Commodity Futures Trading Commission Securities and Exchange Commission

Tuesday,
December 21, 2010
Part III
Commodity Futures
Trading Commission
17 CFR Part 1
Securities and
Exchange
Commission
17 CFR Part 240
Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘Major
Swap Participant,’’ ‘‘Major Security-Based
Swap Participant’’ and ‘‘Eligible Contract
Participant’’; Proposed Rule
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80174 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
COMMODITY FUTURES TRADING ‘‘Definitions’’ must be in the subject field Advisor, at 202–551–5550, Division of
COMMISSION of responses submitted via e-mail, and Trading and Markets, Securities and
clearly indicated on written Exchange Commission, 100 F Street,
17 CFR Part 1 submissions. All comments must be NE., Washington, DC 20549–7010.
submitted in English, or if not, SUPPLEMENTARY INFORMATION:
RIN 3038–AD06
accompanied by an English translation.
All comments provided in any I. Background
SECURITIES AND EXCHANGE
COMMISSION electronic form or on paper will be On July 21, 2010, President Obama
published on the CFTC Web site, signed the Dodd-Frank Act into law.1
17 CFR Part 240 without review and without removal of Title VII of the Dodd-Frank Act 2
personally identifying information. All established a comprehensive new
[Release No. 34–63452; File No. S7–39–10] comments are subject to the CFTC regulatory framework for swaps and
Privacy Policy. security-based swaps. The legislation
RIN 3235–AK65 was enacted, among other reasons, to
SEC reduce risk, increase transparency, and
Further Definition of ‘‘Swap Dealer,’’
Electronic Comments promote market integrity within the
‘‘Security-Based Swap Dealer,’’ ‘‘Major
financial system, including by:
Swap Participant,’’ ‘‘Major Security- • Use the Commission’s Internet
(1) Providing for the registration and
Based Swap Participant’’ and ‘‘Eligible comment form (http://www.sec.gov/
comprehensive regulation of swap
Contract Participant’’ rules/proposed.shtml);
• Send an e-mail to rule- dealers, security-based swap dealers,
AGENCY: Commodity Futures Trading comments@sec.gov. Please include File major swap participants and major
Commission; Securities and Exchange Number S7–39–10 on the subject line; security-based swap participants;
Commission. or (2) imposing clearing and trade
ACTION: Joint proposed rule; proposed • Use the Federal eRulemaking Portal execution requirements on swaps and
interpretations. (http://www.regulations.gov). Follow the security-based swaps, subject to certain
instructions for submitting comments. exceptions; (3) creating rigorous
SUMMARY: In accordance with Section recordkeeping and real-time reporting
712(d)(1) of Title VII of the Dodd-Frank Paper Comments regimes; and (4) enhancing the
Wall Street Reform and Consumer • Send paper comments in triplicate rulemaking and enforcement authorities
Protection Act of 2010 (‘‘Dodd-Frank to Elizabeth M. Murphy, Secretary, of the Commissions with respect to,
Act’’), the Commodity Futures Trading Securities and Exchange Commission, among others, all registered entities and
Commission (‘‘CFTC’’) and the Securities 100 F Street, NE., Washington, DC intermediaries subject to the
and Exchange Commission (‘‘SEC’’) 20549–1090. Commissions’ oversight.
(collectively, the ‘‘Commissions’’), in All submissions should refer to File More specifically, the Dodd-Frank Act
consultation with the Board of Number S7–39–10. This file number provides that the CFTC will regulate
Governors of the Federal Reserve should be included on the subject line ‘‘swaps,’’ and the SEC will regulate
System, are proposing rules and if e-mail is used. To help us process and ‘‘security-based swaps.’’ The Dodd-Frank
interpretative guidance under the review your comments more efficiently, Act also adds to the CEA and Exchange
Commodity Exchange Act (‘‘CEA’’), 7 please use only one method. The Act definitions of the terms ‘‘swap
U.S.C. 1 et seq., and the Securities Commission will post all comments on dealer,’’ ‘‘security-based swap dealer,’’
Exchange Act of 1934 (‘‘Exchange Act’’), the Commission’s Internet Web site ‘‘major swap participant,’’ ‘‘major
15 U.S.C. 78a et seq., to further define (http://www.sec.gov/rules/ security-based swap participant,’’ and
the terms ‘‘swap dealer,’’ ‘‘security-based proposed.shtml). Comments are also ‘‘eligible contract participant.’’ These
swap dealer,’’ ‘‘major swap participant,’’ available for Web site viewing and terms are defined in Sections 721 and
‘‘major security-based swap participant,’’ printing in the Commission’s Public 761 of the Dodd-Frank Act and, with
and ‘‘eligible contract participant.’’ Reference Room, 100 F Street, NE., respect to the term ‘‘eligible contract
DATES: Submit comments on or before Washington, DC 20549, on official participant,’’ in Section 1a(18) of the
February 22, 2011. business days between the hours of 10 CEA,3 as re-designated and amended by
a.m. and 3 p.m. All comments received Section 721 of the Dodd-Frank Act.
ADDRESSES: Comments may be
will be posted without change; we do Section 712(d)(1) of the Dodd-Frank
submitted by any of the following Act provides that the CFTC and the
methods: not edit personal identifying
information from submissions. You SEC, in consultation with the Board of
CFTC: Governors of the Federal Reserve
• Agency Web site, via its Comments should submit only information that
System, shall jointly further define the
Online process: http:// you wish to make available publicly.
terms ‘‘swap,’’ ‘‘security-based swap,’’
comments.cftc.gov. Follow the FOR FURTHER INFORMATION CONTACT:
‘‘swap dealer,’’ ‘‘security-based swap
instructions for submitting comments CFTC: Mark Fajfar, Assistant General dealer,’’ ‘‘major swap participant,’’
through the Web site. Counsel, at 202–418–6636, ‘‘major security-based swap participant,’’
• Mail: David A. Stawick, Secretary, mfajfar@cftc.gov, Julian E. Hammar, ‘‘eligible contract participant,’’ and
Commodity Futures Trading Assistant General Counsel, at 202–418– ‘‘security-based swap agreement.’’
Commission, Three Lafayette Centre, 5118, jhammar@cftc.gov, or David E.

1155 21st Street, NW., Washington, DC Aron, Counsel, at 202–418–6621, 1 See Dodd-Frank Wall Street Reform and
20581. daron@cftc.gov, Office of General Consumer Protection Act, Public Law 111–203, 124
• Hand Delivery/Courier: Same as Counsel, Commodity Futures Trading Stat. 1376 (2010). The text of the Dodd-Frank Act
mail above. Commission, Three Lafayette Centre, may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
• Federal eRulemaking Portal: 1155 21st Street, NW., Washington, DC 2 Pursuant to Section 701 of the Dodd-Frank Act,
Comments also may be submitted at 20581; SEC: Joshua Kans, Senior Special Title VII may be cited as the ‘‘Wall Street
http://www.regulations.gov. Follow the Counsel, Jeffrey Dinwoodie, Attorney Transparency and Accountability Act of 2010.’’
instructions for submitting comments. Advisor, or Richard Grant, Attorney 3 See 7 U.S.C. 1a(18).
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80175
Further, Section 721(c) of the Dodd- significantly affect those markets. The (i) Holding oneself out as a dealer in
Frank Act requires the CFTC to adopt a rules not only will help determine swaps or security-based swaps,
rule to further define the terms ‘‘swap,’’ which entities will be subject to (ii) Making a market in swaps or
‘‘swap dealer,’’ ‘‘major swap participant,’’ comprehensive regulation of their swap security-based swaps,
and ‘‘eligible contract participant,’’ and and security-based swap activities, but (iii) Regularly entering into swaps or
Section 761(b) of the Dodd-Frank Act may also cause certain entities to security-based swaps with
permits the SEC to adopt a rule to modify their activities to avoid being counterparties as an ordinary course of
further define the terms ‘‘security-based subject to the regulations. As a result, business for one’s own account, or
swap,’’ ‘‘security-based swap dealer,’’ we are aware of the importance of (iv) Engaging in activity causing
‘‘major security-based swap participant,’’ crafting these rules carefully to oneself to be commonly known in the
and ‘‘eligible contract participant,’’ with maximize the benefits of the regulation trade as a dealer or market maker in
regard to security-based swaps, for the imposed by the Dodd-Frank Act, and to swaps or security-based swaps.11
purpose of including transactions and do so in a way that is flexible enough The definitions are disjunctive, in that
entities that have been structured to to respond to market developments. a person that engages in any of the
evade Title VII of the Dodd-Frank Act.4 While we preliminarily believe that enumerated dealing activities is a swap
In light of the requirements in the these proposals, if adopted, would dealer or security-based swap dealer
Dodd-Frank Act noted above, the CFTC appropriately effect the intent of the even if the person does not engage in
and the SEC issued a joint Advance Dodd-Frank Act, we are very interested any of the other enumerated activities.
Notice of Proposed Rulemaking in commenters’ views as to whether we The definitions, in contrast, do not
(‘‘ANPRM’’) on August 13, 2010, have achieved this purpose, and, if not, include a person that enters into swaps
requesting public comment regarding how to improve these proposals.8 or security-based swaps ‘‘for such
the definitions of ‘‘swap,’’ ‘‘security- person’s own account, either
based swap,’’ ‘‘security-based swap II. Definitions of ‘‘Swap Dealer’’ and individually or in a fiduciary capacity,
agreement,’’ ‘‘swap dealer,’’ ‘‘security- ‘‘Security-Based Swap Dealer’’ but not as a part of a regular
based swap dealer,’’ ‘‘major swap The Dodd-Frank Act defines the terms business.’’ 12 The Dodd-Frank Act also
participant,’’ ‘‘major security-based swap ‘‘swap dealer’’ and ‘‘security-based swap instructs the Commissions to exempt
participant,’’ and ‘‘eligible contract dealer’’ in terms of whether a person from designation as a dealer an entity
participant’’ in Title VII of the Dodd- engages in certain types of activities that ‘‘engages in a de minimis quantity
Frank Act.5 The Commissions reviewed involving swaps or security-based of [swap or security-based swap] dealing
more than 80 comments in response to swaps.9 Persons that meet either of in connection with transactions with or
the ANPRM. The Commissions also those definitions are subject to statutory on behalf of its customers.’’ 13 Moreover,
informally solicited comments on the requirements related to, among other the definition of ‘‘swap dealer’’ (but not
definitions on their respective Web things, registration, margin, capital and the definition of ‘‘security-based swap
sites.6 In addition, the staffs of the CFTC business conduct.10 dealer’’) provides that an insured
and the SEC have met with many The two definitions in general depository institution is not to be
market participants and other interested encompass persons that engage in any of considered a swap dealer ‘‘to the extent
parties to discuss the definitions.7 the following types of activity: it offers to enter into a swap with a
In this release, the Commissions customer in connection with originating
propose to further define ‘‘swap dealer,’’ 8 In addition, we recognize that the
a loan with that customer.’’ 14
‘‘security-based swap dealer,’’ ‘‘major appropriateness of these proposals also should be
The definitions also provide that a
swap participant,’’ ‘‘major security-based considered in light of the substantive requirements person may be designated as a dealer for
swap participant’’ and ‘‘eligible contract that will be applicable to dealers and major one or more types, classes or categories
participant,’’ and propose related rules, participants, including capital, margin and business of swaps, security-based swaps, or
conduct requirements, which are the subject of
and also discuss certain factors that are separate rulemakings. For example, whether the
activities without being designated a
relevant to market participants when definition of a major participant is too broad or too dealer for other types, classes or
determining their status with respect to narrow may well depend in part on the substantive categories or activities.15
the defined terms. In developing these requirements applicable to such entities, and The Commissions are proposing rules
whether those substantive requirements are
proposals, the Commissions have been themselves appropriate may in turn depend in part
to further define certain aspects of the
mindful that the markets for swaps and on the scope of the major participant definition. We meaning of ‘‘swap dealer’’ and ‘‘security-
security-based swaps are evolving, and therefore encourage comments that take into based swap dealer,’’ and are providing
that the rules that we adopt will, as account the interplay between the proposed guidance on how the Commissions
definitions and these substantive requirements.
intended by the Dodd-Frank Act, 9 See Section 721 of the Dodd-Frank Act (defining
propose to interpret these terms. This
‘‘swap dealer’’ in new Section 1a(49) of the CEA, 7 release specifically addresses: (A) The
4 The definitions of the terms ‘‘swap,’’ ‘‘security-
U.S.C. 1a(49)) and Section 761 of the Dodd-Frank types of activities that would cause a
based swap,’’ and ‘‘security-based swap agreement,’’ Act (defining ‘‘security-based swap dealer’’ in new person to be a swap dealer or security-
and regulations regarding mixed swaps are the Section 3(a)(71) of the Exchange Act, 15 U.S.C.
subject of a separate rulemaking by the
based swap dealer, including
78c(a)(71)).
Commissions. 10 The Dodd-Frank Act excludes from the
differences in how those two definitions
5 See Definitions Contained in Title VII of Dodd-
Exchange Act definition of ‘‘dealer’’ persons who should be applied; (B) the statutory
Frank Wall Street Reform and Consumer Protection engage in security-based swap transactions with provisions requiring the Commissions to
Act, Exchange Act Rel. No. 34–62717, 75 FR 51429 eligible contract participants. See Section 3(a)(5) of exempt persons from the dealer
(Aug. 20, 2010). The comment period for the the Exchange Act, 15 U.S.C. 78c(a)(5), as amended
ANPRM closed on September 20, 2010. by Section 761(a)(1) of the Dodd-Frank Act. 11 See CEA section 1a(49)(A); Exchange Act
6 Comments were solicited by the CFTC at
The Dodd-Frank Act does not include comparable
http://www.cftc.gov/LawRegulation/DoddFrankAct/ section 3(a)(71)(A).
amendments for persons who act as brokers in 12 See CEA section 1a(49)(C); Exchange Act
OTC_2_Definitions.html and the SEC at http:// swaps and security-based swaps. Because security-
www.sec.gov/spotlight/regreformcomments.shtml/. based swaps are a type of security, persons who act section 3(a)(71)(C).
7 The views expressed in the comments in 13 See CEA section 1a(49)(D); Exchange Act
as brokers in connection with security-based swaps
response to the ANPRM, in response to the must, absent an exemption, register with the SEC section 3(a)(71)(D).
14 CEA section 1a(49)(A).
Commissions’ informal solicitation, and at such as a broker pursuant to Exchange Act section 15(a),
meetings are collectively referred to as the views of and comply with the Exchange Act’s requirements 15 See CEA section 1a(49)(B); Exchange Act
‘‘commenters.’’ applicable to brokers. section 3(a)(71)(B).
definitions in connection with de out’’ as a dealer should qualify as a swap are diverse, and there does not appear
minimis activity; (C) the exception from dealer only if it ‘‘consistently and to be a single set of criteria that can be
the ‘‘swap dealer’’ definition in systematically markets itself as a dealer determinative in all markets.
connection with loans by insured to third-parties.’’ 16 At the same time, we note that there
depository institutions; (D) the Many commenters called for the may be certain distinguishing
possibility that a person may be exclusion of particular types of persons characteristics of swap dealers and
considered a dealer for some types, from the definition of swap dealer or security-based swap dealers, including
classes or categories of swaps, security- security-based swap dealer. Several that:
based swaps, or activities but not others; commenters maintained that • Dealers tend to accommodate
and (E) certain interpretative issues that commercial end-users of swaps or demand for swaps and security-based
arise in particular situations. The security-based swaps that enter into swaps from other parties;
Commissions request comment on all swaps or security-based swaps to hedge • Dealers are generally available to
aspects of the proposals, including the or mitigate commercial risk should be enter into swaps or security-based
particular points noted in the discussion excluded from the definitions. Another swaps to facilitate other parties’ interest
below. commenter stated the definitions should in entering into those instruments;
exclude persons who use swaps or • Dealers tend not to request that
A. Swap and Security-Based Swap security-based swaps for bona fide other parties propose the terms of swaps
Dealing Activity hedging. Other commenters indicated or security-based swaps; rather, dealers
1. Comments Regarding Dealing that cooperatives that enter into swaps tend to enter into those instruments on
Activities in connection with the business of their their own standard terms or on terms
members should be excluded. they arrange in response to other
Commenters provided numerous parties’ interest; and
Commenters also stated that if all of a
examples of conduct they viewed as
person’s swaps are cleared on an • Dealers tend to be able to arrange
dealing activities—as well as conduct customized terms for swaps or security-
exchange or derivatives clearing
they did not view as dealing activities. based swaps upon request, or to create
organization, the person should not be
For example, many of the commenters new types of swaps or security-based
deemed to be a dealer. One commenter
stated that dealers provide ‘‘bid/ask’’ or swaps at the dealer’s own initiative.
stated competitive power suppliers
‘‘two-way’’ prices for swaps on a regular We also recognize that the principles
should be excluded, and another stated
basis, or regularly participate in both relevant to identifying dealing activity
that the dealer definition should not
sides of the swap market. Some involving swaps can differ from
apply to futures commission merchants
commenters indicated that dealers comparable principles associated with
that act economically like brokers.
perform an intermediary function. Other Commenters, particularly those in the security-based swaps. These differences
commenters stated that a person holds securities industry, urged the are due, in part, to differences in how
itself out as a dealer if it consistently Commissions to interpret the definitions those instruments are used. For
and systematically markets itself as a of swap dealer and security-based swap example, because security-based swaps
swap dealer to third parties. Some dealer consistently with precedent that may be used to hedge or gain economic
commenters described market makers in distinguishes between dealers in exposure to underlying securities (while
the swap markets as persons that stand securities and traders in securities. recognizing distinctions between
ready to buy or sell swaps at all times, However, one commenter also noted securities-based swaps and other types
are open to doing swaps business on that some concepts from the securities of securities, as discussed below), there
both sides of a market, or make bids to and commodities laws may not easily be is a basis to build upon the same
buy and offers to sell swaps or a type applied to these markets. principles that are presently used to
of swap at all times. Commenters stated identify dealers for other types of
that a person should be included in the 2. Application of the Core Tests to securities. Accordingly, we separately
definition of dealer if its sole or ‘‘Swap Dealers’’ and ‘‘Security-Based address how the core tests would apply
dominant line of business is swaps Swap Dealers’’ to swap dealers and to security-based
activity. One commenter urged the The Dodd-Frank Act defines the terms swap dealers.
Commissions to adopt a swap ‘‘swap dealer’’ and ‘‘security-based swap a. Application to Swap Dealers
association’s definition of a primary dealer’’ in a functional manner,
member as the definition of dealer. encompassing how a person holds itself The definition of swap dealer should
Some commenters stated that the out in the market, the nature of the be informed by the differences between
definition of dealer should be read conduct engaged in by the person, and swaps, on the one hand, and securities
narrowly. For example, some how the market perceives the person’s and commodities, on the other.
commenters suggested that the market activities. This suggests that the Transactions in cash market securities
maker concept should not encompass definitions should not be interpreted in and commodities generally involve
persons that provide occasional quotes a constrained or overly technical purchases and sales of tangible or
or that do not make bids or offers manner. Rigid standards would not intangible property. Swaps, in contrast,
consistently or at all times. Another provide the necessary flexibility to are notional contracts requiring the
commenter stated that a willingness to respond to evolution in the ways that performance of agreed terms by each
buy or sell a swap or security-based dealers enter into swaps and security- party.17 Thus, many of the concepts
swap at a particular time does not based swaps. The different types of cited by commenters, such as whether a
constitute market making absent the swap and security-based swap markets person buys and sells swaps or makes
creating of a two-way market. One a two-sided market in swaps or trades
commenter suggested that solely acting 16 See letter from Eric Dennison, Sr. Vice within a bid/offer spread, cannot
as a market maker should not cause a President and General Counsel, Stephanie Miller,
person to be a dealer, since firms may Assistant General Counsel—Commodities, and Bill 17 As discussed below, however (see note 42,
Hellinghausen, Director of Regulatory Affairs, EDF infra), the Dodd-Frank Act amended the Exchange
have commercial purposes for offering Trading, dated September 20, 2010 (distinguishing Act definitions of ‘‘buy,’’ ‘‘purchase,’’ ‘‘sale’’ and
two-way trades. Another commenter transactions that the commenter enters into as part ‘‘sell’’ to apply to particular actions involving
stated that an entity that ‘‘holds itself of energy management services). security-based swaps.
necessarily be applied to all types of significant uncertainty among based swaps may be used to hedge risks
swaps to determine if the person is a commenters. The commenters point out associated with the ownership of certain
swap dealer. We understand that market that its literal terms could encompass other types of securities,22 and security-
participants do use this terminology many parties who regularly enter into based swaps may be used to gain
colloquially to describe the process of swaps without engaging in any form of economic exposure akin to ownership of
entering into a swap. For example, a swap dealing activity. In this regard, certain other types of securities.23 As a
person seeking a fixed/floating interest clause (A)(iii) of the definition should result, the SEC would consider the same
rate swap may inquire as to the fixed be read in combination with the express factors that are relevant to determining
rates, spread above the floating rate and exception in subparagraph (C) of the whether a person is a ‘‘dealer’’ under the
other payments that another person swap dealer definition, which excludes Exchange Act as also generally relevant
would require in order to enter into a ‘‘a person that enters into swaps for such to the analysis of whether a person is a
swap. But, while these persons may person’s own account, either security-based swap dealer.
discuss bids, offers, prices and so forth, individually or in a fiduciary capacity, The Exchange Act has been
the parties are negotiating the terms of but not as a part of a regular business.’’ interpreted to distinguish between
a contract, they are not negotiating the Thus, the difference between the ‘‘dealers’’ and ‘‘traders.’’ In this context,
price at which they will transfer inclusion in clause (A)(iii) and the the SEC previously has noted that the
ownership of tangible or intangible exclusion in subparagraph (C) is dealer-trader distinction:
property. Accordingly, these concepts whether or not the person enters into Recognizes that dealers normally have a
are not determinative of whether a swaps as a part of, or as an ordinary regular clientele, hold themselves out as
person is a ‘‘swap dealer.’’ course of, a ‘‘regular business.’’ 20 We buying or selling securities at a regular place
Instead, persons who are swap dealers believe that persons who enter into of business, have a regular turnover of
swaps as a part of a ‘‘regular business’’ inventory (or participate in the sale or
may be identified by the functional role
are those persons whose function is to distribution of new issues, such as by acting
they fulfill in the swap markets. As as an underwriter), and generally provide
noted above, swap dealers tend to accommodate demand for swaps from liquidity services in transactions with
accommodate demand and to be other parties and enter into swaps in investors (or, in the case of dealers who are
available to enter into swaps to facilitate response to interest expressed by other market makers, for other professionals).24
other parties’ interest in swaps parties. Conversely, persons who do not
fulfill this function should not be Other non-exclusive factors that are
(although swap dealers may also relevant for distinguishing between
advance their own investment and deemed to enter into swaps as part of a
‘‘regular business’’ and are not likely to dealers and non-dealers can include the
liquidity objectives by entering into receipt of customer property and the
such swaps). In addition, swap dealers be swap dealers.
In sum, to determine if a person is a furnishing of incidental advice in
can often be identified by their connection with transactions.
relationships with counterparties. Swap swap dealer, we would consider that
person’s activities in relation to the The markets involving security-based
dealers tend to enter into swaps with swaps are distinguishable in certain
more counterparties than do non- other parties with which it interacts in
the swap markets. If the person is respects from markets involving cash
dealers, and in some markets, non- market securities—particularly with
dealers tend to constitute a large portion available to accommodate demand for
regard to the concepts of ‘‘inventory’’
of swap dealers’ counterparties. In swaps from other parties, tends to
(which generally appears inapplicable
contrast, non-dealers tend to enter into propose terms, or tends to engage in the
in this context) 25 and ‘‘regular place of
swaps with swap dealers more often other activities discussed above, then
business.’’ For example, the suggestion
than with other non-dealers.18 The the person is likely to be a swap dealer.
that dealers are more likely to operate at
Commissions can most efficiently Persons that rarely engage in such
a ‘‘regular place of business’’ than traders
achieve the purposes underlying Title activities are less likely to be deemed
should not be construed in a way that
VII of the Dodd-Frank Act—to reduce swap dealers.
We request comment on this ignores the reality of how the security-
risk and to enhance operational based swap markets operate (or that
interpretive approach for identifying
standards and fair dealing in the swap
whether a person is a swap dealer.
markets—by focusing their attention on (not including security-based swaps, other than
those persons whose function is to serve b. Application to Security-Based Swap security-based swaps with or for persons that are
not eligible contract participants) for such person’s
as the points of connection in those Dealers own account, either individually or in a fiduciary
markets. The definition of swap dealer, The definition of ‘‘security-based capacity, but not as a part of a regular business.’’
construed functionally in the manner swap dealer’’ has parallels to the Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C.
set forth above, will help to identify 78c(a)(5)(A) and (B), as amended by Section
definition of ‘‘dealer’’ under the 761(a)(1) of the Dodd-Frank Act.
those persons. Exchange Act.21 In addition, security- 22 For example, an entity that owns a particular
Clause (A)(iii) of the statutory security may use a security-based swap to hedge the
definition of swap dealer, which entered into swaps as an agent for customers (i.e., risks of that security. Conversely, an entity may
includes any person that ‘‘regularly for the customers’ accounts) would be required to seek to offset exposure involving a security-based
enters into swaps with counterparties as register as either a Futures Commission Merchant, swap by using another security as a hedge.
Introducing Broker, Commodity Pool Operator or 23 For example, an entity may enter into a
an ordinary course of business for its Commodity Trading Advisor, depending on the security-based swap to gain economic exposure
own account,’’ 19 has been the subject of nature of the person’s activity. akin to a long or short position in a stock or bond,
20 The definition of ‘‘security-based swap dealer’’ without having to engage in a cash market
18 Some of the commenters appeared to suggest is structured similarly, and should be interpreted transaction for that instrument.
that significant parts of the swap markets operate similarly. 24 Securities Exchange Act Release No. 47364
without the involvement of swap dealers. We 21 The Exchange Act in relevant part defines (Feb. 13, 2003) (footnotes omitted).
believe that this analysis is likely incorrect, and that ‘‘dealer’’ to mean ‘‘any person engaged in the 25 In particular, an analysis that considers dealers
the parties that fulfill the function of dealers should business of buying and selling securities (not to differ from traders in part because dealers have
be identified and are likely to be swap dealers. including security-based swaps, other than security- regular turnover in ‘‘inventory’’ appears not to apply
19 We interpret this reference to a person entering based swaps with or for persons that are not eligible in the context of security-based swaps, given that
into swaps ‘‘with counterparties * * * for its own contract participants) for such person’s own those instruments are created by contract between
account’’ to refer to a person entering into a swap account through a broker or otherwise,’’ but with an two market counterparties, rather than reflecting
as a principal, and not as an agent. A person who exception for ‘‘a person that buys or sells securities financial rights issued by third-parties.
ignores evolution in dealing practices c. Issues Common to Both Definitions dealer or security-based swap dealer
involving other types of securities). i. Holding Oneself Out as, and Being may appropriately reflect, among other
Dealers may use a variety of methods to Commonly Known in the Trade as, a factors, the perspective of persons with
communicate their availability to enter Swap Dealer or Security-Based Swap substantial experience with and
into security-based swaps with other Dealer knowledge of the swap and security-
market participants. The dealer-trader based swap markets, regardless of
As noted above, the application of whether an entity is known as a dealer
distinction should not be applied to the
these definitions to persons that ‘‘hold by persons without that experience and
security-based swap markets without
themselves out’’ as dealers or that are knowledge.
taking those distinctions into account.26
‘‘commonly known in the trade’’ as
Even in light of those differences, dealers highlights the need for a ii. Making a Market in Swaps or
however, we believe that the dealer- functional interpretation of the dealer Security-Based Swaps
trader distinction provides an important definitions. We believe that factors that A number of commenters suggested
analytical tool to assist in determining may reasonably indicate that a person is that the market making component of
whether a person is a ‘‘security-based holding itself out as a dealer or is the definitions should apply only to
swap dealer.’’ commonly known in the trade as a persons that quote a two-sided market
Commenters have raised concerns dealer may include (but are not limited consistently or at all times. Some
that the ambit of the security-based to) the following: commenters also suggested that a
swap dealer definition could encompass • Contacting potential counterparties person’s willingness to buy or to sell a
end-users that use security-based swaps to solicit interest in swaps or security- swap or security-based swap at any
for hedging their business risks. based swaps, particular time should not be deemed to
Deeming those entities to be security- • Developing new types of swaps or be market making activity. While
security-based swaps (which may continuous two-sided quotations and a
based swap dealers due to their hedging
include financial products that contain willingness to stand ready to buy and
activities could discourage their use of
swaps or security-based swaps) and sell a security are important indicators
hedging transactions or subject them to of market making in the equities
informing potential counterparties of
a regulatory framework that was not markets,29 these indicia may not be
the availability of such swaps or
intended to address their businesses and appropriate in the context of the swap
security-based swaps and a willingness
could subject them to unnecessary costs. to enter into such swaps or security- or security-based swap markets, given
Under the dealer-trader distinction, based swaps with the potential that parties do not enter into many types
however, we would expect entities that counterparties, of swaps or security-based swaps on a
use security-based swaps to hedge their • Membership in a swap association continuous basis, and that parties may
business risks, absent other activity, in a category reserved for dealers, use a variety of methods for
likely would not be dealers.27 Also, as • Providing marketing materials (such communicating their willingness to
discussed below, both the ‘‘security- as a Web site) that describe the types of enter into swaps or security-based
based swap dealer’’ definition and the swaps or security-based swaps that one swaps. Any analysis that would impute
dealer-trader distinction in part turn on is willing to enter into with other to the definitions a ‘‘continuous’’ activity
whether a person holds itself out as a parties, or requirement may cause certain persons
dealer. • Generally expressing a willingness that engage in non-continuous dealing
We request comment on the to offer or provide a range of financial activities not to be regulated as swap
application of the dealer-trader products that would include swaps or dealers or security-based swap dealers.
security-based swaps. We have not identified anything in the
distinction as part of the analysis of
Notably, holding oneself out as a statutory text or legislative history of the
whether a person is a security-based
security-based swap dealer would likely Dodd-Frank Act to suggest that Congress
swap dealer. intended such a result.
encompass a situation in which a
person that is a ‘‘dealer’’ in another type iii. No Predominance Test
of security enters into a security-based
swap with a customer.28 Another Although some commenters suggested
26 The definition of ‘‘security-based swap dealer,’’
example of holding oneself out as a that a person should be a swap dealer
unlike the Exchange Act’s definition of ‘‘dealer,’’ security-based swap dealer would likely or security-based swap dealer only if
does not specifically refer to ‘‘buying’’ and ‘‘selling.’’
be an entity expressing its availability to such activity is the person’s sole or
We do not believe that this language difference is
provide liquidity to counterparties that predominant business, the statutory
significant, however, as the Dodd-Frank Act definition does not contain a
amended the Exchange Act definitions of ‘‘buy’’ and seek to enter into security-based swaps,
regardless of the ‘‘direction’’ of the predominance test or otherwise depend
‘‘purchase,’’ and the Exchange Act definitions of
‘‘sale’’ and ‘‘sell,’’ to encompass the execution, transaction or across a broad spectrum upon the level of the person’s dealing
termination (prior to its scheduled maturity date), of risks (e.g., credit default swaps activity, other than the de minimis
assignment, exchange or similar transfer or related to a variety of issuers). exception discussed below. A
conveyance of, or extinguishing of rights or predominance standard would not
obligations under, a security-based swap. See Dodd-
The determination of who is
Frank Act sections 761(a)(3), (4) (amending commonly known in the trade as a swap 29 See Exchange Act Release No. 58875 (Oct. 14,
Exchange Act sections 3(a)(13), (14)). 2008), 73 FR 61690 (Oct. 17, 2008) (‘‘Although
27 Of course, if a person’s other activities satisfy 28 For example, if a person that is a dealer in determining whether or not a market maker is
the definition of security-based swap dealer, it must securities that are not security-based swaps enters engaged in bona-fide market making would depend
comply with the applicable requirements with into a security-based swap transaction with one of on the facts and circumstances of the particular
its cash market customers, the person would appear activity, factors that indicate a market maker is
regard to all of its security-based swap activities,
to be engaged in security-based swap dealing engaged in bona-fide market making activities may
absent an order to the contrary, as discussed below. activity with that customer. In that circumstance, include, for example, whether the market maker
Also, as discussed below, we would expect end- the customer reasonably would be expected to view incurs any economic or market risk with respect to
users to use security-based swaps for hedging the person as a dealer for purposes of the security- the securities (e.g., by putting their own capital at
purposes less commonly than they use swaps for based swap, making the applicable business risk to provide continuous two-sided quotes in
hedging purposes. conduct requirements particularly important. markets).’’).
provide a workable test of dealer status commenters are requested to address B. De Minimis Exemption to the
because many of the parties that are whether additional guidance is Definitions
commonly acknowledged as swap or advisable to help identify dealer activity The Dodd-Frank Act requires that the
security-based swap dealers also engage and to promote effective enforcement of Commissions exempt, from designation
in other businesses that often outweigh the requirements applicable to swap as a ‘‘swap dealer’’ or ‘‘security-based
their swap or security-based swap dealers and security-based swap dealers. swap dealer,’’ a person who ‘‘engages in
dealing business in terms of transaction a de minimis quantity of [swap or
volume or other measures. Based on the 3. Designation of a Person as a Swap
security-based swap] dealing in
plain meaning of the statutory Dealer connection with transactions with or on
definition, so long as a person engages behalf of its customers.’’ 33 The statutory
in dealing activity that is not de The Dodd-Frank Act has amended the
CEA and the Exchange Act to require a definitions do not require that the
minimis, as discussed below, the person Commissions fix a specific level of swap
is a swap dealer or security-based swap person that meets either of the
definitions to register as a swap dealer activity that will be considered de
dealer.30 minimis, but instead require that the
and/or security-based swap dealer,31
iv. Application of the Definition to New Commissions ‘‘promulgate regulations to
and the Commissions are proposing
Types of Swaps and New Activities establish factors with respect to the
separate rules regarding this registration
The Commissions intend to apply the making of this determination to
requirement. In connection with the exempt.’’
definitions of swap dealer and security- registration requirement, market
based swap dealer flexibly when the participants are in a position to assess 1. Comments Regarding the De Minimis
development of innovative business their activities to determine whether Exemption
models is accompanied by new types of they function in the manner described Some commenters asserted that the de
dealer activity. As discussed above, the in the definitions. In addition, the minimis exemption should be linked to
Commissions generally intend to follow Commissions have the authority to take systemic risk concerns, stating that
a ‘‘facts-and-circumstances’’ approach persons engaged in dealing activities
enforcement actions in response to a
with respect to identifying dealing that do not pose systemic risk should be
dealer’s failure to register. In
activities. The dealer definitions must
determining whether a person meets the able to take advantage of the exemption.
be flexible enough to cover appropriate
applicable definitions, the Commissions Other commenters suggested that a
persons as the swap markets evolve.
may use information from other person’s dealing activities should be
v. Request for Comment regulators, swap data repositories, considered de minimis if they do not
The Commissions request comment registered clearing agencies, derivatives pose undue risks to the person.
on these interpretations of holding clearing organizations and other Commenters also expressed the view
oneself out as a dealer and being sources. that the application of the exemption
commonly known in the trade as a should be based on quantitative criteria.
dealer, as well as the lack of a 4. Application of the Swap Dealer
Definition to Agricultural Commodities 2. Proposed Rule Regarding the De
predominance test, and the application Minimis Exemption
of the definitions to new types of swaps Section 723(c)(3)(B) of the Dodd- The Commissions preliminarily
and new activities. Commenters Frank Act provides that swaps in
particularly are requested to address the believe that the ‘‘de minimis’’ exemption
agricultural commodities shall be should be interpreted to address
relevance, to the dealer analysis, of subject to such terms and conditions as
activities such as an entity’s amounts of dealing activity that are
the CFTC may prescribe. In a separate sufficiently small that they do not
membership in a swap execution facility
rulemaking, the CFTC has proposed a warrant registration to address concerns
(‘‘SEF’’) or a security-based SEF, or use
definition of the term ‘‘agricultural implicated by the regulations governing
of facilities that may not be SEFs or
security-based SEFs. Are there factors commodity.’’ 32 Acting under the swap dealers and security-based swap
that would lead entities to become authority in Section 723(c)(3)(B), the dealers.34 In other words, the exemption
members of SEFs that would not make CFTC may develop particular terms and should apply only when an entity’s
membership relevant to the dealer conditions for the interpretation of the dealing activity is so minimal that
analysis? Commenters also are swap dealer definition when it is applying dealer regulations to the entity
requested to generally address how the applied to dealing in swaps in would not be warranted.
agricultural commodities. Any such We thus preliminarily do not agree
dealer analysis should appropriately
terms and conditions would not be with those commenters that argued that
apply the requirements applicable to
dealers (e.g., capital, margin and applicable to the definition of security- 33 See CEA section 1a(49)(D); Exchange Act
business conduct requirements) to the based swap dealer. The CFTC requests section 3(a)(71)(D).
entities that should be subject to those comment on the application of the swap 34 The Title VII requirements applicable to swap
requirements. In addition, commenters dealer definition to dealers, including and security-based swap dealers include, for
are requested to address how the dealer potentially agricultural cooperatives, example: requirements that dealers conform to
regulatory standards relating to the confirmation,
definitions should be applied to entities that limit their dealing activity processing, netting, documentation and valuation of
such as, for example, Federal home loan primarily to swaps in agricultural swaps and security-based swaps (CEA section 4s(i),
banks subject to restrictions limiting commodities. The CFTC may consider Exchange Act section 15F(i)); requirements that
their dealing activities to particular any comments on this topic for both the dealers disclose, to regulators, information
concerning terms and conditions of swaps or
types of counterparties. Finally, definition of swap dealer and also for security-based swaps, as well as information
any rulemaking regarding swaps in concerning trading practices, financial integrity
30 As one example, a non-financial company that protections and other trading information (CEA
agricultural commodities.
engages in both swap dealing and other commercial section 4s(j)(3), Exchange Act section 15F(j)(3));
activities would fall within the definition of swap conflicts of interest provisions (CEA section 4s(j)(5),
31 See CEA section 4s(a)–(b); Exchange Act
dealer because of its swap dealing activities, Exchange Act section 15F(j)(5)); and chief
notwithstanding that it also engages in other section 15F(a)–(b). compliance officer requirements (CEA section 4s(k),
commercial activities. 32 See 75 FR 65586 (Oct. 26, 2010). Exchange Act section 15F(k)).
a de minimis quantity of dealing should proposed threshold would reflect 20 Commissions preliminarily believe that
be measured in relation to the level of instruments of that size. Given the an entity that enters into swaps or
the person’s other activities (or other customer protection issues raised by security-based swaps, in a dealer
swap or security-based swap activities). swaps and security-based swaps— capacity, with a larger number of
Aside from the fact that the statute does including the risks that counterparties counterparties should be registered to
not explicitly call for a relative test, may not fully appreciate when entering help achieve Title VII’s orderly market
such an approach would lead to the into swaps or security-based swaps—we goals, and thus cannot be said to engage
result that larger and more active believe that this notional amount in a de minimis quantity of dealing
companies, which presumably would be reflects a reasonable limit for identifying (even if the aggregate effective notional
more able to influence the swap those entities that engage in a de amount of the swaps or security-based
markets, would be more likely to qualify minimis level of dealing activity.37 This swaps is less than the thresholds noted
for the exemption than smaller and less standard would measure an entity’s above).42 For purposes of determining
active companies. Also, a relative test quantity of dealing on a gross basis the number of counterparties, we
not only would require a means of (without consideration of the market preliminarily believe that counterparties
measuring the person’s dealing risk offsets associated with combining who are members of an affiliated group
activities, but also would require a long and short positions) to reflect the would generally count as one
means of measuring the larger scope of entity’s overall amount of dealing counterparty, given that the purpose of
activities to which its swap dealing or activity. Similarly, the proposed the limit is to measure the scope of
security-based swap dealing activities notional threshold would not account dealer’s interaction with separate
are to be compared, thus introducing for the amount of collateral held by or counterparties.43
unnecessary complexity to the provided by the entity, nor other risk Finally, the proposed rule would
exemption’s application. mitigating factors, in determining provide that, to take advantage of the de
Our proposed factors for the de whether it engages in a de minimis minimis exemption, the entity could not
minimis exemption seek to focus the quantity of dealing, given that dealer have entered into more than 20 swaps
availability of the exemption toward status focuses on an entity’s absolute or security-based swaps (as applicable)
entities for which registration would not level of activity, and is not directly as a dealer during the prior 12 months.44
be warranted from a regulatory point of based on the risks that an entity poses As is the case for the limitation on the
view in light of the limited nature of or faces.38 number of counterparties, the
their dealing activities. At the same In addition, the aggregate effective Commissions preliminarily believe that
time, we recognize that this focus does notional amount of such swaps or an entity that enters into a larger
not appear to readily translate into security-based swaps, in which the number of swaps or security-based
objective criteria. Thus, while the person’s counterparty is a ‘‘special swaps, in a dealer capacity, would, if
proposed factors discussed below reflect entity’’ (as that term is defined in CEA registered, help achieve Title VII’s
our attempt to delimit the de minimis Section 4s(h)(2)(C) and Exchange Act orderly market goals, and thus cannot be
exemption appropriately, we recognize Section 15F(h)(2)(C)),39 that an entity said to engage in a de minimis quantity
that a range of alternative approaches enters into over the prior 12 months of dealing. For these purposes, we
may be reasonable, and we are could not exceed $25 million.40 The would expect that each separate
particularly interested in commenters’ Dodd-Frank Act provided special transaction the entity enters into under
suggestions as to the appropriate factors. protections to special entities in a swap or security-based swap master
The first proposed factor is that the connection with swaps and security- agreement in general would count as
aggregate effective notional amount, based swaps, and we preliminarily entering into a swap or security-based
measured on a gross basis, of swaps or believe that this lower proposed swap, but that an amendment of an
security-based swaps that an entity threshold reasonably reflects the special existing swap or security-based swap in
enters into over the prior 12 months in protections afforded to those entities. which the counterparty remained the
connection with its dealing activities 35 In addition, to take advantage of the same and the underlying item remained
could not exceed $100 million.36 We de minimis exemption, the proposed substantially the same would not count
understand that in general the notional rule would provide that the entity could as a new swap or security based swap.45
size of a small swap or security-based not have entered into swaps or security-
swap is $5 million or less, and this based swaps (as applicable) as a dealer 12 months provides certainty. As of the end of each
with more than 15 counterparties, other month, the entity will know whether it may qualify
35 The de minimis exemption specifically places than security-based swap dealers, over for the exemption during the following month.
42 Similarly, because all the de minimis factors
limits on a person’s dealing activity involving the prior 12 months.41 The
swaps or security-based swaps. Thus, these limits must be satisfied, a person who enters into only a
would not apply to swap or security-based swap single swap or security-based swap, as a swap
37 We preliminarily believe that activity above
activity that does not itself constitute dealing dealer, with a single counterparty could not qualify
activity, such as activity in which a person hedges this amount would be sufficient to warrant dealer for the de minimis exemption if that swap or
or mitigates a commercial risk of its business that registration to bring about the benefits of such security-based swap exceeds the effective notional
is unrelated to a dealing business (i.e., as discussed registration. amount threshold.
38 Also, allowing offsets for collateral would 43 For this purpose, an affiliated group would be
above, when the person did not accommodate
demand from the other party, respond to the other result in a de minimis standard that could defined as any group of entities that is under
party’s interest in swaps or security-based swaps, encompass positions of virtually unlimited size. common control and that reports information or
39 The term ‘‘special entity’’ encompasses: Federal prepares its financial statements on a consolidated
solicit the other party, propose economic terms,
intermediate between parties, provide liquidity, or agencies; States, State agencies and political basis.
engage in other dealing activities). See part II.A.2, subdivisions (including cities, counties and 44 See proposed CEA rule 1.3(ppp)(4)(iv);
supra. municipalities); ‘‘employee benefit plans’’ as proposed Exchange Act rule 3a71–2(d).
36 See proposed CEA rule 1.3(ppp)(4)(ii); defined under the Employee Retirement Income 45 For these purposes only, an amendment to an
proposed Exchange Act rule 3a71–2(a). To the Security Act of 1974 (‘‘ERISA’’); ‘‘governmental existing swap or security-based swap would not
extent that the stated notional amount of a swap or plans’’ as defined under ERISA; and endowments. need to be counted as a new swap or security-based
40 See proposed CEA rule 1.3(ppp)(4)(ii);
security-based swap is leveraged or enhanced by its swap if the underlying item is substantially the
structure, the calculation shall be based on the proposed Exchange Act rule 3a71–2(b). same as the original item. This may occur, for
effective notional amount of the swap or security- 41 See proposed CEA rule 1.3(ppp)(4)(iii); example, to reflect the effect of a corporate action
based swap rather than on its stated notional proposed Exchange Act rule 3a71–2(c). That these such as a merger. An amendment would be counted
amount. tests measure the entity’s activities over the prior as a new swap or security-based swap, however, to
The proposed rule would not whether the proposed threshold for appear in the definition of ‘‘security-
distinguish between different types of transactions with ‘‘special entities’’ based swap dealer.’’
swaps or security-based swaps into would provide a disincentive to dealers
1. Comments Regarding the Exclusion
which entities may enter (e.g., rate entering into transactions with such
for Swaps in Connection With Loans
swaps versus other commodity swaps, entities.
or credit default swaps versus equity Commenters further are requested to Three IDIs commented on this aspect
swaps). The Commissions preliminarily address whether the factors may of the definition, stating that the
do not believe that the ceiling for appropriately account for the size of the exclusion should encompass any swap
distinguishing de minimis dealing swap or security-based swap activities entered into contemporaneously with a
activities from other dealing activities compared to the size of the entity; how loan that is related to any of the
appropriately turns upon the particular an entity’s swaps or security-based borrower’s activities that affect the
type of swap or security-based swap.46 swaps with affiliated counterparties ability to repay the loan and can be
The Commissions request comment should be treated for purposes of the hedged. Thus, in their view, the
on the proposed rule regarding the de test; and whether the exemption’s exclusion should cover exchange rate
minimis exemption. Commenters factors should vary depending on the and physical commodity swaps in
particularly are requested to address type of swap or security-based swap at addition to interest rate swaps. The IDIs
whether certain of the proposed factors issue. also said the exclusion should apply to
should be modified or eliminated; for In addition, commenters are requested amendments, restructurings and
example, should the proposed $100 to address the significance of the fact workouts of loans, and to lenders that
million limit on annual notional swaps that the statutory de minimis exemption act through a syndicate.
or security-based swaps entered into in specifically references transactions with Another commenter expressed similar
a dealer capacity be raised or lowered to or on behalf of a customer. Does that views, and also asked for clarification
better implement the intended scope of mean the exemption was intended to whether the exclusion applies to all
the de minimis exemption—i.e., to specifically address dealing activity as aspects of the definition, or if it applies
exclude entities for which dealer an accommodation to an entity’s only to whether a person is commonly
regulation would not be warranted? customers? If so, should the exemption known in the trade as a swap dealer.
Should we adopt different thresholds be conditioned on the presence of an The CFTC preliminarily believes the
that would appropriately limit the existing relationship between the entity exclusion applies to all aspects of the
exemption so it encompasses only those and the counterparty that does not swap dealer definition.
entities whose dealing activities are
entail swap or security-based swap
such that dealer regulation is not 2. Proposed Rule Regarding the
dealing activity, and if so, which types
warranted? To what extent would Exclusion for Swaps in Connection
of relationships should be treated as
certain entities be expected to reduce or With Loans
creating a ‘‘customer’’ relationship?
otherwise adjust their dealing activity to
Commenters also are requested to The CFTC preliminarily interprets the
fall within the scope of the de minimis
address whether the de minimis word ‘‘offer’’ in this exclusion to include
exemption? Would there be any adverse
exemption should excuse an entity from scenarios where the IDI requires the
implications for market participants if
having to comply with certain customer to enter into a swap, or the
this happens? To what extent could the
regulatory requirements imposed on customer asks the IDI to enter into a
proposed factors potentially reduce
dealing activity, and in doing so reduce swap dealers or security-based swap swap, specifically in connection with a
the liquidity available in the swap or dealers, while also mandating loan made by that IDI. Also, the
security-based swap market? compliance with other dealer proposed rule provides that, in order to
Commenters also are requested to requirements. In addition, commenters prevent evasion, the statutory exclusion
address whether the rule should seek to are requested to address whether, in lieu does not apply where (i) The purpose of
identify only certain types of of the self-executing approach proposed the swap is not linked to the financial
counterparties with which a person here, the Commissions instead should terms of the loan; (ii) the IDI enters into
could engage in dealing activities under require that entities which seek relief a ‘‘sham’’ loan; or (iii) the purported
the exemption. We also particularly under this de minimis exemption must ‘‘loan’’ is actually a synthetic loan such
request comment on the proposed $25 submit exemptive requests to the as a loan credit default swap or loan
million notional threshold for dealer relevant agency for the agency’s total return swap.
transactions with ‘‘special entities,’’ consideration and action. Commenters The proposed rule would apply the
including whether that proposed further are requested to address whether statutory exclusion only to swaps that
threshold should be raised or lowered, the proposed notional threshold for the are connected to the financial terms of
and whether an entity that enters into de minimis exception should be subject the loan, such as, for example, its
dealing transactions with ‘‘special to a formula that permits automatic duration, interest rate, currency or
entities’’ should be able to take periodic adjustments to the threshold, principal amount. Although
advantage of the exemption at all. In such as to reflect changes in market size commenters urged that this exclusion be
addition, we request comment on or in the size of typical contracts. extended to other aspects of the lending
C. Statutory Exclusion for Swaps in relationship, we preliminarily believe
the extent that the change in the underlying item
Connection With Originating a Loan that it would not be appropriate that
modifies the economic risk reflected by the swap this exclusion from the swap dealer
or security-based swap. The ‘‘swap dealer’’ definition excludes definition encompass swaps that are
46 The Exchange Act’s definition of ‘‘dealer’’ does
an insured depository institution (‘‘IDI’’) connected to the borrower’s other
not include a de minimis exemption. Thus, an
entity that engages in dealing activity involving ‘‘to the extent it offers to enter into a business activities, even if the loan
securities (other than security-based swaps with swap with a customer in connection agreement requires that the borrower
eligible contract participants) would be required to with originating a loan with that enter into such swaps or otherwise
register as a ‘‘dealer’’ under the Exchange Act, and customer.’’ 47 This exclusion does not
comply with the Exchange Act’s requirements
refers to them. We preliminarily believe
applicable to dealers, absent some other exception that a broader reading of the exclusion
or exemption from registration. 47 See CEA section 1a(49)(A). could encompass all swap activity
between an IDI and its borrowers, which whether this exclusion should also dealer for only specified categories of
we do not think is intended. apply to swaps entered into during part swaps, security-based swaps, or
The origination of commercial loans or all of the duration of the loan. activities, without being classified as a
is a complex process, and the CFTC dealer for all categories.51 This proposed
preliminarily believes that this D. Designation as a Dealer for Certain
rule would afford persons an
exclusion should be available to all IDIs Types, Classes, or Categories of Swaps,
opportunity to seek, on an appropriate
that are a source of funds to a borrower. Security-Based Swaps, or Activities
showing, a limited designation based on
For example, all IDIs that are part of a The statutory definitions include a facts and circumstances applicable to
loan syndicate providing a loan to a provision stating that a person may be their particular activities. The
borrower could claim this exclusion designated as a dealer for one or more Commissions anticipate that a swap
with respect to swaps entered into with types, classes or categories of swaps, dealer could seek a limited designation
the borrower that are connected to the security-based swaps, or activities at the same time as, or at a later time
financial terms of the loan. Similarly, without being considered a swap dealer subsequent to, the person’s initial
the proposed exclusion could be or security-based swap dealer for other registration as a swap dealer.
claimed with respect to such swaps types, classes or categories of swaps, The CFTC understands that there may
entered into by any IDI that participates security-based swaps, or activities. This potentially be non-financial entities,
in or obtains a participation in such provision is permissive and does not such as physical commodity firms, that
loan by means of a transfer or require the Commissions to designate conduct swap dealing activity through a
otherwise.48 Also, an IDI that is a source persons as dealers for only a limited set division of the entity, and not a
of funds for the refinancing of a loan of types, classes or categories of swaps, separately-incorporated subsidiary. In
(whether directly or through a security-based swaps, or activities. these instances, the entity’s swap
syndicate, participation or otherwise) dealing activity would not be a core
could claim the exclusion if it enters 1. Comments Regarding Limited
Designation as a Swap Dealer or component of the entity’s overall
into a swap with the refinancing business. If this type of entity registered
borrower. Security-Based Swap Dealer
as a swap dealer, the CFTC anticipates
We emphasize that this proposed One commenter stated that the that certain swap dealer requirements
exclusion, by its statutory terms, is Commissions should allow a person to would apply to the swap dealing
available only to IDIs. If an IDI were to register as a swap dealer or security- activities of the division, but not
transfer its participation in a loan to a based swap dealer for only a limited set necessarily to the swap activities of
non-IDI, then the non-IDI would not be of types, classes or categories of swaps other parts of the entity.
able to claim this exclusion, regardless or security-based swaps. Another The Commissions request comment
of the terms of the loan or the manner commenter expressed the view that a on the proposed rules regarding limited
of the transfer. Similarly, a non-IDI that person designated as a swap dealer or designation as a swap dealer or security-
is part of a loan syndicate with IDIs security-based swap dealer should be based swap dealer. Commenters
would not be able to claim the designated as such for all types of swaps particularly are requested to address the
exclusion. or security-based swaps, respectively. circumstances in which such limited
In sum, the proposed exclusion may
2. Proposed Rule Regarding Limited purpose designations would be
be claimed by a person that meets the
Designation as a Swap Dealer or appropriate, the factors that the
following three conditions: (i) The
Security-Based Swap Dealer Commissions should consider when
person is an IDI; (ii) the person is the
addressing such requests, and the type
source of funds to a borrower in In general, the Commissions propose
of information requestors should
connection with a loan (either directly that a person that satisfies the definition
provide in support of their request. For
or through syndication, participation, of swap dealer or security-based swap
example, would it be appropriate to
refinancing or otherwise); and (iii) the dealer would be a dealer for all types,
grant such limited purpose designations
person enters into a swap with the classes or categories of swaps or
borrower that is connected to the only to entities that do not otherwise
security-based swaps, or activities
financial terms of the loan (so long as fall within the definition of a financial
involving swaps or security-based
the loan is not a sham or a synthetic entity, and whose dealing activity is
swaps, in which the person engages.49
loan). below a defined threshold of the entity’s
Thus, the person would be subject to all
The CFTC requests comment on the overall activity? At what level should
regulatory requirements applicable to
proposed rule relating to the statutory the Commissions set such a threshold?
dealers for all swaps or security-based
exclusion for swaps in connection with Which of the requirements applicable to
swaps into which it enters. We propose
originating a loan, and in particular on dealers should or should not apply to
this approach because it may be difficult
whether this statutory exclusion should such entity’s non-dealing activities in
for swap dealers and security-based
be extended beyond swaps that are swaps and security-based swaps?
swap dealers to separate their dealing In addition, commenters are requested
connected to the financial terms of the activities from their other activities
loan, and if so, why. The CFTC also to address whether the Commissions
involving swaps or security-based should provide for limited purpose
requests comment on whether this swaps.50
exclusion should apply only to swaps designations of swap dealers or security-
The proposed rule also states,
that are entered into contemporaneously based swap dealers through some other
however, that the Commissions may
with the IDI’s origination of the loan mechanism as an alternative to, or in

provide for a person to be designated as
(and if so, how ‘‘contemporaneously’’ a swap dealer or security-based swap 51 CEA section 1a(49)(B); Exchange Act section
should be defined for this purpose), or 3(a)(71)(B). As discussed below, the Commissions
49 See proposed CEA rule 1.3(ppp)(3); proposed
preliminarily believe that there are four major
48 The CFTC preliminarily believes that the Exchange Act rule 3a71–1(c). categories of swaps and two major categories of
proposed exclusion could be claimed by any IDI 50 For example, in order to efficiently impose the security-based swaps. See part IV.A, infra. The
that participates in a loan through any means that dealer requirements on only the person’s dealing designation as a swap dealer or security-based swap
involves a payment to a lender to take the place of activities, it may be necessary for the person to have dealer may, for example, be limited in terms of
that lender, including an ‘‘English style’’ separate books and records and a separate these categories or in terms of particular activities
participation. compliance regime for its dealing activities. of the person.
addition to, case-by-case evaluations of commonly known as a dealer. To the institutions. This institution stated that
individual applications. If so, what extent, however, that an entity seeks to it enters into offsetting swaps with
criteria and procedures would be use transactions between persons under larger financial institutions so that it is
appropriate for making limited purpose common control to avoid one of the in a neutral position between the
designations through this type of dealer definitions, the Commissions counterparties and the larger financial
approach? Also, should the limited have the authority to prohibit practices institutions.
purpose designation apply on a designed to evade the requirements The result of these arrangements is
provisional basis starting at the time applicable to swap dealers and security- that such persons engage in activities
that the entity makes an application for based swap dealers.53 that are similar in many respects to
a limited purpose designation? The Commissions invite comment as those of a swap dealer as set out in the
Finally, commenters also are asked to to how the swap dealer and security- definition—the person enters into swaps
address whether such limited purpose based swap dealer definitions should be to accommodate demand from other
designations should be conditioned in applied to members of an affiliated parties, it enters into swaps with a
any way, such as by the provision of group. Commenters particularly are relatively large number of non-dealers,
information of the type that would be invited to address how the Commissions and it holds itself out as willing to enter
required with respect to an entity’s should interpret common control for into swaps. It may be that the swap
swaps or security-based swaps these purposes, and whether this dealing activities of these aggregators
involving the particular category or interpretation should be limited to would not exceed the de minimis
activity for which they are not wholly-owned affiliates. threshold, and therefore they would not
designated as a dealer. be swap dealers. The CFTC, in
2. Application to Particular Swap particular, requests comment as to how
E. Certain Interpretative Issues Markets the de minimis threshold would apply
1. Affiliate Issues The swap markets are diverse and to such persons. If their activity would
We preliminarily believe that the encompass a variety of situations in exceed the de minimis threshold set
word ‘‘person’’ in the swap dealer and which parties enter into swaps with forth in the proposed rule, the
security-based swap dealer definitions each other. We believe it is helpful to Commissions request comment on the
should be interpreted to mean that the the understanding of the rule to discuss application of the swap dealer
designation applies with respect to a some of these situations, particularly definition to their activity.
particular legal person. That is, for those that have been raised by
b. Physical Market Participants
example, we would not view a trading commenters, here. The situations
discussed below include persons who The markets in physical commodities
desk or other discrete business unit that
enter into swaps as aggregators, as part such as oil, natural gas, chemicals and
is not a separately organized legal
of their participation in physical metals are complex and varied. They
person as a swap dealer; rather, the legal
markets, or in connection with the involve a large number of market
person of which it is a part would be the
generation and transmission of participants that, over time, have
swap dealer. Also, an affiliated group of
electricity. We invite comment as to developed highly customized
legal persons under common control
what aspects of the parties’ conduct in transactions and market practices that
could include more than one dealer.
these situations should, or should not, facilitate efficiencies in their market in
Within such a group, any legal person
be considered swap dealing activities, unique ways. Some of these transactions
that engages in swap or security-based
and whether the parties involved in would be encompassed by the statutory
swap dealing activities would be a swap
these situations are swap dealers. definition of ‘‘swap,’’ and some
dealer or security-based swap dealer, as
participants in these markets engage in
applicable. a. Aggregators swap dealing activities that are above
In determining whether a particular
Commenters explained that some the proposed de minimis threshold. The
legal person is a swap dealer or security-
persons enter into swaps with other Commissions invite comment as to any
based swap dealer, we preliminarily
parties in order to aggregate the swap different or additional factors that
believe it would be appropriate for the
positions of the other parties into a size should be considered in applying the
person to consider the economic reality
that would be more amenable to swap dealer definition to participants in
of any swaps and security-based swaps
entering into swaps in the larger swap these markets.
it enters into with affiliates (i.e., legal
persons under common control with the market, or otherwise to make entering c. Electricity Generation and
person at issue), including whether into such swaps more efficient. For Transmission
those swaps and security-based swaps example, certain cooperatives enter into
swaps with smaller cooperatives, The use of swaps in the generation
simply represent an allocation of risk and transmission of electricity is highly
within a corporate group.52 Swaps and smaller businesses or their members in
order to establish a position in a complex because electricity cannot be
security-based swaps between persons stored and therefore is generated,
under common control may not involve commodity that is large enough to be
traded on a swap or futures market. transmitted and used on a continuous,
the interaction with unaffiliated persons real-time basis. Also, the number and
that we believe is a hallmark of the Similarly, one smaller financial
institution explained that it enters into variety of participants in the electricity
elements of the definitions that refer to market is very large and some electricity
swaps with counterparties whose swap
holding oneself out as a dealer or being services are provided as a public good
positions would not be large enough to
52 Such swaps and security-based swaps should be of interest to larger financial rather than for profit. Nevertheless,
be considered in this way only for purposes of
some participants engage in swap
determining whether a particular person is a swap 53 See Dodd-Frank Act sections 721(b)(2), dealing activities as described above
dealer or security-based swap dealer and does not 761(b)(3). For example, it would not be permissible that are above the de minimis threshold
necessarily apply in the context of the Exchange for an entity that provides liquidity on one side of set forth in the proposed rule. The
Act’s general definition of ‘‘dealer.’’ The swaps and the market to use affiliated entities to provide
security-based swaps, moreover, would continue to liquidity on the other side in an attempt to avoid
Commissions invite comment as to any
be subject to all laws and requirements applicable having to register as a swap or security-based swap different or additional factors that
to such swaps and security-based swaps. dealer. should be considered in applying the
swap dealer definition to participants in unlawful for a non-ECP to enter into a suggesting that Congress intended the
the generation and transmission of security-based swap unless a Commissions to undertake a wholesale
electricity. Specifically, the registration statement is in effect. While revision of the ECP definition.
Commissions invite comment on this means that non-ECPs cannot enter Accordingly, the Commissions are
whether there are special into swaps on SEFs or on a bilateral, off- limiting the further definition of the
considerations, including without exchange basis, it also opens swaps to term ECP to the discrete issues
limitation special considerations arising non-ECPs, so long as the swaps are discussed below.
from section 201(f) of the Federal Power entered into on, or subject to the rules
C. New ECP categories
Act, related to non-profit, public power of, a DCM. Similarly, while non-ECPs
systems such as rural electric cannot enter into security-based swaps The CEA definition of ECP generally
cooperatives and entities operating as unless the transaction is effected on a is comprised of regulated persons; 60
political subdivisions of a State, and the national securities exchange and the entities defined as ECPs based on a total
applicability of the exemptive authority security-based swap has an effective asset test (e.g., a corporation,
in section 722(f) of the Dodd-Frank Act registration statement, it also opens partnership, proprietorship,
to address those considerations. security-based swaps to non-ECPs. organization, trust, or other entity with
Congress also amended 58 the ECP total assets exceeding $10 million) 61 or
III. Amendments to Definition of definition in Section 721(a)(9) of the an alternative monetary test coupled
Eligible Contract Participant Dodd-Frank Act by: (1) Raising a with a non-monetary component (e.g.,
A. Overview threshold that governmental entities an entity with a net worth in excess of
may use to qualify as ECPs, in certain $1 million and engaging in business-
The Commodity Futures
situations, from $25 million in related hedging; 62 or certain employee
Modernization Act of 2000 (‘‘CFMA’’) 54
discretionary investments to $50 million benefit plans, the investment decisions
generally excluded or exempted
in such investments; and (2) replacing of which are made by one of four
transactions between eligible contract
the ‘‘total asset’’ standard for individuals enumerated types of regulated
participants (‘‘ECPs’’) from most entities 63); and certain governmental
to qualify as ECPs with a discretionary
provisions of the CEA.55 Section entities and individuals that meet
investment standard.59
723(a)(1)(A) of the Dodd-Frank Act defined thresholds.64
repeals those exclusions and B. Commenters’ Views Persons in the new major swap
exemptions. ECP status remains The ECP definition elicited comment participant, major security-based swap
important, however, because Section from nine commenters. The comments participant, swap dealer and security-
723(a)(2) of the Dodd-Frank Act renders ranged from requests not to increase the based swap dealer categories are likely
it unlawful for a non-ECP to enter into monetary thresholds for governmental to be among the most active and largest
a swap other than on, or subject to the employee benefit plans in certain users of swaps and security-based
rules of, a designated contract market instances to suggestions to dramatically swaps. Accordingly, the Commissions
(‘‘DCM’’).56 Section 763(e) of the Dodd- raise them across the board, and from propose to further define the term ECP
Frank Act also renders it unlawful for a requests not to change the definition in to include these new categories, which
non-ECP to enter into a security-based a way that would limit the commenter’s will permit such persons to enter into
swap unless such transaction is effected access to swaps to specific proposals to swaps and security-based swaps on
on a national securities exchange address such otherwise limited access. SEFs and on a bilateral basis (where
registered pursuant to Section 6(b) of In the Dodd-Frank Act, Congress otherwise permitted under the Dodd-
the Exchange Act.57 In addition, Section addressed aspects of the ECP definition Frank Act and regulations thereunder).
768(b) of the Dodd-Frank Act makes it that it found to be of particular concern We seek comment on this proposed
regarding governmental entities and expansion of the ECP definition.
54 Public Law 106–554, 114 Stat. 2763 (Dec. 21,
individuals. Otherwise, though, persons
2000). D. Relationship Between Retail Foreign
who qualified for exclusions or
55 See CEA sections 2(d) (Excluded Derivative Currency and ECP Status in the Context
exemptions to enter into bilateral, off-
Transactions), 2(e) (Excluded Electronic Trading of a Commodity Pool
Facilities), 2(g) (Excluded Swap Transactions) and exchange swaps prior to the Dodd-Frank
2(h) (Legal Certainty for Certain Transactions in Act will still qualify to do so with Prior to the Dodd-Frank Act, clause
Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). respect to non-standardized swaps (A)(iv) of the ECP definition provided
The CFMA also excluded swap agreements from the that a commodity pool was an ECP if the
definitions of ‘‘security’’ in Section 3(a)(10) of the
under the Dodd-Frank Act, with the
Exchange Act and Section 2(a)(1) of the Securities exceptions discussed below. We have pool and its operator met certain
Act. See Section 3A of the Exchange Act, 15 U.S.C. not identified any legislative history requirements (i.e., the commodity pool
78c–1, and Section 2A of the Securities Act, 15 has $5 million in total assets and is
U.S.C. 77b–1 (both of which have been modified by 58 The changes to the ECP definition made by the operated by a commodity pool operator
the Dodd-Frank Act). The CFMA, however,
provided that the SEC had antifraud authority over
Dodd-Frank Act originated in the Administration’s regulated under the CEA or subject to
‘‘White Paper’’ on financial regulatory reform. See
security-based swap agreements. Financial Regulatory Reform, A New Foundation:
56 Section 723(a)(2) of the Dodd-Frank Act adds 60 CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii),
Rebuilding Financial Supervision and Regulation,
new subsection (e) to CEA section 2 (7 U.S.C. 2(e)). available at http://www.financialstability.gov/docs/ (ix), (x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii),
New CEA section 2(e) provides that ‘‘[i]t shall be regs/FinalReprot_web.pdf, at 48–49 (June 17, 2009) (ix), (x)), as redesignated by Section 721(a)(9) of the
unlawful for any person, other than an eligible (‘‘Current law seeks to protect unsophisticated Dodd-Frank Act.
61 CEA section 1a(18)(A)(v)(I) (7 U.S.C.
contract participant, to enter into a swap unless the parties from entering into inappropriate derivatives
swap is entered into on, or subject to the rules of, transactions by limiting the types of counterparties 1a(18)(A)(v)(I)), as redesignated by Section 721(a)(9)
a board of trade designated as a contract market that could participate in those markets. But the of the Dodd-Frank Act.
under section 5.’’ 62 CEA section 1a(18)(A)(v)(III) (7 U.S.C.
limits are not sufficiently stringent.’’).
57 Section 763(e) of the Dodd-Frank Act adds 59 The monetary component of ECP status for 1a(18)(A)(v)(III)), as redesignated by Section
paragraph (l) to Exchange Act section 6. New individuals remains the same under the amended 721(a)(9) of the Dodd-Frank Act.
63 CEA section 1a(18)(A)(vi) (7 U.S.C.
Exchange section 6(l) provides that ‘‘[i]t shall be ECP definition: More than $10 million (but now in
unlawful for any person to effect a transaction in discretionary investments, not in total assets), or $5 1a(18)(A)(vi)), as redesignated by Section 721(a)(9)
a security-based swap with or for a person that is million if the transactions for which ECP status is of the Dodd-Frank Act.
not an eligible contract participant, unless such necessary are for risk management of an asset or 64 CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C.
transaction is effected on a national securities liability the individual owns or incurs, or is 1a(18)(A)(vii) and (xi), as redesignated by Section
exchange registered pursuant to subsection (b).’’ reasonably likely to own or incur. 721(a)(9) of the Dodd-Frank Act.
foreign regulation), regardless of their own participants, the Commissions IV. Definitions of ‘‘Major Swap
whether each pool participant was itself propose to preclude a Retail Forex Pool Participant’’ and ‘‘Major Security-Based
an ECP.65 Section 741(b)(10) of the from being an ECP pursuant to clause Swap Participant’’
Dodd-Frank Act amended clause (A)(iv) (A)(iv) of the ECP definition if there is The definitions of ‘‘major swap
of the ECP definition to provide that a a non-ECP participant at any investment participant’’ and ‘‘major security-based
commodity pool engaging in retail level (e.g., a participant in the pool itself swap participant’’ (also jointly referred
foreign currency transactions of the type (a direct participant), an investor or to as the ‘‘major participant’’ definitions)
described in CEA sections 2(c)(2)(B) or participant in a fund or pool that invests respectively focus on the market
2(c)(2)(C) ; 66 (‘‘retail forex’’ and such in the pool in question (an indirect impacts and risks associated with an
pools, ‘‘Retail Forex Pools’’) no longer participant), an investor or participant entity’s swap and security-based swap
qualifies as an ECP for those purposes in a fund or pool that invests in that positions. In this respect, the major
if any participant in the pool is not investor fund or pool (also an indirect participant definitions differ from the
independently an ECP. The participant), etc.). definitions of ‘‘swap dealer’’ and
Commissions believe that in some cases Similarly, the Commissions believe ‘‘security-based swap dealer,’’ which
commodity pools unable to satisfy the that some commodity pools unable to focus on an entity’s activities and
conditions of clause (A)(iv) of the ECP satisfy the total asset or regulated status account for the amount or significance
definition may rely on clause (A)(v) to components of clause (A)(iv) of the ECP of those activities only in the context of
qualify as ECPs instead for purposes of definition may rely on clause (A)(v) to the de minimis exception.
retail forex. Clause (A)(v) of the ECP qualify as ECPs instead. The Despite those differences in focus,
definition applies to business entities Commissions are of the view that a persons that meet the major participant
irrespective of their form of organization commodity pool that cannot satisfy the definitions in large part must follow the
(i.e., corporations, partnerships, monetary and regulatory status same statutory requirements that apply
proprietorships, organizations, trusts conditions prescribed in clause (A)(iv) to swap dealers and security-based swap
and other entities), and contains a $1 should not qualify as an ECP in reliance dealers.68 In this way, the statute
million net worth test where such an on clause (A)(v) of the ECP definition. applies comprehensive regulation to
entity ‘‘enters into an agreement, Therefore, the Commissions propose to entities whose swap or security-based
contract, or transaction in connection further define the term ECP to prevent swap activities do not cause them to be
with the conduct of the entity’s business such an entity from qualifying as an ECP dealers, but nonetheless could pose a
or to manage the risk associated with an pursuant to clause (A)(v) of the ECP high degree of risk to the U.S. financial
asset or liability owned or incurred or definition. system generally.69
reasonably likely to be owned or The major participant definitions are
incurred by the entity in the conduct of E. Request for comment similar in their key provisions, although
the entity’s business.’’ 67 The Commissions request comment one exception, as discussed below, is
The Commissions believe that on all aspects of the proposed available only in connection with the
permitting Retail Forex Pools with one amendments to the definition of ‘‘major swap participant’’ definition.
or more non-ECP participants to achieve ‘‘eligible contract participant.’’ Are the Both major participant definitions
ECP status by relying on clause (A)(v) of proposed interpretations with respect to encompass persons that satisfy any of
the ECP definition would frustrate the Retail Forex Pools and other commodity three alternative tests: 70
intent of Congress in denying ECP status pools appropriate? Do entities described • The first test encompasses persons
to Retail Forex Pools under clause in the various enumerated ECP that maintain a ‘‘substantial position’’ in
(A)(iv). Consequently, the Commissions categories (other than commodity pools) any of the ‘‘major’’ categories of swaps or
propose to further define the term ECP rely on clause (A)(v) to qualify as ECPs? security-based swaps, as those
to preclude a Retail Forex Pool with one If so, should an entity that would be categories are determined by the CFTC
or more non-ECP participants from described in one of the clauses of
qualifying as an ECP by relying on paragraph (A) of the ECP definition, but
68 In particular, under CEA section 4s and
clause (A)(v) of the ECP definition if Exchange Act section 15F, dealers and major
cannot satisfy the conditions prescribed participants in swaps or security-based swaps
such Retail Forex Pool is not an ECP in that clause, be prohibited from generally are subject to the same types of margin,
due to the language added to clause relying on clause (A)(v) of the ECP capital, business conduct and certain other
(A)(iv) of the ECP definition by section definition? requirements, unless an exclusion applies. See CEA
741(b)(10) of the Dodd-Frank Act (i.e., section 4s(h)(4), (5); Exchange Act section 15F(h)(4),
In addition, should the Commissions (5).
because the pool contains one or more further narrow any or all of the ECP 69 As discussed below, the tests of the major
non-ECP participants). Because categories? Why or why not? If so, what participant definitions use terms—particularly
commodity pools can be structured in additional conditions would be ‘‘systemically important,’’ ‘‘significantly impact the
various ways and can have one or more financial system’’ or ‘‘create substantial counterparty
appropriate? Should the Commissions exposure’’—that denote a focus on entities that pose
feeder funds and/or pools, many with define the term ‘‘discretionary basis,’’ as a high degree of risk through their swap and
65 CEA section 1a(12)(A)(iv) (7 U.S.C.
requested by one commenter, either security-based swap activities. In addition, the link
solely for purposes of clause (A)(vii) or between the major participant definition and risk
1a(12)(A)(iv)). was highlighted during the Congressional debate on
66 7 U.S.C. 2(c)(2)(B) and (C). See generally clause (A)(xi), or for both clauses? the statute. See 156 Cong. Rec. S5907 (daily ed. July
‘‘Regulation of Off-Exchange Retail Foreign Alternatively, should the Commissions 15, 2010) (dialogue between Senators Hagen and
Exchange Transactions and Intermediaries,’’ 75 FR add any additional categories of ECPs, Lincoln, discussing how the goal of the major
55410 (Final Rule; Sept. 10, 2010) (discussing the such as the following categories participant definition was to ‘‘focus on risk factors
new CFTC retail forex regulatory regime); that contributed to the recent financial crisis, such
‘‘Regulation of Off-Exchange Retail Foreign suggested by commenters: Commercial as excessive leverage, under-collateralization of
Exchange Transactions and Intermediaries,’’ 75 FR real estate developers; energy or swap positions, and a lack of information about the
3282 (Proposed Rule; Jan. 20, 2010) (providing agricultural cooperatives or their aggregate size of positions’’).
historical background on the regulation of retail members; or firms using swaps as 70 Also, neither major participant definition
forex transactions). encompasses an entity that meets the respective
67 CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), hedges pursuant to the terms of the swap dealer or security-based swap dealer
as redesignated by Section 721(a)(9) of the Dodd- CFTC’s Swap Policy Statement? If so, definition. See CEA section 1a(33)(A); Exchange Act
Frank Act. which ones and why? section 3(a)(67)(A)(i).
or SEC as applicable. This test excludes underlying commercial risks related to A. ‘‘Major’’ Categories of Swaps and
both ‘‘positions held for hedging or interest rate and foreign currency Securities-Based Swaps
mitigating commercial risk,’’ and exposures, 90 percent or more of which The first and third tests of the
positions maintained by or contracts arise from financing that facilitates the statutory major participant definitions
held by any employee benefit plan (as purchase or lease of products, 90 encompass entities that have a
defined in paragraphs (3) and (32) of percent or more of which are substantial position in a ‘‘major’’
section 3 of ERISA (29 U.S.C. 1002)) for manufactured by the parent company or category of swaps or security-based
the primary purpose of hedging or another subsidiary of the parent swaps. The Commissions are
mitigating risks directly associated with company.’’ 76 responsible for designating these
the operation of the plan.71 Although the two major participant ‘‘major’’ categories.78
• The second test encompasses definitions are similar, they address The Commissions propose to
persons whose outstanding swaps or instruments that reflect different types designate ‘‘major’’ categories of swaps
security-based swaps create ‘‘substantial of risks and that can be used by end- and security-based swaps in a manner
counterparty exposure that could have users and other market participants for that reflects the risk profiles of these
serious adverse effects on the financial different purposes. Interpretation of the various instruments and the different
stability of the United States banking definitions must appropriately account purposes for which end-users make use
system or financial markets.’’ 72 for those differences. of the various instruments. We
• The third test encompasses any The Commissions are proposing rules preliminarily believe that it is important
‘‘financial entity’’ that is ‘‘highly to further define the ‘‘major swap not to parse these ‘‘major’’ categories so
leveraged relative to the amount of participant’’ and ‘‘major security-based finely as to base the ‘‘substantial
capital such entity holds and that is not swap participant’’ definitions, by position’’ thresholds on unduly narrow
subject to capital requirements specifically addressing: (a) The ‘‘major’’ risks that would reduce those
established by an appropriate Federal categories of swaps or securities-based thresholds’ effectiveness as risk
banking agency’’ and that maintains a swaps; (b) the meaning of ‘‘substantial measures. The ‘‘major’’ categories will
‘‘substantial position’’ in swaps or position’’; (c) the meaning of ‘‘hedging or apply only for purposes of the major
security-based swaps for any of the mitigating commercial risk’’; (d) the participant definitions and are not
‘‘major’’ categories of swaps or security- meaning of ‘‘substantial counterparty necessarily determinative with respect
based swaps.73 exposure that could have serious to any other provision of the Dodd-
The statute directs the CFTC or the adverse effects on the financial stability Frank Act or the regulations adopted
SEC to define ‘‘substantial position’’ for of the United States banking system or thereunder.
the respective definition at the financial markets’’; and (e) the meanings
threshold that it determines to be of ‘‘financial entity’’ and ‘‘highly 1. Major Categories of Swaps
‘‘prudent for the effective monitoring, leveraged.’’ We also are proposing rules We propose to designate four ‘‘major’’
management, and oversight of entities to specify the use of a daily average categories of swaps for purposes of the
that are systemically important or can methodology for identifying whether a ‘‘major swap participant’’ definition. The
significantly impact the financial system person meets one of the major four categories are rate swaps, credit
of the United States.’’ The definitions participant definitions, provide for a swaps, equity swaps and other
further provide that when defining reevaluation period for certain entities commodity swaps.79 The first category
‘‘substantial position,’’ the CFTC or SEC that exceed the relevant daily average by would encompass any swap which is
‘‘shall consider the person’s relative a small amount, and provide for a primarily based on one or more
position in uncleared as opposed to minimum length of time before a person reference rates, such as swaps of
cleared [swaps or security-based swaps] may no longer be deemed a major payments determined by fixed and
and may take into consideration the participant. floating interest rates, currency
value and quality of collateral held We further propose that the CFTC or exchange rates, inflation rates or other
against counterparty exposures.’’ 74 SEC may limit an entity’s designation as monetary rates. The second category
Both major participant definitions a major participant to only certain types, would encompass any swap that is
provide that a person may be designated classes or categories of swaps or primarily based on instruments of
as a major participant for one or more security-based swaps. We also address indebtedness, including but not limited
categories of swaps or security-based certain additional interpretive issues to any swap primarily based on one or
swaps without being classified as a that commenters have raised. Finally, more indices related to debt
major participant for all classes of swaps while the Commissions also are not instruments, or any swap that is an
or security-based swaps.75 proposing any exclusions from the index credit default swap or total return
Finally, the definition of ‘‘major swap major participant definitions, we are
participant’’—but not the definition of soliciting comment as to whether enhance enforcement of major participant
‘‘major security-based swap certain types of entities should be regulation.
78 See CEA section 1a(33)(A)(i), (iii); Exchange
participant’’—includes an exception for excluded from the definitions’
Act section 3(a)(67)(a)(2)(i), (iii). One commenter
any ‘‘entity whose primary business is application.77 suggested that we determine these categories by
providing financing, and uses reference to the types of instruments specifically
76 See CEA section 1a(33)(D). listed in the statutory definition of ‘‘swap.’’ See
derivatives for the purpose of hedging
77 In light of the significant and novel issues Northwestern Mutual letter (suggesting that, for
71 See CEA section 1a(33)(A)(i); Exchange Act raised by the major participant definitions, the regulatory consistency, each type of swap listed in
Commissions recognize the importance of the definition and options on each of those swaps
section 3(a)(67)(A)(ii)(I). should be considered to be an individual major
72 See CEA section 1a(33)(A)(ii); Exchange Act
monitoring the swap and security-based swap
markets following adoption of major participant category). The statutory definition of ‘‘swap’’ lists 22
section 3(a)(67)(A)(ii)(II). rules. This will help us evaluate whether the rules different types of swaps.
73 See CEA section 1a(33)(A)(iii); Exchange Act
appropriately reflect how market participants use 79 See proposed CEA rule 1.3(rrr). For the
section 3(a)(67)(A)(ii)(III). these instruments, and will help us consider the avoidance of doubt, the term ‘‘swap’’ as it is used
74 See CEA Section 1a(33)(B); Exchange Act
impact of market evolution and the ways in which in the definitions of the major swap categories in
section 3(a)(67)(B). market participants may change their practices in rule 1.3(rrr) has the meaning set forth in section
75 See CEA section 1a(33)(C); Exchange Act response to the rules, so we may identify potential 1a(47) of the CEA and the rules promulgated
section 3(a)(67)(C). improvements to the rules or other actions to thereunder.
swap on one or more indices of debt commodities not included in the other additional ‘‘major’’ categories of
instruments. The third category would categories? security-based swaps.
encompass any swap that is primarily
2. Major Categories of Security-Based B. ‘‘Substantial Position’’
based on equity securities, such as any
Swaps
swap primarily based on one or more As noted above, the Commissions are
indices of equity securities, or any total We propose to designate two ‘‘major’’
categories of security-based swaps for required to define the term ‘‘substantial
return swap on one or more equity position’’ as a threshold that is ‘‘prudent
indices. The fourth category would purposes of the ‘‘major security-based
swap definition.’’ The first category for the effective monitoring,
encompass any swap not included in management, and oversight of entities
any of the first three categories. This would encompass any security-based
swap that is based, in whole or in part, that are systemically important or can
fourth category would generally significantly impact the financial system
include, for example and not by way of on one or more instruments of
indebtedness (including loans), or a of the United States.’’ 84 This raises two
limitation, any swap for which the fundamental issues: (i) What types of
primary underlying item is a physical credit event relating to one or more
issuers or securities, including but not measures should be used to identify the
commodity or the price or any other risks posed by an entity’s swap or
aspect of a physical commodity.80 limited to any security-based swap that
is a credit default swap, total return security-based swap positions; and (ii)
The four major categories of swaps are swap on one or more debt instruments, for each of those measures, how much
intended to cover all swaps. Each swap debt swap, debt index swap, or credit risk should be required to evidence a
would be in the category that most spread.81 The second category would ‘‘substantial position’’?
closely describes the primary item encompass any other security-based
underlying the swap. If a swap is based 1. Commenters’ Views
swaps not included in the first category;
on more than one underlying item of this category would include, for Commenters have expressed diverse
different types, the swap would be in example, equity swaps.82 views as to what should constitute a
the category that describes the The proposed categories reflect the substantial position. A number of
underlying item that is likely to have fact that entities that transact in commenters suggested the use of a test
the most significant effect on the security-based swaps for non- based on the current uncollateralized
economic return of the swap. The speculative purposes would be expected mark-to-market exposure posed by an
proposed categories are consistent with to use the respective instruments for entity’s swap or security-based swap
market statistics that distinguish different purposes. For example, swaps positions, after taking bilateral netting
between these general types of swaps, as based on instruments of indebtedness, agreements into account. Two
well as market infrastructures that have such as credit derivatives, can be used commenters suggested specific dollar
been established for these types of to hedge the risks associated with the amounts of uncollateralized exposure to
swaps. default of a counterparty or debt use as the substantial position
We request comment on this proposed obligation. Equity swaps can be used, threshold.85 Several commenters
method of allocating swaps among among other ways, to hedge the risks expressed the view that positions
‘‘major’’ categories. Commenters associated with equity ownership or subject to central clearing should be
particularly are asked to address gain synthetic exposure to equities.83 entirely excluded from the analysis, or
whether there are any types of swaps The proposed categories also are at least should be discounted for
that would have unclear status under consistent with market statistics that purposes of the analysis.86
this proposal, as well as whether all currently distinguish between those
swaps instead should be placed into a general types of security-based swaps, Some commenters opposed using the
single ‘‘major’’ category for purposes of as well as market infrastructures, notional amount of swap or security-
the ‘‘major swap participant’’ definition, including separate trade warehouses, based swap positions to set the
or whether there should be additional that have been established for credit threshold, stating that the notional
‘‘major’’ categories of swaps. default swaps and equity swaps. amount is not indicative of the risks
Commenters are also asked to address We request comment on this proposed associated with a position. Some
whether the rate swap category should method of allocating security-based commenters similarly opposed using
be divided into two separate swaps between two ‘‘major’’ categories. measures of swap or security-based
categories—one for swaps based on rates In particular, we request comment on swap volume to set the threshold,
of exchange between different whether there are any types of security-
currencies, and another for swaps based based swaps that would have unclear 84 See CEA section 1a(33)(B); Exchange Act
status under this proposal, as well as section 3(a)(67)(B).

on interest rates, inflation rates and 85 See letter from Timothy W. Cameron, Esq.,
other monetary rates—and if so, in whether all security-based swaps Managing Director, SIFMA Asset Management
which category cross-currency rate instead should be placed into a single Group, dated September 20, 2010 (‘‘SIFMA AMG
swaps should be included. Also, should ‘‘major’’ category for purposes of the letter’’) (suggesting a standard of $2.5 billion average
‘‘major security-based swap participant’’ exposure in any calendar quarter based on the
the major swap category for other entity’s entire portfolio of swaps and security-based
commodity swaps be divided into two definition, or whether there should be swaps, other than foreign exchange swaps and
separate categories—one for swaps forwards); letter from Gus Sauter, Chief Investment
81 This category does not encompass a security-
based on agricultural commodities, and Officer, Vanguard, dated September 20, 2010
based swap that is based on an instrument of (‘‘Vanguard letter’’) (suggesting that the applicable
another for swaps based on all other indebtedness solely in connection with the swap’s threshold be $500 million in uncollateralized
financing leg. exposure for any single major swap category or $1
80 The term ‘‘commodity’’ as defined in Section 82 See proposed Exchange Act rule 3a67–2. billion aggregate exposure across all major
1a(9) of the CEA, 7 U.S.C. 1a(9), and CFTC Rule 83 At the same time, we note that the distinctions categories).
§ 1.3(e), 17 CFR 1.3(e) includes interest rates, between these proposed ‘‘major’’ categories of 86 See letter from Jennifer J. Kalb, Associate
foreign exchange rates, and equity and debt indices ‘‘security-based swaps’’ arguably are less significant General Counsel, Metropolitan Life Insurance
as well as physical commodities. Thus, the fourth than the distinctions among the proposed major Company, dated September 20, 2010 (‘‘MetLife
category of swaps is entitled ‘‘other commodity categories of ‘‘swaps’’ (such as, for example, the letter’’) (suggesting that cleared trades be subject to
swaps’’ because it includes any swap not included distinction between other commodity swaps and a lesser ‘‘charge’’ for purposes of the substantial
in the other three categories. rate swaps). position calculation, or be excluded entirely).
contending that the number of trades 2. Proposed Substantial Position exposure thus would not appear to be
does not reflect risk.87 Thresholds sufficient to satisfy the systemic
A few commenters addressed the The Commissions recognize that it is importance standard required by the
possibility that the threshold could take important for the substantial position statute.
into account the potential future risks thresholds to be set using objective Tests based on measures of potential
associated with a position, in addition numerical criteria. Objective criteria future exposure—which would address
to the risks associated with should permit regulators, market an estimate of how much the value of
uncollateralized current exposure.88 participants and entities that may be a swap or security-based swap might
Some commenters suggested that the subject to the regulations to readily change against an entity over the
evaluate whether swap or security-based remaining life of the contract—could
threshold take into account the potential
swap positions meet the thresholds, and address the gap left by a current
riskiness of the particular type of
should promote the predictable uncollateralized exposure test. Potential
instrument at issue. Some commenters
application and enforcement of the future exposure tests, however, would
maintained that the threshold should
requirements governing major reflect only an estimate of that type of
take into account the number of
participants. risk, and would only be as effective as
counterparties an entity has, the size of
In determining the substantial the factors used by the test.
an entity’s positions compared to the
position thresholds—in light of what is While we have considered several
size of the market, the size of an entity’s
‘‘prudent for the effective monitoring, other types of tests that could be used
swap or security-based swap positions
management, and oversight’’ of entities to determine the substantial position
compared to the entity’s ability to
that are systemically important or can threshold, we preliminarily do not
absorb losses of that magnitude, or the
significantly impact the U.S. financial believe that the advantages of those tests
financial strength of an entity’s
system—the Commissions are mindful justify their disadvantages. For example,
counterparties. Several commenters
that tests based on current while a threshold based on the number
stated that the threshold should be
uncollateralized exposure and tests of an entity’s counterparties could help
based on an average measure over time,
based on potential future exposure both identify highly interconnected entities
so that short-term spikes in measures
have respective advantages and (a factor that some have argued is
such as exposure would not by
disadvantages. We thus are proposing important for identifying an entity’s
themselves cause an entity to meet the
tests that would account for both types systemic risk), it also has been argued
major participant definitions. Some
of exposure. that a large number of counterparties
commenters suggested that the
A test that focuses solely on the could mean that the losses associated
substantial position threshold should
current uncollateralized exposure with that entity’s default would be
reflect an amount of ‘‘systemic risk.’’ 89
associated with an entity’s swap and divided and absorbed by many
87 But see letter from Christopher A. Klem, Ropes security-based swap positions should counterparties without broader market
& Gray, dated September 2, 2010 (test should provide a reasonable measure of the effects.91 While a threshold that is based
account for frequency of trading and frequency of theoretical amount of potential risk that on an entity’s financial strength would
trading with non-dealers).
an entity would pose to its help account for the possibility of an
88 See letter from Andrew Baker, Chief Executive
counterparties if the entity currently entity’s default as well as the effects of
Officer, Alternative Investment Management such a default, it would not address
Association, dated September 24, 2010 (‘‘AIMA were to default.90 Such a test also
letter’’) (discussing possible methods of estimating should be relatively clear-cut for market swap-related risks to the market that are
the maximum risk of loss related to positions); letter entities to implement, and would be not directly linked to the entity’s
from Warren Davis, Of Counsel, Sutherland Asbill
based on calculations that we expect default. In other words, an entity that
& Brennan LLP on behalf of the Federal Home Loan has large out-of-the-money swap or
Banks, dated September 20, 2010 (in addressing that market entities would perform as a
‘‘substantial counterparty exposure’’ test, noting the matter of course. security-based swap positions and faces
possibility of accounting for the potential exposure At the same time, a focus solely on a margin call may cause significant
of a portfolio).
current uncollateralized exposure could price movements in the swaps or
89 See letter from Edward J. Rosen, Cleary Gottlieb
be overly narrow by failing to identify security-based swaps and in the related
Steen & Hamilton LLP, dated September 21, 2010
(‘‘Cleary letter’’) (suggesting that the threshold risky entities until some time after they reference entities or assets if the entity
should be akin to the amount that is required for begin to pose the level of risk that chooses to unwind its positions, even if
a non-financial entity to be designated as
should subject them to regulation as the entity itself does not appear to
systemically important under Title I of the Dodd- present a large threat of default. These
Frank Act). major participants. Because exposure
can change significantly over short movements may be exacerbated if other
Section 113 of the Dodd-Frank Act provides that
the Financial Stability Oversight Council (‘‘FSOC’’) periods of time, and a swap or security- entities have similar positions.
may determine that a non-bank financial company based swap position that may pose large Moreover, although substantial
shall be supervised by the Federal Reserve Board,
potential exposures nonetheless would position thresholds based on the
subject to prudential standards, if the FSOC financial strength of an entity’s
‘‘determines that material financial distress at the often have a mark-to-market exposure of
U.S. nonbank financial company, or the nature, zero at inception, an entity’s positions counterparties would help measure the
scope, size, scale, concentration, may already pose significant risk to potential that an entity’s default would
interconnectedness, or mix of the activities of the
counterparties and to the market even have a broader impact, such thresholds
U.S. nonbank financial company, could pose a could result in disparate results between
threat to the financial stability of the United States.’’ before its uncollateralized mark-to-
In making that determination, the FSOC is to market exposure increases up to the two entities with identical positions,
consider: Leverage; off-balance sheet exposures; applicable threshold. A test that focuses
transactions and relationships with other significant 91 See AIMA letter (‘‘An entity that has only a
non-bank financial companies and bank holding solely on current uncollateralized small number of counterparties may only affect a
companies; importance as a source of credit and small number of entities directly, should it fail, but
liquidity; extent to which assets are managed rather 90 In practice, however, this measure may the impact could be significant if the position is
than owned; the nature, scope, size, scale, underestimate the amount of risk that an entity large and the counterparty is a systemically
concentration, interconnectedness and mix of poses to its counterparties, given that it may take important entity. A diversified exposure to multiple
activities; presence of a primary financial regulator; multiple days to liquidate a defaulting entity’s swap entities could affect more entities but is likely to be
assets and liabilities; and any other appropriate or security-based swap positions, during which smaller and thus shares the losses in the industry
risk-related factors. time prices may move against the defaulting entity. and having less systemic impact.’’).
and also could encourage concentration A person would apply this proposed This proposed test would account for
of exposure or potential future exposure substantial position test on a major the risk mitigating effects of netting
within a few counterparties. While tests category-by-major category basis, agreements 96 by permitting an entity to
that are based on the volume of an examining its positions with each calculate its exposure on a net basis, by
entity’s swaps or security-based swaps counterparty with which the person has applying the terms of master netting
may be helpful in identifying significant swaps or security-based swaps in the agreements entered into between the
swap or security-based swap activity, particular category. For each entity and a single counterparty.97
such tests would not directly be counterparty, the person would When calculating the net exposure the
germane to the current or potential determine the dollar value of the entity may take into account offsetting
future exposure posed by an entity’s aggregate current exposure arising from positions with that particular
swap and security-based swap each of its swap or security-based swap counterparty involving swaps, security-
positions. Finally, while we have positions with negative value (subject to based swaps and securities financing
considered the feasibility of tests that the netting provisions described below) transactions (consisting of securities
take specific contract features into in that major category by marking-to- lending and borrowing, securities
account (e.g., triggers that require the market using industry standard margin lending and repurchase and
payment of mark-to-market margin if an practices, and deduct from that amount reverse repurchase agreements) to the
entity’s credit rating is lowered), we the aggregate value of the collateral the extent that is consistent with the offsets
preliminarily believe that simpler tests person has posted with respect to the provided by the master netting
of exposure can more efficiently identify swap or security-based swap positions. agreement.98
the risks associated with particular The aggregate uncollateralized outward The Commissions preliminarily
swap or security-based swap positions. exposure would be the sum of those believe that this approach is appropriate
After considering these alternatives, uncollateralized amounts over all because it avoids identifying a
the Commissions are proposing two counterparties with which the person position’s exposure as being
tests to define ‘‘substantial position.’’ has entered into swaps or security-based ‘‘uncollateralized’’ when there is no
One test would focus exclusively on an swaps in the applicable major current counterparty risk associated
entity’s current uncollateralized category.93 with it due to offsets under a netting
exposure; the other would supplement a The proposed test would not agreement with the counterparty.99 In
current uncollateralized exposure prescribe any particular methodology
measure with an additional measure for measuring current exposure or the Also, it is important to recognize that while we
that estimates potential future exposure. expect that other regulatory requirements
value of collateral posted,94 and instead applicable to the valuation of swap or security-
A position that satisfies either test would provide that the method should based swap positions and collateral would be
would be a ‘‘substantial position.’’ be consistent with counterparty relevant to certain calculations relating to major
The Commissions, however, request practices and industry practices participant status, our proposed rules would not be
comment on whether it would be relevant for other purposes, such as in the context
generally.95 of capital and margin requirements.
appropriate to use other types of 96 Section 362(b)(17) of the United States
approaches for determining whether an As noted above, the statutory definitions require Bankruptcy Code generally provides derivatives
entity has a substantial position—as an us to consider the presence of central clearing in contracts with a safe harbor from the Bankruptcy
alternative to, or in addition to, the two setting the substantial position threshold. This test Code’s automatic stay, thus allowing parties to
proposed tests. would account for the risk-mitigating effects of these contracts to enforce their contractual rights,
central clearing in that centrally cleared swaps and including those associated with netting and offsets,
a. Proposed Current Exposure Test security-based swaps are subject to mark-to-market even after a counterparty has filed for bankruptcy.
margining that would largely eliminate the In addition, Section 210(c)(8)(A) of the Dodd-
The proposed first substantial uncollateralized exposure associated with a Frank Act reaffirms the enforceability of netting and
position test, which would focus solely position, effectively resulting in cleared positions offset provisions in certain derivatives contracts
on current uncollateralized exposure, in being excluded from the analysis. with insolvent counterparties that have been placed
93 See proposed CEA rule 1.3(sss)(2); proposed under the receivership of the Federal Deposit
general would set the substantial Exchange Act rule 3a67–3(b)(2). Insurance Corporation (‘‘FDIC’’). However, the
position threshold by reference to the 94 Depending on the particular circumstances of Dodd-Frank Act also places certain limitations on
sum of the uncollateralized current the swap or security-based swap, such collateral the timing by which netting rights may be exercised
exposure, obtained by marking-to- may be posted to a third-party custodian, directly when the FDIC has been appointed as the receiver
market using industry standard to the counterparty, or in accordance with the rules of an insolvent counterparty. See Dodd-Frank Act
of a derivatives clearing organization or clearing section 210(c)(10)(B).
practices, arising from each of the agency. 97 To the extent that the two counterparties
person’s positions with negative value 95 Consistent with industry practices, we would maintain multiple netting agreements (e.g., separate
in each of the applicable ‘‘major’’ expect that entities may value exposure based on agreements for dollar-denominated and euro-
category of swaps or security-based measures that take into account the amounts that denominated instruments), the calculation would
would be payable if the transaction were account only for the netting permitted under the
swaps (other than positions excluded netting agreement that is relevant to the swap or
terminated. Also, to the extent the valuation of
from consideration, such as positions collateral posted in connection with swaps or security-based swap at issue.
for the purpose of ‘‘hedging or mitigating security-based swaps is subject to other rules or 98 See proposed CEA rule 1.3(sss)(2)(iii)(A);
commercial risk’’).92 regulations, we would expect that the valuation of proposed Exchange Act rule 3a67–3(b)(3)(A). As is
collateral for purposes of the major participant the case for the proposed rules on valuation, the
92 See proposed CEA rule 1.3(sss)(2); proposed calculations would be consistent with those proposed rules regarding possible offsets of various
Exchange Act rule 3a67–3(b)(1). In other words, the applicable rules. positions are for purposes of determining major
test would measure the portion of the exposure that At the same time, we recognize that there can be participant status only. Other rules proposed by the
is not offset by the posting of collateral. If a position disputes or uncertainty as to an entity’s exposure Commissions may address the extent to which, if
was collateralized only partially, the value of the in connection with swap and security-based swap any, persons such as dealers and major participants
collateral posted would be offset against the total positions, and as to the valuation of the collateral may offset positions for other purposes.
it has posted in connection with those positions. In 99 If, for example, an entity was $X out of the
exposure, and the test would measure the residual
part of the exposure. We recognize that there may some circumstances this could lead to uncertainty money in connection with a security-based swap,
be operational delays between changes in exposure as to whether the entity is a major participant. As but was $X in the money with the same
and the resulting exchanges of collateral, and in addressed below, we are requesting comment as to counterparty in connection with a swap, there
general we would not expect that operational delays the potential significance of these issues, and as to would be no economic need for the entities to
associated with the daily exchange of collateral whether we should set forth additional guidance or exchange collateral in connection with those
would be considered to lead to uncollateralized mandate the use of specific standards with respect offsetting positions. A test that fails to account for
exposure for these purposes. to these valuations. Continued
calculating current uncollateralized entity’s total overall uncollateralized preliminarily believe that the proposed
exposure, however, the entity may not exposure. substantial position thresholds would
take into account the market risk offsets For purposes of the definition of reasonably be expected to apply to
associated with holding positions with ‘‘major swap participant,’’ the entities that have the potential of
multiple counterparties.100 Also, the Commissions are proposing to set the satisfying the statutory criteria of
entity may not ‘‘double count’’ any offset current uncollateralized exposure systemic importance or significant
or collateral—once any item of collateral threshold at a daily average of $1 billion impact to the U.S. financial system. As
or any position with positive value has in the applicable major category of discussed below, however, we welcome
been applied against current exposure, swaps, except that the threshold for the comments on the appropriateness of the
the same item cannot be applied for rate swap category would be a daily proposed threshold.
purposes of this test against any other average of $3 billion. For purposes of These proposed thresholds would be
exposure. the definition of ‘‘major security-based evaluated by reference to a calculation
The proposal to permit this type of swap participant,’’ this threshold would of the mean of an entity’s
netting, however, raises questions as to be based on a daily average of $1 billion uncollateralized exposure measured at
how an entity’s net out-of-the-money in the applicable major category of the close of each business day,
exposure with a counterparty, and the security-based swaps.103 We beginning on the first business day of
collateral posted with respect to its preliminarily believe that these each calendar quarter and continuing
positions with the counterparty, should proposed thresholds are appropriate for through the last business day of that
be allocated among swap positions, identifying entities that, through their quarter.107 In this regard, the
security-based swap positions and other swap and security-based swap activities, Commissions have taken into account
positions specified in the rule.101 In have a significant potential to pose the commenters’ concerns that an entity’s
particular, when an entity has not fully systemic importance or risks to the U.S. exposure should not be evaluated based
collateralized its net current exposure to financial system that the major on a single point in time, as short-term
a particular counterparty with which it participant definition and associated market fluctuations may not fairly
has a netting agreement, there may be statutory requirements were intended to reflect the risks of the entity’s positions.
questions regarding how to attribute the address, but we also recognize that it is The use of a daily average approach
net out-of-the-money positions and possible that the appropriate threshold should help address commenters’
associated collateral to its swap or should be higher or lower. In proposing concerns about the impact of short-term
security-based swap positions. We these specific thresholds, we have price fluctuations, and also help
preliminarily believe that an entity that sought to take into account several preclude the possibility that an entity
has net uncollateralized exposure to a factors: (i) The ability of the financial may seek to use short-term transactions
counterparty should, for purposes of the system to absorb losses of a particular to distort the measure of exposure.
test, allocate that net uncollateralized size; 104 (ii) the appropriateness of The Commissions request comment
exposure pro rata in a manner that setting ‘‘prudent’’ thresholds that are on the proposed current
reflects the exposure associated with materially below the level that could uncollateralized exposure test.
each of its out-of-the-money swap cause significant losses to the financial Commenters particularly are requested
positions, security-based swap positions system as it would not be appropriate to address whether the proposed
and non-swap positions.102 This for the substantial position test to threshold amounts of current
allocation would be intended to cause encompass entities only after they pose uncollateralized exposure are
the measure of uncollateralized significant risks to the market through appropriate, and, if not, what alternative
exposure connected with swaps or their swap or security-based swap higher or lower threshold amounts
security-based swaps for purposes of the activity; 105 and (iii) the need to account would appropriately identify entities
test to reasonably reflect the relative for the possibility that multiple market that pose the types of risks that the
contribution of those instruments to an participants may fail close in time, definition was intended to address. In
rather than focusing narrowly on the this regard, commenters specifically are
this netting of exposure could lead the entities to potential impact of a single participant’s requested to address whether bank Tier
engage in needless offsetting exchanges of
collateral. default.106 Based on these factors, we 1 capital provides a good indicative
100 See proposed CEA rule 1.3(sss)(2)(iii)(C); reference of the ability of major dealers
proposed Exchange Act rule 3a67–3(b)(2)(iii). While 103 See proposed CEA rule 1.3(sss)(1); proposed to absorb losses of a particular size, or
recognizing that offsetting positions of that type Exchange Act rule 3a67–3(a)(1). whether alternative reference points for
would reduce the market risk facing the entity, the 104 In this regard, the Commissions preliminarily
the analysis (e.g., the size of the swap
offsets would not be expected to directly mitigate believe that the ‘‘Tier 1’’ capital of major dealer
the risks that the entity’s counterparties would face banks provides relevant information about the market or security-based swap market)
if the entity were to default. ability of the financial system to absorb losses of a would also be applied. Commenters are
101 This issue does not arise to the extent that an particular size. We note that, among U.S. banks that requested to address whether
entity’s net positions with a counterparty are fully are dealers in credit derivatives, the six largest uncollateralized mark-to-market
collateralized. banks account for the vast majority of dealing
102 In other words, if an entity’s out-of-the-money activities. We understand that the most liquid ‘‘Tier exposure is the appropriate way to
rate swap positions have $W exposure, its out-of- 1’’ regulatory capital for those six banks ranges from measure current exposure, and if not,
the-money other commodity swap positions have $14 billion to $113 billion. what alternative approach is more
105 In other words, the proposed thresholds are
$X exposure, its out-of-the-money security-based appropriate, and why. Commenters also
swap positions have $Y exposure, and its other out- intended to be low enough to provide for the
are requested to address whether the
of-the money positions covered by that netting appropriately early regulation of an entity whose
agreement have $Z exposure, fractions of the swap or security-based swap positions have a
collateral equal to W/(W+X+Y+Z) should be reasonable potential of posing significant fail close in time. That $3 billion could represent
allocated to the rate swap positions, X/(W+X+Y+Z) counterparty risks and risks to the market that stress a significant impairment of the ability of some
to the other commodity swap positions and Y/ the financial system, while being high enough that major dealers to absorb losses, as reflected by their
(W+X+Y+Z) to the security-based swap positions. A it would not unduly burden entities that are Tier 1 capital.
similar process should be used for allocating net materially less likely to pose these types of risks. We also are mindful of the views expressed by
out-of-the-money exposure across the categories of 106 For example, the proposed $1 billion the two commenters that suggested particular dollar
swaps and security-based swaps that have out-of- threshold for swaps and security-based swaps values for the threshold. See note 85, supra.
the-money exposure when one or more categories would reflect a potential loss of $3 billion if three 107 See proposed CEA rule 1.3(sss)(4); proposed
are in-the-money. large swap or security-based swap entities were to Exchange Act rule 3a67–3(d).
proposed thresholds reasonably address commenters are requested to address uncollateralized exposure to account for
the need to set the threshold at a whether the proposed current exposure bilateral netting agreements; whether
prudent level so as to avoid the test should be modified to account for additional types of positions should be
possibility that the substantial position the risks associated with the expected included within the netting provisions;
test would encompass entities only after time lag between an entity’s default and whether the proposal appropriately
they pose significant risks to the market, the liquidation of its swap or security- takes into account the netting of
whether the proposed thresholds based swap positions. exposures and collateral involving
reasonably address the possibility that Commenters also are requested to positions in financial instruments other
multiple market entities could fail close address whether we should set forth than swaps, security-based swaps and
in time, and whether the proposed additional guidance or mandate the use securities financing transactions and if
thresholds reasonably address the fact of specific standards with respect to the so, whether any limitations to such
that swap or security-based swap measure of exposure or valuing offsetting would be necessary or
activities would comprise only part of collateral posted, or should specify appropriate; whether the netting
the risks to the market posed by an particular procedures in the event of provisions should accommodate
entity. To what extent would this valuation disputes. What particular offsetting positions involving the net
proposed definition of ‘‘substantial industry standard documentation and equity balance in an entity’s securities
position’’ have an effect on the activities other methodologies could be used to account (e.g., free credit balances, other
of entities that potentially may be measure exposure and value collateral? credit balances, and fully paid
deemed to be major participants? What Also, how could regulatory securities), and if so, whether any
impact could these types of effects have requirements applicable to the valuation limitations to such offsetting would be
on liquidity, on risk-taking or risk- of collateral be relevant to the valuation necessary or appropriate; whether the
reducing activities, or on other aspects of collateral for purposes of the major netting provisions should accommodate
of the relevant markets? participant definitions? offsets for exposures, or collateral
Also, more fundamentally, we request Commenters are invited to address connected with the positions that an
comment on whether the substantial whether the rule should provide that, in entity has with the affiliate of a
position analysis also should encompass measuring their current uncollateralized counterparty; and whether the proposed
a test that does not account for the exposure, entities must value collateral method of allocating the
collateral posted in connection with an in a way that is at least as conservative uncollateralized portion of exposures
entity’s exposure, given that tests that as such collateral would be valued among the different types of financial
account for the posting of collateral according to applicable haircuts or other instruments that are all subject to a
would not encompass entities that have adjustments dictated by applicable single netting agreement is appropriate.
very large swap or security-based swap regulations. Commenters further are Commenters also are requested to
positions that are fully collateralized requested to address whether the test address whether the proposed current
(either by the posting of bilateral should exclude certain types of uncollateralized exposure test would
collateral or by virtue of central collateral that cannot readily be valued. pose significant monitoring burdens
clearing). In that light, should the Also, commenters are requested to upon entities that have swap or
analysis seek to capture entities that address whether the proposed method security-based swap positions that are
have very large positions in light of of evaluation—the mean of an entity’s significant enough to potentially meet
potential market disruptions such uncollateralized exposure measures at the current uncollateralized exposure
entities could cause, regardless of the close of each business day, threshold. Should we provide guidance
whether the positions are collateralized? beginning on the first business day of as to policies and procedures that such
Commenters further are requested to each calendar quarter and continuing an entity should be able to follow to
address whether such thresholds should through the last business day of that demonstrate that it does not meet the
also account for entities that have large quarter—would be unduly burdensome applicable thresholds?
in-the-money positions that may or potentially subject to gaming or
indicate their potential significance to evasion. b. Proposed Current Exposure Plus
the market. In this regard, commenters Should the proposed approach for Potential Future Exposure test
also are asked to address whether the measuring uncollateralized current The second proposed test would
thresholds should specifically address exposure be amended or supplemented, account both for current
entities with large in-the-money such as by establishing requirements for uncollateralized exposure (as discussed
positions that lead them to receive large how exposure should be measured or above) and for the potential future
amounts of collateral posted by their collateral should be valued in certain exposure associated with swap or
counterparties, particularly to the extent circumstances (e.g., requiring the security-based swap positions in the
that such collateralized in-the-money valuation of certain types of collateral to applicable ‘‘major’’ category of swaps or
positions could later turn and lead the be conservative during times of rapid security-based swaps. This additional
entity to incur losses. price changes in the relevant asset test would allow the major participant
In addition, commenters are requested class)? Should current exposure and analysis to take into account estimates
to address whether and how it would be collateral be required to be valued in of how the value of an entity’s swap or
appropriate to adjust the threshold accordance with US generally accepted security-based swap positions may
amounts over time, including whether accounting principles? Would move against the entity over time.
these proposed current uncollateralized measurement according to such The potential future exposure portion
exposure thresholds should periodically principles differ in any respects from of this proposed test would be based on
be adjusted by formula to reflect measurement under the proposal, and, if an entity’s ‘‘aggregate potential outward
changes in the ability of the market to so, how? exposure,’’ which would reflect the
absorb losses over time, or changes in In addition, commenters are requested potential exposure of the entity’s swap
other criteria over time. Commenters to address the proposed netting or security-based swap positions in the
further are requested to address whether provisions of this test, including: applicable ‘‘major’’ category of swap or
the test will be practical for potential whether the proposed test would security-based swaps, subject to certain
major participants to use. Moreover, reasonably permit the measure of adjustments. Bank capital standards also
make use of this type of test,108 and this the stated notional amount is leveraged the risk mitigation effects of central
proposal builds upon those standards or enhanced by the particular structure, clearing and mark-to-market margining.
but modifies them to focus on the risk this calculation would be based on the In particular, if the swap or security-
that an entity poses to its counterparties position’s effective notional amount.110 based swap positions are cleared by a
(rather than on the risk that At the same time, the proposed registered clearing agency or subject to
counterparties pose to an entity). In measures would contain adjustments for daily mark-to-market margining,113 the
doing so, this proposal seeks to use a certain types of positions that pose measures of potential future exposure
test that can be implemented by a range relatively lower potential risks.111 In would further be adjusted to equal
of market participants, and that can be addition, the general risk-adjusted twenty percent of the potential future
expected to lead to reproducible results notional measures of potential future exposure calculated using the
across market participants with exposure would be reduced to reflect methodology described above.114 The
identical swap or security-based swap the risk mitigation effects of master Commissions preliminarily believe that
portfolios, rather than relying on netting agreements, in a manner a significant downward adjustment
alternative tests (e.g., value at risk consistent with bank capital would be appropriate because clearing
measures or stress testing standards.112 and daily mark-to-market margining
methodologies) that may be costly for The proposed measures of potential would be expected to reduce the
market participants to implement and future exposure would contain further potential future risks posed by an
that would not be expected to lead to downward adjustments to account for entity’s swap or security-based swap
reproducible results across participants. positions. Also, it is appropriate to
The exposure measures in general 110 See proposed CEA rule 1.3(sss)(3)(ii);
incentivize the use of central clearing
would be based on the total notional proposed Exchange Act rule 3a67–3(c)(2)(i)(B). For and daily mark-to-market margining as
purposes of this rule, in the case of positions that
principal amount of those positions, represent the sale of an option on a swap or practices for helping to control risks. We
adjusted by certain risk factors that security-based swap (other than the sale of an are not proposing to entirely eliminate
reflect the type of swap or security- option permitting the person exercising the option such cleared and margined positions
based swap at issue and the duration of to purchase a credit default swap), we would view from the analysis of potential future
the effective notional amount of the option as being
the position.109 For positions in which equal to the effective notional amount of the exposure, however, because clearing
underlying swap or security-based swap, and we may not entirely eliminate the risks
108 See 12 CFR part 3, app. C, section 32 (Office
would view the duration used for purposes of the posed by an entity’s potential default,115
of the Comptroller of the Currency bank capital formula as being equal to the sum of the duration and daily mark-to-market margining
standards). of the option and the duration of the underlying
109 For example, consistent with the bank swap or security-based swap.
would not eliminate the risks associated
standards, the multiplier for equity swaps would 111 The analysis would exclude swap or security- with large intra-day price movements.
range from 0.06 for equity swaps of one year or less based swap positions that constitute the purchase While the proposed amount of the
to 0.10 for equity swaps with a maturity of more of an option, such that the person has no additional adjustment seeks to balance these
than five years. See proposed Exchange Act rule payment obligations under the position, as well as
3a67–3(c)(2)(i)(A). For security-based swaps based other positions on which the person has prepaid or 113 For these purposes, a swap or security-based
on the credit of a reference entity, the multiplier otherwise satisfied all of its payment obligations.
would be 0.1. swap would be considered to be subject to daily
See proposed Exchange Act rule 3a67–3(c)(2)(i)(C).
The current bank capital standards contain a mark-to-market margining if, and for as long as, the
For similar reasons, the potential outward counterparties follow the daily practice of
distinction based on whether the credit derivative exposure associated with a position by which a
is on ‘‘investment grade’’ or ‘‘non-investment grade’’ exchanging collateral to reflect changes in exposure
person buys credit protection using a credit default (after taking into account any other positions
reference entities, providing a 0.1 multiplier for the swap would be capped at the net present value of
former and a lower 0.05 multiplier for the latter. We addressed by a netting agreement between the
the unpaid premiums. See proposed CEA rule parties). If a person is permitted to maintain an
preliminarily do not believe that a test that
1.3(sss)(3)(ii)(A)(4); proposed Exchange Act rule uncollateralized ‘‘threshold’’ amount under the
distinguishes among reference entities by reference
3a67–3(c)(2)(i)(D). agreement, that amount (regardless of actual
to their credit ratings would be appropriate for 112 In particular, for swaps or security-based
purposes of these definitions, particularly in light exposure) would be considered current
of the fact that the Dodd-Frank Act mandates the swaps subject to master netting agreements the uncollateralized exposure for purposes of the test.
substitution of credit ratings with other standards potential exposure associated with the person’s Also, if the agreement provides for a minimum
of creditworthiness in U.S. regulations. See Dodd- swap or security-based swaps with each transfer amount in excess of $1 million, the entirety
Frank Act section 939A. counterparty would equal a weighted average of the of that amount would be considered current
potential exposure in the applicable ‘‘major’’ uncollateralized exposure. See proposed CEA rule
The multipliers in part will be a function of the
category of swaps or security-based swaps with a 1.3(sss)(3)(iii)(B); proposed Exchange Act rule
remaining maturity of the swap or security-based
particular counterparty as calculated without 3a67–3(c)(3)(ii).
swap. If the swap or security-based swap, however,
is structured such that on specified dates the reference to netting, and that amount reduced by In this way, the measure of potential future
outstanding exposure is settled and the terms are the ratio of net current replacement cost to gross exposure would reflect for the risk mitigating
reset so the market value is zero, the remaining current replacement cost of all swap and security- benefits of daily margining, while specifically
maturity would equal the time until the next reset based swap positions with that counterparty, accounting for industry practices that limit those
date. consistent with the following equation: PNet = 0.4 benefits. Of course, to take advantage of this
x PGross + 0.6 x NGR x PGross. adjustment it is not enough to the agreement to
Although we recognize that these risk multipliers
may suggest a lower than expected volatility of Under this formula, PNet is the potential exposure provide for daily mark-to-market margining—the
credit or equity derivatives of that duration, this in the applicable ‘‘major’’ category of swaps or parties must actually follow that practice.
may be offset by the fact that the proposed security-based swaps adjusted for bilateral netting; 114 See proposed CEA rule 1.3(sss)(3)(iii)(A);
calculations of potential future exposure do not PGross is the potential exposure in that category proposed Exchange Act rule 3a67–3(c)(3).
directly account for portfolio netting or collateral without adjustment for bilateral netting; and NGR 115 For example, the central counterparties that
updates that could mitigate future exposure. We is the ratio of net current replacement cost to gross clear credit default swaps do not necessarily
preliminarily believe that the use of these current replacement cost. See proposed CEA rule become the counterparties of their members’
thresholds (and proposed related calculations) for 1.3(sss)(3)(ii)(B); proposed Exchange Act rule 3a67– customers (although even absent direct privity
purposes of identifying major participants are 3(c)(2)(ii). those central counterparties benefit customers by
consistent with similar bank capital standards and The ‘‘NGR’’ ratio is intended to serve as a type of providing for protection of collateral they post as
are therefore suitable for use as an estimate of proxy for the impact of netting on potential future margin, and by providing procedures for the
potential future exposure. We are also cognizant exposure, but does not serve as a precise indicator portability of the customer’s positions in the event
that requiring a more complete calculation of of future changes in net exposure relative to gross of a dealer’s default). As a result, central clearing
potential future exposure may be costly and exposure, as the ratio and potential exposure can may not eliminate the counterparty risk that the
burdensome for participants, especially those who be influenced by many idiosyncratic properties of customer poses to the dealer. Even then, however,
would otherwise not meet the thresholds for major individual portfolios. See Basle Committee on required mark-to-market margining should help
swap or security-based swap participant and would Banking Supervision, ‘‘The Treatment of the Credit control that risk, and central clearing thus would
not have systems in place to perform a more Risk Associated with Certain Off-Balance-Sheet be expected to reduce the likelihood that an entity’s
complete calculation. Items’’ (July 1994). default would lead to broader market impacts.
competing factors, we recognize that position threshold. Commenters collateralized in-the-money positions
alternative higher or lower downward particularly are requested to address the could later turn and cause losses to an
adjustments may also be appropriate. appropriateness of using potential entity? In addition, for positions that
For purposes of the ‘‘major swap exposure risk adjustments derived from represent the sale of options on swaps
participant’’ definition, the substantial bank capital rules; and the or security-based swaps, would the
position threshold would be $2 billion appropriateness of using bank capital effective notional amount of the option
in daily average current uncollateralized methodologies for addressing positions for purposes of the calculation properly
exposure plus aggregate potential subject to netting agreements. Also, be deemed to be the notional amount of
outward exposure in the applicable should this test be supplemented by a the underlying instrument (or should
major swap category, except that the test that accounts for the notional the notional amount of the option vary
threshold for the rate swap category amount of an entity’s swap or security- based on the link between the changes
would be a daily average of $6 billion. based swap positions without risk- in the value of the option and changes
For purposes of the ‘‘major security- adjustments, to focus on entities that in the value of the underlying), and
based swap participant’’ definition, the have very large swap or security-based would the duration of the option
substantial position threshold would be swap positions? properly be deemed to be the sum of the
$2 billion in daily average current Commenters are requested to address duration of the option and the duration
uncollateralized exposure plus aggregate whether the proposed threshold of the underlying swap or security-
potential outward exposure in any amounts for the proposed current based swap?
major security-based swap category.116 exposure plus potential future exposure Commenters also are requested to
These proposed amounts reflect the test are appropriate, and if not, what address whether the risk adjustment for
same factors discussed above in the alternative threshold amounts would be credit derivatives should reflect the
context of the current uncollateralized more appropriate, and why. In addition, riskiness of the underlying reference
exposure test,117 but are raised to reflect commenters are requested to address the entity, and, if so, how should that be
the fact that potential future exposure is proposed method of discounting the accomplished in a way that does not
a measure of potential risk over time, potential future exposure associated rely on the use of credit ratings.
and hence is less likely to pose a direct, with cleared positions or positions
The proposed test of potential future
immediate impact on the markets than subject to daily mark-to-market
exposure is based in part on the
current measures of uncollateralized margining to equal 20 percent of what
application of fixed multipliers to the
exposure. We recognize that alternative the measure of potential future exposure
would be otherwise. Would a larger or notional amounts, or effective notional
risk thresholds may also be appropriate, amounts, of swaps and security-based
and we welcome comment on potential smaller discount be appropriate? Is
there data available that may assist with swaps. In this regard, commenters are
alternatives. invited to discuss whether there are
In light of the amount of this reaching the appropriate discount
factor? Also, in that regard, should both alternative tests that would be more
threshold and the underlying risk
sets of discounts be equal, or should effective to determine potential future
adjustments, we preliminarily do not
cleared positions be subject to more of exposure or otherwise to supplement an
believe that an entity would need to
a discount than uncleared positions uncollateralized current exposure test,
calculate its potential future exposure
subject to daily mark-to-market and whether such alternative tests may
for purposes of the test unless the entity
margining? Commenters also are invited be more effectively developed in the
has large notional positions. For
to address whether the proposed near future, when additional data
example, in light of the proposed risk
discounts for cleared positions or regarding swap and security-based swap
adjustment of 0.10 for credit derivatives,
positions that are marked-to-market positions are likely to be available. In
an entity that does not have any
would make it unnecessary or particular, commenters are requested to
uncollateralized current exposure
duplicative for this test separately to identify any tests based on non-
would have to have notional positions
account for netting agreements. Also, if proprietary risk models that could be
of at least $20 billion to potentially meet
an entity currently has posted excess uniformly applied by all potential major
the $2 billion threshold, even before
collateral in connection with a position, participants to measure potential future
accounting for the discounts associated
should the amount of that current exposure. Commenters who propose
with netting agreements. If those swaps
overcollateralization be deducted from alternative tests are asked to address
or security-based swaps are cleared or
its measure of potential future how the tests would provide consistent
subject to mark-to-market margining, the
exposure? results across different types of swaps
additional 20 percent risk adjustment
Commenters also are requested to and security-based swaps, including
would mean that the entity without
address whether the proposed test in customized instruments, in the different
current uncollateralized exposure
connection with purchases of credit major categories. Commenters are also
would have to have cleared notional
protection—which would cap the invited to address, on the other hand,
positions of at least $100 billion to
measure of exposure at the net present whether a single test based on
possibly meet that threshold.118
value of unpaid premiums—would raise uncollateralized current exposure (i.e.,
The Commissions request comment
problems in implementation, and without any test of potential future
on this proposed use of a current
whether we should propose any exposure) would be adequate for
exposure plus potential future exposure
particular discount rate to be used in identifying entities whose swap or
test to determine the substantial
conducting the calculation (and, if so, security-based swap positions pose a

116 See proposed Exchange Act rule 3a67–3(a)(2). what discount rate should be relatively high degree of risk to
117 See notes 103 to 106, supra, and appropriate). Also, should the measure counterparties and to the markets. In
accompanying text. of potential future exposure in addition, commenters are invited to
118 Based on these thresholds, we preliminarily connection with purchases of credit identify any tests or thresholds below
believe that only relatively few entities would protection and options also account for which a party would be deemed not to
regularly have to perform these potential future
exposure calculations with regard to their security-
collateral that a counterparty has posted be a major swap participant, without
based swaps. See notes 181 and 182, infra, and in connection with an entity’s in-the- needing to calculate the exposure tests
accompanying text. money positions, given that such set forth in the proposed rule.
Commenters further are requested to manage risks that they otherwise would are using swaps or security-based swaps
address whether and how it would be manage.121 Commenters also took the to hedge or mitigate commercial risk
appropriate to adjust the threshold position that the addition of the word generally may qualify for the clearing
amounts over time, including whether ‘‘mitigating’’ was intended to expand the exemption, no such statutory restriction
these proposed thresholds should exclusion beyond what would have applies with respect to the exclusion for
periodically be adjusted by formula to been encompassed had only the term hedging positions in the first major
reflect changes in the ability of the ‘‘hedging’’ been used.122 participant test. Accordingly, with
market to absorb losses over time, or respect to the first major participant test,
1. Proposed Interpretation
changes in other criteria over time. In it appears that positions established to
addition, commenters are requested to In interpreting the meaning of
‘‘hedging or mitigating commercial risk’’ hedge or mitigate commercial risk may
address whether the proposed use of a
for purposes of the first test of the major qualify for the exclusion, regardless of
daily average measure for purposes of
participant definitions, the the nature of the entity—i.e., whether a
this test would be burdensome for
potential major participants to Commissions first note that virtually financial entity (including a bank) or a
implement, and, if so, how often should identical language is found in the Dodd- non-financial entity.125
potential participants have to measure Frank provisions granting an exception In general, we are premising the
these amounts. Commenters also are from the mandatory clearing proposed exclusion on the principle
requested to address whether any such requirement to non-financial entities that swaps or security-based swaps
tests should seek to reflect the that are using swaps or security-based necessary to the conduct or management
maximum level of exposure associated swaps to hedge or mitigate commercial of a person’s commercial activities
with a position, rather than risk- risk.123 Because Congress used virtually should not be included in the
adjusted estimates of exposure proposed identical language in both instances, the calculation of a person’s substantial
here. Commissions intend to interpret the position.126 In this regard, the
In addition, commenters are requested phrase ‘‘hedging or mitigating Commissions preliminarily believe that
to address whether this proposed test commercial risk’’ with respect to the
whether an activity is commercial
would pose significant monitoring participant definitions in the same
should not be determined solely by the
burdens upon entities that have swap or manner as the phrase ‘‘hedge or mitigate
person’s organizational status as a for-
security-based swap positions that are commercial risk’’ in the exception from
the mandatory clearing requirement.124 profit company, a non-profit
significant enough to potentially meet
The Commissions also note that organization or a governmental entity.
the combined current uncollateralized
exposure and potential future exposure although only non-financial entities that Rather, the determinative factor should
test. Should we provide guidance as to be whether the underlying activity to
policies and procedures that such an 121 See Cleary letter (also urging inclusion of ‘‘all which the swap relates is commercial in
entity should be able to follow to be able risks’’ arising in connection with a company’s nature.127
business activities, including risks incidental to a
to demonstrate that it does not meet the company’s ordinary course of business). 125 The presence of the third major participant
applicable thresholds? 122 See MetLife letter (addition of mitigation
test suggests that financial entities generally may
‘‘plainly indicates that this exclusion intends an
C. ‘‘Hedging or Mitigating Commercial expansive definition of hedging and can also
not be precluded from taking advantage of the
Risk’’ hedging exclusion in the first test. The third test,
encompass non-speculative derivatives positions
used to manage economic risk, including which does not account for hedging, specifically
The first test of the major participant potentially diversification and synthetic asset applies to non-bank financial entities that are
definitions excludes positions held for strategies, such as the conservative ‘replication’ highly leveraged and have a substantial position in
‘‘hedging or mitigating commercial risk’’ strategy permitted under State insurance laws’’); a major category of swaps or security-based swaps.
letter from Joanne R. Medero, Managing Director, That test would be redundant if the hedging
from the substantial position exclusion in the first major participant test were
BlackRock, dated September 20, 2010 (addressing
analysis.119 the parallel context of the exclusion for ERISA plan entirely unavailable to financial entities.
Commenters took the position that positions). Also, had the statute intended the phrase ‘‘hedge
this exclusion from the major 123 See CEA section 2(h)(7)(A); Exchange Act or mitigate commercial risk’’ to apply only to
participant definitions should section 3C(g)(1)(B) (exception from mandatory activities of or positions held by non-financial
clearing requirements when one or more entities, it would not have been necessary to
encompass a variety of uses of swaps include an additional provision in the statute
counterparties are not ‘‘financial entities’’ and are
and security-based swaps to hedge risks using swaps or security-based swaps ‘‘to hedge or generally restricting the availability of the clearing
faced by non-financial entities.120 Some mitigate commercial risk’’). The definition of exception to non-financial entities.
126 The scope of the proposed exclusion is based
commenters also suggested that the commercial risk here is for purposes of only the
exclusion should be interpreted to major participant definitions and, to the extent the on our understanding that when a swap or security-
interpretation is similar, for purposes of the end- based swap is used to hedge an entity’s commercial
address risks such as ‘‘balance sheet user exception from the mandatory clearing activities, the gains or losses associated with the
risk,’’ the ‘‘risk of under-diversification,’’ requirement. The concept of commercial risk may swap or security-based swap itself will be offset by
and hedges undertaken on a portfolio be interpreted differently for other purposes under losses or gains in the entity’s commercial activities,
basis. Some commenters favored the CEA and the Exchange Act. and hence the risks posed by the swap or security-
124 There is a technical difference in the way based swap to counterparties or the industry
interpreting this exclusion to permit its those provisions use the concept of hedging and generally will be mitigated.
use by insurers and banks. One mitigating commercial risk—in that the major 127 We do not concur with the suggestion that the
commenter emphasized the need to participant definitions specifically refer to use of the word ‘‘mitigating’’ within the major
avoid taking interpretations that would ‘‘positions held for hedging and mitigating participant definitions was intended to mean
commercial risk’’ while the end-user exception something significantly more than hedging. Other
encourage commercial entities not to refers to a counterparty that ‘‘is using [swaps or provisions of the Dodd-Frank Act appear to use the
security-based swaps] to hedge or mitigate terms ‘‘hedging’’ and ‘‘mitigating’’ interchangeably;
119 See CEA section 1a(33)(A)(i)(I); Exchange Act
commercial risk.’’ That difference is consistent with for example, certain provisions of the Dodd-Frank
section 3(a)(67)(A)(i)(I). the different language used in the two places Act refer to ‘‘risk-mitigating hedging activities.’’ See
120 See, e.g., letter from Coalition for Derivatives (particularly the use of ‘‘substantial position’’ in the Dodd-Frank Act section 619 (adding Section 13 to
End-Users, dated September 20, 2010 (discussing, major participant definitions) and we do not see a the Bank Holding Company Act of 1956); Dodd-
inter alia, a supplier’s use of credit derivatives in reason why the use of the term in the context of Frank Act section 619 (adding Section 27B to the
connection with a cash receivable, and a company’s the major participant definitions should be Securities Act of 1933). Title VII also refers to
use of equity derivatives in connection with a stock construed differently than its use in the comparable ‘‘[h]edging and other similar risk mitigating
repurchase program). clearing exception. activities.’’ Dodd-Frank Act section 716(d)(1).
a. Proposed Exclusion in the ‘‘Major affiliates, should be covered; whether regardless of their status under
Swap Participant’’ Definition industry-specific rules on hedging, or accounting guidelines.
As a general matter, the CFTC rules that apply only to certain At the same time, the security-based
preliminarily believes that whether a categories of commodity or asset classes swap position could not be held for a
position hedges or mitigates commercial are appropriate at this time; whether purpose that is in the nature of
risk should be determined by the facts swaps facilitating asset optimization or speculation or trading.131 In addition,
and circumstances at the time the swap dynamic hedging should be included; the security-based swap position could
is entered into, and should take into and whether hedge effectiveness should not be held to hedge or mitigate the risk
account the person’s overall hedging be addressed. Commenters are requested of another security-based swap position
and risk mitigation strategies. At the to discuss both the policy and legal or swap position unless that other
same time, the swap position could not bases underlying their comments. position itself is held for the purpose of
be held for a purpose that is in the b. Proposed Exclusion in the ‘‘Major hedging or mitigating commercial risk
nature of speculation, investing or Security-Based Swap Participant’’ as defined by the rule or CEA rule
trading. Although the line between Definition 1.3(ttt).132
speculation, investing or trading, on the We look forward to commenters’
The proposed meaning of ‘‘hedging or views on whether the proposed
one hand, and hedging, on the other, mitigating commercial risk’’ for
can at times be difficult to discern, the standard strikes an appropriate balance
purposes of the ‘‘major security-based in determining which positions may be
statute nonetheless requires such swap participant’’ definition would
determinations.128 The CFTC expects excluded for purposes of the first major
require that a security-based swap participant test. We recognize that there
that a person’s overall hedging and risk position be economically appropriate to
management strategies will help inform are other reasonable views as to what
the reduction of risks in the conduct positions may appropriately be
whether or not a particular position is and management of a commercial
properly considered to hedge or mitigate considered to be for the purposes of
enterprise, where they arise from the hedging or mitigating commercial risk.
commercial risk. Although the potential change in the value of assets,
definition includes swaps that are We also recognize the importance of
liabilities and services connected with providing as clear guidance as possible
recognized as hedges for accounting the ordinary course of business of the
purposes or as bona fide hedging for as to what is or is not a hedging position
enterprise.129 This standard is intended for these purposes.
purposes of an exemption from position to exclude from the first major
limits under the CEA, the swaps The proposal also would condition
participant test security-based swaps
included within the proposed exclusion the entity’s ability to exclude these
that pose limited risk to the market and
are not limited to those categories. security-based swap positions on the
to counterparties because the positions
Rather, the proposal covers swaps entity engaging in certain specified
would be substantially related to
hedging or mitigating any of a person’s activities related to documenting the
offsetting risks from an entity’s
business risks, regardless of their status underlying risks and assessing the
commercial operations.130 The security-
under accounting guidelines or the bona effectiveness of the hedge in connection
based swaps included within the
fide hedging exemption. with the positions.133 These activities
proposed rule would not be limited to
The CFTC invites comment on are intended to help ensure that
those recognized as hedges for
whether swaps qualifying for the positions excluded for purposes of the
accounting purposes; rather, the
hedging or risk mitigation exclusion proposal has been drafted to cover 131 See proposed Exchange Act rule 3a67–4(b)(1).
should be limited to swaps where the security-based swaps used in the For these purposes, we preliminarily believe that
underlying hedged item is a non- broader range of transactions commonly security-based swap positions that are held for the
financial commodity. Commenters may referred to as economic hedges, purpose of speculation or trading are those
also address whether swaps subject to positions that are held intentionally for short-term
this exception should hedge or mitigate 129 See proposed Exchange Act rule 3a67–4(a).
resale and/or with the intent of benefiting from
actual or expected short-term price movements or
commercial risk on a single risk or an The concept of ‘‘economically appropriate’’ already
to lock in arbitrage profits, as well as security-based
aggregate risk basis, and on a single is found in rules under the CEA pertaining to the
swap positions that hedge other positions that
definition of ‘‘bona fide hedging’’ for purposes of an
entity or a consolidated basis. The CFTC exemption from position limits. See CEA rule
themselves are held for the purpose of speculation
also invites comment on whether risks or trading. Thus, for example, positions that would
1.3(z). In the context of the definition of ‘‘major
be part of a ‘‘trading book’’ of an entity such as a
such as the foreign exchange, currency, security-based swap participant,’’ we may take into
bank would not constitute hedging positions that
or interest rate risk relating to offshore account existing interpretations of that term under
the CEA, but only to the extent that such may be excluded for purposes of the first major
interpretations would appropriately be applied to participant test.
128 We preliminarily believe that swap positions 132 See proposed Exchange Act rule 3a67–4(b)(2).
the use of security-based swaps for hedging.
that are held for the purpose of speculation or The SEC preliminarily plans to interpret the
133 See proposed Exchange Act rule 3a67–4(a)(3).
trading are, for example, those positions that are concept of ‘‘economically appropriate’’ based on The proposal particularly would require the person
held primarily to take an outright view on the whether a reasonably prudent person would to: Identify and document the risks that are being
direction of the market, including positions held for consider the security-based swap to be appropriate reduced by the security-based swap position;
short term resale, or to obtain arbitrage profits. for managing the identified commercial risk. The establish and document a method of assessing the
Swap positions that hedge other positions that SEC also preliminarily believes that for a security- effectiveness of the security-based swap as a hedge;
themselves are held for the purpose of speculation based swap to be deemed ‘‘economically and regularly assess the effectiveness of the
or trading are also speculative or trading positions. appropriate’’ in this context, it should not introduce security-based swap as a hedge.
We preliminarily believe that swap positions that any new material quantum of risks (i.e., it cannot We expect that market participants that have
are held for the purpose of investing are, for reflect over-hedging that could reasonably have a security-based swap activities significant enough
example, those positions that are held primarily to speculative effect) and it should not introduce any that they may be major participants would already
obtain an appreciation in value of the swap position basis risk or other new types of risk (other than the engage in risk assessment activities for their
itself, without regard to using the swap to hedge an counterparty risk that is attendant to all security- hedging positions, either formally or informally,
underlying risk. In contrast, a swap position related based swaps) more than reasonably necessary to and thus we do not believe that the proposed
to a non-swap investment (such as the purchase of manage the identified risk. requirements would disrupt existing business
an asset that a commercial enterprise will use to 130 These hedging positions would include practices. Instead, the proposal is intended to create
produce income or otherwise advance its activities, such as the management of receivables, standards that will allow market participants to
commercial interests) may be a hedging position if that arise out of the ordinary course of an entity’s confirm their compliance with the rule by
it otherwise qualifies for the definition of hedging commercial operations, including activities that are formalizing risk assessment activities that should
or mitigating commercial risk. incidental to those operations. already be part of an effective hedging program.
first major participant test would not securities of such other person or any of specified commercial risk? Should the
extend to positions that are not entered its affiliates; test be generally identical to the
into to reduce or hedge commercial • Positions established by a bank to proposed test, but with the substitution
risks, or that at a later time no longer manage counterparty risks in of the phrase ‘‘highly effective’’ or
substantially serve to reduce or mitigate connection with loans the bank has ‘‘reasonably effective’’ (or another
such risks.134 made; and standard) for ‘‘economically
We preliminarily believe that this • Positions to close out or reduce any appropriate’’? Should the test be based
proposed approach would facilitate the of those positions. on accounting principles for hedging
following types of security-based swap 2. Request for Comments treatment (i.e., a quantitative test
positions: requiring the hedge to be within a
• Positions established to manage the We request comment on the proposed certain band of effectiveness)?
risk posed by a customer’s, supplier’s or definition of ‘‘hedging or mitigating Commenters also are requested to
counterparty’s potential default in commercial risk’’ for purposes of both address the proposed restrictions on
connection with: financing provided to the ‘‘major swap participant’’ and the positions in the nature of speculation or
a customer in connection with the sale ‘‘major security-based swap participant’’ trading. Is it appropriate not to permit
of real property or a good, product or definitions. Commenters particularly are any speculative or trading positions
service; a customer’s lease of real requested to address whether the from being deemed for the purpose of
property or a good, product or service; proposed definitions would adequately hedging or mitigating commercial risk?
a customer’s agreement to purchase real limit the types of swaps or security- What would be the impact of such an
property or a good, product or service in based swaps that are encompassed by interpretation on an entity’s risk
the future; or a supplier’s commitment the definition, such that the definitions mitigation practices? Also, is the
to provide or sell a good, product or do not encompass positions that serve dividing line between speculative and
service in the future; 135 speculative, trading or other non- trading positions on the one hand, and
• Positions established to manage the hedging purposes. In this regard, do the positions eligible to be considered to be
risk posed by a financial counterparty proposed definitions appropriately hedging positions on the other hand,
(different from the counterparty to the exclude from the scope of the definition sufficiently clear? Is such a line
hedging position at issue) in connection swaps and security-based swaps that appropriately based on whether the
with a separate transaction (including a would be less likely to pose risks to position is intended to be held for the
position involving a credit derivative, counterparties and the market, by virtue short-term versus long-term intent?
equity swap, other security-based swap, of gains or losses on those swaps being Would some alternative criteria be
interest rate swap, commodity swap, offset by losses or gains associated with preferable in terms of setting forth
foreign exchange swap or other swap, an entity’s commercial operations? objective standards for identifying risk
option, or future that itself is for the Commenters further are requested to reducing hedging positions and
purpose of hedging or mitigating address whether the proposed distinguishing them from other
commercial risk pursuant to the rule or ‘‘economically appropriate’’ standard positions? Also, would additional
CEA rule 1.3(ttt)); would effectively limit the positions standards or other guidance be
• Positions established to manage encompassed by the definition. If not, appropriate to help ensure that
equity or market risk associated with what alternative standards (e.g., positions used in connection with
certain employee compensation plans, standards derived from accounting speculative or trading purposes do not
including the risk associated with principles) would more effectively fall within the definition?
market price variations in connection identify hedging positions and We further request comment on the
with stock-based compensation plans, distinguish those from positions held proposal that a swap or security-based
such as deferred compensation plans for other purposes? In that regard, is the swap would not fall within the
and stock appreciation rights; concept of ‘‘economically appropriate’’ definition of ‘‘hedging or mitigating
• Positions established to manage well-understood, and, if not, is there commercial risk’’ if it is held to hedge
equity market price risks connected another concept that would more or mitigate the risk of another swap or
with certain business combinations, effectively delimit the nature of the security-based swap, unless that other
such as a corporate merger or relationship between the swap or position itself is held for the purpose of
consolidation or similar plan or security-based swap position and the hedging or mitigating commercial risk.
acquisition in which securities of a risk being hedged or mitigated? Also, in One consequence of this approach
person are exchanged for securities of the context of the definition of this term might be that a particular swap or
any other person (unless the sole for purposes of security-based swaps, security-based swap hedging a
purpose of the transaction is to change should existing interpretive guidance particular type of risk would be
an issuer’s domicile solely within the pertaining to the concept of included or excluded based solely on
United States), or a transfer of assets of ‘‘economically appropriate’’ with respect whether that risk arises from another
a person to another person in to the CEA’s bona fide hedging swap or security-based swap or from a
consideration of the issuance of exemption for position limits be different type of transaction.136 Is this
considered, and, if so, to what extent? the appropriate approach? What would
134 This condition does not mandate that an entity We further request comment on possible be the consequences of this approach for
follow a particular set of procedures to take alternative approaches to the test
advantage of the exclusion. We would expect that identifying positions entered into for the 136 For example, under this proposal an entity
an entity that already engages in these types of risk purpose of hedging or mitigating may exclude from the first major participant test a
assessment procedures in connection with its security-based swap used to manage the credit risk
existing business activities to be able to rely on commercial risk. For example, should posed by a customer’s default in connection with
those procedures to satisfy the condition. These the test require the entity excluding a financing that an entity provides to that customer.
conditions also could be satisfied by the entity’s use position to have a reasonable basis to The entity may not exclude an identical security-
of a third-party to assist with these risk assessment believe, and to actually believe, that the based swap, however, if that security-based swap is
activities. used to hedge the credit risk associated with a
135 The references here to customers and excluded swap would be a ‘‘highly second swap or security-based swap that itself is
counterparties do not include swap or security- effective,’’ ‘‘reasonably effective’’ or not for the purpose of hedging or mitigating
based swap counterparties. ‘‘economically appropriate’’ hedge of a commercial risk.
different types of entities? How would or mitigated by that position, and if not, which uses of security-based swaps by
the proposed approach affect the risk what additional requirements are registered investment companies would
management practices of entities that needed? Should additional guidance be fall within the exclusion.
are close to the proposed threshold? Is provided regarding whether
D. ‘‘Substantial Counterparty Exposure’’
it appropriate to include both positions components of risks (in assets, liabilities
within the major participant or services) or whether risks in The second test of the major
calculations? If this general approach in portfolios (of assets, liabilities or participant definitions addresses
the proposed rule were adopted, should services) may be identified as the entities whose swaps and security-based
there be any exceptions to the commercial risks that are being hedged swaps ‘‘create substantial counterparty
approach? What alternative approaches or mitigated by the position, and, if so, exposure that could have serious
might be considered? For example, which components? Also, should adverse effects on the financial stability
would it be appropriate to exclude a additional guidance be provided with of the United States banking system or
swap or security-based swap that hedges respect to the form of documentation or financial markets.’’ 137 Unlike the first
another swap or security-based swap the elements of the hedging relationship test of the major participant definitions,
from the calculation? What would be that should be documented, and, if so, this test does not focus on positions in
the advantages and disadvantages of this which elements? Moreover, if a swap or a ‘‘major’’ category of swaps or security-
approach? security-based swap that was hedging at based swaps. Also, unlike the first test,
Moreover, commenters are requested inception were no longer to serve a this test does not explicitly exclude
to address whether the definition hedging purpose over time, should it no hedging positions or certain ERISA plan
should encompass a quantitative test longer fall within the definition of positions from the analysis.
that would limit the total value of swaps hedging or mitigating commercial risk? Some commenters suggested that the
and security-based swaps that an entity In addition, should the rule specify second major participant definition test
may include under this rule to be no the frequency with which an entity should be interpreted in a manner
more than the total value of underlying should assess the effectiveness of the similar to the first test. Many
risk identified by such entity. If so, what hedge? Also, should we provide commenters stated that the analysis
measurement should be used for additional guidance on the acceptable should also reflect netting agreements
determining an entity’s total value of methods of assessing effectiveness? Is a and the posting of collateral. Some
swaps and security-based swaps and qualitative assessment adequate to commenters stated that the test should
total value of underlying risk, and what assess effectiveness or should a exclude hedging positions, and cleared
methods or procedures should entities quantitative assessment also be positions.
be required to follow when calculating required? Should the rule establish a We preliminarily believe that the
and comparing the two values? level of offset between the position and second major participant definition
In addition, commenters are requested the hedged risk, below which the test’s focus on the counterparty risk
to address whether the proposed position would not be considered to be associated with an entity’s swap or
procedural requirements, in the context effective at reducing risk, and, if so, security-based swap positions is similar
of this definition for purposes of the what is the level of offset (or range of enough to the ‘‘substantial position’’
‘‘major security-based swap participant’’ levels) below which the position should risks embedded in the first test that the
analysis, are appropriate. In this regard, not be considered to be effective? Are second test appropriately takes into
commenters are requested to discuss there methods for assessing account the same measures of current
whether there are any advantages or effectiveness that should not be uncollateralized exposure and potential
disadvantages to providing more permitted for these purposes? future exposure that are used in our
specific procedural requirements; Commenters also are requested to proposal for the first test. For the second
whether the proposed procedural address whether the proposal also test, however, the thresholds must focus
requirements will alter business should encompass certain activities in on the entirety of an entity’s swap
practices to the extent that a transition which an entity hedges an affiliate’s positions or security-based swap
period is necessary before they are risks. positions, rather than on positions in
implemented; and whether specific We further request comment on how
any specific ‘‘major’’ category. In
guidance is required to address how the the definition should apply to hedging
addition, this second test does not
proposed procedural requirements will activities by financial entities.
explicitly account for positions for
affect existing positions. In addition, Commenters particularly are invited to
hedging commercial risk or ERISA
commenters are requested to address address whether financial entities
positions.
whether the proposed procedural should be able to rely on this exclusion,
Accordingly, these proposed
requirements should include a or whether financial entities should face
calculations of substantial counterparty
requirement to quantify the underlying special limits in the context of this
exposure would be performed in largely
risk and the effectiveness of the hedge, exclusion. Commenters further are
the same way as the calculation of
and whether such quantitative requested to address how the proposed
substantial position in the first major
assessments would impose significant provisions excluding positions in the
participant definition tests, except that
systems costs or other costs. Also, nature of speculation or trading from the
the amounts would be calculated by
should an assessment of hedging definition would apply to activities by
reference to all of the person’s swap or
effectiveness be required at all, in light banks, including permissible trading
security-based swap positions, rather
of the costs that may be associated with activities by banks, and, in particular,
than by reference to a specific ‘‘major’’
such a requirement? whether it is appropriate to exclude
More generally, would the proposed category of such positions.138
positions that are part of an entity’s
standards for identifying positions for For purposes of the ‘‘major swap
‘‘trading book.’’
the purpose of hedging or mitigating Commenters also are requested to participant’’ definition, the CFTC
commercial risk suffice to allow a address the application of the proposal 137 See CEA section 1a(33)(A)(ii); Exchange Act
person holding a security-based swap to registered investment companies, section 3(a)(67)(A)(ii)(II).
position to identify and document the including whether additional guidance 138 See proposed CEA rule 1.3(uuu)(2); proposed
commercial risks that are being hedged would be appropriate with respect to Exchange Act rule 3a67–5(b)(1).
proposes that the second major substantial counterparty exposure, given technical changes to avoid circularity,
participant definition test be satisfied by its focus on the systemic risks arising we propose to use the same definition
a current uncollateralized exposure of from the entirety of a person’s portfolio, in the major participant definitions.146
$5 billion, or a combined current should include a measure to take into Commenters are requested to address
uncollateralized exposure and potential account the person’s combined swap our proposed definition of ‘‘financial
future exposure of $8 billion, across the positions and security-based swap entity.’’
entirety of an entity’s swap positions.139 positions. 2. Meaning of ‘‘Highly Leveraged’’
For purposes of the ‘‘major security-
E. ‘‘Financial Entity’’ and ‘‘Highly Some commenters have stated that the
based swap participant’’ definition, the
Leveraged’’ term ‘‘highly leveraged’’ should be
SEC proposes that the second test be
satisfied by a current uncollateralized The third test of the major participant interpreted by looking at the leverage
exposure of $2 billion, or a combined definitions addresses any ‘‘financial associated with other firms in an
current uncollateralized exposure and entity,’’ other than one subject to capital entity’s line of business, rather than by
potential future exposure of $4 billion, requirements established by an applying an across-the-board measure of
across the entirety of an entity’s appropriate Federal banking agency,143 leverage.147 One commenter suggested
security-based swap positions.140 We that is ‘‘highly leveraged relative to the that higher leverage may be warranted
look forward to commenters’ views as to amount of capital’’ the entity holds, and for entities with a smaller capital base,
whether alternative thresholds would be that maintains a substantial position in and another commenter suggested that
more appropriate to achieve the a ‘‘major’’ category of swaps or security- we look at analogous banking
statutory goals. based swaps. This test does not permit regulations rather than creating a new
These proposed thresholds in part are an exclusion for positions held for regime for measuring leverage. Some
based on the same factors that underpin hedging. commenters suggested ways of
the proposed ‘‘substantial position’’ As discussed below, we are proposing addressing specific items for purposes
thresholds.141 The proposed thresholds, specific definitions of the terms of determining leverage.148
however, also reflect the fact that this ‘‘financial entity’’ and ‘‘highly The Commissions recognize that
test must account for an entity’s leveraged.’’ In addition, we request traditional balance sheet measures of
positions across four major swap comment on whether we should include leverage have limitations as tools for
categories or two major security-based additional regulators within the
146 See proposed CEA rule 1.3(vvv)(1); proposed
swap categories.142 These proposed proposed interpretation of what is an
Exchange Act rule 3a67–6(a). To avoid circularity,
thresholds, moreover, have further been appropriate Federal banking agency. the meaning of ‘‘financial entity’’ for purposes of the
raised to reflect the fact that this second ‘‘major swap participant’’ definition would not
1. Meaning of ‘‘financial entity’’
test (unlike the first major participant encompass any ‘‘swap dealer’’ or ‘‘major swap
test) encompasses certain hedging While the third major participant participant’’ (but would encompass ‘‘security-based
definition test does not explicitly define swaps dealers’’ and ‘‘major security-based swap
positions that, in general, we would participants’’). The meaning of ‘‘financial entity’’ for
expect to pose fewer risks to ‘‘financial entity,’’ Title VII of the Dodd- purposes of the ‘‘major security-based swap
counterparties and to the markets as a Frank Act defines ‘‘financial entity’’ in participant’’ definition would not encompass any
the context of the end-user exception ‘‘security-based swap dealer’’ or ‘‘major security-
whole than positions that are not for based swap participant (but would encompass
purposes of hedging. from mandatory clearing (an exception ‘‘swap dealers’’ and ‘‘major swap participants’’). For
We request comment on this proposal. that generally is not available to those both definitions, ‘‘financial entity’’ would include
Commenters particularly are requested entities).144 Some commenters have any: commodity pool (as defined in section 1a(10)
to address whether the proposed use of pointed out that using that definition of the CEA); private fund (as defined in section
202(a) of the Investment Advisers Act of 1940);
current uncollateralized exposure and here would produce circular results.145 employee benefit plan as defined in paragraphs (3)
potential future exposure tests We preliminarily do not believe there and (32) of section 3 of the Employee Retirement
(including the parts of those tests that is a basis to define ‘‘financial entity’’ for Income Security Act of 1974; and person
purposes of the major participant predominantly engaged in activities that are in the
account for positions that are cleared or business of banking or financial in nature (as
subject to mark-to-market margining) are definitions in a way that materially defined in section 4(k) of the Bank Holding
appropriate, and whether the proposed differs from the definition used in the Company Act of 1956).
thresholds are set at an appropriate end-user exception from mandatory 147 See letter from Robert Pickel, Executive Vice
level. Should the thresholds be higher clearing. Using the same basic definition Chairman, International Swaps and Derivatives
also would appear to be consistent with Association, Inc., dated September 20, 2010
or lower? If so, what alternative (suggesting that ‘‘leverage ratio limits to which
threshold amounts would be more the statute’s intent to treat non-financial banks and other regulated entities are subject would
appropriate, and why? Commenters also end-users differently than financial be unsuitably low for other enterprises’’); letter from
entities. Accordingly, other than Steve Martinie, Assistant General Counsel and
are requested to address whether the Assistant Secretary, The Northwestern Mutual Life
test should exclude commercial risk and Insurance Company, dated September 20, 2010
143 Sections 721 and 761 of the Dodd-Frank Act
ERISA hedging positions, on the (‘‘Northwestern Mutual letter’’) (suggesting that
add a definition of the term ‘‘appropriate Federal financial firms require less cushion than other
grounds that those hedging positions banking agency’’ in sections 1a and 3(a) of the CEA entities because financial firms are able to match
may not raise the same degree of risk to and the Exchange Act, respectively, 7 U.S.C. 1a(2), their assets and liabilities more closely).
counterparties as other swap or security- 15 U.S.C. 78c(a)(72). The Commissions propose to 148 See Northwestern Mutual letter (suggesting
based swap positions. Comments are refer to those statutory definitions for purposes of that the Commissions recognize that liabilities such
the rules. as bank deposits and insurance policy reserves are
also requested on whether the test of
144 See CEA section 2(h)(7)(C)(i); Exchange Act

not leverage); Vanguard letter (suggesting that
section 3C(g)(3)(A). leverage should relate to debt financing and should
139 See proposed CEA rule 1.3(uuu)(1). 145 See Cleary letter (also addressing status of
not encompass potential leveraging effects posed by
140 See proposed Exchange Act rule 3a67–5(a). broker-dealers and futures commission merchants derivatives); SIFMA AMG letter (suggesting that the
141 See notes 103 to 106 and 117, supra, and as part of the analysis). Commissions take into account the difference
accompanying text. The circularity would result because, for between non-recourse and recourse obligations, the
142 Thus, these proposed thresholds in part would purposes of the end-user clearing exception, difference between notional amounts payable and
account for an entity that has large positions in ‘‘financial entity’’ is defined to include swap actual payable obligations, and the difference
more than one major category of swaps or security- dealers, security-based swap dealers, major swap between actual financial obligations and leverage
based swaps, but that does not meet the substantial participants, and major security-based swap embedded in a derivative that affects returns but
position threshold for either. participants. does not result in a payment obligation).
evaluating an entity’s ability to meet its company poses to the financial stability stability and thus may suggest that a
obligations. In part this is because such of the United States.’’ 150 higher standard is appropriate for
measures of leverage do not directly This requirement in Title I suggests entities that do not pose the same degree
account for the potential risks posed by potential alternative approaches to the of threat. Alternatively, the 8 to 1 ratio
specific instruments on the balance definition of ‘‘highly leveraged’’ for could be consistent with the exemption
sheet, or financial instruments that are purposes of the major participant in the third test of the major participant
held off of an entity’s balance sheet (as definitions. On the one hand, the 15 to definitions for financial institutions that
may be the case with an entity’s swap 1 limit may represent an upper limit of are subject to capital requirements set
and security-based swap positions). At acceptable leverage, indicating that the by the Federal banking agencies, as it is
the same time, we preliminarily do not limit for the major participant possible that financial institutions were
believe that it is necessary to use more definitions should be lower so as to specifically excluded from the third test
complex measures of risk-adjusted create a buffer between entities at that based on the presumption that they
leverage here, particularly given that the upper limit and entities that are not generally are highly leveraged, and
third test in the major participant highly leveraged. On the other hand, the hence would have been covered by the
definitions already addresses those Title 1 requirement, which applies only third test if they were not expressly
types of risks by considering whether an when the entity in question poses a exempted. Based on our analysis of
entity has a substantial position in a ‘‘grave threat’’ to financial stability, may financial statements it appears that
major category of swaps or security- indicate that the 15 to 1 leverage ratio those institutions generally have
based swaps. We are also mindful of the is also the appropriate test of whether leverage ratios of approximately 10 to 1,
costs that entities would face if forced an entity poses the systemic risk which may suggest that the ‘‘highly
to undertake a complex risk-adjusted concerns implicated by the major leveraged’’ threshold would have to be
leverage calculation, especially for participant definitions. lower for those institutions to be
entities that would not already be For these reasons, we propose two potentially subject to the third test.
performing this type of analysis.149 possible definitions of the point at Such an approach would help to ensure
Additionally, we preliminarily do not which an entity would be ‘‘highly that the third test of the major
believe that it is necessary for the leveraged’’—either an entity would be participant definition applies to
leverage standard to account for the ‘‘highly leveraged’’ if the ratio of its total financial entities that are not subject to
degree of leverage associated with liabilities to equity is in excess of 8 to capital requirements set by the Federal
different types of financial entities. 1, or an entity would be ‘‘highly banking agencies, but that have leverage
leveraged’’ if the ratio of its total ratios similar to institutions that are
Although the third test of the major subject to those requirements.
liabilities to equity is in excess of 15 to
participant definitions does not define The Commissions request comment
1. In either case, the determination
‘‘highly leveraged,’’ we note that on the proposed alternative definitions
would be measured at the close of
Congress addressed the issue of leverage of ‘‘highly leveraged.’’ Commenters
business on the last business day of the
in Title I of the Dodd-Frank Act. There, particularly are requested to specifically
applicable fiscal quarter. To promote
Congress provided that the Board of address the relative merits of the
consistent application of this leverage
Governors of the Federal Reserve proposed alternative 8 to 1 and 15 to 1
test, entities that file quarterly reports
System must require a bank holding standards, as well as other standards
on Form 10–Q and annual reports on
company with total consolidated assets that they believe would be appropriate
Form 10–K with the SEC would
equal to or greater than $50 billion, or for these purposes.152
determine their total liabilities and
a nonbank financial company Commenters further are requested to
equity based on the financial statements
supervised by the Board of Governors, address whether a risk-adjusted leverage
included with such filings.151 All other
to maintain a debt to equity ratio of no ratio should be used, and, if so, how the
entities would calculate the value of
more than 15 to 1 if the FSOC ratio should be calculated (including
total liabilities and equity consistent
determines ‘‘that such company poses a whether particular items should be
with the proper application of U.S.
grave threat to the financial stability of included or excluded when making this
generally accepted accounting
the United States and that the calculation), and whether a risk-
principles.
imposition of such requirement is adjusted leverage ratio could be
We believe that the 15 to 1 ratio could
necessary to mitigate the risk that such developed relying on measures already
be consistent with the use of that ratio
149 The Basel Committee on Banking Supervision
in Title I, which, as noted above, 152 In this regard, we recognize that under
recently proposed one method for calculating risk-

provides that the 15 to 1 leverage ratio Exchange Act rule 15c3–1, a broker-dealer may
adjusted leverage in its Consultative Document would be applied to a bank holding determine its required minimum net capital, among
entitled: ‘‘Strengthening the resilience of the company or nonbank financial company other ways, by applying a financial ratio that
banking sector’’ (Dec. 2009). This proposal would subject to Title I as a maximum only if provides that its aggregate indebtedness shall not
create a new leverage ratio based on a comparison exceed 1500% of its net capital (i.e., a 15 to 1
of capital to total exposure. Total exposure for these
it is determined that the company poses aggregate indebtedness to net capital ratio).
purposes would be measured by, among other a ‘‘grave threat’’ to financial stability. Exchange Act Rule 17a–11 further requires that
things, including the notional value of all written Commenters are requested to address broker-dealers that use such method to establish
credit protection, severely limiting the recognition whether the proposed 15 to 1 standard their required minimum net capital must provide
given to netting, and calculating the risks associated notice to regulators if their aggregate indebtedness
with off-balance sheet derivatives transactions, as
used in Title I suggests that a standard exceeds 1200% of their net capital (i.e., a 12 to 1
measured by the current exposure method for higher than 15 to 1 should be used here, aggregate indebtedness to net capital ratio). We
calculating future risks outlined in Basel II. The given that the Title I standard is recognize that these measures, however, reflect a
Consultative Document drew over 150 comments applicable only to large entities that also different ratio of total liabilities to equity; for
from the international financial community, which example, the calculation of aggregate indebtedness
included both those in support of, and those that
pose a ‘‘grave threat’’ to financial in rule 15c3–1 excludes certain liabilities, and the
questioned the inclusion of a risk-adjusted leverage calculation of net capital includes certain
150 See Dodd-Frank Act section 165(j)(1).
ratio within the Basel framework. The Basel subordinated debt—meaning that these measures
Committee on Banking Supervision expects to 151 These entities would include those that would respectively be equivalent to ratios higher
deliver a full package of reforms by the end of 2010, submit periodic reports on a voluntary basis to the than 15:1 or 12:1 when converted to a balance sheet
based on the Consultative Document released in SEC, as well as those that are required to file ratio of liabilities to equity such as that used under
December 2009 and comments received thereon. periodic reports with the SEC. the proposed rule.
calculated by entities as a matter of We also propose to provide a of the reevaluation period; whether
course.153 Commenters further are reevaluation for entities that meet one or there would be any risks arising from
requested to address whether the more of the applicable major participant delaying registration as a major
leverage ratio should be revised to thresholds, but only by a modest participant for an entity that exceeds the
require that the amount of potential amount.155 In particular, an thresholds, but qualifies for the
future exposure (as outlined in the unregistered entity that has met these reevaluation period; and whether four
‘‘substantial position’’ discussion above) criteria as a result of its swap or consecutive quarters of not meeting the
be combined with total liabilities before security-based swap activities in a fiscal criteria for major participant status after
such number is compared to equity for quarter, but without exceeding any registration is granted is the appropriate
purposes of calculating the ratio, and, if applicable threshold by more than amount of time that a major participant
so, whether the proposed ratios would twenty percent, would not immediately should be required to stay in the status.
still be appropriate; whether the rule be subject to the timing requirements In addition, we request comment on
should more specifically address issues discussed above. Instead, that entity the appropriateness of the proposed
as to how certain types of positions or would become subject to those reevaluation period. Commenters
liabilities should be accounted for when requirements if the entity exceeded any particularly are requested to address
calculating leverage; whether the of the applicable daily average whether it is likely that unusual market
proposed timing of the measurement— thresholds in the next fiscal quarter.156 conditions could cause an entity to
the close of business on the last We preliminarily believe this type of exceed the proposed thresholds over the
business day of the applicable fiscal reevaluation period would avoid course of a quarter (based on a daily
quarter—would be potentially subject to applying the major participant average) without generally raising the
gaming or evasion; and whether the rule requirements to entities that meet the types of risks that the thresholds were
text should particularly prescribe how major participant criteria for only a intended to identify. Also, should the
separate categories of entities calculate short time due to unusual activity. use of the reevaluation period be
In addition, we propose that any conditioned on requiring any entity
leverage.
entity that is deemed to be a major relying on the reevaluation period to
F. Implementation Standard, participant would retain that status make a representation, or otherwise
Reevaluation Period and Minimum until such time that it does not exceed demonstrate, that it exceeded the
Duration of Status any of the applicable thresholds for four threshold due to a one-time
consecutive quarters after the entity extraordinary event, and that it will be
While the analysis of whether an becomes registered.157 Commentators below the threshold at the next time of
entity is a major participant is backward raised concerns about the possibility of measurement?
looking, an entity that meets the criteria entities moving in and out of the status
for being a major participant is required on a rapid basis,158 and we believe that G. Limited Purpose Designations
to register with the CFTC and/or the this proposal appropriately addresses In general, a person that meets the
SEC, and comply with the requirements that concern in a way that would help definition of major participant will be
applicable to major participants. We promote the predictable application and considered to be a major participant
recognize that these entities will need enforcement of the requirements with respect to all categories of swaps
time to complete their applications for governing major participants. or security-based swaps, as applicable,
registration and to come into The Commissions request comment and with regard to all activities
compliance with the applicable on these proposals. Commenters involving those instruments.159 As
requirements. We thus propose that an particularly are requested to address: discussed above, however, the statutory
unregistered entity that meets the major Whether two months is an adequate definitions provide that a person may be
participant criteria as a result of its amount of time for entities that have designated as a major participant for one
swap or security-based swap activities met the criteria to submit an application or more categories of swaps or security-
in a fiscal quarter would not be deemed for registration; whether there is an based swaps without being classified as
to be a major participant until the earlier adequate amount of time to make the a major participant for all categories.160
of the date on which it submits a necessary internal changes to come into Thus, as with the definitions of ‘‘swap
complete application for registration compliance with the requirements dealer’’ and ‘‘security-based swap
pursuant to CEA Section 4s(b) or applicable to major participants before dealer,’’ we propose to provide that
Exchange Act Section 15F(b), or two being subject to those requirements as a major participants who engage in
months after the end of that quarter.154 result of a registration becoming significant activity with respect to only
We preliminarily believe that this effective; whether twenty percent is the certain types, classes or categories of
would provide entities with an appropriate threshold for applicability swaps or security-based swaps may
appropriate amount of time to apply for apply for relief with respect to other
155 Commenters raised concerns over an entity
registration and, with the time between types of swaps or security-based swaps
qualifying as a major participant due to an unusual
the submission of an application and event. See, e.g., letter from American Benefits from certain of the requirements that are
the effectiveness of the registration, to Council and Committee on the Investment of applicable to major participants. The
comply with the requirements Employee Benefit Assets, dated September 20, 2010 Commissions anticipate that a major
applicable to major participants, (stating that quirky volatility may affect the
determinations). participant could seek a limited
without permitting undue delay. designation at the same time as, or at a
156 See proposed CEA rule 1.3(qqq)(4)(ii);
proposed Exchange Act rules 3a67–7(b). later time subsequent to, the person’s
153 For example, would adjustments akin to those 157 See proposed CEA rule 1.3(qqq)(5); proposed
initial registration as a major
discussed above in the context of broker-dealer net Exchange Act rules 3a67–7(c)(1). participant. Because of the variety of
capital provide a more useful measure of leverage 158 See Vanguard letter (suggesting that entities
for these purposes? should remain in the status after qualification for
situations in which major participants
154 See proposed CEA rule 1.3(qqq)(4)(i); an extended defined period such as one calendar
159 See proposed CEA rule 1.3(qqq)(2); proposed
proposed Exchange Act rule 3a67–7(a). The year); AIMA letter (noting that recategorization of
Commissions are proposing separate rules regarding entities could be disruptive for entities’ business Exchange Act rule 3a67–1(c).
the registration requirements and processes for models and could be administratively burdensome 160 CEA section 1a(33)(C); Exchange Act section
major participants. for the Commissions). 3(a)(67)(C).
may enter into swaps or security-based ERISA plans should be broadly such other accounts as the entity that
swaps, it is difficult to set out at this excluded. has entered into the swaps or security-
time the conditions, if any, which While the Commissions are not based swaps) for the purpose of evading
would allow a person to be designated proposing to make this type of exclusion the regulations applicable to major
as a major participant with respect to available to additional types of entities, participants.163 In addition, we note that
only certain types, classes or categories we request comment on whether we since the major participant definitions
of swaps or security-based swaps. should do so. If so, what type of entities focus on the entity that enters into
The Commissions request comment should receive this type of exclusion, swaps or security-based swaps, all of the
on the proposed rules regarding limited and why do the concerns that led to the managed positions of which a person is
designation as a major participant. enactment of the major participant the beneficial owner are to be aggregated
Commenters particularly are requested requirements in the Dodd-Frank Act not (along with such beneficial owner’s
to address the circumstances in which apply to such entities? other positions) for purposes of
such limited purpose designations 2. Application of Major Participant determining whether such beneficial
would be appropriate, and to address Definitions to Managed Accounts owner is a major participant.164
the factors that the Commissions should The Commissions request comment
consider when addressing such Some commenters have stated that on the application of the major
requests, and the type of information asset managers and investment advisers participant definitions to managed
requestors should provide in support of should not be deemed to be major accounts. Commenters particularly are
their request. Commenters also are participants by virtue of the swap and requested to address: whether
asked to address whether such limited security-based swap positions held by additional guidance is necessary to
purpose designations should be the accounts they manage. These address issues relating to the
conditioned in any way, such as by the commenters have emphasized that asset application of the major participant
provision of information of the type that managers and investment advisers are definition to managed accounts;
would be required with respect to an separate legal entities from the accounts whether there are areas of potential
entity’s swaps or security-based swaps that they administer, the accounts abuse, and if so, what they may be.
involving the particular category or themselves are the counterparties to the Commenters further are requested to
activity for which they are not swaps and security-based swaps, and address whether the Commissions
designated as a major participant. managers and advisers do not maintain should adopt anti-evasion rules to
capital to support the trades of their address areas of potential abuse, and if
H. Additional Interpretive Issues clients. One commenter also expressed so, how such rules should be crafted.
Commenters have raised additional the view that the positions of individual In addition, commenters are requested
issues related to the major participant accounts under the advisement of a to discuss any implementation concerns
definitions. single asset manager should not be that may arise if the beneficial owner of
aggregated for the purpose of the major a managed account meets one of the
1. Exclusion for ERISA Plan Positions participant definitions because different major participant definitions; for
As discussed above, the first test of accounts managed by an asset manager example, would the beneficial owner
the major participant definitions may use the same positions for different face any impediments in terms of
excludes from the analysis ‘‘positions purposes.162 identifying whether it falls within the
maintained by any employee benefit Preliminarily, we do not believe that major participant definitions? Also,
plan (or any contract held by such a the major participant definitions should what implementation issues would arise
plan) as defined in paragraphs (3) and be construed to aggregate the accounts with respect to applying the major
(32) of section 3 of ERISA (29 U.S.C. managed by asset managers or participant definitions to managed
1002) for the primary purpose of investment advisers to determine if the accounts and/or their beneficial owners
hedging or mitigating any risk directly asset manager or investment adviser if the accounts’ advisers or managers are
associated with the operation of the itself is a major participant. The major not subject to regulation as major
plan.’’ Some commenters suggested that participant definitions apply to the participants?
the exclusion should encompass entities that actually ‘‘maintain’’
activities such as portfolio rebalancing substantial positions in swaps and 3. Application of Major Participant
and diversification, and gaining security-based swaps or that have swaps Definitions to Positions of Affiliated
exposure to alternative asset classes, or security-based swaps that create Entities
and that this type of exclusion also substantial counterparty exposure. The The issues discussed above with
should apply to certain other types of Commissions have the authority to regard to managed accounts also are
entities.161 adopt anti-evasion rules to address the related to the separate issue of whether
We preliminarily do not believe that possibility that persons who enter into the major participant tests should, in
it is necessary to propose a rule to swaps and security-based swaps may some circumstances, aggregate the swap
further define the scope of this attempt to allocate the swaps and and security-based swap positions of
exclusion. In this regard, we note that security-based swaps among different entities that are affiliated. Absent that
this ERISA plan exclusion, unlike the accounts (thereby attempting to treat type of aggregation, an entity could seek
other exclusion in the first major to evade major participant status by
participant test, is not limited to 162 In addition, a colloquy on the Senate floor
allocating swap or security-based swap
‘‘commercial’’ risk, which may be addressed the status of managed accounts for
purposes of the major participant definitions,
construed to mean that hedging by particularly focusing on whether the analysis 163 See Dodd-Frank Act sections 721(b)(2),
should ‘‘look at the aggregate positions of funds 761(b)(3).

161 See Cleary letter (addressing welfare plans or managed by asset managers or at the individual 164 This guidance relates only to the application
entities holding assets of such plans, such as fund level?’’ In response, it was stated that, ‘‘[a]s a of the major participant definitions to managed
voluntary employee beneficiary associations, general rule, the CFTC and the SEC should look at accounts. It is not intended to apply to the
employer group trusts or bank-maintained each entity on an individual basis when treatment of managed accounts with respect to any
collective trusts); see also letter from Jane Hamblen, determining its status as a major swap participant.’’ other rules promulgated by the CFTC or SEC to
State of Wisconsin Investment Board, dated See 156 Cong. Rec. S5907 (daily ed. July 15, 2010) implement Title VII of the Dodd-Frank Act or to any
September 20, 2010. (colloquy between Senators Hagan and Lincoln). other applicable rules or requirements.
positions among a number of affiliated or third parties provide guarantees on (including an affiliate of the named
entities. behalf of unaffiliated entities. counterparty to the swap or security-
In situations in which a parent is the Commenters further are requested to based swap) that provides a guarantee of
majority owner of a subsidiary entity, address any issues that would arise with the named counterparty’s obligations,
we preliminarily believe that the major regard to the effective implementation either in the form of a guarantee or
participant tests may appropriately of the requirements applicable to major through some other form of credit
aggregate the subsidiary’s swaps or participants in the context of this type support whereby the guarantor agrees to
security-based swaps at the parent for of attributions. satisfy margin obligations of the named
purposes of the substantial position
4. Application of Major Participant counterparty and/or periodic payment
analyses.165 Attributing those positions
Definitions to Inter-Affiliate Swaps and obligations of the named counterparty.
to a parent appears consistent with the
Security-Based Swaps
concepts of ‘‘substantial position’’ and 5. Legacy Portfolios
‘‘substantial counterparty exposure,’’ Several commenters have suggested
given that the parent would effectively that swaps and security-based swaps Some commenters have stated that
be the beneficiary of the transaction. In between affiliated counterparties should certain entities that maintain legacy
those circumstances, however, there not be considered within the analysis of portfolios of credit default swaps that
still may be questions as to whether the whether an entity’s swap or security- previously had been entered into in
requirements applicable to major based swap positions cause it to be a connection with the activities of
participants—e.g., capital, margin and major participant. Such inter-affiliate monoline insurers and ‘‘credit derivative
business conduct—should be placed swaps and security-based swaps may be product companies’’ should not be
upon the parent or the subsidiary. We used to achieve various operational and considered major participants. The
recognize that it may be appropriate at internal efficiency objectives. commenters argued that these entities
times to apply such requirements upon The Commissions preliminarily
would be unable to comply with the
the subsidiary to the extent that the believe that when a person analyzes its
capital and margin requirements
subsidiary is acting on behalf of the swap or security-based swap positions
under the major participant definitions, applicable to major participants, and
parent.166
it would be appropriate for the person that regulation as major participants is
Commenters particularly are invited
to discuss when it would be appropriate to consider the economic reality of any unnecessary given that the entities are
to apply the major participant swaps or security-based swaps it enters not writing any additional swaps or
definitions to entities that are the into with wholly owned affiliates, security-based swaps.
majority owner of subsidiaries that enter including whether the swaps and We request comment on whether the
into swaps or security-based swaps, or security-based swaps simply represent rules further defining major swap
whether attribution of a subsidiary’s an allocation of risk within a corporate participant and major security-based
security-based swap positions is group.167 Such swaps and security- swap participant should exclude such
generally inappropriate. Also, to the based swaps among wholly-owned entities from the major participant
extent this type of attribution is affiliates may not pose the exceptional definition if their swap and security-
appropriate, to what extent should the risks to the U.S. financial system that based swap positions are limited to
subsidiary retain responsibilities for are the basis for the major participant those types of legacy positions. The
complying with the capital, margin, definitions. As discussed above in the exclusion from the definition could be
business conduct and other context of managed accounts, however, conditional, and any such excluded
requirements applicable to major an entity would not be able to evade the
entity would be required to provide the
participants? requirements applicable to major
Commenters further are requested to Commissions with position information
participants by allocating among
address whether the swaps or security- of the type that registered major
multiple affiliates swap or security-
based swaps of corporate subsidiaries in based swap positions of which it is the participants would be required to
some circumstances should be beneficial owner. provide. We invite comment on any
attributed to an entity that itself is not The Commissions request comment other conditions that might be
the majority owner of the direct on the treatment of inter-affiliate swaps appropriate to an exclusion of such
counterparty to a swap or security-based and security-based swaps between legacy portfolios from the major
swap. Moreover, should this type of wholly-owned affiliates of the same participant definitions.
attribution apply when one entity corporate parent in connection with the
controls another entity, and, if so, how 6. Potential Exclusions
major participant definitions.
should the concept of control be defined Commenters also are requested to Some commenters stated that the
for these purposes? In addition, address whether similar interpretations major participant definitions should not
commenters are requested to address should apply to swaps and security- be interpreted to apply to entities such
whether, as an alternative approach, this based swaps between entities within a as investment companies,168 ERISA
type of attribution would be appropriate consolidated group as determined in plans, registered broker-dealers and/or
specifically when a parent provides accordance with U.S. generally accepted
guarantees on behalf of its subsidiaries, registered futures commission
accounting principles. Commenters
further are requested to discuss whether
165 Arguably, the basis for this type of attribution

the major participant definition should
would be even stronger if the parent wholly owns
the subsidiary. An attribution rule that only be interpreted to encompass an entity 168 See letter from Karrie McMillan, General
addresses 100 percent ownership situations,
Counsel, Investment Company Institute, dated
however, may readily be susceptible to gaming if 167 Such swaps and security-based swaps should
the parent were to sell a very small interest in the September 20, 2010 (registered investment
be considered in this way only for purposes of
subsidiary to another party. determining whether a particular person is a major companies should be excluded from the major
166 It may also be appropriate to address these participant. The swaps and security-based swaps participant (and dealer) definitions, or else the
issues in connection with the rule proposals would continue to be subject to all laws and terms of the definitions should be interpreted to
addressing the substantive requirements applicable requirements applicable to such swaps and clarify that mutual funds generally will not be
to major participants. security-based swaps. major participants).
merchants,169 and long-term investors from the major participant definitions, the public; (2) efficiency,
such as sovereign wealth funds.170 particularly in light of the provisions of competitiveness, and financial integrity
These comments, and the rationale the Dodd-Frank Act governing its of futures markets; (3) price discovery;
behind the comments, raise the issue of territorial reach, and whether the (4) sound risk management practices;
whether we should exclude, answer in part should be determined and (5) other public interest
conditionally or unconditionally, based on whether the entity’s considerations. The CFTC may in its
certain types of entities from the major obligations are backed by the full faith discretion give greater weight to any one
participant definitions, on the grounds and credit of the foreign government. of the five enumerated areas and could
that such entities do not present the in its discretion determine that,
risks that underpin the major V. Administrative Law Matters—CEA
notwithstanding its costs, a particular
participant definitions and/or to avoid Revisions (Definitions of ‘‘Swap Dealer’’
rule is necessary or appropriate to
duplication of existing regulation. While and ‘‘Major Swap Participant,’’ and
protect the public interest or to
we are not proposing any such Amendments to Definition of ‘‘Eligible
effectuate any of the provisions or
exclusions, we request comment as to Contract Participant’’)
accomplish any of the purposes of the
whether we should exclude certain A. Regulatory Flexibility Act CEA.
types of entities, including those noted The Regulatory Flexibility Act
above, as well as to entities subject to 1. Summary of Proposed Requirements
requires that agencies consider whether
bank capital rules, State-regulated The proposed regulations would
the rules they propose will have a
insurers, private and State pension further define the terms ‘‘swap dealer,’’
significant economic impact on a
plans, and registered derivatives ‘‘eligible contract participant,’’ ‘‘major
substantial number of small entities
clearing organizations or clearing swap participant,’’ and related terms,
and, if so, provide a regulatory
agencies. including ‘‘substantial position’’ and
flexibility analysis respecting the
Commenters particularly are ‘‘substantial counterparty exposure.’’
impact.171 The rules proposed by the
requested to address whether such The proposed regulations regarding
CFTC provide definitions that will
exclusions are necessary and eligible contract participants are
largely be used in future rulemakings
appropriate in light of the proposed clarifying changes that are not expected
and which, by themselves, impose no
rules that would be applicable to major to have substantive effects on market
significant new regulatory requirements.
participants, whether any conditions participants. The proposed regulations
Accordingly, the Chairman, on behalf of
would be appropriate for such further defining swap dealer and major
the CFTC, hereby certifies pursuant to 5
exclusions, and whether modifying swap participant are significant because
U.S.C. 605(b) that the proposed rules
those proposed rules would more any entity determined to be a swap
will not have a significant economic
effectively address these issues than dealer or major swap participant would
impact on a substantial number of small
granting specific exclusions from the be subject to registration, margin,
entities.
major participant definitions for specific capital, and business conduct
types of entities. Commenters also are B. Paperwork Reduction Act requirements set forth in the Dodd-
particularly requested to discuss The proposed rule will not impose Frank Act, as those requirements are
whether banks should be excluded from any new recordkeeping or information implemented in rules proposed or to be
the major participant definitions collection requirements, or other proposed by the CFTC. Those
because of the regulation to which they collections of information that require requirements will likely lead to
already are subject. Commenters also are approval of the Office of Management compliance costs, capital holding costs,
requested to discuss whether registered and Budget under the Paperwork and margin posting costs, which have
investment companies should be Reduction Act.172 The CFTC invites been or will be addressed in the CFTC’s
excluded from the major participant public comment on the accuracy of its proposals to implement those
definitions because of the regulations to estimate that no additional requirements. On the other hand, those
which they already are subject, and recordkeeping or information collection requirements will likely lead to benefits
whether registered investment requirements or changes to existing in the form of increased market
companies would be able to comply collection requirements would result transparency, reduced counterparty risk
with capital and margin requirements from the rules proposed herein. and a lower incidence of systemic crises
applicable to major participants. and other market failures. This
Commenters also particularly are C. Cost-Benefit Analysis discussion concerns the costs and
requested to address whether sovereign Section 15(a) of the CEA 173 requires benefits arising from the proposed
wealth funds or other entities linked to the CFTC to consider the costs and definitional tests themselves, in terms of
foreign governments should be excluded benefits of its actions before issuing a the burden on market participants to
rulemaking under the CEA. By its terms, determine how the proposed definitions
169 See letter from The Swaps & Derivatives Section 15(a) does not require the CFTC apply, and the benefits arising from the
Marketing Ass’n, dated September 20, 2010 (certain to quantify the costs and benefits of a specificity of the proposals.
hedged positions of broker-dealers and futures
commission merchants with customers should not
rule or to determine whether the 2. Proposed Regulations Regarding
be considered as part of the substantial position benefits of the rulemaking outweigh its ‘‘Eligible Contract Participant’’
analysis); Cleary letter (registered and well- costs; rather, it requires that the CFTC
capitalized broker-dealers and futures commission ‘‘consider’’ the costs and benefits of its The proposal regarding ‘‘eligible
merchants should not fall within the scope of the

actions. Section 15(a) further specifies contract participant’’ would provide that
third major participant test). swap dealers and major swap
170 See letter from Lee Ming Chua, General that the costs and benefits shall be
Counsel, Government of Singapore Investment evaluated in light of five broad areas of participants would qualify as eligible
Corp., dated September 20, 2010 (stating that the market and public concern: (1) contract participants. The CFTC
major participant definitions were not intended to Protection of market participants and believes this proposal is in line with the
apply to long-term financial investors); see also expectations of market participants and
letter from Richard M. Whiting, The Financial
Services Roundtable, dated September 20, 2010
171 5 U.S.C. 601 et seq. would impose virtually no costs while
(major participant definitions should exclude firms 172 44 U.S.C. 3501 et seq. providing the benefit of greater
that solely act as investors). 173 7 U.S.C. 19(a). certainty. The proposal would also
provide that certain commodity pools whether or not it is encompassed by the limited situations, more detailed
could not qualify as eligible contract definition. regulations are appropriate. The CFTC
participants under certain provisions The proposal regarding the de believes that these detailed criteria will
specified in the proposal. The CFTC minimis exemption, on the other hand, permit market participants to make a
believes that this proposal clarifies the would impose lower costs because of relatively quick and low-cost
interpretation of this aspect of the the precise, quantitative nature of the determination of whether the exemption
eligible contract participant definition proposed exemption. A market or exclusion apply. The proposal for
and would prevent the commodity participant would incur only the cost of requests for a limited swap dealer
pools from using a provision of the determining the applicable quantities, designation provides the benefit of
definition that was not intended to such as notional value, number of flexibility to allow each market
apply to the commodity pools. Thus, swaps, number of counterparties, and so participant making this request to
while the proposal would potentially forth set out in the proposal. The CFTC determine how to do so.
impose some costs on the commodity believes that relatively few market
participants would have to determine 4. Proposed Regulations Regarding
pools that could no longer rely on
whether the de minimis exemption ‘‘Major Swap Participant’’
certain provisions of the definition,
benefits would arise from preventing the applies to their activities, and there The proposal regarding ‘‘major swap
misinterpretation of the definition. would be only a low number of participant’’ would further define the
instances where application of the term by setting out quantitative
3. Proposed Regulations Regarding quantitative tests would be uncertain. thresholds against which a market
‘‘Swap Dealer’’ Similarly, the CFTC believes that participant would compare its swap
The proposal regarding ‘‘swap dealer’’ insured depository institutions would activities to determine whether it is
would further define the term by incur relatively low costs to apply the encompassed by the definition. The
providing that any person that engages proposed exclusion of swaps in proposal would require that potential
in specified activities is a swap dealer. connection with originating loans major swap participants analyze their
The proposal describes these activities because the proposed criteria relate to swaps in detail to determine, for
qualitatively and in relatively general matters in which the institution is example, which of their swaps are
terms that apply in the same way to all directly involved. subject to netting agreements or mark-
parts of the swap markets. With regard Last, the costs of the voluntary to-market collateralization and the
to the de minimis exemption from the process for a request for a limited amount of collateral posted with respect
definition, the proposal sets out bright- designation as a swap dealer are to the swaps. The proposal includes a
line quantitative tests to determine if a difficult to predict because they would general, qualitative definition of the
person’s swap dealing activity is de depend on the complexity of the person swaps that may be excluded from the
minimis. For the exclusion of swaps in making the request and the particular comparison because they are used to
connection with originating a loan by an factors that are relevant to the limited ‘‘hedge or mitigate commercial risk.’’
insured depository institution, the designation. The CFTC believes that the Like the swap dealer proposal, there is
proposal describes the scope of the person making the request would have a voluntary process by which a major
exclusion qualitatively in terms that broad discretion in determining how to swap participant may request that the
depend primarily on the terms of the do so and thereby could control the CFTC limit the major swap participant
swaps that would be eligible for the costs of the request to some extent. designation to certain aspects of the
exclusion and the identity of the parties person’s activity.
b. Benefits
to the swap. Also, the proposal includes
The benefits of the proposed a. Costs
a voluntary process by which a swap
dealer may request that the CFTC limit regulations further defining ‘‘swap The costs to a market participant from
the swap dealer designation to certain dealer’’ include that they set out a single the proposed regulations further
aspects of the person’s activity. set of criteria to be applied by all market defining ‘‘major swap participant’’
participants. Thus, the proposed would arise primarily from its need to
a. Costs regulations create a level playing field analyze its swaps and determine
The costs to a market participant from that permits all market participants to whether it has a ‘‘substantial position’’ or
the proposed regulations further determine, on an equal basis, which ‘‘substantial counterparty exposure’’ as
defining ‘‘swap dealer’’ would arise activities would potentially lead to defined in the proposal. The proposed
primarily from its need to review its designation as a swap dealer. The rule defines potential future exposure
activities and determine, as a qualitative proposed regulations are set out in plain by a factor of the dollar notational value
matter, whether its activities are of the language terms that may be understood of the swap. The Commission also
type described in the proposal. As its and applied by all market participants considered market-based tests of
activities change from time to time, it without relying on the technical potential future exposure such as
would be necessary to repeat this expertise that may be required to margin requirements or other valuations
review, and ongoing compliance costs implement more elaborate tests. The of the outstanding position. The
may arise if the market participant CFTC believes that the proposal can be Commission decided in favor of a more
determines that it should adapt its fairly applied by substantially all market easily implementable test rather than
activities so as to not be encompassed participants who could potentially be market-based criteria for potential future
by the definition. Because the proposed swap dealers. exposure, given that daily variation in
regulations are qualitative and on Regarding the proposals regarding the market prices is captured by the current
relatively general terms, there may be de minimis exemption and the exposure calculation. The CFTC
multiple interpretations of the general exclusion of swaps in connection with believes that because the proposed
criteria by market participants. A market the origination of loans, benefits arise quantitative thresholds are high, only
participant whose activities fall within from the relatively specific, quantitative very few market participants would
the realm of those described in the nature of the proposals. Since these have to conduct a detailed analysis to
proposal may have to incur the costs of proposals are expected to be applied by determine whether they are
a more focused review to determine relatively few market participants in encompassed by the proposed
definition. The cost of the detailed costs and benefits of the proposed rules 1. Summary of Collection of Information
analysis would vary for each market with their comments. Proposed Exchange Act rule 3a67–4
participant, depending on the particular would define the term ‘‘hedging or
characteristics of its swaps. Similarly, D. Consideration of Impact on the
Economy mitigating commercial risk.’’ 176
the costs to a market participant of Security-based swap positions that meet
determining whether it uses swaps to For purposes of the Small Business this proposed definition would be
hedge or mitigate commercial risk Regulatory Enforcement Fairness Act of excluded from the ‘‘substantial position’’
would depend on how the market 1996 (‘‘SBREFA’’) 174 the CFTC must analysis under the first test of the
participant uses swaps. It is possible advise the Office of Management and proposed definition of major security-
that for some market participants with Budget as to whether the proposed rules based swap participant.
complex positions in swaps, the costs of constitute a ‘‘major’’ rule. Under For a security-based swap position to
the analysis could be relatively high. SBREFA, a rule is considered ‘‘major’’ be held for the purpose of hedging or
As is the case for the similar proposal where, if adopted, it results or is likely mitigating commercial risk under
regarding swap dealers, the costs of the to result in: (1) An annual effect on the proposed rule 3a67–4, the person
voluntary process for a request for a economy of $100 million or more (either holding the position must satisfy several
limited designation as a major swap in the form of an increase or a decrease); conditions, including the following:
participant are difficult to predict (2) a major increase in costs or prices for (i) The person must identify and
because they would depend on the consumers or individual industries; or document the risks that are being
complexity of the particular case. The (3) significant adverse effect on reduced by the security-based swap
CFTC believes that the person making competition, investment or innovation. position;
the request would have broad discretion (ii) The person must establish and
If a rule is ‘‘major,’’ its effectiveness will
in determining how to do so and document a method of assessing the
generally be delayed for 60 days
thereby could control the costs of the effectiveness of the security-based
pending Congressional review. We do
request to some extent. swaps as a hedge; and
not believe that any of the proposed
(iii) The person must regularly assess
b. Benefits rules, in their current form, would
the effectiveness of the security-based
constitute a major rule.
The benefits of the proposed swap as a hedge.
We request comment on the potential
regulations further defining ‘‘major swap 2. Proposed Use of Information
impact of the proposed rules on the
participant’’ include that they set out a
economy on an annual basis, on the The collections of information in
quantitative, bright-line test that can be
costs or prices for consumers or proposed rule 3a67–4 are designed to
applied at a relatively low cost. Also,
individual industries, and on help prevent abuse of the exclusion and
the definition of ‘‘hedging or mitigating
competition, investment or innovation. to help ensure that the exclusion is only
commercial risk’’ is stated in general
Commenters are requested to provide available to those entities that are
terms that may be flexibly applied by
empirical data and other factual support engaged in legitimate hedging or risk
potential major swap participants. In
for their views to the extent possible. mitigating activities.
preparing this proposal, the CFTC
considered other methods of defining VI. Administrative Law Matters— 3. Respondents
‘‘major swap participant,’’ including Exchange Act Rules (Definitions of The collections of information in
multi-factor analyses, stress tests and ‘‘Security-Based Swap Dealer’’ and proposed rule 3a67–4 would apply to
adversary processes. The CFTC believes ‘‘Major Security-Based Swap those entities seeking to exclude the
that these other methods would impose Participant’’) security-based swap positions held for
significantly higher costs for both the hedging or mitigating commercial risk
market participants that would have to A. Paperwork Reduction Act Analysis
from the substantial position
apply them and for the CFTC (and, Certain provisions of the proposed calculation. As discussed below in
indirectly, the taxpayer), without rules may impose new ‘‘collection of Section VI.B.4., based on the current
providing additional benefits. The costs information’’ requirements within the market, we estimate that approximately
would result primarily from the need to meaning of the Paperwork Reduction 10 entities have security-based swap
retain qualified experts who would Act of 1995 (‘‘PRA’’).175 The SEC has positions of a magnitude that they could
devote significant time and other submitted them to the Office of potentially reach the major security-
resources to a detailed analysis of Management and Budget (‘‘OMB’’) for based swap participant thresholds.
multiple aspects of the potential major review in accordance with 44 U.S.C. Accordingly, we estimate that
swap participant’s swap positions. The 3507 and 5 CFR 1320.11. The title of the approximately 10 entities would seek to
benefits that could justify more costly new collection of information is avail themselves of the exclusion from
proposals include reductions in ‘‘Procedural Requirements Associated
arbitrary differences in results and with the Definition of ‘Hedging or 176 As noted previously, the concept of ‘‘hedging
greater consistency and predictability. Mitigating Commercial Risk.’’’ An or mitigating commercial risk’’ also is found in the
However, other potential methods of statutory provisions granting an exception to end-
agency may not conduct or sponsor, and users from the mandatory clearing requirement in
further defining ‘‘major swap a person is not required to respond to, connection with swaps and security-based swaps.
participant’’ do not appear likely to a collection of information unless it See CEA section 2(h)(7)(A); Exchange Act section
provide such benefits to an extent that displays a currently valid OMB control 3C(g)(1)(B) (exception from mandatory clearing
would justify the higher costs. requirements when one or more counterparties are
number. OMB has not yet assigned a not ‘‘financial entities’’ and are using swaps or
5. Request for Comment control number to the new collection of security-based swaps ‘‘to hedge or mitigate
information. commercial risk’’). If the proposed rule 3a67–4
The CFTC invites public comment on definition of ‘‘hedging or mitigating commercial
its cost-benefit considerations. risk’’ is used any future SEC rulemakings, including
174 Public Law 104–121, Title II, 110 Stat. 857
rulemaking with respect to the end-user exception,
Commenters are also invited to submit (1996) (codified in various sections of 5 U.S.C., 15 any necessary discussion of administrative law
any data or other information that they U.S.C. and as a note to 5 U.S.C. 601). matters relating to the use of proposed rule 3a67–
may have quantifying or qualifying the 175 44 U.S.C. 3501 et seq. 4 will be provided at that time.
the substantial position calculation for where the SEC has obtained the make a decision concerning the
security-based swap positions held for information, the SEC would consider collections of information between 30
hedging or mitigating commercial risk. requests for confidential treatment on a and 60 days after publication, a
case-by-case basis. comment to OMB is best assured of
4. Total Annual Reporting and
having its full effect if OMB receives it
Recordkeeping Burden 7. Record Retention Period
within 30 days of publication.
We do not anticipate that the Proposed rule 3a67–4 does not
proposed collection of information in contain a specific record retention B. Consideration of Benefits and Costs
proposed rule 3a67–4 would cause the requirement. Nonetheless, we would 1. Introduction
estimated 10 entities to incur any new expect the approximately 10 entities
costs. We believe that only highly that may seek to use the exclusion for The Dodd-Frank Act added
sophisticated market participants would positions held for hedging or mitigating definitions of ‘‘security-based swap
potentially meet the proposed commercial risk to maintain the records dealer’’ and ‘‘major security-based swap
thresholds for the major security-based they create in connection with the participant’’ to the Exchange Act in
swap participant designation and thus exclusion. Because we understand from conjunction with other provisions that
have a need to take advantage of the our staff’s discussions with industry require entities meeting either of those
exclusion for positions held for hedging participants that the entities that have definitions to register with the SEC and
or mitigating commercial risk (and be security-based swap positions and to be subject to capital, margin, business
required to meet the attendant exposures of this magnitude currently conduct and certain other requirements.
collection requirements). We create and maintain the documentation Consistent with the direction of the
understand from our staff’s discussions proposed to be required in rule 3a67–4, Dodd-Frank Act, the SEC is proposing
with industry participants that the as part of their ordinary course business rules to further define ‘‘major security-
entities that have security-based swap and risk management practices, we do based swap participant’’ along with
positions and exposures of this not expect any new burdens or costs additional terms used in that definition.
magnitude currently create and will be imposed to maintain the records. The SEC also is proposing rules to
maintain the documentation proposed further define ‘‘security-based swap
8. Request for Comments
to be required in rule 3a67–4, as part of dealer’’ and to set forth factors for
their ordinary course business and risk The SEC invites comments on these determining the availability of the de
management practices.177 Thus, we do estimates. Pursuant to 44 U.S.C. minimis exception from that definition.
not believe that any new burdens or 3506(c)(2)(B), the SEC requests We believe that these proposed rules are
costs will be imposed on the comments in order to: (a) Evaluate consistent with the purposes of the
approximately 10 entities that may seek whether the collection of information is Dodd-Frank Act, and, as appropriate, set
to use the exclusion. We therefore necessary for the proper performance of forth objective standards to facilitate
estimate the total annual reporting and our functions, including whether the market participants’ compliance with
recordkeeping burden associated with information will have practical utility; the amendments that the Dodd-Frank
proposed rule 3a67–4 to be minimal. (b) evaluate the accuracy of our estimate Act made to the Exchange Act. Market
of the burden of the collection of participants, however, may incur costs
5. Collection of Information is information; (c) determine whether
Mandatory associated with certain of these
there are ways to enhance the quality, proposed rules.
The collections of information in utility, and clarity of the information to
proposed rule 3a67–4 would be be collected; and (d) evaluate whether The SEC believes that there would be
mandatory for those entities seeking to there are ways to minimize the burden two categories of potential costs. First,
exclude positions they hold for hedging of the collection of information on those there would be costs associated with the
or mitigating commercial risk from the who respond, including through the use regulatory requirements that would
substantial position calculation. of automated collection techniques or apply to a ‘‘security-based swap dealer’’
other forms of information technology. or a ‘‘major security-based swap
6. Confidentiality participant’’ (e.g., the registration,
Persons submitting comments on the
There is no proposed requirement that collection of information requirements margin, capital, and business conduct
the collections of information in should direct them to the Office of requirements that would be imposed on
proposed rule 3a67–4 be provided to the Management and Budget, Attention: security-based swap dealers and major
SEC or a third party on a regular, Desk Officer for the Securities and security-based swap participants).
ordinary course basis. In a situation Exchange Commission, Office of While the specific costs and benefits
Information and Regulatory Affairs, associated with these regulatory
177 Some entities follow these types of procedures
Washington, DC 20503, and should also requirements are being addressed in the
so that their hedging transactions will qualify for
send a copy of their comments to SEC’s proposals to implement those
hedge accounting treatment under generally requirements, we recognize that the
accepted accounting principles, which requires Elizabeth M. Murphy, Secretary,
procedures similar to those in proposed rule 3a67– Securities and Exchange Commission, costs and benefits of these proposed
4. Hedging relationships involving security-based 100 F Street, NE., Washington, DC definitions are directly linked to the
swaps that qualify for the hedging or mitigating
20549–1090, with reference to File No. costs and benefits of the requirements
commercial risk exception in the proposed rule are applicable to dealers and major
not limited to those recognized as hedges for S7–39–10. Requests for materials
accounting purposes. We believe that all of the submitted to OMB by the SEC with participants. We welcome comment on
estimated 10 entities that have security-based swap regard to this collection of information the costs and benefits of these proposed
positions of a magnitude that they could potentially
should be in writing, with reference to definitions in that broader context.
be deemed to be major security-based swap
participants already identify and document their File No. S7–39–10, and be submitted to Second, there may be costs that
risk management activities (including their the Securities and Exchange entities incur in determining whether
security-based swap positions used to hedge or Commission, Records Management, they qualify as a ‘‘security-based swap
mitigate commercial risks) and assess the
effectiveness of those activities as a matter of their
Office of Filings and Information dealer’’ or a ‘‘major security-based swap
ordinary business practice—even if they are not Services, 100 F Street, NE., Washington, participant’’ under the proposed
seeking hedge accounting treatment. DC 20549–1090. As OMB is required to definitional rules. These costs, along
with the benefits associated with the the SEC designate ‘‘major’’ categories of predictable application and enforcement
proposed rules, are discussed below. security-based swaps by setting forth of the requirements governing major
two such ‘‘major’’ categories—one security-based swap participants by
2. Proposed Exchange Act rule 3a67–1—
consisting of credit derivatives and the permitting market participants to
Definition of ‘‘Major Security-Based
other consisting of equity-swaps and readily evaluate whether their security-
Swap Participant’’ other security-based swaps. We believe based swap positions meet the
Proposed Exchange Act rule 3a67–1 that these proposed categories would thresholds.
would largely restate the statutory have the benefit of being consistent with The first ‘‘substantial position’’ test
definition of ‘‘major security-based swap the different ways in which those would encompass entities that have a
participant,’’ to consolidate the products are used, as well as market daily average uncollateralized mark-to-
definition and related interpretations for statistics and current market market exposure of $1 billion in a major
ease of reference. infrastructures (particularly the separate category of security-based swaps. The
A person that meets the definition of trade warehouses for credit default second ‘‘substantial position’’ test would
major security-based swap participant swaps and equity swaps). Although, as encompass entities that have a daily
generally will be subject to the discussed below, this categorization is average combined uncollateralized
requirements applicable to major relevant to the ‘‘substantial position’’ mark-to-market exposure and potential
security-based swap participants tests of the ‘‘major security-based swap future exposure of $2 billion. Potential
without regard to the purpose for which participant’’ definition, we believe that future exposure would be measured,
it enters into a security-based swap, and the categorization itself would not consistent with bank capital rules,
without regard to the particular category impose any costs on market largely by multiplying notional
of security-based swap.178 However, the participants. While the categorization positions by risk factors. Additional
statutory definitions provide that a may affect the costs that market adjustments would reflect netting
person may be designated as a major participants will incur from particular agreements, the presence of central
security-based swap participant for one statutory and regulatory requirements clearing and the presence of daily mark-
or more categories of security-based applicable to major security-based swap to-market margining practices.
swaps or for particular activities participants,180 those costs are being As previously noted, there will be
without being classified as a major addressed in our proposals to costs associated with the registration,
security-based swap participant for all implement those requirements. margin, capital, business conduct, and
categories or activities.179 Proposed rule 4. Proposed Exchange Act Rule 3a76– other requirements that will be imposed
3a67–1 would provide that a major 3—Definition of ‘‘Substantial Position’’ on major security-based swap
security-based swap participant that participants. Those costs are being
engages in significant activity with Proposed Exchange Act rule 3a67–3 addressed in the SEC’s rule proposals to
respect to only certain types, classes or would define the term ‘‘substantial implement those requirements. We also
categories of security-based swaps or position,’’ which is used in the first and believe that there will be costs incurred
only in connection with specified third tests of the definition of ‘‘major by entities in determining whether they
activities, could obtain relief with security-based swap participant.’’ The meet the definition of major security-
respect to other types of security-based Dodd-Frank Act requires the SEC to based swap participant. These costs are
swaps from certain of the requirements define this term. We have proposed two discussed below.
that are applicable to major security- tests for identifying the presence of a Based on the current over-the-counter
based swap participants. The rule substantial position—one test based on derivatives market, we estimate that no
would have the benefit of implementing a daily average measure of more than 10 entities that are not
the statutory provision and providing uncollateralized mark-to-market otherwise security-based swap dealers
that major security-based swap exposure, and one based on a daily would have either uncollateralized
participants may obtain relief from the average measure of combined mark-to-market positions 181 or
SEC. A person that seeks to be uncollateralized mark-to-market
considered to be a major security-based exposure and potential future exposure. 181 We believe that an estimate of an entity’s
swap participant only with respect to Both of these daily measures would be mark-to-market exposure associated with its
calculated and averaged over a calendar security-based swap positions can be derived from
one category of security-based swaps, or the level of an entity’s notional positions. We
only with respect to certain activities, quarter. recognize that the ratio of exposure to notional
would be expected to incur costs in We believe that this proposed amount will vary by market participant and by
connection with requesting an order definition would have the benefit of position. We understand that mark-to-market
providing objective criteria that exposures associated with credit derivative
from the SEC. However, any such costs positions on average are equal to approximately
would be voluntarily incurred by any reasonably would measure the risks three percent of an entity’s level of notional
person seeking to take advantage of that associated with security-based swap positions in credit derivatives. This estimate is
limited designation, and thus we positions, and reflect the counterparty based on second quarter 2010 U.S. bank market
risk and risk to the market factors that statistics involving credit derivatives, given that
preliminarily do believe that those costs banks have credit derivative positions with gross
would be attributable to the statute and are embedded within the ‘‘major positive fair value (which would equate to negative
not to this rule. security-based swap participant’’ fair value for the banks’ counterparties) of $403
definition. We also believe that the billion, compared to total notional credit derivative
3. Proposed Exchange Act Rule 3a67– proposed use of objective numerical positions of $13.9 trillion. See Office of the
2—‘‘Major’’ Categories of Security-Based Comptroller of the Currency, ‘‘OCC’s Quarterly

criteria for the substantial position Report on Bank Trading and Derivatives Activities’’
Swaps thresholds would promote the (Second Quarter 2010) at 4 & Table 12. This data
Proposed Exchange Act rule 3a67–2 suggests that, on average, an entity would need to
180 For example, distinguishing between have notional credit derivative positions of roughly
would fulfill Congress’s mandate that categories of security-based swaps may cause some $33 billion to meet our proposed threshold for the
entities to incur additional costs to calculate their first substantial position test, $1 billion in mark-to-
178 The specific costs associated with these market exposure.
major security-based swap participant status with
regulatory requirements will be addressed in the respect to each category. Similarly, categorization We understand, based on our staff’s discussions
SEC’s proposals to implement those requirements. may affect whether an entity ultimately qualifies as with industry, that approximately 39 entities have
179 See Exchange Act section 3(a)(67)(C). a major security-based swap participant. Continued
combined uncollateralized current associated with the continuing use and first test of the major participant
exposure and potential future exposure monitoring of the testing.184 We definition. The proposed rule is
of a magnitude 182 that may rise close estimate that the one-time programming intended to be objective and promote
enough to the levels of our proposed cost would be approximately $13,444 the predictable application and
thresholds to necessitate monitoring to per entity, and $134,440 for all enforcement of the requirements
determine whether they meet those entities.185 We estimate that the annual governing major security-based swap
thresholds. Additionally, we ongoing costs would be approximately participants.
preliminarily believe that all of these $7,260 per entity, and $72,600 for all For a security-based swap position to
approximately 10 entities currently entities.186 be held for the purpose of hedging or
maintain highly sophisticated financial mitigating commercial risk under
5. Proposed Exchange Act Rule 3a67– proposed Exchange Act rule 3a67–4, the
operations in order to achieve the large
4—Definition of ‘‘Hedging or Mitigating person holding the position must satisfy
security-based swap positions
Commercial Risk’’ certain conditions:
necessitating their use of the tests.
We expect the costs associated with Proposed Exchange Act rule 3a67–4 (i) The person must identify and
the proposed substantial position tests would define the term ‘‘hedging or document the risks that are being
to be modest for these entities. We mitigating commercial risk.’’ Security- reduced by the security-based swap
understand that the entities that have based swap positions that meet that position;
this magnitude of security-based swap definition are excluded from the (ii) The person must establish and
positions already monitor and collect all ‘‘substantial position’’ analysis under the document a method of assessing the
of the data necessary for the proposed effectiveness of the security-based swap
substantial position tests. Preliminarily, and to oversee and manage the entire programming as a hedge; and
we understand that these entities process; approximately 40 hours of work from a (iii) The person must regularly assess
Programmer Analyst to make the necessary the effectiveness of the security-based
already use automated systems to gauge programming changes to the existing automated
their positions and exposures and assist system and to test the system; approximately 8 swap as a hedge.
in their risk management. Accordingly, hours of work from a Senior Internal Auditor to Proposed rule 3a67–4 would affect
we estimate that each of the entities perform quality assurance to ensure that the whether an entity will meet the
automated system is properly performing the definition of major security-based swap
would incur a one-time programming proposed tests; and approximately 3 hours of work
cost,183 as well as ongoing costs from the entity’s Chief Financial Officer to monitor
participant. The specific costs
the process. We estimate that the hourly wage of a associated with these regulatory
credit default swap notional positions of roughly Compliance Attorney, Compliance Manager, requirements are being addressed in the
$33 billion or above. We understand that the large Programmer Analyst, Senior Internal Auditor, and SEC’s proposals to implement those
majority of those entities are banks or hedge funds Chief Financial Officer would be approximately
$291, $294, $190, $195, and $450, respectively. The
requirements.
(which we would expect to fully collateralize their
positions with dealers as a matter of course). We $291/hour figure for a Compliance Attorney, the While we expect that there could be
further understand that banks, securities firms, and $294/hour figure for a Compliance Manager, the some potential costs associated with the
hedge funds typically collateralize most or all of $190/hour figure for a Programmer Analyst, and the procedural requirements of proposed
their mark-to-market exposure to U.S. banks as a $195/hour figure for a Senior Internal Auditor are rule 3a67–4, as described in Section
matter of practice. See OCC’s Quarterly Report on from SIFMA’s Management & Professional Earnings
Bank Trading and Derivatives Activities (second in the Securities Industry 2009, modified by SEC VI.B.4., supra, we expect only highly
quarter 2010) at 6. Therefore, it is not clear if any staff to account for an 1800-hour work-year and sophisticated entities to hold security-
entities would have uncollateralized credit default multiplied by 5.35 to account for bonuses, firm size, based swap positions of a magnitude
swap positions near the proposed first substantial employee benefits, and overhead. The $450/hour that would require use of the proposed
position threshold of $1 billion uncollateralized figure for a Chief Financial Officer is from http://
outward exposure. www.payscale.com, modified by SEC staff to tests. Thus, we do not anticipate that
182 The proposed risk multiplier of 0.1 for credit account for an 1800-hour work-year and multiplied these proposed procedural requirements
derivatives would require an entity to have a by 5.35 to account for bonuses, firm size, employee would cause market participants to
notional position of $20 billion in credit derivatives benefits, and overhead. See http:// incur costs that they do not incur
to reach the proposed $2 billion potential future www.payscale.com (last visited Nov. 1, 2010).
exposure threshold (even before accounting for 184 We anticipate that each entity would incur already as a matter of their ordinary
netting adjustments). The proposed additional ongoing monitoring costs to evaluate their test business and risk management
multiplier of 0.2 for security-based swaps cleared results and to ensure that the tests are properly run. practices. Accordingly, we do not
by a registered clearing agency or subject to daily We estimate that each entity would have a Senior expect that the proposed definition of
mark-to-market margining would mean that an Internal Auditor spend approximately 4 hours each
entity with credit derivative positions that are quarter (or a total of 16 hours annually) to perform
‘‘hedging or mitigating commercial risk’’
cleared or subject to daily mark-to-market this quality assurance. We also estimate that each would impose any costs on the
margining would need a notional position in credit entity would need a Compliance Attorney, a potentially affected entities beyond
derivatives of at least $100 billion to potentially Compliance Manager, and its Chief Financial those already regularly incurred by
reach the proposed $2 billion potential future Officer to each spend approximately 1 hour each
exposure threshold. In this example, we are quarter (or a total of 4 hours annually) to monitor
these entities as a matter of course.
assuming an uncollateralized outward exposure of the entity’s test results and the entity’s status under 6. Proposed Exchange Act Rule 3a67–
zero. the proposed rule.
We understand, based on our staff’s discussions 185 The estimated one-time programming cost of
5—Definition of ‘‘Substantial
with industry, that there are approximately 10 non- approximately $13,444 per entity and $134,440 for Counterparty Exposure That Could Have
dealer entities that have a notional position in all entities was calculated as follows: (Compliance Serious Adverse Effects on The
credit derivatives of over $50 billion. Attorney at $291 per hour for 2 hours) + Financial Stability of The United States
183 For each of the entities, we estimate that the (Compliance Manager at $294 per hour for 8 hours)
+ (Programmer Analyst at $190 per hour for 40
Banking System or Financial Markets’’
initial programming would require the following
levels of work from a Compliance Attorney, hours) + (Senior Internal Auditor at $195 per hour Proposed Exchange Act rule 3a67–5
Compliance Manager, Programmer Analyst, Senior for 8 hours) + (Chief Financial Officer at $450 per would define ‘‘substantial counterparty
Internal Auditor, and Chief Financial Officer. The hour for 3 hours) × (10 entities) = $134,440.
estimated contributions are as follows: 186 The estimated ongoing monitoring cost of exposure that could have serious
approximately 2 hours of work from a Compliance approximately $7,260 per year per entity and adverse effects on the financial stability
Attorney to advise the entity’s compliance $72,600 per year for all entities was calculated as of the United States banking system or
department on the legal requirements associated follows: (Senior Internal Auditor at $195 per hour financial markets,’’ a term that
with the proposed tests; approximately 8 hours of for 16 hours) (Compliance Attorney at $291 per
work from a Compliance Manager to assist a hour for 4 hours) + (Compliance Manager at $294
comprises part of the second test of the
Programmer Analyst in making the necessary per hour for 4 hours) + (Chief Financial Officer at ‘‘major security-based swap participant’’
changes to the entity’s existing automated system $450 per hour for 4 hours) × (10 entities) = $72,600. definition. This proposed rule would
parallel the ‘‘substantial position’’ objective criteria to implement and participants’ ease of reference. We are
analysis discussed above, but would further define the third test. not proposing to further define the four
examine an entity’s security-based swap Additionally, we believe that the specific tests set forth in the ‘‘security-
positions as a whole (rather than proposed use of these objective based swap dealer’’ definition. However,
focusing on a particular ‘‘major’’ definitions and numerical criteria our release contains interpretive
category), and would not exclude would promote the predictable language that would have the benefit of
certain hedging positions. Consistent application and enforcement of the providing additional legal certainty to
with this broader scope, and the requirements governing major security- market participants. While market
proposal that there be two ‘‘major’’ based swap participants by permitting participants would incur certain costs to
categories of security-based swaps, the market participants to readily evaluate analyze whether their security-based
thresholds used in this test would be whether they meet the threshold for swap activities cause them to be on the
two times the comparable ‘‘substantial major security-based swap participant ‘‘dealer’’ side of the dealer-trader
position’’ thresholds. We believe that status. distinction (which would require them
this approach reasonably would We do not believe that the proposed to register with the SEC and comply
measure the counterparty exposure definition of ‘‘financial entity’’ would with the other requirements applicable
associated with the entirety of an impose any significant costs on market to security-based swap dealers unless
entity’s security-based swap positions, entities, given the objective nature of the they can take advantage of the de
consistent with the risk factors in the definition. We also do not believe that minimis exception), these costs would
‘‘major security-based swap participant’’ the proposed definition of ‘‘highly be incurred because of the statutory
definition. Additionally, we believe that leveraged’’—a balance sheet test that change, rather than due to proposed rule
the proposed definition would provide would be based on the ratio of an 3a71–1. The Dodd-Frank Act
objective criteria and promote the entity’s liabilities and equity, and that, determined that persons that engage in
predictable application and enforcement in the case of entities subject to public dealing activities involving security-
of the requirements governing major reporting requirements, could be based swaps should be subject to
security-based swap participants by derived from financial statements filed comprehensive regulation, and any such
permitting market participants to with the SEC—would impose any analytic costs arise from Congress’s
readily evaluate whether their security- significant costs on entities that have determination to amend the Exchange
based swap positions meet the proposed security-based swap positions large Act.188
thresholds. enough to potentially meet the
We believe that the same ‘‘substantial position’’ requirement that 10. Proposed Exchange Act Rule 3a71–
approximately 10 entities would is part of the third test. 2—de Minimis Exception
calculate their substantial counterparty Proposed Exchange Act rule 3a71–2
8. Proposed Exchange Act Rule 3a67–
exposure under this rule as would would set forth factors for determining
7—Timing Requirements, Reevaluation
undertake the substantial position whether a person that otherwise would
Period and Termination of Status
calculation under proposed rule 3a67–3. be a security-based swap dealer can take
Given that the threshold for this Proposed Exchange Act rule 3a67–7 advantage of the de minimis exception.
proposed rule is derived from the would set forth methods for specifying The Dodd-Frank Act directed the SEC to
calculations of substantial position that when an entity that satisfies the tests promulgate these factors.189 The
would be mandated by proposed rule specified within the definition of ‘‘major proposed factors would account for an
3a67–3, we do not anticipate that it security-based swap participant’’ would entity’s annual notional security-based
would create any costs outside of those be deemed to meet that definition. The swap positions in a dealing capacity, its
already covered in the discussion of the proposed rule also would address the total notional security-based swap
estimated costs associated with the termination of an entity’s status as a positions in a dealing capacity when the
proposed definition of substantial major security-based swap participant. counterparty is a ‘‘special entity,’’ 190
position. We believe that the proposed rule and its total number of counterparties
would set forth pragmatic standards for and security-based swaps as a dealer.
7. Proposed Exchange Act Rule 3a67–
permitting entities that have security- We believe that these factors
6—Definitions of ‘‘Financial Entity’’ and
based swap positions that require appropriately would focus on dealing
‘‘Highly Leveraged’’
registration to go through the activities that do not warrant an entity’s
Proposed Exchange Act rule 3a67–6 registration process, and to terminate regulation as a security-based swap
would define the terms ‘‘financial their status when appropriate. We dealer. We also believe that these
entity’’ and ‘‘highly leveraged,’’ both of believe that this proposed rule would objective numerical criteria for the de
which are used in the third test of the impose no direct costs on market minimis exception would promote the
‘‘major security-based swap participant’’ entities.187 predictable application and enforcement
definition. The proposed definition of
9. Proposed Exchange Act Rule 3a71– of the de minimis exception from
‘‘financial entity’’ would be consistent
1—Definition of ‘‘Security-Based Swap security-based swap dealer status.
with the use of that term in the Title VII In general, we would expect a person
exception from mandatory clearing for Dealer’’
that enters into security-based swaps in
end-users of security-based swaps Proposed Exchange Act rule 3a71–1 a dealing capacity would, as a matter of
(subject to limited technical changes). largely would restate the statutory course, be aware of the notional amount
One of the two alternative proposed definition of ‘‘security-based swap

definitions of ‘‘highly leveraged’’ would dealer,’’ to consolidate the definition 188 Based on our staff’s discussions with industry,
be consistent with a standard used in and related interpretations for market we estimate that approximately 50 entities may be
Title I of the Dodd-Frank Act, while the required to register as security-based swap dealers
other alternative is based on an 187 As noted above, we recognize that major following implementation of these proposed rules.
security-based swap participants will incur costs The specific costs associated with these regulatory
understanding of typical leverage ratios requirements will be addressed in the SEC’s
associated with the registration and termination of
for certain financial entities. We believe registration processes. These costs will be proposals to implement those requirements.
that these proposed alternative addressed in the SEC rule’s proposals to implement 189 See Section 761(a)(6) of the Dodd-Frank Act.
standards would apply reasonable those requirements. 190 See Section 15F(h)(2)(C) of the Exchange Act.
of those positions, whether a particular Commenters particularly are requested While our decisions on how to further
counterparty is a ‘‘special entity,’’ and to address whether the proposed scope define the terms may have some effect
the total number of counterparties and of the dealer and major participant on competition (e.g., our determinations
security-based swaps it has in a dealer definitions are appropriate in light of regarding the proposed definition of
capacity. As a result, we believe that the costs and benefits associated with substantial position will affect whether
there would be no new costs incurred those substantive rules. entities qualify as major security-based
by entities in assessing the availability swap participants), we preliminarily do
C. Consideration of Burden on
of the de minimis exception. Moreover, not believe that our decisions would
Competition, and Promotion of
any costs associated with ensuring that impose additional competitive burdens
Efficiency, Competition, and Capital
a person can take advantage of the de on entities outside of those that
Formation
minimis exception would be voluntarily Congress previously imposed through
incurred by entities that engage in Section 3(f) of the Exchange Act its decision in Title VII of the Dodd-
dealing activities that seek to take requires the SEC, whenever it engages in Frank Act to regulate and differentiate
advantage of the exception. rulemaking and is required to consider security-based swap market
or determine whether an action is participants. Moreover, we believe that
11. Request for Comments necessary or appropriate in the public defining substantial position will help
The SEC requests comment on these interest, to consider whether the action provide market participants with legal
estimated benefits and costs. would promote efficiency, competition, certainty regarding their need to register
Commenters particularly are requested and capital formation.191 In addition, as major security-based swap
to address: the accuracy of our estimate Section 23(a)(2) of the Exchange Act 192 participants and is necessary and
that there would be approximately 10 requires the SEC, when adopting rules appropriate to implement the purposes
entities in the market (that would not under the Exchange Act, to consider the of regulating security-based swap
otherwise be security-based swap impact such rules would have on dealers and major security-based swap
dealers) that would have security-based competition. Section 23(a)(2) of the participants.
swap positions of a magnitude that may Exchange Act also prohibits the SEC
We also preliminarily believe that the
rise close enough to the levels of our from adopting any rule that would
proposed rules would promote
proposed thresholds to necessitate impose a burden on competition not
efficiency. We believe that the proposed
monitoring to determine whether they necessary or appropriate in furtherance
rules would set forth clear objective
meet those thresholds; the accuracy of of the purposes of the Exchange Act.
our estimate that there would be We preliminarily do not believe that standards to facilitate market
approximately 50 entities in the market the proposed rules would result in any participants’ compliance with the
that may be required to register as burden on competition that is not amendments that the Dodd-Frank Act
security-based swap dealers following necessary or appropriate in furtherance made to the Exchange Act. Moreover,
implementation of the proposed rules; of the purposes of the Exchange Act. We we believe that the proposed rules
the accuracy of our estimates of the are proposing rules to further define would promote the predictable
costs associated with entities ‘‘major security-based swap participant,’’ application and enforcement of the
performing the proposed substantial along with several terms used in that Exchange Act. We also have considered
position tests; whether the entities that definition. We are also proposing rules what effect, if any, our proposed rules
have security-based swap positions that to further define ‘‘security-based swap would have on capital formation. We
are significant enough to potentially dealer’’ and to set forth factors for preliminarily do not believe that our
meet one or more of the tests in the determining the availability of the de proposed rules would have a negative
‘‘major security-based swap participant’’ minimis exception from that definition. effect on capital formation.
definition would, as a matter of course, We believe that the proposed rules are The SEC requests comment on the
already have the data necessary to consistent with the purposes of Title VII effect of the proposed rules on
perform the two proposed substantial of the Dodd-Frank Act, and, as efficiency, competition, and capital
position tests, and if not, what appropriate, set forth objective formation. Commenters are particularly
additional data would they need and standards to facilitate market requested to address whether entities
how much time and expense would participants’ compliance with the would change their behavior to avoid
gathering that data require; whether amendments that Title VII of the Dodd- meeting the proposed definitions of
these same entities would, as a matter Frank Act made to the Exchange Act. ‘‘security-based swap dealer’’ or ‘‘major
of course, already comply with the These amendments mandate that the security-based swap participant,’’ and if
proposed procedural requirements SEC regulate major security-based swap so, how. Commenters are also requested
associated with the exclusion for participants and security-based swap to address the effect, if any, that the
positions that are for the purpose of dealers, which include some, but not proposed definitions of ‘‘substantial
‘‘hedging or mitigating commercial risk;’’ all, entities that enter into security- position,’’ ‘‘hedging or mitigating
and whether entities would change their based swaps. Although regulation of commercial risk,’’ ‘‘substantial
behavior to avoid meeting the proposed certain security-based swap market counterparty exposure,’’ ‘‘financial
definitions of ‘‘security-based swap participants may result in competitive entity,’’ or ‘‘highly leveraged,’’ or the
dealer’’ or ‘‘major security-based swap burdens to these entities when proposed categories of security-based
participant,’’ and if so, what, if any, compared to unregulated security-based swaps would have on business
economic costs would be associated swap market participants, these burdens decisions, trading behavior, transaction
with such behavioral changes. stem directly from Congress’s decision costs, or capital allocation. We also
In addition, and more generally, we to impose regulation on a specified set request comment on the effect, if any
request comment on the costs and of security-based swap market that the proposed de minimis exception
benefits of these proposed definitions in participants through the Dodd-Frank to the definition of security-based swap
the broader context of the substantive Act. dealer would have on business
rules, including capital, margin and decisions, trading behavior, transaction
business conduct rules, applicable to 191 15 U.S.C. 78c(f). costs, or capital allocation, and if so,
dealers and major participants. 192 15 U.S.C. 78w(a)(2). how. Commenters are particularly
encouraged to provide quantitative For purposes of SEC rulemaking in on a substantial number of small entities
information to support their views. connection with the RFA, a small entity for purposes of the RFA.
includes: (i) When used with reference The SEC encourages written
D. Consideration of Impact on the comments regarding this certification.
to an ‘‘issuer’’ or a ‘‘person,’’ other than
Economy The SEC requests that commenters
an investment company, an ‘‘issuer’’ or
For purposes of SBREFA, the SEC ‘‘person’’ that, on the last day of its most describe the nature of any impact on
must advise the Office of Management recent fiscal year, had total assets of $5 small entities and provide empirical
and Budget as to whether the proposed million or less,198 or (ii) a broker-dealer data to illustrate the extent of the
rules constitute a ‘‘major’’ rule. Under with total capital (net worth plus impact.
SBREFA, a rule is considered ‘‘major’’ subordinated liabilities) of less than VII. Statutory Basis and Rule Text
where, if adopted, it results or is likely $500,000 on the date in the prior fiscal
to result in: (1) An annual effect on the year as of which its audited financial List of Subjects
economy of $100 million or more (either statements were prepared pursuant to 17 CFR Part 1
in the form of an increase or a decrease); Rule 17a–5(d) under the Exchange
(2) a major increase in costs or prices for Act,199 or, if not required to file such Definitions.
consumers or individual industries; or statements, a broker-dealer with total 17 CFR Part 240
(3) significant adverse effect on capital (net worth plus subordinated
Reporting and recordkeeping
competition, investment or innovation. liabilities) of less than $500,000 on the
requirements, Securities.
If a rule is ‘‘major,’’ its effectiveness will last day of the preceding fiscal year (or
generally be delayed for 60 days in the time that it has been in business, Commodity Futures Trading
pending Congressional review. We do if shorter); and is not affiliated with any Commission
not believe that any of the proposed person (other than a natural person) that Text of Proposed Rules
rules, in their current form, would is not a small business or small
constitute a major rule. organization.200 Under the standards For the reasons stated in this release,
adopted by the Small Business the CFTC is proposing to amend 17 CFR
We request comment on the potential
Administration, small entities in the part 1 as follows:
impact of the proposed rules on the
economy on an annual basis, on the finance and insurance industry include
PART 1—GENERAL REGULATIONS
costs or prices for consumers or the following: (i) For entities engaged in
UNDER THE COMMODITY EXCHANGE
individual industries, and on credit intermediation and related
ACT
competition, investment or innovation. activities, entities with $175 million or
Commenters are requested to provide less in assets; 201 (ii) for entities engaged 1. The authority citation for part 1 is
empirical data and other factual support in non-depository credit intermediation revised to read as follows:
for their views to the extent possible. and certain other activities, entities with Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c,
$7 million or less in annual receipts; 202 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o,
E. Regulatory Flexibility Act (iii) for entities engaged in financial 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a–1,
Certification investments and related activities, 16, 16a, 19, 21, 23, and 24, as amended by
entities with $7 million or less in Title VII of the Dodd-Frank Wall Street
The Regulatory Flexibility Act
annual receipts; 203 (iv) for insurance Reform and Consumer Protection Act, Pub. L.
(‘‘RFA’’) 193 requires Federal agencies, in 111–203, 124 Stat. 1376 (2010).
promulgating rules, to consider the carriers and entities engaged in related
impact of those rules on small entities. activities, entities with $7 million or 2. Amend § 1.3 by:
Section 603(a) 194 of the Administrative less in annual receipts; 204 and (v) for a. Adding paragraph (m); and
funds, trusts, and other financial b. As proposed to be amended at 75
Procedure Act,195 as amended by the
vehicles, entities with $7 million or less FR 63762, October 18, 2010, and 75 FR
RFA, generally requires the SEC to
in annual receipts.205 77576, December 13, 2010, adding (ppp)
undertake a regulatory flexibility
Based on feedback from industry through (vvv) to read as follows:
analysis of all proposed rules, or
proposed rule amendments, to participants about the security-based § 1.3 Definitions
determine the impact of such swap markets, the SEC preliminarily
believes that entities that would qualify * * * * *
rulemaking on ‘‘small entities.’’ 196 (m) Eligible contract participant. This
Section 605(b) of the RFA provides that as security-based swap dealers and
term has the meaning set forth in
this requirement shall not apply to any major security-based swap market
Section 1a(18) of the Commodity
proposed rule or proposed rule participants, whether registered broker-
Exchange Act, except that:
amendment, which if adopted, would dealers or not, exceed the thresholds (1) A major swap participant, as
not have a significant economic impact defining ‘‘small entities’’ set out above. defined in Section 1a(33) of the
on a substantial number of small Thus, the SEC believes it is unlikely that Commodity Exchange Act and
entities.197 the proposed rules would have a § 1.3(qqq), is an eligible contract
significant economic impact any small participant;
193 5 U.S.C. 601 et seq.
entity. (2) A swap dealer, as defined in
194 5 U.S.C. 603(a). For the foregoing reasons, the SEC Section 1a(49) of the Commodity
195 5 U.S.C. 551 et seq. certifies that the proposed rules would Exchange Act and § 1.3(ppp), is an
196 Although Section 601(b) of the RFA defines not have a significant economic impact eligible contract participant;
the term ‘‘small entity,’’ the statute permits the
Commissions to formulate their own definitions. 198 See
(3) A major security-based swap
17 CFR 240.0–10(a).
The SEC has adopted definitions for the term small 199 See
participant, as defined in Section
17 CFR 240.17a–5(d).
entity for the purposes of SEC rulemaking in 200 See 17 CFR 240.0–10(c).
3(a)(67) of the Securities Exchange Act
accordance with the RFA. Those definitions, as 201 See 13 CFR 121.201 (Subsector 522). of 1934 (15 U.S.C. 78c(a)(67)) and
relevant to this proposed rulemaking, are set forth
in Rule 0–10, 17 CFR 240.0–10. See Securities
202 See id. at Subsector 522. § 240.3a67–1 of this title, is an eligible
Exchange Act Release No. 18451 (Jan. 28, 1982), 47 203 See id. at Subsector 523. contract participant;
FR 5215 (Feb. 4, 1982) (File No. AS–305). 204 See id. at Subsector 524. (4) A security-based swap dealer, as
197 See 5 U.S.C. 605(b). 205 See id. at Subsector 525. defined in Section 3(a)(71) of the
Securities and Exchange Act of 1934 (15 more than $25 million with regard to pursuant to the loan or any refinancing
U.S.C. 78c(a)(71)) and § 240.3a71–1 of swaps in which the counterparty is a of the loan.
this title, is an eligible contract ‘‘special entity’’ (as that term is defined (iii) The term loan shall not include:
participant; in Section 4s(h)(2)(C) of the Commodity (A) Any transaction that is a sham,
(5) A commodity pool with one or Exchange Act). For purposes of this whether or not intended to qualify for
more direct or indirect participants that paragraph, if the stated notional amount the exclusion from the definition of the
is not an eligible contract participant is of a swap is leveraged or enhanced by term swap dealer in this rule; or
not an eligible contract participant for the structure of the swap, the (B) Any synthetic loan, including
purposes of Sections 2(c)(2)(B)(vi) and calculation shall be based on the without limitation a loan credit default
2(c)(2)(C)(vii) of the Commodity effective notional amount of the swap swap or loan total return swap.
Exchange Act; and rather than on the stated notional (qqq) Major Swap Participant. (1) In
(6) A commodity pool that does not amount. general. The term major swap
have total assets exceeding $5,000,000 (ii) The person has not entered into participant means any person:
or that is not operated by a person swaps in connection with those (i) That is not a swap dealer; and
described in clause (A)(iv)(II) of Section activities with more than 15 (ii)(A) That maintains a substantial
1a(18) of the Commodity Exchange Act counterparties, other than swap dealers, position in swaps for any of the major
is not an eligible contract participant over the course of the immediately swap categories, excluding both
pursuant to clause (A)(v) of such preceding 12 months. In determining positions held for hedging or mitigating
Section. the number of counterparties, all commercial risk, and positions
counterparties that are members of a maintained by any employee benefit
* * * * * plan (or any contract held by such a
(ppp) Swap Dealer. (1) In general. The single group of persons under common
control shall be considered to be a plan) as defined in paragraphs (3) and
term ‘‘swap dealer’’ means any person (32) of Section 3 of the Employee
who: single counterparty.
(iii) The person has not entered into Retirement Income Security Act of 1974
(i) Holds itself out as a dealer in (29 U.S.C. 1002) for the primary purpose
swaps; more than 20 swaps in connection with
those activities over the course of the of hedging or mitigating any risk
(ii) Makes a market in swaps; directly associated with the operation of
(iii) Regularly enters into swaps with immediately preceding 12 months. For
purposes of this paragraph, each the plan;
counterparties as an ordinary course of (B) Whose outstanding swaps create
business for its own account; or transaction entered into under a master
agreement for swaps shall constitute a substantial counterparty exposure that
(iv) Engages in any activity causing it could have serious adverse effects on
to be commonly known in the trade as distinct swap, but entering into an
amendment of an existing swap in the financial stability of the United
a dealer or market maker in swaps. States banking system or financial
(2) Exception. The term ‘‘swap dealer’’ which the counterparty to such swap
remains the same and the item markets; or
does not include a person that enters (C) That is a financial entity that:
into swaps for such person’s own underlying such swap remains
substantially the same shall not (1) Is highly leveraged relative to the
account, either individually or in a amount of capital such entity holds and
fiduciary capacity, but not as a part of constitute entering into a swap.
(5) Insured depository institution that is not subject to capital
regular business. requirements established by an
swaps in connection with originating
(3) Scope. A person who is a swap appropriate Federal banking agency (as
loans to customers. Swaps entered into
dealer shall be deemed to be a swap defined in Section 1a(2) of the
by an insured depository institution
dealer with respect to each swap it Commodity Exchange Act); and
with a customer in connection with
enters into, regardless of the category of (2) Maintains a substantial position in
originating a loan with that customer
the swap or the person’s activities in outstanding swaps in any major swap
shall not be considered in determining
connection with the swap. However, if category.
whether such person is a swap dealer.
a person makes an application to limit (i) A swap shall be considered to have (2) Scope of designation. A person
its designation as a swap dealer to been entered into in connection with that is a major swap participant shall be
specified categories of swaps or originating a loan only if the rate, asset, deemed to be a major swap participant
specified activities of the person in liability or other notional item with respect to each swap it enters into,
connection with swaps, the Commission underlying such swap is, or is directly regardless of the category of the swap or
shall determine whether the person’s related to, a financial term of such loan. the person’s activities in connection
designation as a swap dealer shall be so The financial terms of a loan include, with the swap. However, if a person
limited. A person may make such without limitation, the loan’s duration, makes an application to limit its
application to limit its designation at rate of interest, the currency or designation as a major swap participant
the same time as, or at a later time currencies in which it is made and its to specified categories of swaps or
subsequent to, the person’s initial principal amount. specified activities of the person in
registration as a swap dealer. (ii) An insured depository institution connection with swaps, the Commission
(4) De minimis exception. A person shall be considered to have originated a shall determine whether the person’s
shall not be deemed to be a swap dealer loan with a customer if the insured designation as a major swap participant
as a result of swap dealing activity depository institution: shall be so limited. A person may make
involving counterparties that meets each (A) Directly transfers the loan amount such application to limit its designation
of the following conditions: to the customer; at the same time as, or at a later time
(i) The swap positions connected with (B) Is a part of a syndicate of lenders subsequent to, the person’s initial
those activities into which the person that is the source of the loan amount registration as a major swap participant.
enters over the course of the that is transferred to the customer; (3) Timing requirements. A person
immediately preceding 12 months have (C) Purchases or receives a that is not registered as a major swap
an aggregate gross notional amount of participation in the loan; or participant, but that meets the criteria in
no more than $100 million, and have an (D) Otherwise is the source of funds this rule to be a major swap participant
aggregate gross notional amount of no that are transferred to the customer as a result of its swap activities in a
fiscal quarter, will not be deemed to be including but not limited to any swap shall, with respect to each of its swap
a major swap participant until the based on one or more broad-based counterparties in a given major swap
earlier of the date on which it submits indices of equity securities and any total category:
a complete application for registration return swap on one or more equity (A) Determine the dollar value of the
as a major swap participant or two indices. aggregate current exposure arising from
months after the end of that quarter. (4) Other commodity swaps. Any each of its swap positions with negative
(4) Reevaluation period. swap that is not included in the rate value (subject to the netting provisions
Notwithstanding paragraph (qqq)(3) of swap, credit swap or equity swap described below) in that major category
this section, if a person that is not categories. by marking-to-market using industry
registered as a major swap participant (sss) Substantial position. (1) In standard practices; and
meets the criteria in this rule to be a general. For purposes of Section 1a(33) (B) Deduct from that dollar amount
major swap participant in a fiscal of the Commodity Exchange Act and the aggregate value of the collateral the
quarter, but does not exceed any § 1.3(qqq), the term substantial position person has posted with respect to the
applicable threshold by more than means swap positions, other than swap positions. The aggregate
twenty percent in that quarter: positions that are excluded from uncollateralized outward exposure shall
(i) That person will not immediately consideration, that equal or exceed any be the sum of those uncollateralized
be subject to the timing requirements of the following thresholds in the amounts across all of the person’s swap
specified in paragraph (qqq)(3) of this specified major category of swaps: counterparties in the applicable major
section; but (i) For rate swaps: category.
(ii) That person will become subject to (A) $3 billion in daily average (iii) Relevance of netting agreements.
the timing requirements specified in aggregate uncollateralized outward (A) If the person has a master netting
paragraph (3) at the end of the next exposure; or agreement in effect with a particular
fiscal quarter if the person exceeds any (B) $6 billion in: counterparty, the person may measure
of the applicable daily average (1) Daily average aggregate the current exposure arising from its
thresholds in that next fiscal quarter. uncollateralized outward exposure plus swaps in any major category on a net
(5) Termination of status. A person (2) Daily average aggregate potential basis, applying the terms of the
that is deemed to be a major swap outward exposure. agreement. Calculation of net exposure
participant shall continue to be deemed (ii) For credit swaps: may take into account offsetting
a major swap participant until such time (A) $1 billion in daily average positions entered into with that
that its swap activities do not exceed aggregate uncollateralized outward particular counterparty involving swaps
any of the daily average thresholds set exposure; or (in any swap category) as well as
forth within this rule for four (B) $2 billion in: security-based swaps and securities
consecutive fiscal quarters after the date (1) Daily average aggregate financing transactions (consisting of
on which the person becomes registered uncollateralized outward exposure plus securities lending and borrowing,
as a major swap participant. (2) Daily average aggregate potential securities margin lending and
(rrr) Category of swaps; major swap outward exposure. repurchase and reverse repurchase
category. For purposes of Sections (iii) For equity swaps: agreements), to the extent these are
1a(33) and 1a(49) of the Commodity (A) $1 billion in daily average consistent with the offsets permitted by
Exchange Act and §§ 1.3(ppp) and aggregate uncollateralized outward the master netting agreement.
1.3(qqq), the terms major swap category, exposure; or (B) Such adjustments may not take
category of swaps and any similar terms (B) $2 billion in: into account any offset associated with
mean any of the categories of swaps (1) Daily average aggregate positions that the person has with
listed below. For the avoidance of uncollateralized outward exposure plus separate counterparties.
doubt, the term swap as it is used in this (2) Daily average aggregate potential (3) Aggregate potential outward
§ 1.3(rrr) has the meaning set forth in outward exposure. exposure. (i) In general. Aggregate
Section 1a(47) of the Commodity (iv) For other commodity swaps: potential outward exposure in any
Exchange Act and the rules thereunder. (A) $1 billion in daily average major swap category means the sum of:
(1) Rate swaps. Any swap which is aggregate uncollateralized outward (A) The aggregate potential outward
primarily based on one or more exposure; or exposure for each of the person’s swap
reference rates, including but not (B) $2 billion in: positions in a major swap category that
limited to any swap of payments (1) Daily average aggregate are not subject to daily mark-to-market
determined by fixed and floating uncollateralized outward exposure plus margining and are not cleared by a
interest rates, currency exchange rates, (2) Daily average aggregate potential registered clearing agency or derivatives
inflation rates or other monetary rates, outward exposure. clearing organization, as calculated in
any foreign exchange swap, as defined (2) Aggregate uncollateralized accordance with paragraph (sss)(3)(ii);
in Section 1a(25) of the Commodity outward exposure. (i) In general. and
Exchange Act, and any foreign exchange Aggregate uncollateralized outward (B) The aggregate potential outward
option. exposure in general means the sum of exposure for each of the person’s swap
(2) Credit swaps. Any swap that is the current exposure, obtained by positions in such major swap category
primarily based on instruments of marking-to-market using industry that are subject to daily mark-to-market
indebtedness, including but not limited standard practices, of each of the margining or are cleared by a registered
to any swap primarily based on one or person’s swap positions with negative clearing agency or derivatives clearing
more broad-based indices related to debt value in a major swap category, less the organization, as calculated in
instruments, and any swap that is an value of the collateral the person has accordance with paragraph (sss)(3)(iii)
index credit default swap or total return posted in connection with those of this section.
swap on one or more indices of debt positions. (ii) Calculation of potential outward
instruments. (ii) Calculation of aggregate exposure for swaps that are not subject
(3) Equity swaps. Any swap that is uncollateralized outward exposure. In to daily mark-to-market margining and
primarily based on equity securities, calculating this amount the person are not cleared by a registered clearing
agency or derivatives clearing exposure equals the total notional commodities’’ conversion factors are to
organization. (A) In general. (1) For principal amount of those positions, be used. If a swap is structured such
positions in swaps that are not subject adjusted by the following multipliers on that on specified dates any outstanding
to daily mark-to-market margining and a position-by-position basis reflecting exposure is settled and the terms are
are not cleared by a registered clearing the type of swap. For any swap that reset so that the market value of the
agency or a derivatives clearing does not appropriately fall within any of swap is zero, the remaining maturity
organization, potential outward the specified categories, the ‘‘other equals the time until the next reset date.
TABLE TO § 1.3 (SSS)—CONVERSION FACTOR MATRIX FOR SWAPS

Foreign exchange Precious metals
Residual maturity Interest rate Other commodities
rate and gold (except gold)
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. Note to paragraph (sss)(3)(ii)(B): PNet is the amount shall be added to the person’s
If the stated notional amount on a potential outward exposure, adjusted for aggregate uncollateralized outward
position is leveraged or enhanced by the bilateral netting, of the person’s swaps with exposure for purposes of paragraph
structure of the position, the calculation a particular counterparty; PGross is that (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B), as
potential outward exposure without
in paragraph (sss)(3)(ii)(A)(1) of this adjustment for bilateral netting; and NGR is
applicable.
section shall be based on the effective the ratio of net current exposure to gross (4) Calculation of daily average.
notional amount of the position rather current exposure. Measures of daily average aggregate
than on the stated notional amount. uncollateralized outward exposure and
(3) Exclusion of certain positions. The (iii) Calculation of potential outward daily average aggregate potential
calculation in paragraph exposure for swaps that are subject to outward exposure shall equal the
(sss)(3)(ii)(A)(1) of this section shall daily mark-to-market margining or are arithmetic mean of the applicable
exclude: cleared by a registered clearing agency measure of exposure at the close of each
(i) Positions that constitute the or derivatives clearing organization. For business day, beginning the first
purchase of an option, such that the positions in swaps that are subject to business day of each calendar quarter
person has no additional payment daily mark-to-market margining or and continuing through the last
obligations under the position; and cleared by a registered clearing agency business day of that quarter.
(ii) Other positions for which the or derivatives clearing organization:
(ttt) Hedging or mitigating commercial
person has prepaid or otherwise (A) Potential outward exposure equals
risk. For purposes of Section 1a(33) of
satisfied all of its payment obligations. the potential exposure that would be
the Commodity Exchange Act and
(4) Adjustment for certain positions. attributed to such positions using the
§ 1.3(qqq), a swap position shall be
Notwithstanding paragraph procedures in paragraph (sss)(3)(ii) of
deemed to be held for the purpose of
(sss)(3)(ii)(A)(1) of this section, the this section multiplied by 0.2.
hedging or mitigating commercial risk
potential outward exposure associated (B) For purposes of this calculation, a when:
with a position by which a person buys swap shall be considered to be subject
credit protection using a credit default (1) Such position:
to daily mark-to-market margining if,
swap or index credit default swap is and for so long as, the counterparties (i) Is economically appropriate to the
capped at the net present value of the follow the daily practice of exchanging reduction of risks in the conduct and
unpaid premiums. collateral to reflect changes in the management of a commercial enterprise,
(B) Adjustment for netting current exposure arising from the swap where the risks arise from:
agreements. Notwithstanding paragraph (after taking into account any other (A) The potential change in the value
(sss)(3)(ii)(A) of this section, for financial positions addressed by a of assets that a person owns, produces,
positions subject to master netting netting agreement between the manufactures, processes, or
agreements the potential outward counterparties. If the person is merchandises or reasonably anticipates
exposure associated with the person’s permitted by agreement to maintain a owning, producing, manufacturing,
swaps with each counterparty equals a threshold for which it is not required to processing, or merchandising in the
weighted average of the potential post collateral, the total amount of that ordinary course of business of the
outward exposure for the person’s threshold (regardless of the actual enterprise;
swaps with that counterparty as exposure at any time) shall be added to (B) The potential change in the value
calculated under paragraph the person’s aggregate uncollateralized of liabilities that a person has incurred
(sss)(3)(ii)(A), and that amount reduced outward exposure for purposes of or reasonably anticipates incurring in
by the ratio of net current exposure to paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or the ordinary course of business of the
gross current exposure, consistent with (iv)(B) of this section, as applicable. If enterprise; or
the following equation as calculated on the minimum transfer amount under the (C) The potential change in the value
a counterparty-by-counterparty basis: agreement is in excess of $1 million, the of services that a person provides,
PNet = 0.4 * PGross + 0.6 * NGR * PGross entirety of the minimum transfer purchases, or reasonably anticipates
providing or purchasing in the ordinary by reference to all of the person’s swap 3, 80b–4, 80b–11, and 7201 et seq., 18 U.S.C.
course of business of the enterprise; positions, rather than by reference to a 1350; and 12 U.S.C. 5221(e)(3), unless
(D) The potential change in the value specific major swap category. otherwise noted.
of assets, services, inputs, products, or (vvv) Financial entity; highly * * * * *
commodities that a person owns, leveraged. (1) For purposes of Section Sections 3a67–1 through 3a67–7 and
produces, manufactures, processes, 1a(33) of the Commodity Exchange Act sections 3a71–1 and 3a71–2 are also issued
merchandises, leases, or sells, or and § 1.3(qqq), the term ‘‘financial under Pub. L. 111–203, §§ 712, 761(b), 124
Stat. 1841 (2010).
reasonably anticipates owning, entity’’ means:
producing, manufacturing, processing, (i) A security-based swap dealer; * * * * *
merchandising, leasing, or selling in the (ii) A major security-based swap 2. Add §§ 240.3a67–1 through
ordinary course of business of the participant; 240.3a67–7 and §§ 240.3a71–1,
enterprise; (iii) A commodity pool as defined in 240.3a71–2 to read as follows:
(E) Any potential change in value Section 1a(10) of the Commodity * * * * *
related to any of the foregoing arising Exchange Act; Sec.
from foreign exchange rate movements (iv) A private fund as defined in 240.3a67 1—Definition of ‘‘Major Security-
Section 202(a) of the Investment based Swap Participant.’’
associated with such assets, liabilities,
Advisers Act of 1940 (15 U.S.C. 80b– 240.3a67 2—Categories of Security-based
services, inputs, products, or Swaps.
commodities; or 2(a));
(v) An employee benefit plan as 240.3a67 3—Definition of ‘‘Substantial
(F) Any fluctuation in interest, Position.’’
currency, or foreign exchange rate defined in paragraphs (3) and (32) of 240.3a67 4—Definition of ‘‘Hedging or
exposures arising from a person’s Section 3 of the Employee Retirement Mitigating Commercial Risk.’’
current or anticipated assets or Income Security Act of 1974 (29 U.S.C. 240.3a67 5—Definition of ‘‘Substantial
liabilities; or 1002); and Counterparty Exposure.’’
(ii) Qualifies as bona fide hedging for (vi) A person predominantly engaged 240.3a67 6—Definitions of ‘‘Financial
purposes of an exemption from position in activities that are in the business of Entity’’ and ‘‘Highly Leveraged.’’
limits under the Commodity Exchange banking or financial in nature, as 240.3a67 7—Timing Requirements,
defined in Section 4(k) of the Bank Reevaluation Period, and Termination of
Act; or Status.
(iii) Qualifies for hedging treatment Holding Company Act of 1956.
(2) For purposes of Section 1a(33) of 240.3a71 1—Definition of ‘‘Security-based
under Financial Accounting Standards Swap Dealer.
Board Accounting Standards the Commodity Exchange Act and
240.3a71 2—De minimis Exception.
Codification Topic 815, Derivatives and § 1.3(qqq), the term ‘‘highly leveraged’’
means the existence of a ratio of an * * * * *
Hedging (formerly known as Statement
No. 133); and entity’s total liabilities to equity in § 240.3a67–1 Definition of ‘‘Major Security-
(2) Such position is: excess of [8 to 1 or 15 to 1] as measured based Swap Participant.’’
(i) Not held for a purpose that is in the at the close of business on the last (a) General. Major security-based
nature of speculation, investing or business day of the applicable fiscal swap participant means any person:
trading; quarter. For this purpose, liabilities and (1) That is not a security-based swap
(ii) Not held to hedge or mitigate the equity should each be determined in dealer; and
risk of another swap or securities-based accordance with U.S. generally accepted (2)(i) That maintains a substantial
swap position, unless that other accounting principles. position in security-based swaps for any
position itself is held for the purpose of Securities and Exchange Commission of the major security-based swap
hedging or mitigating commercial risk categories, excluding both positions
as defined by this rule or § 240.3a67–4 Pursuant to the Exchange Act, 15 held for hedging or mitigating
of this title. U.S.C. 78a et seq., and particularly, commercial risk, and positions
(uuu) Substantial counterparty Sections 3 and 23 thereof, and Sections maintained by any employee benefit
exposure. (1) In general. For purposes of 712 and 761(b) of the Dodd-Frank Act, plan (or any contract held by such a
Section 1a(33) of the Act and § 1.3(qqq), the SEC is proposing to adopt Rules plan) as defined in paragraphs (3) and
the phrase substantial counterparty 3a67–1, 3a67–2, 3a67–3, 3a67–4, 3a67– (32) of section 3 of the Employee
exposure that could have serious 5, 3a67–6, 3a67–7, 3a71–1, and 3a71–2 Retirement Income Security Act of 1974
adverse effects on the financial stability under the Exchange Act. (29 U.S.C. 1002) for the primary purpose
of the United States banking system or Text of Proposed Rules of hedging or mitigating any risk
financial markets means a swap directly associated with the operation of
position that satisfies either of the For the reasons stated in the
the plan;
following thresholds: preamble, the SEC is proposing to (ii) Whose outstanding security-based
(i) $5 billion in daily average amend Title 17, Chapter II of the Code swaps create substantial counterparty
aggregate uncollateralized outward of the Federal Regulations as follows: exposure that could have serious
exposure; or adverse effects on the financial stability
PART 240—GENERAL RULES AND
(ii) $8 billion in: of the United States banking system or
(A) Daily average aggregate REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934 financial markets; or
uncollateralized outward exposure plus (iii) That is a financial entity that:
(B) Daily average aggregate potential 1. The authority citation for part 240 (A) Is highly leveraged relative to the
outward exposure. is amended by adding the following amount of capital such entity holds and
(2) Calculation methodology. For citation in numerical order: that is not subject to capital
these purposes, the terms ‘‘daily average requirements established by an
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
aggregate uncollateralized outward 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, appropriate Federal banking agency (as
exposure’’ and ‘‘daily average aggregate 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, defined in 15 U.S.C. 78c(a)(72)); and
potential outward exposure’’ have the 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78o– (B) Maintains a substantial position in
same meaning as in § 1.3(sss), except 4, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, outstanding security-based swaps in any
that these amounts shall be calculated 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– major security-based swap category.
(b) Scope of designation. A person (1) $1 billion in daily average particular counterparty involving
that is a major security-based swap aggregate uncollateralized outward security-based swaps (in any swap
participant in general shall be deemed exposure; or category) as well as swaps and securities
to be a major security-based swap (2) $2 billion in: financing transactions (consisting of
participant with respect to each (i) Daily average aggregate securities lending and borrowing,
security-based swap it enters into, uncollateralized outward exposure; plus securities margin lending and
regardless of the category of the (ii) Daily average aggregate potential repurchase and reverse repurchase
security-based swap or the person’s outward exposure. agreements), to the extent these are
activities in connection with the (b) Aggregate uncollateralized consistent with the offsets permitted by
outward exposure. (1) General. the master netting agreement.
security-based swap, unless the
Aggregate uncollateralized outward
Commission limits the person’s (ii) Such adjustments may not take
exposure in general means the sum of
designation as a major security-based into account any offset associated with
the current exposure, obtained by
swap participant to specified categories positions that the person has with
marking-to-market using industry
of security-based swaps or specified separate counterparties.
standard practices, of each of the
activities of the person in connection person’s security-based swap positions (c) Aggregate potential outward
with security-based swaps. with negative value in a major security- exposure. (1) General. Aggregate
based swap category, less the value of potential outward exposure means the
§ 240.3a67–2 Categories of Security-based
Swaps. the collateral the person has posted in sum of:
connection with those positions. (i) The aggregate potential outward
For purposes of sections 3(a)(67) and (2) Calculation of aggregate exposure for each of the person’s
3(a)(71) of the Act, 15 U.S.C. 78c(a)(67) uncollateralized outward exposure. In security-based swap positions in a major
and 78c(a)(71), and the rules calculating this amount the person security-based swap category that are
thereunder, the terms major security- shall, with respect to each of its not cleared by a registered clearing
based swap category, category of security-based swap counterparties in a agency or subject to daily mark-to-
security-based swaps and any similar given major security-based swap market margining, as calculated in
terms mean either of the following category: accordance with paragraph (c)(2) of this
categories of security-based swaps: (i) Determine the dollar value of the section; and
(a) Security-based credit derivatives. aggregate current exposure arising from (ii) The aggregate potential outward
Any security-based swap that is based, each of its security-based swap exposure for each of the person’s
in whole or in part, on one or more positions with negative value (subject to security-based swap positions in a major
instruments of indebtedness (including the netting provisions described below) security-based swap category that are
loans), or on a credit event relating to in that major category by marking-to-
cleared by a registered clearing agency
one or more issuers or securities, market using industry standard
or subject to daily mark-to-market
including but not limited to any practices; and
(ii) Deduct from that dollar amount margining, as calculated in accordance
security-based swap that is a credit with paragraph (c)(3) of this section.
the aggregate value of the collateral the
default swap, total return swap on one (2) Calculation of potential outward
person has posted with respect to the
or more debt instruments, debt swap, exposure for security-based swaps that
security-based swap positions. The
debt index swap, or credit spread. are not cleared by a registered clearing
aggregate uncollateralized outward
(b) Other security-based swaps. Any exposure shall be the sum of those agency or subject to daily mark-to-
security-based swap not described in uncollateralized amounts across all of market margining.
paragraph (a) of this section. the person’s security-based swap (i) General. (A)(1) For positions in
counterparties in the applicable major security-based swaps that are not
§ 240.3a67–3 Definition of ‘‘Substantial
category. cleared by a registered clearing agency
Position.’’
(3) Relevance of netting agreements. or subject to daily mark-to-market
(a) General. For purposes of section (i) If a person has a master netting margining, potential outward exposure
3(a)(67) of the Act, 15 U.S.C. 78c(a)(67), agreement with a counterparty, the equals the total notional principal
and § 240.3a67–1 of this chapter, the person may measure the current amount of those positions, multiplied
term substantial position means exposure arising from its security-based by the following factors on a position-
security-based swap positions, other swaps in any major category on a net by-position basis reflecting the type of
than positions that are excluded from basis, applying the terms of the security-based swap. For any security-
consideration, that equal or exceed agreement. Calculation of net exposure based swap that is not of the ‘‘credit’’ or
either of the following thresholds in any may take into account offsetting ‘‘equity’’ type, the ‘‘other’’ conversion
major category of security-based swaps: positions entered into with that 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 the remaining maturity equals the time in paragraph (c)(2)(i)(A) of this section
structured such that on specified dates until the next reset date. shall be based on the effective notional
any outstanding exposure is settled and (B) Use of effective notional amounts. amount of the position rather than on
the terms are reset so that the market If the stated notional amount on a the stated notional amount.
value of the security-based swap is zero, position is leveraged or enhanced by the
structure of the position, the calculation
(C) Exclusion of certain positions. The If the person is permitted by agreement commercial risk as defined by this
calculation in paragraph (c)(2)(i)(A) of to maintain a threshold for which it is section or 17 CFR 1.3(ttt); and
this section shall exclude: not required to post collateral, the total (c) The person holding the position
(1) Positions that constitute the amount of that threshold (regardless of satisfies the following additional
purchase of an option, such that the the actual exposure at any time) shall be conditions:
person has no additional payment added to the person’s aggregate (1) The person identifies and
obligations under the position; and uncollateralized outward exposure for documents the risks that are being
(2) Other positions for which the purposes of paragraph (a)(2) of this reduced by the security-based swap
person has prepaid or otherwise section. If the minimum transfer amount position;
satisfied all of its payment obligations. under the agreement is in excess of $1 (2) The person establishes and
(D) Adjustment for certain positions. million, the entirety of the minimum documents a method of assessing the
Notwithstanding paragraph (c)(2)(i)(A) transfer amount shall be added to the effectiveness of the security-based swap
of this section, the potential outward person’s aggregate uncollateralized as a hedge; and
exposure associated with a position by outward exposure for purposes of (3) The person regularly assesses the
which a person buys credit protection paragraph (a)(2) of this section. effectiveness of the security-based swap
using a credit default swap is capped at (d) Calculation of daily average. as a hedge.
the net present value of the unpaid Measures of daily average aggregate
premiums. § 240.3a67–5 Definition of ‘‘Substantial
uncollateralized outward exposure and
Counterparty Exposure.’’
(ii) Adjustment for netting daily average aggregate potential
agreements. Notwithstanding paragraph outward exposure shall equal the (a) General. For purposes of section
(c)(2)(i) of this section, for positions arithmetic mean of the applicable 3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),
subject to master netting agreements the measure of exposure at the close of each and § 240.3a67–1 of this chapter, the
potential outward exposure associated business day, beginning the first term substantial counterparty exposure
with the person’s security-based swaps business day of each calendar quarter that could have serious adverse effects
with each counterparty equals a and continuing through the last on the financial stability of the United
weighted average of the potential business day of that quarter. States banking system or financial
outward exposure for the person’s markets means a security-based swap
security-based swaps with that § 240.3a67–4 Definition of ‘‘Hedging or position that satisfies either of the
Mitigating Commercial Risk.’’ following thresholds:
counterparty as calculated under
paragraph (c)(2)(i) of this section, and For purposes of section 3(a)(67) of the (1) $2 billion in daily average
that amount reduced by the ratio of net Act, 15 U.S.C. 78c(a)(67), and aggregate uncollateralized outward
current exposure to gross current § 240.3a67–1 of this chapter, a security- exposure; or
exposure, consistent with the following based swap position shall be deemed to (2) $4 billion in:
equation as calculated on a be held for the purpose of hedging or (i) Daily average aggregate
counterparty-by-counterparty basis: mitigating commercial risk when: uncollateralized outward exposure; plus
(a) Such position is economically (ii) Daily average aggregate potential
PNet = 0.4 × PGross + 0.6 × NGR × PGross
appropriate to the reduction of risks that outward exposure.
Note to paragraph (c)(2)(ii). Where: PNet is are associated with the present conduct (b) Calculation. For these purposes,
the potential outward exposure, adjusted for and management of a commercial daily average aggregate uncollateralized
bilateral netting, of the person’s security- enterprise, or are reasonably expected to outward exposure and daily average
based swaps with a particular counterparty; arise in the future conduct and aggregate potential outward exposure
PGross is that potential outward exposure management of the commercial shall be calculated the same way as is
without adjustment for bilateral netting; and
NGR is the ratio of net current exposure to
enterprise, where such risks arise from: prescribed in § 240.3a67–3 of this
gross current exposure.
(1) The potential change in the value chapter, except that these amounts shall
of assets that a person owns, produces, be calculated by reference to all of the
(3) Calculation of potential outward manufactures, processes, or person’s security-based swap positions,
exposure for security-based swaps that merchandises or reasonably anticipates rather than by reference to a specific
are cleared by a registered clearing owning, producing, manufacturing, major security-based swap category.
agency or subject to daily mark-to- processing, or merchandising in the
market margining. For positions in ordinary course of business of the § 240.3a67–6 Definitions of ‘‘Financial
security-based swaps that are cleared by enterprise; Entity’’ and ‘‘Highly Leveraged.’’
a registered clearing agency or subject to (2) The potential change in the value (a) For purposes of section 3(a)(67) of
daily mark-to-market margining: of liabilities that a person has incurred the Act, 15 U.S.C. 78c(a)(67), and
(i) Potential outward exposure equals or reasonably anticipates incurring in § 240.3a67–1 of this chapter, the term
the potential outward exposure that the ordinary course of business of the financial entity means:
would be attributed to such positions enterprise; or (1) A swap dealer;
using the procedures in paragraph (c)(2) (3) The potential change in the value (2) A major swap participant;
of this section, multiplied by 0.2. of services that a person provides, (3) A commodity pool as defined in
(ii) For purposes of this calculation, a purchases, or reasonably anticipates section 1a(10) of the Commodity
security-based swap shall be considered providing or purchasing in the ordinary Exchange Act (7 U.S.C. 1a(10));
to be subject to daily mark-to-market course of business of the enterprise; (4) A private fund as defined in
margining if, and for as long as, the (b) Such position is: section 202(a) of the Investment
counterparties follow the daily practice (1) Not held for a purpose that is in Advisers Act of 1940 (15 U.S.C. 80b–
of exchanging collateral to reflect the nature of speculation or trading; and 2(a));
changes in the current exposure arising (2) Not held to hedge or mitigate the (5) An employee benefit plan as
from the security-based swap (after risk of another security-based swap defined in paragraphs (3) and (32) of
taking into account any other financial position or swap position, unless that section 3 of the Employee Retirement
positions addressed by a netting other position itself is held for the Income Security Act of 1974 (29 U.S.C.
agreement between the counterparties). purpose of hedging or mitigating 1002); and
(6) A person predominantly engaged fiscal quarters after the date on which stated notional amount of a security-
in activities that are in the business of the person becomes registered as a based swap is leveraged or enhanced by
banking or financial in nature, as major security-based swap participant. the structure of the security-based swap,
defined in section 4(k) of the Bank the calculation shall be based on the
§ 240.3a71–1 Definition of ‘‘Security-based
Holding Company Act of 1956 (12 effective notional amount of the
Swap Dealer.’’
U.S.C. 1843k). security-based swap rather than on the
(b) For purposes of section 3(a)(67) of (a) General. The term security-based stated notional amount.
the Act, 15 U.S.C. 78c(a)(67), and swap dealer in general means any
person who: (b) No more than 15 counterparties.
§ 240.3a67–1 of this chapter, the term
(1) Holds itself out as a dealer in The person does not enter into security-
highly leveraged means the existence of
security-based swaps; based swaps in connection with those
a ratio of an entity’s total liabilities to
(2) Makes a market in security-based activities with more than 15
equity in excess of [8 to 1 or 15 to 1]
swaps; counterparties, other than security-
as measured at the close of business on
(3) Regularly enters into security- based swap dealers, over the course of
the last business day of the applicable
based swaps with counterparties as an the immediately preceding 12 months.
fiscal quarter. For this purpose,
ordinary course of business for its own In determining the number of
liabilities and equity should each be
account; or counterparties, all counterparties that
determined in accordance with U.S.
(4) Engages in any activity causing it are members of a single affiliated group
generally accepted accounting
to be commonly known in the trade as shall be considered to be a single
principles.
a dealer or market maker in security- counterparty.
§ 240.3a67–7 Timing Requirements, based swaps. (c) No more than 20 security-based
Reevaluation Period, and Termination of (b) Exception. The term security-
swaps. The person has not entered into
Status. based swap dealer does not include a
more than 20 security-based swaps in
(a) Timing requirements. A person person that enters into security-based
connection with those activities over the
that is not registered as a major security- swaps for such person’s own account,
course of the immediately preceding 12
based swap participant, but that meets either individually or in a fiduciary
months. For purposes of this paragraph,
the criteria in § 240.3a67–1 of this capacity, but not as a part of regular
each transaction entered into under a
chapter to be a major security-based business.
(c) Scope of designation. A person master agreement for security-based
swap participant as a result of its
that is a security-based swap dealer in swaps shall constitute a distinct
security-based swap activities in a fiscal
general shall be deemed to be a security- security-based swap, but entering into
quarter, will not be deemed to be a
based swap dealer with respect to each an amendment of an existing security-
major security-based swap participant
security-based swap it enters into, based swap in which the counterparty
until the earlier of the date on which it
regardless of the category of the to such swap remains the same and the
submits a complete application for
security-based swap or the person’s notional item underlying such security-
registration pursuant to 15 U.S.C. 78o–
activities in connection with the based swap remains substantially the
8 or two months after the end of that
security-based swap, unless the same shall not constitute entering into
quarter.
(b) Reevaluation period. Commission limits the person’s a security-based swap.
Notwithstanding paragraph (a) of this designation as a major security-based Dated: December 1, 2010.
section, if a person that is not registered swap participant to specified categories By the Commodity Futures Trading
as a major security-based swap of security-based swaps or specified Commission.
participant meets the criteria in activities of the person in connection David A. Stawick,
§ 240.3a67–1 of this chapter to be a with security-based swaps. Secretary.
major security-based swap participant
in a fiscal quarter, but does not exceed § 240.3a71–2 De minimis Exception. Dated: December 7, 2010.
any applicable threshold by more than For purposes of section 3(a)(71) of the By the Securities and Exchange
twenty percent in that quarter: Act, 15 U.S.C. 78c(a)(71), and Commission.
(1) That person will not immediately § 240.3a71–1 of this chapter, a person Elizabeth M. Murphy,
be subject to the timing requirements shall not be deemed to be a security- Secretary.
specified in paragraph (a) of this based swap dealer as a result of
section; but security-based swap dealing activity Additional Statement by the
(2) That person will become subject to involving counterparties that meets each Commodity Futures Trading
the timing requirements specified in of the following conditions: Commission Regarding the Joint
paragraph (a) of this section at the end (a) Notional amount of outstanding Proposed Rule Entitled ‘‘Further
of the next fiscal quarter if the person security-based swap positions. The Definition of ‘Swap Dealer,’ ‘Security-
exceeds any of the applicable daily security-based swap positions Based Swap Dealer,’ ‘Major Swap
average thresholds in that next fiscal connected with those activities into Participant,’ ‘Major Security-Based
quarter. which the person enters over the course Swap Participant,’ and ‘Eligible
(c) Termination of status. A person of the immediately preceding 12 months Contract Participant.’’’
that is deemed to be a major security- have an aggregate gross notional amount
based swap participant shall continue to of no more than $100 million and have On this matter, Chairman Gensler and
be deemed a major security-based swap an aggregate gross notional amount of Commissioners Dunn and Chilton voted
participant until such time that its no more than $25 million with regard to in the affirmative; Commissioners
security-based swap activities do not security-based swaps in which the Sommers and O’Malia voted in the
exceed any of the daily average counterparty is a ‘‘special entity’’ (as that negative.
thresholds set forth within § 240.3a67– term is defined in 15 U.S.C. 78o–8). For [FR Doc. 2010–31130 Filed 12–20–10; 8:45 am]
1 of this chapter for four consecutive purposes of this paragraph (a), if the BILLING CODE 6351–01–P; 8011–01–P

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Tuesday,

December 21, 2010

Commission, Three Lafayette Centre, 5118, jhammar@cftc.gov, or David E.

‘‘commenters.’’ applicable to brokers. section 3(a)(71)(B).

with the IDI’s origination of the loan mechanism as an alternative to, or in

status under this proposal, as well as section 3(a)(67)(B).

conducting the calculation (and, if so, security-based swap positions pose a

144 See CEA section 2(h)(7)(C)(i); Exchange Act

recently proposed one method for calculating risk-

156 See proposed CEA rule 1.3(qqq)(4)(ii);

major participants. for the Commissions). 3(a)(67)(C).

should ‘‘look at the aggregate positions of funds 761(b)(3).

165 Arguably, the basis for this type of attribution

merchants should not fall within the scope of the

2—‘‘Major’’ Categories of Security-Based Comptroller of the Currency, ‘‘OCC’s Quarterly

One of the two alternative proposed definition of ‘‘security-based swap

TABLE TO § 1.3 (SSS)—CONVERSION FACTOR MATRIX FOR SWAPS

One year or less ...................................................... 0.00 0.01 0.07 0.10

Residual maturity Credit Equity

One year or less .................................................................................................................................. 0.10 0.06

Residual maturity Credit Equity Other

One year or less ............................................................................................ 0.10 0.06 0.10

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