Federal Register, Volume 77 Issue 137 (Tuesday, July 17, 2012)[Federal Register Volume 77, Number 137 (Tuesday, July 17, 2012)]
[Proposed Rules]
[Pages 41940-41952]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17357]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AD47
Clearing Exemption for Certain Swaps Entered Into by Cooperatives
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is proposing a rule pursuant to its authority under
Section 4(c) of the Commodity Exchange Act (CEA) allowing cooperatives
meeting certain conditions to elect not to submit for clearing certain
swaps that such cooperatives would otherwise be required to clear in
accordance with Section 2(h)(1) of the CEA.
DATES: Comments must be received on or before August 16, 2012.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD47,
by any of the following methods:
Commission Web Site: http://comments.cftc.gov. Follow the
instructions for submitting comments through the Web site.
Mail: David A. Stawick, Secretary of the Commission, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov. Follow the
instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. ``Exempt Cooperatives'' must be clearly
indicated on all comment submissions. Comments will be posted as
received to http://www.cftc.gov. You should submit only information
that you wish to make
[[Page 41941]]
available publicly. If you wish the Commission to consider information
that is exempt from disclosure under the Freedom of Information Act, a
petition for confidential treatment of the exempt information may be
submitted according to the established procedures in CFTC Regulation
145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations may be accessed through
the Commission's Web site, http://www.cftc.gov.
_____________________________________-
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of a
submission from www.cftc.gov that it may deem to be inappropriate for
publication, such as obscene language. All submissions that have been
redacted or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT: Erik F. Remmler, Associate Director,
202-418-7630, Division of Clearing and Risk, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street NW., Washington,
DC 20581.
I. Background
The CEA, as amended by Title VII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the ``Dodd-Frank Act''),\2\
establishes a comprehensive new regulatory framework for swaps. The CEA
requires a swap: (1) To be submitted for clearing through a derivatives
clearing organization (DCO) if the Commission has determined that the
swap is required to be cleared, unless an exception to the clearing
requirement applies; (2) to be reported to a swap data repository (SDR)
or the Commission; and (3) if such swap is subject to a clearing
requirement, to be executed on a designated contract market (DCM) or
swap execution facility (SEF), unless no DCM or SEF has made the swap
available to trade.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376 (2010), available at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
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Section 2(h)(1)(A) of the CEA establishes a clearing requirement
for swaps, providing that ``it shall be unlawful for any person to
engage in a swap unless that person submits such swap for clearing to a
[DCO] that is registered under [the CEA] or a [DCO] that is exempt from
registration under [the CEA] if the swap is required to be cleared.''
\3\ However, Section 2(h)(7)(A) of the CEA provides that the clearing
requirement of Section 2(h)(1)(A) shall not apply to a swap if one of
the counterparties to the swap: ``(i) is not a financial entity; (ii)
is using swaps to hedge or mitigate commercial risk; and (iii) notifies
the Commission, in a manner set forth by the Commission, how it
generally meets its financial obligations associated with entering into
non-cleared swaps'' (referred to hereinafter as the ``end-user
exception'').\4\ The Commission has promulgated Sec. 39.6 to implement
certain provisions of Section 2(h)(7). Accordingly, any swap that is
required to be cleared by the Commission pursuant to Section 2(h)(2) of
the CEA must be submitted to a DCO for clearing by the counterparties
unless the conditions of Sec. 39.6 are satisfied.
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\3\ See Section 2(h)(1)(A) of the CEA, 7 U.S.C. 2(h)(1)(A).
\4\ See Section 2(h)(7)(A) of the CEA, 7 U.S.C. 2(h)(7)(A).
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Congress adopted the end-user exception in Section 2(h)(7) of the
CEA to permit certain non-financial companies to continue using non-
cleared swaps to hedge risks associated with their underlying
businesses, such as manufacturing, energy exploration, farming,
transportation, or other commercial activities. Additionally, in
Section 2(h)(7)(C)(ii) of the CEA, the Commission was directed to
``consider whether to exempt from the definition of `financial entity'
small banks, savings associations, farm credit system institutions and
credit unions including:
(I) Depository institutions with total assets of $10,000,000,000 or
less;
(II) Farm credit system institutions with total assets of
$10,000,000,000 or less; or
(III) Credit unions with total assets of $10,000,000,000 or less.''
In Sec. 39.6(d), the Commission identifies which financial
entities are small financial institutions and establishes an exemption
for these small financial institutions pursuant to Section
2(h)(7)(C)(ii) (the ``small financial institution exemption''). The
small financial institution exemption largely adopts the language of
Section 2(h)(7)(C)(ii) providing for an exemption for the types of
Section 2(h)(7)(C)(ii) institutions having total assets of $10 billion
or less.
On December 23, 2010, the Commission published for public comment a
notice of proposed rulemaking (NPRM) for Sec. 39.6.\5\ Several parties
that commented on the Sec. 39.6 NPRM recommended that the Commission
provide relief from clearing for cooperatives.\6\ These commenters
primarily reasoned \7\ that the member ownership nature of cooperatives
and the fact that cooperatives act on behalf of members that are non-
financial entities or small financial institutions justified an
extension of the end-user exception to the cooperatives. In effect,
they proposed that because a cooperative acts in place of its members
when facing the larger financial markets on behalf of the members, the
end-user exception that would be available to a cooperative's members
should pass through to the cooperative. Accordingly, if the members
themselves could elect the end-user exception, then the Commission
should permit the cooperatives to do so as well.
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\5\ See 75 FR 80747 (Dec. 23, 2010).
\6\ See, e.g., Agricultural Leaders of Michigan (ALM), The Farm
Credit Council (FCC), Allegheny Electric Cooperative, Inc. (AEC),
Garkane Energy Cooperative, Inc. (GEC), National Council of Farmer
Cooperatives, Dairy Farmers of America, and National Rural Utilities
Cooperative Finance Corporation (CFC). All comments referred to in
this NPRM were comments received on the Sec. 39.6 NPRM and can be
found on the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=937.
\7\ Other reasons given for providing an exemption from clearing
for cooperatives, including risk considerations, are discussed
below.
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However, Section 2(h)(7) of the CEA does not differentiate
cooperatives from other types of entities and therefore, cooperatives
that are ``financial entities,'' as defined in Section 2(h)(7)(i) of
the CEA, would be prohibited from electing the end-user exception
unless they qualify for the small financial institution exemption. Some
commenters recommended including cooperatives that are ``financial
entities'' with total assets in excess of $10 billion in the small
financial institution exemption.\8\ However, as explained in greater
detail in the final release for Sec. 39.6, Section 2(h)(7)(C)(ii) of
the CEA focused on asset size and not on the structure of the financial
entity. Accordingly, only cooperatives that are financial entities with
total assets of $10 billion or less can qualify as small financial
institutions.
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\8\ See, e.g., FCC, CFC, AEC, ALM, and GEC.
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Notwithstanding the foregoing, the Commission recognizes that the
member ownership structure of cooperatives and the merits of
effectively passing through the end-user exception available to members
to the cooperative warrant consideration. Accordingly, the Commission
is using the authority provided in Section 4(c) of the CEA to propose
Sec. 39.6(f), which would permit cooperatives that meet certain
qualifications to elect not to clear certain swaps that are otherwise
[[Page 41942]]
required to be cleared pursuant to Section 2(h)(1)(A) of the CEA
(hereinafter referred to as the ``cooperative exemption'').
II. Cooperatives
Cooperatives that are ``financial entities'' as defined in Section
2(h)(7)(C)(i) of the CEA generally serve as the collective asset
liability manager for their members. In this role, the cooperatives
face the financial markets on behalf of their members. For example,
they borrow money on a wholesale basis and then lend those funds to
their members to meet their funding needs at a lower cost than would
otherwise be available to the members individually. The commenters on
the Sec. 39.6 NPRM noted that financial cooperatives also enter into
swaps with members primarily in connection with originating loans to
the members for the purpose of hedging interest rate risk associated
with the loans.\9\ The cooperatives also enter into swaps with other
financial entities, typically Swap Dealers (``SDs'') or Major Swap
Participants (``MSPs''), to hedge the risks associated with the swaps
they execute with their members or to hedge risks associated with their
wholesale borrowing activities. The cooperatives use their size and
resources on behalf of their members to provide more efficient
financing and hedging than the members might achieve on their own.
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\9\ See, e.g., FCC, CFC, AEC, ALM, and GEC.
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Several commenters also noted that financial cooperative swap
activities in connection with loans to members pose less risk to the
financial system.\10\ The cooperatives often enter into swaps with
other financial institutions, typically on a matched book basis, to
hedge the underlying risk of those member swaps. According to
commenters, such matched book swaps pose less risk to the cooperatives
because the market risk is largely passed through. Similar comments
were made with respect to small financial institutions and the
Commission acknowledged this as one reason for adopting the small
financial institution exemption.
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\10\ See, e.g., FCC, CFC, AEC, ALM, and GEC.
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Some cooperatives have more than $10 billion in total assets, but
act on behalf of members that are non-financial entities, small
financial institutions, or other cooperatives whose members consist of
such entities.\11\ For example, there are four Farm Credit System (FCS)
banks chartered under Federal law, each of which has assets in excess
of $10 billion. The FCS banks are cooperatives primarily owned by their
cooperative associations.\12\ The Farm Credit Act authorizes the banks
``to make loans and commitments to eligible cooperative associations.''
\13\ The FCS association members are, in turn, authorized to make loans
to farmers and ranchers, rural residents, and persons furnishing farm-
related services.\14\ In effect, FCS bank cooperatives lend to FCS
associations, which lend to farmers, and farmers own the FCS
associations, which own the FCS banks. In addition to the example of
the FCS banks as provided in Federal law, other cooperatives formed
under Federal and state laws also have a similar entity structure in
that they are owned by their members and they exist primarily to serve
those members.
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\11\ See, e.g., FCC, CFC, AEC, ALM, and GEC.
\12\ See 12 U.S.C. 2124(c) (providing that ``[v]oting stock may
be issued or transferred and held only by * * * cooperative
associations eligible to borrow from the banks'').
\13\ Id. Sec. 2128(a).
\14\ See id. Sec. 2075.
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III. The Proposed Cooperative Exemption Rule
A. Introduction
In proposing an exemption for certain swaps entered into by
cooperatives that are financial entities, the Commission is very much
aware that central clearing of swaps is a primary focus of Title VII of
the Dodd-Frank Act. Central clearing mitigates financial system risks
that result from swaps and any exemption therefrom should be narrowly
drawn to minimize the impact on the risk mitigation benefits of
clearing and should also be in line with the end-user exception
requirements of Section 2(h)(7) of the CEA. Accordingly, the Commission
has sought to narrow the cooperative exemption appropriately.
B. Regulation 39.6(f)(1). Definition of Exempt Cooperative
The proposed rule would apply only to cooperatives that are
financial entities as defined in Section 2(h)(7)(C)(i) of the CEA. The
end-user exception is generally available to commercial (i.e. non-
financial) cooperatives, or financial cooperatives that meet the
requirements of the small financial institution exemption, that are
seeking an exception for swaps that hedge or mitigate commercial risk.
Proposed paragraph (f)(1) would provide that each member of the
cooperative seeking to elect the cooperative exemption must be a non-
financial entity, a financial institution to which the small financial
institution exemption applies, or itself a cooperative each of whose
members fall into those categories. This provision would limit the
cooperative exemption to cooperatives whose members are entities that
could elect the end-user exception themselves. With this provision, the
Commission is assuring that the cooperative exemption does not become
overly broad and available to cooperatives with members that are non-
exempt financial entities as defined in Section 2(h)(7)(C) of the
CEA.\15\
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\15\ For example, the cooperative exemption would not be
available to the Federal Home Loan Banks, whose membership includes
financial entities that are not small financial institutions.
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C. Regulation 39.6(f)(2). Swaps to Which the Cooperative Exemption
Applies
Proposed paragraph (f)(2)(i) limits application of the cooperative
exemption to swaps entered into with members of the exempt cooperative
in connection with originating loans \16\ for members or swaps entered
into by exempt cooperatives that hedge or mitigate risks associated
with member loans or member loan-related swaps. This provision assures
that the cooperative exemption is only used as a pass through for swaps
with members who would themselves be able to elect the end-user
exception and for swaps that hedge or mitigate risk in connection with
member loans and swaps as would be required by Section 2(h)(7)(A)(ii)
of the CEA for those member swaps. The primary rationale for the
cooperative exemption is based on the unique relationship between
cooperatives and their member owners. Expanding this exemption to
include swaps with non-member entities with which a cooperative may do
business (other than swaps used to hedge risks related to member loans
or swaps) would go beyond the purpose of the exemption, which is to
pass the member's end-user exception through to the cooperative because
of the unique member-owner structure of cooperatives. Furthermore,
allowing cooperatives to enter into non-cleared swaps with non-members
or swaps that serve purposes other than hedging member loans or swaps
would give the cooperatives, which are large financial entities, a
market advantage over their competitors that is not justified by their
cooperative structure or the provisions of the Dodd-Frank Act.
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\16\ The meaning of ``in connection with originating a loan'' is
similarly used in the definition of swap dealer in Sec. 1.3(ggg) of
the CEA. See 77 FR 30596, 30744 (May 23, 2012). For purposes of
consistency, that meaning is incorporated in the cooperative
exception rule.
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Additionally, for the cooperative exemption to benefit all members
of cooperatives who would otherwise be able to elect the end-user
exception themselves, the proposed exemption would be available to all
qualifying
[[Page 41943]]
cooperatives, including those with total assets greater than $10
billion.\17\ The Commission remains mindful that larger financial
institutions pose greater risk to the financial system than small
financial institutions, such as those identified in Section
2(h)(7)(C)(ii) of the CEA, because larger financial institutions are
more likely to be interconnected with a greater number of market
participants and therefore more likely to transfer risk widely. In
keeping with this concern and in recognition of the larger asset size
of cooperatives that will be able to use the cooperative exemption, the
Commission, in its proposal, is limiting the cooperative exemption to
swaps in connection with member loans. Several commenters who requested
an exemption for cooperatives justified the request in part on the
basis that cooperatives principally use swaps in connection with
originating loans to members. These commenters noted that such swaps
are relatively low risk. To minimize the risk a cooperative exemption
might pose to the financial system, the proposed rule would limit the
exemption to swaps in connection with originating loans to members and
swaps used by the cooperatives to hedge or mitigate risks related to
member loans or risks arising from swaps entered into with members
related to such loans.
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\17\ Some financial cooperatives such as CoBank, and AgriBank
FCB, have total assets in excess of $50 billion.
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D. Regulation 39.6(f)(3). Reporting
Under Section 4(c) of the CEA, the Commission can subject such
exemptive relief to appropriate terms and conditions.\18\ To this end,
the Commission believes it is appropriate to impose certain reporting
requirements on any entities that may be exempted from the clearing
requirement by this rule. These reporting requirements are effectively
identical to the reporting requirements for the end-user exception. For
the end-user exception, Section 2(h)(7)(A)(iii) of the CEA requires
that one of the counterparties to the swap must notify ``the Commission
in a manner set forth by the Commission how it generally meets its
financial obligations associated with entering into non-cleared
swaps.'' Regulation 39.6(b) implements Section 2(h)(7)(A)(iii) by
requiring one of the counterparties (the ``reporting counterparty'') to
provide, or cause to be provided, to a registered SDR, or if no
registered SDR is available, to the Commission, information about how
the counterparty electing the exception generally expects to meet its
financial obligations associated with non-cleared swaps. In addition,
Sec. 39.6(b) requires the reporting counterparty to provide certain
information that the Commission will use to monitor compliance with,
and prevent abuse of, the end-user exception. The reporting
counterparty would be required to provide the information at the time
the electing counterparty elects the end-user exception.
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\18\ See Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1).
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Proposed Sec. 39.6(f)(3) would require the same reporting required
for the end-user exception whenever the cooperative exemption is
elected for the same reasons. For purposes of regulatory consistency,
Sec. 39.6(f)(3) incorporates the provisions of Sec. 39.6(b) with only
those changes needed to apply the provisions to the cooperative
exemption.
IV. Section 4(c) of the Commodity Exchange Act
Section 4(c)(1) of the CEA provides that, in order to promote
responsible economic or financial innovation and fair competition, the
Commission, by rule, regulation or order, after notice and opportunity
for hearing, may exempt any agreement, contract, or transaction, or
class thereof, including any person or class of persons offering,
entering into, rendering advice or rendering other services with
respect to the agreement, contract, or transaction, from the contract
market designation requirement of Section 4(a) of the CEA, or any other
provision of the CEA other than certain enumerated provisions.\19\
Through this exemptive regulation, the Commission proposes that
cooperatives meeting certain conditions are the class of persons that
should be exempted from the clearing requirement for certain types of
swaps. As discussed in more detail above, such cooperatives act on
behalf of their members in certain financial matters and to that
extent, the proposed rule effectively provides for passing through the
end-user exception available to such cooperatives' members to the
cooperatives.
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\19\ 7 U.S.C. 6(c).
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The end-user exception provided in Section 2(h)(7) of the CEA is
not available to an entity that is a ``financial entity'' as defined in
Section 2(h)(7)(C)(i) unless such entity is exempt from the definition
because it is a small financial institution as provided in Section
2(h)(7)(C)(ii) of the CEA and Sec. 39.6(d). As explained in greater
detail in the final release for Sec. 39.6, Section 2(h)(7)(C)(ii) of
the CEA focused exclusively on asset size for determining what
financial entities could qualify for the small financial institution
exemption. Furthermore, the $10 billion limit identified in that
section guides the Commission's consideration of the small financial
institution exemption absent convincing evidence that a different asset
level is warranted. Section 2(h)(7)(C)(ii) does not provide special
consideration for cooperatives that meet the definition of ``financial
entity'' and therefore the asset size limit applies to them.
Cooperatives have a member ownership structure in which the
cooperatives exist to serve their member owners and do not act for
their own profit.\20\ Furthermore, the member owners of the cooperative
collectively have full control and governance of the cooperative. In a
real sense, the cooperative is not separable from its member owners. As
described above, some cooperatives provide financial services to their
members including lending and providing swaps to members and hedging
those activities with other financial entities such as SDs. The
memberships of some of these cooperatives consist of entities that each
could elect the end-user exception if acting alone. However, some of
those cooperatives meet the definition of ``financial entity'' and have
assets in excess of $10 billion, and therefore the end-user exception
is unavailable to them. Accordingly, the cooperative members would not
benefit from the end-user exception if they use their cooperative as
the preferred vehicle for hedging commercial risks in the greater
financial marketplace. In light of this, the Commission is exercising
its authority under Section 4(c) of the CEA to propose Sec. 39.6(f)
and establish the cooperative exemption.
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\20\ For example, the CFC was formed as a nonprofit corporation
under the District of Columbia Cooperative Association Act of 1940
to arrange financing for its members and their patrons and for the
``primary and mutual benefit of the patrons of the Association and
their patrons, as ultimate consumers.'' CFC Articles of
Incorporation, Art. 1.
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The Commission believes that there are benefits to having
cooperatives execute risk hedging or mitigation strategies with, and on
behalf of, their members. The FCC has commented that ``[t]o provide
tailored financing products for farmers and farm-related businesses,
Farm Credit System institutions rely on the safe use of derivatives to
manage interest rate, liquidity, and balance sheet risk, primarily in
the form of interest rate swaps.'' The FCS institutions include the
four FCS cooperative banks, each of which has total assets in excess of
$10 billion. Using the substantial, finance-focused resources of the
cooperative to
[[Page 41944]]
undertake hedging activities for the numerous members of the
cooperative promotes greater economic efficiency and lower costs for
the members. The Commission believes that the use of swaps in this
manner by cooperatives on behalf of their members constitutes financial
innovation that is beneficial for the public.
In light of the foregoing, the Commission believes that the
adoption of proposed Sec. 39.6(f) and its attendant terms and
conditions would promote responsible economic and financial innovation
and fair competition.
The Commission requests public comment on whether the proposed
regulation satisfies the requirements for exemption under Section 4(c)
of the CEA and on all aspects of the proposed regulation. The
Commission welcomes any quantifiable data and analysis that would
assist the Commission in this rulemaking. In particular, the Commission
is requesting comment on the following questions:
Has the Commission correctly limited the exemption to
cooperatives in which each member is: A non-financial entity, a
financial entity to which the small financial institution exemption
applies, or a cooperative each of whose members fall into those
categories?
Are there cooperatives in which not all members are a non-
financial entity, a financial entity to which the small financial
institution exemption applies, or a cooperative each of whose members
fall into those categories? If so, should the proposed definition of
``exempt cooperative'' be modified to include them? Would such
inclusion undermine the narrow pass through focus of the rule? Is it
possible that financial entities that do not currently operate as
cooperatives and for which the clearing requirement is intended could
reorganize or create cooperatives to take advantage of the proposed
cooperative exemption? If so, how could the proposed rule be modified
to prevent that from happening? Should affiliates of financial entities
identified in Sections 2(h)(7)(C)(i)(I) through (VII) of the CEA be
expressly excluded from the definition of exempt cooperative?
The Commission invites comment on whether the types of
swaps for which the cooperative exemption may be elected should be
expanded or further limited and why. If so, please describe such
expansion or limitation specifically. Is the provision allowing for
swaps that hedge or mitigate risk ``related to loans to members'' too
limited or not limited enough? What clarifying language could be added
to more effectively identify such swaps that would be consistent with
the rationale used for the proposed rule regarding the cooperative
standing in place of its members when entering into hedging swaps with
other financial entities? Are there practical or other considerations
in identifying which swaps serve to hedge or mitigate the risk of
member loans or member loan related swaps?
Are there additional or alternative considerations that
should be reviewed by the Commission regarding the proposed cooperative
exemption?
V. Consideration of Costs and Benefits
A. Background
In the wake of the financial crisis of 2008, Congress adopted the
Dodd-Frank Act, which, among other things, requires the Commission to
determine whether a particular swap, or group, category, type or class
of swaps, shall be required to be cleared.\21\ Specifically, Section
723(a)(3) of the Dodd-Frank Act amended Section 2(h)(1)(A) of the CEA
to make it ``unlawful for any person to engage in a swap unless that
person submits such swap for clearing to a [DCO] that is registered
under the CEA or a [DCO] that is exempt from registration under [the
CEA] if the swap is required to be cleared.'' This clearing requirement
is designed to reduce counterparty risk associated with swaps and, in
turn, mitigate the potential systemic impact of such risk and reduce
the likelihood for swaps to cause or exacerbate instability in the
financial system.\22\ It reflects a fundamental premise of the Dodd-
Frank Act: the use of properly regulated and functioning central
clearing can reduce systemic risk.
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\21\ See Section 2(h)(2) of the CEA, 7 U.S.C. 2(h)(2).
\22\ When a bilateral swap is moved into clearing, the DCO
becomes the counterparty to each of the original participants in the
swap. This standardizes counterparty risk for the original swap
participants in that they each bear the same risk attributable to
facing the DCO as counterparty. In addition, DCOs exist for the
primary purpose of managing credit exposure from the swaps being
cleared and therefore DCOs are effective at mitigating counterparty
risk through the use of risk management frameworks. These frameworks
model risk and collect defined levels of initial and variation
margin from the counterparties that are adjusted for changing market
conditions and use guarantee funds and other risk management tools
for the purpose of assuring that, in the event of a member default,
all other counterparties remain whole. DCOs have demonstrated
resilience in the face of past market stress. Most recently, they
remained financially sound and effectively settled positions in the
midst of turbulent events in 2007-2008 that threatened the financial
health and stability of many other types of entities.
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Notwithstanding the benefits of clearing, Section 2(h)(7) of the
CEA provides the end-user exception if one of the swap counterparties:
``(i) is not a financial entity; (ii) is using swaps to hedge or
mitigate commercial risk; and (iii) notifies the Commission, in a
manner set forth by the Commission, how it generally meets its
financial obligations associated with entering into non-cleared
swaps.'' Section 2(h)(7)(C)(ii) of the CEA directs the Commission to
consider making the end-user exception available to small banks,
savings associations, credit unions, and farm credit institutions,
including those institutions with total assets of $10 billion or less,
through an exemption from the definition of ``financial entity.'' \23\
In Sec. 39.6(d), the Commission establishes the small financial
institution exemption for these institutions. The small financial
institution exemption largely adopts the language of Section
2(h)(7)(C)(ii) providing for an exemption for the institutions
identified in Section 2(h)(7)(C)(ii) that have total assets of $10
billion or less.
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\23\ See CEA 2(h)(7)(C)(ii).
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Through proposed Sec. 39.6(f), the Commission would use the
authority provided in Section 4(c) of the CEA to permit ``exempt
cooperatives,'' as defined in Sec. 39.6(f)(1), to elect not to clear
certain swaps that are otherwise required to be cleared pursuant to
Section 2(h)(1)(A) of the CEA, notwithstanding that these cooperatives
are financial entities that do not qualify for the small financial
institution exemption because their assets exceed $10 billion.
Specifically, an ``exempt cooperative'' is a cooperative under Federal
or state law that is a financial entity each member of which is
eligible for the end-user exception, or is another cooperative composed
of members, each of whom is eligible for the end-user exception. An
exempt cooperative would not be required to clear swaps with members in
connection with member loans, or swaps used by the exempt cooperative
to hedge or mitigate risk arising in connection with such swaps with
members or loans to members.
On December 23, 2010, the Commission published for public comment
an NPRM for Sec. 39.6 proposing the end-user exception.\24\ Several
parties that commented on the Sec. 39.6 NPRM recommended that the
Commission provide relief from clearing for cooperatives. These
commenters reasoned \25\ that the member ownership nature of
cooperatives and the fact that they act on behalf of members that are
non-financial entities or small financial
[[Page 41945]]
institutions justified an extension of the end-user exception to the
cooperatives. In effect, the commenters posit that because a
cooperative takes the place of its members to face the larger financial
markets on behalf of the members, the end-user exception that would be
available to a cooperative's members should pass through to the
cooperative. Accordingly, if the members themselves could elect the
end-user exception, then the Commission should permit the cooperatives
to do so as well.
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\24\ See 75 FR 80747.
\25\ Other reasons given for providing an exemption from
clearing for cooperatives, including risk considerations, are
discussed above in this NPRM.
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The Commission is proposing such an exemption herein for certain
cooperatives, and it is the costs and benefits of this exemption that
the Commission considers in the discussion that follows.
B. Statutory Requirement To Consider the Costs and Benefits of the
Commission's Action: CEA Section 15(a)
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. Accordingly, the Commission considers the
costs and benefits resulting from its own discretionary determinations
with respect to the Section 15(a) factors.
The costs and benefits of the Commission's action in this
rulemaking are measured against the level of costs and benefits that
would exist absent this rulemaking. Absent this rulemaking, all
cooperatives that are financial entities as defined in Section
2(h)(7)(C)(i) of the CEA and which are not otherwise exempt from that
definition would be unable to elect the end-user exception pursuant to
Section 2(h)(7)(A)(i) of the CEA, which specifies that to elect the
end-user exception a counterparty must not be a financial entity. Thus,
the foundation against which this rulemaking's costs and benefits are
measured is the statutory requirement that cooperatives within the
definition of financial entities and with assets exceeding $10 billion,
remain subject to the clearing requirement of Section 2(h)(1)(A) of the
CEA. Additionally, the Commission considers the rulemaking's costs and
benefits relative to alternatives besides that of abstaining from
action.
As discussed in more detail below, the Commission is able to
estimate certain reporting costs. The dollar estimates are offered as
ranges with upper and lower bounds, which is necessary to accommodate
the uncertainty that surrounds them. The Commission notes that the most
likely outcome with respect to each estimate is a cost above the lower
bound and below the upper bound.
The discussion below considers the rule's costs and benefits as
well as alternatives to the rule. The discussion concludes with a
consideration of the rule's costs and benefits in light of the five
factors specified in Section 15(a) of the CEA.
C. Costs and Benefits of the Proposed Rule
1. Costs and Benefits to Electing Entities
Without this proposed 4(c) rule, cooperatives meeting the criteria
of the proposed exemption would have to engage in cleared swaps
pursuant to Section 2(h)(1)(A) of the CEA when they are either: (1)
Transacting with a member who does not elect the end-user exception, or
(2) transacting with another financial entity to hedge or mitigate risk
related to loans with members or swaps with members related to such
loans. Extending the end-user exception to such entities in these
circumstances benefits them in that they will not have to bear the
costs of clearing that each may incur. These costs include certain
capital costs and fees associated with clearing.\26\
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\26\ Transacting swaps bilaterally is not without cost, of
course, and the Commission notes that uncleared swaps have
associated costs as well. For example, when a market participant
faces a swap dealer or other counterparty in an uncleared swap, the
uncleared swap contains an implicit line of credit upon which the
market participant effectively draws when its swap position is out
of the money. Counterparties charge for this implicit line of credit
in the spread they offer on uncollateralized, uncleared swaps.
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Regarding fees, DCOs typically charge FCMs an initial transaction
fee for each of the FCM customers' swaps that are cleared, as well as
an annual maintenance fee for each of their customers' open positions.
For example, not including customer-specific and volume discounts, the
transaction fees for interest rate swaps at CME range from $1 to $24
per million notional amount and the maintenance fees are $2 per year
per million notional amount for open positions.\27\ LCH transaction
fees for interest rate swaps range from $1 to $20 per million notional
amount, and the maintenance fee ranges from $5 to $20 per swap per
month, depending on the number of outstanding swap positions that an
entity has with the DCO.\28\
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\27\ See CME pricing charts at: http://www.cmegroup.com/trading/cds/files/CDS-Fees.pdf; http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Customer-Fee.pdf; and http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Self-Clearing-Fee.pdf.
\28\ See LCH pricing for clearing services related to OTC
interest rate swaps at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.
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It is within the FCM's discretion to determine whether or how to
pass these fees on to their customers, but the Commission believes that
FCMs generally pass these fees straight through to their customers. To
the extent that this is true, allowing exempt cooperatives to elect not
to clear swaps that meet the requirements of the proposed rule will
result in the exempt cooperatives not having to pay such clearing
related fees with respect to those swaps. The Commission requests
comment on whether and how FCMs pass DCO fees on to their customers,
and to what extent this creates clearing-related costs for exempt
cooperatives entering into swaps meeting the conditions proposed in
this rule. If possible, please provide quantitative information related
to this issue.
The proposed rule may also impact the capital that cooperatives
that are financial entities are required to hold with respect to their
swap positions pursuant to prudential regulatory capital requirements.
As stated above, when compared to a situation in which the proposed
exemption is not available, the proposed exemption will reduce the
number of swaps that eligible cooperatives are required to clear. The
Commission anticipates that reducing the number of swaps that such
cooperatives clear will impact their capital ratios in such a way as to
reduce the amount of capital that eligible cooperatives are required to
hold. This creates both benefits and costs. Regarding benefits, this
increases the cooperative's lending capacity, enabling them to lend
more to their members without retaining or raising additional capital.
As for costs, this allows eligible cooperatives to become more highly
leveraged, which increases the counterparty risk that they pose to
their members and other market participants with whom they transact.
The Commission invites comment on the effects of required clearing on
the capital requirements for financial cooperatives. To the extent
possible, please quantify the anticipated effect of the proposed
exemption on relevant capital ratios as well as the costs and benefits
resulting from changes in the cooperatives' leverage and lending
capacity.
[[Page 41946]]
Clearing swaps creates an obligation for counterparties to the
cleared swap to post both initial and variation margin related to that
position. A clearing exemption may reduce the amount of capital that an
entity has to post in order to cover its positions, particularly if
that entity does not post margin directly to its counterparties with
respect to some or all of its uncleared positions.\29\ However, in the
case of unmargined swaps, dealers typically account for the
counterparty risk that they face in the absence of margin by adjusting
the terms of the swap. The additional cost embedded in an unmargined
swap to account for additional counterparty risk is likely to be
roughly equivalent to the cost associated with a line of credit that
would be used to post margin for that position if it were cleared.\30\
The Commission, therefore, believes that this is an implicit cost in
unmargined swaps that is made explicit by clearing swaps, rather than a
new cost created by clearing. Therefore the exemption is not expected
to significantly alter exempt cooperatives' costs in this area. The
Commission invites comment regarding the expected effect of this
proposed exemption on the amount and cost of collateral posted by
entities eligible for the exemption. Wherever possible, please quantify
costs and benefits.
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\29\ This assessment assumes similar levels of netting and
compression in both uncleared and cleared portfolios. These
assumptions are not necessarily valid in all cases. Moving swaps
into clearing can--depending on the number of counterparties a
market participant originally faced with uncleared swaps, the margin
agreements in place with those counterparties, and the number of
DCOs that eventually clear those positions--reduce the amount of
margin that an entity has to post.
\30\ Mello, Antonio S., and John E. Parsons, ``Margins,
Liquidity, and the Cost of Hedging.'' MIT Center for Energy and
Environmental Policy Research, May 2012.
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Regarding reporting, cooperatives electing the cooperative
exemption will have some reporting costs. The proposed rule requires
that exempt cooperatives adhere to the reporting requirements of Sec.
39.6(b). For each swap where the exemption is elected, either the
cooperative or its counterparty (if the counterparty is an SD or MSP)
must report: (1) That the election of the exemption is being made; (2)
which party is the electing counterparty; and (3) certain information
specific to the electing counterparty unless that information has
already been provided by the electing counterparty through an annual
filing. The third set of information comprises data that is likely to
remain relatively constant for many, but not all, electing
counterparties and therefore, does not require swap-by-swap reporting
and can be reported less frequently. In addition, for entities that are
registered with the SEC, the reporting party will also be required to
report: (1) The SEC filer's central index key number; and (2) that an
appropriate committee of the board of directors has approved the
decision for that entity to enter into swaps that are exempt from the
requirements of Sections 2(h)(1) and 2(h)(8) of the Act.
When entering into swaps with members and electing the exemption,
exempt cooperatives will be responsible to report this information.
When cooperatives enter into swaps with SDs or MSPs, the SDs or MSPs
will be responsible to report this information. Entities would bear
costs related to the personnel hours committed to reporting the
required information. As described below in the subsection entitled
``Number of Exempt Cooperatives and Swaps'' in the section entitled
``Paperwork Reduction Act,'' the Commission estimates that
approximately ten cooperatives will be eligible for the cooperative
exemption. For purposes of estimating costs, the Commission assumes
that each potential exempt cooperative is likely to function as the
reporting counterparty for at least some of their exempted swaps in any
given year because they would be responsible for reporting when
transacting exempted swaps with members.
A review of information provided for five cooperatives that likely
would be exempt cooperatives showed a range of swap usage from none to
as many as approximately 200 swaps a year with most entering into less
than 50 swaps a year. Using the high end of reported swaps for the five
cooperatives for which information was available, an estimate of 50
swaps per year was calculated. The Commission believes this estimate is
high because some of the reported swaps may not meet the requirements
of the proposed rule and several cooperatives for which information was
not available to the Commission likely undertake little if any, swap
activity. However, for purposes of the cost calculations, the
Commission assumes that each of the ten potential exempt cooperatives
will enter into 50 swaps each year. Accordingly, we estimate that
exempt cooperatives may elect the cooperative exemption for 500 swaps
each year. The Commission invites comment regarding the estimated
number of swaps conducted by each cooperative that would be eligible
under this proposed rule. In addition, the Commission invites comment
regarding the per cooperative average and total notional value of swaps
that would be eligible under the cooperative exemption.
For each exempted swap, to comply with the swap-by-swap reporting
requirements in Sec. Sec. 39.6(b)(1)(i) and (ii), the reporting
counterparty will be required to check one box indicating the exemption
is being elected and complete one field identifying the electing
counterparty. The Commission expects that this information will be
entered into the appropriate reporting system concurrently with
additional information that is required under the CEA and other
Commission regulations promulgated thereunder. Therefore, each
reporting counterparty is likely to spend 15 seconds to two minutes per
transaction in incremental time entering the swap-by-swap information
into the reporting system, or in the aggregate, 1.5 hours to 17 hours
per year for all 500 estimated swaps. A financial analyst's average
salary is $208/hour, which corresponds to approximately $1-$7 per
transaction or in aggregate, $300-$3,500 per year for all 500 estimated
swaps.\31\
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\31\ Wage estimates are taken from the SIFMA ``Report on
Management and Professional Earnings in the Securities Industry
2011.'' Hourly wages are calculated assuming 1,800 hours per year
and a multiplier of 5.35 to account for overhead and bonuses. In
light of the challenges of developing precise estimates, the results
of calculations have been rounded.
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Regulation 39.6(b)(1)(iii) allows for certain counterparty specific
information identified therein to be reported either swap-by-swap by
the reporting counterparty or annually by the electing counterparty.
For the end-user exception for which that section also applies, the
alternative options may be useful in instances where electing
counterparties enter into very few swaps each year and the reporting
counterparties will report this information for them on a swap-by-swap
basis. However, for the cooperative exemption, the exempt cooperative
is the electing counterparty and will also likely be the reporting
counterparty for swaps entered into with members. Furthermore, the
Commission expects that, assuming the cooperative is the reporting
counterparty, the time burden for the first swap entered into by an
exempt cooperative in collecting and reporting the information required
by Sec. 39.6(b)(1)(iii) will be approximately the same as the time
burden for collecting and reporting the information for the annual
filing. Given the cost equivalence for annual reporting to reporting a
single swap if the exempt cooperative is both the electing and
reporting counterparty, the Commission assumes that all ten exempt
cooperatives will make an annual filing
[[Page 41947]]
of the information required for Sec. 39.6(1)(iii). The Commission
estimates that it will take an average of 30 minutes to 90 minutes to
complete and submit the annual filing. The average hourly wage for a
compliance attorney is $390, which means that the annual per
cooperative cost for the filing is likely to be between $200 and $590.
If all ten eligible cooperatives were to undertake an annual filing,
the aggregate cost would be $2,000 to $5,900.
Furthermore, when an exempt cooperative is not functioning as the
reporting counterparty (i.e. when transacting with a SD or MSP), it
may, at certain times, need to communicate information to its reporting
counterparties in order to facilitate reporting. That information may
include, among other things, whether the electing counterparty has
filed an annual report pursuant to Sec. 39.6(b) and information to
facilitate any due diligence that the reporting counterparty may
conduct. These costs will likely vary substantially depending on the
number of different reporting counterparties with whom an electing
counterparty conducts transactions, how frequently the electing
counterparty enters into swaps, whether the electing counterparty
undertakes an annual filing, and the due diligence that the reporting
counterparty chooses to conduct. Therefore, the Commission believes
that it is difficult to estimate these costs reliably at this time.
Nevertheless, the Commission estimates that non-reporting electing
counterparties will incur between five minutes and ten hours of annual
burden hours, or in the aggregate, between approximately one hour and
100 hours. The hourly wage for a compliance attorney is $390, which
means that the annual aggregate cost for communicating information to
the reporting counterparty is likely to be between $400 and $39,000.
Given the unknowns associated with this cost estimate noted above, the
Commission does not believe this wide range can be narrowed without
further information.
2. Costs and Benefits for Counterparties to Electing Cooperatives
Reduced clearing of swaps by exempt cooperatives likely will
increase counterparty risk for both exempt cooperatives and their
counterparties. Cooperatives will be more exposed to financial
instability in their counterparties, and conversely, the cooperatives'
counterparties may be exposed to any instability that might develop
within the exempt cooperatives. This could be problematic for an exempt
cooperative if one of the dealers with which the cooperative has large
uncleared positions experiences financial instability, or if groups of
members whose financial strength may be highly correlated and whose
aggregate uncleared positions with the cooperative are large, encounter
financial challenges. Conversely, if an exempt cooperative becomes
insolvent and its positions with a SD or MSP are substantial, it is
possible that its uncleared positions could be large enough to create
or exacerbate instability at the SD or MSP, and could also create
significant exposure for the members the cooperative serves. In this
way, financial instability at one of the cooperative's counterparties
could adversely impact the other counterparties of that cooperative.
However, these risks may be mitigated through negotiated collateral
agreements between exempt cooperatives and their counterparties. The
Commission understands that many swaps in the uncleared market are
subject to such agreements.\32\ The Commission invites comment on the
size of exposures between potential exempt cooperatives and other
financial entities, the size and number of positions between exempt
cooperatives and their members, and the extent to which uncleared swaps
between exempt cooperatives and financial entities, and transactions
between exempt cooperatives and their members, are currently
collateralized. Please quantify estimates, where possible.
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\32\ The 2012 ISDA Margin Survey indicates that 71% of all OTC
derivatives transactions were subject to collateral agreements
during 2011, but notes that the degree of collateralization may vary
significantly depending on the type of derivative and counterparties
entering into a transaction.
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In a similar vein, some members of exempt cooperatives are
commercial entities that, in the absence of this exemption, could elect
not to clear swaps by using the end-user exception. The proposed
cooperative exemption does not affect the ability of those members to
elect the end-user exemption, but it does constrain their ability to
forego the end-user exception when entering into transactions with
exempt cooperatives that are eligible for the proposed exemption. In
other words, either the exempt cooperative or the member may elect not
to clear the swap, and neither party may compel the other to clear the
swap. To the extent that members are unconstrained in their choice of
counterparties, this is not problematic. Members could still go to a SD
or other financial entity, which has no clearing exemption election
ability, to access the terms and counterparty protection that a cleared
position provides. However, if members are constrained in their choice
of counterparties (i.e. if they do not have sufficient size or
experience to transact with a SD, or if they need the collateral that
is already pledged with the loan to secure a corresponding swap) they
will not be able to elect a cleared transaction when using swaps that
are required to be cleared unless the cooperative agrees to clearing.
The Commission invites comment regarding the extent to which this
consideration represents a cost to members of cooperatives that would
be eligible for the exemption under the criteria proposed in this rule.
If possible, please quantify any such costs.
3. Costs and Benefits to the Public
The public generally has an interest in required clearing because
of its potential to reduce counterparty risk among large,
interconnected institutions, and to facilitate rapid resolution of
outstanding positions held by such institutions in the event of their
default. By narrowly crafting the proposed cooperative exemption to
incorporate qualifying criteria limiting both the types of institutions
and the types of swaps that are eligible, the Commission expects the
proposed exemption to appropriately conserve this public interest.
Moreover, for this narrow category of swaps proposed for exemption, the
potential remains for exempt cooperatives and their counterparties to
mitigate residual counterparty risk through negotiated collateral
agreements. The Commission invites comment regarding the extent to
which this proposed exemption would impose costs or provide benefits on
the public, including the expected impact of negotiated collateral
agreements. Please provide quantification where possible.
D. Costs and Benefits Compared to Alternatives
The proposed cooperative exemption includes two important limiting
criteria. First, each member of a cooperative must independently be
able to elect the end-user exception or be a cooperative whose members
can elect the end-user exception. Second, the swaps for which exempt
cooperatives may make use of the proposed rule only includes those
entered into by the cooperative with its members in connection with
originating loans or swaps that hedge or mitigate risks associated with
such swaps or associated with member loans.
The Commission considered including cooperatives consisting of
members that could not elect the end-user exception. Such an exemption
would assist in ensuring that a greater number of cooperatives and
their members are able to elect not to clear
[[Page 41948]]
swaps. However, the Commission believes that such an exemption would
significantly undermine Congress' intent to promote clearing and be
inconsistent with the end-user exception provided for in Section
2(h)(7) of the CEA. This alternative could allow any large financial
entities such as SDs or MSPs, which Congress clearly intended the
clearing requirement to apply to without exception, to form
cooperatives with other entities that would be exempt from the clearing
requirement. By contrast, with the proposed provision, the Commission
is assuring that the cooperative exemption does not become overly broad
and available to cooperatives with members that are financial entities
as defined in Section 2(h)(7)(C) of the CEA.
The Commission also considered exempting any swap transacted by an
exempt cooperative. However, the Commission was concerned that
financial entities such as SDs, MSPs, or non-member borrowers that are
financial entities would be able to avoid clearing by entering into
swaps through an exempt cooperative. For example, from a SD's
perspective, taking a long position on a swap with another SD would
require clearing. However, the two parties could have essentially the
same economic arrangement if the first SD goes long on the swap with an
exempt cooperative, and the second SD takes a short position on the
same swap with the same exempt cooperative. The exempt cooperative
would be even, and the two SDs would have created a synthetic swap that
avoided the clearing requirement. The proposed provision avoids such a
scenario by ensuring that the cooperative exemption is only used as a
pass through for swaps with members who would themselves be able to
elect the end-user exception and for swaps that hedge or mitigate risk
in connection member loans or swaps as would be required by Section
2(h)(7)(A)(ii) of the CEA.
The Commission invites comment regarding the extent to which the
requirements in the definition of exempt cooperative may be too
restrictive for cooperatives that the commenter believes should have
the benefit of the proposed cooperative exemption or are not
restrictive enough to protect the public interest in requiring clearing
of certain swaps. Similarly, the Commission invites comment on whether
the limitation on the types of swaps for which the cooperative
exemption may be elected should be expanded or further limited and why.
Please describe such specific expansion or further limitation
contemplated and the costs and benefits that could result therefrom.
E. Section 15(a) Factors
1. Protection of Market Participants and the Public
As described above, allowing exempt cooperatives to exempt certain
swaps from required clearing will reduce the DCO and FCM clearing fees
that such entities may otherwise bear. This, in turn, provides benefits
to the members of exempt cooperatives, who would otherwise absorb such
costs as they are passed through by the cooperatives to their members
in the form of fees or less desirable spreads on swaps or loans
conducted with the cooperative. In addition, the exemption may reduce
the amount of capital that exempt cooperatives must allocate to margin
accounts with their FCM.
The proposed rule is narrowly tailored to exempt only swaps that
are associated with positions established in connection with loans made
to customers, or that hedge or mitigate risk arising in connection with
such member loans or swaps. Further, it is otherwise generally
consistent with the requirements for the end-user exception as provided
in Section 2(h)(7) of the CEA and Sec. 39.6. Given the proposed
cooperative exemption's limited scope and the remaining potential for
exempt cooperatives and their counterparties to mitigate residual
counterparty risk through negotiated collateral agreements, the
Commission does not anticipate that the proposed rule would materially
compromise protection of market participants and the public. The
Commission requests comment on the extent to which the limitations on
the entities and transactions eligible for the proposed exemption will
limit risk to market participants and the public. If possible, please
quantify relevant estimates.
2. Efficiency, Competitiveness, and Financial Integrity of Swap Markets
While the proposed rule would take swaps out of clearing, it limits
any compromise of the financial integrity of the swap markets insomuch
as it is narrowly tailored to include only cooperatives that are made
up entirely of entities that could elect the end-user exception, and
only swaps related to originating loans between the cooperative and
such members. The Commission invites comment on the effects of the
proposed rule on efficiency, competitiveness, and financial integrity
of swap markets.
3. Price Discovery
Clearing, in general, encourages better price discovery because it
eliminates the importance of counterparty creditworthiness in pricing
swaps cleared through a given DCO. That is, by making the counterparty
creditworthiness of all swaps of a certain type essentially the same,
prices should reflect factors related to the terms of the swap, rather
than the idiosyncratic risk posed by the entities trading it.\33\ To
the extent that the cooperative exemption reduces the number of swaps
subject to required clearing, it will lessen the beneficial effects of
required clearing for price discovery. However, the Commission assumes
that the number of swaps eligible for this exemption, estimated above
at 500 a year, will be a de minimis fraction of all those that are
otherwise required to be cleared. The Commission invites comment on the
effects of the proposed rule on price discovery.
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\33\ See Chen, K., et al. ``An Analysis of CDS Transactions:
Implications for Public Reporting,'' September 2011, Federal Reserve
Bank of New York Staff Reports, at 14.
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4. Sound Risk Management Practices
To the extent that a swap is removed from clearing, all other
things being constant, it is a detriment to a sound risk management
regime. To the extent that exempt cooperatives enter into uncleared
swaps on the basis of this proposed rule, it likely increases the
amount of counterparty risk that exempt cooperatives and their
counterparties face. For the public, it increases the risk that
financial distress at one or more cooperatives could spread to other
financial institutions with which those cooperatives have concentrated
positions. However, as discussed above, this additional risk may be
reduced by the presence of bilateral margin agreements, which the
Commission believes are often used in the absence of clearing.
Furthermore, the Commission believes that, given the small number of
swaps that will be exempted from clearing as a result of the proposed
rule, estimated above to be 500 each year, these risks to the public
will be minimized. The Commission invites comment regarding the effect
of the proposed rule on the risk exposure of the cooperatives meeting
the criteria proposed in this rule, their counterparties, and the
public. Where possible, please quantify any costs or benefits that are
relevant.
[[Page 41949]]
5. Other Public Interest Considerations
The Commission has not identified any public interest
considerations relevant to this proposed rule beyond those already
noted above.
F. Public Comment on the Cost-Benefit Considerations
The Commission invites public comment on all aspects of the cost-
benefit considerations. More specifically, the Commission also requests
comment on the following.
Would a cooperative exemption have any adverse impact on
competition?
Would a cooperative exemption have an impact on fees or other
charges for any products and/or services?
Would a cooperative exemption result in efficiencies or other
benefits not described in this NPRM?
Commenters are also invited to submit any data or other information
that they may have quantifying or qualifying the costs and benefits of
the proposal with their comment letters.
VI. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act \34\ (``RFA'') requires that
agencies consider whether proposed rules will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis on the impact.
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\34\ See 5 U.S.C. 601 et seq.
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The proposed rule will not have a significant economic impact on a
substantial number of small entities. The proposed rule would affect
cooperatives, their members, and potentially the counterparties with
whom they trade. These entities could be SDs, MSPs, and eligible
contract participants (ECPs).\35\ The Commission has previously
established certain definitions of ``small entities'' to be used by the
Commission in evaluating the impact of its rules on small entities in
accordance with the RFA. In that regard, the Commission has certified
previously that SDs and MSPs are not small entities for purposes of the
RFA.\36\ The Commission is making a similar determination for purposes
of this proposal. The proposed rules would also affect SDRs, which the
Commission has similarly determined not to be small entities for
purposes of the RFA. The Commission is making the same determination
with respect to the proposed rules.
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\35\ It is possible that a cooperative or members thereof may
not be ECPs. However, pursuant to Section 2(e) of the CEA, if a
counterparty to a swap is not an ECP, then such swap must be entered
into on, or subject to the rules of, a board of trade designated as
a contract market under Section 5 of the CEA. All such swaps are
required to be cleared by the board of trade. In effect all swaps
entered into by a cooperative or a member that is not an ECP will
need to be executed on a board of trade and therefore will be
cleared.
\36\ See 77 FR 30596, 30701 (May 23, 2012).
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The Commission has previously determined that ECPs are not small
entities for purposes of the RFA.\37\ However, in its proposal of rule
Sec. 39.6, the Commission received a joint comment (``Electric
Associations Letter'') from the National Rural Electric Cooperative
Association, the American Public Power Association and the Large Public
Power Council (the ``Associations'') asserting that certain members of
the Associations may both be ECPs under the CEA and small businesses
under the RFA.\38\ These members of the Associations, as the Commission
understands, have been determined to be small entities by the Small
Business Administration (``SBA'') because they are ``primarily engaged
in the generation, transmission, and/or distribution of electric energy
for sale and [their] total electric output for the preceding fiscal
year did not exceed 4 million megawatt hours.'' \39\ The Electric
Associations Letter states that the Associations' members are ``not
financial entities'' and ``engage in swaps only to mitigate or hedge
commercial risks.'' \40\ Because the Associations' members that have
been determined by the SBA to be small entities would be using swaps to
hedge commercial risk, the Commission expects that they would be able
to use the end-user exception from the clearing requirement and
therefore would not be affected to any significant extent by this
proposed exemption.
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\37\ See 66 FR 20740, 20743 (Apr. 25, 2001).
\38\ See joint letter from EEI, NRECA, and ESPA, dated Nov. 4,
2011, (Electric Associations Letter), commenting on Swap Transaction
Compliance and Implementation Schedule: Clearing and Trade Execution
Requirements under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20,
2011).
\39\ Small Business Administration, Table of Small Business Size
Standards, Nov. 5, 2010.
\40\ See Electric Associations Letter, at 2.
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Accordingly, because nearly all of the entities that may be
affected by the proposed cooperative exemption are not small entities,
and because the few ECPs that have been determined by the SBA to be
small entities are unlikely to be affected to any significant extent by
the proposed exemption, the Chairman, on behalf of the Commission,
hereby certifies, pursuant to 5 U.S.C. 605(b), that the proposed
regulation would not have a significant economic impact on a
substantial number of small entities. The Commission invites public
comment on this determination.
B. Paperwork Reduction Act
1. Overview
The Paperwork Reduction Act (PRA) \41\ imposes certain requirements
on Federal agencies in connection with their conducting or sponsoring
any collection of information as defined by the PRA. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number issued by the Office of Management and Budget (OMB). Certain
provisions of this proposed rule would result in new collection of
information requirements, within the meaning of the PRA, for exempt
cooperatives. These new reporting requirements for exempt cooperatives
are not currently covered by any existing OMB control number and OMB
has not yet assigned a control number for this new collection. The
Commission therefore is submitting this proposal to the OMB for review
in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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\41\ 44 U.S.C. 3501 et seq.
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The title for this collection of information is ``Rule 39.6(f)
Cooperative Clearing Exemption Notification.'' If adopted, this new
collection of information would be mandatory for those parties availing
themselves of the cooperative exemption. The Commission will protect
proprietary information according to the Freedom of Information Act and
17 CFR Part 145, ``Commission Records and Information.'' In addition,
Section 8(a)(1) of the CEA strictly prohibits the Commission, unless
specifically authorized by the CEA, from making public ``data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.'' The Commission is also required to protect certain
information contained in a government system of records according to
the Privacy Act of 1974, 5 U.S.C. 552a.
2. Information Provided by Reporting Entities
This proposed cooperative exemption rule would trigger certain
reporting conditions under proposed Sec. 39.6(f)(3) that must be
satisfied for exempt cooperatives. These conditions are designed to
notify the Commission when the exemption from the clearing requirements
in Section 2(h)(1)(A) of the CEA is being elected, address Commission
concerns regarding exempt cooperative swap risk, and provide the
Commission with information necessary to regulate swap markets. In
particular,
[[Page 41950]]
the reporting conditions in proposed Sec. 39.6(f)(3), which requires
compliance with reporting requirements under Sec. 39.6(b) for swaps
for which the cooperative exemption is elected, would establish new
collection of information requirements within the meaning of the PRA.
Additionally, exempt cooperatives may be required to supplement their
reporting systems for purposes of complying with the proposed reporting
requirements.
For each swap where the exemption is elected, either the
cooperative or its counterparty (if the counterparty is an SD or MSP)
must report: (1) That the election of the exemption is being made; (2)
which party is the electing counterparty; and (3) certain information
specific to the electing counterparty unless that information has
already been provided by the electing counterparty through an annual
filing. The third set of information comprises data that is likely to
remain relatively constant for many, but not all, electing
counterparties and therefore, does not require swap-by-swap reporting
and can be reported less frequently. In addition, for entities that are
registered with the SEC, the reporting party will also be required to
report: (1) The SEC filer's central index key number; and (2) that an
appropriate committee of the board of directors has approved the
decision for that entity to enter into swaps that are exempt from the
requirements of Section 2(h)(1)(A) of the CEA.
When entering into swaps with members and electing the exemption,
exempt cooperatives will likely be responsible to report this
information. When cooperatives enter into swaps with SDs or MSPs, the
SDs or MSPs will be responsible to report this information. However,
the cooperatives would bear costs related to the personnel hours
committed to reporting the required information.
The Commission provides estimates of the time burden required for
exempt cooperatives to comply with the proposed requirements below.\42\
The estimates include quantifiable costs, including one-time and annual
burden hours and costs per cooperative, and costs that are incurred on
a swap-by-swap basis. The dollar estimates are offered as ranges with
upper and lower bounds, which is necessary to accommodate uncertainty
regarding the estimates.
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\42\ See 5 CFR 1320.3(b) for the definition of the term
``burden.''
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3. Number of Exempt Cooperatives and Swaps
The total reporting related costs of the cooperative exemption
would depend on the number of cooperatives electing the cooperative
exemption, as well as the number of swaps for which cooperatives would
elect to use the exemption. In addition, as described in more detail
below, the cost will also depend on whether the cooperatives choose the
annual reporting option permitted by the proposed rule.
To identify the number of cooperatives that could elect the
cooperative exemption, the Commission first considered what types of
cooperatives may be financial entities with total assets in excess of
$10 billion since non-financial cooperatives or cooperatives that are
financial entities with assets of $10 billion or less can use the end-
user exception in the alternative and the costs of reporting thereunder
have already been addressed in the end-user exception rulemaking. Given
the comments received for the end-user exception NPRM regarding
cooperatives and consideration of other financial cooperatives the
Commission is aware of, the Commission believes that cooperatives that
may meet the definition of exempt cooperative could be farm credit
system cooperatives, credit unions, and financial cooperatives that
provide financing in the rural electric space. Based on a review of
data available from the regulators for these entities and information
provided by commenters, the Commission believes there are approximately
ten cooperatives that will meet the definition of ``financial entity''
in Section 2(h)(7)(C)(i)(VIII) of the CEA and which will not be exempt
from that definition as small financial institutions because they have
total assets in excess of $10 billion. Each of these is likely to
function as the reporting counterparty for at least some of their
exempted swaps in any given year since they would likely be responsible
for reporting when transacting exempted swaps with members.
A review of information provided for five cooperatives that likely
would be exempt cooperatives showed a range of swap usage from none to
as many as approximately 200 swaps a year with most entering into less
than 50 swaps a year. Using the high end of reported swaps for the five
cooperatives for which information was available, an estimate of 50
swaps per year was calculated. The Commission believes this estimate is
high because some of the reported swaps may not meet the requirements
of the proposed rule and several cooperatives for which information was
not available to the Commission likely undertake little, if any, swap
activity. However, for purposes of the cost calculations, we will
assume that each of the ten potential exempt cooperatives will enter
into 50 swaps per year. Accordingly, we estimate that exempt
cooperatives may elect the cooperative exemption for 500 swaps each
year.
4. Proposed Sec. 39.6(f)(3) Reporting Requirements Cost Estimate
a. Ongoing Reporting Burden Hours and Costs
Proposed Sec. 39.6(f)(3) would require exempt cooperatives that
are reporting counterparties to comply with the reporting requirements
in paragraph (b) of Sec. 39.6, which require delivering specified
information to a registered SDR or, if no registered SDR is available,
the Commission. Counterparties must also undertake reporting pursuant
to Sec. 39.6(b) if the end-user exception is elected.
Assuming that the exempt cooperative is the reporting counterparty,
it would have to report the information required in Sec. 39.6(b)(1)(i)
and (ii) for each swap for which it elects the cooperative exemption.
To comply with Sec. 39.6(b)(1)(i) and (ii), each reporting
counterparty would be required to check one box in the SDR or
Commission reporting data fields indicating that the exempt cooperative
is electing not to clear the swap. The Commission expects that each
reporting counterparty would likely spend 15 seconds to two minutes per
transaction entering this information into the reporting system, or in
the aggregate, 1.5 hours to 17 hours per year for all 500 estimated
swaps. Using a financial analyst's average salary of $208/hour, these
burden hour costs would equal between less than $1 and $7 for each
transaction, or approximately $300 to $3,500 per year for all 500
transactions.\43\
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\43\ Wage estimates are taken from the SIFMA ``Report on
Management and Professional Earnings in the Securities Industry
2011.'' Hourly wages are calculated assuming 1,800 hours per year
and a multiplier of 5.35 to account for overhead and bonuses. In
light of the challenges of developing precise estimates, the results
of all calculations have been rounded.
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Regulation 39.6(b)(1)(iii) allows for certain counterparty specific
information identified therein to be reported either swap-by-swap by
the reporting counterparty or annually by the electing counterparty.
For the end-user exception, the alternative options may be useful in
instances where electing counterparties enter into very
[[Page 41951]]
few swaps each year and the reporting counterparties will report this
information for them on a swap-by-swap basis. However, for the
cooperative exemption, the exempt cooperative is the electing
counterparty and will also likely be the reporting counterparty for
swaps entered into with members. Furthermore, the Commission expects
that, assuming the cooperative is the reporting counterparty, the time
burden for the first swap entered into by an exempt cooperative in
collecting and reporting the information required by Sec.
39.6(b)(1)(iii) will be approximately the same as the time burden for
collecting and reporting the information for the annual filing. Given
the cost equivalence for annual reporting to reporting a single swap if
the exempt cooperative is the electing counterparty and the reporting
counterparty, the Commission assumes that all ten exempt cooperatives
will make an annual filing of the information required for Sec.
39.6(1)(iii). The Commission estimates that it will take an average of
30 minutes to 90 minutes to complete and submit the annual filing. The
average hourly wage for a compliance attorney is $390, which means that
the annual per cooperative cost for the filing is likely to be between
$200 and $590. If all ten eligible cooperatives were to undertake an
annual filing, the aggregate cost would be $2,000 to $5,900.
b. Other Costs
i. Updating Reporting Procedures
The Commission believes that cooperatives electing the cooperative
exemption would have established reporting systems to comply with other
Commission rules regarding swap reporting generally. Reporting
counterparties may need to modify their reporting systems in order to
accommodate the additional data fields required by this rule. The
Commission estimates that those modifications would create a one-time
expense of approximately one to ten burden hours per reporting
counterparty. The Commission estimates that the hourly wage for a
senior programmer is $341, which means that the one-time, per entity
cost for modifying reporting systems to comply with proposed Sec.
39.6(f)(3) would likely be between $340 and $3,400, and the aggregate
one-time cost for all ten potential exempt cooperatives is estimated to
be $3,400 to $34,100.
ii. Burden on Non-Reporting Cooperatives
When an exempt cooperative is not functioning as the reporting
counterparty (i.e. when transacting with a SD or MSP), it may, at
certain times, need to communicate information to its reporting
counterparties in order to facilitate reporting. That information may
include, among other things, whether the exempt cooperative has filed
an annual report pursuant to Sec. 39.6(b) and information to
facilitate any due diligence that the reporting counterparty may
conduct. These costs will likely vary substantially depending on the
number of different reporting counterparties with whom an exempt
cooperative conducts transactions, how frequently the exempt
cooperative enters into swaps, whether the exempt cooperative
undertakes an annual filing, and the due diligence that the reporting
counterparty chooses to conduct. Therefore, the Commission believes
that it is difficult to estimate these costs reliably at this time.
Nevertheless, the Commission estimates that a non-reporting exempt
cooperative will incur between five minutes and ten hours of annual
burden hours. The hourly wage for a compliance attorney is $390, which
means that the annual aggregate cost for communicating information to
the reporting counterparty is likely to be between $400 and $39,000.
Given the unknowns associated with this cost estimate noted above, the
Commission does not believe this wide range can be narrowed without
further information.
c. Reporting Cost Summary
The reporting costs described above are summarized in the following
table.
Summary of Reporting-Related Costs
----------------------------------------------------------------------------------------------------------------
Aggregate hours per annum
Reporting \44\ Cost range \45\ Notes
----------------------------------------------------------------------------------------------------------------
(1) Swap-by-Swap Reporting to 1.5-17....................... $300 to $3,500............... This assumes that
SDR or Commission (Sec. Sec. ($208/hour).................. all exempt
39.6(b)(1)(i) and (ii)). cooperatives
will be
reporting
counterparties.
(2) Electing Counterparty 5-15......................... $2,000-$5,900................ This assumes that
Annual Reporting (Sec. ($390/hour).................. all exempt
39.6(b)(1)(iii)). cooperatives
will be
reporting
counterparties
and will elect
annual reporting
for Sec.
39.6(b)(1)(iii)
information.
(3) Updating Reporting 10-100....................... $3,400-$34,100............... This assumes that
Procedures (Sec. 39.6(f)(3)). ($341/hour).................. all exempt
cooperatives
will have to
update reporting
procedures. This
is a one-time
cost in the
first year.
(4) Non-Reporting 1.0-100...................... $400-$39,000................. This estimate
Counterparties (Sec. ($390/hour).................. assumes all
39.6(f)(3)). exempt
cooperatives are
non-reporting
counterparties
for some swaps
and each spends
between five
minutes to ten
hours each year
on this task.
--------------------------------------------------------------------------------
Estimated Reporting Total.. 18-232....................... $6,100-$82,500............... Sum of rows (1)
(125 midpoint)............... ($44,300 midpoint)........... through (4).
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3. Information Collection Comments
The Commission invites public comment on any aspect of the
reporting burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission solicits comments in order to: (i) Evaluate whether the
proposed collection of information is necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility; (ii) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collection of
information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(iv) minimize the burden of the collection of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
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\44\ Hours estimates reflect total burden hours for the ten
exempt cooperatives, rounded to nearest half-hour.
\45\ The total burden costs are aggregate costs for the ten
exempt cooperatives, rounded to nearest hundred dollars.
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[[Page 41952]]
Comments may be submitted directly to the Office of Information and
Regulatory Affairs (``OIRA'') in OMB, by fax at (202) 395-6566, or by
email at [email protected]. Please provide the Commission
with a copy of submitted comments so that they can be considered in
connection with a final rule. Refer to the Addresses section of this
release for comment submission instructions to the Commission. A copy
of the supporting statements for the collections of information
discussed above may be obtained by visiting www.RegInfo.gov. OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication of this release in the Federal
Register. Consequently, a comment to OMB is most assured of being fully
effective if received by OMB (and the Commission) within 30 days after
publication.
List of Subjects in 17 CFR Part 39
Business and industry, Clearing, Commodity futures, Cooperatives,
Reporting requirements, Swaps.
For the reasons stated in the preamble, the Commission proposes to
amend 17 CFR part 39 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
1. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 2 and 7a-1 as amended by Pub. L. 111-203,
124 Stat. 1376.
2. Amend Sec. 39.6, to add paragraph (f) to read as follows:
Sec. 39.6 Exceptions to the clearing requirement.
* * * * *
(f) Exemption for cooperatives. Exempt cooperatives may elect not
to clear certain swaps identified in paragraph (f)(2) of this section
that are otherwise subject to the clearing requirement of section
2(h)(1)(A) of the Act if the following requirements are satisfied.
(1) For the purposes of this paragraph, an exempt cooperative means
a cooperative:
(i) Formed and existing pursuant to Federal or state law as a
cooperative;
(ii) That is a ``financial entity,'' as defined in section
2(h)(7)(C)(i) of the Act, solely because of section 2(h)(7)(C)(i)(VIII)
of the Act; and
(iii) Each member of which is not a ``financial entity,'' as
defined in section 2(h)(7)(C)(i) of the Act, or if any member is a
financial entity solely because of section 2(h)(7)(C)(i)(VIII) of the
Act, such member is:
(A) Exempt from the definition of ``financial entity'' pursuant to
paragraph (d) of this section; or
(B) A cooperative formed under Federal or state law as a
cooperative and each member thereof is either not a ``financial
entity,'' as defined in section 2(h)(7)(C)(i) of the Act, or is exempt
from the definition of ``financial entity'' pursuant to paragraph (d)
of this section.
(2) An exempt cooperative may elect not to clear a swap that is
subject to the clearing requirement of section 2(h)(1)(A) of the Act if
the swap:
(i) Is entered into with a member of the exempt cooperative in
connection with originating a loan or loans for the member, which means
the requirements of Sec. 1.3(ggg)(5)(i), (ii), and (iii) are
satisfied; provided that, for this purpose, the term ``insured
depository institution'' as used in those sections is replaced with the
term ``exempt cooperative'' and the word ``customer'' is replaced with
the word ``member;'' or
(ii) Hedges or mitigates commercial risk, in accordance with
paragraph (c) of this section, related to loans to members or arising
from a swap or swaps that meet the requirements of paragraph (f)(2)(i)
of this section.
(3) An exempt cooperative that elects the exemption provided in
paragraph (f) of this section shall comply with the requirements of
paragraph (b) of this section. For this purpose, the exempt cooperative
shall be the ``electing counterparty,'' as such term is used in
paragraph (b), and for purposes of paragraph (b)(1)(iii)(A), the
reporting counterparty shall report that an exemption is being elected
in accordance with paragraph (f) of this section.
Issued in Washington, DC, on July 10, 2012, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Clearing Exemption for Certain Swaps Entered Into by
Cooperatives--Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, O'Malia and Wetjen voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rule that would permit certain
cooperatives to choose not to clear member-related swaps.
One of the primary goals of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act) was to lower risk to
the financial system by requiring standardized swaps between
financial entities to be cleared.
Congress provided that non-financial entities, such as farmers,
ranchers, manufacturers and other end users, should be able to
choose whether or not to clear those swaps that hedge or mitigate
commercial risks.
Cooperatives act on behalf of and are an extension of their
members. Thus, I believe it is appropriate that those cooperatives
made up entirely of members that could individually qualify for the
end-user exception should qualify as well themselves as end users in
certain circumstances.
The proposed cooperative exemption is narrowly tailored, and
extends only to:
Swaps entered into with members of the cooperative in
connection with originating loans for members; and
Swaps entered into by a cooperative to hedge or
mitigate risks associated with member loans or member loan related
swaps.
[FR Doc. 2012-17357 Filed 7-16-12; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: July 17, 2012