[Federal Register Volume 75, Number 244 (Tuesday, December 21, 2010)]
[Proposed Rules]
[Pages 80174-80218]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-31130]
[[Page 80173]]
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Part III
Commodity Futures Trading Commission
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17 CFR Part 1
Securities and Exchange Commission
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17 CFR Part 240
Further Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,''
``Major Swap Participant,'' ``Major Security-Based Swap Participant''
and ``Eligible Contract Participant''; Proposed Rule
Federal Register / Vol. 75 , No. 244 / Tuesday, December 21, 2010 /
Proposed Rules
[[Page 80174]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AD06
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-63452; File No. S7-39-10]
RIN 3235-AK65
Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant''
AGENCY: Commodity Futures Trading Commission; Securities and Exchange
Commission.
ACTION: Joint proposed rule; proposed interpretations.
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SUMMARY: In accordance with Section 712(d)(1) of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-
Frank Act''), the Commodity Futures Trading Commission (``CFTC'') and
the Securities and Exchange Commission (``SEC'') (collectively, the
``Commissions''), in consultation with the Board of Governors of the
Federal Reserve System, are proposing rules and interpretative guidance
under the Commodity Exchange Act (``CEA''), 7 U.S.C. 1 et seq., and the
Securities Exchange Act of 1934 (``Exchange Act''), 15 U.S.C. 78a et
seq., to further define the terms ``swap dealer,'' ``security-based
swap dealer,'' ``major swap participant,'' ``major security-based swap
participant,'' and ``eligible contract participant.''
DATES: Submit comments on or before February 22, 2011.
ADDRESSES: Comments may be submitted by any of the following methods:
CFTC:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: Comments also may be submitted
at http://www.regulations.gov. Follow the instructions for submitting
comments. ``Definitions'' must be in the subject field of responses
submitted via e-mail, and clearly indicated on written submissions. All
comments must be submitted in English, or if not, accompanied by an
English translation. All comments provided in any electronic form or on
paper will be published on the CFTC Web site, without review and
without removal of personally identifying information. All comments are
subject to the CFTC Privacy Policy.
SEC
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an e-mail to [email protected]. Please include
File Number S7-39-10 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-39-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: CFTC: Mark Fajfar, Assistant General
Counsel, at 202-418-6636, [email protected], Julian E. Hammar, Assistant
General Counsel, at 202-418-5118, [email protected], or David E. Aron,
Counsel, at 202-418-6621, [email protected], Office of General Counsel,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581; SEC: Joshua Kans, Senior Special
Counsel, Jeffrey Dinwoodie, Attorney Advisor, or Richard Grant,
Attorney Advisor, at 202-551-5550, Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street, NE., Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act into
law.\1\ Title VII of the Dodd-Frank Act \2\ established a comprehensive
new regulatory framework for swaps and security-based swaps. The
legislation was enacted, among other reasons, to reduce risk, increase
transparency, and promote market integrity within the financial system,
including by: (1) Providing for the registration and comprehensive
regulation of swap dealers, security-based swap dealers, major swap
participants and major security-based swap participants; (2) imposing
clearing and trade execution requirements on swaps and security-based
swaps, subject to certain exceptions; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
rulemaking and enforcement authorities of the Commissions with respect
to, among others, all registered entities and intermediaries subject to
the Commissions' oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
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More specifically, the Dodd-Frank Act provides that the CFTC will
regulate ``swaps,'' and the SEC will regulate ``security-based swaps.''
The Dodd-Frank Act also adds to the CEA and Exchange Act definitions of
the terms ``swap dealer,'' ``security-based swap dealer,'' ``major swap
participant,'' ``major security-based swap participant,'' and
``eligible contract participant.'' These terms are defined in Sections
721 and 761 of the Dodd-Frank Act and, with respect to the term
``eligible contract participant,'' in Section 1a(18) of the CEA,\3\ as
re-designated and amended by Section 721 of the Dodd-Frank Act.
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\3\ See 7 U.S.C. 1a(18).
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Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and
the SEC, in consultation with the Board of Governors of the Federal
Reserve System, shall jointly further define the terms ``swap,''
``security-based swap,'' ``swap dealer,'' ``security-based swap
dealer,'' ``major swap participant,'' ``major security-based swap
participant,'' ``eligible contract participant,'' and ``security-based
swap agreement.''
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Further, Section 721(c) of the Dodd-Frank Act requires the CFTC to
adopt a rule to further define the terms ``swap,'' ``swap dealer,''
``major swap participant,'' and ``eligible contract participant,'' and
Section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to
further define the terms ``security-based swap,'' ``security-based swap
dealer,'' ``major security-based swap participant,'' and ``eligible
contract participant,'' with regard to security-based swaps, for the
purpose of including transactions and entities that have been
structured to evade Title VII of the Dodd-Frank Act.\4\
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\4\ The definitions of the terms ``swap,'' ``security-based
swap,'' and ``security-based swap agreement,'' and regulations
regarding mixed swaps are the subject of a separate rulemaking by
the Commissions.
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In light of the requirements in the Dodd-Frank Act noted above, the
CFTC and the SEC issued a joint Advance Notice of Proposed Rulemaking
(``ANPRM'') on August 13, 2010, requesting public comment regarding the
definitions of ``swap,'' ``security-based swap,'' ``security-based swap
agreement,'' ``swap dealer,'' ``security-based swap dealer,'' ``major
swap participant,'' ``major security-based swap participant,'' and
``eligible contract participant'' in Title VII of the Dodd-Frank
Act.\5\ The Commissions reviewed more than 80 comments in response to
the ANPRM. The Commissions also informally solicited comments on the
definitions on their respective Web sites.\6\ In addition, the staffs
of the CFTC and the SEC have met with many market participants and
other interested parties to discuss the definitions.\7\
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\5\ See Definitions Contained in Title VII of Dodd-Frank Wall
Street Reform and Consumer Protection Act, Exchange Act Rel. No. 34-
62717, 75 FR 51429 (Aug. 20, 2010). The comment period for the ANPRM
closed on September 20, 2010.
\6\ Comments were solicited by the CFTC at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html and the SEC at
http://www.sec.gov/spotlight/regreformcomments.shtml/.
\7\ The views expressed in the comments in response to the
ANPRM, in response to the Commissions' informal solicitation, and at
such meetings are collectively referred to as the views of
``commenters.''
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In this release, the Commissions propose to further define ``swap
dealer,'' ``security-based swap dealer,'' ``major swap participant,''
``major security-based swap participant'' and ``eligible contract
participant,'' and propose related rules, and also discuss certain
factors that are relevant to market participants when determining their
status with respect to the defined terms. In developing these
proposals, the Commissions have been mindful that the markets for swaps
and security-based swaps are evolving, and that the rules that we adopt
will, as intended by the Dodd-Frank Act, significantly affect those
markets. The rules not only will help determine which entities will be
subject to comprehensive regulation of their swap and security-based
swap activities, but may also cause certain entities to modify their
activities to avoid being subject to the regulations. As a result, we
are aware of the importance of crafting these rules carefully to
maximize the benefits of the regulation imposed by the Dodd-Frank Act,
and to do so in a way that is flexible enough to respond to market
developments. While we preliminarily believe that these proposals, if
adopted, would appropriately effect the intent of the Dodd-Frank Act,
we are very interested in commenters' views as to whether we have
achieved this purpose, and, if not, how to improve these proposals.\8\
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\8\ In addition, we recognize that the appropriateness of these
proposals also should be considered in light of the substantive
requirements that will be applicable to dealers and major
participants, including capital, margin and business conduct
requirements, which are the subject of separate rulemakings. For
example, whether the definition of a major participant is too broad
or too narrow may well depend in part on the substantive
requirements applicable to such entities, and whether those
substantive requirements are themselves appropriate may in turn
depend in part on the scope of the major participant definition. We
therefore encourage comments that take into account the interplay
between the proposed definitions and these substantive requirements.
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II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''
The Dodd-Frank Act defines the terms ``swap dealer'' and
``security-based swap dealer'' in terms of whether a person engages in
certain types of activities involving swaps or security-based swaps.\9\
Persons that meet either of those definitions are subject to statutory
requirements related to, among other things, registration, margin,
capital and business conduct.\10\
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\9\ See Section 721 of the Dodd-Frank Act (defining ``swap
dealer'' in new Section 1a(49) of the CEA, 7 U.S.C. 1a(49)) and
Section 761 of the Dodd-Frank Act (defining ``security-based swap
dealer'' in new Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71)).
\10\ The Dodd-Frank Act excludes from the Exchange Act
definition of ``dealer'' persons who engage in security-based swap
transactions with eligible contract participants. See Section
3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by
Section 761(a)(1) of the Dodd-Frank Act.
The Dodd-Frank Act does not include comparable amendments for
persons who act as brokers in swaps and security-based swaps.
Because security-based swaps are a type of security, persons who act
as brokers in connection with security-based swaps must, absent an
exemption, register with the SEC as a broker pursuant to Exchange
Act section 15(a), and comply with the Exchange Act's requirements
applicable to brokers.
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The two definitions in general encompass persons that engage in any
of the following types of activity:
(i) Holding oneself out as a dealer in swaps or security-based
swaps,
(ii) Making a market in swaps or security-based swaps,
(iii) Regularly entering into swaps or security-based swaps with
counterparties as an ordinary course of business for one's own account,
or
(iv) Engaging in activity causing oneself to be commonly known in
the trade as a dealer or market maker in swaps or security-based
swaps.\11\
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\11\ See CEA section 1a(49)(A); Exchange Act section
3(a)(71)(A).
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The definitions are disjunctive, in that a person that engages in
any of the enumerated dealing activities is a swap dealer or security-
based swap dealer even if the person does not engage in any of the
other enumerated activities.
The definitions, in contrast, do not include a person that enters
into swaps or security-based swaps ``for such person's own account,
either individually or in a fiduciary capacity, but not as a part of a
regular business.'' \12\ The Dodd-Frank Act also instructs the
Commissions to exempt from designation as a dealer an entity that
``engages in a de minimis quantity of [swap or security-based swap]
dealing in connection with transactions with or on behalf of its
customers.'' \13\ Moreover, the definition of ``swap dealer'' (but not
the definition of ``security-based swap dealer'') provides that an
insured depository institution is not to be considered a swap dealer
``to the extent it offers to enter into a swap with a customer in
connection with originating a loan with that customer.'' \14\
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\12\ See CEA section 1a(49)(C); Exchange Act section
3(a)(71)(C).
\13\ See CEA section 1a(49)(D); Exchange Act section
3(a)(71)(D).
\14\ CEA section 1a(49)(A).
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The definitions also provide that a person may be designated as a
dealer for one or more types, classes or categories of swaps, security-
based swaps, or activities without being designated a dealer for other
types, classes or categories or activities.\15\
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\15\ See CEA section 1a(49)(B); Exchange Act section
3(a)(71)(B).
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The Commissions are proposing rules to further define certain
aspects of the meaning of ``swap dealer'' and ``security-based swap
dealer,'' and are providing guidance on how the Commissions propose to
interpret these terms. This release specifically addresses: (A) The
types of activities that would cause a person to be a swap dealer or
security-based swap dealer, including differences in how those two
definitions should be applied; (B) the statutory provisions requiring
the Commissions to exempt persons from the dealer
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definitions in connection with de minimis activity; (C) the exception
from the ``swap dealer'' definition in connection with loans by insured
depository institutions; (D) the possibility that a person may be
considered a dealer for some types, classes or categories of swaps,
security-based swaps, or activities but not others; and (E) certain
interpretative issues that arise in particular situations. The
Commissions request comment on all aspects of the proposals, including
the particular points noted in the discussion below.
A. Swap and Security-Based Swap Dealing Activity
1. Comments Regarding Dealing Activities
Commenters provided numerous examples of conduct they viewed as
dealing activities--as well as conduct they did not view as dealing
activities. For example, many of the commenters stated that dealers
provide ``bid/ask'' or ``two-way'' prices for swaps on a regular basis,
or regularly participate in both sides of the swap market. Some
commenters indicated that dealers perform an intermediary function.
Other commenters stated that a person holds itself out as a dealer if
it consistently and systematically markets itself as a swap dealer to
third parties. Some commenters described market makers in the swap
markets as persons that stand ready to buy or sell swaps at all times,
are open to doing swaps business on both sides of a market, or make
bids to buy and offers to sell swaps or a type of swap at all times.
Commenters stated that a person should be included in the definition of
dealer if its sole or dominant line of business is swaps activity. One
commenter urged the Commissions to adopt a swap association's
definition of a primary member as the definition of dealer.
Some commenters stated that the definition of dealer should be read
narrowly. For example, some commenters suggested that the market maker
concept should not encompass persons that provide occasional quotes or
that do not make bids or offers consistently or at all times. Another
commenter stated that a willingness to buy or sell a swap or security-
based swap at a particular time does not constitute market making
absent the creating of a two-way market. One commenter suggested that
solely acting as a market maker should not cause a person to be a
dealer, since firms may have commercial purposes for offering two-way
trades. Another commenter stated that an entity that ``holds itself
out'' as a dealer should qualify as a swap dealer only if it
``consistently and systematically markets itself as a dealer to third-
parties.'' \16\
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\16\ See letter from Eric Dennison, Sr. Vice President and
General Counsel, Stephanie Miller, Assistant General Counsel--
Commodities, and Bill Hellinghausen, Director of Regulatory Affairs,
EDF Trading, dated September 20, 2010 (distinguishing transactions
that the commenter enters into as part of energy management
services).
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Many commenters called for the exclusion of particular types of
persons from the definition of swap dealer or security-based swap
dealer. Several commenters maintained that commercial end-users of
swaps or security-based swaps that enter into swaps or security-based
swaps to hedge or mitigate commercial risk should be excluded from the
definitions. Another commenter stated the definitions should exclude
persons who use swaps or security-based swaps for bona fide hedging.
Other commenters indicated that cooperatives that enter into swaps in
connection with the business of their members should be excluded.
Commenters also stated that if all of a person's swaps are cleared on
an exchange or derivatives clearing organization, the person should not
be deemed to be a dealer. One commenter stated competitive power
suppliers should be excluded, and another stated that the dealer
definition should not apply to futures commission merchants that act
economically like brokers.
Commenters, particularly those in the securities industry, urged
the Commissions to interpret the definitions of swap dealer and
security-based swap dealer consistently with precedent that
distinguishes between dealers in securities and traders in securities.
However, one commenter also noted that some concepts from the
securities and commodities laws may not easily be applied to these
markets.
2. Application of the Core Tests to ``Swap Dealers'' and ``Security-
Based Swap Dealers''
The Dodd-Frank Act defines the terms ``swap dealer'' and
``security-based swap dealer'' in a functional manner, encompassing how
a person holds itself out in the market, the nature of the conduct
engaged in by the person, and how the market perceives the person's
activities. This suggests that the definitions should not be
interpreted in a constrained or overly technical manner. Rigid
standards would not provide the necessary flexibility to respond to
evolution in the ways that dealers enter into swaps and security-based
swaps. The different types of swap and security-based swap markets are
diverse, and there does not appear to be a single set of criteria that
can be determinative in all markets.
At the same time, we note that there may be certain distinguishing
characteristics of swap dealers and security-based swap dealers,
including that:
Dealers tend to accommodate demand for swaps and security-
based swaps from other parties;
Dealers are generally available to enter into swaps or
security-based swaps to facilitate other parties' interest in entering
into those instruments;
Dealers tend not to request that other parties propose the
terms of swaps or security-based swaps; rather, dealers tend to enter
into those instruments on their own standard terms or on terms they
arrange in response to other parties' interest; and
Dealers tend to be able to arrange customized terms for
swaps or security-based swaps upon request, or to create new types of
swaps or security-based swaps at the dealer's own initiative.
We also recognize that the principles relevant to identifying
dealing activity involving swaps can differ from comparable principles
associated with security-based swaps. These differences are due, in
part, to differences in how those instruments are used. For example,
because security-based swaps may be used to hedge or gain economic
exposure to underlying securities (while recognizing distinctions
between securities-based swaps and other types of securities, as
discussed below), there is a basis to build upon the same principles
that are presently used to identify dealers for other types of
securities. Accordingly, we separately address how the core tests would
apply to swap dealers and to security-based swap dealers.
a. Application to Swap Dealers
The definition of swap dealer should be informed by the differences
between swaps, on the one hand, and securities and commodities, on the
other. Transactions in cash market securities and commodities generally
involve purchases and sales of tangible or intangible property. Swaps,
in contrast, are notional contracts requiring the performance of agreed
terms by each party.\17\ Thus, many of the concepts cited by
commenters, such as whether a person buys and sells swaps or makes a
two-sided market in swaps or trades within a bid/offer spread, cannot
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necessarily be applied to all types of swaps to determine if the person
is a swap dealer. We understand that market participants do use this
terminology colloquially to describe the process of entering into a
swap. For example, a person seeking a fixed/floating interest rate swap
may inquire as to the fixed rates, spread above the floating rate and
other payments that another person would require in order to enter into
a swap. But, while these persons may discuss bids, offers, prices and
so forth, the parties are negotiating the terms of a contract, they are
not negotiating the price at which they will transfer ownership of
tangible or intangible property. Accordingly, these concepts are not
determinative of whether a person is a ``swap dealer.''
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\17\ As discussed below, however (see note 42, infra), the Dodd-
Frank Act amended the Exchange Act definitions of ``buy,''
``purchase,'' ``sale'' and ``sell'' to apply to particular actions
involving security-based swaps.
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Instead, persons who are swap dealers may be identified by the
functional role they fulfill in the swap markets. As noted above, swap
dealers tend to accommodate demand and to be available to enter into
swaps to facilitate other parties' interest in swaps (although swap
dealers may also advance their own investment and liquidity objectives
by entering into such swaps). In addition, swap dealers can often be
identified by their relationships with counterparties. Swap dealers
tend to enter into swaps with more counterparties than do non-dealers,
and in some markets, non-dealers tend to constitute a large portion of
swap dealers' counterparties. In contrast, non-dealers tend to enter
into swaps with swap dealers more often than with other non-
dealers.\18\ The Commissions can most efficiently achieve the purposes
underlying Title VII of the Dodd-Frank Act--to reduce risk and to
enhance operational standards and fair dealing in the swap markets--by
focusing their attention on those persons whose function is to serve as
the points of connection in those markets. The definition of swap
dealer, construed functionally in the manner set forth above, will help
to identify those persons.
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\18\ Some of the commenters appeared to suggest that significant
parts of the swap markets operate without the involvement of swap
dealers. We believe that this analysis is likely incorrect, and that
the parties that fulfill the function of dealers should be
identified and are likely to be swap dealers.
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Clause (A)(iii) of the statutory definition of swap dealer, which
includes any person that ``regularly enters into swaps with
counterparties as an ordinary course of business for its own account,''
\19\ has been the subject of significant uncertainty among commenters.
The commenters point out that its literal terms could encompass many
parties who regularly enter into swaps without engaging in any form of
swap dealing activity. In this regard, clause (A)(iii) of the
definition should be read in combination with the express exception in
subparagraph (C) of the swap dealer definition, which excludes ``a
person that enters into swaps for such person's own account, either
individually or in a fiduciary capacity, but not as a part of a regular
business.'' Thus, the difference between the inclusion in clause
(A)(iii) and the exclusion in subparagraph (C) is whether or not the
person enters into swaps as a part of, or as an ordinary course of, a
``regular business.'' \20\ We believe that persons who enter into swaps
as a part of a ``regular business'' are those persons whose function is
to accommodate demand for swaps from other parties and enter into swaps
in response to interest expressed by other parties. Conversely, persons
who do not fulfill this function should not be deemed to enter into
swaps as part of a ``regular business'' and are not likely to be swap
dealers.
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\19\ We interpret this reference to a person entering into swaps
``with counterparties * * * for its own account'' to refer to a
person entering into a swap as a principal, and not as an agent. A
person who entered into swaps as an agent for customers (i.e., for
the customers' accounts) would be required to register as either a
Futures Commission Merchant, Introducing Broker, Commodity Pool
Operator or Commodity Trading Advisor, depending on the nature of
the person's activity.
\20\ The definition of ``security-based swap dealer'' is
structured similarly, and should be interpreted similarly.
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In sum, to determine if a person is a swap dealer, we would
consider that person's activities in relation to the other parties with
which it interacts in the swap markets. If the person is available to
accommodate demand for swaps from other parties, tends to propose
terms, or tends to engage in the other activities discussed above, then
the person is likely to be a swap dealer. Persons that rarely engage in
such activities are less likely to be deemed swap dealers.
We request comment on this interpretive approach for identifying
whether a person is a swap dealer.
b. Application to Security-Based Swap Dealers
The definition of ``security-based swap dealer'' has parallels to
the definition of ``dealer'' under the Exchange Act.\21\ In addition,
security-based swaps may be used to hedge risks associated with the
ownership of certain other types of securities,\22\ and security-based
swaps may be used to gain economic exposure akin to ownership of
certain other types of securities.\23\ As a result, the SEC would
consider the same factors that are relevant to determining whether a
person is a ``dealer'' under the Exchange Act as also generally
relevant to the analysis of whether a person is a security-based swap
dealer.
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\21\ The Exchange Act in relevant part defines ``dealer'' to
mean ``any person engaged in the business of buying and selling
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract
participants) for such person's own account through a broker or
otherwise,'' but with an exception for ``a person that buys or sells
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract
participants) for such person's own account, either individually or
in a fiduciary capacity, but not as a part of a regular business.''
Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 78c(a)(5)(A) and
(B), as amended by Section 761(a)(1) of the Dodd-Frank Act.
\22\ For example, an entity that owns a particular security may
use a security-based swap to hedge the risks of that security.
Conversely, an entity may seek to offset exposure involving a
security-based swap by using another security as a hedge.
\23\ For example, an entity may enter into a security-based swap
to gain economic exposure akin to a long or short position in a
stock or bond, without having to engage in a cash market transaction
for that instrument.
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The Exchange Act has been interpreted to distinguish between
``dealers'' and ``traders.'' In this context, the SEC previously has
noted that the dealer-trader distinction:
Recognizes that dealers normally have a regular clientele, hold
themselves out as buying or selling securities at a regular place of
business, have a regular turnover of inventory (or participate in
the sale or distribution of new issues, such as by acting as an
underwriter), and generally provide liquidity services in
transactions with investors (or, in the case of dealers who are
market makers, for other professionals).\24\
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\24\ Securities Exchange Act Release No. 47364 (Feb. 13, 2003)
(footnotes omitted).
Other non-exclusive factors that are relevant for distinguishing
between dealers and non-dealers can include the receipt of customer
property and the furnishing of incidental advice in connection with
transactions.
The markets involving security-based swaps are distinguishable in
certain respects from markets involving cash market securities--
particularly with regard to the concepts of ``inventory'' (which
generally appears inapplicable in this context) \25\ and ``regular
place of business.'' For example, the suggestion that dealers are more
likely to operate at a ``regular place of business'' than traders
should not be construed in a way that ignores the reality of how the
security-based swap markets operate (or that
[[Page 80178]]
ignores evolution in dealing practices involving other types of
securities). Dealers may use a variety of methods to communicate their
availability to enter into security-based swaps with other market
participants. The dealer-trader distinction should not be applied to
the security-based swap markets without taking those distinctions into
account.\26\ Even in light of those differences, however, we believe
that the dealer-trader distinction provides an important analytical
tool to assist in determining whether a person is a ``security-based
swap dealer.''
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\25\ In particular, an analysis that considers dealers to differ
from traders in part because dealers have regular turnover in
``inventory'' appears not to apply in the context of security-based
swaps, given that those instruments are created by contract between
two market counterparties, rather than reflecting financial rights
issued by third-parties.
\26\ The definition of ``security-based swap dealer,'' unlike
the Exchange Act's definition of ``dealer,'' does not specifically
refer to ``buying'' and ``selling.'' We do not believe that this
language difference is significant, however, as the Dodd-Frank Act
amended the Exchange Act definitions of ``buy'' and ``purchase,''
and the Exchange Act definitions of ``sale'' and ``sell,'' to
encompass the execution, termination (prior to its scheduled
maturity date), assignment, exchange or similar transfer or
conveyance of, or extinguishing of rights or obligations under, a
security-based swap. See Dodd-Frank Act sections 761(a)(3), (4)
(amending Exchange Act sections 3(a)(13), (14)).
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Commenters have raised concerns that the ambit of the security-
based swap dealer definition could encompass end-users that use
security-based swaps for hedging their business risks. Deeming those
entities to be security-based swap dealers due to their hedging
activities could discourage their use of hedging transactions or
subject them to a regulatory framework that was not intended to address
their businesses and could subject them to unnecessary costs. Under the
dealer-trader distinction, however, we would expect entities that use
security-based swaps to hedge their business risks, absent other
activity, likely would not be dealers.\27\ Also, as discussed below,
both the ``security-based swap dealer'' definition and the dealer-
trader distinction in part turn on whether a person holds itself out as
a dealer.
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\27\ Of course, if a person's other activities satisfy the
definition of security-based swap dealer, it must comply with the
applicable requirements with regard to all of its security-based
swap activities, absent an order to the contrary, as discussed
below. Also, as discussed below, we would expect end-users to use
security-based swaps for hedging purposes less commonly than they
use swaps for hedging purposes.
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We request comment on the application of the dealer-trader
distinction as part of the analysis of whether a person is a security-
based swap dealer.
c. Issues Common to Both Definitions
i. Holding Oneself Out as, and Being Commonly Known in the Trade as, a
Swap Dealer or Security-Based Swap Dealer
As noted above, the application of these definitions to persons
that ``hold themselves out'' as dealers or that are ``commonly known in
the trade'' as dealers highlights the need for a functional
interpretation of the dealer definitions. We believe that factors that
may reasonably indicate that a person is holding itself out as a dealer
or is commonly known in the trade as a dealer may include (but are not
limited to) the following:
Contacting potential counterparties to solicit interest in
swaps or security-based swaps,
Developing new types of swaps or security-based swaps
(which may include financial products that contain swaps or security-
based swaps) and informing potential counterparties of the availability
of such swaps or security-based swaps and a willingness to enter into
such swaps or security-based swaps with the potential counterparties,
Membership in a swap association in a category reserved
for dealers,
Providing marketing materials (such as a Web site) that
describe the types of swaps or security-based swaps that one is willing
to enter into with other parties, or
Generally expressing a willingness to offer or provide a
range of financial products that would include swaps or security-based
swaps.
Notably, holding oneself out as a security-based swap dealer would
likely encompass a situation in which a person that is a ``dealer'' in
another type of security enters into a security-based swap with a
customer.\28\ Another example of holding oneself out as a security-
based swap dealer would likely be an entity expressing its availability
to provide liquidity to counterparties that seek to enter into
security-based swaps, regardless of the ``direction'' of the
transaction or across a broad spectrum of risks (e.g., credit default
swaps related to a variety of issuers).
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\28\ For example, if a person that is a dealer in securities
that are not security-based swaps enters into a security-based swap
transaction with one of its cash market customers, the person would
appear to be engaged in security-based swap dealing activity with
that customer. In that circumstance, the customer reasonably would
be expected to view the person as a dealer for purposes of the
security-based swap, making the applicable business conduct
requirements particularly important.
The determination of who is commonly known in the trade as a swap
dealer or security-based swap dealer may appropriately reflect, among
other factors, the perspective of persons with substantial experience
with and knowledge of the swap and security-based swap markets,
regardless of whether an entity is known as a dealer by persons without
that experience and knowledge.
ii. Making a Market in Swaps or Security-Based Swaps
A number of commenters suggested that the market making component
of the definitions should apply only to persons that quote a two-sided
market consistently or at all times. Some commenters also suggested
that a person's willingness to buy or to sell a swap or security-based
swap at any particular time should not be deemed to be market making
activity. While continuous two-sided quotations and a willingness to
stand ready to buy and sell a security are important indicators of
market making in the equities markets,\29\ these indicia may not be
appropriate in the context of the swap or security-based swap markets,
given that parties do not enter into many types of swaps or security-
based swaps on a continuous basis, and that parties may use a variety
of methods for communicating their willingness to enter into swaps or
security-based swaps. Any analysis that would impute to the definitions
a ``continuous'' activity requirement may cause certain persons that
engage in non-continuous dealing activities not to be regulated as swap
dealers or security-based swap dealers. We have not identified anything
in the statutory text or legislative history of the Dodd-Frank Act to
suggest that Congress intended such a result.
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\29\ See Exchange Act Release No. 58875 (Oct. 14, 2008), 73 FR
61690 (Oct. 17, 2008) (``Although determining whether or not a
market maker is engaged in bona-fide market making would depend on
the facts and circumstances of the particular activity, factors that
indicate a market maker is engaged in bona-fide market making
activities may include, for example, whether the market maker incurs
any economic or market risk with respect to the securities (e.g., by
putting their own capital at risk to provide continuous two-sided
quotes in markets).'').
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iii. No Predominance Test
Although some commenters suggested that a person should be a swap
dealer or security-based swap dealer only if such activity is the
person's sole or predominant business, the statutory definition does
not contain a predominance test or otherwise depend upon the level of
the person's dealing activity, other than the de minimis exception
discussed below. A predominance standard would not
[[Page 80179]]
provide a workable test of dealer status because many of the parties
that are commonly acknowledged as swap or security-based swap dealers
also engage in other businesses that often outweigh their swap or
security-based swap dealing business in terms of transaction volume or
other measures. Based on the plain meaning of the statutory definition,
so long as a person engages in dealing activity that is not de minimis,
as discussed below, the person is a swap dealer or security-based swap
dealer.\30\
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\30\ As one example, a non-financial company that engages in
both swap dealing and other commercial activities would fall within
the definition of swap dealer because of its swap dealing
activities, notwithstanding that it also engages in other commercial
activities.
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iv. Application of the Definition to New Types of Swaps and New
Activities
The Commissions intend to apply the definitions of swap dealer and
security-based swap dealer flexibly when the development of innovative
business models is accompanied by new types of dealer activity. As
discussed above, the Commissions generally intend to follow a ``facts-
and-circumstances'' approach with respect to identifying dealing
activities. The dealer definitions must be flexible enough to cover
appropriate persons as the swap markets evolve.
v. Request for Comment
The Commissions request comment on these interpretations of holding
oneself out as a dealer and being commonly known in the trade as a
dealer, as well as the lack of a predominance test, and the application
of the definitions to new types of swaps and new activities. Commenters
particularly are requested to address the relevance, to the dealer
analysis, of activities such as an entity's membership in a swap
execution facility (``SEF'') or a security-based SEF, or use of
facilities that may not be SEFs or security-based SEFs. Are there
factors that would lead entities to become members of SEFs that would
not make membership relevant to the dealer analysis? Commenters also
are requested to generally address how the dealer analysis should
appropriately apply the requirements applicable to dealers (e.g.,
capital, margin and business conduct requirements) to the entities that
should be subject to those requirements. In addition, commenters are
requested to address how the dealer definitions should be applied to
entities such as, for example, Federal home loan banks subject to
restrictions limiting their dealing activities to particular types of
counterparties. Finally, commenters are requested to address whether
additional guidance is advisable to help identify dealer activity and
to promote effective enforcement of the requirements applicable to swap
dealers and security-based swap dealers.
3. Designation of a Person as a Swap Dealer
The Dodd-Frank Act has amended the CEA and the Exchange Act to
require a person that meets either of the definitions to register as a
swap dealer and/or security-based swap dealer,\31\ and the Commissions
are proposing separate rules regarding this registration requirement.
In connection with the registration requirement, market participants
are in a position to assess their activities to determine whether they
function in the manner described in the definitions. In addition, the
Commissions have the authority to take enforcement actions in response
to a dealer's failure to register. In determining whether a person
meets the applicable definitions, the Commissions may use information
from other regulators, swap data repositories, registered clearing
agencies, derivatives clearing organizations and other sources.
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\31\ See CEA section 4s(a)-(b); Exchange Act section 15F(a)-(b).
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4. Application of the Swap Dealer Definition to Agricultural
Commodities
Section 723(c)(3)(B) of the Dodd-Frank Act provides that swaps in
agricultural commodities shall be subject to such terms and conditions
as the CFTC may prescribe. In a separate rulemaking, the CFTC has
proposed a definition of the term ``agricultural commodity.'' \32\
Acting under the authority in Section 723(c)(3)(B), the CFTC may
develop particular terms and conditions for the interpretation of the
swap dealer definition when it is applied to dealing in swaps in
agricultural commodities. Any such terms and conditions would not be
applicable to the definition of security-based swap dealer. The CFTC
requests comment on the application of the swap dealer definition to
dealers, including potentially agricultural cooperatives, that limit
their dealing activity primarily to swaps in agricultural commodities.
The CFTC may consider any comments on this topic for both the
definition of swap dealer and also for any rulemaking regarding swaps
in agricultural commodities.
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\32\ See 75 FR 65586 (Oct. 26, 2010).
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B. De Minimis Exemption to the Definitions
The Dodd-Frank Act requires that the Commissions exempt, from
designation as a ``swap dealer'' or ``security-based swap dealer,'' a
person who ``engages in a de minimis quantity of [swap or security-
based swap] dealing in connection with transactions with or on behalf
of its customers.'' \33\ The statutory definitions do not require that
the Commissions fix a specific level of swap activity that will be
considered de minimis, but instead require that the Commissions
``promulgate regulations to establish factors with respect to the
making of this determination to exempt.''
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\33\ See CEA section 1a(49)(D); Exchange Act section
3(a)(71)(D).
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1. Comments Regarding the De Minimis Exemption
Some commenters asserted that the de minimis exemption should be
linked to systemic risk concerns, stating that persons engaged in
dealing activities that do not pose systemic risk should be able to
take advantage of the exemption. Other commenters suggested that a
person's dealing activities should be considered de minimis if they do
not pose undue risks to the person. Commenters also expressed the view
that the application of the exemption should be based on quantitative
criteria.
2. Proposed Rule Regarding the De Minimis Exemption
The Commissions preliminarily believe that the ``de minimis''
exemption should be interpreted to address amounts of dealing activity
that are sufficiently small that they do not warrant registration to
address concerns implicated by the regulations governing swap dealers
and security-based swap dealers.\34\ In other words, the exemption
should apply only when an entity's dealing activity is so minimal that
applying dealer regulations to the entity would not be warranted.
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\34\ The Title VII requirements applicable to swap and security-
based swap dealers include, for example: requirements that dealers
conform to regulatory standards relating to the confirmation,
processing, netting, documentation and valuation of swaps and
security-based swaps (CEA section 4s(i), Exchange Act section
15F(i)); requirements that dealers disclose, to regulators,
information concerning terms and conditions of swaps or security-
based swaps, as well as information concerning trading practices,
financial integrity protections and other trading information (CEA
section 4s(j)(3), Exchange Act section 15F(j)(3)); conflicts of
interest provisions (CEA section 4s(j)(5), Exchange Act section
15F(j)(5)); and chief compliance officer requirements (CEA section
4s(k), Exchange Act section 15F(k)).
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We thus preliminarily do not agree with those commenters that
argued that
[[Page 80180]]
a de minimis quantity of dealing should be measured in relation to the
level of the person's other activities (or other swap or security-based
swap activities). Aside from the fact that the statute does not
explicitly call for a relative test, such an approach would lead to the
result that larger and more active companies, which presumably would be
more able to influence the swap markets, would be more likely to
qualify for the exemption than smaller and less active companies. Also,
a relative test not only would require a means of measuring the
person's dealing activities, but also would require a means of
measuring the larger scope of activities to which its swap dealing or
security-based swap dealing activities are to be compared, thus
introducing unnecessary complexity to the exemption's application.
Our proposed factors for the de minimis exemption seek to focus the
availability of the exemption toward entities for which registration
would not be warranted from a regulatory point of view in light of the
limited nature of their dealing activities. At the same time, we
recognize that this focus does not appear to readily translate into
objective criteria. Thus, while the proposed factors discussed below
reflect our attempt to delimit the de minimis exemption appropriately,
we recognize that a range of alternative approaches may be reasonable,
and we are particularly interested in commenters' suggestions as to the
appropriate factors.
The first proposed factor is that the aggregate effective notional
amount, measured on a gross basis, of swaps or security-based swaps
that an entity enters into over the prior 12 months in connection with
its dealing activities \35\ could not exceed $100 million.\36\ We
understand that in general the notional size of a small swap or
security-based swap is $5 million or less, and this proposed threshold
would reflect 20 instruments of that size. Given the customer
protection issues raised by swaps and security-based swaps--including
the risks that counterparties may not fully appreciate when entering
into swaps or security-based swaps--we believe that this notional
amount reflects a reasonable limit for identifying those entities that
engage in a de minimis level of dealing activity.\37\ This standard
would measure an entity's quantity of dealing on a gross basis (without
consideration of the market risk offsets associated with combining long
and short positions) to reflect the entity's overall amount of dealing
activity. Similarly, the proposed notional threshold would not account
for the amount of collateral held by or provided by the entity, nor
other risk mitigating factors, in determining whether it engages in a
de minimis quantity of dealing, given that dealer status focuses on an
entity's absolute level of activity, and is not directly based on the
risks that an entity poses or faces.\38\
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\35\ The de minimis exemption specifically places limits on a
person's dealing activity involving swaps or security-based swaps.
Thus, these limits would not apply to swap or security-based swap
activity that does not itself constitute dealing activity, such as
activity in which a person hedges or mitigates a commercial risk of
its business that is unrelated to a dealing business (i.e., as
discussed above, when the person did not accommodate demand from the
other party, respond to the other party's interest in swaps or
security-based swaps, solicit the other party, propose economic
terms, intermediate between parties, provide liquidity, or engage in
other dealing activities). See part II.A.2, supra.
\36\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange
Act rule 3a71-2(a). To the extent that the stated notional amount of
a swap or security-based swap is leveraged or enhanced by its
structure, the calculation shall be based on the effective notional
amount of the swap or security-based swap rather than on its stated
notional amount.
\37\ We preliminarily believe that activity above this amount
would be sufficient to warrant dealer registration to bring about
the benefits of such registration.
\38\ Also, allowing offsets for collateral would result in a de
minimis standard that could encompass positions of virtually
unlimited size.
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In addition, the aggregate effective notional amount of such swaps
or security-based swaps, in which the person's counterparty is a
``special entity'' (as that term is defined in CEA Section 4s(h)(2)(C)
and Exchange Act Section 15F(h)(2)(C)),\39\ that an entity enters into
over the prior 12 months could not exceed $25 million.\40\ The Dodd-
Frank Act provided special protections to special entities in
connection with swaps and security-based swaps, and we preliminarily
believe that this lower proposed threshold reasonably reflects the
special protections afforded to those entities.
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\39\ The term ``special entity'' encompasses: Federal agencies;
States, State agencies and political subdivisions (including cities,
counties and municipalities); ``employee benefit plans'' as defined
under the Employee Retirement Income Security Act of 1974
(``ERISA''); ``governmental plans'' as defined under ERISA; and
endowments.
\40\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange
Act rule 3a71-2(b).
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In addition, to take advantage of the de minimis exemption, the
proposed rule would provide that the entity could not have entered into
swaps or security-based swaps (as applicable) as a dealer with more
than 15 counterparties, other than security-based swap dealers, over
the prior 12 months.\41\ The Commissions preliminarily believe that an
entity that enters into swaps or security-based swaps, in a dealer
capacity, with a larger number of counterparties should be registered
to help achieve Title VII's orderly market goals, and thus cannot be
said to engage in a de minimis quantity of dealing (even if the
aggregate effective notional amount of the swaps or security-based
swaps is less than the thresholds noted above).\42\ For purposes of
determining the number of counterparties, we preliminarily believe that
counterparties who are members of an affiliated group would generally
count as one counterparty, given that the purpose of the limit is to
measure the scope of dealer's interaction with separate
counterparties.\43\
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\41\ See proposed CEA rule 1.3(ppp)(4)(iii); proposed Exchange
Act rule 3a71-2(c). That these tests measure the entity's activities
over the prior 12 months provides certainty. As of the end of each
month, the entity will know whether it may qualify for the exemption
during the following month.
\42\ Similarly, because all the de minimis factors must be
satisfied, a person who enters into only a single swap or security-
based swap, as a swap dealer, with a single counterparty could not
qualify for the de minimis exemption if that swap or security-based
swap exceeds the effective notional amount threshold.
\43\ For this purpose, an affiliated group would be defined as
any group of entities that is under common control and that reports
information or prepares its financial statements on a consolidated
basis.
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Finally, the proposed rule would provide that, to take advantage of
the de minimis exemption, the entity could not have entered into more
than 20 swaps or security-based swaps (as applicable) as a dealer
during the prior 12 months.\44\ As is the case for the limitation on
the number of counterparties, the Commissions preliminarily believe
that an entity that enters into a larger number of swaps or security-
based swaps, in a dealer capacity, would, if registered, help achieve
Title VII's orderly market goals, and thus cannot be said to engage in
a de minimis quantity of dealing. For these purposes, we would expect
that each separate transaction the entity enters into under a swap or
security-based swap master agreement in general would count as entering
into a swap or security-based swap, but that an amendment of an
existing swap or security-based swap in which the counterparty remained
the same and the underlying item remained substantially the same would
not count as a new swap or security based swap.\45\
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\44\ See proposed CEA rule 1.3(ppp)(4)(iv); proposed Exchange
Act rule 3a71-2(d).
\45\ For these purposes only, an amendment to an existing swap
or security-based swap would not need to be counted as a new swap or
security-based swap if the underlying item is substantially the same
as the original item. This may occur, for example, to reflect the
effect of a corporate action such as a merger. An amendment would be
counted as a new swap or security-based swap, however, to the extent
that the change in the underlying item modifies the economic risk
reflected by the swap or security-based swap.
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[[Page 80181]]
The proposed rule would not distinguish between different types of
swaps or security-based swaps into which entities may enter (e.g., rate
swaps versus other commodity swaps, or credit default swaps versus
equity swaps). The Commissions preliminarily do not believe that the
ceiling for distinguishing de minimis dealing activities from other
dealing activities appropriately turns upon the particular type of swap
or security-based swap.\46\
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\46\ The Exchange Act's definition of ``dealer'' does not
include a de minimis exemption. Thus, an entity that engages in
dealing activity involving securities (other than security-based
swaps with eligible contract participants) would be required to
register as a ``dealer'' under the Exchange Act, and comply with the
Exchange Act's requirements applicable to dealers, absent some other
exception or exemption from registration.
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The Commissions request comment on the proposed rule regarding the
de minimis exemption. Commenters particularly are requested to address
whether certain of the proposed factors should be modified or
eliminated; for example, should the proposed $100 million limit on
annual notional swaps or security-based swaps entered into in a dealer
capacity be raised or lowered to better implement the intended scope of
the de minimis exemption--i.e., to exclude entities for which dealer
regulation would not be warranted? Should we adopt different thresholds
that would appropriately limit the exemption so it encompasses only
those entities whose dealing activities are such that dealer regulation
is not warranted? To what extent would certain entities be expected to
reduce or otherwise adjust their dealing activity to fall within the
scope of the de minimis exemption? Would there be any adverse
implications for market participants if this happens? To what extent
could the proposed factors potentially reduce dealing activity, and in
doing so reduce the liquidity available in the swap or security-based
swap market?
Commenters also are requested to address whether the rule should
seek to identify only certain types of counterparties with which a
person could engage in dealing activities under the exemption. We also
particularly request comment on the proposed $25 million notional
threshold for dealer transactions with ``special entities,'' including
whether that proposed threshold should be raised or lowered, and
whether an entity that enters into dealing transactions with ``special
entities'' should be able to take advantage of the exemption at all. In
addition, we request comment on whether the proposed threshold for
transactions with ``special entities'' would provide a disincentive to
dealers entering into transactions with such entities.
Commenters further are requested to address whether the factors may
appropriately account for the size of the swap or security-based swap
activities compared to the size of the entity; how an entity's swaps or
security-based swaps with affiliated counterparties should be treated
for purposes of the test; and whether the exemption's factors should
vary depending on the type of swap or security-based swap at issue.
In addition, commenters are requested to address the significance
of the fact that the statutory de minimis exemption specifically
references transactions with or on behalf of a customer. Does that mean
the exemption was intended to specifically address dealing activity as
an accommodation to an entity's customers? If so, should the exemption
be conditioned on the presence of an existing relationship between the
entity and the counterparty that does not entail swap or security-based
swap dealing activity, and if so, which types of relationships should
be treated as creating a ``customer'' relationship?
Commenters also are requested to address whether the de minimis
exemption should excuse an entity from having to comply with certain
regulatory requirements imposed on swap dealers or security-based swap
dealers, while also mandating compliance with other dealer
requirements. In addition, commenters are requested to address whether,
in lieu of the self-executing approach proposed here, the Commissions
instead should require that entities which seek relief under this de
minimis exemption must submit exemptive requests to the relevant agency
for the agency's consideration and action. Commenters further are
requested to address whether the proposed notional threshold for the de
minimis exception should be subject to a formula that permits automatic
periodic adjustments to the threshold, such as to reflect changes in
market size or in the size of typical contracts.
C. Statutory Exclusion for Swaps in Connection With Originating a Loan
The ``swap dealer'' definition excludes an insured depository
institution (``IDI'') ``to the extent it offers to enter into a swap
with a customer in connection with originating a loan with that
customer.'' \47\ This exclusion does not appear in the definition of
``security-based swap dealer.''
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\47\ See CEA section 1a(49)(A).
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1. Comments Regarding the Exclusion for Swaps in Connection With Loans
Three IDIs commented on this aspect of the definition, stating that
the exclusion should encompass any swap entered into contemporaneously
with a loan that is related to any of the borrower's activities that
affect the ability to repay the loan and can be hedged. Thus, in their
view, the exclusion should cover exchange rate and physical commodity
swaps in addition to interest rate swaps. The IDIs also said the
exclusion should apply to amendments, restructurings and workouts of
loans, and to lenders that act through a syndicate.
Another commenter expressed similar views, and also asked for
clarification whether the exclusion applies to all aspects of the
definition, or if it applies only to whether a person is commonly known
in the trade as a swap dealer. The CFTC preliminarily believes the
exclusion applies to all aspects of the swap dealer definition.
2. Proposed Rule Regarding the Exclusion for Swaps in Connection With
Loans
The CFTC preliminarily interprets the word ``offer'' in this
exclusion to include scenarios where the IDI requires the customer to
enter into a swap, or the customer asks the IDI to enter into a swap,
specifically in connection with a loan made by that IDI. Also, the
proposed rule provides that, in order to prevent evasion, the statutory
exclusion does not apply where (i) The purpose of the swap is not
linked to the financial terms of the loan; (ii) the IDI enters into a
``sham'' loan; or (iii) the purported ``loan'' is actually a synthetic
loan such as a loan credit default swap or loan total return swap.
The proposed rule would apply the statutory exclusion only to swaps
that are connected to the financial terms of the loan, such as, for
example, its duration, interest rate, currency or principal amount.
Although commenters urged that this exclusion be extended to other
aspects of the lending relationship, we preliminarily believe that it
would not be appropriate that this exclusion from the swap dealer
definition encompass swaps that are connected to the borrower's other
business activities, even if the loan agreement requires that the
borrower enter into such swaps or otherwise refers to them. We
preliminarily believe that a broader reading of the exclusion could
encompass all swap activity
[[Page 80182]]
between an IDI and its borrowers, which we do not think is intended.
The origination of commercial loans is a complex process, and the
CFTC preliminarily believes that this exclusion should be available to
all IDIs that are a source of funds to a borrower. For example, all
IDIs that are part of a loan syndicate providing a loan to a borrower
could claim this exclusion with respect to swaps entered into with the
borrower that are connected to the financial terms of the loan.
Similarly, the proposed exclusion could be claimed with respect to such
swaps entered into by any IDI that participates in or obtains a
participation in such loan by means of a transfer or otherwise.\48\
Also, an IDI that is a source of funds for the refinancing of a loan
(whether directly or through a syndicate, participation or otherwise)
could claim the exclusion if it enters into a swap with the refinancing
borrower.
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\48\ The CFTC preliminarily believes that the proposed exclusion
could be claimed by any IDI that participates in a loan through any
means that involves a payment to a lender to take the place of that
lender, including an ``English style'' participation.
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We emphasize that this proposed exclusion, by its statutory terms,
is available only to IDIs. If an IDI were to transfer its participation
in a loan to a non-IDI, then the non-IDI would not be able to claim
this exclusion, regardless of the terms of the loan or the manner of
the transfer. Similarly, a non-IDI that is part of a loan syndicate
with IDIs would not be able to claim the exclusion.
In sum, the proposed exclusion may be claimed by a person that
meets the following three conditions: (i) The person is an IDI; (ii)
the person is the source of funds to a borrower in connection with a
loan (either directly or through syndication, participation,
refinancing or otherwise); and (iii) the person enters into a swap with
the borrower that is connected to the financial terms of the loan (so
long as the loan is not a sham or a synthetic loan).
The CFTC requests comment on the proposed rule relating to the
statutory exclusion for swaps in connection with originating a loan,
and in particular on whether this statutory exclusion should be
extended beyond swaps that are connected to the financial terms of the
loan, and if so, why. The CFTC also requests comment on whether this
exclusion should apply only to swaps that are entered into
contemporaneously with the IDI's origination of the loan (and if so,
how ``contemporaneously'' should be defined for this purpose), or
whether this exclusion should also apply to swaps entered into during
part or all of the duration of the loan.
D. Designation as a Dealer for Certain Types, Classes, or Categories of
Swaps, Security-Based Swaps, or Activities
The statutory definitions include a provision stating that a person
may be designated as a dealer for one or more types, classes or
categories of swaps, security-based swaps, or activities without being
considered a swap dealer or security-based swap dealer for other types,
classes or categories of swaps, security-based swaps, or activities.
This provision is permissive and does not require the Commissions to
designate persons as dealers for only a limited set of types, classes
or categories of swaps, security-based swaps, or activities.
1. Comments Regarding Limited Designation as a Swap Dealer or Security-
Based Swap Dealer
One commenter stated that the Commissions should allow a person to
register as a swap dealer or security-based swap dealer for only a
limited set of types, classes or categories of swaps or security-based
swaps. Another commenter expressed the view that a person designated as
a swap dealer or security-based swap dealer should be designated as
such for all types of swaps or security-based swaps, respectively.
2. Proposed Rule Regarding Limited Designation as a Swap Dealer or
Security-Based Swap Dealer
In general, the Commissions propose that a person that satisfies
the definition of swap dealer or security-based swap dealer would be a
dealer for all types, classes or categories of swaps or security-based
swaps, or activities involving swaps or security-based swaps, in which
the person engages.\49\ Thus, the person would be subject to all
regulatory requirements applicable to dealers for all swaps or
security-based swaps into which it enters. We propose this approach
because it may be difficult for swap dealers and security-based swap
dealers to separate their dealing activities from their other
activities involving swaps or security-based swaps.\50\
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\49\ See proposed CEA rule 1.3(ppp)(3); proposed Exchange Act
rule 3a71-1(c).
\50\ For example, in order to efficiently impose the dealer
requirements on only the person's dealing activities, it may be
necessary for the person to have separate books and records and a
separate compliance regime for its dealing activities.
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The proposed rule also states, however, that the Commissions may
provide for a person to be designated as a swap dealer or security-
based swap dealer for only specified categories of swaps, security-
based swaps, or activities, without being classified as a dealer for
all categories.\51\ This proposed rule would afford persons an
opportunity to seek, on an appropriate showing, a limited designation
based on facts and circumstances applicable to their particular
activities. The Commissions anticipate that a swap dealer could seek a
limited designation at the same time as, or at a later time subsequent
to, the person's initial registration as a swap dealer.
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\51\ CEA section 1a(49)(B); Exchange Act section 3(a)(71)(B). As
discussed below, the Commissions preliminarily believe that there
are four major categories of swaps and two major categories of
security-based swaps. See part IV.A, infra. The designation as a
swap dealer or security-based swap dealer may, for example, be
limited in terms of these categories or in terms of particular
activities of the person.
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The CFTC understands that there may potentially be non-financial
entities, such as physical commodity firms, that conduct swap dealing
activity through a division of the entity, and not a separately-
incorporated subsidiary. In these instances, the entity's swap dealing
activity would not be a core component of the entity's overall
business. If this type of entity registered as a swap dealer, the CFTC
anticipates that certain swap dealer requirements would apply to the
swap dealing activities of the division, but not necessarily to the
swap activities of other parts of the entity.
The Commissions request comment on the proposed rules regarding
limited designation as a swap dealer or security-based swap dealer.
Commenters particularly are requested to address the circumstances in
which such limited purpose designations would be appropriate, the
factors that the Commissions should consider when addressing such
requests, and the type of information requestors should provide in
support of their request. For example, would it be appropriate to grant
such limited purpose designations only to entities that do not
otherwise fall within the definition of a financial entity, and whose
dealing activity is below a defined threshold of the entity's overall
activity? At what level should the Commissions set such a threshold?
Which of the requirements applicable to dealers should or should not
apply to such entity's non-dealing activities in swaps and security-
based swaps?
In addition, commenters are requested to address whether the
Commissions should provide for limited purpose designations of swap
dealers or security-based swap dealers through some other mechanism as
an alternative to, or in
[[Page 80183]]
addition to, case-by-case evaluations of individual applications. If
so, what criteria and procedures would be appropriate for making
limited purpose designations through this type of approach? Also,
should the limited purpose designation apply on a provisional basis
starting at the time that the entity makes an application for a limited
purpose designation?
Finally, commenters also are asked to address whether such limited
purpose designations should be conditioned in any way, such as by the
provision of information of the type that would be required with
respect to an entity's swaps or security-based swaps involving the
particular category or activity for which they are not designated as a
dealer.
E. Certain Interpretative Issues
1. Affiliate Issues
We preliminarily believe that the word ``person'' in the swap
dealer and security-based swap dealer definitions should be interpreted
to mean that the designation applies with respect to a particular legal
person. That is, for example, we would not view a trading desk or other
discrete business unit that is not a separately organized legal person
as a swap dealer; rather, the legal person of which it is a part would
be the swap dealer. Also, an affiliated group of legal persons under
common control could include more than one dealer. Within such a group,
any legal person that engages in swap or security-based swap dealing
activities would be a swap dealer or security-based swap dealer, as
applicable.
In determining whether a particular legal person is a swap dealer
or security-based swap dealer, we preliminarily believe it would be
appropriate for the person to consider the economic reality of any
swaps and security-based swaps it enters into with affiliates (i.e.,
legal persons under common control with the person at issue), including
whether those swaps and security-based swaps simply represent an
allocation of risk within a corporate group.\52\ Swaps and security-
based swaps between persons under common control may not involve the
interaction with unaffiliated persons that we believe is a hallmark of
the elements of the definitions that refer to holding oneself out as a
dealer or being commonly known as a dealer. To the extent, however,
that an entity seeks to use transactions between persons under common
control to avoid one of the dealer definitions, the Commissions have
the authority to prohibit practices designed to evade the requirements
applicable to swap dealers and security-based swap dealers.\53\
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\52\ Such swaps and security-based swaps should be considered in
this way only for purposes of determining whether a particular
person is a swap dealer or security-based swap dealer and does not
necessarily apply in the context of the Exchange Act's general
definition of ``dealer.'' The swaps and security-based swaps,
moreover, would continue to be subject to all laws and requirements
applicable to such swaps and security-based swaps.
\53\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3). For
example, it would not be permissible for an entity that provides
liquidity on one side of the market to use affiliated entities to
provide liquidity on the other side in an attempt to avoid having to
register as a swap or security-based swap dealer.
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The Commissions invite comment as to how the swap dealer and
security-based swap dealer definitions should be applied to members of
an affiliated group. Commenters particularly are invited to address how
the Commissions should interpret common control for these purposes, and
whether this interpretation should be limited to wholly-owned
affiliates.
2. Application to Particular Swap Markets
The swap markets are diverse and encompass a variety of situations
in which parties enter into swaps with each other. We believe it is
helpful to the understanding of the rule to discuss some of these
situations, particularly those that have been raised by commenters,
here. The situations discussed below include persons who enter into
swaps as aggregators, as part of their participation in physical
markets, or in connection with the generation and transmission of
electricity. We invite comment as to what aspects of the parties'
conduct in these situations should, or should not, be considered swap
dealing activities, and whether the parties involved in these
situations are swap dealers.
a. Aggregators
Commenters explained that some persons enter into swaps with other
parties in order to aggregate the swap positions of the other parties
into a size that would be more amenable to entering into swaps in the
larger swap market, or otherwise to make entering into such swaps more
efficient. For example, certain cooperatives enter into swaps with
smaller cooperatives, smaller businesses or their members in order to
establish a position in a commodity that is large enough to be traded
on a swap or futures market. Similarly, one smaller financial
institution explained that it enters into swaps with counterparties
whose swap positions would not be large enough to be of interest to
larger financial institutions. This institution stated that it enters
into offsetting swaps with larger financial institutions so that it is
in a neutral position between the counterparties and the larger
financial institutions.
The result of these arrangements is that such persons engage in
activities that are similar in many respects to those of a swap dealer
as set out in the definition--the person enters into swaps to
accommodate demand from other parties, it enters into swaps with a
relatively large number of non-dealers, and it holds itself out as
willing to enter into swaps. It may be that the swap dealing activities
of these aggregators would not exceed the de minimis threshold, and
therefore they would not be swap dealers. The CFTC, in particular,
requests comment as to how the de minimis threshold would apply to such
persons. If their activity would exceed the de minimis threshold set
forth in the proposed rule, the Commissions request comment on the
application of the swap dealer definition to their activity.
b. Physical Market Participants
The markets in physical commodities such as oil, natural gas,
chemicals and metals are complex and varied. They involve a large
number of market participants that, over time, have developed highly
customized transactions and market practices that facilitate
efficiencies in their market in unique ways. Some of these transactions
would be encompassed by the statutory definition of ``swap,'' and some
participants in these markets engage in swap dealing activities that
are above the proposed de minimis threshold. The Commissions invite
comment as to any different or additional factors that should be
considered in applying the swap dealer definition to participants in
these markets.
c. Electricity Generation and Transmission
The use of swaps in the generation and transmission of electricity
is highly complex because electricity cannot be stored and therefore is
generated, transmitted and used on a continuous, real-time basis. Also,
the number and variety of participants in the electricity market is
very large and some electricity services are provided as a public good
rather than for profit. Nevertheless, some participants engage in swap
dealing activities as described above that are above the de minimis
threshold set forth in the proposed rule. The Commissions invite
comment as to any different or additional factors that should be
considered in applying the
[[Page 80184]]
swap dealer definition to participants in the generation and
transmission of electricity. Specifically, the Commissions invite
comment on whether there are special considerations, including without
limitation special considerations arising from section 201(f) of the
Federal Power Act, related to non-profit, public power systems such as
rural electric cooperatives and entities operating as political
subdivisions of a State, and the applicability of the exemptive
authority in section 722(f) of the Dodd-Frank Act to address those
considerations.
III. Amendments to Definition of Eligible Contract Participant
A. Overview
The Commodity Futures Modernization Act of 2000 (``CFMA'') \54\
generally excluded or exempted transactions between eligible contract
participants (``ECPs'') from most provisions of the CEA.\55\ Section
723(a)(1)(A) of the Dodd-Frank Act repeals those exclusions and
exemptions. ECP status remains important, however, because Section
723(a)(2) of the Dodd-Frank Act renders it unlawful for a non-ECP to
enter into a swap other than on, or subject to the rules of, a
designated contract market (``DCM'').\56\ Section 763(e) of the Dodd-
Frank Act also renders it unlawful for a non-ECP to enter into a
security-based swap unless such transaction is effected on a national
securities exchange registered pursuant to Section 6(b) of the Exchange
Act.\57\ In addition, Section 768(b) of the Dodd-Frank Act makes it
unlawful for a non-ECP to enter into a security-based swap unless a
registration statement is in effect. While this means that non-ECPs
cannot enter into swaps on SEFs or on a bilateral, off-exchange basis,
it also opens swaps to non-ECPs, so long as the swaps are entered into
on, or subject to the rules of, a DCM. Similarly, while non-ECPs cannot
enter into security-based swaps unless the transaction is effected on a
national securities exchange and the security-based swap has an
effective registration statement, it also opens security-based swaps to
non-ECPs.
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\54\ Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000).
\55\ See CEA sections 2(d) (Excluded Derivative Transactions),
2(e) (Excluded Electronic Trading Facilities), 2(g) (Excluded Swap
Transactions) and 2(h) (Legal Certainty for Certain Transactions in
Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). The CFMA also
excluded swap agreements from the definitions of ``security'' in
Section 3(a)(10) of the Exchange Act and Section 2(a)(1) of the
Securities Act. See Section 3A of the Exchange Act, 15 U.S.C. 78c-1,
and Section 2A of the Securities Act, 15 U.S.C. 77b-1 (both of which
have been modified by the Dodd-Frank Act). The CFMA, however,
provided that the SEC had antifraud authority over security-based
swap agreements.
\56\ Section 723(a)(2) of the Dodd-Frank Act adds new subsection
(e) to CEA section 2 (7 U.S.C. 2(e)). New CEA section 2(e) provides
that ``[i]t shall be unlawful for any person, other than an eligible
contract participant, to enter into a swap unless the swap is
entered into on, or subject to the rules of, a board of trade
designated as a contract market under section 5.''
\57\ Section 763(e) of the Dodd-Frank Act adds paragraph (l) to
Exchange Act section 6. New Exchange section 6(l) provides that
``[i]t shall be unlawful for any person to effect a transaction in a
security-based swap with or for a person that is not an eligible
contract participant, unless such transaction is effected on a
national securities exchange registered pursuant to subsection
(b).''
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Congress also amended \58\ the ECP definition in Section 721(a)(9)
of the Dodd-Frank Act by: (1) Raising a threshold that governmental
entities may use to qualify as ECPs, in certain situations, from $25
million in discretionary investments to $50 million in such
investments; and (2) replacing the ``total asset'' standard for
individuals to qualify as ECPs with a discretionary investment
standard.\59\
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\58\ The changes to the ECP definition made by the Dodd-Frank
Act originated in the Administration's ``White Paper'' on financial
regulatory reform. See Financial Regulatory Reform, A New
Foundation: Rebuilding Financial Supervision and Regulation,
available at http://www.financialstability.gov/docs/regs/FinalReprot_web.pdf, at 48-49 (June 17, 2009) (``Current law seeks
to protect unsophisticated parties from entering into inappropriate
derivatives transactions by limiting the types of counterparties
that could participate in those markets. But the limits are not
sufficiently stringent.'').
\59\ The monetary component of ECP status for individuals
remains the same under the amended ECP definition: More than $10
million (but now in discretionary investments, not in total assets),
or $5 million if the transactions for which ECP status is necessary
are for risk management of an asset or liability the individual owns
or incurs, or is reasonably likely to own or incur.
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B. Commenters' Views
The ECP definition elicited comment from nine commenters. The
comments ranged from requests not to increase the monetary thresholds
for governmental employee benefit plans in certain instances to
suggestions to dramatically raise them across the board, and from
requests not to change the definition in a way that would limit the
commenter's access to swaps to specific proposals to address such
otherwise limited access.
In the Dodd-Frank Act, Congress addressed aspects of the ECP
definition that it found to be of particular concern regarding
governmental entities and individuals. Otherwise, though, persons who
qualified for exclusions or exemptions to enter into bilateral, off-
exchange swaps prior to the Dodd-Frank Act will still qualify to do so
with respect to non-standardized swaps under the Dodd-Frank Act, with
the exceptions discussed below. We have not identified any legislative
history suggesting that Congress intended the Commissions to undertake
a wholesale revision of the ECP definition. Accordingly, the
Commissions are limiting the further definition of the term ECP to the
discrete issues discussed below.
C. New ECP categories
The CEA definition of ECP generally is comprised of regulated
persons; \60\ entities defined as ECPs based on a total asset test
(e.g., a corporation, partnership, proprietorship, organization, trust,
or other entity with total assets exceeding $10 million) \61\ or an
alternative monetary test coupled with a non-monetary component (e.g.,
an entity with a net worth in excess of $1 million and engaging in
business-related hedging; \62\ or certain employee benefit plans, the
investment decisions of which are made by one of four enumerated types
of regulated entities \63\); and certain governmental entities and
individuals that meet defined thresholds.\64\
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\60\ CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix),
(x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix), (x)),
as redesignated by Section 721(a)(9) of the Dodd-Frank Act.
\61\ CEA section 1a(18)(A)(v)(I) (7 U.S.C. 1a(18)(A)(v)(I)), as
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
\62\ CEA section 1a(18)(A)(v)(III) (7 U.S.C. 1a(18)(A)(v)(III)),
as redesignated by Section 721(a)(9) of the Dodd-Frank Act.
\63\ CEA section 1a(18)(A)(vi) (7 U.S.C. 1a(18)(A)(vi)), as
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
\64\ CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C.
1a(18)(A)(vii) and (xi), as redesignated by Section 721(a)(9) of the
Dodd-Frank Act.
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Persons in the new major swap participant, major security-based
swap participant, swap dealer and security-based swap dealer categories
are likely to be among the most active and largest users of swaps and
security-based swaps. Accordingly, the Commissions propose to further
define the term ECP to include these new categories, which will permit
such persons to enter into swaps and security-based swaps on SEFs and
on a bilateral basis (where otherwise permitted under the Dodd-Frank
Act and regulations thereunder).
We seek comment on this proposed expansion of the ECP definition.
D. Relationship Between Retail Foreign Currency and ECP Status in the
Context of a Commodity Pool
Prior to the Dodd-Frank Act, clause (A)(iv) of the ECP definition
provided that a commodity pool was an ECP if the pool and its operator
met certain requirements (i.e., the commodity pool has $5 million in
total assets and is operated by a commodity pool operator regulated
under the CEA or subject to
[[Page 80185]]
foreign regulation), regardless of whether each pool participant was
itself an ECP.\65\ Section 741(b)(10) of the Dodd-Frank Act amended
clause (A)(iv) of the ECP definition to provide that a commodity pool
engaging in retail foreign currency transactions of the type described
in CEA sections 2(c)(2)(B) or 2(c)(2)(C) ; \66\ (``retail forex'' and
such pools, ``Retail Forex Pools'') no longer qualifies as an ECP for
those purposes if any participant in the pool is not independently an
ECP. The Commissions believe that in some cases commodity pools unable
to satisfy the conditions of clause (A)(iv) of the ECP definition may
rely on clause (A)(v) to qualify as ECPs instead for purposes of retail
forex. Clause (A)(v) of the ECP definition applies to business entities
irrespective of their form of organization (i.e., corporations,
partnerships, proprietorships, organizations, trusts and other
entities), and contains a $1 million net worth test where such an
entity ``enters into an agreement, contract, or transaction in
connection with the conduct of the entity's business or to manage the
risk associated with an asset or liability owned or incurred or
reasonably likely to be owned or incurred by the entity in the conduct
of the entity's business.'' \67\
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\65\ CEA section 1a(12)(A)(iv) (7 U.S.C. 1a(12)(A)(iv)).
\66\ 7 U.S.C. 2(c)(2)(B) and (C). See generally ``Regulation of
Off-Exchange Retail Foreign Exchange Transactions and
Intermediaries,'' 75 FR 55410 (Final Rule; Sept. 10, 2010)
(discussing the new CFTC retail forex regulatory regime);
``Regulation of Off-Exchange Retail Foreign Exchange Transactions
and Intermediaries,'' 75 FR 3282 (Proposed Rule; Jan. 20, 2010)
(providing historical background on the regulation of retail forex
transactions).
\67\ CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), as
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
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The Commissions believe that permitting Retail Forex Pools with one
or more non-ECP participants to achieve ECP status by relying on clause
(A)(v) of the ECP definition would frustrate the intent of Congress in
denying ECP status to Retail Forex Pools under clause (A)(iv).
Consequently, the Commissions propose to further define the term ECP to
preclude a Retail Forex Pool with one or more non-ECP participants from
qualifying as an ECP by relying on clause (A)(v) of the ECP definition
if such Retail Forex Pool is not an ECP due to the language added to
clause (A)(iv) of the ECP definition by section 741(b)(10) of the Dodd-
Frank Act (i.e., because the pool contains one or more non-ECP
participants). Because commodity pools can be structured in various
ways and can have one or more feeder funds and/or pools, many with
their own participants, the Commissions propose to preclude a Retail
Forex Pool from being an ECP pursuant to clause (A)(iv) of the ECP
definition if there is a non-ECP participant at any investment level
(e.g., a participant in the pool itself (a direct participant), an
investor or participant in a fund or pool that invests in the pool in
question (an indirect participant), an investor or participant in a
fund or pool that invests in that investor fund or pool (also an
indirect participant), etc.).
Similarly, the Commissions believe that some commodity pools unable
to satisfy the total asset or regulated status components of clause
(A)(iv) of the ECP definition may rely on clause (A)(v) to qualify as
ECPs instead. The Commissions are of the view that a commodity pool
that cannot satisfy the monetary and regulatory status conditions
prescribed in clause (A)(iv) should not qualify as an ECP in reliance
on clause (A)(v) of the ECP definition. Therefore, the Commissions
propose to further define the term ECP to prevent such an entity from
qualifying as an ECP pursuant to clause (A)(v) of the ECP definition.
E. Request for comment
The Commissions request comment on all aspects of the proposed
amendments to the definition of ``eligible contract participant.'' Are
the proposed interpretations with respect to Retail Forex Pools and
other commodity pools appropriate? Do entities described in the various
enumerated ECP categories (other than commodity pools) rely on clause
(A)(v) to qualify as ECPs? If so, should an entity that would be
described in one of the clauses of paragraph (A) of the ECP definition,
but cannot satisfy the conditions prescribed in that clause, be
prohibited from relying on clause (A)(v) of the ECP definition?
In addition, should the Commissions further narrow any or all of
the ECP categories? Why or why not? If so, what additional conditions
would be appropriate? Should the Commissions define the term
``discretionary basis,'' as requested by one commenter, either solely
for purposes of clause (A)(vii) or clause (A)(xi), or for both clauses?
Alternatively, should the Commissions add any additional categories of
ECPs, such as the following categories suggested by commenters:
Commercial real estate developers; energy or agricultural cooperatives
or their members; or firms using swaps as hedges pursuant to the terms
of the CFTC's Swap Policy Statement? If so, which ones and why?
IV. Definitions of ``Major Swap Participant'' and ``Major Security-
Based Swap Participant''
The definitions of ``major swap participant'' and ``major security-
based swap participant'' (also jointly referred to as the ``major
participant'' definitions) respectively focus on the market impacts and
risks associated with an entity's swap and security-based swap
positions. In this respect, the major participant definitions differ
from the definitions of ``swap dealer'' and ``security-based swap
dealer,'' which focus on an entity's activities and account for the
amount or significance of those activities only in the context of the
de minimis exception.
Despite those differences in focus, persons that meet the major
participant definitions in large part must follow the same statutory
requirements that apply to swap dealers and security-based swap
dealers.\68\ In this way, the statute applies comprehensive regulation
to entities whose swap or security-based swap activities do not cause
them to be dealers, but nonetheless could pose a high degree of risk to
the U.S. financial system generally.\69\
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\68\ In particular, under CEA section 4s and Exchange Act
section 15F, dealers and major participants in swaps or security-
based swaps generally are subject to the same types of margin,
capital, business conduct and certain other requirements, unless an
exclusion applies. See CEA section 4s(h)(4), (5); Exchange Act
section 15F(h)(4), (5).
\69\ As discussed below, the tests of the major participant
definitions use terms--particularly ``systemically important,''
``significantly impact the financial system'' or ``create
substantial counterparty exposure''--that denote a focus on entities
that pose a high degree of risk through their swap and security-
based swap activities. In addition, the link between the major
participant definition and risk was highlighted during the
Congressional debate on the statute. See 156 Cong. Rec. S5907 (daily
ed. July 15, 2010) (dialogue between Senators Hagen and Lincoln,
discussing how the goal of the major participant definition was to
``focus on risk factors that contributed to the recent financial
crisis, such as excessive leverage, under-collateralization of swap
positions, and a lack of information about the aggregate size of
positions'').
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The major participant definitions are similar in their key
provisions, although one exception, as discussed below, is available
only in connection with the ``major swap participant'' definition. Both
major participant definitions encompass persons that satisfy any of
three alternative tests: \70\
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\70\ Also, neither major participant definition encompasses an
entity that meets the respective swap dealer or security-based swap
dealer definition. See CEA section 1a(33)(A); Exchange Act section
3(a)(67)(A)(i).
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The first test encompasses persons that maintain a
``substantial position'' in any of the ``major'' categories of swaps or
security-based swaps, as those categories are determined by the CFTC
[[Page 80186]]
or SEC as applicable. This test excludes both ``positions held for
hedging or mitigating commercial risk,'' and positions maintained by or
contracts held by any employee benefit plan (as defined in paragraphs
(3) and (32) of section 3 of ERISA (29 U.S.C. 1002)) for the primary
purpose of hedging or mitigating risks directly associated with the
operation of the plan.\71\
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\71\ See CEA section 1a(33)(A)(i); Exchange Act section
3(a)(67)(A)(ii)(I).
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The second test encompasses persons whose outstanding
swaps or security-based swaps create ``substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets.''
\72\
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\72\ See CEA section 1a(33)(A)(ii); Exchange Act section
3(a)(67)(A)(ii)(II).
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The third test encompasses any ``financial entity'' that
is ``highly leveraged relative to the amount of capital such entity
holds and that is not subject to capital requirements established by an
appropriate Federal banking agency'' and that maintains a ``substantial
position'' in swaps or security-based swaps for any of the ``major''
categories of swaps or security-based swaps.\73\
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\73\ See CEA section 1a(33)(A)(iii); Exchange Act section
3(a)(67)(A)(ii)(III).
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The statute directs the CFTC or the SEC to define ``substantial
position'' for the respective definition at the threshold that it
determines to be ``prudent for the effective monitoring, management,
and oversight of entities that are systemically important or can
significantly impact the financial system of the United States.'' The
definitions further provide that when defining ``substantial
position,'' the CFTC or SEC ``shall consider the person's relative
position in uncleared as opposed to cleared [swaps or security-based
swaps] and may take into consideration the value and quality of
collateral held against counterparty exposures.'' \74\
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\74\ See CEA Section 1a(33)(B); Exchange Act section
3(a)(67)(B).
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Both major participant definitions provide that a person may be
designated as a major participant for one or more categories of swaps
or security-based swaps without being classified as a major participant
for all classes of swaps or security-based swaps.\75\
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\75\ See CEA section 1a(33)(C); Exchange Act section
3(a)(67)(C).
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Finally, the definition of ``major swap participant''--but not the
definition of ``major security-based swap participant''--includes an
exception for any ``entity whose primary business is providing
financing, and uses derivatives for the purpose of hedging underlying
commercial risks related to interest rate and foreign currency
exposures, 90 percent or more of which arise from financing that
facilitates the purchase or lease of products, 90 percent or more of
which are manufactured by the parent company or another subsidiary of
the parent company.'' \76\
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\76\ See CEA section 1a(33)(D).
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Although the two major participant definitions are similar, they
address instruments that reflect different types of risks and that can
be used by end-users and other market participants for different
purposes. Interpretation of the definitions must appropriately account
for those differences.
The Commissions are proposing rules to further define the ``major
swap participant'' and ``major security-based swap participant''
definitions, by specifically addressing: (a) The ``major'' categories
of swaps or securities-based swaps; (b) the meaning of ``substantial
position''; (c) the meaning of ``hedging or mitigating commercial
risk''; (d) the meaning of ``substantial counterparty exposure that
could have serious adverse effects on the financial stability of the
United States banking system or financial markets''; and (e) the
meanings of ``financial entity'' and ``highly leveraged.'' We also are
proposing rules to specify the use of a daily average methodology for
identifying whether a person meets one of the major participant
definitions, provide for a reevaluation period for certain entities
that exceed the relevant daily average by a small amount, and provide
for a minimum length of time before a person may no longer be deemed a
major participant.
We further propose that the CFTC or SEC may limit an entity's
designation as a major participant to only certain types, classes or
categories of swaps or security-based swaps. We also address certain
additional interpretive issues that commenters have raised. Finally,
while the Commissions also are not proposing any exclusions from the
major participant definitions, we are soliciting comment as to whether
certain types of entities should be excluded from the definitions'
application.\77\
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\77\ In light of the significant and novel issues raised by the
major participant definitions, the Commissions recognize the
importance of monitoring the swap and security-based swap markets
following adoption of major participant rules. This will help us
evaluate whether the rules appropriately reflect how market
participants use these instruments, and will help us consider the
impact of market evolution and the ways in which market participants
may change their practices in response to the rules, so we may
identify potential improvements to the rules or other actions to
enhance enforcement of major participant regulation.
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A. ``Major'' Categories of Swaps and Securities-Based Swaps
The first and third tests of the statutory major participant
definitions encompass entities that have a substantial position in a
``major'' category of swaps or security-based swaps. The Commissions
are responsible for designating these ``major'' categories.\78\
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\78\ See CEA section 1a(33)(A)(i), (iii); Exchange Act section
3(a)(67)(a)(2)(i), (iii). One commenter suggested that we determine
these categories by reference to the types of instruments
specifically listed in the statutory definition of ``swap.'' See
Northwestern Mutual letter (suggesting that, for regulatory
consistency, each type of swap listed in the definition and options
on each of those swaps should be considered to be an individual
major category). The statutory definition of ``swap'' lists 22
different types of swaps.
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The Commissions propose to designate ``major'' categories of swaps
and security-based swaps in a manner that reflects the risk profiles of
these various instruments and the different purposes for which end-
users make use of the various instruments. We preliminarily believe
that it is important not to parse these ``major'' categories so finely
as to base the ``substantial position'' thresholds on unduly narrow
risks that would reduce those thresholds' effectiveness as risk
measures. The ``major'' categories will apply only for purposes of the
major participant definitions and are not necessarily determinative
with respect to any other provision of the Dodd-Frank Act or the
regulations adopted thereunder.
1. Major Categories of Swaps
We propose to designate four ``major'' categories of swaps for
purposes of the ``major swap participant'' definition. The four
categories are rate swaps, credit swaps, equity swaps and other
commodity swaps.\79\ The first category would encompass any swap which
is primarily based on one or more reference rates, such as swaps of
payments determined by fixed and floating interest rates, currency
exchange rates, inflation rates or other monetary rates. The second
category would encompass any swap that is primarily based on
instruments of indebtedness, including but not limited to any swap
primarily based on one or more indices related to debt instruments, or
any swap that is an index credit default swap or total return
[[Page 80187]]
swap on one or more indices of debt instruments. The third category
would encompass any swap that is primarily based on equity securities,
such as any swap primarily based on one or more indices of equity
securities, or any total return swap on one or more equity indices. The
fourth category would encompass any swap not included in any of the
first three categories. This fourth category would generally include,
for example and not by way of limitation, any swap for which the
primary underlying item is a physical commodity or the price or any
other aspect of a physical commodity.\80\
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\79\ See proposed CEA rule 1.3(rrr). For the avoidance of doubt,
the term ``swap'' as it is used in the definitions of the major swap
categories in rule 1.3(rrr) has the meaning set forth in section
1a(47) of the CEA and the rules promulgated thereunder.
\80\ The term ``commodity'' as defined in Section 1a(9) of the
CEA, 7 U.S.C. 1a(9), and CFTC Rule Sec. 1.3(e), 17 CFR 1.3(e)
includes interest rates, foreign exchange rates, and equity and debt
indices as well as physical commodities. Thus, the fourth category
of swaps is entitled ``other commodity swaps'' because it includes
any swap not included in the other three categories.
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The four major categories of swaps are intended to cover all swaps.
Each swap would be in the category that most closely describes the
primary item underlying the swap. If a swap is based on more than one
underlying item of different types, the swap would be in the category
that describes the underlying item that is likely to have the most
significant effect on the economic return of the swap. The proposed
categories are consistent with market statistics that distinguish
between these general types of swaps, as well as market infrastructures
that have been established for these types of swaps.
We request comment on this proposed method of allocating swaps
among ``major'' categories. Commenters particularly are asked to
address whether there are any types of swaps that would have unclear
status under this proposal, as well as whether all swaps instead should
be placed into a single ``major'' category for purposes of the ``major
swap participant'' definition, or whether there should be additional
``major'' categories of swaps. Commenters are also asked to address
whether the rate swap category should be divided into two separate
categories--one for swaps based on rates of exchange between different
currencies, and another for swaps based on interest rates, inflation
rates and other monetary rates--and if so, in which category cross-
currency rate swaps should be included. Also, should the major swap
category for other commodity swaps be divided into two separate
categories--one for swaps based on agricultural commodities, and
another for swaps based on all other commodities not included in the
other categories?
2. Major Categories of Security-Based Swaps
We propose to designate two ``major'' categories of security-based
swaps for purposes of the ``major security-based swap definition.'' The
first category would encompass any security-based swap that is based,
in whole or in part, on one or more instruments of indebtedness
(including loans), or a credit event relating to one or more issuers or
securities, including but not limited to any security-based swap that
is a credit default swap, total return swap on one or more debt
instruments, debt swap, debt index swap, or credit spread.\81\ The
second category would encompass any other security-based swaps not
included in the first category; this category would include, for
example, equity swaps.\82\
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\81\ This category does not encompass a security-based swap that
is based on an instrument of indebtedness solely in connection with
the swap's financing leg.
\82\ See proposed Exchange Act rule 3a67-2.
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The proposed categories reflect the fact that entities that
transact in security-based swaps for non-speculative purposes would be
expected to use the respective instruments for different purposes. For
example, swaps based on instruments of indebtedness, such as credit
derivatives, can be used to hedge the risks associated with the default
of a counterparty or debt obligation. Equity swaps can be used, among
other ways, to hedge the risks associated with equity ownership or gain
synthetic exposure to equities.\83\ The proposed categories also are
consistent with market statistics that currently distinguish between
those general types of security-based swaps, as well as market
infrastructures, including separate trade warehouses, that have been
established for credit default swaps and equity swaps.
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\83\ At the same time, we note that the distinctions between
these proposed ``major'' categories of ``security-based swaps''
arguably are less significant than the distinctions among the
proposed major categories of ``swaps'' (such as, for example, the
distinction between other commodity swaps and rate swaps).
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We request comment on this proposed method of allocating security-
based swaps between two ``major'' categories. In particular, we request
comment on whether there are any types of security-based swaps that
would have unclear status under this proposal, as well as whether all
security-based swaps instead should be placed into a single ``major''
category for purposes of the ``major security-based swap participant''
definition, or whether there should be additional ``major'' categories
of security-based swaps.
B. ``Substantial Position''
As noted above, the Commissions are required to define the term
``substantial position'' as a threshold that is ``prudent for the
effective monitoring, management, and oversight of entities that are
systemically important or can significantly impact the financial system
of the United States.'' \84\ This raises two fundamental issues: (i)
What types of measures should be used to identify the risks posed by an
entity's swap or security-based swap positions; and (ii) for each of
those measures, how much risk should be required to evidence a
``substantial position''?
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\84\ See CEA section 1a(33)(B); Exchange Act section
3(a)(67)(B).
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1. Commenters' Views
Commenters have expressed diverse views as to what should
constitute a substantial position. A number of commenters suggested the
use of a test based on the current uncollateralized mark-to-market
exposure posed by an entity's swap or security-based swap positions,
after taking bilateral netting agreements into account. Two commenters
suggested specific dollar amounts of uncollateralized exposure to use
as the substantial position threshold.\85\ Several commenters expressed
the view that positions subject to central clearing should be entirely
excluded from the analysis, or at least should be discounted for
purposes of the analysis.\86\
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\85\ See letter from Timothy W. Cameron, Esq., Managing
Director, SIFMA Asset Management Group, dated September 20, 2010
(``SIFMA AMG letter'') (suggesting a standard of $2.5 billion
average exposure in any calendar quarter based on the entity's
entire portfolio of swaps and security-based swaps, other than
foreign exchange swaps and forwards); letter from Gus Sauter, Chief
Investment Officer, Vanguard, dated September 20, 2010 (``Vanguard
letter'') (suggesting that the applicable threshold be $500 million
in uncollateralized exposure for any single major swap category or
$1 billion aggregate exposure across all major categories).
\86\ See letter from Jennifer J. Kalb, Associate General
Counsel, Metropolitan Life Insurance Company, dated September 20,
2010 (``MetLife letter'') (suggesting that cleared trades be subject
to a lesser ``charge'' for purposes of the substantial position
calculation, or be excluded entirely).
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Some commenters opposed using the notional amount of swap or
security-based swap positions to set the threshold, stating that the
notional amount is not indicative of the risks associated with a
position. Some commenters similarly opposed using measures of swap or
security-based swap volume to set the threshold,
[[Page 80188]]
contending that the number of trades does not reflect risk.\87\
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\87\ But see letter from Christopher A. Klem, Ropes & Gray,
dated September 2, 2010 (test should account for frequency of
trading and frequency of trading with non-dealers).
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A few commenters addressed the possibility that the threshold could
take into account the potential future risks associated with a
position, in addition to the risks associated with uncollateralized
current exposure.\88\ Some commenters suggested that the threshold take
into account the potential riskiness of the particular type of
instrument at issue. Some commenters maintained that the threshold
should take into account the number of counterparties an entity has,
the size of an entity's positions compared to the size of the market,
the size of an entity's swap or security-based swap positions compared
to the entity's ability to absorb losses of that magnitude, or the
financial strength of an entity's counterparties. Several commenters
stated that the threshold should be based on an average measure over
time, so that short-term spikes in measures such as exposure would not
by themselves cause an entity to meet the major participant
definitions. Some commenters suggested that the substantial position
threshold should reflect an amount of ``systemic risk.'' \89\
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\88\ See letter from Andrew Baker, Chief Executive Officer,
Alternative Investment Management Association, dated September 24,
2010 (``AIMA letter'') (discussing possible methods of estimating
the maximum risk of loss related to positions); letter from Warren
Davis, Of Counsel, Sutherland Asbill & Brennan LLP on behalf of the
Federal Home Loan Banks, dated September 20, 2010 (in addressing
``substantial counterparty exposure'' test, noting the possibility
of accounting for the potential exposure of a portfolio).
\89\ See letter from Edward J. Rosen, Cleary Gottlieb Steen &
Hamilton LLP, dated September 21, 2010 (``Cleary letter'')
(suggesting that the threshold should be akin to the amount that is
required for a non-financial entity to be designated as systemically
important under Title I of the Dodd-Frank Act).
Section 113 of the Dodd-Frank Act provides that the Financial
Stability Oversight Council (``FSOC'') may determine that a non-bank
financial company shall be supervised by the Federal Reserve Board,
subject to prudential standards, if the FSOC ``determines that
material financial distress at the U.S. nonbank financial company,
or the nature, scope, size, scale, concentration,
interconnectedness, or mix of the activities of the U.S. nonbank
financial company, could pose a threat to the financial stability of
the United States.'' In making that determination, the FSOC is to
consider: Leverage; off-balance sheet exposures; transactions and
relationships with other significant non-bank financial companies
and bank holding companies; importance as a source of credit and
liquidity; extent to which assets are managed rather than owned; the
nature, scope, size, scale, concentration, interconnectedness and
mix of activities; presence of a primary financial regulator; assets
and liabilities; and any other appropriate risk-related factors.
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2. Proposed Substantial Position Thresholds
The Commissions recognize that it is important for the substantial
position thresholds to be set using objective numerical criteria.
Objective criteria should permit regulators, market participants and
entities that may be subject to the regulations to readily evaluate
whether swap or security-based swap positions meet the thresholds, and
should promote the predictable application and enforcement of the
requirements governing major participants.
In determining the substantial position thresholds--in light of
what is ``prudent for the effective monitoring, management, and
oversight'' of entities that are systemically important or can
significantly impact the U.S. financial system--the Commissions are
mindful that tests based on current uncollateralized exposure and tests
based on potential future exposure both have respective advantages and
disadvantages. We thus are proposing tests that would account for both
types of exposure.
A test that focuses solely on the current uncollateralized exposure
associated with an entity's swap and security-based swap positions
should provide a reasonable measure of the theoretical amount of
potential risk that an entity would pose to its counterparties if the
entity currently were to default.\90\ Such a test also should be
relatively clear-cut for market entities to implement, and would be
based on calculations that we expect that market entities would perform
as a matter of course.
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\90\ In practice, however, this measure may underestimate the
amount of risk that an entity poses to its counterparties, given
that it may take multiple days to liquidate a defaulting entity's
swap or security-based swap positions, during which time prices may
move against the defaulting entity.
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At the same time, a focus solely on current uncollateralized
exposure could be overly narrow by failing to identify risky entities
until some time after they begin to pose the level of risk that should
subject them to regulation as major participants. Because exposure can
change significantly over short periods of time, and a swap or
security-based swap position that may pose large potential exposures
nonetheless would often have a mark-to-market exposure of zero at
inception, an entity's positions may already pose significant risk to
counterparties and to the market even before its uncollateralized mark-
to-market exposure increases up to the applicable threshold. A test
that focuses solely on current uncollateralized exposure thus would not
appear to be sufficient to satisfy the systemic importance standard
required by the statute.
Tests based on measures of potential future exposure--which would
address an estimate of how much the value of a swap or security-based
swap might change against an entity over the remaining life of the
contract--could address the gap left by a current uncollateralized
exposure test. Potential future exposure tests, however, would reflect
only an estimate of that type of risk, and would only be as effective
as the factors used by the test.
While we have considered several other types of tests that could be
used to determine the substantial position threshold, we preliminarily
do not believe that the advantages of those tests justify their
disadvantages. For example, while a threshold based on the number of an
entity's counterparties could help identify highly interconnected
entities (a factor that some have argued is important for identifying
an entity's systemic risk), it also has been argued that a large number
of counterparties could mean that the losses associated with that
entity's default would be divided and absorbed by many counterparties
without broader market effects.\91\ While a threshold that is based on
an entity's financial strength would help account for the possibility
of an entity's default as well as the effects of such a default, it
would not address swap-related risks to the market that are not
directly linked to the entity's default. In other words, an entity that
has large out-of-the-money swap or security-based swap positions and
faces a margin call may cause significant price movements in the swaps
or security-based swaps and in the related reference entities or assets
if the entity chooses to unwind its positions, even if the entity
itself does not appear to present a large threat of default. These
movements may be exacerbated if other entities have similar positions.
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\91\ See AIMA letter (``An entity that has only a small number
of counterparties may only affect a small number of entities
directly, should it fail, but the impact could be significant if the
position is large and the counterparty is a systemically important
entity. A diversified exposure to multiple entities could affect
more entities but is likely to be smaller and thus shares the losses
in the industry and having less systemic impact.'').
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Moreover, although substantial position thresholds based on the
financial strength of an entity's counterparties would help measure the
potential that an entity's default would have a broader impact, such
thresholds could result in disparate results between two entities with
identical positions,
[[Page 80189]]
and also could encourage concentration of exposure or potential future
exposure within a few counterparties. While tests that are based on the
volume of an entity's swaps or security-based swaps may be helpful in
identifying significant swap or security-based swap activity, such
tests would not directly be germane to the current or potential future
exposure posed by an entity's swap and security-based swap positions.
Finally, while we have considered the feasibility of tests that take
specific contract features into account (e.g., triggers that require
the payment of mark-to-market margin if an entity's credit rating is
lowered), we preliminarily believe that simpler tests of exposure can
more efficiently identify the risks associated with particular swap or
security-based swap positions.
After considering these alternatives, the Commissions are proposing
two tests to define ``substantial position.'' One test would focus
exclusively on an entity's current uncollateralized exposure; the other
would supplement a current uncollateralized exposure measure with an
additional measure that estimates potential future exposure. A position
that satisfies either test would be a ``substantial position.''
The Commissions, however, request comment on whether it would be
appropriate to use other types of approaches for determining whether an
entity has a substantial position--as an alternative to, or in addition
to, the two proposed tests.
a. Proposed Current Exposure Test
The proposed first substantial position test, which would focus
solely on current uncollateralized exposure, in general would set the
substantial position threshold by reference to the sum of the
uncollateralized current exposure, obtained by marking-to-market using
industry standard practices, arising from each of the person's
positions with negative value in each of the applicable ``major''
category of swaps or security-based swaps (other than positions
excluded from consideration, such as positions for the purpose of
``hedging or mitigating commercial risk'').\92\
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\92\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act
rule 3a67-3(b)(1). In other words, the test would measure the
portion of the exposure that is not offset by the posting of
collateral. If a position was collateralized only partially, the
value of the collateral posted would be offset against the total
exposure, and the test would measure the residual part of the
exposure. We recognize that there may be operational delays between
changes in exposure and the resulting exchanges of collateral, and
in general we would not expect that operational delays associated
with the daily exchange of collateral would be considered to lead to
uncollateralized exposure for these purposes.
As noted above, the statutory definitions require us to consider
the presence of central clearing in setting the substantial position
threshold. This test would account for the risk-mitigating effects
of central clearing in that centrally cleared swaps and security-
based swaps are subject to mark-to-market margining that would
largely eliminate the uncollateralized exposure associated with a
position, effectively resulting in cleared positions being excluded
from the analysis.
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A person would apply this proposed substantial position test on a
major category-by-major category basis, examining its positions with
each counterparty with which the person has swaps or security-based
swaps in the particular category. For each counterparty, the person
would determine the dollar value of the aggregate current exposure
arising from each of its swap or security-based swap positions with
negative value (subject to the netting provisions described below) in
that major category by marking-to-market using industry standard
practices, and deduct from that amount the aggregate value of the
collateral the person has posted with respect to the swap or security-
based swap positions. The aggregate uncollateralized outward exposure
would be the sum of those uncollateralized amounts over all
counterparties with which the person has entered into swaps or
security-based swaps in the applicable major category.\93\
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\93\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act
rule 3a67-3(b)(2).
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The proposed test would not prescribe any particular methodology
for measuring current exposure or the value of collateral posted,\94\
and instead would provide that the method should be consistent with
counterparty practices and industry practices generally.\95\
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\94\ Depending on the particular circumstances of the swap or
security-based swap, such collateral may be posted to a third-party
custodian, directly to the counterparty, or in accordance with the
rules of a derivatives clearing organization or clearing agency.
\95\ Consistent with industry practices, we would expect that
entities may value exposure based on measures that take into account
the amounts that would be payable if the transaction were
terminated. Also, to the extent the valuation of collateral posted
in connection with swaps or security-based swaps is subject to other
rules or regulations, we would expect that the valuation of
collateral for purposes of the major participant calculations would
be consistent with those applicable rules.
At the same time, we recognize that there can be disputes or
uncertainty as to an entity's exposure in connection with swap and
security-based swap positions, and as to the valuation of the
collateral it has posted in connection with those positions. In some
circumstances this could lead to uncertainty as to whether the
entity is a major participant. As addressed below, we are requesting
comment as to the potential significance of these issues, and as to
whether we should set forth additional guidance or mandate the use
of specific standards with respect to these valuations.
Also, it is important to recognize that while we expect that
other regulatory requirements applicable to the valuation of swap or
security-based swap positions and collateral would be relevant to
certain calculations relating to major participant status, our
proposed rules would not be relevant for other purposes, such as in
the context of capital and margin requirements.
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This proposed test would account for the risk mitigating effects of
netting agreements \96\ by permitting an entity to calculate its
exposure on a net basis, by applying the terms of master netting
agreements entered into between the entity and a single
counterparty.\97\ When calculating the net exposure the entity may take
into account offsetting positions with that particular counterparty
involving swaps, security-based swaps and securities financing
transactions (consisting of securities lending and borrowing,
securities margin lending and repurchase and reverse repurchase
agreements) to the extent that is consistent with the offsets provided
by the master netting agreement.\98\
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\96\ Section 362(b)(17) of the United States Bankruptcy Code
generally provides derivatives contracts with a safe harbor from the
Bankruptcy Code's automatic stay, thus allowing parties to these
contracts to enforce their contractual rights, including those
associated with netting and offsets, even after a counterparty has
filed for bankruptcy.
In addition, Section 210(c)(8)(A) of the Dodd-Frank Act
reaffirms the enforceability of netting and offset provisions in
certain derivatives contracts with insolvent counterparties that
have been placed under the receivership of the Federal Deposit
Insurance Corporation (``FDIC''). However, the Dodd-Frank Act also
places certain limitations on the timing by which netting rights may
be exercised when the FDIC has been appointed as the receiver of an
insolvent counterparty. See Dodd-Frank Act section 210(c)(10)(B).
\97\ To the extent that the two counterparties maintain multiple
netting agreements (e.g., separate agreements for dollar-denominated
and euro-denominated instruments), the calculation would account
only for the netting permitted under the netting agreement that is
relevant to the swap or security-based swap at issue.
\98\ See proposed CEA rule 1.3(sss)(2)(iii)(A); proposed
Exchange Act rule 3a67-3(b)(3)(A). As is the case for the proposed
rules on valuation, the proposed rules regarding possible offsets of
various positions are for purposes of determining major participant
status only. Other rules proposed by the Commissions may address the
extent to which, if any, persons such as dealers and major
participants may offset positions for other purposes.
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The Commissions preliminarily believe that this approach is
appropriate because it avoids identifying a position's exposure as
being ``uncollateralized'' when there is no current counterparty risk
associated with it due to offsets under a netting agreement with the
counterparty.\99\ In
[[Page 80190]]
calculating current uncollateralized exposure, however, the entity may
not take into account the market risk offsets associated with holding
positions with multiple counterparties.\100\ Also, the entity may not
``double count'' any offset or collateral--once any item of collateral
or any position with positive value has been applied against current
exposure, the same item cannot be applied for purposes of this test
against any other exposure.
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\99\ If, for example, an entity was $X out of the money in
connection with a security-based swap, but was $X in the money with
the same counterparty in connection with a swap, there would be no
economic need for the entities to exchange collateral in connection
with those offsetting positions. A test that fails to account for
this netting of exposure could lead the entities to engage in
needless offsetting exchanges of collateral.
\100\ See proposed CEA rule 1.3(sss)(2)(iii)(C); proposed
Exchange Act rule 3a67-3(b)(2)(iii). While recognizing that
offsetting positions of that type would reduce the market risk
facing the entity, the offsets would not be expected to directly
mitigate the risks that the entity's counterparties would face if
the entity were to default.
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The proposal to permit this type of netting, however, raises
questions as to how an entity's net out-of-the-money exposure with a
counterparty, and the collateral posted with respect to its positions
with the counterparty, should be allocated among swap positions,
security-based swap positions and other positions specified in the
rule.\101\ In particular, when an entity has not fully collateralized
its net current exposure to a particular counterparty with which it has
a netting agreement, there may be questions regarding how to attribute
the net out-of-the-money positions and associated collateral to its
swap or security-based swap positions. We preliminarily believe that an
entity that has net uncollateralized exposure to a counterparty should,
for purposes of the test, allocate that net uncollateralized exposure
pro rata in a manner that reflects the exposure associated with each of
its out-of-the-money swap positions, security-based swap positions and
non-swap positions.\102\ This allocation would be intended to cause the
measure of uncollateralized exposure connected with swaps or security-
based swaps for purposes of the test to reasonably reflect the relative
contribution of those instruments to an entity's total overall
uncollateralized exposure.
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\101\ This issue does not arise to the extent that an entity's
net positions with a counterparty are fully collateralized.
\102\ In other words, if an entity's out-of-the-money rate swap
positions have $W exposure, its out-of-the-money other commodity
swap positions have $X exposure, its out-of-the-money security-based
swap positions have $Y exposure, and its other out-of-the money
positions covered by that netting agreement have $Z exposure,
fractions of the collateral equal to W/(W+X+Y+Z) should be allocated
to the rate swap positions, X/(W+X+Y+Z) to the other commodity swap
positions and Y/(W+X+Y+Z) to the security-based swap positions. A
similar process should be used for allocating net out-of-the-money
exposure across the categories of swaps and security-based swaps
that have out-of-the-money exposure when one or more categories are
in-the-money.
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For purposes of the definition of ``major swap participant,'' the
Commissions are proposing to set the current uncollateralized exposure
threshold at a daily average of $1 billion in the applicable major
category of swaps, except that the threshold for the rate swap category
would be a daily average of $3 billion. For purposes of the definition
of ``major security-based swap participant,'' this threshold would be
based on a daily average of $1 billion in the applicable major category
of security-based swaps.\103\ We preliminarily believe that these
proposed thresholds are appropriate for identifying entities that,
through their swap and security-based swap activities, have a
significant potential to pose the systemic importance or risks to the
U.S. financial system that the major participant definition and
associated statutory requirements were intended to address, but we also
recognize that it is possible that the appropriate threshold should be
higher or lower. In proposing these specific thresholds, we have sought
to take into account several factors: (i) The ability of the financial
system to absorb losses of a particular size; \104\ (ii) the
appropriateness of setting ``prudent'' thresholds that are materially
below the level that could cause significant losses to the financial
system as it would not be appropriate for the substantial position test
to encompass entities only after they pose significant risks to the
market through their swap or security-based swap activity; \105\ and
(iii) the need to account for the possibility that multiple market
participants may fail close in time, rather than focusing narrowly on
the potential impact of a single participant's default.\106\ Based on
these factors, we preliminarily believe that the proposed substantial
position thresholds would reasonably be expected to apply to entities
that have the potential of satisfying the statutory criteria of
systemic importance or significant impact to the U.S. financial system.
As discussed below, however, we welcome comments on the appropriateness
of the proposed threshold.
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\103\ See proposed CEA rule 1.3(sss)(1); proposed Exchange Act
rule 3a67-3(a)(1).
\104\ In this regard, the Commissions preliminarily believe that
the ``Tier 1'' capital of major dealer banks provides relevant
information about the ability of the financial system to absorb
losses of a particular size. We note that, among U.S. banks that are
dealers in credit derivatives, the six largest banks account for the
vast majority of dealing activities. We understand that the most
liquid ``Tier 1'' regulatory capital for those six banks ranges from
$14 billion to $113 billion.
\105\ In other words, the proposed thresholds are intended to be
low enough to provide for the appropriately early regulation of an
entity whose swap or security-based swap positions have a reasonable
potential of posing significant counterparty risks and risks to the
market that stress the financial system, while being high enough
that it would not unduly burden entities that are materially less
likely to pose these types of risks.
\106\ For example, the proposed $1 billion threshold for swaps
and security-based swaps would reflect a potential loss of $3
billion if three large swap or security-based swap entities were to
fail close in time. That $3 billion could represent a significant
impairment of the ability of some major dealers to absorb losses, as
reflected by their Tier 1 capital.
We also are mindful of the views expressed by the two commenters
that suggested particular dollar values for the threshold. See note
85, supra.
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These proposed thresholds would be evaluated by reference to a
calculation of the mean of an entity's uncollateralized exposure
measured at the close of each business day, beginning on the first
business day of each calendar quarter and continuing through the last
business day of that quarter.\107\ In this regard, the Commissions have
taken into account commenters' concerns that an entity's exposure
should not be evaluated based on a single point in time, as short-term
market fluctuations may not fairly reflect the risks of the entity's
positions. The use of a daily average approach should help address
commenters' concerns about the impact of short-term price fluctuations,
and also help preclude the possibility that an entity may seek to use
short-term transactions to distort the measure of exposure.
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\107\ See proposed CEA rule 1.3(sss)(4); proposed Exchange Act
rule 3a67-3(d).
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The Commissions request comment on the proposed current
uncollateralized exposure test. Commenters particularly are requested
to address whether the proposed threshold amounts of current
uncollateralized exposure are appropriate, and, if not, what
alternative higher or lower threshold amounts would appropriately
identify entities that pose the types of risks that the definition was
intended to address. In this regard, commenters specifically are
requested to address whether bank Tier 1 capital provides a good
indicative reference of the ability of major dealers to absorb losses
of a particular size, or whether alternative reference points for the
analysis (e.g., the size of the swap market or security-based swap
market) would also be applied. Commenters are requested to address
whether uncollateralized mark-to-market exposure is the appropriate way
to measure current exposure, and if not, what alternative approach is
more appropriate, and why. Commenters also are requested to address
whether the
[[Page 80191]]
proposed thresholds reasonably address the need to set the threshold at
a prudent level so as to avoid the possibility that the substantial
position test would encompass entities only after they pose significant
risks to the market, whether the proposed thresholds reasonably address
the possibility that multiple market entities could fail close in time,
and whether the proposed thresholds reasonably address the fact that
swap or security-based swap activities would comprise only part of the
risks to the market posed by an entity. To what extent would this
proposed definition of ``substantial position'' have an effect on the
activities of entities that potentially may be deemed to be major
participants? What impact could these types of effects have on
liquidity, on risk-taking or risk-reducing activities, or on other
aspects of the relevant markets?
Also, more fundamentally, we request comment on whether the
substantial position analysis also should encompass a test that does
not account for the collateral posted in connection with an entity's
exposure, given that tests that account for the posting of collateral
would not encompass entities that have very large swap or security-
based swap positions that are fully collateralized (either by the
posting of bilateral collateral or by virtue of central clearing). In
that light, should the analysis seek to capture entities that have very
large positions in light of potential market disruptions such entities
could cause, regardless of whether the positions are collateralized?
Commenters further are requested to address whether such thresholds
should also account for entities that have large in-the-money positions
that may indicate their potential significance to the market. In this
regard, commenters also are asked to address whether the thresholds
should specifically address entities with large in-the-money positions
that lead them to receive large amounts of collateral posted by their
counterparties, particularly to the extent that such collateralized in-
the-money positions could later turn and lead the entity to incur
losses.
In addition, commenters are requested to address whether and how it
would be appropriate to adjust the threshold amounts over time,
including whether these proposed current uncollateralized exposure
thresholds should periodically be adjusted by formula to reflect
changes in the ability of the market to absorb losses over time, or
changes in other criteria over time. Commenters further are requested
to address whether the test will be practical for potential major
participants to use. Moreover, commenters are requested to address
whether the proposed current exposure test should be modified to
account for the risks associated with the expected time lag between an
entity's default and the liquidation of its swap or security-based swap
positions.
Commenters also are requested to address whether we should set
forth additional guidance or mandate the use of specific standards with
respect to the measure of exposure or valuing collateral posted, or
should specify particular procedures in the event of valuation
disputes. What particular industry standard documentation and other
methodologies could be used to measure exposure and value collateral?
Also, how could regulatory requirements applicable to the valuation of
collateral be relevant to the valuation of collateral for purposes of
the major participant definitions?
Commenters are invited to address whether the rule should provide
that, in measuring their current uncollateralized exposure, entities
must value collateral in a way that is at least as conservative as such
collateral would be valued according to applicable haircuts or other
adjustments dictated by applicable regulations. Commenters further are
requested to address whether the test should exclude certain types of
collateral that cannot readily be valued. Also, commenters are
requested to address whether the proposed method of evaluation--the
mean of an entity's uncollateralized exposure measures at the close of
each business day, beginning on the first business day of each calendar
quarter and continuing through the last business day of that quarter--
would be unduly burdensome or potentially subject to gaming or evasion.
Should the proposed approach for measuring uncollateralized current
exposure be amended or supplemented, such as by establishing
requirements for how exposure should be measured or collateral should
be valued in certain circumstances (e.g., requiring the valuation of
certain types of collateral to be conservative during times of rapid
price changes in the relevant asset class)? Should current exposure and
collateral be required to be valued in accordance with US generally
accepted accounting principles? Would measurement according to such
principles differ in any respects from measurement under the proposal,
and, if so, how?
In addition, commenters are requested to address the proposed
netting provisions of this test, including: whether the proposed test
would reasonably permit the measure of uncollateralized exposure to
account for bilateral netting agreements; whether additional types of
positions should be included within the netting provisions; whether the
proposal appropriately takes into account the netting of exposures and
collateral involving positions in financial instruments other than
swaps, security-based swaps and securities financing transactions and
if so, whether any limitations to such offsetting would be necessary or
appropriate; whether the netting provisions should accommodate
offsetting positions involving the net equity balance in an entity's
securities account (e.g., free credit balances, other credit balances,
and fully paid securities), and if so, whether any limitations to such
offsetting would be necessary or appropriate; whether the netting
provisions should accommodate offsets for exposures, or collateral
connected with the positions that an entity has with the affiliate of a
counterparty; and whether the proposed method of allocating the
uncollateralized portion of exposures among the different types of
financial instruments that are all subject to a single netting
agreement is appropriate.
Commenters also are requested to address whether the proposed
current uncollateralized exposure test would pose significant
monitoring burdens upon entities that have swap or security-based swap
positions that are significant enough to potentially meet the current
uncollateralized exposure threshold. Should we provide guidance as to
policies and procedures that such an entity should be able to follow to
demonstrate that it does not meet the applicable thresholds?
b. Proposed Current Exposure Plus Potential Future Exposure test
The second proposed test would account both for current
uncollateralized exposure (as discussed above) and for the potential
future exposure associated with swap or security-based swap positions
in the applicable ``major'' category of swaps or security-based swaps.
This additional test would allow the major participant analysis to take
into account estimates of how the value of an entity's swap or
security-based swap positions may move against the entity over time.
The potential future exposure portion of this proposed test would
be based on an entity's ``aggregate potential outward exposure,'' which
would reflect the potential exposure of the entity's swap or security-
based swap positions in the applicable ``major'' category of swap or
security-based swaps, subject to certain adjustments. Bank capital
standards also
[[Page 80192]]
make use of this type of test,\108\ and this proposal builds upon those
standards but modifies them to focus on the risk that an entity poses
to its counterparties (rather than on the risk that counterparties pose
to an entity). In doing so, this proposal seeks to use a test that can
be implemented by a range of market participants, and that can be
expected to lead to reproducible results across market participants
with identical swap or security-based swap portfolios, rather than
relying on alternative tests (e.g., value at risk measures or stress
testing methodologies) that may be costly for market participants to
implement and that would not be expected to lead to reproducible
results across participants.
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\108\ See 12 CFR part 3, app. C, section 32 (Office of the
Comptroller of the Currency bank capital standards).
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The exposure measures in general would be based on the total
notional principal amount of those positions, adjusted by certain risk
factors that reflect the type of swap or security-based swap at issue
and the duration of the position.\109\ For positions in which the
stated notional amount is leveraged or enhanced by the particular
structure, this calculation would be based on the position's effective
notional amount.\110\
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\109\ For example, consistent with the bank standards, the
multiplier for equity swaps would range from 0.06 for equity swaps
of one year or less to 0.10 for equity swaps with a maturity of more
than five years. See proposed Exchange Act rule 3a67-3(c)(2)(i)(A).
For security-based swaps based on the credit of a reference entity,
the multiplier would be 0.1.
The current bank capital standards contain a distinction based
on whether the credit derivative is on ``investment grade'' or
``non-investment grade'' reference entities, providing a 0.1
multiplier for the former and a lower 0.05 multiplier for the
latter. We preliminarily do not believe that a test that
distinguishes among reference entities by reference to their credit
ratings would be appropriate for purposes of these definitions,
particularly in light of the fact that the Dodd-Frank Act mandates
the substitution of credit ratings with other standards of
creditworthiness in U.S. regulations. See Dodd-Frank Act section
939A.
The multipliers in part will be a function of the remaining
maturity of the swap or security-based swap. If the swap or
security-based swap, however, is structured such that on specified
dates the outstanding exposure is settled and the terms are reset so
the market value is zero, the remaining maturity would equal the
time until the next reset date.
Although we recognize that these risk multipliers may suggest a
lower than expected volatility of credit or equity derivatives of
that duration, this may be offset by the fact that the proposed
calculations of potential future exposure do not directly account
for portfolio netting or collateral updates that could mitigate
future exposure. We preliminarily believe that the use of these
thresholds (and proposed related calculations) for purposes of
identifying major participants are consistent with similar bank
capital standards and are therefore suitable for use as an estimate
of potential future exposure. We are also cognizant that requiring a
more complete calculation of potential future exposure may be costly
and burdensome for participants, especially those who would
otherwise not meet the thresholds for major swap or security-based
swap participant and would not have systems in place to perform a
more complete calculation.
\110\ See proposed CEA rule 1.3(sss)(3)(ii); proposed Exchange
Act rule 3a67-3(c)(2)(i)(B). For purposes of this rule, in the case
of positions that represent the sale of an option on a swap or
security-based swap (other than the sale of an option permitting the
person exercising the option to purchase a credit default swap), we
would view the effective notional amount of the option as being
equal to the effective notional amount of the underlying swap or
security-based swap, and we would view the duration used for
purposes of the formula as being equal to the sum of the duration of
the option and the duration of the underlying swap or security-based
swap.
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At the same time, the proposed measures would contain adjustments
for certain types of positions that pose relatively lower potential
risks.\111\ In addition, the general risk-adjusted notional measures of
potential future exposure would be reduced to reflect the risk
mitigation effects of master netting agreements, in a manner consistent
with bank capital standards.\112\
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\111\ The analysis would exclude swap or security-based swap
positions that constitute the purchase of an option, such that the
person has no additional payment obligations under the position, as
well as other positions on which the person has prepaid or otherwise
satisfied all of its payment obligations. See proposed Exchange Act
rule 3a67-3(c)(2)(i)(C).
For similar reasons, the potential outward exposure associated
with a position by which a person buys credit protection using a
credit default swap would be capped at the net present value of the
unpaid premiums. See proposed CEA rule 1.3(sss)(3)(ii)(A)(4);
proposed Exchange Act rule 3a67-3(c)(2)(i)(D).
\112\ In particular, for swaps or security-based swaps subject
to master netting agreements the potential exposure associated with
the person's swap or security-based swaps with each counterparty
would equal a weighted average of the potential exposure in the
applicable ``major'' category of swaps or security-based swaps with
a particular counterparty as calculated without reference to
netting, and that amount reduced by the ratio of net current
replacement cost to gross current replacement cost of all swap and
security-based swap positions with that counterparty, consistent
with the following equation: PNet = 0.4 x PGross + 0.6 x NGR x
PGross.
Under this formula, PNet is the potential exposure in the
applicable ``major'' category of swaps or security-based swaps
adjusted for bilateral netting; PGross is the potential exposure in
that category without adjustment for bilateral netting; and NGR is
the ratio of net current replacement cost to gross current
replacement cost. See proposed CEA rule 1.3(sss)(3)(ii)(B); proposed
Exchange Act rule 3a67-3(c)(2)(ii).
The ``NGR'' ratio is intended to serve as a type of proxy for
the impact of netting on potential future exposure, but does not
serve as a precise indicator of future changes in net exposure
relative to gross exposure, as the ratio and potential exposure can
be influenced by many idiosyncratic properties of individual
portfolios. See Basle Committee on Banking Supervision, ``The
Treatment of the Credit Risk Associated with Certain Off-Balance-
Sheet Items'' (July 1994).
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The proposed measures of potential future exposure would contain
further downward adjustments to account for the risk mitigation effects
of central clearing and mark-to-market margining. In particular, if the
swap or security-based swap positions are cleared by a registered
clearing agency or subject to daily mark-to-market margining,\113\ the
measures of potential future exposure would further be adjusted to
equal twenty percent of the potential future exposure calculated using
the methodology described above.\114\ The Commissions preliminarily
believe that a significant downward adjustment would be appropriate
because clearing and daily mark-to-market margining would be expected
to reduce the potential future risks posed by an entity's swap or
security-based swap positions. Also, it is appropriate to incentivize
the use of central clearing and daily mark-to-market margining as
practices for helping to control risks. We are not proposing to
entirely eliminate such cleared and margined positions from the
analysis of potential future exposure, however, because clearing may
not entirely eliminate the risks posed by an entity's potential
default,\115\ and daily mark-to-market margining would not eliminate
the risks associated with large intra-day price movements. While the
proposed amount of the adjustment seeks to balance these
[[Page 80193]]
competing factors, we recognize that alternative higher or lower
downward adjustments may also be appropriate.
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\113\ For these purposes, a swap or security-based swap would be
considered to be subject to daily mark-to-market margining if, and
for as long as, the counterparties follow the daily practice of
exchanging collateral to reflect changes in exposure (after taking
into account any other positions addressed by a netting agreement
between the parties). If a person is permitted to maintain an
uncollateralized ``threshold'' amount under the agreement, that
amount (regardless of actual exposure) would be considered current
uncollateralized exposure for purposes of the test. Also, if the
agreement provides for a minimum transfer amount in excess of $1
million, the entirety of that amount would be considered current
uncollateralized exposure. See proposed CEA rule
1.3(sss)(3)(iii)(B); proposed Exchange Act rule 3a67-3(c)(3)(ii).
In this way, the measure of potential future exposure would
reflect for the risk mitigating benefits of daily margining, while
specifically accounting for industry practices that limit those
benefits. Of course, to take advantage of this adjustment it is not
enough to the agreement to provide for daily mark-to-market
margining--the parties must actually follow that practice.
\114\ See proposed CEA rule 1.3(sss)(3)(iii)(A); proposed
Exchange Act rule 3a67-3(c)(3).
\115\ For example, the central counterparties that clear credit
default swaps do not necessarily become the counterparties of their
members' customers (although even absent direct privity those
central counterparties benefit customers by providing for protection
of collateral they post as margin, and by providing procedures for
the portability of the customer's positions in the event of a
dealer's default). As a result, central clearing may not eliminate
the counterparty risk that the customer poses to the dealer. Even
then, however, required mark-to-market margining should help control
that risk, and central clearing thus would be expected to reduce the
likelihood that an entity's default would lead to broader market
impacts.
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For purposes of the ``major swap participant'' definition, the
substantial position threshold would be $2 billion in daily average
current uncollateralized exposure plus aggregate potential outward
exposure in the applicable major swap category, except that the
threshold for the rate swap category would be a daily average of $6
billion. For purposes of the ``major security-based swap participant''
definition, the substantial position threshold would be $2 billion in
daily average current uncollateralized exposure plus aggregate
potential outward exposure in any major security-based swap
category.\116\ These proposed amounts reflect the same factors
discussed above in the context of the current uncollateralized exposure
test,\117\ but are raised to reflect the fact that potential future
exposure is a measure of potential risk over time, and hence is less
likely to pose a direct, immediate impact on the markets than current
measures of uncollateralized exposure. We recognize that alternative
risk thresholds may also be appropriate, and we welcome comment on
potential alternatives.
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\116\ See proposed Exchange Act rule 3a67-3(a)(2).
\117\ See notes 103 to 106, supra, and accompanying text.
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In light of the amount of this threshold and the underlying risk
adjustments, we preliminarily do not believe that an entity would need
to calculate its potential future exposure for purposes of the test
unless the entity has large notional positions. For example, in light
of the proposed risk adjustment of 0.10 for credit derivatives, an
entity that does not have any uncollateralized current exposure would
have to have notional positions of at least $20 billion to potentially
meet the $2 billion threshold, even before accounting for the discounts
associated with netting agreements. If those swaps or security-based
swaps are cleared or subject to mark-to-market margining, the
additional 20 percent risk adjustment would mean that the entity
without current uncollateralized exposure would have to have cleared
notional positions of at least $100 billion to possibly meet that
threshold.\118\
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\118\ Based on these thresholds, we preliminarily believe that
only relatively few entities would regularly have to perform these
potential future exposure calculations with regard to their
security-based swaps. See notes 181 and 182, infra, and accompanying
text.
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The Commissions request comment on this proposed use of a current
exposure plus potential future exposure test to determine the
substantial position threshold. Commenters particularly are requested
to address the appropriateness of using potential exposure risk
adjustments derived from bank capital rules; and the appropriateness of
using bank capital methodologies for addressing positions subject to
netting agreements. Also, should this test be supplemented by a test
that accounts for the notional amount of an entity's swap or security-
based swap positions without risk-adjustments, to focus on entities
that have very large swap or security-based swap positions?
Commenters are requested to address whether the proposed threshold
amounts for the proposed current exposure plus potential future
exposure test are appropriate, and if not, what alternative threshold
amounts would be more appropriate, and why. In addition, commenters are
requested to address the proposed method of discounting the potential
future exposure associated with cleared positions or positions subject
to daily mark-to-market margining to equal 20 percent of what the
measure of potential future exposure would be otherwise. Would a larger
or smaller discount be appropriate? Is there data available that may
assist with reaching the appropriate discount factor? Also, in that
regard, should both sets of discounts be equal, or should cleared
positions be subject to more of a discount than uncleared positions
subject to daily mark-to-market margining? Commenters also are invited
to address whether the proposed discounts for cleared positions or
positions that are marked-to-market would make it unnecessary or
duplicative for this test separately to account for netting agreements.
Also, if an entity currently has posted excess collateral in connection
with a position, should the amount of that current
overcollateralization be deducted from its measure of potential future
exposure?
Commenters also are requested to address whether the proposed test
in connection with purchases of credit protection--which would cap the
measure of exposure at the net present value of unpaid premiums--would
raise problems in implementation, and whether we should propose any
particular discount rate to be used in conducting the calculation (and,
if so, what discount rate should be appropriate). Also, should the
measure of potential future exposure in connection with purchases of
credit protection and options also account for collateral that a
counterparty has posted in connection with an entity's in-the-money
positions, given that such collateralized in-the-money positions could
later turn and cause losses to an entity? In addition, for positions
that represent the sale of options on swaps or security-based swaps,
would the effective notional amount of the option for purposes of the
calculation properly be deemed to be the notional amount of the
underlying instrument (or should the notional amount of the option vary
based on the link between the changes in the value of the option and
changes in the value of the underlying), and would the duration of the
option properly be deemed to be the sum of the duration of the option
and the duration of the underlying swap or security-based swap?
Commenters also are requested to address whether the risk
adjustment for credit derivatives should reflect the riskiness of the
underlying reference entity, and, if so, how should that be
accomplished in a way that does not rely on the use of credit ratings.
The proposed test of potential future exposure is based in part on
the application of fixed multipliers to the notional amounts, or
effective notional amounts, of swaps and security-based swaps. In this
regard, commenters are invited to discuss whether there are alternative
tests that would be more effective to determine potential future
exposure or otherwise to supplement an uncollateralized current
exposure test, and whether such alternative tests may be more
effectively developed in the near future, when additional data
regarding swap and security-based swap positions are likely to be
available. In particular, commenters are requested to identify any
tests based on non-proprietary risk models that could be uniformly
applied by all potential major participants to measure potential future
exposure. Commenters who propose alternative tests are asked to address
how the tests would provide consistent results across different types
of swaps and security-based swaps, including customized instruments, in
the different major categories. Commenters are also invited to address,
on the other hand, whether a single test based on uncollateralized
current exposure (i.e., without any test of potential future exposure)
would be adequate for identifying entities whose swap or security-based
swap positions pose a relatively high degree of risk to counterparties
and to the markets. In addition, commenters are invited to identify any
tests or thresholds below which a party would be deemed not to be a
major swap participant, without needing to calculate the exposure tests
set forth in the proposed rule.
[[Page 80194]]
Commenters further are requested to address whether and how it
would be appropriate to adjust the threshold amounts over time,
including whether these proposed thresholds should periodically be
adjusted by formula to reflect changes in the ability of the market to
absorb losses over time, or changes in other criteria over time. In
addition, commenters are requested to address whether the proposed use
of a daily average measure for purposes of this test would be
burdensome for potential major participants to implement, and, if so,
how often should potential participants have to measure these amounts.
Commenters also are requested to address whether any such tests should
seek to reflect the maximum level of exposure associated with a
position, rather than risk-adjusted estimates of exposure proposed
here.
In addition, commenters are requested to address whether this
proposed test would pose significant monitoring burdens upon entities
that have swap or security-based swap positions that are significant
enough to potentially meet the combined current uncollateralized
exposure and potential future exposure test. Should we provide guidance
as to policies and procedures that such an entity should be able to
follow to be able to demonstrate that it does not meet the applicable
thresholds?
C. ``Hedging or Mitigating Commercial Risk''
The first test of the major participant definitions excludes
positions held for ``hedging or mitigating commercial risk'' from the
substantial position analysis.\119\
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\119\ See CEA section 1a(33)(A)(i)(I); Exchange Act section
3(a)(67)(A)(i)(I).
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Commenters took the position that this exclusion from the major
participant definitions should encompass a variety of uses of swaps and
security-based swaps to hedge risks faced by non-financial
entities.\120\ Some commenters also suggested that the exclusion should
be interpreted to address risks such as ``balance sheet risk,'' the
``risk of under-diversification,'' and hedges undertaken on a portfolio
basis. Some commenters favored interpreting this exclusion to permit
its use by insurers and banks. One commenter emphasized the need to
avoid taking interpretations that would encourage commercial entities
not to manage risks that they otherwise would manage.\121\ Commenters
also took the position that the addition of the word ``mitigating'' was
intended to expand the exclusion beyond what would have been
encompassed had only the term ``hedging'' been used.\122\
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\120\ See, e.g., letter from Coalition for Derivatives End-
Users, dated September 20, 2010 (discussing, inter alia, a
supplier's use of credit derivatives in connection with a cash
receivable, and a company's use of equity derivatives in connection
with a stock repurchase program).
\121\ See Cleary letter (also urging inclusion of ``all risks''
arising in connection with a company's business activities,
including risks incidental to a company's ordinary course of
business).
\122\ See MetLife letter (addition of mitigation ``plainly
indicates that this exclusion intends an expansive definition of
hedging and can also encompass non-speculative derivatives positions
used to manage economic risk, including potentially diversification
and synthetic asset strategies, such as the conservative
`replication' strategy permitted under State insurance laws'');
letter from Joanne R. Medero, Managing Director, BlackRock, dated
September 20, 2010 (addressing the parallel context of the exclusion
for ERISA plan positions).
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1. Proposed Interpretation
In interpreting the meaning of ``hedging or mitigating commercial
risk'' for purposes of the first test of the major participant
definitions, the Commissions first note that virtually identical
language is found in the Dodd-Frank provisions granting an exception
from the mandatory clearing requirement to non-financial entities that
are using swaps or security-based swaps to hedge or mitigate commercial
risk.\123\ Because Congress used virtually identical language in both
instances, the Commissions intend to interpret the phrase ``hedging or
mitigating commercial risk'' with respect to the participant
definitions in the same manner as the phrase ``hedge or mitigate
commercial risk'' in the exception from the mandatory clearing
requirement.\124\ The Commissions also note that although only non-
financial entities that are using swaps or security-based swaps to
hedge or mitigate commercial risk generally may qualify for the
clearing exemption, no such statutory restriction applies with respect
to the exclusion for hedging positions in the first major participant
test. Accordingly, with respect to the first major participant test, it
appears that positions established to hedge or mitigate commercial risk
may qualify for the exclusion, regardless of the nature of the entity--
i.e., whether a financial entity (including a bank) or a non-financial
entity.\125\
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\123\ See CEA section 2(h)(7)(A); Exchange Act section
3C(g)(1)(B) (exception from mandatory clearing requirements when one
or more counterparties are not ``financial entities'' and are using
swaps or security-based swaps ``to hedge or mitigate commercial
risk''). The definition of commercial risk here is for purposes of
only the major participant definitions and, to the extent the
interpretation is similar, for purposes of the end-user exception
from the mandatory clearing requirement. The concept of commercial
risk may be interpreted differently for other purposes under the CEA
and the Exchange Act.
\124\ There is a technical difference in the way those
provisions use the concept of hedging and mitigating commercial
risk--in that the major participant definitions specifically refer
to ``positions held for hedging and mitigating commercial risk''
while the end-user exception refers to a counterparty that ``is
using [swaps or security-based swaps] to hedge or mitigate
commercial risk.'' That difference is consistent with the different
language used in the two places (particularly the use of
``substantial position'' in the major participant definitions) and
we do not see a reason why the use of the term in the context of the
major participant definitions should be construed differently than
its use in the comparable clearing exception.
\125\ The presence of the third major participant test suggests
that financial entities generally may not be precluded from taking
advantage of the hedging exclusion in the first test. The third
test, which does not account for hedging, specifically applies to
non-bank financial entities that are highly leveraged and have a
substantial position in a major category of swaps or security-based
swaps. That test would be redundant if the hedging exclusion in the
first major participant test were entirely unavailable to financial
entities.
Also, had the statute intended the phrase ``hedge or mitigate
commercial risk'' to apply only to activities of or positions held
by non-financial entities, it would not have been necessary to
include an additional provision in the statute generally restricting
the availability of the clearing exception to non-financial
entities.
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In general, we are premising the proposed exclusion on the
principle that swaps or security-based swaps necessary to the conduct
or management of a person's commercial activities should not be
included in the calculation of a person's substantial position.\126\ In
this regard, the Commissions preliminarily believe that whether an
activity is commercial should not be determined solely by the person's
organizational status as a for-profit company, a non-profit
organization or a governmental entity. Rather, the determinative factor
should be whether the underlying activity to which the swap relates is
commercial in nature.\127\
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\126\ The scope of the proposed exclusion is based on our
understanding that when a swap or security-based swap is used to
hedge an entity's commercial activities, the gains or losses
associated with the swap or security-based swap itself will be
offset by losses or gains in the entity's commercial activities, and
hence the risks posed by the swap or security-based swap to
counterparties or the industry generally will be mitigated.
\127\ We do not concur with the suggestion that the use of the
word ``mitigating'' within the major participant definitions was
intended to mean something significantly more than hedging. Other
provisions of the Dodd-Frank Act appear to use the terms ``hedging''
and ``mitigating'' interchangeably; for example, certain provisions
of the Dodd-Frank Act refer to ``risk-mitigating hedging
activities.'' See Dodd-Frank Act section 619 (adding Section 13 to
the Bank Holding Company Act of 1956); Dodd-Frank Act section 619
(adding Section 27B to the Securities Act of 1933). Title VII also
refers to ``[h]edging and other similar risk mitigating
activities.'' Dodd-Frank Act section 716(d)(1).
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[[Page 80195]]
a. Proposed Exclusion in the ``Major Swap Participant'' Definition
As a general matter, the CFTC preliminarily believes that whether a
position hedges or mitigates commercial risk should be determined by
the facts and circumstances at the time the swap is entered into, and
should take into account the person's overall hedging and risk
mitigation strategies. At the same time, the swap position could not be
held for a purpose that is in the nature of speculation, investing or
trading. Although the line between speculation, investing or trading,
on the one hand, and hedging, on the other, can at times be difficult
to discern, the statute nonetheless requires such determinations.\128\
The CFTC expects that a person's overall hedging and risk management
strategies will help inform whether or not a particular position is
properly considered to hedge or mitigate commercial risk. Although the
definition includes swaps that are recognized as hedges for accounting
purposes or as bona fide hedging for purposes of an exemption from
position limits under the CEA, the swaps included within the proposed
exclusion are not limited to those categories. Rather, the proposal
covers swaps hedging or mitigating any of a person's business risks,
regardless of their status under accounting guidelines or the bona fide
hedging exemption.
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\128\ We preliminarily believe that swap positions that are held
for the purpose of speculation or trading are, for example, those
positions that are held primarily to take an outright view on the
direction of the market, including positions held for short term
resale, or to obtain arbitrage profits. Swap positions that hedge
other positions that themselves are held for the purpose of
speculation or trading are also speculative or trading positions.
We preliminarily believe that swap positions that are held for
the purpose of investing are, for example, those positions that are
held primarily to obtain an appreciation in value of the swap
position itself, without regard to using the swap to hedge an
underlying risk. In contrast, a swap position related to a non-swap
investment (such as the purchase of an asset that a commercial
enterprise will use to produce income or otherwise advance its
commercial interests) may be a hedging position if it otherwise
qualifies for the definition of hedging or mitigating commercial
risk.
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The CFTC invites comment on whether swaps qualifying for the
hedging or risk mitigation exclusion should be limited to swaps where
the underlying hedged item is a non-financial commodity. Commenters may
also address whether swaps subject to this exception should hedge or
mitigate commercial risk on a single risk or an aggregate risk basis,
and on a single entity or a consolidated basis. The CFTC also invites
comment on whether risks such as the foreign exchange, currency, or
interest rate risk relating to offshore affiliates, should be covered;
whether industry-specific rules on hedging, or rules that apply only to
certain categories of commodity or asset classes are appropriate at
this time; whether swaps facilitating asset optimization or dynamic
hedging should be included; and whether hedge effectiveness should be
addressed. Commenters are requested to discuss both the policy and
legal bases underlying their comments.
b. Proposed Exclusion in the ``Major Security-Based Swap Participant''
Definition
The proposed meaning of ``hedging or mitigating commercial risk''
for purposes of the ``major security-based swap participant''
definition would require that a security-based swap position be
economically appropriate to the reduction of risks in the conduct and
management of a commercial enterprise, where they arise from the
potential change in the value of assets, liabilities and services
connected with the ordinary course of business of the enterprise.\129\
This standard is intended to exclude from the first major participant
test security-based swaps that pose limited risk to the market and to
counterparties because the positions would be substantially related to
offsetting risks from an entity's commercial operations.\130\ The
security-based swaps included within the proposed rule would not be
limited to those recognized as hedges for accounting purposes; rather,
the proposal has been drafted to cover security-based swaps used in the
broader range of transactions commonly referred to as economic hedges,
regardless of their status under accounting guidelines.
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\129\ See proposed Exchange Act rule 3a67-4(a). The concept of
``economically appropriate'' already is found in rules under the CEA
pertaining to the definition of ``bona fide hedging'' for purposes
of an exemption from position limits. See CEA rule 1.3(z). In the
context of the definition of ``major security-based swap
participant,'' we may take into account existing interpretations of
that term under the CEA, but only to the extent that such
interpretations would appropriately be applied to the use of
security-based swaps for hedging.
The SEC preliminarily plans to interpret the concept of
``economically appropriate'' based on whether a reasonably prudent
person would consider the security-based swap to be appropriate for
managing the identified commercial risk. The SEC also preliminarily
believes that for a security-based swap to be deemed ``economically
appropriate'' in this context, it should not introduce any new
material quantum of risks (i.e., it cannot reflect over-hedging that
could reasonably have a speculative effect) and it should not
introduce any basis risk or other new types of risk (other than the
counterparty risk that is attendant to all security-based swaps)
more than reasonably necessary to manage the identified risk.
\130\ These hedging positions would include activities, such as
the management of receivables, that arise out of the ordinary course
of an entity's commercial operations, including activities that are
incidental to those operations.
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At the same time, the security-based swap position could not be
held for a purpose that is in the nature of speculation or
trading.\131\ In addition, the security-based swap position could not
be held to hedge or mitigate the risk of another security-based swap
position or swap position unless that other position itself is held for
the purpose of hedging or mitigating commercial risk as defined by the
rule or CEA rule 1.3(ttt).\132\
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\131\ See proposed Exchange Act rule 3a67-4(b)(1). For these
purposes, we preliminarily believe that security-based swap
positions that are held for the purpose of speculation or trading
are those positions that are held intentionally for short-term
resale and/or with the intent of benefiting from actual or expected
short-term price movements or to lock in arbitrage profits, as well
as security-based swap positions that hedge other positions that
themselves are held for the purpose of speculation or trading. Thus,
for example, positions that would be part of a ``trading book'' of
an entity such as a bank would not constitute hedging positions that
may be excluded for purposes of the first major participant test.
\132\ See proposed Exchange Act rule 3a67-4(b)(2).
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We look forward to commenters' views on whether the proposed
standard strikes an appropriate balance in determining which positions
may be excluded for purposes of the first major participant test. We
recognize that there are other reasonable views as to what positions
may appropriately be considered to be for the purposes of hedging or
mitigating commercial risk. We also recognize the importance of
providing as clear guidance as possible as to what is or is not a
hedging position for these purposes.
The proposal also would condition the entity's ability to exclude
these security-based swap positions on the entity engaging in certain
specified activities related to documenting the underlying risks and
assessing the effectiveness of the hedge in connection with the
positions.\133\ These activities are intended to help ensure that
positions excluded for purposes of the
[[Page 80196]]
first major participant test would not extend to positions that are not
entered into to reduce or hedge commercial risks, or that at a later
time no longer substantially serve to reduce or mitigate such
risks.\134\
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\133\ See proposed Exchange Act rule 3a67-4(a)(3). The proposal
particularly would require the person to: Identify and document the
risks that are being reduced by the security-based swap position;
establish and document a method of assessing the effectiveness of
the security-based swap as a hedge; and regularly assess the
effectiveness of the security-based swap as a hedge.
We expect that market participants that have security-based swap
activities significant enough that they may be major participants
would already engage in risk assessment activities for their hedging
positions, either formally or informally, and thus we do not believe
that the proposed requirements would disrupt existing business
practices. Instead, the proposal is intended to create standards
that will allow market participants to confirm their compliance with
the rule by formalizing risk assessment activities that should
already be part of an effective hedging program.
\134\ This condition does not mandate that an entity follow a
particular set of procedures to take advantage of the exclusion. We
would expect that an entity that already engages in these types of
risk assessment procedures in connection with its existing business
activities to be able to rely on those procedures to satisfy the
condition. These conditions also could be satisfied by the entity's
use of a third-party to assist with these risk assessment
activities.
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We preliminarily believe that this proposed approach would
facilitate the following types of security-based swap positions:
Positions established to manage the risk posed by a
customer's, supplier's or counterparty's potential default in
connection with: financing provided to a customer in connection with
the sale of real property or a good, product or service; a customer's
lease of real property or a good, product or service; a customer's
agreement to purchase real property or a good, product or service in
the future; or a supplier's commitment to provide or sell a good,
product or service in the future; \135\
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\135\ The references here to customers and counterparties do not
include swap or security-based swap counterparties.
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Positions established to manage the risk posed by a
financial counterparty (different from the counterparty to the hedging
position at issue) in connection with a separate transaction (including
a position involving a credit derivative, equity swap, other security-
based swap, interest rate swap, commodity swap, foreign exchange swap
or other swap, option, or future that itself is for the purpose of
hedging or mitigating commercial risk pursuant to the rule or CEA rule
1.3(ttt));
Positions established to manage equity or market risk
associated with certain employee compensation plans, including the risk
associated with market price variations in connection with stock-based
compensation plans, such as deferred compensation plans and stock
appreciation rights;
Positions established to manage equity market price risks
connected with certain business combinations, such as a corporate
merger or consolidation or similar plan or acquisition in which
securities of a person are exchanged for securities of any other person
(unless the sole purpose of the transaction is to change an issuer's
domicile solely within the United States), or a transfer of assets of a
person to another person in consideration of the issuance of securities
of such other person or any of its affiliates;
Positions established by a bank to manage counterparty
risks in connection with loans the bank has made; and
Positions to close out or reduce any of those positions.
2. Request for Comments
We request comment on the proposed definition of ``hedging or
mitigating commercial risk'' for purposes of both the ``major swap
participant'' and the ``major security-based swap participant''
definitions. Commenters particularly are requested to address whether
the proposed definitions would adequately limit the types of swaps or
security-based swaps that are encompassed by the definition, such that
the definitions do not encompass positions that serve speculative,
trading or other non-hedging purposes. In this regard, do the proposed
definitions appropriately exclude from the scope of the definition
swaps and security-based swaps that would be less likely to pose risks
to counterparties and the market, by virtue of gains or losses on those
swaps being offset by losses or gains associated with an entity's
commercial operations? Commenters further are requested to address
whether the proposed ``economically appropriate'' standard would
effectively limit the positions encompassed by the definition. If not,
what alternative standards (e.g., standards derived from accounting
principles) would more effectively identify hedging positions and
distinguish those from positions held for other purposes? In that
regard, is the concept of ``economically appropriate'' well-understood,
and, if not, is there another concept that would more effectively
delimit the nature of the relationship between the swap or security-
based swap position and the risk being hedged or mitigated? Also, in
the context of the definition of this term for purposes of security-
based swaps, should existing interpretive guidance pertaining to the
concept of ``economically appropriate'' with respect to the CEA's bona
fide hedging exemption for position limits be considered, and, if so,
to what extent? We further request comment on possible alternative
approaches to the test identifying positions entered into for the
purpose of hedging or mitigating commercial risk. For example, should
the test require the entity excluding a position to have a reasonable
basis to believe, and to actually believe, that the excluded swap would
be a ``highly effective,'' ``reasonably effective'' or ``economically
appropriate'' hedge of a specified commercial risk? Should the test be
generally identical to the proposed test, but with the substitution of
the phrase ``highly effective'' or ``reasonably effective'' (or another
standard) for ``economically appropriate''? Should the test be based on
accounting principles for hedging treatment (i.e., a quantitative test
requiring the hedge to be within a certain band of effectiveness)?
Commenters also are requested to address the proposed restrictions
on positions in the nature of speculation or trading. Is it appropriate
not to permit any speculative or trading positions from being deemed
for the purpose of hedging or mitigating commercial risk? What would be
the impact of such an interpretation on an entity's risk mitigation
practices? Also, is the dividing line between speculative and trading
positions on the one hand, and positions eligible to be considered to
be hedging positions on the other hand, sufficiently clear? Is such a
line appropriately based on whether the position is intended to be held
for the short-term versus long-term intent? Would some alternative
criteria be preferable in terms of setting forth objective standards
for identifying risk reducing hedging positions and distinguishing them
from other positions? Also, would additional standards or other
guidance be appropriate to help ensure that positions used in
connection with speculative or trading purposes do not fall within the
definition?
We further request comment on the proposal that a swap or security-
based swap would not fall within the definition of ``hedging or
mitigating commercial risk'' if it is held to hedge or mitigate the
risk of another swap or security-based swap, unless that other position
itself is held for the purpose of hedging or mitigating commercial
risk. One consequence of this approach might be that a particular swap
or security-based swap hedging a particular type of risk would be
included or excluded based solely on whether that risk arises from
another swap or security-based swap or from a different type of
transaction.\136\ Is this the appropriate approach? What would be the
consequences of this approach for
[[Page 80197]]
different types of entities? How would the proposed approach affect the
risk management practices of entities that are close to the proposed
threshold? Is it appropriate to include both positions within the major
participant calculations? If this general approach in the proposed rule
were adopted, should there be any exceptions to the approach? What
alternative approaches might be considered? For example, would it be
appropriate to exclude a swap or security-based swap that hedges
another swap or security-based swap from the calculation? What would be
the advantages and disadvantages of this approach?
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\136\ For example, under this proposal an entity may exclude
from the first major participant test a security-based swap used to
manage the credit risk posed by a customer's default in connection
with financing that an entity provides to that customer. The entity
may not exclude an identical security-based swap, however, if that
security-based swap is used to hedge the credit risk associated with
a second swap or security-based swap that itself is not for the
purpose of hedging or mitigating commercial risk.
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Moreover, commenters are requested to address whether the
definition should encompass a quantitative test that would limit the
total value of swaps and security-based swaps that an entity may
include under this rule to be no more than the total value of
underlying risk identified by such entity. If so, what measurement
should be used for determining an entity's total value of swaps and
security-based swaps and total value of underlying risk, and what
methods or procedures should entities be required to follow when
calculating and comparing the two values?
In addition, commenters are requested to address whether the
proposed procedural requirements, in the context of this definition for
purposes of the ``major security-based swap participant'' analysis, are
appropriate. In this regard, commenters are requested to discuss
whether there are any advantages or disadvantages to providing more
specific procedural requirements; whether the proposed procedural
requirements will alter business practices to the extent that a
transition period is necessary before they are implemented; and whether
specific guidance is required to address how the proposed procedural
requirements will affect existing positions. In addition, commenters
are requested to address whether the proposed procedural requirements
should include a requirement to quantify the underlying risk and the
effectiveness of the hedge, and whether such quantitative assessments
would impose significant systems costs or other costs. Also, should an
assessment of hedging effectiveness be required at all, in light of the
costs that may be associated with such a requirement?
More generally, would the proposed standards for identifying
positions for the purpose of hedging or mitigating commercial risk
suffice to allow a person holding a security-based swap position to
identify and document the commercial risks that are being hedged or
mitigated by that position, and if not, what additional requirements
are needed? Should additional guidance be provided regarding whether
components of risks (in assets, liabilities or services) or whether
risks in portfolios (of assets, liabilities or services) may be
identified as the commercial risks that are being hedged or mitigated
by the position, and, if so, which components? Also, should additional
guidance be provided with respect to the form of documentation or the
elements of the hedging relationship that should be documented, and, if
so, which elements? Moreover, if a swap or security-based swap that was
hedging at inception were no longer to serve a hedging purpose over
time, should it no longer fall within the definition of hedging or
mitigating commercial risk?
In addition, should the rule specify the frequency with which an
entity should assess the effectiveness of the hedge? Also, should we
provide additional guidance on the acceptable methods of assessing
effectiveness? Is a qualitative assessment adequate to assess
effectiveness or should a quantitative assessment also be required?
Should the rule establish a level of offset between the position and
the hedged risk, below which the position would not be considered to be
effective at reducing risk, and, if so, what is the level of offset (or
range of levels) below which the position should not be considered to
be effective? Are there methods for assessing effectiveness that should
not be permitted for these purposes?
Commenters also are requested to address whether the proposal also
should encompass certain activities in which an entity hedges an
affiliate's risks.
We further request comment on how the definition should apply to
hedging activities by financial entities. Commenters particularly are
invited to address whether financial entities should be able to rely on
this exclusion, or whether financial entities should face special
limits in the context of this exclusion. Commenters further are
requested to address how the proposed provisions excluding positions in
the nature of speculation or trading from the definition would apply to
activities by banks, including permissible trading activities by banks,
and, in particular, whether it is appropriate to exclude positions that
are part of an entity's ``trading book.''
Commenters also are requested to address the application of the
proposal to registered investment companies, including whether
additional guidance would be appropriate with respect to which uses of
security-based swaps by registered investment companies would fall
within the exclusion.
D. ``Substantial Counterparty Exposure''
The second test of the major participant definitions addresses
entities whose swaps and security-based swaps ``create substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the United States banking system or financial
markets.'' \137\ Unlike the first test of the major participant
definitions, this test does not focus on positions in a ``major''
category of swaps or security-based swaps. Also, unlike the first test,
this test does not explicitly exclude hedging positions or certain
ERISA plan positions from the analysis.
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\137\ See CEA section 1a(33)(A)(ii); Exchange Act section
3(a)(67)(A)(ii)(II).
---------------------------------------------------------------------------
Some commenters suggested that the second major participant
definition test should be interpreted in a manner similar to the first
test. Many commenters stated that the analysis should also reflect
netting agreements and the posting of collateral. Some commenters
stated that the test should exclude hedging positions, and cleared
positions.
We preliminarily believe that the second major participant
definition test's focus on the counterparty risk associated with an
entity's swap or security-based swap positions is similar enough to the
``substantial position'' risks embedded in the first test that the
second test appropriately takes into account the same measures of
current uncollateralized exposure and potential future exposure that
are used in our proposal for the first test. For the second test,
however, the thresholds must focus on the entirety of an entity's swap
positions or security-based swap positions, rather than on positions in
any specific ``major'' category. In addition, this second test does not
explicitly account for positions for hedging commercial risk or ERISA
positions.
Accordingly, these proposed calculations of substantial
counterparty exposure would be performed in largely the same way as the
calculation of substantial position in the first major participant
definition tests, except that the amounts would be calculated by
reference to all of the person's swap or security-based swap positions,
rather than by reference to a specific ``major'' category of such
positions.\138\
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\138\ See proposed CEA rule 1.3(uuu)(2); proposed Exchange Act
rule 3a67-5(b)(1).
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For purposes of the ``major swap participant'' definition, the CFTC
[[Page 80198]]
proposes that the second major participant definition test be satisfied
by a current uncollateralized exposure of $5 billion, or a combined
current uncollateralized exposure and potential future exposure of $8
billion, across the entirety of an entity's swap positions.\139\ For
purposes of the ``major security-based swap participant'' definition,
the SEC proposes that the second test be satisfied by a current
uncollateralized exposure of $2 billion, or a combined current
uncollateralized exposure and potential future exposure of $4 billion,
across the entirety of an entity's security-based swap positions.\140\
We look forward to commenters' views as to whether alternative
thresholds would be more appropriate to achieve the statutory goals.
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\139\ See proposed CEA rule 1.3(uuu)(1).
\140\ See proposed Exchange Act rule 3a67-5(a).
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These proposed thresholds in part are based on the same factors
that underpin the proposed ``substantial position'' thresholds.\141\
The proposed thresholds, however, also reflect the fact that this test
must account for an entity's positions across four major swap
categories or two major security-based swap categories.\142\ These
proposed thresholds, moreover, have further been raised to reflect the
fact that this second test (unlike the first major participant test)
encompasses certain hedging positions that, in general, we would expect
to pose fewer risks to counterparties and to the markets as a whole
than positions that are not for purposes of hedging.
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\141\ See notes 103 to 106 and 117, supra, and accompanying
text.
\142\ Thus, these proposed thresholds in part would account for
an entity that has large positions in more than one major category
of swaps or security-based swaps, but that does not meet the
substantial position threshold for either.
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We request comment on this proposal. Commenters particularly are
requested to address whether the proposed use of current
uncollateralized exposure and potential future exposure tests
(including the parts of those tests that account for positions that are
cleared or subject to mark-to-market margining) are appropriate, and
whether the proposed thresholds are set at an appropriate level. Should
the thresholds be higher or lower? If so, what alternative threshold
amounts would be more appropriate, and why? Commenters also are
requested to address whether the test should exclude commercial risk
and ERISA hedging positions, on the grounds that those hedging
positions may not raise the same degree of risk to counterparties as
other swap or security-based swap positions. Comments are also
requested on whether the test of substantial counterparty exposure,
given its focus on the systemic risks arising from the entirety of a
person's portfolio, should include a measure to take into account the
person's combined swap positions and security-based swap positions.
E. ``Financial Entity'' and ``Highly Leveraged''
The third test of the major participant definitions addresses any
``financial entity,'' other than one subject to capital requirements
established by an appropriate Federal banking agency,\143\ that is
``highly leveraged relative to the amount of capital'' the entity
holds, and that maintains a substantial position in a ``major''
category of swaps or security-based swaps. This test does not permit an
exclusion for positions held for hedging.
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\143\ Sections 721 and 761 of the Dodd-Frank Act add a
definition of the term ``appropriate Federal banking agency'' in
sections 1a and 3(a) of the CEA and the Exchange Act, respectively,
7 U.S.C. 1a(2), 15 U.S.C. 78c(a)(72). The Commissions propose to
refer to those statutory definitions for purposes of the rules.
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As discussed below, we are proposing specific definitions of the
terms ``financial entity'' and ``highly leveraged.'' In addition, we
request comment on whether we should include additional regulators
within the proposed interpretation of what is an appropriate Federal
banking agency.
1. Meaning of ``financial entity''
While the third major participant definition test does not
explicitly define ``financial entity,'' Title VII of the Dodd-Frank Act
defines ``financial entity'' in the context of the end-user exception
from mandatory clearing (an exception that generally is not available
to those entities).\144\ Some commenters have pointed out that using
that definition here would produce circular results.\145\
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\144\ See CEA section 2(h)(7)(C)(i); Exchange Act section
3C(g)(3)(A).
\145\ See Cleary letter (also addressing status of broker-
dealers and futures commission merchants as part of the analysis).
The circularity would result because, for purposes of the end-
user clearing exception, ``financial entity'' is defined to include
swap dealers, security-based swap dealers, major swap participants,
and major security-based swap participants.
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We preliminarily do not believe there is a basis to define
``financial entity'' for purposes of the major participant definitions
in a way that materially differs from the definition used in the end-
user exception from mandatory clearing. Using the same basic definition
also would appear to be consistent with the statute's intent to treat
non-financial end-users differently than financial entities.
Accordingly, other than technical changes to avoid circularity, we
propose to use the same definition in the major participant
definitions.\146\
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\146\ See proposed CEA rule 1.3(vvv)(1); proposed Exchange Act
rule 3a67-6(a). To avoid circularity, the meaning of ``financial
entity'' for purposes of the ``major swap participant'' definition
would not encompass any ``swap dealer'' or ``major swap
participant'' (but would encompass ``security-based swaps dealers''
and ``major security-based swap participants''). The meaning of
``financial entity'' for purposes of the ``major security-based swap
participant'' definition would not encompass any ``security-based
swap dealer'' or ``major security-based swap participant (but would
encompass ``swap dealers'' and ``major swap participants''). For
both definitions, ``financial entity'' would include any: commodity
pool (as defined in section 1a(10) of the CEA); private fund (as
defined in section 202(a) of the Investment Advisers Act of 1940);
employee benefit plan as defined in paragraphs (3) and (32) of
section 3 of the Employee Retirement Income Security Act of 1974;
and person predominantly engaged in activities that are in the
business of banking or financial in nature (as defined in section
4(k) of the Bank Holding Company Act of 1956).
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Commenters are requested to address our proposed definition of
``financial entity.''
2. Meaning of ``Highly Leveraged''
Some commenters have stated that the term ``highly leveraged''
should be interpreted by looking at the leverage associated with other
firms in an entity's line of business, rather than by applying an
across-the-board measure of leverage.\147\ One commenter suggested that
higher leverage may be warranted for entities with a smaller capital
base, and another commenter suggested that we look at analogous banking
regulations rather than creating a new regime for measuring leverage.
Some commenters suggested ways of addressing specific items for
purposes of determining leverage.\148\
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\147\ See letter from Robert Pickel, Executive Vice Chairman,
International Swaps and Derivatives Association, Inc., dated
September 20, 2010 (suggesting that ``leverage ratio limits to which
banks and other regulated entities are subject would be unsuitably
low for other enterprises''); letter from Steve Martinie, Assistant
General Counsel and Assistant Secretary, The Northwestern Mutual
Life Insurance Company, dated September 20, 2010 (``Northwestern
Mutual letter'') (suggesting that financial firms require less
cushion than other entities because financial firms are able to
match their assets and liabilities more closely).
\148\ See Northwestern Mutual letter (suggesting that the
Commissions recognize that liabilities such as bank deposits and
insurance policy reserves are not leverage); Vanguard letter
(suggesting that leverage should relate to debt financing and should
not encompass potential leveraging effects posed by derivatives);
SIFMA AMG letter (suggesting that the Commissions take into account
the difference between non-recourse and recourse obligations, the
difference between notional amounts payable and actual payable
obligations, and the difference between actual financial obligations
and leverage embedded in a derivative that affects returns but does
not result in a payment obligation).
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The Commissions recognize that traditional balance sheet measures
of leverage have limitations as tools for
[[Page 80199]]
evaluating an entity's ability to meet its obligations. In part this is
because such measures of leverage do not directly account for the
potential risks posed by specific instruments on the balance sheet, or
financial instruments that are held off of an entity's balance sheet
(as may be the case with an entity's swap and security-based swap
positions). At the same time, we preliminarily do not believe that it
is necessary to use more complex measures of risk-adjusted leverage
here, particularly given that the third test in the major participant
definitions already addresses those types of risks by considering
whether an entity has a substantial position in a major category of
swaps or security-based swaps. We are also mindful of the costs that
entities would face if forced to undertake a complex risk-adjusted
leverage calculation, especially for entities that would not already be
performing this type of analysis.\149\ Additionally, we preliminarily
do not believe that it is necessary for the leverage standard to
account for the degree of leverage associated with different types of
financial entities.
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\149\ The Basel Committee on Banking Supervision recently
proposed one method for calculating risk-adjusted leverage in its
Consultative Document entitled: ``Strengthening the resilience of
the banking sector'' (Dec. 2009). This proposal would create a new
leverage ratio based on a comparison of capital to total exposure.
Total exposure for these purposes would be measured by, among other
things, including the notional value of all written credit
protection, severely limiting the recognition given to netting, and
calculating the risks associated with off-balance sheet derivatives
transactions, as measured by the current exposure method for
calculating future risks outlined in Basel II. The Consultative
Document drew over 150 comments from the international financial
community, which included both those in support of, and those that
questioned the inclusion of a risk-adjusted leverage ratio within
the Basel framework. The Basel Committee on Banking Supervision
expects to deliver a full package of reforms by the end of 2010,
based on the Consultative Document released in December 2009 and
comments received thereon.
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Although the third test of the major participant definitions does
not define ``highly leveraged,'' we note that Congress addressed the
issue of leverage in Title I of the Dodd-Frank Act. There, Congress
provided that the Board of Governors of the Federal Reserve System must
require a bank holding company with total consolidated assets equal to
or greater than $50 billion, or a nonbank financial company supervised
by the Board of Governors, to maintain a debt to equity ratio of no
more than 15 to 1 if the FSOC determines ``that such company poses a
grave threat to the financial stability of the United States and that
the imposition of such requirement is necessary to mitigate the risk
that such company poses to the financial stability of the United
States.'' \150\
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\150\ See Dodd-Frank Act section 165(j)(1).
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This requirement in Title I suggests potential alternative
approaches to the definition of ``highly leveraged'' for purposes of
the major participant definitions. On the one hand, the 15 to 1 limit
may represent an upper limit of acceptable leverage, indicating that
the limit for the major participant definitions should be lower so as
to create a buffer between entities at that upper limit and entities
that are not highly leveraged. On the other hand, the Title 1
requirement, which applies only when the entity in question poses a
``grave threat'' to financial stability, may indicate that the 15 to 1
leverage ratio is also the appropriate test of whether an entity poses
the systemic risk concerns implicated by the major participant
definitions.
For these reasons, we propose two possible definitions of the point
at which an entity would be ``highly leveraged''--either an entity
would be ``highly leveraged'' if the ratio of its total liabilities to
equity is in excess of 8 to 1, or an entity would be ``highly
leveraged'' if the ratio of its total liabilities to equity is in
excess of 15 to 1. In either case, the determination would be measured
at the close of business on the last business day of the applicable
fiscal quarter. To promote consistent application of this leverage
test, entities that file quarterly reports on Form 10-Q and annual
reports on Form 10-K with the SEC would determine their total
liabilities and equity based on the financial statements included with
such filings.\151\ All other entities would calculate the value of
total liabilities and equity consistent with the proper application of
U.S. generally accepted accounting principles.
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\151\ These entities would include those that submit periodic
reports on a voluntary basis to the SEC, as well as those that are
required to file periodic reports with the SEC.
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We believe that the 15 to 1 ratio could be consistent with the use
of that ratio in Title I, which, as noted above, provides that the 15
to 1 leverage ratio would be applied to a bank holding company or
nonbank financial company subject to Title I as a maximum only if it is
determined that the company poses a ``grave threat'' to financial
stability. Commenters are requested to address whether the proposed 15
to 1 standard used in Title I suggests that a standard higher than 15
to 1 should be used here, given that the Title I standard is applicable
only to large entities that also pose a ``grave threat'' to financial
stability and thus may suggest that a higher standard is appropriate
for entities that do not pose the same degree of threat. Alternatively,
the 8 to 1 ratio could be consistent with the exemption in the third
test of the major participant definitions for financial institutions
that are subject to capital requirements set by the Federal banking
agencies, as it is possible that financial institutions were
specifically excluded from the third test based on the presumption that
they generally are highly leveraged, and hence would have been covered
by the third test if they were not expressly exempted. Based on our
analysis of financial statements it appears that those institutions
generally have leverage ratios of approximately 10 to 1, which may
suggest that the ``highly leveraged'' threshold would have to be lower
for those institutions to be potentially subject to the third test.
Such an approach would help to ensure that the third test of the major
participant definition applies to financial entities that are not
subject to capital requirements set by the Federal banking agencies,
but that have leverage ratios similar to institutions that are subject
to those requirements.
The Commissions request comment on the proposed alternative
definitions of ``highly leveraged.'' Commenters particularly are
requested to specifically address the relative merits of the proposed
alternative 8 to 1 and 15 to 1 standards, as well as other standards
that they believe would be appropriate for these purposes.\152\
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\152\ In this regard, we recognize that under Exchange Act rule
15c3-1, a broker-dealer may determine its required minimum net
capital, among other ways, by applying a financial ratio that
provides that its aggregate indebtedness shall not exceed 1500% of
its net capital (i.e., a 15 to 1 aggregate indebtedness to net
capital ratio). Exchange Act Rule 17a-11 further requires that
broker-dealers that use such method to establish their required
minimum net capital must provide notice to regulators if their
aggregate indebtedness exceeds 1200% of their net capital (i.e., a
12 to 1 aggregate indebtedness to net capital ratio). We recognize
that these measures, however, reflect a different ratio of total
liabilities to equity; for example, the calculation of aggregate
indebtedness in rule 15c3-1 excludes certain liabilities, and the
calculation of net capital includes certain subordinated debt--
meaning that these measures would respectively be equivalent to
ratios higher than 15:1 or 12:1 when converted to a balance sheet
ratio of liabilities to equity such as that used under the proposed
rule.
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Commenters further are requested to address whether a risk-adjusted
leverage ratio should be used, and, if so, how the ratio should be
calculated (including whether particular items should be included or
excluded when making this calculation), and whether a risk-adjusted
leverage ratio could be developed relying on measures already
[[Page 80200]]
calculated by entities as a matter of course.\153\ Commenters further
are requested to address whether the leverage ratio should be revised
to require that the amount of potential future exposure (as outlined in
the ``substantial position'' discussion above) be combined with total
liabilities before such number is compared to equity for purposes of
calculating the ratio, and, if so, whether the proposed ratios would
still be appropriate; whether the rule should more specifically address
issues as to how certain types of positions or liabilities should be
accounted for when calculating leverage; whether the proposed timing of
the measurement--the close of business on the last business day of the
applicable fiscal quarter--would be potentially subject to gaming or
evasion; and whether the rule text should particularly prescribe how
separate categories of entities calculate leverage.
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\153\ For example, would adjustments akin to those discussed
above in the context of broker-dealer net capital provide a more
useful measure of leverage for these purposes?
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F. Implementation Standard, Reevaluation Period and Minimum Duration of
Status
While the analysis of whether an entity is a major participant is
backward looking, an entity that meets the criteria for being a major
participant is required to register with the CFTC and/or the SEC, and
comply with the requirements applicable to major participants. We
recognize that these entities will need time to complete their
applications for registration and to come into compliance with the
applicable requirements. We thus propose that an unregistered entity
that meets the major participant criteria as a result of its swap or
security-based swap activities in a fiscal quarter would not be deemed
to be a major participant until the earlier of the date on which it
submits a complete application for registration pursuant to CEA Section
4s(b) or Exchange Act Section 15F(b), or two months after the end of
that quarter.\154\ We preliminarily believe that this would provide
entities with an appropriate amount of time to apply for registration
and, with the time between the submission of an application and the
effectiveness of the registration, to comply with the requirements
applicable to major participants, without permitting undue delay.
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\154\ See proposed CEA rule 1.3(qqq)(4)(i); proposed Exchange
Act rule 3a67-7(a). The Commissions are proposing separate rules
regarding the registration requirements and processes for major
participants.
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We also propose to provide a reevaluation for entities that meet
one or more of the applicable major participant thresholds, but only by
a modest amount.\155\ In particular, an unregistered entity that has
met these criteria as a result of its swap or security-based swap
activities in a fiscal quarter, but without exceeding any applicable
threshold by more than twenty percent, would not immediately be subject
to the timing requirements discussed above. Instead, that entity would
become subject to those requirements if the entity exceeded any of the
applicable daily average thresholds in the next fiscal quarter.\156\ We
preliminarily believe this type of reevaluation period would avoid
applying the major participant requirements to entities that meet the
major participant criteria for only a short time due to unusual
activity.
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\155\ Commenters raised concerns over an entity qualifying as a
major participant due to an unusual event. See, e.g., letter from
American Benefits Council and Committee on the Investment of
Employee Benefit Assets, dated September 20, 2010 (stating that
quirky volatility may affect the determinations).
\156\ See proposed CEA rule 1.3(qqq)(4)(ii); proposed Exchange
Act rules 3a67-7(b).
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In addition, we propose that any entity that is deemed to be a
major participant would retain that status until such time that it does
not exceed any of the applicable thresholds for four consecutive
quarters after the entity becomes registered.\157\ Commentators raised
concerns about the possibility of entities moving in and out of the
status on a rapid basis,\158\ and we believe that this proposal
appropriately addresses that concern in a way that would help promote
the predictable application and enforcement of the requirements
governing major participants.
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\157\ See proposed CEA rule 1.3(qqq)(5); proposed Exchange Act
rules 3a67-7(c)(1).
\158\ See Vanguard letter (suggesting that entities should
remain in the status after qualification for an extended defined
period such as one calendar year); AIMA letter (noting that
recategorization of entities could be disruptive for entities'
business models and could be administratively burdensome for the
Commissions).
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The Commissions request comment on these proposals. Commenters
particularly are requested to address: Whether two months is an
adequate amount of time for entities that have met the criteria to
submit an application for registration; whether there is an adequate
amount of time to make the necessary internal changes to come into
compliance with the requirements applicable to major participants
before being subject to those requirements as a result of a
registration becoming effective; whether twenty percent is the
appropriate threshold for applicability of the reevaluation period;
whether there would be any risks arising from delaying registration as
a major participant for an entity that exceeds the thresholds, but
qualifies for the reevaluation period; and whether four consecutive
quarters of not meeting the criteria for major participant status after
registration is granted is the appropriate amount of time that a major
participant should be required to stay in the status.
In addition, we request comment on the appropriateness of the
proposed reevaluation period. Commenters particularly are requested to
address whether it is likely that unusual market conditions could cause
an entity to exceed the proposed thresholds over the course of a
quarter (based on a daily average) without generally raising the types
of risks that the thresholds were intended to identify. Also, should
the use of the reevaluation period be conditioned on requiring any
entity relying on the reevaluation period to make a representation, or
otherwise demonstrate, that it exceeded the threshold due to a one-time
extraordinary event, and that it will be below the threshold at the
next time of measurement?
G. Limited Purpose Designations
In general, a person that meets the definition of major participant
will be considered to be a major participant with respect to all
categories of swaps or security-based swaps, as applicable, and with
regard to all activities involving those instruments.\159\ As discussed
above, however, the statutory definitions provide that a person may be
designated as a major participant for one or more categories of swaps
or security-based swaps without being classified as a major participant
for all categories.\160\ Thus, as with the definitions of ``swap
dealer'' and ``security-based swap dealer,'' we propose to provide that
major participants who engage in significant activity with respect to
only certain types, classes or categories of swaps or security-based
swaps may apply for relief with respect to other types of swaps or
security-based swaps from certain of the requirements that are
applicable to major participants. The Commissions anticipate that a
major participant could seek a limited designation at the same time as,
or at a later time subsequent to, the person's initial registration as
a major participant. Because of the variety of situations in which
major participants
[[Page 80201]]
may enter into swaps or security-based swaps, it is difficult to set
out at this time the conditions, if any, which would allow a person to
be designated as a major participant with respect to only certain
types, classes or categories of swaps or security-based swaps.
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\159\ See proposed CEA rule 1.3(qqq)(2); proposed Exchange Act
rule 3a67-1(c).
\160\ CEA section 1a(33)(C); Exchange Act section 3(a)(67)(C).
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The Commissions request comment on the proposed rules regarding
limited designation as a major participant. Commenters particularly are
requested to address the circumstances in which such limited purpose
designations would be appropriate, and to address the factors that the
Commissions should consider when addressing such requests, and the type
of information requestors should provide in support of their request.
Commenters also are asked to address whether such limited purpose
designations should be conditioned in any way, such as by the provision
of information of the type that would be required with respect to an
entity's swaps or security-based swaps involving the particular
category or activity for which they are not designated as a major
participant.
H. Additional Interpretive Issues
Commenters have raised additional issues related to the major
participant definitions.
1. Exclusion for ERISA Plan Positions
As discussed above, the first test of the major participant
definitions excludes from the analysis ``positions maintained by any
employee benefit plan (or any contract held by such a plan) as defined
in paragraphs (3) and (32) of section 3 of ERISA (29 U.S.C. 1002) for
the primary purpose of hedging or mitigating any risk directly
associated with the operation of the plan.'' Some commenters suggested
that the exclusion should encompass activities such as portfolio
rebalancing and diversification, and gaining exposure to alternative
asset classes, and that this type of exclusion also should apply to
certain other types of entities.\161\
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\161\ See Cleary letter (addressing welfare plans or entities
holding assets of such plans, such as voluntary employee beneficiary
associations, employer group trusts or bank-maintained collective
trusts); see also letter from Jane Hamblen, State of Wisconsin
Investment Board, dated September 20, 2010.
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We preliminarily do not believe that it is necessary to propose a
rule to further define the scope of this exclusion. In this regard, we
note that this ERISA plan exclusion, unlike the other exclusion in the
first major participant test, is not limited to ``commercial'' risk,
which may be construed to mean that hedging by ERISA plans should be
broadly excluded.
While the Commissions are not proposing to make this type of
exclusion available to additional types of entities, we request comment
on whether we should do so. If so, what type of entities should receive
this type of exclusion, and why do the concerns that led to the
enactment of the major participant requirements in the Dodd-Frank Act
not apply to such entities?
2. Application of Major Participant Definitions to Managed Accounts
Some commenters have stated that asset managers and investment
advisers should not be deemed to be major participants by virtue of the
swap and security-based swap positions held by the accounts they
manage. These commenters have emphasized that asset managers and
investment advisers are separate legal entities from the accounts that
they administer, the accounts themselves are the counterparties to the
swaps and security-based swaps, and managers and advisers do not
maintain capital to support the trades of their clients. One commenter
also expressed the view that the positions of individual accounts under
the advisement of a single asset manager should not be aggregated for
the purpose of the major participant definitions because different
accounts managed by an asset manager may use the same positions for
different purposes.\162\
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\162\ In addition, a colloquy on the Senate floor addressed the
status of managed accounts for purposes of the major participant
definitions, particularly focusing on whether the analysis should
``look at the aggregate positions of funds managed by asset managers
or at the individual fund level?'' In response, it was stated that,
``[a]s a general rule, the CFTC and the SEC should look at each
entity on an individual basis when determining its status as a major
swap participant.'' See 156 Cong. Rec. S5907 (daily ed. July 15,
2010) (colloquy between Senators Hagan and Lincoln).
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Preliminarily, we do not believe that the major participant
definitions should be construed to aggregate the accounts managed by
asset managers or investment advisers to determine if the asset manager
or investment adviser itself is a major participant. The major
participant definitions apply to the entities that actually
``maintain'' substantial positions in swaps and security-based swaps or
that have swaps or security-based swaps that create substantial
counterparty exposure. The Commissions have the authority to adopt
anti-evasion rules to address the possibility that persons who enter
into swaps and security-based swaps may attempt to allocate the swaps
and security-based swaps among different accounts (thereby attempting
to treat such other accounts as the entity that has entered into the
swaps or security-based swaps) for the purpose of evading the
regulations applicable to major participants.\163\ In addition, we note
that since the major participant definitions focus on the entity that
enters into swaps or security-based swaps, all of the managed positions
of which a person is the beneficial owner are to be aggregated (along
with such beneficial owner's other positions) for purposes of
determining whether such beneficial owner is a major participant.\164\
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\163\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3).
\164\ This guidance relates only to the application of the major
participant definitions to managed accounts. It is not intended to
apply to the treatment of managed accounts with respect to any other
rules promulgated by the CFTC or SEC to implement Title VII of the
Dodd-Frank Act or to any other applicable rules or requirements.
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The Commissions request comment on the application of the major
participant definitions to managed accounts. Commenters particularly
are requested to address: whether additional guidance is necessary to
address issues relating to the application of the major participant
definition to managed accounts; whether there are areas of potential
abuse, and if so, what they may be. Commenters further are requested to
address whether the Commissions should adopt anti-evasion rules to
address areas of potential abuse, and if so, how such rules should be
crafted.
In addition, commenters are requested to discuss any implementation
concerns that may arise if the beneficial owner of a managed account
meets one of the major participant definitions; for example, would the
beneficial owner face any impediments in terms of identifying whether
it falls within the major participant definitions? Also, what
implementation issues would arise with respect to applying the major
participant definitions to managed accounts and/or their beneficial
owners if the accounts' advisers or managers are not subject to
regulation as major participants?
3. Application of Major Participant Definitions to Positions of
Affiliated Entities
The issues discussed above with regard to managed accounts also are
related to the separate issue of whether the major participant tests
should, in some circumstances, aggregate the swap and security-based
swap positions of entities that are affiliated. Absent that type of
aggregation, an entity could seek to evade major participant status by
allocating swap or security-based swap
[[Page 80202]]
positions among a number of affiliated entities.
In situations in which a parent is the majority owner of a
subsidiary entity, we preliminarily believe that the major participant
tests may appropriately aggregate the subsidiary's swaps or security-
based swaps at the parent for purposes of the substantial position
analyses.\165\ Attributing those positions to a parent appears
consistent with the concepts of ``substantial position'' and
``substantial counterparty exposure,'' given that the parent would
effectively be the beneficiary of the transaction. In those
circumstances, however, there still may be questions as to whether the
requirements applicable to major participants--e.g., capital, margin
and business conduct--should be placed upon the parent or the
subsidiary. We recognize that it may be appropriate at times to apply
such requirements upon the subsidiary to the extent that the subsidiary
is acting on behalf of the parent.\166\
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\165\ Arguably, the basis for this type of attribution would be
even stronger if the parent wholly owns the subsidiary. An
attribution rule that only addresses 100 percent ownership
situations, however, may readily be susceptible to gaming if the
parent were to sell a very small interest in the subsidiary to
another party.
\166\ It may also be appropriate to address these issues in
connection with the rule proposals addressing the substantive
requirements applicable to major participants.
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Commenters particularly are invited to discuss when it would be
appropriate to apply the major participant definitions to entities that
are the majority owner of subsidiaries that enter into swaps or
security-based swaps, or whether attribution of a subsidiary's
security-based swap positions is generally inappropriate. Also, to the
extent this type of attribution is appropriate, to what extent should
the subsidiary retain responsibilities for complying with the capital,
margin, business conduct and other requirements applicable to major
participants?
Commenters further are requested to address whether the swaps or
security-based swaps of corporate subsidiaries in some circumstances
should be attributed to an entity that itself is not the majority owner
of the direct counterparty to a swap or security-based swap. Moreover,
should this type of attribution apply when one entity controls another
entity, and, if so, how should the concept of control be defined for
these purposes? In addition, commenters are requested to address
whether, as an alternative approach, this type of attribution would be
appropriate specifically when a parent provides guarantees on behalf of
its subsidiaries, or third parties provide guarantees on behalf of
unaffiliated entities.
Commenters further are requested to address any issues that would
arise with regard to the effective implementation of the requirements
applicable to major participants in the context of this type of
attributions.
4. Application of Major Participant Definitions to Inter-Affiliate
Swaps and Security-Based Swaps
Several commenters have suggested that swaps and security-based
swaps between affiliated counterparties should not be considered within
the analysis of whether an entity's swap or security-based swap
positions cause it to be a major participant. Such inter-affiliate
swaps and security-based swaps may be used to achieve various
operational and internal efficiency objectives.
The Commissions preliminarily believe that when a person analyzes
its swap or security-based swap positions under the major participant
definitions, it would be appropriate for the person to consider the
economic reality of any swaps or security-based swaps it enters into
with wholly owned affiliates, including whether the swaps and security-
based swaps simply represent an allocation of risk within a corporate
group.\167\ Such swaps and security-based swaps among wholly-owned
affiliates may not pose the exceptional risks to the U.S. financial
system that are the basis for the major participant definitions. As
discussed above in the context of managed accounts, however, an entity
would not be able to evade the requirements applicable to major
participants by allocating among multiple affiliates swap or security-
based swap positions of which it is the beneficial owner.
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\167\ Such swaps and security-based swaps should be considered
in this way only for purposes of determining whether a particular
person is a major participant. The swaps and security-based swaps
would continue to be subject to all laws and requirements applicable
to such swaps and security-based swaps.
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The Commissions request comment on the treatment of inter-affiliate
swaps and security-based swaps between wholly-owned affiliates of the
same corporate parent in connection with the major participant
definitions. Commenters also are requested to address whether similar
interpretations should apply to swaps and security-based swaps between
entities within a consolidated group as determined in accordance with
U.S. generally accepted accounting principles. Commenters further are
requested to discuss whether the major participant definition should be
interpreted to encompass an entity (including an affiliate of the named
counterparty to the swap or security-based swap) that provides a
guarantee of the named counterparty's obligations, either in the form
of a guarantee or through some other form of credit support whereby the
guarantor agrees to satisfy margin obligations of the named
counterparty and/or periodic payment obligations of the named
counterparty.
5. Legacy Portfolios
Some commenters have stated that certain entities that maintain
legacy portfolios of credit default swaps that previously had been
entered into in connection with the activities of monoline insurers and
``credit derivative product companies'' should not be considered major
participants. The commenters argued that these entities would be unable
to comply with the capital and margin requirements applicable to major
participants, and that regulation as major participants is unnecessary
given that the entities are not writing any additional swaps or
security-based swaps.
We request comment on whether the rules further defining major swap
participant and major security-based swap participant should exclude
such entities from the major participant definition if their swap and
security-based swap positions are limited to those types of legacy
positions. The exclusion from the definition could be conditional, and
any such excluded entity would be required to provide the Commissions
with position information of the type that registered major
participants would be required to provide. We invite comment on any
other conditions that might be appropriate to an exclusion of such
legacy portfolios from the major participant definitions.
6. Potential Exclusions
Some commenters stated that the major participant definitions
should not be interpreted to apply to entities such as investment
companies,\168\ ERISA plans, registered broker-dealers and/or
registered futures commission
[[Page 80203]]
merchants,\169\ and long-term investors such as sovereign wealth
funds.\170\
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\168\ See letter from Karrie McMillan, General Counsel,
Investment Company Institute, dated September 20, 2010 (registered
investment companies should be excluded from the major participant
(and dealer) definitions, or else the terms of the definitions
should be interpreted to clarify that mutual funds generally will
not be major participants).
\169\ See letter from The Swaps & Derivatives Marketing Ass'n,
dated September 20, 2010 (certain hedged positions of broker-dealers
and futures commission merchants with customers should not be
considered as part of the substantial position analysis); Cleary
letter (registered and well-capitalized broker-dealers and futures
commission merchants should not fall within the scope of the third
major participant test).
\170\ See letter from Lee Ming Chua, General Counsel, Government
of Singapore Investment Corp., dated September 20, 2010 (stating
that the major participant definitions were not intended to apply to
long-term financial investors); see also letter from Richard M.
Whiting, The Financial Services Roundtable, dated September 20, 2010
(major participant definitions should exclude firms that solely act
as investors).
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These comments, and the rationale behind the comments, raise the
issue of whether we should exclude, conditionally or unconditionally,
certain types of entities from the major participant definitions, on
the grounds that such entities do not present the risks that underpin
the major participant definitions and/or to avoid duplication of
existing regulation. While we are not proposing any such exclusions, we
request comment as to whether we should exclude certain types of
entities, including those noted above, as well as to entities subject
to bank capital rules, State-regulated insurers, private and State
pension plans, and registered derivatives clearing organizations or
clearing agencies.
Commenters particularly are requested to address whether such
exclusions are necessary and appropriate in light of the proposed rules
that would be applicable to major participants, whether any conditions
would be appropriate for such exclusions, and whether modifying those
proposed rules would more effectively address these issues than
granting specific exclusions from the major participant definitions for
specific types of entities. Commenters also are particularly requested
to discuss whether banks should be excluded from the major participant
definitions because of the regulation to which they already are
subject. Commenters also are requested to discuss whether registered
investment companies should be excluded from the major participant
definitions because of the regulations to which they already are
subject, and whether registered investment companies would be able to
comply with capital and margin requirements applicable to major
participants.
Commenters also particularly are requested to address whether
sovereign wealth funds or other entities linked to foreign governments
should be excluded from the major participant definitions, particularly
in light of the provisions of the Dodd-Frank Act governing its
territorial reach, and whether the answer in part should be determined
based on whether the entity's obligations are backed by the full faith
and credit of the foreign government.
V. Administrative Law Matters--CEA Revisions (Definitions of ``Swap
Dealer'' and ``Major Swap Participant,'' and Amendments to Definition
of ``Eligible Contract Participant'')
A. Regulatory Flexibility Act
The Regulatory Flexibility Act requires that agencies consider
whether the rules they propose will have a significant economic impact
on a substantial number of small entities and, if so, provide a
regulatory flexibility analysis respecting the impact.\171\ The rules
proposed by the CFTC provide definitions that will largely be used in
future rulemakings and which, by themselves, impose no significant new
regulatory requirements. Accordingly, the Chairman, on behalf of the
CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed
rules will not have a significant economic impact on a substantial
number of small entities.
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\171\ 5 U.S.C. 601 et seq.
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B. Paperwork Reduction Act
The proposed rule will not impose any new recordkeeping or
information collection requirements, or other collections of
information that require approval of the Office of Management and
Budget under the Paperwork Reduction Act.\172\ The CFTC invites public
comment on the accuracy of its estimate that no additional
recordkeeping or information collection requirements or changes to
existing collection requirements would result from the rules proposed
herein.
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\172\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Analysis
Section 15(a) of the CEA \173\ requires the CFTC to consider the
costs and benefits of its actions before issuing a rulemaking under the
CEA. By its terms, Section 15(a) does not require the CFTC to quantify
the costs and benefits of a rule or to determine whether the benefits
of the rulemaking outweigh its costs; rather, it requires that the CFTC
``consider'' the costs and benefits of its actions. Section 15(a)
further specifies that the costs and benefits shall be evaluated in
light of five broad areas of market and public concern: (1) Protection
of market participants and the public; (2) efficiency, competitiveness,
and financial integrity of futures markets; (3) price discovery; (4)
sound risk management practices; and (5) other public interest
considerations. The CFTC may in its discretion give greater weight to
any one of the five enumerated areas and could in its discretion
determine that, notwithstanding its costs, a particular rule is
necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the CEA.
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\173\ 7 U.S.C. 19(a).
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1. Summary of Proposed Requirements
The proposed regulations would further define the terms ``swap
dealer,'' ``eligible contract participant,'' ``major swap
participant,'' and related terms, including ``substantial position''
and ``substantial counterparty exposure.'' The proposed regulations
regarding eligible contract participants are clarifying changes that
are not expected to have substantive effects on market participants.
The proposed regulations further defining swap dealer and major swap
participant are significant because any entity determined to be a swap
dealer or major swap participant would be subject to registration,
margin, capital, and business conduct requirements set forth in the
Dodd-Frank Act, as those requirements are implemented in rules proposed
or to be proposed by the CFTC. Those requirements will likely lead to
compliance costs, capital holding costs, and margin posting costs,
which have been or will be addressed in the CFTC's proposals to
implement those requirements. On the other hand, those requirements
will likely lead to benefits in the form of increased market
transparency, reduced counterparty risk and a lower incidence of
systemic crises and other market failures. This discussion concerns the
costs and benefits arising from the proposed definitional tests
themselves, in terms of the burden on market participants to determine
how the proposed definitions apply, and the benefits arising from the
specificity of the proposals.
2. Proposed Regulations Regarding ``Eligible Contract Participant''
The proposal regarding ``eligible contract participant'' would
provide that swap dealers and major swap participants would qualify as
eligible contract participants. The CFTC believes this proposal is in
line with the expectations of market participants and would impose
virtually no costs while providing the benefit of greater certainty.
The proposal would also
[[Page 80204]]
provide that certain commodity pools could not qualify as eligible
contract participants under certain provisions specified in the
proposal. The CFTC believes that this proposal clarifies the
interpretation of this aspect of the eligible contract participant
definition and would prevent the commodity pools from using a provision
of the definition that was not intended to apply to the commodity
pools. Thus, while the proposal would potentially impose some costs on
the commodity pools that could no longer rely on certain provisions of
the definition, benefits would arise from preventing the
misinterpretation of the definition.
3. Proposed Regulations Regarding ``Swap Dealer''
The proposal regarding ``swap dealer'' would further define the
term by providing that any person that engages in specified activities
is a swap dealer. The proposal describes these activities qualitatively
and in relatively general terms that apply in the same way to all parts
of the swap markets. With regard to the de minimis exemption from the
definition, the proposal sets out bright-line quantitative tests to
determine if a person's swap dealing activity is de minimis. For the
exclusion of swaps in connection with originating a loan by an insured
depository institution, the proposal describes the scope of the
exclusion qualitatively in terms that depend primarily on the terms of
the swaps that would be eligible for the exclusion and the identity of
the parties to the swap. Also, the proposal includes a voluntary
process by which a swap dealer may request that the CFTC limit the swap
dealer designation to certain aspects of the person's activity.
a. Costs
The costs to a market participant from the proposed regulations
further defining ``swap dealer'' would arise primarily from its need to
review its activities and determine, as a qualitative matter, whether
its activities are of the type described in the proposal. As its
activities change from time to time, it would be necessary to repeat
this review, and ongoing compliance costs may arise if the market
participant determines that it should adapt its activities so as to not
be encompassed by the definition. Because the proposed regulations are
qualitative and on relatively general terms, there may be multiple
interpretations of the general criteria by market participants. A
market participant whose activities fall within the realm of those
described in the proposal may have to incur the costs of a more focused
review to determine whether or not it is encompassed by the definition.
The proposal regarding the de minimis exemption, on the other hand,
would impose lower costs because of the precise, quantitative nature of
the proposed exemption. A market participant would incur only the cost
of determining the applicable quantities, such as notional value,
number of swaps, number of counterparties, and so forth set out in the
proposal. The CFTC believes that relatively few market participants
would have to determine whether the de minimis exemption applies to
their activities, and there would be only a low number of instances
where application of the quantitative tests would be uncertain.
Similarly, the CFTC believes that insured depository institutions would
incur relatively low costs to apply the proposed exclusion of swaps in
connection with originating loans because the proposed criteria relate
to matters in which the institution is directly involved.
Last, the costs of the voluntary process for a request for a
limited designation as a swap dealer are difficult to predict because
they would depend on the complexity of the person making the request
and the particular factors that are relevant to the limited
designation. The CFTC believes that the person making the request would
have broad discretion in determining how to do so and thereby could
control the costs of the request to some extent.
b. Benefits
The benefits of the proposed regulations further defining ``swap
dealer'' include that they set out a single set of criteria to be
applied by all market participants. Thus, the proposed regulations
create a level playing field that permits all market participants to
determine, on an equal basis, which activities would potentially lead
to designation as a swap dealer. The proposed regulations are set out
in plain language terms that may be understood and applied by all
market participants without relying on the technical expertise that may
be required to implement more elaborate tests. The CFTC believes that
the proposal can be fairly applied by substantially all market
participants who could potentially be swap dealers.
Regarding the proposals regarding the de minimis exemption and the
exclusion of swaps in connection with the origination of loans,
benefits arise from the relatively specific, quantitative nature of the
proposals. Since these proposals are expected to be applied by
relatively few market participants in limited situations, more detailed
regulations are appropriate. The CFTC believes that these detailed
criteria will permit market participants to make a relatively quick and
low-cost determination of whether the exemption or exclusion apply. The
proposal for requests for a limited swap dealer designation provides
the benefit of flexibility to allow each market participant making this
request to determine how to do so.
4. Proposed Regulations Regarding ``Major Swap Participant''
The proposal regarding ``major swap participant'' would further
define the term by setting out quantitative thresholds against which a
market participant would compare its swap activities to determine
whether it is encompassed by the definition. The proposal would require
that potential major swap participants analyze their swaps in detail to
determine, for example, which of their swaps are subject to netting
agreements or mark-to-market collateralization and the amount of
collateral posted with respect to the swaps. The proposal includes a
general, qualitative definition of the swaps that may be excluded from
the comparison because they are used to ``hedge or mitigate commercial
risk.'' Like the swap dealer proposal, there is a voluntary process by
which a major swap participant may request that the CFTC limit the
major swap participant designation to certain aspects of the person's
activity.
a. Costs
The costs to a market participant from the proposed regulations
further defining ``major swap participant'' would arise primarily from
its need to analyze its swaps and determine whether it has a
``substantial position'' or ``substantial counterparty exposure'' as
defined in the proposal. The proposed rule defines potential future
exposure by a factor of the dollar notational value of the swap. The
Commission also considered market-based tests of potential future
exposure such as margin requirements or other valuations of the
outstanding position. The Commission decided in favor of a more easily
implementable test rather than market-based criteria for potential
future exposure, given that daily variation in market prices is
captured by the current exposure calculation. The CFTC believes that
because the proposed quantitative thresholds are high, only very few
market participants would have to conduct a detailed analysis to
determine whether they are encompassed by the proposed
[[Page 80205]]
definition. The cost of the detailed analysis would vary for each
market participant, depending on the particular characteristics of its
swaps. Similarly, the costs to a market participant of determining
whether it uses swaps to hedge or mitigate commercial risk would depend
on how the market participant uses swaps. It is possible that for some
market participants with complex positions in swaps, the costs of the
analysis could be relatively high.
As is the case for the similar proposal regarding swap dealers, the
costs of the voluntary process for a request for a limited designation
as a major swap participant are difficult to predict because they would
depend on the complexity of the particular case. The CFTC believes that
the person making the request would have broad discretion in
determining how to do so and thereby could control the costs of the
request to some extent.
b. Benefits
The benefits of the proposed regulations further defining ``major
swap participant'' include that they set out a quantitative, bright-
line test that can be applied at a relatively low cost. Also, the
definition of ``hedging or mitigating commercial risk'' is stated in
general terms that may be flexibly applied by potential major swap
participants. In preparing this proposal, the CFTC considered other
methods of defining ``major swap participant,'' including multi-factor
analyses, stress tests and adversary processes. The CFTC believes that
these other methods would impose significantly higher costs for both
the market participants that would have to apply them and for the CFTC
(and, indirectly, the taxpayer), without providing additional benefits.
The costs would result primarily from the need to retain qualified
experts who would devote significant time and other resources to a
detailed analysis of multiple aspects of the potential major swap
participant's swap positions. The benefits that could justify more
costly proposals include reductions in arbitrary differences in results
and greater consistency and predictability. However, other potential
methods of further defining ``major swap participant'' do not appear
likely to provide such benefits to an extent that would justify the
higher costs.
5. Request for Comment
The CFTC invites public comment on its cost-benefit considerations.
Commenters are also invited to submit any data or other information
that they may have quantifying or qualifying the costs and benefits of
the proposed rules with their comments.
D. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA'') \174\ the CFTC must advise the Office of
Management and Budget as to whether the proposed rules constitute a
``major'' rule. Under SBREFA, a rule is considered ``major'' where, if
adopted, it results or is likely to result in: (1) An annual effect on
the economy of $100 million or more (either in the form of an increase
or a decrease); (2) a major increase in costs or prices for consumers
or individual industries; or (3) significant adverse effect on
competition, investment or innovation. If a rule is ``major,'' its
effectiveness will generally be delayed for 60 days pending
Congressional review. We do not believe that any of the proposed rules,
in their current form, would constitute a major rule.
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\174\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
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We request comment on the potential impact of the proposed rules on
the economy on an annual basis, on the costs or prices for consumers or
individual industries, and on competition, investment or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
VI. Administrative Law Matters--Exchange Act Rules (Definitions of
``Security-Based Swap Dealer'' and ``Major Security-Based Swap
Participant'')
A. Paperwork Reduction Act Analysis
Certain provisions of the proposed rules may impose new
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\175\ The SEC has submitted
them to the Office of Management and Budget (``OMB'') for review in
accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. The title of the new
collection of information is ``Procedural Requirements Associated with
the Definition of `Hedging or Mitigating Commercial Risk.''' An agency
may not conduct or sponsor, and a person is not required to respond to,
a collection of information unless it displays a currently valid OMB
control number. OMB has not yet assigned a control number to the new
collection of information.
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\175\ 44 U.S.C. 3501 et seq.
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1. Summary of Collection of Information
Proposed Exchange Act rule 3a67-4 would define the term ``hedging
or mitigating commercial risk.'' \176\ Security-based swap positions
that meet this proposed definition would be excluded from the
``substantial position'' analysis under the first test of the proposed
definition of major security-based swap participant.
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\176\ As noted previously, the concept of ``hedging or
mitigating commercial risk'' also is found in the statutory
provisions granting an exception to end-users from the mandatory
clearing requirement in connection with swaps and security-based
swaps. See CEA section 2(h)(7)(A); Exchange Act section 3C(g)(1)(B)
(exception from mandatory clearing requirements when one or more
counterparties are not ``financial entities'' and are using swaps or
security-based swaps ``to hedge or mitigate commercial risk''). If
the proposed rule 3a67-4 definition of ``hedging or mitigating
commercial risk'' is used any future SEC rulemakings, including
rulemaking with respect to the end-user exception, any necessary
discussion of administrative law matters relating to the use of
proposed rule 3a67-4 will be provided at that time.
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For a security-based swap position to be held for the purpose of
hedging or mitigating commercial risk under proposed rule 3a67-4, the
person holding the position must satisfy several conditions, including
the following:
(i) The person must identify and document the risks that are being
reduced by the security-based swap position;
(ii) The person must establish and document a method of assessing
the effectiveness of the security-based swaps as a hedge; and
(iii) The person must regularly assess the effectiveness of the
security-based swap as a hedge.
2. Proposed Use of Information
The collections of information in proposed rule 3a67-4 are designed
to help prevent abuse of the exclusion and to help ensure that the
exclusion is only available to those entities that are engaged in
legitimate hedging or risk mitigating activities.
3. Respondents
The collections of information in proposed rule 3a67-4 would apply
to those entities seeking to exclude the security-based swap positions
held for hedging or mitigating commercial risk from the substantial
position calculation. As discussed below in Section VI.B.4., based on
the current market, we estimate that approximately 10 entities have
security-based swap positions of a magnitude that they could
potentially reach the major security-based swap participant thresholds.
Accordingly, we estimate that approximately 10 entities would seek to
avail themselves of the exclusion from
[[Page 80206]]
the substantial position calculation for security-based swap positions
held for hedging or mitigating commercial risk.
4. Total Annual Reporting and Recordkeeping Burden
We do not anticipate that the proposed collection of information in
proposed rule 3a67-4 would cause the estimated 10 entities to incur any
new costs. We believe that only highly sophisticated market
participants would potentially meet the proposed thresholds for the
major security-based swap participant designation and thus have a need
to take advantage of the exclusion for positions held for hedging or
mitigating commercial risk (and be required to meet the attendant
collection requirements). We understand from our staff's discussions
with industry participants that the entities that have security-based
swap positions and exposures of this magnitude currently create and
maintain the documentation proposed to be required in rule 3a67-4, as
part of their ordinary course business and risk management
practices.\177\ Thus, we do not believe that any new burdens or costs
will be imposed on the approximately 10 entities that may seek to use
the exclusion. We therefore estimate the total annual reporting and
recordkeeping burden associated with proposed rule 3a67-4 to be
minimal.
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\177\ Some entities follow these types of procedures so that
their hedging transactions will qualify for hedge accounting
treatment under generally accepted accounting principles, which
requires procedures similar to those in proposed rule 3a67-4.
Hedging relationships involving security-based swaps that qualify
for the hedging or mitigating commercial risk exception in the
proposed rule are not limited to those recognized as hedges for
accounting purposes. We believe that all of the estimated 10
entities that have security-based swap positions of a magnitude that
they could potentially be deemed to be major security-based swap
participants already identify and document their risk management
activities (including their security-based swap positions used to
hedge or mitigate commercial risks) and assess the effectiveness of
those activities as a matter of their ordinary business practice--
even if they are not seeking hedge accounting treatment.
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5. Collection of Information is Mandatory
The collections of information in proposed rule 3a67-4 would be
mandatory for those entities seeking to exclude positions they hold for
hedging or mitigating commercial risk from the substantial position
calculation.
6. Confidentiality
There is no proposed requirement that the collections of
information in proposed rule 3a67-4 be provided to the SEC or a third
party on a regular, ordinary course basis. In a situation where the SEC
has obtained the information, the SEC would consider requests for
confidential treatment on a case-by-case basis.
7. Record Retention Period
Proposed rule 3a67-4 does not contain a specific record retention
requirement. Nonetheless, we would expect the approximately 10 entities
that may seek to use the exclusion for positions held for hedging or
mitigating commercial risk to maintain the records they create in
connection with the exclusion. Because we understand from our staff's
discussions with industry participants that the entities that have
security-based swap positions and exposures of this magnitude currently
create and maintain the documentation proposed to be required in rule
3a67-4, as part of their ordinary course business and risk management
practices, we do not expect any new burdens or costs will be imposed to
maintain the records.
8. Request for Comments
The SEC invites comments on these estimates. Pursuant to 44 U.S.C.
3506(c)(2)(B), the SEC requests comments in order to: (a) Evaluate
whether the collection of information is necessary for the proper
performance of our functions, including whether the information will
have practical utility; (b) evaluate the accuracy of our estimate of
the burden of the collection of information; (c) determine whether
there are ways to enhance the quality, utility, and clarity of the
information to be collected; and (d) evaluate whether there are ways to
minimize the burden of the collection of information on those who
respond, including through the use of automated collection techniques
or other forms of information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090, with reference to File No. S7-39-10.
Requests for materials submitted to OMB by the SEC with regard to this
collection of information should be in writing, with reference to File
No. S7-39-10, and be submitted to the Securities and Exchange
Commission, Records Management, Office of Filings and Information
Services, 100 F Street, NE., Washington, DC 20549-1090. As OMB is
required to make a decision concerning the collections of information
between 30 and 60 days after publication, a comment to OMB is best
assured of having its full effect if OMB receives it within 30 days of
publication.
B. Consideration of Benefits and Costs
1. Introduction
The Dodd-Frank Act added definitions of ``security-based swap
dealer'' and ``major security-based swap participant'' to the Exchange
Act in conjunction with other provisions that require entities meeting
either of those definitions to register with the SEC and to be subject
to capital, margin, business conduct and certain other requirements.
Consistent with the direction of the Dodd-Frank Act, the SEC is
proposing rules to further define ``major security-based swap
participant'' along with additional terms used in that definition. The
SEC also is proposing rules to further define ``security-based swap
dealer'' and to set forth factors for determining the availability of
the de minimis exception from that definition. We believe that these
proposed rules are consistent with the purposes of the Dodd-Frank Act,
and, as appropriate, set forth objective standards to facilitate market
participants' compliance with the amendments that the Dodd-Frank Act
made to the Exchange Act. Market participants, however, may incur costs
associated with certain of these proposed rules.
The SEC believes that there would be two categories of potential
costs. First, there would be costs associated with the regulatory
requirements that would apply to a ``security-based swap dealer'' or a
``major security-based swap participant'' (e.g., the registration,
margin, capital, and business conduct requirements that would be
imposed on security-based swap dealers and major security-based swap
participants). While the specific costs and benefits associated with
these regulatory requirements are being addressed in the SEC's
proposals to implement those requirements, we recognize that the costs
and benefits of these proposed definitions are directly linked to the
costs and benefits of the requirements applicable to dealers and major
participants. We welcome comment on the costs and benefits of these
proposed definitions in that broader context.
Second, there may be costs that entities incur in determining
whether they qualify as a ``security-based swap dealer'' or a ``major
security-based swap participant'' under the proposed definitional
rules. These costs, along
[[Page 80207]]
with the benefits associated with the proposed rules, are discussed
below.
2. Proposed Exchange Act rule 3a67-1--Definition of ``Major Security-
Based Swap Participant''
Proposed Exchange Act rule 3a67-1 would largely restate the
statutory definition of ``major security-based swap participant,'' to
consolidate the definition and related interpretations for ease of
reference.
A person that meets the definition of major security-based swap
participant generally will be subject to the requirements applicable to
major security-based swap participants without regard to the purpose
for which it enters into a security-based swap, and without regard to
the particular category of security-based swap.\178\ However, the
statutory definitions provide that a person may be designated as a
major security-based swap participant for one or more categories of
security-based swaps or for particular activities without being
classified as a major security-based swap participant for all
categories or activities.\179\ Proposed rule 3a67-1 would provide that
a major security-based swap participant that engages in significant
activity with respect to only certain types, classes or categories of
security-based swaps or only in connection with specified activities,
could obtain relief with respect to other types of security-based swaps
from certain of the requirements that are applicable to major security-
based swap participants. The rule would have the benefit of
implementing the statutory provision and providing that major security-
based swap participants may obtain relief from the SEC. A person that
seeks to be considered to be a major security-based swap participant
only with respect to one category of security-based swaps, or only with
respect to certain activities, would be expected to incur costs in
connection with requesting an order from the SEC. However, any such
costs would be voluntarily incurred by any person seeking to take
advantage of that limited designation, and thus we preliminarily do
believe that those costs would be attributable to the statute and not
to this rule.
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\178\ The specific costs associated with these regulatory
requirements will be addressed in the SEC's proposals to implement
those requirements.
\179\ See Exchange Act section 3(a)(67)(C).
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3. Proposed Exchange Act Rule 3a67-2--``Major'' Categories of Security-
Based Swaps
Proposed Exchange Act rule 3a67-2 would fulfill Congress's mandate
that the SEC designate ``major'' categories of security-based swaps by
setting forth two such ``major'' categories--one consisting of credit
derivatives and the other consisting of equity-swaps and other
security-based swaps. We believe that these proposed categories would
have the benefit of being consistent with the different ways in which
those products are used, as well as market statistics and current
market infrastructures (particularly the separate trade warehouses for
credit default swaps and equity swaps). Although, as discussed below,
this categorization is relevant to the ``substantial position'' tests
of the ``major security-based swap participant'' definition, we believe
that the categorization itself would not impose any costs on market
participants. While the categorization may affect the costs that market
participants will incur from particular statutory and regulatory
requirements applicable to major security-based swap participants,\180\
those costs are being addressed in our proposals to implement those
requirements.
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\180\ For example, distinguishing between categories of
security-based swaps may cause some entities to incur additional
costs to calculate their major security-based swap participant
status with respect to each category. Similarly, categorization may
affect whether an entity ultimately qualifies as a major security-
based swap participant.
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4. Proposed Exchange Act Rule 3a76-3--Definition of ``Substantial
Position''
Proposed Exchange Act rule 3a67-3 would define the term
``substantial position,'' which is used in the first and third tests of
the definition of ``major security-based swap participant.'' The Dodd-
Frank Act requires the SEC to define this term. We have proposed two
tests for identifying the presence of a substantial position--one test
based on a daily average measure of uncollateralized mark-to-market
exposure, and one based on a daily average measure of combined
uncollateralized mark-to-market exposure and potential future exposure.
Both of these daily measures would be calculated and averaged over a
calendar quarter.
We believe that this proposed definition would have the benefit of
providing objective criteria that reasonably would measure the risks
associated with security-based swap positions, and reflect the
counterparty risk and risk to the market factors that are embedded
within the ``major security-based swap participant'' definition. We
also believe that the proposed use of objective numerical criteria for
the substantial position thresholds would promote the predictable
application and enforcement of the requirements governing major
security-based swap participants by permitting market participants to
readily evaluate whether their security-based swap positions meet the
thresholds.
The first ``substantial position'' test would encompass entities
that have a daily average uncollateralized mark-to-market exposure of
$1 billion in a major category of security-based swaps. The second
``substantial position'' test would encompass entities that have a
daily average combined uncollateralized mark-to-market exposure and
potential future exposure of $2 billion. Potential future exposure
would be measured, consistent with bank capital rules, largely by
multiplying notional positions by risk factors. Additional adjustments
would reflect netting agreements, the presence of central clearing and
the presence of daily mark-to-market margining practices.
As previously noted, there will be costs associated with the
registration, margin, capital, business conduct, and other requirements
that will be imposed on major security-based swap participants. Those
costs are being addressed in the SEC's rule proposals to implement
those requirements. We also believe that there will be costs incurred
by entities in determining whether they meet the definition of major
security-based swap participant. These costs are discussed below.
Based on the current over-the-counter derivatives market, we
estimate that no more than 10 entities that are not otherwise security-
based swap dealers would have either uncollateralized mark-to-market
positions \181\ or
[[Page 80208]]
combined uncollateralized current exposure and potential future
exposure of a magnitude \182\ that may rise close enough to the levels
of our proposed thresholds to necessitate monitoring to determine
whether they meet those thresholds. Additionally, we preliminarily
believe that all of these approximately 10 entities currently maintain
highly sophisticated financial operations in order to achieve the large
security-based swap positions necessitating their use of the tests.
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\181\ We believe that an estimate of an entity's mark-to-market
exposure associated with its security-based swap positions can be
derived from the level of an entity's notional positions. We
recognize that the ratio of exposure to notional amount will vary by
market participant and by position. We understand that mark-to-
market exposures associated with credit derivative positions on
average are equal to approximately three percent of an entity's
level of notional positions in credit derivatives. This estimate is
based on second quarter 2010 U.S. bank market statistics involving
credit derivatives, given that banks have credit derivative
positions with gross positive fair value (which would equate to
negative fair value for the banks' counterparties) of $403 billion,
compared to total notional credit derivative positions of $13.9
trillion. See Office of the Comptroller of the Currency, ``OCC's
Quarterly Report on Bank Trading and Derivatives Activities''
(Second Quarter 2010) at 4 & Table 12. This data suggests that, on
average, an entity would need to have notional credit derivative
positions of roughly $33 billion to meet our proposed threshold for
the first substantial position test, $1 billion in mark-to-market
exposure.
We understand, based on our staff's discussions with industry,
that approximately 39 entities have credit default swap notional
positions of roughly $33 billion or above. We understand that the
large majority of those entities are banks or hedge funds (which we
would expect to fully collateralize their positions with dealers as
a matter of course). We further understand that banks, securities
firms, and hedge funds typically collateralize most or all of their
mark-to-market exposure to U.S. banks as a matter of practice. See
OCC's Quarterly Report on Bank Trading and Derivatives Activities
(second quarter 2010) at 6. Therefore, it is not clear if any
entities would have uncollateralized credit default swap positions
near the proposed first substantial position threshold of $1 billion
uncollateralized outward exposure.
\182\ The proposed risk multiplier of 0.1 for credit derivatives
would require an entity to have a notional position of $20 billion
in credit derivatives to reach the proposed $2 billion potential
future exposure threshold (even before accounting for netting
adjustments). The proposed additional multiplier of 0.2 for
security-based swaps cleared by a registered clearing agency or
subject to daily mark-to-market margining would mean that an entity
with credit derivative positions that are cleared or subject to
daily mark-to-market margining would need a notional position in
credit derivatives of at least $100 billion to potentially reach the
proposed $2 billion potential future exposure threshold. In this
example, we are assuming an uncollateralized outward exposure of
zero.
We understand, based on our staff's discussions with industry,
that there are approximately 10 non-dealer entities that have a
notional position in credit derivatives of over $50 billion.
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We expect the costs associated with the proposed substantial
position tests to be modest for these entities. We understand that the
entities that have this magnitude of security-based swap positions
already monitor and collect all of the data necessary for the proposed
substantial position tests. Preliminarily, we understand that these
entities already use automated systems to gauge their positions and
exposures and assist in their risk management. Accordingly, we estimate
that each of the entities would incur a one-time programming cost,\183\
as well as ongoing costs associated with the continuing use and
monitoring of the testing.\184\ We estimate that the one-time
programming cost would be approximately $13,444 per entity, and
$134,440 for all entities.\185\ We estimate that the annual ongoing
costs would be approximately $7,260 per entity, and $72,600 for all
entities.\186\
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\183\ For each of the entities, we estimate that the initial
programming would require the following levels of work from a
Compliance Attorney, Compliance Manager, Programmer Analyst, Senior
Internal Auditor, and Chief Financial Officer. The estimated
contributions are as follows: approximately 2 hours of work from a
Compliance Attorney to advise the entity's compliance department on
the legal requirements associated with the proposed tests;
approximately 8 hours of work from a Compliance Manager to assist a
Programmer Analyst in making the necessary changes to the entity's
existing automated system and to oversee and manage the entire
programming process; approximately 40 hours of work from a
Programmer Analyst to make the necessary programming changes to the
existing automated system and to test the system; approximately 8
hours of work from a Senior Internal Auditor to perform quality
assurance to ensure that the automated system is properly performing
the proposed tests; and approximately 3 hours of work from the
entity's Chief Financial Officer to monitor the process. We estimate
that the hourly wage of a Compliance Attorney, Compliance Manager,
Programmer Analyst, Senior Internal Auditor, and Chief Financial
Officer would be approximately $291, $294, $190, $195, and $450,
respectively. The $291/hour figure for a Compliance Attorney, the
$294/hour figure for a Compliance Manager, the $190/hour figure for
a Programmer Analyst, and the $195/hour figure for a Senior Internal
Auditor are from SIFMA's Management & Professional Earnings in the
Securities Industry 2009, modified by SEC staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead. The $450/hour figure for
a Chief Financial Officer is from http://www.payscale.com, modified
by SEC staff to account for an 1800-hour work-year and multiplied by
5.35 to account for bonuses, firm size, employee benefits, and
overhead. See http://www.payscale.com (last visited Nov. 1, 2010).
\184\ We anticipate that each entity would incur ongoing
monitoring costs to evaluate their test results and to ensure that
the tests are properly run. We estimate that each entity would have
a Senior Internal Auditor spend approximately 4 hours each quarter
(or a total of 16 hours annually) to perform this quality assurance.
We also estimate that each entity would need a Compliance Attorney,
a Compliance Manager, and its Chief Financial Officer to each spend
approximately 1 hour each quarter (or a total of 4 hours annually)
to monitor the entity's test results and the entity's status under
the proposed rule.
\185\ The estimated one-time programming cost of approximately
$13,444 per entity and $134,440 for all entities was calculated as
follows: (Compliance Attorney at $291 per hour for 2 hours) +
(Compliance Manager at $294 per hour for 8 hours) + (Programmer
Analyst at $190 per hour for 40 hours) + (Senior Internal Auditor at
$195 per hour for 8 hours) + (Chief Financial Officer at $450 per
hour for 3 hours) x (10 entities) = $134,440.
\186\ The estimated ongoing monitoring cost of approximately
$7,260 per year per entity and $72,600 per year for all entities was
calculated as follows: (Senior Internal Auditor at $195 per hour for
16 hours) (Compliance Attorney at $291 per hour for 4 hours) +
(Compliance Manager at $294 per hour for 4 hours) + (Chief Financial
Officer at $450 per hour for 4 hours) x (10 entities) = $72,600.
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5. Proposed Exchange Act Rule 3a67-4--Definition of ``Hedging or
Mitigating Commercial Risk''
Proposed Exchange Act rule 3a67-4 would define the term ``hedging
or mitigating commercial risk.'' Security-based swap positions that
meet that definition are excluded from the ``substantial position''
analysis under the first test of the major participant definition. The
proposed rule is intended to be objective and promote the predictable
application and enforcement of the requirements governing major
security-based swap participants.
For a security-based swap position to be held for the purpose of
hedging or mitigating commercial risk under proposed Exchange Act rule
3a67-4, the person holding the position must satisfy certain
conditions:
(i) The person must identify and document the risks that are being
reduced by the security-based swap position;
(ii) The person must establish and document a method of assessing
the effectiveness of the security-based swap as a hedge; and
(iii) The person must regularly assess the effectiveness of the
security-based swap as a hedge.
Proposed rule 3a67-4 would affect whether an entity will meet the
definition of major security-based swap participant. The specific costs
associated with these regulatory requirements are being addressed in
the SEC's proposals to implement those requirements.
While we expect that there could be some potential costs associated
with the procedural requirements of proposed rule 3a67-4, as described
in Section VI.B.4., supra, we expect only highly sophisticated entities
to hold security-based swap positions of a magnitude that would require
use of the proposed tests. Thus, we do not anticipate that these
proposed procedural requirements would cause market participants to
incur costs that they do not incur already as a matter of their
ordinary business and risk management practices. Accordingly, we do not
expect that the proposed definition of ``hedging or mitigating
commercial risk'' would impose any costs on the potentially affected
entities beyond those already regularly incurred by these entities as a
matter of course.
6. Proposed Exchange Act Rule 3a67-5--Definition of ``Substantial
Counterparty Exposure That Could Have Serious Adverse Effects on The
Financial Stability of The United States Banking System or Financial
Markets''
Proposed Exchange Act rule 3a67-5 would define ``substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the United States banking system or financial
markets,'' a term that comprises part of the second test of the ``major
security-based swap participant'' definition. This proposed rule would
[[Page 80209]]
parallel the ``substantial position'' analysis discussed above, but
would examine an entity's security-based swap positions as a whole
(rather than focusing on a particular ``major'' category), and would
not exclude certain hedging positions. Consistent with this broader
scope, and the proposal that there be two ``major'' categories of
security-based swaps, the thresholds used in this test would be two
times the comparable ``substantial position'' thresholds. We believe
that this approach reasonably would measure the counterparty exposure
associated with the entirety of an entity's security-based swap
positions, consistent with the risk factors in the ``major security-
based swap participant'' definition. Additionally, we believe that the
proposed definition would provide objective criteria and promote the
predictable application and enforcement of the requirements governing
major security-based swap participants by permitting market
participants to readily evaluate whether their security-based swap
positions meet the proposed thresholds.
We believe that the same approximately 10 entities would calculate
their substantial counterparty exposure under this rule as would
undertake the substantial position calculation under proposed rule
3a67-3. Given that the threshold for this proposed rule is derived from
the calculations of substantial position that would be mandated by
proposed rule 3a67-3, we do not anticipate that it would create any
costs outside of those already covered in the discussion of the
estimated costs associated with the proposed definition of substantial
position.
7. Proposed Exchange Act Rule 3a67-6--Definitions of ``Financial
Entity'' and ``Highly Leveraged''
Proposed Exchange Act rule 3a67-6 would define the terms
``financial entity'' and ``highly leveraged,'' both of which are used
in the third test of the ``major security-based swap participant''
definition. The proposed definition of ``financial entity'' would be
consistent with the use of that term in the Title VII exception from
mandatory clearing for end-users of security-based swaps (subject to
limited technical changes). One of the two alternative proposed
definitions of ``highly leveraged'' would be consistent with a standard
used in Title I of the Dodd-Frank Act, while the other alternative is
based on an understanding of typical leverage ratios for certain
financial entities. We believe that these proposed alternative
standards would apply reasonable objective criteria to implement and
further define the third test. Additionally, we believe that the
proposed use of these objective definitions and numerical criteria
would promote the predictable application and enforcement of the
requirements governing major security-based swap participants by
permitting market participants to readily evaluate whether they meet
the threshold for major security-based swap participant status.
We do not believe that the proposed definition of ``financial
entity'' would impose any significant costs on market entities, given
the objective nature of the definition. We also do not believe that the
proposed definition of ``highly leveraged''--a balance sheet test that
would be based on the ratio of an entity's liabilities and equity, and
that, in the case of entities subject to public reporting requirements,
could be derived from financial statements filed with the SEC--would
impose any significant costs on entities that have security-based swap
positions large enough to potentially meet the ``substantial position''
requirement that is part of the third test.
8. Proposed Exchange Act Rule 3a67-7--Timing Requirements, Reevaluation
Period and Termination of Status
Proposed Exchange Act rule 3a67-7 would set forth methods for
specifying when an entity that satisfies the tests specified within the
definition of ``major security-based swap participant'' would be deemed
to meet that definition. The proposed rule also would address the
termination of an entity's status as a major security-based swap
participant. We believe that the proposed rule would set forth
pragmatic standards for permitting entities that have security-based
swap positions that require registration to go through the registration
process, and to terminate their status when appropriate. We believe
that this proposed rule would impose no direct costs on market
entities.\187\
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\187\ As noted above, we recognize that major security-based
swap participants will incur costs associated with the registration
and termination of registration processes. These costs will be
addressed in the SEC rule's proposals to implement those
requirements.
---------------------------------------------------------------------------
9. Proposed Exchange Act Rule 3a71-1--Definition of ``Security-Based
Swap Dealer''
Proposed Exchange Act rule 3a71-1 largely would restate the
statutory definition of ``security-based swap dealer,'' to consolidate
the definition and related interpretations for market participants'
ease of reference. We are not proposing to further define the four
specific tests set forth in the ``security-based swap dealer''
definition. However, our release contains interpretive language that
would have the benefit of providing additional legal certainty to
market participants. While market participants would incur certain
costs to analyze whether their security-based swap activities cause
them to be on the ``dealer'' side of the dealer-trader distinction
(which would require them to register with the SEC and comply with the
other requirements applicable to security-based swap dealers unless
they can take advantage of the de minimis exception), these costs would
be incurred because of the statutory change, rather than due to
proposed rule 3a71-1. The Dodd-Frank Act determined that persons that
engage in dealing activities involving security-based swaps should be
subject to comprehensive regulation, and any such analytic costs arise
from Congress's determination to amend the Exchange Act.\188\
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\188\ Based on our staff's discussions with industry, we
estimate that approximately 50 entities may be required to register
as security-based swap dealers following implementation of these
proposed rules. The specific costs associated with these regulatory
requirements will be addressed in the SEC's proposals to implement
those requirements.
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10. Proposed Exchange Act Rule 3a71-2--de Minimis Exception
Proposed Exchange Act rule 3a71-2 would set forth factors for
determining whether a person that otherwise would be a security-based
swap dealer can take advantage of the de minimis exception. The Dodd-
Frank Act directed the SEC to promulgate these factors.\189\ The
proposed factors would account for an entity's annual notional
security-based swap positions in a dealing capacity, its total notional
security-based swap positions in a dealing capacity when the
counterparty is a ``special entity,'' \190\ and its total number of
counterparties and security-based swaps as a dealer. We believe that
these factors appropriately would focus on dealing activities that do
not warrant an entity's regulation as a security-based swap dealer. We
also believe that these objective numerical criteria for the de minimis
exception would promote the predictable application and enforcement of
the de minimis exception from security-based swap dealer status.
---------------------------------------------------------------------------
\189\ See Section 761(a)(6) of the Dodd-Frank Act.
\190\ See Section 15F(h)(2)(C) of the Exchange Act.
---------------------------------------------------------------------------
In general, we would expect a person that enters into security-
based swaps in a dealing capacity would, as a matter of course, be
aware of the notional amount
[[Page 80210]]
of those positions, whether a particular counterparty is a ``special
entity,'' and the total number of counterparties and security-based
swaps it has in a dealer capacity. As a result, we believe that there
would be no new costs incurred by entities in assessing the
availability of the de minimis exception. Moreover, any costs
associated with ensuring that a person can take advantage of the de
minimis exception would be voluntarily incurred by entities that engage
in dealing activities that seek to take advantage of the exception.
11. Request for Comments
The SEC requests comment on these estimated benefits and costs.
Commenters particularly are requested to address: the accuracy of our
estimate that there would be approximately 10 entities in the market
(that would not otherwise be security-based swap dealers) that would
have security-based swap positions of a magnitude that may rise close
enough to the levels of our proposed thresholds to necessitate
monitoring to determine whether they meet those thresholds; the
accuracy of our estimate that there would be approximately 50 entities
in the market that may be required to register as security-based swap
dealers following implementation of the proposed rules; the accuracy of
our estimates of the costs associated with entities performing the
proposed substantial position tests; whether the entities that have
security-based swap positions that are significant enough to
potentially meet one or more of the tests in the ``major security-based
swap participant'' definition would, as a matter of course, already
have the data necessary to perform the two proposed substantial
position tests, and if not, what additional data would they need and
how much time and expense would gathering that data require; whether
these same entities would, as a matter of course, already comply with
the proposed procedural requirements associated with the exclusion for
positions that are for the purpose of ``hedging or mitigating
commercial risk;'' and whether entities would change their behavior to
avoid meeting the proposed definitions of ``security-based swap
dealer'' or ``major security-based swap participant,'' and if so, what,
if any, economic costs would be associated with such behavioral
changes.
In addition, and more generally, we request comment on the costs
and benefits of these proposed definitions in the broader context of
the substantive rules, including capital, margin and business conduct
rules, applicable to dealers and major participants. Commenters
particularly are requested to address whether the proposed scope of the
dealer and major participant definitions are appropriate in light of
the costs and benefits associated with those substantive rules.
C. Consideration of Burden on Competition, and Promotion of Efficiency,
Competition, and Capital Formation
Section 3(f) of the Exchange Act requires the SEC, whenever it
engages in rulemaking and is required to consider or determine whether
an action is necessary or appropriate in the public interest, to
consider whether the action would promote efficiency, competition, and
capital formation.\191\ In addition, Section 23(a)(2) of the Exchange
Act \192\ requires the SEC, when adopting rules under the Exchange Act,
to consider the impact such rules would have on competition. Section
23(a)(2) of the Exchange Act also prohibits the SEC from adopting any
rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------
\191\ 15 U.S.C. 78c(f).
\192\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
We preliminarily do not believe that the proposed rules would
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Exchange Act. We are
proposing rules to further define ``major security-based swap
participant,'' along with several terms used in that definition. We are
also proposing rules to further define ``security-based swap dealer''
and to set forth factors for determining the availability of the de
minimis exception from that definition. We believe that the proposed
rules are consistent with the purposes of Title VII of the Dodd-Frank
Act, and, as appropriate, set forth objective standards to facilitate
market participants' compliance with the amendments that Title VII of
the Dodd-Frank Act made to the Exchange Act. These amendments mandate
that the SEC regulate major security-based swap participants and
security-based swap dealers, which include some, but not all, entities
that enter into security-based swaps. Although regulation of certain
security-based swap market participants may result in competitive
burdens to these entities when compared to unregulated security-based
swap market participants, these burdens stem directly from Congress's
decision to impose regulation on a specified set of security-based swap
market participants through the Dodd-Frank Act.
While our decisions on how to further define the terms may have
some effect on competition (e.g., our determinations regarding the
proposed definition of substantial position will affect whether
entities qualify as major security-based swap participants), we
preliminarily do not believe that our decisions would impose additional
competitive burdens on entities outside of those that Congress
previously imposed through its decision in Title VII of the Dodd-Frank
Act to regulate and differentiate security-based swap market
participants. Moreover, we believe that defining substantial position
will help provide market participants with legal certainty regarding
their need to register as major security-based swap participants and is
necessary and appropriate to implement the purposes of regulating
security-based swap dealers and major security-based swap participants.
We also preliminarily believe that the proposed rules would promote
efficiency. We believe that the proposed rules would set forth clear
objective standards to facilitate market participants' compliance with
the amendments that the Dodd-Frank Act made to the Exchange Act.
Moreover, we believe that the proposed rules would promote the
predictable application and enforcement of the Exchange Act. We also
have considered what effect, if any, our proposed rules would have on
capital formation. We preliminarily do not believe that our proposed
rules would have a negative effect on capital formation.
The SEC requests comment on the effect of the proposed rules on
efficiency, competition, and capital formation. Commenters are
particularly requested to address whether entities would change their
behavior to avoid meeting the proposed definitions of ``security-based
swap dealer'' or ``major security-based swap participant,'' and if so,
how. Commenters are also requested to address the effect, if any, that
the proposed definitions of ``substantial position,'' ``hedging or
mitigating commercial risk,'' ``substantial counterparty exposure,''
``financial entity,'' or ``highly leveraged,'' or the proposed
categories of security-based swaps would have on business decisions,
trading behavior, transaction costs, or capital allocation. We also
request comment on the effect, if any that the proposed de minimis
exception to the definition of security-based swap dealer would have on
business decisions, trading behavior, transaction costs, or capital
allocation, and if so, how. Commenters are particularly
[[Page 80211]]
encouraged to provide quantitative information to support their views.
D. Consideration of Impact on the Economy
For purposes of SBREFA, the SEC must advise the Office of
Management and Budget as to whether the proposed rules constitute a
``major'' rule. Under SBREFA, a rule is considered ``major'' where, if
adopted, it results or is likely to result in: (1) An annual effect on
the economy of $100 million or more (either in the form of an increase
or a decrease); (2) a major increase in costs or prices for consumers
or individual industries; or (3) significant adverse effect on
competition, investment or innovation. If a rule is ``major,'' its
effectiveness will generally be delayed for 60 days pending
Congressional review. We do not believe that any of the proposed rules,
in their current form, would constitute a major rule.
We request comment on the potential impact of the proposed rules on
the economy on an annual basis, on the costs or prices for consumers or
individual industries, and on competition, investment or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
E. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') \193\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) \194\ of the Administrative Procedure
Act,\195\ as amended by the RFA, generally requires the SEC to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
``small entities.'' \196\ Section 605(b) of the RFA provides that this
requirement shall not apply to any proposed rule or proposed rule
amendment, which if adopted, would not have a significant economic
impact on a substantial number of small entities.\197\
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\193\ 5 U.S.C. 601 et seq.
\194\ 5 U.S.C. 603(a).
\195\ 5 U.S.C. 551 et seq.
\196\ Although Section 601(b) of the RFA defines the term
``small entity,'' the statute permits the Commissions to formulate
their own definitions. The SEC has adopted definitions for the term
small entity for the purposes of SEC rulemaking in accordance with
the RFA. Those definitions, as relevant to this proposed rulemaking,
are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange
Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982)
(File No. AS-305).
\197\ See 5 U.S.C. 605(b).
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For purposes of SEC rulemaking in connection with the RFA, a small
entity includes: (i) When used with reference to an ``issuer'' or a
``person,'' other than an investment company, an ``issuer'' or
``person'' that, on the last day of its most recent fiscal year, had
total assets of $5 million or less,\198\ or (ii) a broker-dealer with
total capital (net worth plus subordinated liabilities) of less than
$500,000 on the date in the prior fiscal year as of which its audited
financial statements were prepared pursuant to Rule 17a-5(d) under the
Exchange Act,\199\ or, if not required to file such statements, a
broker-dealer with total capital (net worth plus subordinated
liabilities) of less than $500,000 on the last day of the preceding
fiscal year (or in the time that it has been in business, if shorter);
and is not affiliated with any person (other than a natural person)
that is not a small business or small organization.\200\ Under the
standards adopted by the Small Business Administration, small entities
in the finance and insurance industry include the following: (i) For
entities engaged in credit intermediation and related activities,
entities with $175 million or less in assets; \201\ (ii) for entities
engaged in non-depository credit intermediation and certain other
activities, entities with $7 million or less in annual receipts; \202\
(iii) for entities engaged in financial investments and related
activities, entities with $7 million or less in annual receipts; \203\
(iv) for insurance carriers and entities engaged in related activities,
entities with $7 million or less in annual receipts; \204\ and (v) for
funds, trusts, and other financial vehicles, entities with $7 million
or less in annual receipts.\205\
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\198\ See 17 CFR 240.0-10(a).
\199\ See 17 CFR 240.17a-5(d).
\200\ See 17 CFR 240.0-10(c).
\201\ See 13 CFR 121.201 (Subsector 522).
\202\ See id. at Subsector 522.
\203\ See id. at Subsector 523.
\204\ See id. at Subsector 524.
\205\ See id. at Subsector 525.
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Based on feedback from industry participants about the security-
based swap markets, the SEC preliminarily believes that entities that
would qualify as security-based swap dealers and major security-based
swap market participants, whether registered broker-dealers or not,
exceed the thresholds defining ``small entities'' set out above. Thus,
the SEC believes it is unlikely that the proposed rules would have a
significant economic impact any small entity.
For the foregoing reasons, the SEC certifies that the proposed
rules would not have a significant economic impact on a substantial
number of small entities for purposes of the RFA.
The SEC encourages written comments regarding this certification.
The SEC requests that commenters describe the nature of any impact on
small entities and provide empirical data to illustrate the extent of
the impact.
VII. Statutory Basis and Rule Text
List of Subjects
17 CFR Part 1
Definitions.
17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Commodity Futures Trading Commission
Text of Proposed Rules
For the reasons stated in this release, the CFTC is proposing to
amend 17 CFR part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,
13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.
111-203, 124 Stat. 1376 (2010).
2. Amend Sec. 1.3 by:
a. Adding paragraph (m); and
b. As proposed to be amended at 75 FR 63762, October 18, 2010, and
75 FR 77576, December 13, 2010, adding (ppp) through (vvv) to read as
follows:
Sec. 1.3 Definitions
* * * * *
(m) Eligible contract participant. This term has the meaning set
forth in Section 1a(18) of the Commodity Exchange Act, except that:
(1) A major swap participant, as defined in Section 1a(33) of the
Commodity Exchange Act and Sec. 1.3(qqq), is an eligible contract
participant;
(2) A swap dealer, as defined in Section 1a(49) of the Commodity
Exchange Act and Sec. 1.3(ppp), is an eligible contract participant;
(3) A major security-based swap participant, as defined in Section
3(a)(67) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(67))
and Sec. 240.3a67-1 of this title, is an eligible contract
participant;
(4) A security-based swap dealer, as defined in Section 3(a)(71) of
the
[[Page 80212]]
Securities and Exchange Act of 1934 (15 U.S.C. 78c(a)(71)) and Sec.
240.3a71-1 of this title, is an eligible contract participant;
(5) A commodity pool with one or more direct or indirect
participants that is not an eligible contract participant is not an
eligible contract participant for purposes of Sections 2(c)(2)(B)(vi)
and 2(c)(2)(C)(vii) of the Commodity Exchange Act; and
(6) A commodity pool that does not have total assets exceeding
$5,000,000 or that is not operated by a person described in clause
(A)(iv)(II) of Section 1a(18) of the Commodity Exchange Act is not an
eligible contract participant pursuant to clause (A)(v) of such
Section.
* * * * *
(ppp) Swap Dealer. (1) In general. The term ``swap dealer'' means
any person who:
(i) Holds itself out as a dealer in swaps;
(ii) Makes a market in swaps;
(iii) Regularly enters into swaps with counterparties as an
ordinary course of business for its own account; or
(iv) Engages in any activity causing it to be commonly known in the
trade as a dealer or market maker in swaps.
(2) Exception. The term ``swap dealer'' does not include a person
that enters into swaps for such person's own account, either
individually or in a fiduciary capacity, but not as a part of regular
business.
(3) Scope. A person who is a swap dealer shall be deemed to be a
swap dealer with respect to each swap it enters into, regardless of the
category of the swap or the person's activities in connection with the
swap. However, if a person makes an application to limit its
designation as a swap dealer to specified categories of swaps or
specified activities of the person in connection with swaps, the
Commission shall determine whether the person's designation as a swap
dealer shall be so limited. A person may make such application to limit
its designation at the same time as, or at a later time subsequent to,
the person's initial registration as a swap dealer.
(4) De minimis exception. A person shall not be deemed to be a swap
dealer as a result of swap dealing activity involving counterparties
that meets each of the following conditions:
(i) The swap positions connected with those activities into which
the person enters over the course of the immediately preceding 12
months have an aggregate gross notional amount of no more than $100
million, and have an aggregate gross notional amount of no more than
$25 million with regard to swaps in which the counterparty is a
``special entity'' (as that term is defined in Section 4s(h)(2)(C) of
the Commodity Exchange Act). For purposes of this paragraph, if the
stated notional amount of a swap is leveraged or enhanced by the
structure of the swap, the calculation shall be based on the effective
notional amount of the swap rather than on the stated notional amount.
(ii) The person has not entered into swaps in connection with those
activities with more than 15 counterparties, other than swap dealers,
over the course of the immediately preceding 12 months. In determining
the number of counterparties, all counterparties that are members of a
single group of persons under common control shall be considered to be
a single counterparty.
(iii) The person has not entered into more than 20 swaps in
connection with those activities over the course of the immediately
preceding 12 months. For purposes of this paragraph, each transaction
entered into under a master agreement for swaps shall constitute a
distinct swap, but entering into an amendment of an existing swap in
which the counterparty to such swap remains the same and the item
underlying such swap remains substantially the same shall not
constitute entering into a swap.
(5) Insured depository institution swaps in connection with
originating loans to customers. Swaps entered into by an insured
depository institution with a customer in connection with originating a
loan with that customer shall not be considered in determining whether
such person is a swap dealer.
(i) A swap shall be considered to have been entered into in
connection with originating a loan only if the rate, asset, liability
or other notional item underlying such swap is, or is directly related
to, a financial term of such loan. The financial terms of a loan
include, without limitation, the loan's duration, rate of interest, the
currency or currencies in which it is made and its principal amount.
(ii) An insured depository institution shall be considered to have
originated a loan with a customer if the insured depository
institution:
(A) Directly transfers the loan amount to the customer;
(B) Is a part of a syndicate of lenders that is the source of the
loan amount that is transferred to the customer;
(C) Purchases or receives a participation in the loan; or
(D) Otherwise is the source of funds that are transferred to the
customer pursuant to the loan or any refinancing of the loan.
(iii) The term loan shall not include:
(A) Any transaction that is a sham, whether or not intended to
qualify for the exclusion from the definition of the term swap dealer
in this rule; or
(B) Any synthetic loan, including without limitation a loan credit
default swap or loan total return swap.
(qqq) Major Swap Participant. (1) In general. The term major swap
participant means any person:
(i) That is not a swap dealer; and
(ii)(A) That maintains a substantial position in swaps for any of
the major swap categories, excluding both positions held for hedging or
mitigating commercial risk, and positions maintained by any employee
benefit plan (or any contract held by such a plan) as defined in
paragraphs (3) and (32) of Section 3 of the Employee Retirement Income
Security Act of 1974 (29 U.S.C. 1002) for the primary purpose of
hedging or mitigating any risk directly associated with the operation
of the plan;
(B) Whose outstanding swaps create substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets; or
(C) That is a financial entity that:
(1) Is highly leveraged relative to the amount of capital such
entity holds and that is not subject to capital requirements
established by an appropriate Federal banking agency (as defined in
Section 1a(2) of the Commodity Exchange Act); and
(2) Maintains a substantial position in outstanding swaps in any
major swap category.
(2) Scope of designation. A person that is a major swap participant
shall be deemed to be a major swap participant with respect to each
swap it enters into, regardless of the category of the swap or the
person's activities in connection with the swap. However, if a person
makes an application to limit its designation as a major swap
participant to specified categories of swaps or specified activities of
the person in connection with swaps, the Commission shall determine
whether the person's designation as a major swap participant shall be
so limited. A person may make such application to limit its designation
at the same time as, or at a later time subsequent to, the person's
initial registration as a major swap participant.
(3) Timing requirements. A person that is not registered as a major
swap participant, but that meets the criteria in this rule to be a
major swap participant as a result of its swap activities in a
[[Page 80213]]
fiscal quarter, will not be deemed to be a major swap participant until
the earlier of the date on which it submits a complete application for
registration as a major swap participant or two months after the end of
that quarter.
(4) Reevaluation period. Notwithstanding paragraph (qqq)(3) of this
section, if a person that is not registered as a major swap participant
meets the criteria in this rule to be a major swap participant in a
fiscal quarter, but does not exceed any applicable threshold by more
than twenty percent in that quarter:
(i) That person will not immediately be subject to the timing
requirements specified in paragraph (qqq)(3) of this section; but
(ii) That person will become subject to the timing requirements
specified in paragraph (3) at the end of the next fiscal quarter if the
person exceeds any of the applicable daily average thresholds in that
next fiscal quarter.
(5) Termination of status. A person that is deemed to be a major
swap participant shall continue to be deemed a major swap participant
until such time that its swap activities do not exceed any of the daily
average thresholds set forth within this rule for four consecutive
fiscal quarters after the date on which the person becomes registered
as a major swap participant.
(rrr) Category of swaps; major swap category. For purposes of
Sections 1a(33) and 1a(49) of the Commodity Exchange Act and Sec. Sec.
1.3(ppp) and 1.3(qqq), the terms major swap category, category of swaps
and any similar terms mean any of the categories of swaps listed below.
For the avoidance of doubt, the term swap as it is used in this Sec.
1.3(rrr) has the meaning set forth in Section 1a(47) of the Commodity
Exchange Act and the rules thereunder.
(1) Rate swaps. Any swap which is primarily based on one or more
reference rates, including but not limited to any swap of payments
determined by fixed and floating interest rates, currency exchange
rates, inflation rates or other monetary rates, any foreign exchange
swap, as defined in Section 1a(25) of the Commodity Exchange Act, and
any foreign exchange option.
(2) Credit swaps. Any swap that is primarily based on instruments
of indebtedness, including but not limited to any swap primarily based
on one or more broad-based indices related to debt instruments, and any
swap that is an index credit default swap or total return swap on one
or more indices of debt instruments.
(3) Equity swaps. Any swap that is primarily based on equity
securities, including but not limited to any swap based on one or more
broad-based indices of equity securities and any total return swap on
one or more equity indices.
(4) Other commodity swaps. Any swap that is not included in the
rate swap, credit swap or equity swap categories.
(sss) Substantial position. (1) In general. For purposes of Section
1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the term
substantial position means swap positions, other than positions that
are excluded from consideration, that equal or exceed any of the
following thresholds in the specified major category of swaps:
(i) For rate swaps:
(A) $3 billion in daily average aggregate uncollateralized outward
exposure; or
(B) $6 billion in:
(1) Daily average aggregate uncollateralized outward exposure plus
(2) Daily average aggregate potential outward exposure.
(ii) For credit swaps:
(A) $1 billion in daily average aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate uncollateralized outward exposure plus
(2) Daily average aggregate potential outward exposure.
(iii) For equity swaps:
(A) $1 billion in daily average aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate uncollateralized outward exposure plus
(2) Daily average aggregate potential outward exposure.
(iv) For other commodity swaps:
(A) $1 billion in daily average aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate uncollateralized outward exposure plus
(2) Daily average aggregate potential outward exposure.
(2) Aggregate uncollateralized outward exposure. (i) In general.
Aggregate uncollateralized outward exposure in general means the sum of
the current exposure, obtained by marking-to-market using industry
standard practices, of each of the person's swap positions with
negative value in a major swap category, less the value of the
collateral the person has posted in connection with those positions.
(ii) Calculation of aggregate uncollateralized outward exposure. In
calculating this amount the person shall, with respect to each of its
swap counterparties in a given major swap category:
(A) Determine the dollar value of the aggregate current exposure
arising from each of its swap positions with negative value (subject to
the netting provisions described below) in that major category by
marking-to-market using industry standard practices; and
(B) Deduct from that dollar amount the aggregate value of the
collateral the person has posted with respect to the swap positions.
The aggregate uncollateralized outward exposure shall be the sum of
those uncollateralized amounts across all of the person's swap
counterparties in the applicable major category.
(iii) Relevance of netting agreements. (A) If the person has a
master netting agreement in effect with a particular counterparty, the
person may measure the current exposure arising from its swaps in any
major category on a net basis, applying the terms of the agreement.
Calculation of net exposure may take into account offsetting positions
entered into with that particular counterparty involving swaps (in any
swap category) as well as security-based swaps and securities financing
transactions (consisting of securities lending and borrowing,
securities margin lending and repurchase and reverse repurchase
agreements), to the extent these are consistent with the offsets
permitted by the master netting agreement.
(B) Such adjustments may not take into account any offset
associated with positions that the person has with separate
counterparties.
(3) Aggregate potential outward exposure. (i) In general. Aggregate
potential outward exposure in any major swap category means the sum of:
(A) The aggregate potential outward exposure for each of the
person's swap positions in a major swap category that are not subject
to daily mark-to-market margining and are not cleared by a registered
clearing agency or derivatives clearing organization, as calculated in
accordance with paragraph (sss)(3)(ii); and
(B) The aggregate potential outward exposure for each of the
person's swap positions in such major swap category that are subject to
daily mark-to-market margining or are cleared by a registered clearing
agency or derivatives clearing organization, as calculated in
accordance with paragraph (sss)(3)(iii) of this section.
(ii) Calculation of potential outward exposure for swaps that are
not subject to daily mark-to-market margining and are not cleared by a
registered clearing
[[Page 80214]]
agency or derivatives clearing organization. (A) In general. (1) For
positions in swaps that are not subject to daily mark-to-market
margining and are not cleared by a registered clearing agency or a
derivatives clearing organization, potential outward exposure equals
the total notional principal amount of those positions, adjusted by the
following multipliers on a position-by-position basis reflecting the
type of swap. For any swap that does not appropriately fall within any
of the specified categories, the ``other commodities'' conversion
factors are to be used. If a swap is structured such that on specified
dates any outstanding exposure is settled and the terms are reset so
that the market value of the swap is zero, the remaining maturity
equals the time until the next reset date.
Table to Sec. 1.3 (sss)--Conversion Factor Matrix for Swaps
----------------------------------------------------------------------------------------------------------------
Foreign exchange Precious metals
Residual maturity Interest rate rate and gold (except gold) Other commodities
----------------------------------------------------------------------------------------------------------------
One year or less............ 0.00 0.01 0.07 0.10
Over one to five years...... 0.005 0.05 0.07 0.12
Over five years............. 0.015 0.075 0.08 0.15
----------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------
Residual maturity Credit Equity
------------------------------------------------------------------------
One year or less.............. 0.10 0.06
Over one to five years........ 0.10 0.08
Over five years............... 0.10 0.10
------------------------------------------------------------------------
(2) Use of effective notional amounts. If the stated notional
amount on a position is leveraged or enhanced by the structure of the
position, the calculation in paragraph (sss)(3)(ii)(A)(1) of this
section shall be based on the effective notional amount of the position
rather than on the stated notional amount.
(3) Exclusion of certain positions. The calculation in paragraph
(sss)(3)(ii)(A)(1) of this section shall exclude:
(i) Positions that constitute the purchase of an option, such that
the person has no additional payment obligations under the position;
and
(ii) Other positions for which the person has prepaid or otherwise
satisfied all of its payment obligations.
(4) Adjustment for certain positions. Notwithstanding paragraph
(sss)(3)(ii)(A)(1) of this section, the potential outward exposure
associated with a position by which a person buys credit protection
using a credit default swap or index credit default swap is capped at
the net present value of the unpaid premiums.
(B) Adjustment for netting agreements. Notwithstanding paragraph
(sss)(3)(ii)(A) of this section, for positions subject to master
netting agreements the potential outward exposure associated with the
person's swaps with each counterparty equals a weighted average of the
potential outward exposure for the person's swaps with that
counterparty as calculated under paragraph (sss)(3)(ii)(A), and that
amount reduced by the ratio of net current exposure to gross current
exposure, consistent with the following equation as calculated on a
counterparty-by-counterparty basis:
PNet = 0.4 * PGross + 0.6 * NGR * PGross
Note to paragraph (sss)(3)(ii)(B): PNet is the potential outward
exposure, adjusted for bilateral netting, of the person's swaps with
a particular counterparty; PGross is that potential outward exposure
without adjustment for bilateral netting; and NGR is the ratio of
net current exposure to gross current exposure.
(iii) Calculation of potential outward exposure for swaps that are
subject to daily mark-to-market margining or are cleared by a
registered clearing agency or derivatives clearing organization. For
positions in swaps that are subject to daily mark-to-market margining
or cleared by a registered clearing agency or derivatives clearing
organization:
(A) Potential outward exposure equals the potential exposure that
would be attributed to such positions using the procedures in paragraph
(sss)(3)(ii) of this section multiplied by 0.2.
(B) For purposes of this calculation, a swap shall be considered to
be subject to daily mark-to-market margining if, and for so long as,
the counterparties follow the daily practice of exchanging collateral
to reflect changes in the current exposure arising from the swap (after
taking into account any other financial positions addressed by a
netting agreement between the counterparties. If the person is
permitted by agreement to maintain a threshold for which it is not
required to post collateral, the total amount of that threshold
(regardless of the actual exposure at any time) shall be added to the
person's aggregate uncollateralized outward exposure for purposes of
paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section,
as applicable. If the minimum transfer amount under the agreement is in
excess of $1 million, the entirety of the minimum transfer amount shall
be added to the person's aggregate uncollateralized outward exposure
for purposes of paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B),
as applicable.
(4) Calculation of daily average. Measures of daily average
aggregate uncollateralized outward exposure and daily average aggregate
potential outward exposure shall equal the arithmetic mean of the
applicable measure of exposure at the close of each business day,
beginning the first business day of each calendar quarter and
continuing through the last business day of that quarter.
(ttt) Hedging or mitigating commercial risk. For purposes of
Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), a swap
position shall be deemed to be held for the purpose of hedging or
mitigating commercial risk when:
(1) Such position:
(i) Is economically appropriate to the reduction of risks in the
conduct and management of a commercial enterprise, where the risks
arise from:
(A) The potential change in the value of assets that a person owns,
produces, manufactures, processes, or merchandises or reasonably
anticipates owning, producing, manufacturing, processing, or
merchandising in the ordinary course of business of the enterprise;
(B) The potential change in the value of liabilities that a person
has incurred or reasonably anticipates incurring in the ordinary course
of business of the enterprise; or
(C) The potential change in the value of services that a person
provides, purchases, or reasonably anticipates
[[Page 80215]]
providing or purchasing in the ordinary course of business of the
enterprise;
(D) The potential change in the value of assets, services, inputs,
products, or commodities that a person owns, produces, manufactures,
processes, merchandises, leases, or sells, or reasonably anticipates
owning, producing, manufacturing, processing, merchandising, leasing,
or selling in the ordinary course of business of the enterprise;
(E) Any potential change in value related to any of the foregoing
arising from foreign exchange rate movements associated with such
assets, liabilities, services, inputs, products, or commodities; or
(F) Any fluctuation in interest, currency, or foreign exchange rate
exposures arising from a person's current or anticipated assets or
liabilities; or
(ii) Qualifies as bona fide hedging for purposes of an exemption
from position limits under the Commodity Exchange Act; or
(iii) Qualifies for hedging treatment under Financial Accounting
Standards Board Accounting Standards Codification Topic 815,
Derivatives and Hedging (formerly known as Statement No. 133); and
(2) Such position is:
(i) Not held for a purpose that is in the nature of speculation,
investing or trading;
(ii) Not held to hedge or mitigate the risk of another swap or
securities-based swap position, unless that other position itself is
held for the purpose of hedging or mitigating commercial risk as
defined by this rule or Sec. 240.3a67-4 of this title.
(uuu) Substantial counterparty exposure. (1) In general. For
purposes of Section 1a(33) of the Act and Sec. 1.3(qqq), the phrase
substantial counterparty exposure that could have serious adverse
effects on the financial stability of the United States banking system
or financial markets means a swap position that satisfies either of the
following thresholds:
(i) $5 billion in daily average aggregate uncollateralized outward
exposure; or
(ii) $8 billion in:
(A) Daily average aggregate uncollateralized outward exposure plus
(B) Daily average aggregate potential outward exposure.
(2) Calculation methodology. For these purposes, the terms ``daily
average aggregate uncollateralized outward exposure'' and ``daily
average aggregate potential outward exposure'' have the same meaning as
in Sec. 1.3(sss), except that these amounts shall be calculated by
reference to all of the person's swap positions, rather than by
reference to a specific major swap category.
(vvv) Financial entity; highly leveraged. (1) For purposes of
Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the
term ``financial entity'' means:
(i) A security-based swap dealer;
(ii) A major security-based swap participant;
(iii) A commodity pool as defined in Section 1a(10) of the
Commodity Exchange Act;
(iv) A private fund as defined in Section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-2(a));
(v) An employee benefit plan as defined in paragraphs (3) and (32)
of Section 3 of the Employee Retirement Income Security Act of 1974 (29
U.S.C. 1002); and
(vi) A person predominantly engaged in activities that are in the
business of banking or financial in nature, as defined in Section 4(k)
of the Bank Holding Company Act of 1956.
(2) For purposes of Section 1a(33) of the Commodity Exchange Act
and Sec. 1.3(qqq), the term ``highly leveraged'' means the existence
of a ratio of an entity's total liabilities to equity in excess of [8
to 1 or 15 to 1] as measured at the close of business on the last
business day of the applicable fiscal quarter. For this purpose,
liabilities and equity should each be determined in accordance with
U.S. generally accepted accounting principles.
Securities and Exchange Commission
Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and
particularly, Sections 3 and 23 thereof, and Sections 712 and 761(b) of
the Dodd-Frank Act, the SEC is proposing to adopt Rules 3a67-1, 3a67-2,
3a67-3, 3a67-4, 3a67-5, 3a67-6, 3a67-7, 3a71-1, and 3a71-2 under the
Exchange Act.
Text of Proposed Rules
For the reasons stated in the preamble, the SEC is proposing to
amend Title 17, Chapter II of the Code of the Federal Regulations as
follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for part 240 is amended by adding the
following citation in numerical order:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78p, 78q, 78s,
78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3,
80b-4, 80b-11, and 7201 et seq., 18 U.S.C. 1350; and 12 U.S.C.
5221(e)(3), unless otherwise noted.
* * * * *
Sections 3a67-1 through 3a67-7 and sections 3a71-1 and 3a71-2
are also issued under Pub. L. 111-203, Sec. Sec. 712, 761(b), 124
Stat. 1841 (2010).
* * * * *
2. Add Sec. Sec. 240.3a67-1 through 240.3a67-7 and Sec. Sec.
240.3a71-1, 240.3a71-2 to read as follows:
* * * * *
Sec.
240.3a67 1--Definition of ``Major Security-based Swap Participant.''
240.3a67 2--Categories of Security-based Swaps.
240.3a67 3--Definition of ``Substantial Position.''
240.3a67 4--Definition of ``Hedging or Mitigating Commercial Risk.''
240.3a67 5--Definition of ``Substantial Counterparty Exposure.''
240.3a67 6--Definitions of ``Financial Entity'' and ``Highly
Leveraged.''
240.3a67 7--Timing Requirements, Reevaluation Period, and
Termination of Status.
240.3a71 1--Definition of ``Security-based Swap Dealer.
240.3a71 2--De minimis Exception.
* * * * *
Sec. 240.3a67-1 Definition of ``Major Security-based Swap
Participant.''
(a) General. Major security-based swap participant means any
person:
(1) That is not a security-based swap dealer; and
(2)(i) That maintains a substantial position in security-based
swaps for any of the major security-based swap categories, excluding
both positions held for hedging or mitigating commercial risk, and
positions maintained by any employee benefit plan (or any contract held
by such a plan) as defined in paragraphs (3) and (32) of section 3 of
the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002)
for the primary purpose of hedging or mitigating any risk directly
associated with the operation of the plan;
(ii) Whose outstanding security-based swaps create substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the United States banking system or financial
markets; or
(iii) That is a financial entity that:
(A) Is highly leveraged relative to the amount of capital such
entity holds and that is not subject to capital requirements
established by an appropriate Federal banking agency (as defined in 15
U.S.C. 78c(a)(72)); and
(B) Maintains a substantial position in outstanding security-based
swaps in any major security-based swap category.
[[Page 80216]]
(b) Scope of designation. A person that is a major security-based
swap participant in general shall be deemed to be a major security-
based swap participant with respect to each security-based swap it
enters into, regardless of the category of the security-based swap or
the person's activities in connection with the security-based swap,
unless the Commission limits the person's designation as a major
security-based swap participant to specified categories of security-
based swaps or specified activities of the person in connection with
security-based swaps.
Sec. 240.3a67-2 Categories of Security-based Swaps.
For purposes of sections 3(a)(67) and 3(a)(71) of the Act, 15
U.S.C. 78c(a)(67) and 78c(a)(71), and the rules thereunder, the terms
major security-based swap category, category of security-based swaps
and any similar terms mean either of the following categories of
security-based swaps:
(a) Security-based credit derivatives. Any security-based swap that
is based, in whole or in part, on one or more instruments of
indebtedness (including loans), or on a credit event relating to one or
more issuers or securities, including but not limited to any security-
based swap that is a credit default swap, total return swap on one or
more debt instruments, debt swap, debt index swap, or credit spread.
(b) Other security-based swaps. Any security-based swap not
described in paragraph (a) of this section.
Sec. 240.3a67-3 Definition of ``Substantial Position.''
(a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.
78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial
position means security-based swap positions, other than positions that
are excluded from consideration, that equal or exceed either of the
following thresholds in any major category of security-based swaps:
(1) $1 billion in daily average aggregate uncollateralized outward
exposure; or
(2) $2 billion in:
(i) Daily average aggregate uncollateralized outward exposure; plus
(ii) Daily average aggregate potential outward exposure.
(b) Aggregate uncollateralized outward exposure. (1) General.
Aggregate uncollateralized outward exposure in general means the sum of
the current exposure, obtained by marking-to-market using industry
standard practices, of each of the person's security-based swap
positions with negative value in a major security-based swap category,
less the value of the collateral the person has posted in connection
with those positions.
(2) Calculation of aggregate uncollateralized outward exposure. In
calculating this amount the person shall, with respect to each of its
security-based swap counterparties in a given major security-based swap
category:
(i) Determine the dollar value of the aggregate current exposure
arising from each of its security-based swap positions with negative
value (subject to the netting provisions described below) in that major
category by marking-to-market using industry standard practices; and
(ii) Deduct from that dollar amount the aggregate value of the
collateral the person has posted with respect to the security-based
swap positions. The aggregate uncollateralized outward exposure shall
be the sum of those uncollateralized amounts across all of the person's
security-based swap counterparties in the applicable major category.
(3) Relevance of netting agreements. (i) If a person has a master
netting agreement with a counterparty, the person may measure the
current exposure arising from its security-based swaps in any major
category on a net basis, applying the terms of the agreement.
Calculation of net exposure may take into account offsetting positions
entered into with that particular counterparty involving security-based
swaps (in any swap category) as well as swaps and securities financing
transactions (consisting of securities lending and borrowing,
securities margin lending and repurchase and reverse repurchase
agreements), to the extent these are consistent with the offsets
permitted by the master netting agreement.
(ii) Such adjustments may not take into account any offset
associated with positions that the person has with separate
counterparties.
(c) Aggregate potential outward exposure. (1) General. Aggregate
potential outward exposure means the sum of:
(i) The aggregate potential outward exposure for each of the
person's security-based swap positions in a major security-based swap
category that are not cleared by a registered clearing agency or
subject to daily mark-to-market margining, as calculated in accordance
with paragraph (c)(2) of this section; and
(ii) The aggregate potential outward exposure for each of the
person's security-based swap positions in a major security-based swap
category that are cleared by a registered clearing agency or subject to
daily mark-to-market margining, as calculated in accordance with
paragraph (c)(3) of this section.
(2) Calculation of potential outward exposure for security-based
swaps that are not cleared by a registered clearing agency or subject
to daily mark-to-market margining.
(i) General. (A)(1) For positions in security-based swaps that are
not cleared by a registered clearing agency or subject to daily mark-
to-market margining, potential outward exposure equals the total
notional principal amount of those positions, multiplied by the
following factors on a position-by-position basis reflecting the type
of security-based swap. For any security-based swap that is not of the
``credit'' or ``equity'' type, the ``other'' conversion factors are to
be used:
----------------------------------------------------------------------------------------------------------------
Residual maturity Credit Equity Other
----------------------------------------------------------------------------------------------------------------
One year or less................................. 0.10 0.06 0.10
Over one to five years........................... 0.10 0.08 0.12
Over five years.................................. 0.10 0.10 0.15
----------------------------------------------------------------------------------------------------------------
(2) If a security-based swap is structured such that on specified
dates any outstanding exposure is settled and the terms are reset so
that the market value of the security-based swap is zero, the remaining
maturity equals the time until the next reset date.
(B) Use of effective notional amounts. If the stated notional
amount on a position is leveraged or enhanced by the structure of the
position, the calculation in paragraph (c)(2)(i)(A) of this section
shall be based on the effective notional amount of the position rather
than on the stated notional amount.
[[Page 80217]]
(C) Exclusion of certain positions. The calculation in paragraph
(c)(2)(i)(A) of this section shall exclude:
(1) Positions that constitute the purchase of an option, such that
the person has no additional payment obligations under the position;
and
(2) Other positions for which the person has prepaid or otherwise
satisfied all of its payment obligations.
(D) Adjustment for certain positions. Notwithstanding paragraph
(c)(2)(i)(A) of this section, the potential outward exposure associated
with a position by which a person buys credit protection using a credit
default swap is capped at the net present value of the unpaid premiums.
(ii) Adjustment for netting agreements. Notwithstanding paragraph
(c)(2)(i) of this section, for positions subject to master netting
agreements the potential outward exposure associated with the person's
security-based swaps with each counterparty equals a weighted average
of the potential outward exposure for the person's security-based swaps
with that counterparty as calculated under paragraph (c)(2)(i) of this
section, and that amount reduced by the ratio of net current exposure
to gross current exposure, consistent with the following equation as
calculated on a counterparty-by-counterparty basis:
PNet = 0.4 x PGross + 0.6 x NGR x PGross
Note to paragraph (c)(2)(ii). Where: PNet is the potential
outward exposure, adjusted for bilateral netting, of the person's
security-based swaps with a particular counterparty; PGross is that
potential outward exposure without adjustment for bilateral netting;
and NGR is the ratio of net current exposure to gross current
exposure.
(3) Calculation of potential outward exposure for security-based
swaps that are cleared by a registered clearing agency or subject to
daily mark-to-market margining. For positions in security-based swaps
that are cleared by a registered clearing agency or subject to daily
mark-to-market margining:
(i) Potential outward exposure equals the potential outward
exposure that would be attributed to such positions using the
procedures in paragraph (c)(2) of this section, multiplied by 0.2.
(ii) For purposes of this calculation, a security-based swap shall
be considered to be subject to daily mark-to-market margining if, and
for as long as, the counterparties follow the daily practice of
exchanging collateral to reflect changes in the current exposure
arising from the security-based swap (after taking into account any
other financial positions addressed by a netting agreement between the
counterparties). If the person is permitted by agreement to maintain a
threshold for which it is not required to post collateral, the total
amount of that threshold (regardless of the actual exposure at any
time) shall be added to the person's aggregate uncollateralized outward
exposure for purposes of paragraph (a)(2) of this section. If the
minimum transfer amount under the agreement is in excess of $1 million,
the entirety of the minimum transfer amount shall be added to the
person's aggregate uncollateralized outward exposure for purposes of
paragraph (a)(2) of this section.
(d) Calculation of daily average. Measures of daily average
aggregate uncollateralized outward exposure and daily average aggregate
potential outward exposure shall equal the arithmetic mean of the
applicable measure of exposure at the close of each business day,
beginning the first business day of each calendar quarter and
continuing through the last business day of that quarter.
Sec. 240.3a67-4 Definition of ``Hedging or Mitigating Commercial
Risk.''
For purposes of section 3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),
and Sec. 240.3a67-1 of this chapter, a security-based swap position
shall be deemed to be held for the purpose of hedging or mitigating
commercial risk when:
(a) Such position is economically appropriate to the reduction of
risks that are associated with the present conduct and management of a
commercial enterprise, or are reasonably expected to arise in the
future conduct and management of the commercial enterprise, where such
risks arise from:
(1) The potential change in the value of assets that a person owns,
produces, manufactures, processes, or merchandises or reasonably
anticipates owning, producing, manufacturing, processing, or
merchandising in the ordinary course of business of the enterprise;
(2) The potential change in the value of liabilities that a person
has incurred or reasonably anticipates incurring in the ordinary course
of business of the enterprise; or
(3) The potential change in the value of services that a person
provides, purchases, or reasonably anticipates providing or purchasing
in the ordinary course of business of the enterprise;
(b) Such position is:
(1) Not held for a purpose that is in the nature of speculation or
trading; and
(2) Not held to hedge or mitigate the risk of another security-
based swap position or swap position, unless that other position itself
is held for the purpose of hedging or mitigating commercial risk as
defined by this section or 17 CFR 1.3(ttt); and
(c) The person holding the position satisfies the following
additional conditions:
(1) The person identifies and documents the risks that are being
reduced by the security-based swap position;
(2) The person establishes and documents a method of assessing the
effectiveness of the security-based swap as a hedge; and
(3) The person regularly assesses the effectiveness of the
security-based swap as a hedge.
Sec. 240.3a67-5 Definition of ``Substantial Counterparty Exposure.''
(a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.
78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the United States banking system or financial
markets means a security-based swap position that satisfies either of
the following thresholds:
(1) $2 billion in daily average aggregate uncollateralized outward
exposure; or
(2) $4 billion in:
(i) Daily average aggregate uncollateralized outward exposure; plus
(ii) Daily average aggregate potential outward exposure.
(b) Calculation. For these purposes, daily average aggregate
uncollateralized outward exposure and daily average aggregate potential
outward exposure shall be calculated the same way as is prescribed in
Sec. 240.3a67-3 of this chapter, except that these amounts shall be
calculated by reference to all of the person's security-based swap
positions, rather than by reference to a specific major security-based
swap category.
Sec. 240.3a67-6 Definitions of ``Financial Entity'' and ``Highly
Leveraged.''
(a) For purposes of section 3(a)(67) of the Act, 15 U.S.C.
78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term financial
entity means:
(1) A swap dealer;
(2) A major swap participant;
(3) A commodity pool as defined in section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10));
(4) A private fund as defined in section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-2(a));
(5) An employee benefit plan as defined in paragraphs (3) and (32)
of section 3 of the Employee Retirement Income Security Act of 1974 (29
U.S.C. 1002); and
[[Page 80218]]
(6) A person predominantly engaged in activities that are in the
business of banking or financial in nature, as defined in section 4(k)
of the Bank Holding Company Act of 1956 (12 U.S.C. 1843k).
(b) For purposes of section 3(a)(67) of the Act, 15 U.S.C.
78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term highly
leveraged means the existence of a ratio of an entity's total
liabilities to equity in excess of [8 to 1 or 15 to 1] as measured at
the close of business on the last business day of the applicable fiscal
quarter. For this purpose, liabilities and equity should each be
determined in accordance with U.S. generally accepted accounting
principles.
Sec. 240.3a67-7 Timing Requirements, Reevaluation Period, and
Termination of Status.
(a) Timing requirements. A person that is not registered as a major
security-based swap participant, but that meets the criteria in Sec.
240.3a67-1 of this chapter to be a major security-based swap
participant as a result of its security-based swap activities in a
fiscal quarter, will not be deemed to be a major security-based swap
participant until the earlier of the date on which it submits a
complete application for registration pursuant to 15 U.S.C. 78o-8 or
two months after the end of that quarter.
(b) Reevaluation period. Notwithstanding paragraph (a) of this
section, if a person that is not registered as a major security-based
swap participant meets the criteria in Sec. 240.3a67-1 of this chapter
to be a major security-based swap participant in a fiscal quarter, but
does not exceed any applicable threshold by more than twenty percent in
that quarter:
(1) That person will not immediately be subject to the timing
requirements specified in paragraph (a) of this section; but
(2) That person will become subject to the timing requirements
specified in paragraph (a) of this section at the end of the next
fiscal quarter if the person exceeds any of the applicable daily
average thresholds in that next fiscal quarter.
(c) Termination of status. A person that is deemed to be a major
security-based swap participant shall continue to be deemed a major
security-based swap participant until such time that its security-based
swap activities do not exceed any of the daily average thresholds set
forth within Sec. 240.3a67-1 of this chapter for four consecutive
fiscal quarters after the date on which the person becomes registered
as a major security-based swap participant.
Sec. 240.3a71-1 Definition of ``Security-based Swap Dealer.''
(a) General. The term security-based swap dealer in general means
any person who:
(1) Holds itself out as a dealer in security-based swaps;
(2) Makes a market in security-based swaps;
(3) Regularly enters into security-based swaps with counterparties
as an ordinary course of business for its own account; or
(4) Engages in any activity causing it to be commonly known in the
trade as a dealer or market maker in security-based swaps.
(b) Exception. The term security-based swap dealer does not include
a person that enters into security-based swaps for such person's own
account, either individually or in a fiduciary capacity, but not as a
part of regular business.
(c) Scope of designation. A person that is a security-based swap
dealer in general shall be deemed to be a security-based swap dealer
with respect to each security-based swap it enters into, regardless of
the category of the security-based swap or the person's activities in
connection with the security-based swap, unless the Commission limits
the person's designation as a major security-based swap participant to
specified categories of security-based swaps or specified activities of
the person in connection with security-based swaps.
Sec. 240.3a71-2 De minimis Exception.
For purposes of section 3(a)(71) of the Act, 15 U.S.C. 78c(a)(71),
and Sec. 240.3a71-1 of this chapter, a person shall not be deemed to
be a security-based swap dealer as a result of security-based swap
dealing activity involving counterparties that meets each of the
following conditions:
(a) Notional amount of outstanding security-based swap positions.
The security-based swap positions connected with those activities into
which the person enters over the course of the immediately preceding 12
months have an aggregate gross notional amount of no more than $100
million and have an aggregate gross notional amount of no more than $25
million with regard to security-based swaps in which the counterparty
is a ``special entity'' (as that term is defined in 15 U.S.C. 78o-8).
For purposes of this paragraph (a), if the stated notional amount of a
security-based swap is leveraged or enhanced by the structure of the
security-based swap, the calculation shall be based on the effective
notional amount of the security-based swap rather than on the stated
notional amount.
(b) No more than 15 counterparties. The person does not enter into
security-based swaps in connection with those activities with more than
15 counterparties, other than security-based swap dealers, over the
course of the immediately preceding 12 months. In determining the
number of counterparties, all counterparties that are members of a
single affiliated group shall be considered to be a single
counterparty.
(c) No more than 20 security-based swaps. The person has not
entered into more than 20 security-based swaps in connection with those
activities over the course of the immediately preceding 12 months. For
purposes of this paragraph, each transaction entered into under a
master agreement for security-based swaps shall constitute a distinct
security-based swap, but entering into an amendment of an existing
security-based swap in which the counterparty to such swap remains the
same and the notional item underlying such security-based swap remains
substantially the same shall not constitute entering into a security-
based swap.
Dated: December 1, 2010.
By the Commodity Futures Trading Commission.
David A. Stawick,
Secretary.
Dated: December 7, 2010.
By the Securities and Exchange Commission.
Elizabeth M. Murphy,
Secretary.
Additional Statement by the Commodity Futures Trading Commission
Regarding the Joint Proposed Rule Entitled ``Further Definition of
`Swap Dealer,' `Security-Based Swap Dealer,' `Major Swap Participant,'
`Major Security-Based Swap Participant,' and `Eligible Contract
Participant.'''
On this matter, Chairman Gensler and Commissioners Dunn and Chilton
voted in the affirmative; Commissioners Sommers and O'Malia voted in
the negative.
[FR Doc. 2010-31130 Filed 12-20-10; 8:45 am]
BILLING CODE 6351-01-P; 8011-01-P