[Federal Register Volume 75, Number 246 (Thursday, December 23, 2010)]
[Proposed Rules]
[Pages 80747-80758]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-31578]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AD10
End-User Exception to Mandatory Clearing of Swaps
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is proposing new requirements governing the elective
exception to mandatory clearing of swaps available for swap
counterparties meeting certain conditions under Section 2(h)(7) of the
Commodity Exchange Act, as amended by the Dodd-Frank Wall Street Reform
and Consumer Protection Act. The Commission is requesting comments on
the proposed rule and related matters.
DATES: Comments must be received on or before February 22, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD10,
by any of the following methods:
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 of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow instructions for submitting comments.
Please submit your comments using only one method. All comments
must be submitted in English, or if not, accompanied by an English
translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make
[[Page 80748]]
available publicly. If you wish the Commission to consider information
that is exempt from disclosure under the Freedom of Information Act, a
petition or confidential treatment of the exempt information may be
submitted according to the established procedures in Sec. 145.9 of the
Commission's regulations.\1\ The Commission reserves the right, but
shall have no obligation, to review, pre-screen, filter, redact,
refuse, or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such
as obscene language. All submissions that have been redacted or removed
that contain comments on the merits of the rulemaking will be retained
in the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the Freedom of Information Act.
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\1\ 17 CFR 145.9.
FOR FURTHER INFORMATION CONTACT: Lee Ann Duffy, Assistant General
Counsel, (202) 418-6763, [email protected], or Mark Fajfar, Assistant
General Counsel, (202) 418-6636, [email protected], Office of General
Counsel, Commodity Futures Trading Commission, Three Lafayette Centre,
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1155 21st Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commission is proposing Sec. 39.6 to
govern the elective exception to mandatory clearing of swaps available
to swap counterparties meeting certain conditions. The Commission is
requesting comments on all aspects of the proposed rules and related
matters. The Commission will carefully consider any comments received
and will respond as necessary or appropriate.
I. Introduction
The Commodity Exchange Act (``CEA'' or ``Act''),\2\ as amended by
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (``Dodd-Frank Act'' or ``DFA''),\3\ establishes a comprehensive new
regulatory framework for swaps, security-based swaps, and related
instruments. The Dodd-Frank Act was enacted to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (1) Providing for the registration and
comprehensive regulation of swap dealers and major swap participants;
(2) imposing clearing and trade execution requirements on standardized
derivative products; (3) creating rigorous recordkeeping and real-time
reporting regimes; and (4) enhancing the Commission's rulemaking and
enforcement authorities over all registered entities and intermediaries
subject to the Commission's oversight.
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\2\ 7 U.S.C. 1 et seq.
\3\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
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The Dodd-Frank Act amended the CEA to require that: (1) Swaps be
cleared through a derivatives clearing organization (``DCO'') if they
are of a type that the Commission determines must be cleared, unless an
exception from mandatory clearing applies; (2) swaps be reported to a
registered swap data repository (``SDR'') or the Commission; and (3) if
a swap is subject to a clearing requirement, it be executed on a
registered trading platform, i.e., a swap execution facility or a
designated contract market (``DCM''), unless no facility or market is
available for execution of such swap.\4\
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\4\ The Dodd-Frank Act amends the Securities Exchange Act of
1934 (``Exchange Act'') to provide for a similar regulatory
framework for transactions in security-based swaps regulated by the
Securities and Exchange Commission (``SEC'').
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CEA Section 2(h)(1) provides that it shall be unlawful for any
person to engage in a swap unless that person submits such swap for
clearing to a DCO if the swap is required to be cleared.\5\ However,
Section 2(h)(7) of the CEA also provides that a swap otherwise subject
to mandatory clearing is subject to an elective exception from clearing
if one party to the swap is not a financial entity, is using swaps to
hedge or mitigate commercial risk, and notifies the Commission, in a
manner set forth by the Commission, how it generally meets its
financial obligations associated with entering into non-cleared swaps
(the ``end-user clearing exception'').\6\
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\5\ See Process for Review of Swaps for Mandatory Clearing, 75
FR 67277 (Nov. 2, 2010).
\6\ When entering into a swap with a swap dealer or a major swap
participant, non-financial counterparties are granted a right to
forgo the exception and require clearing for a swap subject to a
clearing mandate from the Commission. Non-financial counterparties
are granted a similar elective right regarding clearing where a swap
has been listed for clearing, but is not the subject of a Commission
clearing mandate. See CEA Section 2(h)(7)(E). The choice to require
or forgo clearing is solely at the nonfinancial counterparty's
discretion. See CEA Section 2(h)(7)(B).
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The Dodd-Frank Act provides the Commission with authority to adopt
rules governing the end-user clearing exception and to prescribe rules,
issue interpretations, or request information from persons claiming the
end-user clearing exception necessary to prevent abuse of the
exception. The Commission is also required to consider whether to
except small banks, savings associations, farm credit system
institutions, and credit unions from the definition of ``financial
entity'' contained in CEA Section 2(h)(7)(C)(ii).
The Commission is proposing Sec. 39.6 to specify requirements for
electing to use, and facilitating compliance with, the exception to
mandatory clearing of swaps established by CEA Section 2(h)(7). The
Commission is also requesting comments regarding the requirements that
should apply to small banks, savings associations, farm credit system
institutions, and credit unions that may wish to elect to use this
clearing exception.
II. Description of Proposed Rule
A. Notification to the Commission
A non-financial entity \7\ that enters into a swap to hedge or
mitigate commercial risk must notify the Commission how it generally
meets its financial obligations associated with non-cleared swaps in
order to use the end-user clearing exception. The CEA authorizes the
Commission to establish the manner of notification and to prescribe
such rules as may be necessary to prevent abuse of the end-user
clearing exception. The Commission is proposing in Sec. 39.6(b) to
require non-financial entities to notify the Commission each time the
end-user clearing exception is elected by delivering specified
information to an SDR in the manner required by proposed rules for
swaps data recordkeeping and reporting.\8\ The specified information
would be
[[Page 80749]]
delivered to the SDR by the reporting counterparty defined in the swap
data recordkeeping and reporting rules together with other information
regarding the swap that is subject to the end-user clearing exception
to form the central record of the swap held by the SDR.
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\7\ CEA Section 2(h)(7)(A)(i) limits availability of the end-
user clearing exception to counterparties to the swap that are not a
financial entity. The term financial entity is defined in CEA
Section 2(h)(7)(C)(i), and includes the following eight entities:
(i) A swap dealer; (ii) a security-based swap dealer; (iii) a major
swap participant; (iv) a major security-based swap participant; (v)
a commodity pool as defined in CEA Section 1a(10); (vi) a private
fund as defined in section 202(a) of the Investment Advisers Act of
1940 (15 U.S.C. 80b-2(a)); (vii) 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); or (viii) 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. 1843(k)). Four of these
terms, ``swap dealer'', ``major swap participant'', ``security-based
swap dealer'' and ``major security-based swap participant'' are
themselves the subject of current proposed joint rulemaking by the
Commission and the SEC. See Further Definition of Swap Dealer,
Security-Based Swap Dealer, Major Swap Participant, Major Security-
Based Swap Participant and Eligible Contract Participant, approved
by the Commission on December 1, 2010, to be published in the
Federal Register on December 21, 2010.
\8\ See Swap Data Recordkeeping and Reporting Requirements, 75
FR 76573, December 8, 2010. The recordkeeping and reporting rules
contemplate that this information may be delivered to the Commission
directly in limited circumstances when an SDR is not available. When
permitted, such delivery would also meet the end-user clearing
exception notice requirement.
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Under the approach set forth in proposed Sec. 39.6(b), whenever
the end-user clearing exception is elected, ten additional items of
information would be required to be provided to the SDR. If the
counterparty electing to use the end-user clearing exception is an
issuer of securities under Exchange Act Section 12 or required to file
periodic reports with the SEC under Exchange Act Section 15(d), two
further items of information would be required: the electing
counterparty's SEC Central Index Key number, and whether the
appropriate governing body of that counterparty has reviewed and
approved the decision not to clear the swap.
1. Meeting Financial Obligations
A non-financial entity electing to use the end-user clearing
exception must notify the Commission of ``how it generally meets its
financial obligations associated with non-cleared swaps'' (``Financial
Obligation Notice''). See CEA Section 2(h)(7)(A)(iii). A principal
feature distinguishing cleared swaps from non-cleared swaps is that
non-cleared swaps do not have a uniform method of mitigating
counterparty credit risk.\9\ Proposed Sec. 39.6(b)(5) would require a
person relying on the end-user clearing exception to provide additional
information regarding the methods used to mitigate credit risk in
connection with non-cleared swaps. If more than one method is used by
the person electing to use the end-user clearing exception, information
must be provided for each of the methods being used.
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\9\ See ``ISDA Collateral Steering Committee, Market Review of
OTC Derivative Bilateral Collateralization Practices (2.0)''
(available at http://www.idsa.org/c_and_a/pdf/Collateral-Market-Review.pdf) (``ISDA Collateralization Practices'')(describing
methods of risk mitigation used in connection with swaps and key
legal foundations supporting collateralization).
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a. Credit Support
Proposed Sec. 39.6(b)(5)(i) requires an indication of whether a
written credit support agreement is being used with respect to the non-
financial entity or entities in connection with the non-cleared swap.
For these purposes, the term credit support agreement may refer to any
agreement, or annex, amendment or supplement to another agreement,
which contemplates the periodic transfer of specified collateral to or
from another party to support payment obligations associated with the
swap or a related portfolio, basket or other combination of securities,
swaps and other instruments. Agreements of this kind are frequently
used to mitigate the counterparty credit risk of swaps and other
instruments that are not centrally cleared, but the use of such
arrangements may be more or less common among certain types of
counterparties and for certain types of swaps.\10\ The proposed
notification would provide the Commission with information regarding
the extent to which credit support agreements are used by non-financial
entities to support their meeting financial obligations associated with
non-cleared swaps.
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\10\ See ISDA Collateralization Practices. See also ``ISDA
Margin Survey 2010'' (available at http://www.isda.org/c_and_a/pdf/ISDA-Margin-Survey-2010.pdf) (``ISDA Margin Survey 2010'')
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b. Pledged or Segregated Assets
Proposed Rule 39.6(b)(5)(ii) requires an indication of whether
payment of all or any portion of the financial obligations associated
with the non-cleared swap are secured by collateral that has been
pledged pursuant to a documented security arrangement not requiring the
transfer of possession of collateral to the swap counterparty. Examples
of this type of arrangement include, but are not limited to, agreements
granting security interests over property of the non-financial entity,
whether or not such security interests are perfected by the filing of a
mortgage, financing statement or similar document, agreements to
transfer assets to collateral agents or escrow agents acting pursuant
to instructions agreed by both parties to a swap, or the posting or
receiving of margin. While such arrangements may be somewhat less
commonly used to mitigate credit risk associated with non-cleared
swaps, the Commission preliminarily believes this method may have
particular importance for certain categories of non-financial entities,
such as enterprises with high levels of fixed assets relative to cash
flows.\11\ Accordingly, the Commission considers it appropriate to
separately categorize this information in the data being collected.
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\11\ See e.g. ISDA Margin Survey 2010 at 9 (noting types of non-
ISDA collateral agreements used and frequency of use).
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c. Guarantee
Proposed Sec. 39.6(b)(5)(iii) requires an indication of whether
all or any portion of the financial obligations associated with the
non-cleared swap are guaranteed in writing by a person or entity other
than the non-financial entity or entities that are party to the swap.
The proposed notification would provide the Commission with information
regarding the role that guarantees by third parties (such as parent
companies, affiliated parties or others) play in meeting financial
obligations associated with non-cleared swaps.\12\
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\12\ See ISDA Collateralization Practices at 20 (identifying
master cross-netting and cross-guarantee structures as common credit
risk mitigation practices).
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d. Sole Reliance on Available Financial Resources
Proposed Rule 39.6(b)(5)(iv) requires an indication of whether the
non-financial entity or entities that are party to the swap intend(s)
to meet the obligations associated with the swap solely by utilizing
available financial resources.\13\ Financial resources available to
meet obligations associated with non-cleared swaps may include various
liquidity sources, including existing assets, investments and cash
balances, cash flow from operations, short-term and long-term lines of
credit, and capital market sources of funding.
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\13\ For a variety of reasons one or both of the counterparties
to some non-cleared swaps may choose not to mitigate credit risk and
instead rely on the general creditworthiness of their opposite
counterparty, given the circumstances and financial terms of the
transaction. See, e.g. Office of the Comptroller of Currency ``Risk
Management of Financial Derivatives'' Comptroller's Handbook
(Jan.1997) at 50 (available at http://www.occ.gov/static/publications/handbook/deriv.pdf) (contemplating that evaluations of
individual counterparty credit limits should aggregate limits for
derivatives with credit limits established for other activities,
including commercial lending).
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e. Other Means
Proposed Sec. 39.6(b)(5)(v) requires an indication of whether the
non-financial entity or entities that are party to the swap intend(s)
to employ means other than those described in proposed Sec.
39.6(b)(5)(i) through (iv) to meet the financial obligations associated
with a swap. This item is intended to separately categorize all other
methods that may be used in the markets today or that may develop in
the future. The Commission anticipates many entities would meet their
financial obligations through one of the specific methods listed in
Sec. 39.6(b)(5)(i) through (iv). The information collected pursuant to
proposed Sec. 39.6(b)(5)(v), however, together with other information
collected, may allow the Commission to gain greater insight regarding
whether additional data concerning methods used to mitigate credit risk
should be collected in the future.
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2. Preventing Abuse of the End-User Clearing Exception
The remaining items of information required by proposed Sec. 39.6
are designed to confirm compliance with particular requirements of CEA
Section 2(h)(7) or otherwise produce information necessary or useful to
aid the Commission in its efforts to prevent abuse of the end-user
clearing exception as contemplated by CEA Section 2(h)(7)(F).
a. Person Electing to Use the End-User Clearing Exception
Proposed Sec. 39.6(b)(1) requires identification of which of the
parties to the swap is electing to use the end-user clearing exception.
b. Financial Entity Status
Proposed Sec. 39.6(b)(2) requires an indication of whether a
person electing to use the end-user clearing exception is a financial
entity as defined in CEA Section 2(h)(7)(C)(i). The exception to
mandatory clearing of swaps under CEA Section 2(h)(7) is only available
to persons that are not financial entities, or are affiliates of non-
financial entities satisfying the requirements of CEA Sections
2(h)(7)(C)(iii) or 2(h)(7)(D).
c. Finance Affiliate Status
Proposed Sec. 39.6(b)(3) requires an indication of whether a
person electing to use the end-user clearing exception is an affiliate
of another person qualifying for the exception under CEA Section
2(h)(7), and satisfies the additional requirements of CEA Sections
2(h)(7)(C)(iii) or 2(h)(7)(D). These sections of the CEA contain
provisions specially designed for captive finance affiliates of persons
qualifying for the end-user clearing exception.\14\ Given the nature of
these provisions, the Commission preliminarily believes it is
appropriate to separately categorize swaps transacted by such finance
affiliates in particular.
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\14\ CEA Section 2(h)(7)(D)(i) provides that affiliates of
persons qualifying for the end-user clearing exception will also
qualify for the end-user clearing exception if the affiliate (1)
acts on behalf of the person and as agent, (2) uses the swap to
hedge or mitigate commercial risk of that person or another
affiliate of that person that is not a financial entity as defined
in CEA Section 2(h)(7)(C)(i), and (3) is not itself one of seven
entities defined in CEA Section 2(h)(7)(D)(ii). The seven entities
are: (i) A swap dealer; (ii) a security-based swap dealer; (iii) a
major swap participant; (iv) a major security-based swap
participant; (v) an issuer that would be an investment company, as
defined in section 3 of the Investment Company Act of 1940 (15
U.S.C. 80a-3), but for paragraph (1) or (7) of subsection c of that
Act (15 U.S.C. 80a-3(c)); (vi) a commodity pool; or (vii) a bank
holding company with over $50,000,000,000 in consolidated assets.
See CEA Section 2(h)(7)(D)(ii). In addition, an affiliate,
subsidiary, or wholly owned entity of a person that qualifies for an
exception under CEA Section 2(h)(7)(A) and which is predominantly
engaged in providing financing for the purchase or lease of
merchandise or manufactured goods of the person shall be excepted
from both the margin requirements described in CEA Section 4s(e) and
the clearing requirement in CEA Section 2(h)(1), provided that the
swaps in question are entered into to mitigate the risk of the
financing activities. See CEA Section 2(h)(7)(D)(iii). Finally,
excluded from the definition of financial entity are those entities
(1) whose primary business is providing financing, and (2) who are
using derivatives to hedge underlying commercial risks related to
interest rate and foreign currency exposures, if 90% or more of
those risks arise from the finance or lease of products, and if 90%
or more of those products are manufactured by the parent company or
another subsidiary of the parent. See CEA Section 2(h)(7)(C)(iii).
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d. Hedging or Mitigating Commercial Risk
Proposed Sec. 39.6(b)(4) requires an indication of whether a
person electing to use the end-user clearing exception is using the
swap being reported to hedge or mitigate commercial risk. The exception
to mandatory clearing of swaps under Section 2(h)(7) of the CEA is only
available to persons that use such swaps to hedge or mitigate
commercial risk. The definition of ``hedging or mitigating commercial
risk'' is discussed below in Section B.
e. End-User Board Approval
Proposed Sec. 39.6(b)(6) requires all persons electing the end-
user clearing exception to indicate whether they are an issuer of
securities registered under Exchange Act Section 12 or required to file
reports under Exchange Act Section 15(d) (``SEC Filer'').\15\ Under CEA
Section 2(j), the exception to mandatory clearing of swaps under CEA
Section 2(h)(7) is available to SEC Filers only if an appropriate
committee of the issuer's board or governing body has reviewed and
approved the issuer's decision to enter into swaps that are subject to
the exception.\16\ When the person electing to use the end-user
clearing exception is an SEC Filer, two additional items of information
must be provided:
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\15\ For these purposes, a counterparty electing to use the end-
user clearing exception is considered to be an issuer of securities
registered under Exchange Act Section 12 or required to file reports
pursuant to Exchange Act Section 15(d) if it is controlled by a
person that is an issuer of securities registered under Exchange Act
Section 12 or required to file reports pursuant to Exchange Act
Section 15(d). See Rule 1-02(x) of SEC Regulation S-X, 17 CFR Sec.
210.1-02(x) (defining subsidiary for purposes of the financial
statements required to be filed as part of registration statements
under Exchange Act Section 12, and annual and other reports under
Exchange Act Sections 13 and 15(d)).
\16\ See CEA Section 2(j). For these purposes, the Commission
considers a committee to be appropriate if it is specifically
authorized to review and approve the issuer's decisions to enter
into swaps.
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Proposed Sec. 39.6(b)(6)(i) requires an SEC Filer
electing to use the end-user clearing exception to specify its SEC
Central Index Key number. Collection of this information will allow the
CFTC to cross reference materials filed with the relevant SDR with
information in periodic reports and other materials filed by the SEC
Filer with the SEC.\17\
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\17\ See Item 305 of SEC Regulation S-K, 17 CFR 229.305.
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Proposed Sec. 39.6(b)(6)(ii) requires confirmation that
an appropriately authorized committee of the board of directors or
equivalent governing body of the SEC Filer has reviewed and approved
the decision of the electing person not to clear the swap being
reported, as required by CEA Section 2(j).\18\
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\18\ For example, a board resolution or an amendment to a board
committee's charter could expressly authorize such committee to
review and approve decisions of the electing person not to clear the
swap being reported. In turn, such board committee could adopt
policies and procedures to review and approve decisions not to clear
swaps, on a periodic basis or subject to other conditions determined
to be satisfactory to the board committee.
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Given the requirements of CEA Section 2(j) and its relationship to
the end-user clearing exception, the Commission preliminarily believes
collection of this information is appropriate to promote compliance
with the requirements of the end-user clearing exception.
Request for Comment:
The Commission generally requests comments on all aspects of the
proposed rules. Additionally, the Commission requests comments on the
following specific issues:
Is it sufficiently clear what information the Commission
is requiring to be reported under proposed Sec. 39.6? If not, why not?
Is it sufficiently clear how information would be reported under
proposed Sec. 39.6 if a swap is between two non-financial entities
both seeking to elect to use the end-user clearing exception? If not,
why not? Are there clarifications or instructions the Commission could
adopt that are useful for parties seeking to elect to use the end-user
clearing exception? If so, what are they and what would be the benefits
of adopting them?
Would it be difficult or prohibitively expensive for
persons to report the information required under the proposed Sec.
39.6? If so, why?
Is the information the Commission proposes to collect in
connection with the Financial Obligation Notice sufficient? Is other
information needed to achieve the purposes of the Dodd-Frank Act? For
example, is it necessary or appropriate for the Commission to collect:
Additional general information on the credit support agreement and the
[[Page 80751]]
collateral practices under the agreement, such as the level of margin
collateral outstanding (e.g., less than or equal to a specified dollar
amount, or greater than a series of progressively higher dollar
amounts); the types of collateral provided (e.g., cash, government
securities, other securities, other collateral), or the frequency of
portfolio reconciliation? Additional general information on specific
terms of the credit support agreement, such as whether the collateral
requirements are unilateral or bilateral provisions and whether there
are contractual terms triggered by changes in the credit rating or
other financial circumstances of one or both of the counterparties?
Additional general information about the guarantor, such as whether or
not the guarantor is a parent or affiliate of the person electing to
use the end-user clearing exception? Additional general information
regarding the assets pledged, such as the type of security interest or
the type of property being used as collateral? Additional general
information regarding the segregation arrangements, such as the
identity of the collateral agent or other third party involved in the
arrangement, and information regarding whether the arrangement involves
a custodian, tri-party or different type of relationship? Additional
general information regarding the adequacy of other means being used,
or the adequacy of the financial resources available, to meet the
financial obligations associated with the non-cleared swap?
Should the Commission provide additional clarity to the
terms used in CEA Sections 2(h)(7)(C)(iii) and 2(h)(7)(D) in proposed
Sec. 39.6 for affiliates electing to use the end-user clearing
exception? Should the Commission adopt more specific requirements to
implement the provisions of CEA Sections 2(h)(7)(C)(iii) and
2(h)(7)(D)? Is there need for the Commission to address the factors to
be taken into account or the manner of calculating the percentage
standards established in CEA Section 2(h)(7)(C)(iii)? Should the
Commission provide further guidance on other terms used in these
sections, such as the meaning of the term ``predominantly engaged'' in
CEA Section 2(h)(7)(D)? If so, what specific rules or guidance should
the Commission consider and what would be the benefits of adopting
them?
Should the Commission provide additional clarity to the
requirements of CEA Section 2(j) to facilitate compliance with proposed
Sec. 39.6 by parties electing to use the end-user clearing exception?
Should the Commission adopt more specific requirements to implement the
provisions of CEA Section 2(j)? If so, what specific rules should the
Commission consider and what would be the benefits of adopting them?
Should the Commission provide additional guidance as to
the meaning of the term ``issuer of securities'' as used in CEA Section
2(j)?
Should the Commission consider requiring parties electing
to use the end-user clearing exception to report additional types of
information, either in order to limit abuse of the exception or for
other reasons? If so, what other information should be reported and
what would be the benefit of requiring such information to be reported?
What categories of information, if any, should not be required to be
reported and why?
What does it mean to abuse the clearing exception under
CEA Section 2(h)(7)(F)? Will some types of swaps be more susceptible to
such abuse than others? For example: Are large or small companies or
other identifiable sub-categories of swap users more or less likely to
abuse the end-user clearing exception than other persons? Are there
certain swap products or counterparties that the Commission should
monitor for abuse more closely than others?
Are there different considerations for small companies or
other identifiable categories of persons who may wish to elect to use
the end-user clearing exception? If so, what are they and how should
the Commission take these considerations into account?
3. Form of Notice to the Commission
Proposed Rule 39.6 provides that a person electing to use the end-
user clearing exception for a swap shall satisfy the notice
requirements of CEA Section 2(h)(7)(A)(iii) upon providing the
information specified in proposed Sec. 39.6 to a registered SDR or, if
no registered SDR is available, the Commission, in the form and manner
generally required for delivery of information specified under proposed
swap data recordkeeping and reporting rules.\19\ Under this approach,
rather than collecting information through a separate process
established by the Commission for these purposes, the information
delivered in compliance with the requirements of proposed Sec. 39.6
and the proposed swap data recordkeeping and reporting rules would
serve as the official notice of a swap covered by the end-user clearing
exception.
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\19\ Proposed Sec. Sec. 45.2 and 45.3 establish the
recordkeeping and reporting requirements for swaps. See Swap Data
Recordkeeping and Reporting Requirements, 75 FR 76573 (Dec. 8,
2010). The information required under proposed Rule 39.6 would be in
addition to these requirements but would be delivered to the SDR by
the reporting counterparty in the same manner as required by the
proposed swap data recordkeeping and reporting rules.
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The CEA, as amended by the Dodd-Frank Act, requires all swaps
(whether cleared or non-cleared) to be reported to a registered SDR or,
if no registered SDR is available, the Commission. See CEA Sections
2(a)(13)(G) (reporting of swaps to SDRs) and 4r (reporting alternatives
for non-cleared swaps). As centralized recordkeeping facilities of
swaps, SDRs are intended to play a critical role in enhancing
transparency in the swap markets. SDRs will enhance transparency by
having complete records of swaps, maintaining the integrity of those
records, and providing effective access to those records to relevant
authorities and the public in line with their respective information
needs.\20\ The Commission recently proposed a series of new rules
relating to the SDR registration process, duties, and core principles
to ensure that SDRs operate in the manner contemplated by the Dodd-
Frank Act amendments to the CEA.\21\
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\20\ In the case of non-cleared swaps, CEA Section 21(c)(2)
requires each SDR to confirm with both parties to the swap the
accuracy of the data submitted to the SDR. CEA Section 4r(c)
requires each party to a non-cleared swap to maintain records of the
swaps held by such party in the form required by the Commission, and
CEA Section 4r(d) provides that these records shall be in a form not
less comprehensive than required to be collected by SDRs. These
records are available for inspection by the Commission and other
specified authorities under CEA Section 4r(c)(2).
\21\ See Swap Data Repositories, approved by the Commission on
Novovember 19, 2010, to be published in a forthcoming issue of the
Federal Register.
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The Commission is proposing to collect notice information for the
end-user clearing exception through SDRs. This will permit detailed
information on the use of the end-user clearing exception to be
collected in conjunction with other swap information in a format well
suited to analysis by the Commission and consistent with the
development of straight-through processing for swaps. Using SDRs should
also help to reduce the administrative burdens of the notice
requirement because the information would be incorporated into a
transaction record already required by the Dodd-Frank Act in connection
with each swap and subject to standards designed to assure the accuracy
of the information collected. The Commission anticipates that empirical
data collected in this manner will aid its ability to evaluate how the
end-user clearing exception is being used and encourage appropriate
deliberation by counterparties prior to its use. The
[[Page 80752]]
Commission also preliminarily believes receiving notification and other
information in connection with CEA Sections 2(h)(7)(A)(iii) and
2(h)(7)(F) through SDRs should allow monitoring for potentially abusive
practices, and timely action to address abusive practices if they were
to develop.\22\
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\22\ The proposed notification method is supported by the
recordkeeping requirements under CEA Section 4r, which will permit
the Commission to review transaction information and take such
action as may be necessary to prevent abuses of the end-user
clearing exception. Such Commission action would be taken in a
manner consistent with our review practices for other transaction
information submitted to SDRs, rather than through a separate
process developed for these purposes, thereby helping to maintain
consistency of regulatory action in comparable areas.
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Request for Comment:
The Commission generally requests comments on all aspects of the
proposed rules. Additionally, the Commission requests comments on the
following specific issues:
Is it appropriate for the Commission to require
notification regarding use of the end-user clearing exception to be
made through SDRs? What are the advantages or disadvantages of the
Commission's proposal?
Does collecting Financial Obligation Notice information
through SDRs provide sufficient assurance that the end-user clearing
exception will be available to non-financial entities wishing to use
the exception? Are SDRs reliable enough to be used for these purposes?
Is Financial Obligation Notice information different from
other information collected by SDRs in any respect that makes use of
SDRs for these purposes inappropriate? If so, how is the notice
information different and why is it inappropriate to use SDRs to
collect the information?
Is there a more feasible and cost effective way for the
Commission to receive notification regarding the use of the end-user
clearing exception? If so, what is the better alternative and in what
ways is it better?
Do the CEA and the associated rules and proposed rules
regulating SDRs and parties to swaps create sufficient assurance that
notice information collected through SDRs will be accurate? Are there
additional protections the Commission should establish to create
greater assurance that the notice information collected will be
accurate? If so, what are they and how will they improve the
information collection process?
Would the person reporting information to the SDR be in a
position to have or be able to obtain, in all cases, the information
the Commission is requiring to be reported under proposed Rule 39.6. If
not, why not? Are there special considerations in this regard when a
swap is between two non-financial entities that are each seeking to
elect to use this exception? Are representations and warranties and
similar established market practices associated with documenting swaps
adequate to ensure the person reporting information to the SDR can
obtain such information when necessary?
How long would it be expected to take for the person
reporting information to the SDR to gather the information required
under proposed Sec. 39.6? Will the time needed to gather the required
information disrupt the transaction process for swaps to any material
extent?
Should the Commission require persons electing to use the
end-user clearing exception to follow additional compliance practices
in some circumstances? For example, should the Commission require
electing persons to create a record of the means being used to mitigate
the credit risk of the swap? Would such a requirement be redundant or
duplicative of other proposed recordkeeping requirements?
Will collecting notice information together with other
transaction information have the advantages expected by the Commission?
For example, will it be useful to analyze information regarding use of
the end-user clearing exception by product type and other transaction
characteristics? Are there other advantages or disadvantages related to
collecting notice information through SDRs that the Commission should
consider? If so, what are they?
Is there reason to believe that collecting information
through SDRs will make it more or less difficult for the Commission to
take action to prevent abuse of the clearing exception? If so, what
Commission actions might be more or less difficult and what
alternatives should the Commission consider?
Does collecting notice information regarding use of the
end-user clearing exception through SDRs create significantly greater
burdens for some parties to swaps compared to others? For example, will
parties who frequently enter into swaps face higher or lower burdens
compared to parties that enter swaps less frequently? Will small
companies face different burdens than large companies? Will non-
financial entities that enter into swaps with other non-financial
entities face different burdens? If so, what steps should the
Commission consider taking to account for these differences?
Are there international or cross-border issues related to
the end-user exception that the Commission should address?
B. Hedging or Mitigating Commercial Risk
To qualify to use the end-user clearing exception with respect to a
particular swap, CEA Section 2(h)(7)(A)(ii) requires that a non-
financial entity must be using the swap to hedge or mitigate commercial
risk. The Commission's proposal deems that the use of a swap is for
hedging purposes in three circumstances. While the proposed definition
in Proposed Sec. 39.6(c) 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 clearing exception are not limited to those two circumstances. See
Proposed Sec. 39.6(c)(1)(ii) and (iii). The proposal also covers swaps
used to hedge or mitigate any of a person's business risks, as defined
by six categories in the proposal, regardless of their status under
accounting guidelines or the bona fide hedging exemption. See Proposed
Sec. 39.6(c)(1)(i). Proposed Sec. 39.6(c)(2) further provides,
however, that a swap is disqualified from the clearing exception if it
is held for a speculative, investing, or trading purpose,\23\ or if it
hedges another swap unless that swap itself is held for hedging
purposes.
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\23\ The Commission preliminarily believes 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.
The Commission preliminarily believes 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 phrase ``hedging or mitigating commercial risk'' is the subject
of current joint rulemaking by the Commission and the SEC.\24\ Through
this joint rulemaking exercise, the Commission is proposing a
definition of ``hedging or mitigating commercial risk''
[[Page 80753]]
that would govern for purposes of the major swap participant definition
under CEA Section 1a(33). The Commission has determined to propose
nearly identical regulatory language in Proposed Sec. 39.6(c) to
define the meaning of the phrase ``hedge or mitigate commercial risk''
as found in CEA Section 2(a)(7)(A)(ii) for purposes of the elective
end-user clearing exception. This parallel approach should allow
consistency of interpretation across the CEA as a whole and help
provide for fair and equivalent treatment for similarly situated
parties.\25\
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\24\ See Further Definition of Swap Dealer, Security-Based Swap
Dealer, Major Swap Participant, Major Security-Based Swap
Participant and Eligible Contract Participant, approved by the
Commission on December 1, 2010, to be published in the Federal
Register on December 21, 2010.
\25\ The Commission notes that the major swap participant
definitional rule does not contemplate applying the definition of
hedging or mitigating commercial risk to affiliates. CEA Sections
2(h)(7)(C)(iii) and 2(h)(7)(D) create certain additional
requirements for affiliates of non-financial entities seeking to
elect the end-user clearing exception, and these requirements must
also be satisfied for the end-user clearing exception to be
available.
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The Commission proposes an inclusive, multi-pronged definition that
allows end users to qualify their hedging transactions in a manner that
best fits their businesses. The Commission preliminarily believes that
such an approach is appropriate, given the elective nature of this
exception. While the line between speculation and hedging can at times
be difficult to discern, the Dodd-Frank Act nonetheless requires such
determinations to be made, and the Commission believes its rules
proposal provides guidance and a measure of certainty in this regard.
Proposed Sec. 39.6(c)(1)(i) takes a narrative approach similar to
that used in Sec. 1.3(z) of the Commission's regulations, which
defines what activities qualify as hedging when used in futures
markets, by enumerating specific risk shifting practices that are
deemed to qualify for purposes of the clearing exception. Proposed
Sec. 39.6(c)(1)(ii) and (iii) assure counterparties that if their swap
qualifies for the bona fide hedge exemptions from positions limits, or
if their swap qualifies for hedge accounting treatment under the FASB
hedge accounting standards, the swap also qualifies for the clearing
exception.
As a general matter, the Commission preliminarily believes that
whether a position is used to hedge or mitigate 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. The Commission 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 for purposes of the clearing exception. In
this regard, the Commission preliminarily believes the question whether
an activity is commercial should not be determined solely by an
entity's organizational status as a for-profit company, a non-profit
organization, or a governmental entity. Instead, the determinative
factor should be whether the underlying activity to which the swap
relates is commercial in nature.
Request for Comment:
The Commission generally requests comments on all aspects of the
proposed rules. Additionally, the Commission requests comments on the
following specific issues:
Should swaps qualifying as hedging or risk mitigating be
limited to swaps where the underlying hedged item is a non-financial
commodity? Commenters may also address whether swaps qualifying as
hedging or risk mitigating 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 Commission 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. The
Commission is interested in whether special considerations are
warranted with respect to the use of non-cleared swaps by agricultural
cooperatives as well as by non-profit, governmental, or municipal
entities engaged in electric power or energy activities. Commenters are
requested to discuss both the policy and legal bases underlying such
comments.
Should the Commission consider adopting a definition of
``hedge or mitigate commercial risk'' in proposed Sec. 39.6(c) that is
different from definition of ``hedging or mitigating commercial risk''
in the major swap participant definitions rule and is specifically
designed to address the circumstances of the end-user clearing
exception? If so, what are the specific considerations associated with
the end-user clearing exception that make a separate definition
desirable? What features would such a definition need in order to be
effective and what would be the benefits of adopting them?
Should the Commission consider adopting a definition of
``hedge or mitigate commercial risk'' in proposed Sec. 39.6(c) that is
different from definition of ``hedging or mitigating commercial risk''
in the major swap participant definitions rule and is specifically
designed to address the circumstances of the end-user clearing
exception? If so, what are the specific considerations associated with
the end-user clearing exception that make a separate definition
desirable? What features would such a definition need in order to be
effective and what would be the benefits of adopting them?
III. Consideration of a Clearing Exception for Small Banks, Savings
Associations, Farm Credit System Institutions, and Credit Unions
Pursuant to CEA Section 2(h)(7)(C)(ii), the Commission is
considering whether to except small banks, savings associations, farm
credit systems institutions, and credit unions from the Act's
definition of financial entity, including specifically those with total
assets of $10,000,000,000 or less (``Small Financial Institutions'').
This type of exception would permit Small Financial Institutions to use
the end-user exception from the mandatory clearing requirement, which
is otherwise unavailable to financial entities.
To inform its consideration of whether it would be appropriate for
the Commission to grant any exception for Small Financial Institutions,
the Commission requests comments on the following specific issues:
Would such an exception be appropriate? If so, what terms
and conditions should apply? Would it be better for the Commission to
simply require Small Financial Institutions to follow the same
practices as other financial institutions in the future? Would such an
exception pose any risks to the swap markets or the financial system?
Why or why not?
How should the Commission take into account the
supervisory regimes to which Small Financial Institutions are currently
subject, and whether those regulatory regimes adequately mitigate any
risks associated with an exception?
Should the Commission consider treating different types of
swaps differently when considering whether any exception should be
available for Small Financial Institutions? If so, what specific
distinctions should be considered by the Commission and what would be
the benefits of adopting them?
Should the Commission consider limiting the availability
of any end-user clearing exception to only some Small Financial
Institutions? Are there differences between Small Financial
[[Page 80754]]
Institutions that should lead to differences in the availability of the
exception? If so, what specific distinctions should be considered by
the Commission and what would be the benefits of adopting them? Would
an across-the-board application of an exception to all Small Financial
Institutions create any advantages or disadvantages for certain Small
Financial Institutions? Would a differentiated application of an
exception create any advantages or disadvantages?
In CEA Section 2(h)(7)(C)(ii), Congress directed the
Commission to consider whether to exempt small banks, savings
associations, farm credit institutions, and credit unions, including
those with total assets of $10 billion or less. The Commission invites
public comment on the $10 billion total assets level. Are there
measures other than total assets of $10 billion, such as financial risk
or capital, which could be used for determining whether an entity
qualifies for an exception, and if so, what are the advantages or
disadvantages of utilizing the alternative measures? Would utilizing
these alternative measures create additional risks, and if so, should
the Commission consider additional measures to address them?
IV. General Request for Comments
The Commission is requesting comments from all members of the
public. The Commission will carefully consider the comments that it
receives. The Commission seeks comment generally on all aspects of the
proposed rules. In addition, the Commission seeks comment on the
following:
Should the Commission clarify or modify any of the
definitions included in the proposed rules? If so, which definitions
and what specific modifications are appropriate or necessary?
Are there aspects of the CEA, the Investment Advisers Act
of 1940 (15 U.S.C. 80), the Employee Retirement Income Security Act of
1974 (29 U.S.C. 1002), or the Bank Holding Company Act of 1956 (12
U.S.C. 184) that are incorporated in the definition that may need to be
taken into consideration by the Commission to ensure the end-user
clearing exception is available in appropriate circumstances? If so,
what specific changes should the Commission consider and what would be
the benefits of adopting them?
Are the obligations in the proposed rules sufficiently
clear? Is additional guidance from the Commission necessary?
What are the technological or administrative burdens of
complying with the rules proposed by the Commission?
Should the Commission implement substantive requirements
in addition to, or in place of, the policies and procedures required in
the proposed rules?
If an entity is designated as a swap dealer or a major
swap participant with respect to only certain of its swaps or
activities, should it be treated as a financial entity under CEA
Section 2(h)(7)(C)(i) and thereby be disqualified from electing to use
the end-user clearing exception with respect to its other swaps or
activities? If so, why? If not, should the Commission require such an
entity to separate those swaps or activities for which it is designated
as a swap dealer or major swap participant from its other swaps or
activities? If so, how? If not, why not?
In addition, the Commission seeks commenters' views regarding any
potential impact of the proposals on non-financial entities expecting
to elect to use the end-user clearing exception, SDRs, other market
participants, and the public generally. The Commission seeks comments
on the proposals as a whole, including their interaction with the other
provisions of the Dodd-Frank Act. The Commission seeks comments on
whether the proposals would help achieve the broader goals of
increasing transparency and accountability in the swap market.
The Commission requests comment generally on whether its proposed
actions today to govern the elective exception to mandatory clearing of
swaps available under CEA Section 2(h)(7) are necessary or appropriate
for those purposes. If commenters do not believe one or all such
actions are necessary and appropriate, why not? What would be the
preferred action?
Title VII requires that the Commission consult and coordinate to
the extent possible with the SEC for the purposes of assuring
regulatory consistency and comparability, to the extent possible, and
states that in adopting rules, the Commission and SEC shall treat
functionally or economically similar products or entities in a similar
manner. Specifically, do the regulatory approaches under the
Commission's proposed rulemaking under DFA Section 723(a) and the SEC's
proposed rulemaking under DFA Section 763(a) result in duplicative or
inconsistent efforts on the part of market participants subject to both
regulatory regimes or result in gaps between those regimes? If so, in
what ways do commenters believe that such duplication, inconsistencies,
or gaps should be minimized? Do commenters believe the approaches
proposed by the Commission and the SEC to govern the elective exception
to mandatory clearing of swaps and security-based swaps are comparable?
If not, why? Do commenters believe there are approaches that would make
the elective exception to mandatory clearing of swaps and security-
based swaps more comparable? If so, what are they and what would be the
benefits of adopting such approaches? Do commenters believe that it
would be appropriate for us to adopt an approach proposed by the SEC
that differs from our proposal? If so, which one? Are there further
distinctions or clarifications that should be made by the Commission
for purposes of the end-user clearing exception that are different from
those being made in connection with the proposed joint rulemaking by
the Commission and the SEC? If so, what are they and what would be the
benefits of adopting them?
Commenters should, whenever possible, provide the Commission with
empirical data to support their views. Commenters suggesting
alternative approaches should provide comprehensive proposals,
including any conditions or limitations that they believe should apply,
the reasons for their suggested approaches, and their analysis
regarding why their suggested approaches would satisfy the statutory
mandate contained in DFA Section 723(a) governing the exception to
mandatory clearing of swaps.
V. Related Matters
A. Cost-Benefit Analysis
Section 15(a) of the Act requires that the Commission, before
promulgating a regulation or issuing an order, consider the costs and
benefits of its action. By its terms, CEA Section 15(a) does not
require the Commission to quantify the costs and benefits of a new
regulation or determine whether the benefits of the regulation outweigh
its costs. Rather, CEA Section 15(a) simply requires the Commission to
``consider the costs and benefits'' of its action.
CEA Section 15(a) specifies that costs and benefits shall be
evaluated in light of the following considerations: (1) Protection of
market participants and the public; (2) efficiency, competitiveness,
and financial integrity of futures markets; (3) price discovery; (4)
sound risk management practices; and (5) other public interest
considerations. Accordingly, the Commission could, in its discretion,
give greater weight to any of the five considerations and could, in its
[[Page 80755]]
discretion, determine that, notwithstanding its costs, a particular
regulation was necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the Act.
Costs
Proposed Sec. 39.6 specifies requirements for using the elective
end-user exception to the mandatory clearing of swaps established by
CEA Section 2(h)(7). The proposal calls for a user-friendly, check-the-
box approach to the Dodd-Frank Act's notification requirement. Proposed
Rule 39.6 would simply require an indication of each method used to
mitigate the credit risk associated with non-cleared swaps. Additional
boxes would indicate whether finance affiliate or a SEC Filer is
involved. The reporting counterparty would further be required to check
a box in order to indicate whether the swap was being used to hedge or
mitigate commercial risk, as defined by proposed Sec. 39.6(c). These
data elements would be provided as part of the overall package of swap-
related information that must generally be submitted by reporting
counterparties to SDRs under the Dodd-Frank Act.
With respect to costs, the Commission has determined that the
notification requirement imposed by the rule proposal will present an
increased cost. Currently, there is no requirement to notify the
Commission of how a swap counterparty generally meets its financial
obligations associated with its non-cleared swaps; therefore, the new
notification requirement necessarily introduces a new cost to the
system. While the Commission must be notified each time an election to
forgo clearing is made, the cost incurred should be minimal since only
general information must be included in the notification. In most
cases, this check-the-box notification process will be performed by the
swap dealer or major swap participant for whom such notification will
represent only a small added cost to the overall cost of complying with
its general reporting and recordkeeping obligations for swaps under the
DFA. End users will provide the notification only for those swaps that
do not involve a swap dealer or a major swap participant.
Benefits
With respect to benefits, the Commission has determined that the
rule proposal should enhance the level of transparency associated with
the OTC swap activity of non-financial entities, grant the Commission
new insights into the practices of non-financial entities, and help the
Commission and other regulators in their efforts to reduce risk in the
financial system.
Proposed Sec. 39.6's collateralization reporting requirements
should allow the Commission to identify the collateral activities of
non-financial entities. The role of OTC swaps in the financial system
came into focus in the aftermath of the financial crisis of 2007;
instituting the proposed rule would strengthen the regulatory regime
that governs OTC swaps, and provide a greater degree of transparency
with regard to non-financial entities in general.
When non-financial entities report that they use alternative
methods to meet their financial obligations related to OTC swaps, they
would provide the Commission with a valuable insight into the practices
of non-financial entities of various types. Although the Commission
expects that most transactions rely on one of the specific methods
listed in Sec. 39.6(b)(5)(i), (ii), (iii), or (iv), the reporting of
the use of alternative methods should help the Commission determine
whether additional data collection could be needed in the future.
Finally, the rule proposal represents a more rigorous reporting
regime, a stated goal of the Dodd-Frank Act. While the reporting
requirements contained in the rule proposal might present increased
costs to non-financial entities seeking to engage in OTC swaps, they
provide the benefits of a greater body of information for the
Commission to analyze.
Summary
In summary, the Commission, after considering the CEA Section 15(a)
factors, finds that the incremental cost imposed by the proposed rules
is outweighed by their expected benefit. Accordingly, the Commission
has determined to propose the rules. The Commission invites public
comment on its cost-benefit considerations. Commenters also are invited
to submit any data or other information that they may have quantifying
or qualifying the costs and benefits of the proposed rules.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires federal agencies,
in proposing regulations, to consider the impact of those regulations
on ``small entities.'' \26\ The proposed rules detailed in this release
would affect organizations including eligible contract participants
(``ECPs'') \27\ and SDRs. The Commission has previously determined that
ECPs are not ``small entities'' for purposes of the RFA.\28\ Since SDRs
are new entities to be regulated by the Commission pursuant to the
Dodd-Frank Act, the Commission has not previously determined whether
they are small entities for the purpose of the RFA. The Commission
therefore has determined that SDRs are not small entities for purposes
of the RFA. Specifically, the Commission has determined that SDRs
should not be considered small entities based on the central role they
will play in the national regulatory scheme overseeing the trading of
swaps, similarly to DCMs and DCOs, which the Commission has previously
determined not to be small entities on the same grounds.\29\ Moreover,
because they will be required to accept swaps across asset classes,
SDRs will require significant operational resources.
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\26\ 5 U.S.C. 601 et seq.
\27\ Under CEA Section 2(e), only ECPs are permitted to
participate in a swap subject to the end-user clearing exception.
\28\ See Opting Out of Segregation, 66 FR 20740 at 20743 (April
25, 2001).
\29\ See A New Regulatory Framework for Clearing Organizations,
66 FR 45604 at 45609 (Aug. 29, 2001)(DCOs); Policy Statement and
Establishment of Definitions of ``Small Entities'' for Purposes of
the Regulatory Flexibility Act, 47 FR 18618 at 18618-18619 (April
30, 1982)(DCMs).
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Accordingly, the Commission does not expect the proposed rules to
have a significant impact on a substantial number of small entities.
Therefore, the Chairman, on behalf of the Commission, hereby certifies,
pursuant to 5 U.S.C. 605(b), that the proposed regulation would not
have a significant economic impact on a substantial number of small
entities. The Commission invites the public to comment on whether the
entities covered by these proposed regulations should be considered
small entities for purposes of the RFA.
C. Paperwork Reduction Act
1. Overview
The Paperwork Reduction Act (``PRA'') \30\ imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. This
proposed rulemaking would result in new collection of information
requirements within the meaning of the PRA. The Commission therefore is
submitting this proposal to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The title for this collection of information is ``Rule 39.6
End-User Non-Cleared Swap Notification'' (OMB control number [3038-
NEW]). If
[[Page 80756]]
adopted, responses to this collection of information would be
mandatory.
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\30\ 44 U.S.C. 3501 et seq.
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An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. OMB has not yet assigned a control
number to the new collection for proposed rule 39.6. The requirements
of new rule 39.6 are not currently covered by any existing OMB control
number.
Proposed Rule 39.6 would require non-financial entities to notify
the Commission each time the end-user clearing exception is elected by
delivering specified information to a registered SDR or, if no
registered SDR is available, the Commission in the manner required by
the proposed part 49 rules for swaps data recordkeeping and reporting.
The notification will occur only once at the beginning of the swap life
cycle. If one of the counterparties to the swap transaction is a swap
dealer or a major swap participant, notification would be provided
through that counterparty. The non-financial counterparty would provide
notice only in the event its counterparty is not a swap dealer or a
major swap participant.
The Commission estimates that there are approximately 30,000 end
users who are counterparties to a swap in a given year. Of these end
users, the Commission estimates that the majority will not be required
to report under proposed Sec. 39.6 because their counterparty is a
swap dealer or major swap participant. In that case, as described
above, the swap dealer or major swap participant is required to make
the report on behalf of the end user. Also, end users who are
counterparties to a swap entered into in a previous year will
presumably have already made the notification under proposed Sec. 39.6
and therefore will not be required to make further notifications under
the rule in subsequent years. Reducing the number of annual end users
by these factors, the Commission estimates that there are approximately
1,000 end users who must report in a given year.\31\ The Commission
estimates that the report will require between approximately 10 minutes
and one hour of burden, per end user per year.\32\ The number of burden
hours per end user may vary depending on various factors, such as the
number of swaps entered into by that end user in the given year.
Therefore, the number of estimated aggregate annual burden hours is
between approximately 167 and 1,000 hours.
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\31\ The Commission requests public comment on this estimate.
\32\ The Commission requests public comment on this estimate.
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2. Confidentiality
The Commission protects proprietary information pursuant to the
Freedom of Information Act and 17 CFR part 145, ``Commission Records
and Information.'' In addition, Section 8(a)(1) of the CEA prohibits
the Commission, unless specifically authorized by the Act, from making
public ``data and information that would separately disclose the
business transactions or market positions of any person and trade
secrets or names of customers.'' \33\ The Commission also is required
to protect certain information contained in a government system of
records pursuant to the Privacy Act of 1974, 5 U.S.C. 552a.
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\33\ 7 U.S.C. 12(a)(1).
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3. Information Collection Comments
The Commission invites the public and other federal agencies to
comment on any aspect of the reporting burden discussed above. Pursuant
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments in order
to: (i) Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information would have practical
utility; (ii) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information; (iii) determine
whether there are ways to enhance the quality, utility, and clarity of
the information to be collected; and (iv) minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs (``OIRA'') in OMB, by fax at (202) 395-6566 or by e-
mail at [email protected]. Please provide the Commission with
a copy of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the Addresses section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. A copy of the supporting statements for the
collections of information discussed above may be obtained by visiting
RegInfo.gov.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission, before adopting a
rule or issuing an order, to take into consideration the public
interest protected by the antitrust laws and endeavor to take the least
anticompetitive means of achieving the objectives of the Act, as well
as the purposes and policies of the CEA.\34\ The Commission did not
identify any means by which the proposed end-user exception could be
implemented to achieve the objectives, purposes and policies of the CEA
in a less anticompetitive manner. The Commission invites comments on
all aspects of its rules proposal in this regard.
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\34\ See also Section 6 of the Dodd-Frank Act.
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E. Consideration of Impact on the Economy
Under the Small Business Enforcement Fairness Act of 1996
(``SBREFA''), federal agencies are called upon to advise the
Administrator of the OIRA in the OMB whether their proposed rules
constitute ``major'' rules.\35\ 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 the costs or prices
for consumers, individual industries, federal, state, or local
government agencies, or geographic regions; or (3) significant adverse
effects on competition, employment, investment, productivity,
innovation, or on the ability of United States-based enterprises to
compete with foreign-based enterprises in domestic and export
markets.\36\ If a rule is ``major,'' its effectiveness will generally
be delayed for 60 days pending Congressional review.
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\35\ See Public Law 104-121 (March 29, 1996), as amended by
Public Law 110-28 (May 25, 2007). The provisions governing
congressional review of agency rulemaking are set forth in SBREFA
Subtitle E, which is codified at 5 U.S.C. 801-808.
\36\ See 5 U.S.C. 804(2).
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The Commission requests comment on whether its proposed rule would,
if adopted, constitute a major rule under SBREFA. Commenters are
requested to provide empirical data and other factual support for their
view to the extent possible.
VI. Statutory Authority
Pursuant to the CEA, and particularly Section 2(h)(7) thereof, the
Commission proposes new Rule 39.6, as set forth below, governing the
exception to mandatory clearing of swaps established by CEA Section
2(h)(7).
[[Page 80757]]
List of Subjects in 17 CFR Part 39
Business and industry, Reporting requirements, Swaps.
For the reasons stated in the preamble, the Commission proposes to
amend 17 CFR part 39 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
1. The authority citation for part 39 is revised to read as
follows:
Authority: 7 U.S.C. 2, 5, 6, 6d, 7a-1, 7a-2, and 7b, as amended
by the Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
2. Section 39.6 is revised to read as follows:
Sec. 39.6 Electing to use the end-user exception to mandatory swap
clearing.
(a) A counterparty to a swap (an ``electing counterparty'') may
elect to use the exception to mandatory clearing under section
2(h)(7)(A)(iii) of the Act if the electing counterparty is not a
``financial entity'' as defined in section 2(h)(7)(C)(i) of the Act, is
using the swap to hedge or mitigate commercial risk as defined in Sec.
39.6(c), and provides or causes to be provided to a registered swap
data repository or, if no registered swap data repository is available,
the Commission, the information specified in Sec. 39.6(b). More than
one counterparty to a swap may be an electing counterparty. If there is
more than one electing counterparty to a swap, the information
specified in Sec. 39.6(b) shall be provided with respect to each of
the electing counterparties.
(b) When an electing counterparty to a swap elects to use the
exception to mandatory clearing under section 2(h)(7)(A)(iii) of the
Act, one of the counterparties to the swap (the ``reporting
counterparty'') shall provide or cause to be provided the following
information to a registered swap data repository or, if no registered
swap data repository is available, the Commission, in the form and
manner required for delivery of information specified under the
Commission's rules:
(1) The identity of the electing counterparty to the swap;
(2) Whether the electing counterparty is a ``financial entity'' as
defined in section 2(h)(7)(C)(i) of the Act;
(3) Whether the electing counterparty is a finance affiliate
meeting the requirements described in sections 2(h)(7)(C)(iii) or
2(h)(7)(D) of the Act;
(4) Whether the swap is used by the electing counterparty to hedge
or mitigate commercial risk as defined in Sec. 39.6(c) under the Act;
(5) Whether the electing counterparty generally expects to meet its
financial obligations associated with its non-cleared swap by using:
(i) A written credit support agreement;
(ii) Pledged or segregated assets (including posting or receiving
margin);
(iii) A written third-party guarantee;
(iv) Solely the electing counterparty's available financial
resources; or
(v) Means other than those described in Sec. 39.6(b)(5)(i), (ii),
(iii) or (iv); and
(6) Whether the electing counterparty is an entity that is an
issuer of securities registered under section 12 of, or is required to
file reports under 15(d) of, the Securities Exchange Act of 1934, and
if so:
(i) The relevant SEC Central Index Key number for that
counterparty; and
(ii) Whether an appropriate committee of the board of directors (or
equivalent body) has reviewed and approved the decision not to clear
the swap.
(c) For purposes of section 2(a)(7)(A)(ii) of the CEA and Sec.
39.6(b)(4), a swap shall be deemed to be used to hedge or mitigate
commercial risk when:
(1) Such swap:
(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 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 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 swap is:
(i) Not used for a purpose that is in the nature of speculation,
investing, or trading; or
(ii) Not used to hedge or mitigate the risk of another swap or
securities-based swap, unless that other swap itself is used to hedge
or mitigate commercial risk as defined by this rule or the equivalent
definitional rule governing security-based swaps promulgated by the
Securities and Exchange Commission under the Securities Exchange Act of
1934.
Issued in Washington, DC, on December 9, 2010, by the
Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to End-User Exception to Mandatory Clearing of Swaps--
Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn and
Chilton voted in the affirmative; Commissioners Sommers and O'Malia
voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rule on the end-user exception. Congress
decided that non-financial entities hedging or mitigating commercial
risk will have a choice of whether to submit their transactions to
clearinghouse.
In essence, the proposal says that, if a company is using a swap
to hedge an asset, liability, input or service that it currently has
or uses or anticipates having or using, it would qualify for the
end-user exception. In addition, the proposal says that if the swap
meets generally accepted accounting principles as a hedge or if it
used for bona fide hedging, the transaction would qualify for the
end-user exception. These non-financial entities would be able to
hedge interest rate risk, currency risk, physical commodity risk or
other types of risk.
The proposed rule does, however, say that if an entity is taking
a position to speculate,
[[Page 80758]]
the transaction would not qualify for the end-user exception.
I also support the series of questions included in the proposal
regarding small financial institutions. In the Dodd-Frank Act,
Congress directed the commission to consider possible exemptions for
small financial institutions. I look forward to hearing from the
public on their views on this and what conditions would be
appropriate for such exemptions.
[FR Doc. 2010-31578 Filed 12-22-10; 8:45 am]
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