition, and Promotion of Efficiency,

Competition, and Capital Formation

Section 3(f) of the Exchange Act \386\ requires the SEC, whenever

it engages in rulemaking and is required to consider or determine

whether an action is necessary or appropriate in the public interest,

to consider whether the action would promote efficiency, competition,

and capital formation. In addition, section 23(a)(2) of the Exchange

Act \387\ requires the SEC, when adopting rules under the Exchange Act,

to consider the impact such rules would have on competition. Section

23(a)(2) of the Exchange Act also prohibits the SEC from adopting any

rule that would impose a burden on competition not necessary or

appropriate in furtherance of the purposes of the Exchange Act.\388\

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\386\ 15 U.S.C. 78c(f).

\387\ 15 U.S.C. 78w(a)(2).

\388\ Id.

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1. Proposed Rule 3a68-1a

The SEC believes that proposed rule 3a68-1a would create an

efficient process for a market participant to determine whether an

index CDS is a swap or a security-based swap by setting forth clear

methods and guidelines, thereby reducing potential uncertainty. Because

swaps and security-based swaps both are regulated pursuant to the Dodd-

Frank Act by either the CFTC or the SEC, and an index CDS would be

either a swap or a security-based swap, regardless of whether the SEC

proposed rule 3a68-1a, the SEC believes that the proposed rule would

not have an adverse effect on capital formation.

Similarly, the SEC believes that proposed rule 3a68-1a would not

impose any significant burdens on competition because an index CDS

would be regulated as a swap or security-based swap regardless of

whether the SEC proposed rule 3a68-1a. The proposed rule is a means of

providing greater clarity for market participants on whether a specific

index CDS is a swap or a security-based swap.

2. Proposed Rule 3a68-1b

The SEC believes that proposed rule 3a68-1b would create an

efficient process for a market participant to determine whether an

index CDS is a swap or a security-based swap by setting forth clear

methods and guidelines, thereby reducing potential uncertainty. Because

swaps and security-based swaps both are regulated pursuant to the Dodd-

Frank Act by either the CFTC or the SEC, and an index CDS would be

either a swap or a security-based swap, regardless of whether the SEC

proposed rule 3a68-1b, the SEC believes that the proposed rule would

not have an adverse effect on capital formation.

Similarly, the SEC believes that proposed rule 3a68-1b would not

impose any significant burdens on competition because an index CDS

would be regulated as a swap or security-based swap regardless of

whether the SEC proposed rule 3a68-1b. The proposed rule is a means of

providing greater clarity for market participants on whether a specific

index CDS is a swap or a security-based swap.

3. Proposed Rule 3a68-2

The SEC believes that proposed rule 3a68-2 would create an

efficient process for a market participant to request the Commissions

to determine whether an

[[Page 29886]]

agreement, contract, or transaction (or class thereof) is a swap,

security-based swap, or both (i.e., a mixed swap) by setting forth

clear methods and guidelines, thereby reducing potential uncertainty.

Because swaps, security-based swaps, and mixed swaps all are regulated

pursuant to the Dodd-Frank Act by either the CFTC, the SEC, or both the

CFTC and SEC, and because market participants still would need to

determine whether an agreement, contract, or transaction (or class

thereof) is a swap, security-based swap, or mixed swap regardless of

whether the SEC proposed rule 3a68-2, the SEC believes that the

proposed rule would not have an adverse effect on capital formation.

In addition, the SEC believes the proposed rule will provide the

opportunity for financial innovation by providing a flexible structure

that will allow for the development of new products, which may promote

capital formation.

Similarly, the SEC believes that proposed rule 3a68-2 would not

impose any significant burdens on competition because, to the extent an

agreement, contract, or transaction (or class thereof) is a swap,

security-based swap, or both (i.e., a mixed swap), that agreement,

contract, or transaction (or class thereof) would be regulated as a

swap, security-based swap, or mixed swap regardless of whether the SEC

proposed rule 3a68-2. The proposed rule is a means of providing a

process for market participants to request clarity regarding whether a

specific agreement, contract, or transaction (or class thereof) is a

swap, security-based swap, or mixed swap.

4. Proposed Rule 3a68-3

The SEC believes that proposed rule 3a68-3 would create an

efficient process for a market participant to determine whether a

security index underlying a Title VII instrument is narrow-based or

broad-based, and therefore whether the Title VII instrument is a swap

or a security-based swap, by setting forth clear methods and

guidelines, thereby reducing potential uncertainty. Because swaps and

security-based swaps both are regulated pursuant to the Dodd-Frank Act

by either the CFTC or the SEC, and a Title VII instrument on a security

index would be either a swap or a security-based swap regardless of

whether the SEC proposed rule 3a68-3, the SEC believes that the

proposed rule would not have an adverse effect on capital formation.

Similarly, the SEC believes that proposed rule 3a68-3 would not

impose any significant burdens on competition because a Title VII

instrument on a security index would be regulated as a swap or

security-based swap regardless of whether the SEC proposed rule 3a68-3.

The proposed rule is a means of providing greater clarity for market

participants regarding whether a specific Title VII instrument on a

security index is a swap or a security-based swap.

5. Proposed Rule 3a68-4

The SEC believes that proposed rule 3a68-4 would create an

efficient process for a market participant to request alternative

regulatory treatment regarding a specified, or specified class of,

mixed swap by setting forth clear methods and guidelines, thereby

reducing potential uncertainty and dual regulatory requirements.

Because a mixed swap is regulated pursuant to the Dodd-Frank Act, and,

absent proposed rule 3a68-4, persons that desire or intend to list,

trade, or clear a mixed swap would be required to comply with all the

statutory provisions in Title VII, including all the rules and

regulations thereunder, that are applicable to both swaps and security-

based swaps, the SEC believes that the proposed rule would not have an

adverse effect on capital formation. Proposed rule 3a68-4 would permit

such persons to request a joint order permitting themto comply with an

alternative regulatory regime that would address the potential dual

regulatory requirements applicable to transactions in mixed swaps under

Title VII.

Similarly, the SEC believes that proposed rule 3a68-4 would not

impose any significant burdens on competition because to the extent an

agreement, contract, or transaction (or class thereof) is a mixed swap,

transactions in that mixed swap would be subject to all of the

statutory provisions of Title VII, including all the rules and

regulations thereunder, that are applicable to both swaps and security-

based swaps, if the Commissions were not to provide alternative

regulatory treatment pursuant to proposed rule 3a68-4.

6. Proposed Rule 3a69-1

The SEC believes that proposed rule 3a69-1 would create an

efficient process for a market participant to determine whether an

agreement, contract, or transaction is an insurance product and is not

a swap by setting forth clear methods and guidelines, thereby reducing

potential uncertainty. Because insurance products and insurance

companies currently are regulated pursuant to state insurance law, and

would continue to be so regardless of whether the SEC proposed rule

3a69-1, the SEC believes that the proposed rule would not have an

adverse effect on capital formation.

Similarly, the SEC believes that proposed rule 3a69-1 would not

impose any significant burdens on competition because insurance

products and insurance companies currently are regulated pursuant to

state insurance law and would continue to be so regardless of whether

the SEC proposed rule 3a69-1. The proposed rule is a means of providing

greater clarity for market participants on whether a specific

agreement, contract, or transaction is an insurance product and is not

a swap.

7. Proposed Rule 3a69-2

The SEC believes that proposed rule 3a69-2 would create an

efficient process for a market participant to determine whether an

agreement, contract, or transaction is a swap, a foreign exchange

forward, or a foreign exchange swap or is subject to certain reporting

and business conduct requirements, by setting forth clear methods and

guidelines, thereby reducing potential uncertainty. Because agreements,

contracts, and transactions that are swaps, foreign exchange forwards,

or foreign exchange swaps under proposed rule 3a69-2 would be swaps,

foreign exchange forwards, or foreign exchange swaps and, in the case

of foreign exchange forwards and foreign exchange swaps, would be

subject to reporting and business conduct requirements under the CEA,

in the absence of proposed rule 3a69-2, the SEC believes that the

proposed rule would not have an adverse effect on capital formation.

Similarly, the SEC believes that proposed rule 3a69-2 would not

impose any significant burdens on competition because swaps, foreign

exchange swaps, and foreign exchange forwards continue to be regulated

as such regardless of whether the SEC proposed rule 3a69-2. The

proposed rule is a means of providing greater clarity for market

participants on whether a specific agreement, contract, or transaction

is a swap, foreign exchange forward, or foreign exchange swap and

whether certain reporting and business conduct requirements apply in

the case of foreign exchange forwards and foreign exchange swaps.

8. Proposed Rule 3a69-3

The SEC believes that proposed rule 3a69-3 would create an

efficient process for registered SDRs, SDs, MSPs, security-based swap

dealers, and major security-based swap participants to determine the

books and records requirements for SBSAs by setting forth

[[Page 29887]]

clear guidelines, thereby reducing potential uncertainty. Proposed rule

3a69-3(c) also would define the term ``security-based swap agreement''

in the same manner as the term is defined in the Exchange Act. Because

SBSAs are swaps, they are subject to certain books and records

requirements under the CEA (and CFTC rules and regulations promulgated

thereunder) that are applicable to swaps and would continue to be so

regardless of whether the SEC proposed rule 3a69-3. The SEC believes

that the proposed rule would thus not have an adverse effect on capital

formation.

Similarly, the SEC believes that proposed rule 3a69-3 would not

impose any significant burdens on competition because SBSAs would be

regulated as swaps regardless of whether the SEC proposed rule 3a69-3.

The proposed rule is a means of providing greater clarity for market

participants regarding SBSAs, including the books and records

requirements for SBSAs.

Request for Comment

154. The SEC requests comment on the possible effects of the

proposed rules under the Exchange Act regarding efficiency,

competition, and capital formation. The SEC requests that commenters

provide views and supporting information regarding any such effects.

The SEC notes that such effects are difficult to quantify. The SEC

seeks comment on possible anti-competitive effects of the proposed

rules under the Exchange Act not already identified. The SEC also

requests comment regarding the competitive effects of pursuing

alternative regulatory approaches that are consistent with section

712(a) and 712(d) of the Dodd-Frank Act. In addition, the SEC requests

comment on how the other provisions of the Dodd-Frank Act for which SEC

rulemaking is required will interact with and influence the competitive

effects of the proposed rules and clarifications under the Exchange

Act.

D. Consideration of Impact on the Economy

For purposes of SBREFA the SEC must advise the OMB as to whether

the proposed rules and interpretive guidance under the Exchange Act

constitute ``major'' rules. Under SBREFA, a rule is considered

``major'' where, if adopted, it results or is likely to result in: (1)

An annual effect on the economy of $100 million or more (either in the

form of an increase or a decrease); (2) a major increase in costs or

prices for consumers or individual industries; or (3) significant

adverse effect on competition, investment or innovation. If a rule is

``major,'' its effectiveness will generally be delayed for 60 days

pending Congressional review.

The SEC requests comment on the potential impact of the proposed

rules and interpretive guidance under the Exchange Act on the economy

on an annual basis, on the costs or prices for consumers or individual

industries, and on competition, investment, or innovation. Commenters

are requested to provide empirical data and other factual support for

their view to the extent possible.

E. Initial Regulatory Flexibility Act Certification

The RFA requires Federal agencies, in promulgating rules, to

consider the impact of those rules on small entities. Section 603(a)

\389\ of the Administrative Procedure Act,\390\ as amended by the RFA,

generally requires the SEC to undertake a regulatory flexibility

analysis of all proposed rules, or proposed rule amendments, to

determine the impact of such rulemaking on ``small entities.'' \391\

Section 605(b) of the RFA states that this requirement shall not apply

to any proposed rule or proposed rule amendment, that, if adopted,

would not have a significant economic impact on a substantial number of

small entities.\392\

---------------------------------------------------------------------------

\389\ 5 U.S.C. 603(a).

\390\ 5 U.S.C. 551 et seq.

\391\ Although section 601(b) of the RFA defines the term

``small entity,'' the statute permits agencies to formulate their

own definitions. The SEC has adopted definitions for the term small

entity for the purposes of SEC rulemaking in accordance with the

RFA. Those definitions, as relevant to this proposed rulemaking, are

set forth in rule 0-10, 17 CFR 240.0-10. See Statement of Management

on Internal Accounting Control, 47 FR 5215, Feb. 4, 1982.

\392\ See 5 U.S.C. 605(b).

---------------------------------------------------------------------------

For purposes of SEC rulemaking in connection with the RFA, a small

entity includes: (i) When used with reference to an ``issuer'' or a

``person,'' other than an investment company, an ``issuer'' or

``person'' that, on the last day of its most recent fiscal year, had

total assets of $5 million or less,\393\ or (ii) a broker-dealer with

total capital (net worth plus subordinated liabilities) of less than

$500,000 on the date in the prior fiscal year as of which its audited

financial statements were prepared pursuant to rule 17a-5(d) under the

Exchange Act,\394\ or, if not required to file such statements, a

broker-dealer with total capital (net worth plus subordinated

liabilities) of less than $500,000 on the last day of the preceding

fiscal year (or in the time that it has been in business, if shorter);

and is not affiliated with any person (other than a natural person)

that is not a small business or small organization.\395\ Under the

standards adopted by the Small Business Administration, small entities

in the finance and insurance industry include the following: (i) For

entities in credit intermediation and related activities, entities with

$175 million or less in assets or, for non-depository credit

intermediation and certain other activities, $7 million or less in

annual receipts; (ii) for entities in financial investments and related

activities, entities with $7 million or less in annual receipts; (iii)

for insurance carriers and entities in related activities, entities

with $7 million or less in annual receipts; and (iv) for funds, trusts,

and other financial vehicles, entities with $7 million or less in

annual receipts.\396\

---------------------------------------------------------------------------

\393\ See 17 CFR 240.0-10(a).

\394\ See 17 CFR 240.17a-5(d).

\395\ See 17 CFR 240.0-10(c).

\396\ See 13 CFR 121.201.

---------------------------------------------------------------------------

Based on the SEC's existing information about the swap markets, the

SEC believes that the swap markets, while broad in scope, are largely

dominated by entities such as those that would be covered by the ``swap

dealer,'' ``security-based swap dealer,'' ``major swap participant,''

and ``major security-based swap participant'' definitions.\397\ The SEC

believes that such entities exceed the thresholds defining ``small

entities'' set out above. Moreover, although it is possible that other

persons may engage in swap and security-based swap transactions, the

SEC does not believe that any of these entities would be ``small

entities'' as defined in rule 0-10 under the Exchange Act.\398\

Feedback from industry participants about the swap markets indicates

that only persons or entities with assets significantly in excess of $5

million (or with annual receipts significantly in excess of $7 million)

participate in the swap markets.

---------------------------------------------------------------------------

\397\ See, e.g., CEA section 1a(49), 7 U.S.C. 1a(49) (defining

``swap dealer''); section 3(a)(71)(A) of the Exchange Act, 15 U.S.C.

78c(a)(71)(A) (defining ``security-based swap dealer''); CEA section

1a(33), 7 U.S.C. 1a(33) (defining ``major swap participant'');

section 3(a)(67)(A) of the Exchange Act, 15 U.S.C. 78c(a)(67)(A)

(defining ``major security-based swap participant''). Such entities

also would include commercial entities that may use swaps to hedge

or mitigate commercial risk.

\398\ See 17 CFR 240.0-10(a).

---------------------------------------------------------------------------

To the extent that a small number of transactions did have a

counterparty that was defined as a ``small entity'' under SEC rule 0-

10, the SEC believes it is unlikely that the proposed rules and

clarifications regarding the Product Definitions, the regulation of

mixed swaps, and the books and records requirements for SBSAs would

have a significant economic impact on that

[[Page 29888]]

entity. The proposed rules and clarifications simply would address

whether certain products fall within the swap definition, address

whether certain products are swaps, security-based swaps, SBSAs, or

mixed swaps, provide a process for requesting interpretations of

whether agreements, contracts, and transactions are swaps, security-

based swaps, and mixed swaps, provide a process for requesting

alternative regulatory treatment for mixed swaps, and establish books

and records requirements for SBSAs, which are applicable to all

entities.

For the foregoing reasons, the SEC certifies that the proposed

rules and clarifications regarding the Product Definitions, the

regulation of mixed swaps, and the books and records requirements for

SBSAs would not have a significant economic impact on a substantial

number of small entities for purposes of the RFA. The SEC encourages

written comments regarding this certification. The SEC requests that

commenters describe the nature of any impact on small entities and

provide empirical data to support the extent of the impact.

X. Statutory Basis and Rule Text

List of Subjects

17 CFR Part 1

Definitions, General swap provisions.

17 CFR Part 240

Reporting and recordkeeping requirements, Securities.

Commodity Futures Trading Commission

Pursuant to the Commodity Exchange Act, 7 U.S.C. 1 et seq., as

amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank

Act''), and sections 712(a)(8), 712(d), 721(a), 721(b), 721(c), 722(d),

and 725(g) of the Dodd-Frank Act, the CFTC is proposing to adopt rules

1.3(xxx) through 1.3(aaaa) and 1.6 through 1.9 under the Commodity

Exchange Act.

Text of Proposed Rules

For the reasons stated in the preamble, the CFTC is proposing to

further amend Title 17, Chapter I, of the Code of Federal Regulations,

as amended at 75 FR 63732, October 18, 2010, 75 FR 65586, Oct. 26,

2010, 75 FR 77576, Dec. 13, 2010, 75 FR 80174, Dec. 21, 2010, and 76 FR

722, Jan. 6, 2011, as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6c, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 7, 7a, 7b, 8, 9, 10, 12, 12a,

12c, 13a, 13a-1, 16, 16a, 21, 23, and 24.

2. Amend Sec. 1.3 by adding paragraphs (xxx), (yyy), (zzz), and

(aaaa) to read as follows:

Sec. 1.3 Definitions.

* * * * *

(xxx) Swap. (1) In general. The term swap has the meaning set forth

in section 1a(47) of the Commodity Exchange Act.

(2) Inclusion of particular products. (i) The term swap includes,

without limiting the meaning set forth in section 1a(47) of the

Commodity Exchange Act, the following agreements, contracts, and

transactions:

(A) A cross-currency swap;

(B) A currency option, foreign currency option, foreign exchange

option and foreign exchange rate option;

(C) A foreign exchange forward;

(D) A foreign exchange swap;

(E) A forward rate agreement; and

(F) A non-deliverable forward involving foreign exchange.

(ii) The term swap does not include an agreement, contract, or

transaction described in paragraph (xxx)(2)(i) of this section that is

otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act.

(3) Foreign exchange forwards and foreign exchange swaps.

Notwithstanding paragraph (xxx)(2) of this section:

(i) A foreign exchange forward or a foreign exchange swap shall not

be considered a swap if the Secretary of the Treasury makes a

determination described in section 1a(47)(E)(i) of the Commodity

Exchange Act.

(ii) Notwithstanding paragraph (xxx)(3)(i) of this section:

(A) The reporting requirements set forth in section 4r of the

Commodity Exchange Act and regulations promulgated thereunder shall

apply to a foreign exchange forward or foreign exchange swap; and

(B) The business conduct standards set forth in section 4s of the

Commodity Exchange Act and regulations promulgated thereunder shall

apply to a swap dealer or major swap participant that is a party to a

foreign exchange forward or foreign exchange swap.

(iii) For purposes of section 1a(47)(E) of the Commodity Exchange

Act and this Sec. 1.3(xxx), the term foreign exchange forward has the

meaning set forth in section 1a(24) of the Commodity Exchange Act.

(iv) For purposes of section 1a(47)(E) of the Commodity Exchange

Act and this Sec. 1.3(xxx), the term foreign exchange swap has the

meaning set forth in section 1a(25) of the Commodity Exchange Act.

(v) For purposes of sections 1a(24) and 1a(25) of the Commodity

Exchange Act and this Sec. 1.3(xxx), the following transactions are

not foreign exchange forwards or foreign exchange swaps:

(A) A currency swap or a cross-currency swap;

(B) A currency option, foreign currency option, foreign exchange

option, or foreign exchange rate option; and

(C) A non-deliverable forward involving foreign exchange.

(4) Insurance. The term swap as used in section 1a(47) of the

Commodity Exchange Act does not include an agreement, contract, or

transaction that:

(i) By its terms or by law, as a condition of performance on the

agreement, contract, or transaction:

(A) Requires the beneficiary of the agreement, contract, or

transaction to have an insurable interest that is the subject of the

agreement, contract, or transaction and thereby carry the risk of loss

with respect to that interest continuously throughout the duration of

the agreement, contract, or transaction;

(B) Requires that loss to occur and to be proved, and that any

payment or indemnification therefor be limited to the value of the

insurable interest;

(C) Is not traded, separately from the insured interest, on an

organized market or over-the-counter; and

(D) With respect to financial guaranty insurance only, in the event

of payment default or insolvency of the obligor, any acceleration of

payments under the policy is at the sole discretion of the insurer; and

(ii) Is provided:

(A) By a company that is organized as an insurance company whose

primary and predominant business activity is the writing of insurance

or the reinsuring of risks underwritten by insurance companies and that

is subject to supervision by the insurance commissioner (or similar

official or agency) of any State or by the United States or an agency

or instrumentality thereof, and such agreement, contract, or

transaction is regulated as insurance under the laws of such State or

of the United States;

(B) By the United States or any of its agencies or

instrumentalities, or pursuant to a statutorily authorized program

thereof; or

[[Page 29889]]

(C) In the case of reinsurance only, by a person located outside

the United States to an insurance company that is eligible under

paragraph (xxx)(4)(ii) of this section, provided that:

(1) Such person is not prohibited by any law of any State or of the

United States from offering such agreement, contract, or transaction to

such an insurance company;

(2) The product to be reinsured meets the requirements under

paragraph (xxx)(4)(i) of this section to be insurance; and

(3) The total amount reimbursable by all reinsurers for such

insurance product cannot exceed the claims or losses paid by the

cedant.

(5) State. For purposes of paragraph (xxx)(4) of this section, the

term State means any state of the United States, the District of

Columbia, Puerto Rico, the U.S. Virgin Islands, or any other possession

of the United States.

(6) Anti-evasion. (i) An agreement, contract, or transaction that

is willfully structured to evade any provision of Subtitle A of the

Wall Street Transparency and Accountability Act of 2010, including any

amendments made to the Commodity Exchange Act thereby (Subtitle A),

shall be deemed a swap for purposes of Subtitle A and the rules,

regulations, and orders of the Commission promulgated thereunder.

(ii) An interest rate swap or currency swap, including but not

limited to a transaction identified in paragraph (xxx)(3)(v) of this

section, that is willfully structured as a foreign exchange forward or

foreign exchange swap to evade any provision of Subtitle A shall be

deemed a swap for purposes of Subtitle A and the rules, regulations,

and orders of the Commission promulgated thereunder.

(iii) An agreement, contract, or transaction of a bank that is not

under the regulatory jurisdiction of an appropriate Federal banking

agency (as defined in section 1a(2) of the Commodity Exchange Act),

where the agreement, contract, or transaction is willfully structured

as an identified banking product (as defined in section 402 of the

Legal Certainty for Bank Products Act of 2000) to evade the provisions

of the Commodity Exchange Act, shall be deemed a swap for purposes of

the Commodity Exchange Act and the rules, regulations, and orders of

the Commission promulgated thereunder.

(iv) The form, label, and written documentation of an agreement,

contract, or transaction shall not be dispositive in determining

whether the agreement, contract, or transaction has been willfully

structured to evade as provided in paragraphs (xxx)(6)(i) through

(xxx)(6)(iii) of this section.

(v) An agreement, contract, or transaction that has been willfully

structured to evade as provided in paragraphs (xxx)(6)(i) through

(xxx)(6)(iii) of this section shall be considered in determining

whether a person is a swap dealer or major swap participant.

(vi) Notwithstanding the foregoing, no agreement, contract, or

transaction structured as a security (including a security-based swap)

under the securities laws (as defined in section 3(a)(47) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed

a swap pursuant to this Sec. 1.3(xxx)(6) or shall be considered for

purposes of paragraph (xxx)(6)(v) of this section.

(yyy) Narrow-based security index as used in the definition of

``security-based swap.''

(1) In general. Except as otherwise provided in paragraphs (zzz)

and (aaaa) of this section, for purposes of section 1a(42) of the

Commodity Exchange Act, the term narrow-based security index has the

meaning set forth in section 1a(35) of the Commodity Exchange Act, and

the rules, regulations and orders of the Commission thereunder.

(2) Tolerance period for swaps traded on designated contract

markets, swap execution facilities, and foreign boards of trade.

Notwithstanding paragraph (yyy)(1) of this section, solely for purposes

of swaps traded on or subject to the rules of a designated contract

market, swap execution facility, or foreign board of trade, a security

index underlying such swaps shall not be considered a narrow-based

security index if:

(i)(A) A swap on the index is traded on or subject to the rules of

a designated contract market, swap execution facility, or foreign board

of trade for at least 30 days as a swap on an index that was not a

narrow-based security index; or

(B) Such index was not a narrow-based security index during every

trading day of the six full calendar months preceding a date no earlier

than 30 days prior to the commencement of trading of a swap on such

index on a market described in paragraph (yyy)(2)(i)(A) of this

section; and

(ii) The index has been a narrow-based security index for no more

than 45 business days over three consecutive calendar months.

(3) Tolerance period for security-based swaps traded on national

securities exchanges or security-based swap execution facilities.

Notwithstanding paragraph (yyy)(1) of this section, solely for purposes

of security-based swaps traded on a national securities exchange or

security-based swap execution facility, a security index underlying

such security-based swaps shall be considered a narrow-based security

index if:

(i)(A) A security-based swap on the index is traded on a national

securities exchange or security-based swap execution facility for at

least 30 days as a security-based swap on a narrow-based security

index; or

(B) Such index was a narrow-based security index during every

trading day of the six full calendar months preceding a date no earlier

than 30 days prior to the commencement of trading of a security-based

swap on such index on a market described in paragraph (yyy)(3)(i)(A) of

this section; and

(ii) The index has been a security index that is not a narrow-based

security index for no more than 45 business days over three consecutive

calendar months.

(4) Grace period. (i) Solely with respect to a swap that is traded

on or subject to the rules of a designated contract market, swap

execution facility, or foreign board of trade, an index that becomes a

narrow-based security index under paragraph (yyy)(2) of this section

solely because it was a narrow-based security index for more than 45

business days over three consecutive calendar months shall not be a

narrow-based security index for the following three calendar months.

(ii) Solely with respect to a security-based swap that is traded on

a national securities exchange or security-based swap execution

facility, an index that becomes a security index that is not a narrow-

based security index under paragraph (yyy)(3) of this section solely

because it was not a narrow-based security index for more than 45

business days over three consecutive calendar months shall be a narrow-

based security index for the following three calendar months.

(zzz) Meaning of ``issuers of securities in a narrow-based security

index'' as used in the definition of ``security-based swap'' as applied

to index credit default swaps.

(1) Notwithstanding paragraph (yyy)(1) of this section, and solely

for purposes of determining whether a credit default swap is a

security-based swap under the definition of ``security-based swap'' in

section 3(a)(68)(A)(ii)(III) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(68)(A)(ii)(III), as incorporated in section 1a(42) of the

Commodity Exchange Act, the term issuers of securities in a narrow-

based security index means issuers of

[[Page 29890]]

securities identified in an index in which:

(i)(A) There are 9 or fewer non-affiliated issuers of securities

that are reference entities in the index, provided that an issuer of

securities shall not be deemed a reference entity for purposes of this

section unless:

(1) A credit event with respect to such reference entity would

result in a payment by the credit protection seller to the credit

protection buyer under the credit default swap based on the related

notional amount allocated to such reference entity; or

(2) The fact of such credit event or the calculation in accordance

with paragraph (zzz)(1)(i)(A)(1) of this section of the amount owed

with respect to such credit event is taken into account in determining

whether to make any future payments under the credit default swap with

respect to any future credit events;

(B) The effective notional amount allocated to any reference entity

included in the index comprises more than 30 percent of the index's

weighting;

(C) The effective notional amount allocated to any five non-

affiliated reference entities included in the index comprises more than

60 percent of the index's weighting; or

(D) Except as provided in paragraph (zzz)(2) of this section, for

each reference entity included in the index, none of the following

criteria is satisfied:

(1) The reference entity is required to file reports pursuant to

section 13 or section 15(d) of the Securities Exchange Act of 1934 (15

U.S.C. 78m or 78o(d));

(2) The reference entity is eligible to rely on the exemption

provided in rule 12g3-2(b) under the Securities Exchange Act of 1934

(17 CFR 240.12g3-2(b));

(3) The reference entity has a worldwide market value of its

outstanding common equity held by non-affiliates of $700 million or

more;

(4) The reference entity (other than an issuing entity of an asset-

backed security as defined in section 3(a)(77) of the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) has outstanding securities

that are notes, bonds, debentures, or evidences of indebtedness having

a total remaining principal amount of at least $1 billion;

(5) The reference entity is the issuer of an exempted security as

defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(12)) (other than any municipal security as defined in

section 3(a)(29) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(29)));

(6) The reference entity is a government of a foreign country or a

political subdivision of a foreign country;

(7) If the reference entity is an issuer of asset-backed securities

as defined in section 3(a)(77) of the Securities Exchange Act of 1934

(15 U.S.C. 78c(a)(77)), such asset-based securities were issued in a

transaction registered under the Securities Act of 1933 (15 U.S.C. 77a

et seq.) and have publicly available distribution reports; and

(8) For a credit default swap entered into solely between eligible

contract participants as defined in section 1a(18) of the Commodity

Exchange Act:

(i) The reference entity (other than a reference entity that is an

issuing entity of an asset-backed security as defined in section

3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)))

provides to the public or to such eligible contract participant

information about the reference entity pursuant to rule 144A(d)(4)

under the Securities Act of 1933 (17 CFR 230.144A(d)(4));

(ii) Financial information about the reference entity (other than a

reference entity that is an issuing entity of an asset-backed security

as defined in section 3(a)(77) of the Securities Exchange Act of 1934

(15 U.S.C. 78c(a)(77))) is otherwise publicly available; or

(iii) In the case of a reference entity that is an issuing entity

of asset-backed securities as defined in section 3(a)(77) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)), information of

the type and level included in public distribution reports for similar

asset-backed securities is publicly available about both the reference

entity and such asset-backed securities; and

(ii)(A) The index is not composed solely of reference entities that

are issuers of exempted securities as defined in section 3(a)(12) of

the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in

effect on the date of enactment of the Futures Trading Act of 1982

(other than any municipal security as defined in section 3(a)(29) of

the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), as in

effect on the date of enactment of the Futures Trading Act of 1982);

and

(B) Without taking into account any portion of the index composed

of reference entities that are issuers of exempted securities as

defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

Futures Trading Act of 1982 (other than any municipal security as

defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(29))), the remaining portion of the index would be a

narrow-based security index under paragraph (zzz)(1)(i) of this

section.

(2) Paragraph (zzz)(1)(i)(D) of this section will not apply with

respect to a reference entity included in the index if:

(i) The effective notional amounts allocated to such reference

entity comprise less than five percent of the index's weighting; and

(ii) The effective notional amounts allocated to reference entities

that satisfy paragraph (zzz)(1)(i)(D) of this section comprise at least

80 percent of the index's weighting.

(3) For purposes of this paragraph (zzz):

(i) A reference entity is affiliated with another entity if it

controls, is controlled by, or is under common control with, that

entity; provided that each reference entity that is an issuing entity

of an asset-backed security as defined in section 3(a)(77) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) will not be

considered affiliated with any other issuing entity of an asset-backed

security.

(ii) Control means ownership of 20 percent or more of an entity's

equity, or the ability to direct the voting of 20 percent or more of

the entity's voting equity.

(iii) The term reference entity includes:

(A) An issuer of securities;

(B) An issuing entity of an asset-based security as defined in

section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(77)); and

(C) A single reference entity or a group of affiliated entities;

provided that each issuing entity of an asset-backed security as

defined in section 3(a)(77) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(77)) is a separate reference entity.

(aaaa) Meaning of ``narrow-based security index'' as used in the

definition of ``security-based swap'' as applied to index credit

default swaps.

(1) Notwithstanding paragraph (yyy)(1) of this section, and solely

for purposes of determining whether a credit default swap is a

security-based swap under the definition of ``security-based swap'' in

section 3(a)(68)(A)(ii)(I) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(68)(A)(ii)(I), as incorporated in section 1a(42) of the

Commodity Exchange Act, the term narrow-based security index means an

index in which:

(i)(A) The index is composed of 9 or fewer securities or securities

that are issued by 9 or fewer non-affiliated issuers, provided that a

security shall

[[Page 29891]]

not be deemed a component of the index for purposes of this section

unless:

(1) A credit event with respect to the issuer of such security or a

credit event with respect to such security would result in a payment by

the credit protection seller to the credit protection buyer under the

credit default swap based on the related notional amount allocated to

such security; or

(2) The fact of such credit event or the calculation in accordance

with paragraph (aaaa)(1)(i)(A)(1) of this section of the amount owed

with respect to such credit event is taken into account in determining

whether to make any future payments under the credit default swap with

respect to any future credit events;

(B) The effective notional amount allocated to the securities of

any issuer included in the index comprises more than 30 percent of the

index's weighting;

(C) The effective notional amount allocated to the securities of

any five non-affiliated issuers included in the index comprises more

than 60 percent of the index's weighting; or

(D) Except as provided in paragraph (aaaa)(2) of this section, for

each security included in the index, none of the following criteria is

satisfied:

(1) The issuer of the security is required to file reports pursuant

to section 13 or section 15(d) of the Securities Exchange Act of 1934

(15 U.S.C. 78m or 78o(d));

(2) The issuer of the security is eligible to rely on the exemption

provided in rule 12g3-2(b) under the Securities Exchange Act of 1934

(17 CFR 240.12g3-2(b));

(3) The issuer of the security has a worldwide market value of its

outstanding common equity held by non-affiliates of $700 million or

more;

(4) The issuer of the security (other than an issuing entity of an

asset-backed security as defined in section 3(a)(77) of the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) has outstanding securities

that are notes, bonds, debentures, or evidences of indebtedness having

a total remaining principal amount of at least $1 billion;

(5) The security is an exempted security as defined in section

3(a)(12) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12))

(other than any municipal security as defined in section 3(a)(29) of

the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29)));

(6) The issuer of the security is a government of a foreign country

or a political subdivision of a foreign country;

(7) If the security is an asset-backed security as defined in

section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(77)), the security was issued in a transaction registered under

the Securities Act of 1933 (15 U.S.C. 77a et seq.) and has publicly

available distribution reports; and

(8) For a credit default swap entered into solely between eligible

contract participants as defined in section 1a(18) of the Commodity

Exchange Act:

(i) The issuer of the security (other than an issuing entity of an

asset-backed security as defined in section 3(a)(77) of the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) provides to the public or

to such eligible contract participant information about such issuer

pursuant to rule 144A(d)(4) of the Securities Act of 1933 (17 CFR

230.144A(d)(4));

(ii) Financial information about the issuer of the security (other

than an asset-backed security as defined in section 3(a)(77) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) is otherwise

publicly available; or

(iii) In the case of an asset-backed security as defined in section

3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)),

information of the type and level included in public distribution

reports for similar asset-backed securities is publicly available about

both the issuing entity and such asset-backed security; and

(ii)(A) The index is not composed solely of exempted securities as

defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

Futures Trading Act of 1982 (other than any municipal security as

defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(29))), as in effect on the date of enactment of the

Futures Trading Act of 1982); and

(B) Without taking into account any portion of the index composed

of exempted securities as defined in section 3(a)(12) of the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in effect on the date

of enactment of the Futures Trading Act of 1982 (other than any

municipal security as defined in section 3(a)(29) of the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), the remaining portion of

the index would be a narrow-based security index under paragraph

(aaaa)(1)(i) of this section.

(2) Paragraph (aaaa)(1)(i)(D) of this section will not apply with

respect to securities of an issuer included in the index if:

(i) The effective notional amounts allocated to all securities of

such issuer included in the index comprise less than five percent of

the index's weighting; and

(ii) The securities that satisfy paragraph (aaaa)(1)(i)(D) of this

section comprise at least 80 percent of the index's weighting.

(3) For purposes of this paragraph (aaaa):

(i) An issuer is affiliated with another issuer if it controls, is

controlled by, or is under common control with, that issuer; provided

that each issuing entity of an asset-backed security as defined in

section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(77)) will not be considered affiliated with any other issuing

entity of an asset-backed security.

(ii) Control means ownership of 20 percent or more of an issuer's

equity, or the ability to direct the voting of 20 percent or more of

the issuer's voting equity.

(iii) The term issuer includes:

(A) An issuer of securities;

(B) An issuing entity of an asset-based security as defined in

section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(77)); and

(C) A single issuer or a group of affiliated issuers; provided that

each issuing entity of an asset-backed security as defined in section

3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))

is a separate issuer.

3. Add Sec. Sec. 1.6 through 1.9 to read as follows:

Sec.

1.6 Anti-evasion.

1.7 Books and records requirements for security-based swap

agreements.

1.8 Interpretation of swaps, security-based swaps, and mixed swaps.

1.9 Regulation of mixed swaps.

* * * * *

Sec. 1.6 Anti-evasion.

(a) It shall be unlawful to conduct activities outside the United

States, including entering into agreements, contracts, and transactions

and structuring entities, to willfully evade or attempt to evade any

provision of the Commodity Exchange Act as enacted by Subtitle A of the

Wall Street Transparency and Accountability Act of 2010 or the rules,

regulations, and orders of the Commission promulgated thereunder

(Subtitle A).

(b) The form, label, and written documentation of an agreement,

contract, or transaction, or an entity, shall not be dispositive in

determining whether the agreement, contract, or transaction, or entity,

has been entered into or structured to willfully evade as

[[Page 29892]]

provided in paragraph (a) of this section.

(c) An activity conducted outside the United States to evade as

provided in paragraph (a) of this section shall be subject to the

provisions of Subtitle A.

(d) Notwithstanding the foregoing, no agreement, contract, or

transaction structured as a security (including a security-based swap)

under the securities laws (as defined in section 3(a)(47) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed

a swap pursuant to this Sec. 1.6.

5. Add Sec. 1.7 to read as follows:

Sec. 1.7 Books and records requirements for security-based swap

agreements.

(a) A person registered as a swap data repository under section 21

of the Commodity Exchange Act and the rules and regulations thereunder:

(1) Shall not be required to keep and maintain additional books and

records regarding security-based swap agreements other than the books

and records regarding swaps required to be kept and maintained pursuant

to section 21 of the Commodity Exchange Act and the rules and

regulations thereunder; and

(2) Shall not be required to collect and maintain additional data

regarding security-based swap agreements other than the data regarding

swaps required to be collected and maintained by such persons pursuant

to section 21 of the Commodity Exchange Act and the rules and

regulations thereunder.

(b) A person shall not be required to keep and maintain additional

books and records, including daily trading records, regarding security-

based swap agreements other than the books and records regarding swaps

required to be kept and maintained by such persons pursuant to section

4s of the Commodity Exchange Act and the rules and regulations

thereunder if such person is registered as:

(1) A swap dealer under section 4s(a)(1) of the Commodity Exchange

Act and the rules and regulations thereunder;

(2) A major swap participant under section 4s(a)(2) of the

Commodity Exchange Act and the rules and regulations thereunder;

(3) A security-based swap dealer under section 15F(a)(1) of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(1)) and the rules

and regulations thereunder; or

(4) A major security-based swap participant under section 15F(a)(2)

of the Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(2)) and the

rules and regulations thereunder.

(c) The term security-based swap agreement has the meaning set

forth in section 1a(47)(A)(v) of the Commodity Exchange Act.

6. Add Sec. 1.8 to read as follows:

Sec. 1.8 Interpretation of swaps, security-based swaps, and mixed

swaps.

(a) In general. Any person may submit a request to the Commission

and the Securities and Exchange Commission to provide a joint

interpretation of whether a particular agreement, contract, or

transaction (or class thereof) is:

(1) A swap, as that term is defined in section 1a(47) of the

Commodity Exchange Act and the rules and regulations promulgated

thereunder;

(2) A security-based swap, as that term is defined in section

1a(42) of the Commodity Exchange Act and the rules and regulations

promulgated thereunder; or

(3) A mixed swap, as that term is defined in section 1a(47)(D) of

the Commodity Exchange Act and the rules and regulations promulgated

thereunder.

(b) Request process. In making a request pursuant to paragraph (a)

of this section, the requesting person must provide the Commission and

the Securities and Exchange Commission with the following:

(1) All material information regarding the terms of the agreement,

contract, or transaction (or class thereof);

(2) A statement of the economic characteristics and purpose of the

agreement, contract, or transaction (or class thereof);

(3) The requesting person's determination as to whether the

agreement, contract, or transaction (or class thereof) should be

characterized as a swap, a security-based swap, or both, (i.e., a mixed

swap), including the basis for such determination; and

(4) Such other information as may be requested by the Commission or

the Securities and Exchange Commission.

(c) Request withdrawal. A person may withdraw a request made

pursuant to paragraph (a) of this section at any time prior to the

issuance of a joint interpretation or joint notice of proposed

rulemaking by the Commission and the Securities and Exchange Commission

in response to the request; provided, however, that notwithstanding

such withdrawal, the Commission and the Securities and Exchange

Commission may provide a joint interpretation of whether the agreement,

contract, or transaction (or class thereof) is a swap, a security-based

swap, or both (i.e., a mixed swap).

(d) Request by the Commission or the Securities and Exchange

Commission. In the absence of a request for a joint interpretation

under paragraph (a) of this section:

(1) If the Commission or the Securities and Exchange Commission

receives a proposal to list, trade, or clear an agreement, contract, or

transaction (or class thereof) that raises questions as to the

appropriate characterization of such agreement, contract, or

transaction (or class thereof) as a swap, a security-based swap, or

both (i.e., a mixed swap), the Commission or the Securities and

Exchange Commission, as applicable, promptly shall notify the other of

the agreement, contract, or transaction (or class thereof); and

(2) The Commission or the Securities and Exchange Commission, or

their Chairmen jointly, may submit a request for a joint interpretation

as described in paragraph (a) of this section; such submission shall be

made pursuant to paragraph (b) of this section, and may be withdrawn

pursuant to paragraph (c) of this section.

(e) Timeframe for joint interpretation. (1) If the Commission and

the Securities and Exchange Commission determine to issue a joint

interpretation as described in paragraph (a) of this section, such

joint interpretation shall be issued within 120 days after receipt of a

complete submission requesting a joint interpretation under paragraph

(a) or (d) of this section.

(2) The Commission and the Securities and Exchange Commission shall

consult with the Board of Governors of the Federal Reserve System prior

to issuing any joint interpretation as described in paragraph (a) of

this section.

(3) If the Commission and the Securities and Exchange Commission

seek public comment with respect to a joint interpretation regarding an

agreement, contract, or transaction (or class thereof), the 120-day

period described in paragraph (e)(1) of this section shall be stayed

during the pendency of the comment period, but shall recommence with

the business day after the public comment period ends.

(4) Nothing in this section shall require the Commission and the

Securities and Exchange Commission to issue any joint interpretation.

(5) If the Commission and the Securities and Exchange Commission do

not issue a joint interpretation within the time period described in

paragraph (e)(1) or (e)(3) of this section, each of the Commission and

the Securities and Exchange Commission shall publicly provide the

reasons for not issuing such a joint interpretation within the

applicable timeframes.

(f) Joint notice of proposed rulemaking. (1) Rather than issue a

joint interpretation pursuant to paragraph (a) of this section, the

Commission and the

[[Page 29893]]

Securities and Exchange Commission may issue a joint notice of proposed

rulemaking, in consultation with the Board of Governors of the Federal

Reserve System, to further define one or more of the terms swap,

security-based swap, or mixed swap.

(2) A joint notice of proposed rulemaking described in paragraph

(f)(1) of this section shall be issued within the timeframe for issuing

a joint interpretation set forth in paragraph (e) of this section.

7. Add Sec. 1.9 to read as follows:

Sec. 1.9 Regulation of mixed swaps.

(a) In general. The term mixed swap has the meaning set forth in

section 1a(47)(D) of the Commodity Exchange Act.

(b) Regulation of bilateral uncleared mixed swaps entered into by

dually-registered dealers or major participants. A mixed swap:

(1) That is neither executed on nor subject to the rules of a

designated contract market, national securities exchange, swap

execution facility, security-based swap execution facility, or foreign

board of trade;

(2) That will not be submitted to a derivatives clearing

organization or registered or exempt clearing agency to be cleared; and

(3) Where at least one party is registered with the Commission as a

swap dealer or major swap participant and also with the Securities and

Exchange Commission as a security-based swap dealer or major security-

based swap participant, shall be subject to:

(i) The following provisions of the Commodity Exchange Act, and the

rules and regulations promulgated thereunder:

(A) Examinations and information sharing: sections 4s(f) and 8 of

the Commodity Exchange Act;

(B) Enforcement: sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c), 6(d), 6c,

6d, 9, 13(a), 13(b), and 23 of the Commodity Exchange Act;

(C) Reporting to a swap data repository: section 4r of the

Commodity Exchange Act;

(D) Real-time reporting: section 2(a)(13) of the Commodity Exchange

Act;

(E) Capital: section 4s(e) of the Commodity Exchange Act; and

(F) Position Limits: section 4a of the Commodity Exchange Act; and

(ii) The provisions of the Federal securities laws, as defined in

section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(47)), and the rules and regulations promulgated thereunder.

(c) Process for determining regulatory treatment for other mixed

swaps--(1) In general. Any person who desires or intends to list,

trade, or clear a mixed swap (or class thereof) that is not subject to

paragraph (b) of this section may request the Commission and the

Securities and Exchange Commission to issue a joint order permitting

the requesting person (and any other person or persons that

subsequently lists, trades, or clears that mixed swap) to comply, as to

parallel provisions only, with specified parallel provisions of either

the Commodity Exchange Act or the Securities Exchange Act of 1934 (15

U.S.C. 78a et seq.), and the rules and regulations thereunder

(collectively, specified parallel provisions), instead of being

required to comply with parallel provisions of both the Commodity

Exchange Act and the Securities Exchange Act of 1934. For purposes of

this paragraph (c), parallel provisions means comparable provisions of

the Commodity Exchange Act and the Securities Exchange Act of 1934 that

were added or amended by the Wall Street Transparency and

Accountability Act of 2010 with respect to swaps and security-based

swaps, and the rules and regulations thereunder.

(2) Request process. A person submitting a request pursuant to

paragraph (c)(1) of this section must provide the Commission and the

Securities and Exchange Commission with the following:

(i) All material information regarding the terms of the specified,

or specified class of, mixed swap;

(ii) The economic characteristics and purpose of the specified, or

specified class of, mixed swap;

(iii) The specified parallel provisions, and the reasons the person

believes such specified parallel provisions would be appropriate for

the mixed swap (or class thereof); and

(iv) An analysis of:

(A) The nature and purposes of the parallel provisions that are the

subject of the request;

(B) The comparability of such parallel provisions;

(C) The extent of any conflicts or differences between such

parallel provisions; and

(D) Such other information as may be requested by the Commission or

the Securities and Exchange Commission.

(3) Request withdrawal. A person may withdraw a request made

pursuant to paragraph (c)(1) of this section at any time prior to the

issuance of a joint order under paragraph (c)(4) of this section by the

Commission and the Securities and Exchange Commission in response to

the request.

(4) Issuance of orders. In response to a request under paragraph

(c)(1) of this section, the Commission and the Securities and Exchange

Commission, as necessary to carry out the purposes of the Wall Street

Transparency and Accountability Act of 2010, may issue a joint order,

after notice and opportunity for comment, permitting the requesting

person (and any other person or persons that subsequently lists,

trades, or clears that mixed swap) to comply, as to parallel provisions

only, with the specified parallel provisions (or another subset of the

parallel provisions that are the subject of the request, as the

Commissions determine is appropriate), instead of being required to

comply with parallel provisions of both the Commodity Exchange Act and

the Securities Exchange Act of 1934. In determining the contents of

such joint order, the Commission and the Securities and Exchange

Commission may consider, among other things:

(i) The nature and purposes of the parallel provisions that are the

subject of the request;

(ii) The comparability of such parallel provisions; and

(iii) The extent of any conflicts or differences between such

parallel provisions.

(5) Timeframe. (i) If the Commission and the Securities and

Exchange Commission determine to issue a joint order as described in

paragraph (c)(4) of this section, such joint order shall be issued

within 120 days after receipt of a complete request for a joint order

under paragraph (c)(1) of this section, which time period shall be

stayed during the pendency of the public comment period provided for in

paragraph (c)(4) of this section and shall recommence with the business

day after the public comment period ends.

(ii) Nothing in this section shall require the Commission and the

Securities and Exchange Commission to issue any joint order.

(iii) If the Commission and the Securities and Exchange Commission

do not issue a joint order within the time period described in

paragraph (c)(5)(i) of this section, each of the Commission and the

Securities and Exchange Commission shall publicly provide the reasons

for not issuing such a joint order within that timeframe.

Securities and Exchange Commission

Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and

particularly, sections 3 and 23 thereof, and sections 712(a)(8),

712(d), 721(a), 761(a) of the Dodd-Frank Act, the SEC is proposing to

adopt rules 3a68-1a through 3a68-4 and

[[Page 29894]]

3a69-1 through 3a69-3 under the Exchange Act.

Text of Proposed Rules

For the reasons stated in the preamble, the SEC is proposing to

amend Title 17, Chapter II of the Code of the Federal Regulations as

follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

1934

1. The general authority citation for Part 240 is revised to read

as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,

77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,

78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 78o-8,

78p, 78q, 78s, 78u-5, 78w, 78x, 78dd(b), 78dd(c), 78ll, 78mm, 80a-

20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq.;

18 U.S.C. 1350; and 12 U.S.C. 5221(e)(3), unless otherwise noted.

* * * * *

2. Add Sec. Sec. 240.3a68-1a through 240.3a68-4 and Sec. Sec.

240.3a69-1 through 240.3a69-3 to read as follows:

240.3a68-1a Meaning of ``issuers of securities in a narrow-based

security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.

240.3a68-1b Meaning of ``narrow-based security index'' as used in

section 3(a)(68)(A)(ii)(I) of the Act.

240.3a68-2 Interpretation of swaps, security-based swaps, and mixed

swaps.

240.3a68-3 Meaning of ``narrow-based security index'' as used in the

definition of ``security-based swap''.

240.3a68-4 Regulation of mixed swaps.

240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of the

Act--insurance.

240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of the

Act--additional products.

240.3a69-3 Books and records requirements for security-based swap

agreements.

* * * * *

Sec. 240.3a68-1a Meaning of ``issuers of securities in a narrow-based

security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.

(a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely

for purposes of determining whether a credit default swap is a

security-based swap under section 3(a)(68)(A)(ii)(III) of the Act (15

U.S.C. 78c(a)(68)(A)(ii)(III)), the term issuers of securities in a

narrow-based security index as used in section 3(a)(68)(A)(ii)(III) of

the Act means issuers of securities identified in an index in which:

(1)(i) There are 9 or fewer non-affiliated issuers of securities

that are reference entities in the index, provided that an issuer of

securities shall not be deemed a reference entity for purposes of this

section unless:

(A) A credit event with respect to such reference entity would

result in a payment by the credit protection seller to the credit

protection buyer under the credit default swap based on the related

notional amount allocated to such reference entity; or

(B) The fact of such credit event or the calculation in accordance

with paragraph (a)(1)(i)(A) of this section of the amount owed with

respect to such credit event is taken into account in determining

whether to make any future payments under the credit default swap with

respect to any future credit events;

(ii) The effective notional amount allocated to any reference

entity included in the index comprises more than 30 percent of the

index's weighting;

(iii) The effective notional amount allocated to any five non-

affiliated reference entities included in the index comprises more than

60 percent of the index's weighting; or

(iv) Except as provided in paragraph (b) of this section, for each

reference entity included in the index, none of the following criteria

is satisfied:

(A) The reference entity is required to file reports pursuant to

section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));

(B) The reference entity is eligible to rely on the exemption

provided in Sec. 240.12g3-2(b) of this chapter;

(C) The reference entity has a worldwide market value of its

outstanding common equity held by non-affiliates of $700 million or

more;

(D) The reference entity (other than an issuing entity of an asset-

backed security as defined in section 3(a)(77) of the Act (15 U.S.C.

78c(a)(77))) has outstanding securities that are notes, bonds,

debentures, or evidences of indebtedness having a total remaining

principal amount of at least $1 billion;

(E) The reference entity is the issuer of an exempted security as

defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other

than any municipal security as defined in section 3(a)(29) of the Act

(15 U.S.C. 78c(a)(29)));

(F) The reference entity is a government of a foreign country or a

political subdivision of a foreign country;

(G) If the reference entity is an issuer of asset-backed securities

as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), such

asset-based securities were issued in a transaction registered under

the Securities Act of 1933 (15 U.S.C. 77a et seq.) and have publicly

available distribution reports; and

(H) For a credit default swap entered into solely between eligible

contract participants as defined in section 3(a)(65) of the Act (15

U.S.C. 78c(a)(65)):

(1) The reference entity (other than a reference entity that is an

issuing entity of an asset-backed security as defined in section

3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) provides to the public or

to such eligible contract participant information about the reference

entity pursuant to Sec. 230.144A(d)(4)) of this chapter;

(2) Financial information about the reference entity (other than a

reference entity that is an issuing entity of an asset-backed security

as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) is

otherwise publicly available; or

(3) In the case of a reference entity that is an issuing entity of

asset-backed securities as defined in section 3(a)(77) of the Act (15

U.S.C. 78c(a)(77)), information of the type and level included in

public distribution reports for similar asset-backed securities is

publicly available about both the reference entity and such asset-

backed securities; and

(2)(i) The index is not composed solely of reference entities that

are issuers of exempted securities as defined in section 3(a)(12) of

the Act (15 U.S.C. 78c(a)(12)), as in effect on the date of enactment

of the Futures Trading Act of 1982 (other than any municipal security

as defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), as

in effect on the date of enactment of the Futures Trading Act of 1982);

and

(ii) Without taking into account any portion of the index composed

of reference entities that are issuers of exempted securities as

defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in

effect on the date of enactment of the Futures Trading Act of 1982

(other than any municipal security as defined in section 3(a)(29) of

the Act (15 U.S.C. 78c(a)(29))), the remaining portion of the index

would be a narrow-based security index under paragraph (a)(1) of this

section.

(b) Paragraph (a)(1)(iv) of this section will not apply with

respect to a reference entity included in the index if:

(1) The effective notional amounts allocated to such reference

entity comprise less than five percent of the index's weighting; and

(2) The effective notional amounts allocated to reference entities

that satisfy paragraph (a)(1)(iv) of this section comprise at least 80

percent of the index's weighting.

(c) For purposes of this Sec. 3a68-1a:

(1) A reference entity is affiliated with another entity if it

controls, is controlled by, or is under common control with,

[[Page 29895]]

that entity; provided that each reference entity that is an issuing

entity of an asset-backed security as defined in section 3(a)(77) of

the Act (15 U.S.C. 78c(a)(77)) will not be considered affiliated with

any other issuing entity of an asset-backed security.

(2) Control means ownership of 20 percent or more of an entity's

equity, or the ability to direct the voting of 20 percent or more of

the entity's voting equity.

(3) The term reference entity includes:

(i) An issuer of securities;

(ii) An issuing entity of an asset-based security as defined in

section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and

(iii) A single reference entity or a group of affiliated entities;

provided that each issuing entity of an asset-backed security as

defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a

separate reference entity.

Sec. 240.3a68-1b Meaning of ``narrow-based security index'' as used

in section 3(a)(68)(A)(ii)(I) of the Act.

(a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely

for purposes of determining whether a credit default swap is a

security-based swap under section 3(a)(68)(A)(ii)(I) of the Act (15

U.S.C. 78c(a)(68)(A)(ii)(I)), the term narrow-based security index as

used in section 3(a)(68)(A)(ii)(I) of the Act means an index in which:

(1)(i) The index is composed of 9 or fewer securities or securities

that are issued by 9 or fewer non-affiliated issuers, provided that a

security shall not be deemed a component of the index for purposes of

this section unless:

(A) A credit event with respect to the issuer of such security or a

credit event with respect to such security would result in a payment by

the credit protection seller to the credit protection buyer under the

credit default swap based on the related notional amount allocated to

such security; or

(B) The fact of such credit event or the calculation in accordance

with paragraph (a)(1)(i)(A) of this section of the amount owed with

respect to such credit event is taken into account in determining

whether to make any future payments under the credit default swap with

respect to any future credit events;

(ii) The effective notional amount allocated to the securities of

any issuer included in the index comprises more than 30 percent of the

index's weighting;

(iii) The effective notional amount allocated to the securities of

any five non-affiliated issuers included in the index comprises more

than 60 percent of the index's weighting; or

(iv) Except as provided in paragraph (b) of this section, for each

security included in the index none of the following criteria is

satisfied:

(A) The issuer of the security is required to file reports pursuant

to section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));

(B) The issuer of the security is eligible to rely on the exemption

provided in Sec. 40.12g3-2(b) of this chapter;

(C) The issuer of the security has a worldwide market value of its

outstanding common equity held by non-affiliates of $700 million or

more;

(D) The issuer of the security (other than an issuing entity of an

asset-backed security as defined in section 3(a)(77) of the Act (15

U.S.C. 78c(a)(77))) has outstanding securities that are notes, bonds,

debentures, or evidences of indebtedness having a total remaining

principal amount of at least $1 billion;

(E) The security is an exempted security as defined in section

3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other than any municipal

security as defined in section 3(a)(29) of the Act (15 U.S.C.

78c(a)(29)));

(F) The issuer of the security is a government of a foreign country

or a political subdivision of a foreign country;

(G) If the security is an asset-backed security as defined in

section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), the security was

issued in a transaction registered under the Securities Act of 1933 (15

U.S.C. 77a et seq.) and has publicly available distribution reports;

and

(H) For a credit default swap entered into solely between eligible

contract participants as defined in section 3(a)(65) of the Act (15

U.S.C. 78c(a)(65)):

(1) The issuer of the security (other than an issuing entity of an

asset-backed security as defined in section 3(a)(77) of the Act (15

U.S.C. 78c(a)(77))) provides to the public or to such eligible contract

participant information about such issuer pursuant to Sec.

230.144A(d)(4)) of this chapter;

(2) Financial information about the issuer of the security (other

than an asset-backed security as defined in section 3(a)(77) of the Act

(15 U.S.C. 78c(a)(77))) is otherwise publicly available; or

(3) In the case of an asset-backed security as defined in section

3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), information of the type and

level included in public distribution reports for similar asset-backed

securities is publicly available about both the issuing entity and such

asset-backed security; and

(2)(i) The index is not composed solely of exempted securities as

defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in

effect on the date of enactment of the Futures Trading Act of 1982

(other than any municipal security as defined in section 3(a)(29) of

the Act (15 U.S.C. 78c(a)(29))), as in effect on the date of enactment

of the Futures Trading Act of 1982); and

(ii) Without taking into account any portion of the index composed

of exempted securities as defined in section 3(a)(12) of the Act (15

U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

Futures Trading Act of 1982 (other than any municipal security as

defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), the

remaining portion of the index would be a narrow-based security index

under paragraph (a)(1) of this section.

(b) Paragraph (a)(1)(iv) of this section will not apply with

respect to securities of an issuer included in the index if:

(1) The effective notional amounts allocated to all securities of

such issuer included in the index comprise less than five percent of

the index's weighting; and

(2) The securities that satisfy paragraph (a)(1)(iv) of this

section comprise at least 80 percent of the index's weighting.

(c) For purposes of this Sec. 240.3a68-1b:

(1) An issuer is affiliated with another issuer if it controls, is

controlled by, or is under common control with, that issuer; provided

that each issuing entity of an asset-backed security as defined in

section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) will not be

considered affiliated with any other issuing entity of an asset-backed

security.

(2) Control means ownership of 20 percent or more of an issuer's

equity, or the ability to direct the voting of 20 percent or more of

the issuer's voting equity.

(3) The term issuer includes:

(i) An issuer of securities;

(ii) An issuing entity of an asset-based security as defined in

section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and

(iii) A single issuer or a group of affiliated issuers; provided

that each issuing entity of an asset-backed security as defined in

section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a separate

issuer.

Sec. 240.3a68-2 Interpretation of swaps, security-based swaps, and

mixed swaps.

(a) In general. Any person may submit a request to the Commission

and the Commodity Futures Trading Commission to provide a joint

interpretation of whether a particular agreement, contract, or

transaction (or

[[Page 29896]]

class thereof) is a swap, as that term is defined in section 3(a)(69)

of the Act (15 U.S.C. 78c(a)(69)) and the rules and regulations

promulgated thereunder, a security-based swap, as that term is defined

in section 3(a)(68) of the Act (15 U.S.C. 78c(a)(68)) and the rules and

regulations promulgated thereunder, or a mixed swap, as that term is

defined in section 3(a)(68)(D) of the Act and the rules and regulations

promulgated thereunder.

(b) Request process. In making a request pursuant to paragraph (a)

of this section, the requesting person must provide the Commission and

the Commodity Futures Trading Commission with the following:

(1) All material information regarding the terms of the agreement,

contract, or transaction (or class thereof);

(2) A statement of the economic characteristics and purpose of the

agreement, contract, or transaction (or class thereof);

(3) The requesting person's determination as to whether the

agreement, contract, or transaction (or class thereof) should be

characterized as a swap, a security-based swap, or both (i.e., a mixed

swap), including the basis for such determination; and

(4) Such other information as may be requested by the Commission or

the Commodity Futures Trading Commission.

(c) Request withdrawal. A person may withdraw a request made

pursuant to paragraph (a) of this section at any time prior to the

issuance of a joint interpretation or joint notice of proposed

rulemaking by the Commission and the Commodity Futures Trading

Commission in response to the request; provided, however, that

notwithstanding such withdrawal, the Commission and the Commodity

Futures Trading Commission may provide a joint interpretation of

whether the agreement, contract, or transaction (or class thereof) is a

swap, a security-based swap, or both (i.e., a mixed swap).

(d) Request by the Commission or the Commodity Futures Trading

Commission. In the absence of a request for a joint interpretation

under paragraph (a) of this section:

(1) If the Commission or the Commodity Futures Trading Commission

receives a proposal to list, trade, or clear an agreement, contract, or

transaction (or class thereof) that raises questions as to the

appropriate characterization of such agreement, contract, or

transaction (or class thereof) as a swap, a security-based swap, or

both (i.e., a mixed swap), the Commission or the Commodity Futures

Trading Commission, as applicable, promptly shall notify the other of

the agreement, contract, or transaction (or class thereof); and

(2) The Commission or the Commodity Futures Trading Commission, or

their Chairmen jointly, may submit a request for a joint interpretation

as described in paragraph (a) of this section; such submission shall be

made pursuant to paragraph (b) of this section, and may be withdrawn

pursuant to paragraph (c) of this section.

(e) Timeframe for joint interpretation.

(1) If the Commission and the Commodity Futures Trading Commission

determine to issue a joint interpretation as described in paragraph (a)

of this section, such joint interpretation shall be issued within 120

days after receipt of a complete submission requesting a joint

interpretation under paragraph (a) or (d) of this section.

(2) The Commission and the Commodity Futures Trading Commission

shall consult with the Board of Governors of the Federal Reserve System

prior to issuing any joint interpretation as described in paragraph (a)

of this section.

(3) If the Commission and the Commodity Futures Trading Commission

seek public comment with respect to a joint interpretation regarding an

agreement, contract, or transaction (or class thereof), the 120-day

period described in paragraph (e)(1) of this section shall be stayed

during the pendency of the comment period, but shall recommence with

the business day after the public comment period ends.

(4) Nothing in this section shall require the Commission and the

Commodity Futures Trading Commission to issue any joint interpretation.

(5) If the Commission and the Commodity Futures Trading Commission

do not issue a joint interpretation within the time period described in

paragraph (e)(1) or (e)(3) of this section, each of the Commission and

the Commodity Futures Trading Commission shall publicly provide the

reasons for not issuing such a joint interpretation within the

applicable timeframes.

(f) Joint notice of proposed rulemaking.

(1) Rather than issue a joint interpretation pursuant to paragraph

(a) of this section, the Commission and the Commodity Futures Trading

Commission may issue a joint notice of proposed rulemaking, in

consultation with the Board of Governors of the Federal Reserve System,

to further define one or more of the terms swap, security-based swap,

or mixed swap.

(2) A joint notice of proposed rulemaking described in paragraph

(f)(1) of this section shall be issued within the timeframe for issuing

a joint interpretation set forth in paragraph (e) of this section.

Sec. 240.3a68-3 Meaning of ``narrow-based security index'' as used in

the definition of ``security-based swap.''

(a) In general. Except as otherwise provided in Sec. 240.3a68-1a

and Sec. 240.3a68-1b of this chapter, for purposes of section 3(a)(68)

of the Act (15 U.S.C. 78c(a)(68)), the term narrow-based security index

has the meaning set forth in section 3(a)(55) of the Act (15 U.S.C.

78c(a)(55)), and the rules, regulations, and orders of the Commission

thereunder.

(b) Tolerance period for swaps traded on designated contract

markets, swap execution facilities and foreign boards of trade.

Notwithstanding paragraph (a) of this section, solely for purposes of

swaps traded on or subject to the rules of a designated contract

market, swap execution facility, or foreign board of trade pursuant to

the Commodity Exchange Act (7 U.S.C. 1 et seq.), a security index

underlying such swaps shall not be considered a narrow-based security

index if:

(1)(i) A swap on the index is traded on or subject to the rules of

a designated contract market, swap execution facility, or foreign board

of trade pursuant to the Commodity Exchange Act (7 U.S.C. 1 et seq.)

for at least 30 days as a swap on an index that was not a narrow-based

security index; or

(ii) Such index was not a narrow-based security index during every

trading day of the six full calendar months preceding a date no earlier

than 30 days prior to the commencement of trading of a swap on such

index on a market described in paragraph (b)(1)(i) of this section; and

(2) The index has been a narrow-based security index for no more

than 45 business days over three consecutive calendar months.

(c) Tolerance period for security-based swaps traded on national

securities exchanges or security-based swap execution facilities.

Notwithstanding paragraph (a) of this section, solely for purposes of

security-based swaps traded on a national securities exchange or

security-based swap execution facility, a security index underlying

such security-based swaps shall be considered a narrow-based security

index if:

(1)(i) A security-based swap on the index is traded on a national

securities

[[Page 29897]]

exchange or security-based swap execution facility for at least 30 days

as a security-based swap on a narrow-based security index; or

(ii) Such index was a narrow-based security index during every

trading day of the six full calendar months preceding a date no earlier

than 30 days prior to the commencement of trading of a security-based

swap on such index on a market described in paragraph (c)(1)(i) of this

section; and

(2) The index has been a security index that is not a narrow-based

security index for no more than 45 business days over three consecutive

calendar months.

(d) Grace period.

(1) Solely with respect to a swap that is traded on or subject to

the rules of a designated contract market, swap execution facility or

foreign board of trade pursuant to the Commodity Exchange Act (7 U.S.C.

1 et seq.), an index that becomes a narrow-based security index under

paragraph (b) of this section solely because it was a narrow-based

security index for more than 45 business days over three consecutive

calendar months shall not be a narrow-based security index for the

following three calendar months.

(2) Solely with respect to a security-based swap that is traded on

a national securities exchange or security-based swap execution

facility, an index that becomes a security index that is not a narrow-

based security index under paragraph (c) of this section solely because

it was not a narrow-based security index for more than 45 business days

over three consecutive calendar months shall be a narrow-based security

index for the following three calendar months.

Sec. 240.3a68-4 Regulation of mixed swaps.

(a) In general. The term mixed swap has the meaning set forth in

section 3(a)(68)(D) of the Act (15 U.S.C. 78c(a)(68)(D)).

(b) Regulation of mixed swaps entered into by dually-registered

dealers or major participants. A mixed swap:

(1) That is neither executed on nor subject to the rules of a

designated contract market, national securities exchange, swap

execution facility, security-based swap execution facility, or foreign

board of trade;

(2) That will not be submitted to a derivatives clearing

organization or registered or exempt clearing agency to be cleared; and

(3) Where at least one party is registered with the Commission as a

security-based swap dealer or major security-based swap participant and

also with the Commodity Futures Trading Commission as a swap dealer or

major swap participant, shall be subject to:

(i) The following provisions of the Commodity Exchange Act (7

U.S.C. 1 et seq.), and the rules and regulations promulgated

thereunder, set forth in the rules and regulations of the Commodity

Futures Trading Commission:

(A) Examinations and information sharing: 7 U.S.C. 6s(f) and 12;

(B) Enforcement: 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9, 13b, 13a-1,

13a-2, 13, 13c(a), 13c(b), 15 and 26;

(C) Reporting to a swap data repository: 7 U.S.C. 6r;

(D) Real-time reporting: 7 U.S.C. 2(a)(13);

(E) Capital: 7 U.S.C. 6s(e); and

(F) Position Limits: 7 U.S.C. 6a; and

(ii) The provisions of the Federal securities laws, as defined in

section 3(a)(47) of the Act (15 U.S.C. 78c(a)(47)), and the rules and

regulations promulgated thereunder.

(c) Process for determining regulatory treatment for mixed swaps.

(1) In general. Any person who desires or intends to list, trade,

or clear a mixed swap (or class thereof) that is not subject to

paragraph (b) of this section may request the Commission and the

Commodity Futures Trading Commission to issue a joint order permitting

the requesting person (and any other person or persons that

subsequently lists, trades, or clears that mixed swap) to comply, as to

parallel provisions only, with specified parallel provisions of either

the Act (15 U.S.C. 78a et seq.) or the Commodity Exchange Act (7 U.S.C.

1 et seq.), and the rules and regulations thereunder (collectively,

specified parallel provisions), instead of being required to comply

with parallel provisions of both the Act and the Commodity Exchange

Act. For purposes of this paragraph (c), parallel provisions means

comparable provisions of the Act and the Commodity Exchange Act that

were added or amended by the Wall Street Transparency and

Accountability Act of 2010 with respect to security-based swaps and

swaps, and the rules and regulations thereunder.

(2) Request process. A person submitting a request pursuant to

paragraph (c)(1) of this section must provide the Commission and the

Commodity Futures Trading Commission with the following:

(i) All material information regarding the terms of the specified,

or specified class of, mixed swap;

(ii) The economic characteristics and purpose of the specified, or

specified class of, mixed swap;

(iii) The specified parallel provisions, and the reasons the person

believes such specified parallel provisions would be appropriate for

the mixed swap (or class thereof); and

(iv) An analysis of:

(A) The nature and purposes of the parallel provisions that are the

subject of the request;

(B) The comparability of such parallel provisions;

(C) The extent of any conflicts or differences between such

parallel provisions; and

(D) Such other information as may be requested by the Commission or

the Commodity Futures Trading Commission.

(3) Request withdrawal. A person may withdraw a request made

pursuant to paragraph (c)(1) of this section at any time prior to the

issuance of a joint order under paragraph (c)(4) of this section by the

Commission and the Commodity Futures Trading Commission in response to

the request.

(4) Issuance of orders. In response to a request under paragraph

(c)(1) of this section, the Commission and the Commodity Futures

Trading Commission, as necessary to carry out the purposes of the Wall

Street Transparency and Accountability Act of 2010, may issue a joint

order, after notice and opportunity for comment, permitting the

requesting person (and any other person or persons that subsequently

lists, trades, or clears that mixed swap) to comply, as to parallel

provisions only, with the specified parallel provisions (or another

subset of the parallel provisions that are the subject of the request,

as the Commissions determine is appropriate), instead of being required

to comply with parallel provisions of both the Act (15 U.S.C. 78a et

seq.) and the Commodity Exchange Act (7 U.S.C. 1 et seq.). In

determining the contents of such joint order, the Commission and the

Commodity Futures Trading Commission may consider, among other things:

(i) The nature and purposes of the parallel provisions that are the

subject of the request;

(ii) The comparability of such parallel provisions; and

(iii) The extent of any conflicts or differences between such

parallel provisions.

(5) Timeframe.

(i) If the Commission and the Commodity Futures Trading Commission

determine to issue a joint order as described in paragraph (c)(4) of

this section, such joint order shall be issued within 120 days after

receipt of a complete request for a joint order under paragraph (c)(1)

of this section, which time period shall be stayed

[[Page 29898]]

during the pendency of the public comment period provided for in

paragraph (c)(4) of this section and shall recommence with the business

day after the public comment period ends.

(ii) Nothing in this section shall require the Commission and the

Commodity Futures Trading Commission to issue any joint order.

(iii) If the Commission and the Commodity Futures Trading

Commission do not issue a joint order within the time period described

in paragraph (c)(5)(i) of this section, each of the Commission and the

Commodity Futures Trading Commission shall publicly provide the reasons

for not issuing such a joint order within that timeframe.

Sec. 240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of

the Act--Insurance

The term swap as used in section 3(a)(69) of the Act (15 U.S.C.

78c(a)(69)) does not include an agreement, contract, or transaction

that:

(a) By its terms or by law, as a condition of performance on the

agreement, contract, or transaction:

(1) Requires the beneficiary of the agreement, contract, or

transaction to have an insurable interest that is the subject of the

agreement, contract, or transaction and thereby carry the risk of loss

with respect to that interest continuously throughout the duration of

the agreement, contract, or transaction;

(2) Requires that loss to occur and to be proved, and that any

payment or indemnification therefor be limited to the value of the

insurable interest;

(3) Is not traded, separately from the insured interest, on an

organized market or over-the-counter; and

(4) With respect to financial guaranty insurance only, in the event

of payment default or insolvency of the obligor, any acceleration of

payments under the policy is at the sole discretion of the insurer; and

(b) Is provided:

(1) By a company that is organized as an insurance company whose

primary and predominant business activity is the writing of insurance

or the reinsuring of risks underwritten by insurance companies and that

is subject to supervision by the insurance commissioner (or similar

official or agency) of any State, as defined in section 3(a)(16) of the

Act (15 U.S.C. 78c(a)(16)), or by the United States or an agency or

instrumentality thereof, and such agreement, contract, or transaction

is regulated as insurance under the laws of such State or of the United

States;

(2) By the United States or any of its agencies or

instrumentalities, or pursuant to a statutorily authorized program

thereof; or

(3) In the case of reinsurance only, by a person located outside

the United States to an insurance company that is eligible under

paragraph (b) of this section, provided that:

(i) Such person is not prohibited by any law of any State or of the

United States from offering such agreement, contract, or transaction to

such an insurance company;

(ii) The product to be reinsured meets the requirements under

paragraph (a) of this section to be insurance; and

(iii) The total amount reimbursable by all reinsurers for such

insurance product cannot exceed the claims or losses paid by the

cedant.

Sec. 240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of

the Act--Additional Products.

(a) In general. The term swap has the meaning set forth in section

3(a)(69) of the Act (15 U.S.C. 78c(a)(69)).

(b) Inclusion of particular products. (1) The term swap includes,

without limiting the meaning set forth in section 3(a)(69) of the Act

(15 U.S.C. 78c(a)(69), the following agreements, contracts, and

transactions:

(i) A cross-currency swap;

(ii) A currency option, foreign currency option, foreign exchange

option and foreign exchange rate option;

(iii) A foreign exchange forward;

(iv) A foreign exchange swap;

(v) A forward rate agreement; and

(vi) A non-deliverable forward involving foreign exchange.

(2) The term swap does not include an agreement, contract, or

transaction described in paragraph (b)(1) of this section that is

otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act

(7 U.S.C. 1a(47)(B)).

(c) Foreign exchange forwards and foreign exchange swaps.

Notwithstanding paragraph (b)(2) of this section:

(1) A foreign exchange forward or a foreign exchange swap shall not

be considered a swap if the Secretary of the Treasury makes a

determination described in section 1a(47)(E)(i) of the Commodity

Exchange Act (7 U.S.C. 1a(47)(E)(i)).

(2) Notwithstanding paragraph (c)(1) of this section:

(i) The reporting requirements set forth in section 4r of the

Commodity Exchange Act (7 U.S.C. 6r) and regulations promulgated

thereunder shall apply to a foreign exchange forward or foreign

exchange swap; and

(ii) The business conduct standards set forth in section 4s of the

Commodity Exchange Act (7 U.S.C. 6s) and regulations promulgated

thereunder shall apply to a swap dealer or major swap participant that

is a party to a foreign exchange forward or foreign exchange swap.

(3) For purposes of section 1a(47)(E) of the Commodity Exchange Act

(7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign

exchange forward has the meaning set forth in section 1a(24) of the

Commodity Exchange Act (7 U.S.C. 1a(24)).

(4) For purposes of section 1a(47)(E) of the Commodity Exchange Act

(7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign

exchange swap has the meaning set forth in section 1a(25) of the

Commodity Exchange Act (7 U.S.C. 1a(25)).

(5) For purposes of sections 1a(24) and 1a(25) of the Commodity

Exchange Act (7 U.S.C. 1a(24) and (25)) and this Sec. 240.3a69-2, the

following transactions are not foreign exchange forwards or foreign

exchange swaps:

(i) A currency swap or a cross-currency swap;

(ii) A currency option, foreign currency option, foreign exchange

option, or foreign exchange rate option; and

(iii) A non-deliverable forward involving foreign exchange.

Sec. 240.3a69-3 Books and records requirements for security-based

swap agreements.

(a) A person registered as a swap data repository under section 21

of the Commodity Exchange Act (7 U.S.C. 24a) and the rules and

regulations thereunder:

(1) Shall not be required to keep and maintain additional books and

records regarding security-based swap agreements other than the books

and records regarding swaps required to be kept and maintained pursuant

to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the

rules and regulations thereunder; and

(2) Shall not be required to collect and maintain additional data

regarding security-based swap agreements other than the data regarding

swaps required to be collected and maintained by such persons pursuant

to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the

rules and regulations thereunder.

(b) A person shall not be required to keep and maintain additional

books and records, including daily trading records, regarding security-

based swap agreements other than the books and records regarding swaps

required to be kept and maintained by such persons pursuant to section

4s of the Commodity Exchange Act (7 U.S.C. 6s) and the rules

[[Page 29899]]

and regulations thereunder if such person is registered as:

(1) A swap dealer under section 4s(a)(1) of the Commodity Exchange

Act (7 U.S.C. 6s(a)(1)) and the rules and regulations thereunder;

(2) A major swap participant under section 4s(a)(2) of the

Commodity Exchange Act (7 U.S.C. 6s(a)(2)) and the rules and

regulations thereunder;

(3) A security-based swap dealer under section 15F(a)(1) of the Act

(15 U.S.C. 78o-10(a)(1)) and the rules and regulations thereunder; or

(4) A major security-based swap participant under section 15F(a)(2)

of the Act (15 U.S.C. 78o-10(a)(2)) and the rules and regulations

thereunder.

(c) The term security-based swap agreement has the meaning set

forth in section 3(a)(78) of the Act (15 U.S.C. 78c(a)(78)).

Dated: April 29, 2011.

By the Commodity Futures Trading Commission.

David A. Stawick,

Secretary.

Dated: April 29, 2011.

By the Securities and Exchange Commission.

Cathy H. Ahn,

Deputy Secretary.

Product Definitions Contained in Title VII of the Dodd-Frank Wall

Street Reform and Consumer Protection Act--CFTC Voting Summary and

Statements of CFTC Commissioners

Note: The following will not appear in the Code of Federal

Regulations.

CFTC Voting Summary

On this matter, Chairman Gensler and Commissioners Dunn, Chilton

and O'Malia voted in the affirmative; Commissioner Sommers voted in the

negative.

Statement of CFTC Chairman Gary Gensler

I support the proposed rulemaking to implement the Dodd-Frank Act's

requirement to further define derivatives products that come under

Title VII of the Act.

The CFTC worked closely with the SEC, in consultation with the

Federal Reserve, on this proposed rule to further define swaps,

security-based swaps, mixed swaps and security-based swap agreements.

The statutory definition of swap is very detailed. This rule is

consistent with that detailed definition and Congressional intent. For

example, interest rate swaps, currency swaps, commodity swaps,

including energy, metals and agricultural swaps, and broad-based index

swaps, such as index credit default swaps, are all swaps. Consistent

with Congress's definition of swaps, the rule also defines options as

swaps.

In preparing the proposed rule, staff worked to address the more

than 80 comments that were submitted by the public in response to the

joint advance notice of proposed rulemaking on product definitions.

Many of the commenters asked that the Commissions specifically provide

guidance on what is not a swap or security-based swap.

For example, under the Commodity Exchange Act, the CFTC does not

regulate forward contracts. Over the decades, there has been a series

of orders, interpretations and cases that market participants have come

to rely upon regarding the exception from futures regulation for

forwards and forwards with embedded options. Consistent with that

history, the Dodd-Frank Act excluded from the definition of swaps ``any

sale of a nonfinancial commodity or security for deferred shipment or

delivery, so long as the transaction is intended to be physically

settled.'' The proposed rule interprets that exclusion in a manner that

is consistent with the Commission's previous history of the forward

exclusion from futures regulation.

Further, consistent with the Dodd-Frank Act, the proposed rule

clarifies that state or Federally regulated insurance products that are

provided by regulated insurance companies will not be regulated under

Title VII of the Act. Similarly, the proposal clarifies that certain

consumer and commercial arrangements that historically have not been

considered swaps, such as consumer mortgage rate locks, contracts to

lock in the price of home heating oil and contracts relating to

inventory or equipment, also will not be regulated under Title VII of

the Act.

Statement of CFTC Commissioner Jill Sommers

I respectfully dissent from the action taken today by the

Commission to issue proposed regulations relating to ``Product

Definitions Contained in Title VII of the Dodd-Frank Wall Street Reform

and Consumer Protection Act.''

I disagree with the approach taken by the Commission with regard to

the proposed ``Anti-Evasion'' provisions. I agree that Dodd-Frank

Section 721(c) directs the Commission to further define certain terms

to include transactions or entities that have been structured to evade

Dodd-Frank. I do not agree that Congress directed the Commission to

promulgate broad ``Anti-Evasion'' provisions, and I point out that the

Securities and Exchange Commission today has declined to promulgate

such provisions in this joint rulemaking.

By promulgating a broad regulation today that essentially says that

any transaction that does not fall within the definition of ``swap''

because it has been structured to evade Dodd-Frank nonetheless is a

swap, the Commission is over-reading its Congressional mandate. The

statutory definition of ``swap'' includes a laundry-list of

transactions that Congress intended to include within the definition.

If Congress intended the definition of ``swap'' also to include a broad

statement that any transaction structured to evade Dodd-Frank is a

``swap,'' Congress would have incorporated such a provision within the

statutory definition. By directing the Commission to ``further define''

the term ``swap'' by rule, Congress is directing the Commission not to

make the broad statement it declined to make, but to think through

whether the definition of ``swap'' needs to be modified by rule to

include specific transactions within the definition.

In addition to my concern about the ``Anti-Evasion'' provisions

included within this proposal, I am concerned about an important issue

that is not raised within this proposal. Multinational organizations

whose statutory mission is to combat poverty and foster economic

development have raised concerns about the application of Dodd-Frank to

their activities. This proposal omits any discussion of their issues.

In my view the following language should be included within the

proposal, and I urge the public to comment upon the issues raised:

Transactions Involving Certain Foreign or Multinational Entities

The swap definition expressly excludes ``any agreement, contract,

or transaction a counterparty of which is a Federal Reserve bank, the

Federal Government, or a Federal agency that is expressly backed by the

full faith and credit of the United States.'' \399\ Some commenters

have suggested that the Commissions should exercise their authority to

further define the terms ``swap'' and ``security-based swap'' to

similarly exclude transactions in which a counterparty is an

international public organization, a foreign central bank, a foreign

sovereign, or a multi-or supra-national organization.\400\ Commenters

[[Page 29900]]

have advanced international comity, national treatment, limited

regulatory resources, limits on the Commissions' respective

extraterritorial jurisdiction, and international harmonization as

rationales for such an approach.\401\

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\399\ 7 U.S.C. 1a(47)(B)(ix).

\400\ See, e.g., letter from Gunter Pleines, Head of Banking

Department, and Diego Devos, General Counsel, Bank for International

Settlements (``BIS Letter''); Cleary Letter. The Commissions note

that various other terms may be used to refer to organizations that

generally: (i) Limit their membership to sovereign nations; (ii) are

established by treaty; (iii) have a separate legal identity from

their members; and (iv) ``are usually specialized and of

international or regional scope'' and ``formed between three or more

nations to work on issues that relate to all of the countries in the

organization. See, e.g., http://portal.unesco.org/en/ev.php-URL_ID=32408&URL_DO=DO_TOPIC&URL_SECCTION=201.html; http://www.geni.org/globalenergy/library/organizations/index.shtml. For

convenience, the Commissions use the term ``supranational

organization'' herein to refer to organizations having such

characteristics.

\401\ See, e.g., BIS Letter (citing Article 1, paragraph 4, of

the proposed EU Regulation on Central Clearing of OTC Derivatives,

available at http://register.consilium.europa.eu/pdf/en/11/st05/st05059.en11.pdf, which excludes from its coverage the BIS,

multilateral development banks, European central banks and similarly

situated ``other national bodies performing similar functions and

other public bodies charged with or intervening in the management of

the public debt'').

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Request for Comment

The Commissions request comment generally on the

appropriate application of the Dodd-Frank Act to international public

organizations, foreign central banks, foreign sovereigns (or foreign

sovereign wealth funds), supranational organizations, and any other

foreign or multinational entity that may be analogous to the entities

excluded from the swap definition in CEA Section 1a(47)(B)(ix).

Should the Commissions further define the terms ``swap''

and ``security-based swap'' to exclude transactions in which a

counterparty is an international public organization, foreign central

bank, foreign sovereign (or foreign sovereign wealth fund),

supranational organization, or any other foreign or multinational

entity that may be analogous to an entity excluded from the swap

definition in CEA Section 1a(47)(B)(ix)? Why or why not? If so, how

should the Commissions delineate the scope of entities whose

transactions would be excluded? Please describe in detail the nature of

the entity whose transactions would be excluded and explain the reasons

for such an exclusion. Would such an exclusion inappropriately cause

transactions that should be regulated as swaps or security-based swaps

to fall outside of the regulatory regime established by the Dodd-Frank

Act? Why or why not?

If the Commissions further define the terms ``swap'' and

``security-based swap'' to exclude any such entity, should the

exclusion be subject to any conditions, or should the exclusion be

limited to particular requirements of Title VII? Why or why not? If so,

what conditions would be appropriate, and/or what requirements of Title

VII should the exclusion apply to, and why?

If the Commissions further define the terms ``swap'' and

``security-based swap'' to exclude any such entity, to what extent

should counterparties to such transactions be subject to the

requirements of Title VII? What would be the appropriate regulatory

treatment of such counterparties in these circumstances?

[FR Doc. 2011-11008 Filed 5-20-11; 8:45 am]

BILLING CODE 6351-01-P; 8011-01-P

Last Updated: May 23, 2011