80174 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010). The text of the Dodd-Frank Act 

may be accessed at http://www.cftc.gov./ 

LawRegulation/OTCDERIVATIVES/index.htm. 

2Pursuant to Section 701 of the Dodd-Frank Act, 

Title VII may be cited as the ‘‘Wall Street 

Transparency and Accountability Act of 2010.’’ 

3See 7 U.S.C. 1a(18). 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 1 

RIN 3038–AD06 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 240 

[Release No. 34–63452; File No. S7–39–10] 

RIN 3235–AK65 

Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ ‘‘Major 

Swap Participant,’’ ‘‘Major SecurityBased Swap Participant’’ and ‘‘Eligible 

Contract Participant’’ 

AGENCY: Commodity Futures Trading 

Commission; Securities and Exchange 

Commission. 

ACTION: Joint proposed rule; proposed 

interpretations. 

SUMMARY: In accordance with Section 

712(d)(1) of Title VII of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act of 2010 (‘‘Dodd-Frank 

Act’’), the Commodity Futures Trading 

Commission (‘‘CFTC’’) and the Securities 

and Exchange Commission (‘‘SEC’’) 

(collectively, the ‘‘Commissions’’), in 

consultation with the Board of 

Governors of the Federal Reserve 

System, are proposing rules and 

interpretative guidance under the 

Commodity Exchange Act (‘‘CEA’’), 7 

U.S.C. 1 et seq., and the Securities 

Exchange Act of 1934 (‘‘Exchange Act’’), 

15 U.S.C. 78a et seq., to further define 

the terms ‘‘swap dealer,’’ ‘‘security-based 

swap dealer,’’ ‘‘major swap participant,’’ 

‘‘major security-based swap participant,’’ 

and ‘‘eligible contract participant.’’ 

DATES: Submit comments on or before 

February 22, 2011. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

CFTC: 

• Agency Web site, via its Comments 

Online process: http:// 

comments.cftc.gov. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: David A. Stawick, Secretary, 

Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street, NW., Washington, DC 

20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: 

Comments also may be submitted at 

http://www.regulations.gov. Follow the 

instructions for submitting comments. 

‘‘Definitions’’ must be in the subject field 

of responses submitted via e-mail, and 

clearly indicated on written 

submissions. All comments must be 

submitted in English, or if not, 

accompanied by an English translation. 

All comments provided in any 

electronic form or on paper will be 

published on the CFTC Web site, 

without review and without removal of 

personally identifying information. All 

comments are subject to the CFTC 

Privacy Policy. 

SEC 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–39–10 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–39–10. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549, on official 

business days between the hours of 10 

a.m. and 3 p.m. All comments received 

will be posted without change; we do 

not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

FOR FURTHER INFORMATION CONTACT: 

CFTC: Mark Fajfar, Assistant General 

Counsel, at 202–418–6636, 

mfajfar@cftc.gov, Julian E. Hammar, 

Assistant General Counsel, at 202–418– 

5118, jhammar@cftc.gov, or David E. 

Aron, Counsel, at 202–418–6621, 

daron@cftc.gov, Office of General 

Counsel, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street, NW., Washington, DC 

20581; SEC: Joshua Kans, Senior Special 

Counsel, Jeffrey Dinwoodie, Attorney 

Advisor, or Richard Grant, Attorney 

Advisor, at 202–551–5550, Division of 

Trading and Markets, Securities and 

Exchange Commission, 100 F Street, 

NE., Washington, DC 20549–7010. 

SUPPLEMENTARY INFORMATION: 

I. Background 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act into law.1

Title VII of the Dodd-Frank Act 2

established a comprehensive new 

regulatory framework for swaps and 

security-based swaps. The legislation 

was enacted, among other reasons, to 

reduce risk, increase transparency, and 

promote market integrity within the 

financial system, including by: 

(1) Providing for the registration and 

comprehensive regulation of swap 

dealers, security-based swap dealers, 

major swap participants and major 

security-based swap participants; 

(2) imposing clearing and trade 

execution requirements on swaps and 

security-based swaps, subject to certain 

exceptions; (3) creating rigorous 

recordkeeping and real-time reporting 

regimes; and (4) enhancing the 

rulemaking and enforcement authorities 

of the Commissions with respect to, 

among others, all registered entities and 

intermediaries subject to the 

Commissions’ oversight. 

More specifically, the Dodd-Frank Act 

provides that the CFTC will regulate 

‘‘swaps,’’ and the SEC will regulate 

‘‘security-based swaps.’’ The Dodd-Frank 

Act also adds to the CEA and Exchange 

Act definitions of the terms ‘‘swap 

dealer,’’ ‘‘security-based swap dealer,’’ 

‘‘major swap participant,’’ ‘‘major 

security-based swap participant,’’ and 

‘‘eligible contract participant.’’ These 

terms are defined in Sections 721 and 

761 of the Dodd-Frank Act and, with 

respect to the term ‘‘eligible contract 

participant,’’ in Section 1a(18) of the 

CEA,3 as re-designated and amended by 

Section 721 of the Dodd-Frank Act. 

Section 712(d)(1) of the Dodd-Frank 

Act provides that the CFTC and the 

SEC, in consultation with the Board of 

Governors of the Federal Reserve 

System, shall jointly further define the 

terms ‘‘swap,’’ ‘‘security-based swap,’’ 

‘‘swap dealer,’’ ‘‘security-based swap 

dealer,’’ ‘‘major swap participant,’’ 

‘‘major security-based swap participant,’’ 

‘‘eligible contract participant,’’ and 

‘‘security-based swap agreement.’’ 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80175 

4The definitions of the terms ‘‘swap,’’ ‘‘securitybased swap,’’ and ‘‘security-based swap agreement,’’ 

and regulations regarding mixed swaps are the 

subject of a separate rulemaking by the 

Commissions. 

5See Definitions Contained in Title VII of DoddFrank Wall Street Reform and Consumer Protection 

Act, Exchange Act Rel. No. 34–62717, 75 FR 51429 

(Aug. 20, 2010). The comment period for the 

ANPRM closed on September 20, 2010. 

6Comments were solicited by the CFTC at 

http://www.cftc.gov/LawRegulation/DoddFrankAct/ 

OTC_2_Definitions.html and the SEC at http:// 

www.sec.gov/spotlight/regreformcomments.shtml/. 

7The views expressed in the comments in 

response to the ANPRM, in response to the 

Commissions’ informal solicitation, and at such 

meetings are collectively referred to as the views of 

‘‘commenters.’’ 

8 In addition, we recognize that the 

appropriateness of these proposals also should be 

considered in light of the substantive requirements 

that will be applicable to dealers and major 

participants, including capital, margin and business 

conduct requirements, which are the subject of 

separate rulemakings. For example, whether the 

definition of a major participant is too broad or too 

narrow may well depend in part on the substantive 

requirements applicable to such entities, and 

whether those substantive requirements are 

themselves appropriate may in turn depend in part 

on the scope of the major participant definition. We 

therefore encourage comments that take into 

account the interplay between the proposed 

definitions and these substantive requirements. 

9See Section 721 of the Dodd-Frank Act (defining 

‘‘swap dealer’’ in new Section 1a(49) of the CEA, 7 

U.S.C. 1a(49)) and Section 761 of the Dodd-Frank 

Act (defining ‘‘security-based swap dealer’’ in new 

Section 3(a)(71) of the Exchange Act, 15 U.S.C. 

78c(a)(71)). 

10The Dodd-Frank Act excludes from the 

Exchange Act definition of ‘‘dealer’’ persons who 

engage in security-based swap transactions with 

eligible contract participants. See Section 3(a)(5) of 

the Exchange Act, 15 U.S.C. 78c(a)(5), as amended 

by Section 761(a)(1) of the Dodd-Frank Act. 

The Dodd-Frank Act does not include comparable 

amendments for persons who act as brokers in 

swaps and security-based swaps. Because securitybased swaps are a type of security, persons who act 

as brokers in connection with security-based swaps 

must, absent an exemption, register with the SEC 

as a broker pursuant to Exchange Act section 15(a), 

and comply with the Exchange Act’s requirements 

applicable to brokers. 

11See CEA section 1a(49)(A); Exchange Act 

section 3(a)(71)(A). 

12See CEA section 1a(49)(C); Exchange Act 

section 3(a)(71)(C). 

13See CEA section 1a(49)(D); Exchange Act 

section 3(a)(71)(D). 

14CEA section 1a(49)(A). 

15See CEA section 1a(49)(B); Exchange Act 

section 3(a)(71)(B). 

Further, Section 721(c) of the DoddFrank Act requires the CFTC to adopt a 

rule to further define the terms ‘‘swap,’’ 

‘‘swap dealer,’’ ‘‘major swap participant,’’ 

and ‘‘eligible contract participant,’’ and 

Section 761(b) of the Dodd-Frank Act 

permits the SEC to adopt a rule to 

further define the terms ‘‘security-based 

swap,’’ ‘‘security-based swap dealer,’’ 

‘‘major security-based swap participant,’’ 

and ‘‘eligible contract participant,’’ with 

regard to security-based swaps, for the 

purpose of including transactions and 

entities that have been structured to 

evade Title VII of the Dodd-Frank Act.4

In light of the requirements in the 

Dodd-Frank Act noted above, the CFTC 

and the SEC issued a joint Advance 

Notice of Proposed Rulemaking 

(‘‘ANPRM’’) on August 13, 2010, 

requesting public comment regarding 

the definitions of ‘‘swap,’’ ‘‘securitybased swap,’’ ‘‘security-based swap 

agreement,’’ ‘‘swap dealer,’’ ‘‘securitybased swap dealer,’’ ‘‘major swap 

participant,’’ ‘‘major security-based swap 

participant,’’ and ‘‘eligible contract 

participant’’ in Title VII of the DoddFrank Act.5 The Commissions reviewed 

more than 80 comments in response to 

the ANPRM. The Commissions also 

informally solicited comments on the 

definitions on their respective Web 

sites.6 In addition, the staffs of the CFTC 

and the SEC have met with many 

market participants and other interested 

parties to discuss the definitions.7

In this release, the Commissions 

propose to further define ‘‘swap dealer,’’ 

‘‘security-based swap dealer,’’ ‘‘major 

swap participant,’’ ‘‘major security-based 

swap participant’’ and ‘‘eligible contract 

participant,’’ and propose related rules, 

and also discuss certain factors that are 

relevant to market participants when 

determining their status with respect to 

the defined terms. In developing these 

proposals, the Commissions have been 

mindful that the markets for swaps and 

security-based swaps are evolving, and 

that the rules that we adopt will, as 

intended by the Dodd-Frank Act, 

significantly affect those markets. The 

rules not only will help determine 

which entities will be subject to 

comprehensive regulation of their swap 

and security-based swap activities, but 

may also cause certain entities to 

modify their activities to avoid being 

subject to the regulations. As a result, 

we are aware of the importance of 

crafting these rules carefully to 

maximize the benefits of the regulation 

imposed by the Dodd-Frank Act, and to 

do so in a way that is flexible enough 

to respond to market developments. 

While we preliminarily believe that 

these proposals, if adopted, would 

appropriately effect the intent of the 

Dodd-Frank Act, we are very interested 

in commenters’ views as to whether we 

have achieved this purpose, and, if not, 

how to improve these proposals.8

II. Definitions of ‘‘Swap Dealer’’ and 

‘‘Security-Based Swap Dealer’’ 

The Dodd-Frank Act defines the terms 

‘‘swap dealer’’ and ‘‘security-based swap 

dealer’’ in terms of whether a person 

engages in certain types of activities 

involving swaps or security-based 

swaps.9 Persons that meet either of 

those definitions are subject to statutory 

requirements related to, among other 

things, registration, margin, capital and 

business conduct.10

The two definitions in general 

encompass persons that engage in any of 

the following types of activity: 

(i) Holding oneself out as a dealer in 

swaps or security-based swaps, 

(ii) Making a market in swaps or 

security-based swaps, 

(iii) Regularly entering into swaps or 

security-based swaps with 

counterparties as an ordinary course of 

business for one’s own account, or 

(iv) Engaging in activity causing 

oneself to be commonly known in the 

trade as a dealer or market maker in 

swaps or security-based swaps.11

The definitions are disjunctive, in that 

a person that engages in any of the 

enumerated dealing activities is a swap 

dealer or security-based swap dealer 

even if the person does not engage in 

any of the other enumerated activities. 

The definitions, in contrast, do not 

include a person that enters into swaps 

or security-based swaps ‘‘for such 

person’s own account, either 

individually or in a fiduciary capacity, 

but not as a part of a regular 

business.’’ 12 The Dodd-Frank Act also 

instructs the Commissions to exempt 

from designation as a dealer an entity 

that ‘‘engages in a de minimis quantity 

of [swap or security-based swap] dealing 

in connection with transactions with or 

on behalf of its customers.’’ 13 Moreover, 

the definition of ‘‘swap dealer’’ (but not 

the definition of ‘‘security-based swap 

dealer’’) provides that an insured 

depository institution is not to be 

considered a swap dealer ‘‘to the extent 

it offers to enter into a swap with a 

customer in connection with originating 

a loan with that customer.’’ 14

The definitions also provide that a 

person may be designated as a dealer for 

one or more types, classes or categories 

of swaps, security-based swaps, or 

activities without being designated a 

dealer for other types, classes or 

categories or activities.15

The Commissions are proposing rules 

to further define certain aspects of the 

meaning of ‘‘swap dealer’’ and ‘‘securitybased swap dealer,’’ and are providing 

guidance on how the Commissions 

propose to interpret these terms. This 

release specifically addresses: (A) The 

types of activities that would cause a 

person to be a swap dealer or securitybased swap dealer, including 

differences in how those two definitions 

should be applied; (B) the statutory 

provisions requiring the Commissions to 

exempt persons from the dealer 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80176 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

16See letter from Eric Dennison, Sr. Vice 

President and General Counsel, Stephanie Miller, 

Assistant General Counsel—Commodities, and Bill 

Hellinghausen, Director of Regulatory Affairs, EDF 

Trading, dated September 20, 2010 (distinguishing 

transactions that the commenter enters into as part 

of energy management services). 

17As discussed below, however (see note 42, 

infra), the Dodd-Frank Act amended the Exchange 

Act definitions of ‘‘buy,’’ ‘‘purchase,’’ ‘‘sale’’ and 

‘‘sell’’ to apply to particular actions involving 

security-based swaps. 

definitions in connection with de 

minimis activity; (C) the exception from 

the ‘‘swap dealer’’ definition in 

connection with loans by insured 

depository institutions; (D) the 

possibility that a person may be 

considered a dealer for some types, 

classes or categories of swaps, securitybased swaps, or activities but not others; 

and (E) certain interpretative issues that 

arise in particular situations. The 

Commissions request comment on all 

aspects of the proposals, including the 

particular points noted in the discussion 

below. 

A. Swap and Security-Based Swap 

Dealing Activity 

1. Comments Regarding Dealing 

Activities 

Commenters provided numerous 

examples of conduct they viewed as 

dealing activities—as well as conduct 

they did not view as dealing activities. 

For example, many of the commenters 

stated that dealers provide ‘‘bid/ask’’ or 

‘‘two-way’’ prices for swaps on a regular 

basis, or regularly participate in both 

sides of the swap market. Some 

commenters indicated that dealers 

perform an intermediary function. Other 

commenters stated that a person holds 

itself out as a dealer if it consistently 

and systematically markets itself as a 

swap dealer to third parties. Some 

commenters described market makers in 

the swap markets as persons that stand 

ready to buy or sell swaps at all times, 

are open to doing swaps business on 

both sides of a market, or make bids to 

buy and offers to sell swaps or a type 

of swap at all times. Commenters stated 

that a person should be included in the 

definition of dealer if its sole or 

dominant line of business is swaps 

activity. One commenter urged the 

Commissions to adopt a swap 

association’s definition of a primary 

member as the definition of dealer. 

Some commenters stated that the 

definition of dealer should be read 

narrowly. For example, some 

commenters suggested that the market 

maker concept should not encompass 

persons that provide occasional quotes 

or that do not make bids or offers 

consistently or at all times. Another 

commenter stated that a willingness to 

buy or sell a swap or security-based 

swap at a particular time does not 

constitute market making absent the 

creating of a two-way market. One 

commenter suggested that solely acting 

as a market maker should not cause a 

person to be a dealer, since firms may 

have commercial purposes for offering 

two-way trades. Another commenter 

stated that an entity that ‘‘holds itself 

out’’ as a dealer should qualify as a swap 

dealer only if it ‘‘consistently and 

systematically markets itself as a dealer 

to third-parties.’’ 16

Many commenters called for the 

exclusion of particular types of persons 

from the definition of swap dealer or 

security-based swap dealer. Several 

commenters maintained that 

commercial end-users of swaps or 

security-based swaps that enter into 

swaps or security-based swaps to hedge 

or mitigate commercial risk should be 

excluded from the definitions. Another 

commenter stated the definitions should 

exclude persons who use swaps or 

security-based swaps for bona fide 

hedging. Other commenters indicated 

that cooperatives that enter into swaps 

in connection with the business of their 

members should be excluded. 

Commenters also stated that if all of a 

person’s swaps are cleared on an 

exchange or derivatives clearing 

organization, the person should not be 

deemed to be a dealer. One commenter 

stated competitive power suppliers 

should be excluded, and another stated 

that the dealer definition should not 

apply to futures commission merchants 

that act economically like brokers. 

Commenters, particularly those in the 

securities industry, urged the 

Commissions to interpret the definitions 

of swap dealer and security-based swap 

dealer consistently with precedent that 

distinguishes between dealers in 

securities and traders in securities. 

However, one commenter also noted 

that some concepts from the securities 

and commodities laws may not easily be 

applied to these markets. 

2. Application of the Core Tests to 

‘‘Swap Dealers’’ and ‘‘Security-Based 

Swap Dealers’’ 

The Dodd-Frank Act defines the terms 

‘‘swap dealer’’ and ‘‘security-based swap 

dealer’’ in a functional manner, 

encompassing how a person holds itself 

out in the market, the nature of the 

conduct engaged in by the person, and 

how the market perceives the person’s 

activities. This suggests that the 

definitions should not be interpreted in 

a constrained or overly technical 

manner. Rigid standards would not 

provide the necessary flexibility to 

respond to evolution in the ways that 

dealers enter into swaps and securitybased swaps. The different types of 

swap and security-based swap markets 

are diverse, and there does not appear 

to be a single set of criteria that can be 

determinative in all markets. 

At the same time, we note that there 

may be certain distinguishing 

characteristics of swap dealers and 

security-based swap dealers, including 

that: 

• Dealers tend to accommodate 

demand for swaps and security-based 

swaps from other parties; 

• Dealers are generally available to 

enter into swaps or security-based 

swaps to facilitate other parties’ interest 

in entering into those instruments; 

• Dealers tend not to request that 

other parties propose the terms of swaps 

or security-based swaps; rather, dealers 

tend to enter into those instruments on 

their own standard terms or on terms 

they arrange in response to other 

parties’ interest; and 

• Dealers tend to be able to arrange 

customized terms for swaps or securitybased swaps upon request, or to create 

new types of swaps or security-based 

swaps at the dealer’s own initiative. 

We also recognize that the principles 

relevant to identifying dealing activity 

involving swaps can differ from 

comparable principles associated with 

security-based swaps. These differences 

are due, in part, to differences in how 

those instruments are used. For 

example, because security-based swaps 

may be used to hedge or gain economic 

exposure to underlying securities (while 

recognizing distinctions between 

securities-based swaps and other types 

of securities, as discussed below), there 

is a basis to build upon the same 

principles that are presently used to 

identify dealers for other types of 

securities. Accordingly, we separately 

address how the core tests would apply 

to swap dealers and to security-based 

swap dealers. 

a. Application to Swap Dealers 

The definition of swap dealer should 

be informed by the differences between 

swaps, on the one hand, and securities 

and commodities, on the other. 

Transactions in cash market securities 

and commodities generally involve 

purchases and sales of tangible or 

intangible property. Swaps, in contrast, 

are notional contracts requiring the 

performance of agreed terms by each 

party.17 Thus, many of the concepts 

cited by commenters, such as whether a 

person buys and sells swaps or makes 

a two-sided market in swaps or trades 

within a bid/offer spread, cannot 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80177 

18Some of the commenters appeared to suggest 

that significant parts of the swap markets operate 

without the involvement of swap dealers. We 

believe that this analysis is likely incorrect, and that 

the parties that fulfill the function of dealers should 

be identified and are likely to be swap dealers. 

19We interpret this reference to a person entering 

into swaps ‘‘with counterparties * * * for its own 

account’’ to refer to a person entering into a swap 

as a principal, and not as an agent. A person who 

entered into swaps as an agent for customers (i.e., 

for the customers’ accounts) would be required to 

register as either a Futures Commission Merchant, 

Introducing Broker, Commodity Pool Operator or 

Commodity Trading Advisor, depending on the 

nature of the person’s activity. 

20The definition of ‘‘security-based swap dealer’’ 

is structured similarly, and should be interpreted 

similarly. 

21The Exchange Act in relevant part defines 

‘‘dealer’’ to mean ‘‘any person engaged in the 

business of buying and selling securities (not 

including security-based swaps, other than securitybased swaps with or for persons that are not eligible 

contract participants) for such person’s own 

account through a broker or otherwise,’’ but with an 

exception for ‘‘a person that buys or sells securities 

(not including security-based swaps, other than 

security-based swaps with or for persons that are 

not eligible contract participants) for such person’s 

own account, either individually or in a fiduciary 

capacity, but not as a part of a regular business.’’ 

Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 

78c(a)(5)(A) and (B), as amended by Section 

761(a)(1) of the Dodd-Frank Act. 

22For example, an entity that owns a particular 

security may use a security-based swap to hedge the 

risks of that security. Conversely, an entity may 

seek to offset exposure involving a security-based 

swap by using another security as a hedge. 

23For example, an entity may enter into a 

security-based swap to gain economic exposure 

akin to a long or short position in a stock or bond, 

without having to engage in a cash market 

transaction for that instrument. 

24Securities Exchange Act Release No. 47364 

(Feb. 13, 2003) (footnotes omitted). 

25 In particular, an analysis that considers dealers 

to differ from traders in part because dealers have 

regular turnover in ‘‘inventory’’ appears not to apply 

in the context of security-based swaps, given that 

those instruments are created by contract between 

two market counterparties, rather than reflecting 

financial rights issued by third-parties. 

necessarily be applied to all types of 

swaps to determine if the person is a 

swap dealer. We understand that market 

participants do use this terminology 

colloquially to describe the process of 

entering into a swap. For example, a 

person seeking a fixed/floating interest 

rate swap may inquire as to the fixed 

rates, spread above the floating rate and 

other payments that another person 

would require in order to enter into a 

swap. But, while these persons may 

discuss bids, offers, prices and so forth, 

the parties are negotiating the terms of 

a contract, they are not negotiating the 

price at which they will transfer 

ownership of tangible or intangible 

property. Accordingly, these concepts 

are not determinative of whether a 

person is a ‘‘swap dealer.’’ 

Instead, persons who are swap dealers 

may be identified by the functional role 

they fulfill in the swap markets. As 

noted above, swap dealers tend to 

accommodate demand and to be 

available to enter into swaps to facilitate 

other parties’ interest in swaps 

(although swap dealers may also 

advance their own investment and 

liquidity objectives by entering into 

such swaps). In addition, swap dealers 

can often be identified by their 

relationships with counterparties. Swap 

dealers tend to enter into swaps with 

more counterparties than do nondealers, and in some markets, nondealers tend to constitute a large portion 

of swap dealers’ counterparties. In 

contrast, non-dealers tend to enter into 

swaps with swap dealers more often 

than with other non-dealers.18 The 

Commissions can most efficiently 

achieve the purposes underlying Title 

VII of the Dodd-Frank Act—to reduce 

risk and to enhance operational 

standards and fair dealing in the swap 

markets—by focusing their attention on 

those persons whose function is to serve 

as the points of connection in those 

markets. The definition of swap dealer, 

construed functionally in the manner 

set forth above, will help to identify 

those persons. 

Clause (A)(iii) of the statutory 

definition of swap dealer, which 

includes any person that ‘‘regularly 

enters into swaps with counterparties as 

an ordinary course of business for its 

own account,’’ 19 has been the subject of 

significant uncertainty among 

commenters. The commenters point out 

that its literal terms could encompass 

many parties who regularly enter into 

swaps without engaging in any form of 

swap dealing activity. In this regard, 

clause (A)(iii) of the definition should 

be read in combination with the express 

exception in subparagraph (C) of the 

swap dealer definition, which excludes 

‘‘a person that enters into swaps for such 

person’s own account, either 

individually or in a fiduciary capacity, 

but not as a part of a regular business.’’ 

Thus, the difference between the 

inclusion in clause (A)(iii) and the 

exclusion in subparagraph (C) is 

whether or not the person enters into 

swaps as a part of, or as an ordinary 

course of, a ‘‘regular business.’’ 20 We 

believe that persons who enter into 

swaps as a part of a ‘‘regular business’’ 

are those persons whose function is to 

accommodate demand for swaps from 

other parties and enter into swaps in 

response to interest expressed by other 

parties. Conversely, persons who do not 

fulfill this function should not be 

deemed to enter into swaps as part of a 

‘‘regular business’’ and are not likely to 

be swap dealers. 

In sum, to determine if a person is a 

swap dealer, we would consider that 

person’s activities in relation to the 

other parties with which it interacts in 

the swap markets. If the person is 

available to accommodate demand for 

swaps from other parties, tends to 

propose terms, or tends to engage in the 

other activities discussed above, then 

the person is likely to be a swap dealer. 

Persons that rarely engage in such 

activities are less likely to be deemed 

swap dealers. 

We request comment on this 

interpretive approach for identifying 

whether a person is a swap dealer. 

b. Application to Security-Based Swap 

Dealers 

The definition of ‘‘security-based 

swap dealer’’ has parallels to the 

definition of ‘‘dealer’’ under the 

Exchange Act.21 In addition, securitybased swaps may be used to hedge risks 

associated with the ownership of certain 

other types of securities,22 and securitybased swaps may be used to gain 

economic exposure akin to ownership of 

certain other types of securities.23 As a 

result, the SEC would consider the same 

factors that are relevant to determining 

whether a person is a ‘‘dealer’’ under the 

Exchange Act as also generally relevant 

to the analysis of whether a person is a 

security-based swap dealer. 

The Exchange Act has been 

interpreted to distinguish between 

‘‘dealers’’ and ‘‘traders.’’ In this context, 

the SEC previously has noted that the 

dealer-trader distinction: 

Recognizes that dealers normally have a 

regular clientele, hold themselves out as 

buying or selling securities at a regular place 

of business, have a regular turnover of 

inventory (or participate in the sale or 

distribution of new issues, such as by acting 

as an underwriter), and generally provide 

liquidity services in transactions with 

investors (or, in the case of dealers who are 

market makers, for other professionals).24

Other non-exclusive factors that are 

relevant for distinguishing between 

dealers and non-dealers can include the 

receipt of customer property and the 

furnishing of incidental advice in 

connection with transactions. 

The markets involving security-based 

swaps are distinguishable in certain 

respects from markets involving cash 

market securities—particularly with 

regard to the concepts of ‘‘inventory’’ 

(which generally appears inapplicable 

in this context) 25 and ‘‘regular place of 

business.’’ For example, the suggestion 

that dealers are more likely to operate at 

a ‘‘regular place of business’’ than traders 

should not be construed in a way that 

ignores the reality of how the securitybased swap markets operate (or that 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80178 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

26The definition of ‘‘security-based swap dealer,’’ 

unlike the Exchange Act’s definition of ‘‘dealer,’’ 

does not specifically refer to ‘‘buying’’ and ‘‘selling.’’ 

We do not believe that this language difference is 

significant, however, as the Dodd-Frank Act 

amended the Exchange Act definitions of ‘‘buy’’ and 

‘‘purchase,’’ and the Exchange Act definitions of 

‘‘sale’’ and ‘‘sell,’’ to encompass the execution, 

termination (prior to its scheduled maturity date), 

assignment, exchange or similar transfer or 

conveyance of, or extinguishing of rights or 

obligations under, a security-based swap. See DoddFrank Act sections 761(a)(3), (4) (amending 

Exchange Act sections 3(a)(13), (14)). 

27Of course, if a person’s other activities satisfy 

the definition of security-based swap dealer, it must 

comply with the applicable requirements with 

regard to all of its security-based swap activities, 

absent an order to the contrary, as discussed below. 

Also, as discussed below, we would expect endusers to use security-based swaps for hedging 

purposes less commonly than they use swaps for 

hedging purposes. 

28For example, if a person that is a dealer in 

securities that are not security-based swaps enters 

into a security-based swap transaction with one of 

its cash market customers, the person would appear 

to be engaged in security-based swap dealing 

activity with that customer. In that circumstance, 

the customer reasonably would be expected to view 

the person as a dealer for purposes of the securitybased swap, making the applicable business 

conduct requirements particularly important. 

29See Exchange Act Release No. 58875 (Oct. 14, 

2008), 73 FR 61690 (Oct. 17, 2008) (‘‘Although 

determining whether or not a market maker is 

engaged in bona-fide market making would depend 

on the facts and circumstances of the particular 

activity, factors that indicate a market maker is 

engaged in bona-fide market making activities may 

include, for example, whether the market maker 

incurs any economic or market risk with respect to 

the securities (e.g., by putting their own capital at 

risk to provide continuous two-sided quotes in 

markets).’’). 

ignores evolution in dealing practices 

involving other types of securities). 

Dealers may use a variety of methods to 

communicate their availability to enter 

into security-based swaps with other 

market participants. The dealer-trader 

distinction should not be applied to the 

security-based swap markets without 

taking those distinctions into account.26

Even in light of those differences, 

however, we believe that the dealertrader distinction provides an important 

analytical tool to assist in determining 

whether a person is a ‘‘security-based 

swap dealer.’’ 

Commenters have raised concerns 

that the ambit of the security-based 

swap dealer definition could encompass 

end-users that use security-based swaps 

for hedging their business risks. 

Deeming those entities to be securitybased swap dealers due to their hedging 

activities could discourage their use of 

hedging transactions or subject them to 

a regulatory framework that was not 

intended to address their businesses and 

could subject them to unnecessary costs. 

Under the dealer-trader distinction, 

however, we would expect entities that 

use security-based swaps to hedge their 

business risks, absent other activity, 

likely would not be dealers.27 Also, as 

discussed below, both the ‘‘securitybased swap dealer’’ definition and the 

dealer-trader distinction in part turn on 

whether a person holds itself out as a 

dealer. 

We request comment on the 

application of the dealer-trader 

distinction as part of the analysis of 

whether a person is a security-based 

swap dealer. 

c. Issues Common to Both Definitions 

i. Holding Oneself Out as, and Being 

Commonly Known in the Trade as, a 

Swap Dealer or Security-Based Swap 

Dealer 

As noted above, the application of 

these definitions to persons that ‘‘hold 

themselves out’’ as dealers or that are 

‘‘commonly known in the trade’’ as 

dealers highlights the need for a 

functional interpretation of the dealer 

definitions. We believe that factors that 

may reasonably indicate that a person is 

holding itself out as a dealer or is 

commonly known in the trade as a 

dealer may include (but are not limited 

to) the following: 

• Contacting potential counterparties 

to solicit interest in swaps or securitybased swaps, 

• Developing new types of swaps or 

security-based swaps (which may 

include financial products that contain 

swaps or security-based swaps) and 

informing potential counterparties of 

the availability of such swaps or 

security-based swaps and a willingness 

to enter into such swaps or securitybased swaps with the potential 

counterparties, 

• Membership in a swap association 

in a category reserved for dealers, 

• Providing marketing materials (such 

as a Web site) that describe the types of 

swaps or security-based swaps that one 

is willing to enter into with other 

parties, or 

• Generally expressing a willingness 

to offer or provide a range of financial 

products that would include swaps or 

security-based swaps. 

Notably, holding oneself out as a 

security-based swap dealer would likely 

encompass a situation in which a 

person that is a ‘‘dealer’’ in another type 

of security enters into a security-based 

swap with a customer.28 Another 

example of holding oneself out as a 

security-based swap dealer would likely 

be an entity expressing its availability to 

provide liquidity to counterparties that 

seek to enter into security-based swaps, 

regardless of the ‘‘direction’’ of the 

transaction or across a broad spectrum 

of risks (e.g., credit default swaps 

related to a variety of issuers). 

The determination of who is 

commonly known in the trade as a swap 

dealer or security-based swap dealer 

may appropriately reflect, among other 

factors, the perspective of persons with 

substantial experience with and 

knowledge of the swap and securitybased swap markets, regardless of 

whether an entity is known as a dealer 

by persons without that experience and 

knowledge. 

ii. Making a Market in Swaps or 

Security-Based Swaps 

A number of commenters suggested 

that the market making component of 

the definitions should apply only to 

persons that quote a two-sided market 

consistently or at all times. Some 

commenters also suggested that a 

person’s willingness to buy or to sell a 

swap or security-based swap at any 

particular time should not be deemed to 

be market making activity. While 

continuous two-sided quotations and a 

willingness to stand ready to buy and 

sell a security are important indicators 

of market making in the equities 

markets,29 these indicia may not be 

appropriate in the context of the swap 

or security-based swap markets, given 

that parties do not enter into many types 

of swaps or security-based swaps on a 

continuous basis, and that parties may 

use a variety of methods for 

communicating their willingness to 

enter into swaps or security-based 

swaps. Any analysis that would impute 

to the definitions a ‘‘continuous’’ activity 

requirement may cause certain persons 

that engage in non-continuous dealing 

activities not to be regulated as swap 

dealers or security-based swap dealers. 

We have not identified anything in the 

statutory text or legislative history of the 

Dodd-Frank Act to suggest that Congress 

intended such a result. 

iii. No Predominance Test 

Although some commenters suggested 

that a person should be a swap dealer 

or security-based swap dealer only if 

such activity is the person’s sole or 

predominant business, the statutory 

definition does not contain a 

predominance test or otherwise depend 

upon the level of the person’s dealing 

activity, other than the de minimis 

exception discussed below. A 

predominance standard would not 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80179 

30As one example, a non-financial company that 

engages in both swap dealing and other commercial 

activities would fall within the definition of swap 

dealer because of its swap dealing activities, 

notwithstanding that it also engages in other 

commercial activities. 

31See CEA section 4s(a)–(b); Exchange Act 

section 15F(a)–(b). 

32See 75 FR 65586 (Oct. 26, 2010). 

33See CEA section 1a(49)(D); Exchange Act 

section 3(a)(71)(D). 

34The Title VII requirements applicable to swap 

and security-based swap dealers include, for 

example: requirements that dealers conform to 

regulatory standards relating to the confirmation, 

processing, netting, documentation and valuation of 

swaps and security-based swaps (CEA section 4s(i), 

Exchange Act section 15F(i)); requirements that 

dealers disclose, to regulators, information 

concerning terms and conditions of swaps or 

security-based swaps, as well as information 

concerning trading practices, financial integrity 

protections and other trading information (CEA 

section 4s(j)(3), Exchange Act section 15F(j)(3)); 

conflicts of interest provisions (CEA section 4s(j)(5), 

Exchange Act section 15F(j)(5)); and chief 

compliance officer requirements (CEA section 4s(k), 

Exchange Act section 15F(k)). 

provide a workable test of dealer status 

because many of the parties that are 

commonly acknowledged as swap or 

security-based swap dealers also engage 

in other businesses that often outweigh 

their swap or security-based swap 

dealing business in terms of transaction 

volume or other measures. Based on the 

plain meaning of the statutory 

definition, so long as a person engages 

in dealing activity that is not de 

minimis, as discussed below, the person 

is a swap dealer or security-based swap 

dealer.30

iv. Application of the Definition to New 

Types of Swaps and New Activities 

The Commissions intend to apply the 

definitions of swap dealer and securitybased swap dealer flexibly when the 

development of innovative business 

models is accompanied by new types of 

dealer activity. As discussed above, the 

Commissions generally intend to follow 

a ‘‘facts-and-circumstances’’ approach 

with respect to identifying dealing 

activities. The dealer definitions must 

be flexible enough to cover appropriate 

persons as the swap markets evolve. 

v. Request for Comment 

The Commissions request comment 

on these interpretations of holding 

oneself out as a dealer and being 

commonly known in the trade as a 

dealer, as well as the lack of a 

predominance test, and the application 

of the definitions to new types of swaps 

and new activities. Commenters 

particularly are requested to address the 

relevance, to the dealer analysis, of 

activities such as an entity’s 

membership in a swap execution facility 

(‘‘SEF’’) or a security-based SEF, or use 

of facilities that may not be SEFs or 

security-based SEFs. Are there factors 

that would lead entities to become 

members of SEFs that would not make 

membership relevant to the dealer 

analysis? Commenters also are 

requested to generally address how the 

dealer analysis should appropriately 

apply the requirements applicable to 

dealers (e.g., capital, margin and 

business conduct requirements) to the 

entities that should be subject to those 

requirements. In addition, commenters 

are requested to address how the dealer 

definitions should be applied to entities 

such as, for example, Federal home loan 

banks subject to restrictions limiting 

their dealing activities to particular 

types of counterparties. Finally, 

commenters are requested to address 

whether additional guidance is 

advisable to help identify dealer activity 

and to promote effective enforcement of 

the requirements applicable to swap 

dealers and security-based swap dealers. 

3. Designation of a Person as a Swap 

Dealer 

The Dodd-Frank Act has amended the 

CEA and the Exchange Act to require a 

person that meets either of the 

definitions to register as a swap dealer 

and/or security-based swap dealer,31

and the Commissions are proposing 

separate rules regarding this registration 

requirement. In connection with the 

registration requirement, market 

participants are in a position to assess 

their activities to determine whether 

they function in the manner described 

in the definitions. In addition, the 

Commissions have the authority to take 

enforcement actions in response to a 

dealer’s failure to register. In 

determining whether a person meets the 

applicable definitions, the Commissions 

may use information from other 

regulators, swap data repositories, 

registered clearing agencies, derivatives 

clearing organizations and other 

sources. 

4. Application of the Swap Dealer 

Definition to Agricultural Commodities 

Section 723(c)(3)(B) of the DoddFrank Act provides that swaps in 

agricultural commodities shall be 

subject to such terms and conditions as 

the CFTC may prescribe. In a separate 

rulemaking, the CFTC has proposed a 

definition of the term ‘‘agricultural 

commodity.’’ 32 Acting under the 

authority in Section 723(c)(3)(B), the 

CFTC may develop particular terms and 

conditions for the interpretation of the 

swap dealer definition when it is 

applied to dealing in swaps in 

agricultural commodities. Any such 

terms and conditions would not be 

applicable to the definition of securitybased swap dealer. The CFTC requests 

comment on the application of the swap 

dealer definition to dealers, including 

potentially agricultural cooperatives, 

that limit their dealing activity 

primarily to swaps in agricultural 

commodities. The CFTC may consider 

any comments on this topic for both the 

definition of swap dealer and also for 

any rulemaking regarding swaps in 

agricultural commodities. 

B. De Minimis Exemption to the 

Definitions 

The Dodd-Frank Act requires that the 

Commissions exempt, from designation 

as a ‘‘swap dealer’’ or ‘‘security-based 

swap dealer,’’ a person who ‘‘engages in 

a de minimis quantity of [swap or 

security-based swap] dealing in 

connection with transactions with or on 

behalf of its customers.’’ 33 The statutory 

definitions do not require that the 

Commissions fix a specific level of swap 

activity that will be considered de 

minimis, but instead require that the 

Commissions ‘‘promulgate regulations to 

establish factors with respect to the 

making of this determination to 

exempt.’’ 

1. Comments Regarding the De Minimis 

Exemption 

Some commenters asserted that the de 

minimis exemption should be linked to 

systemic risk concerns, stating that 

persons engaged in dealing activities 

that do not pose systemic risk should be 

able to take advantage of the exemption. 

Other commenters suggested that a 

person’s dealing activities should be 

considered de minimis if they do not 

pose undue risks to the person. 

Commenters also expressed the view 

that the application of the exemption 

should be based on quantitative criteria. 

2. Proposed Rule Regarding the De 

Minimis Exemption 

The Commissions preliminarily 

believe that the ‘‘de minimis’’ exemption 

should be interpreted to address 

amounts of dealing activity that are 

sufficiently small that they do not 

warrant registration to address concerns 

implicated by the regulations governing 

swap dealers and security-based swap 

dealers.34 In other words, the exemption 

should apply only when an entity’s 

dealing activity is so minimal that 

applying dealer regulations to the entity 

would not be warranted. 

We thus preliminarily do not agree 

with those commenters that argued that 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80180 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

35The de minimis exemption specifically places 

limits on a person’s dealing activity involving 

swaps or security-based swaps. Thus, these limits 

would not apply to swap or security-based swap 

activity that does not itself constitute dealing 

activity, such as activity in which a person hedges 

or mitigates a commercial risk of its business that 

is unrelated to a dealing business (i.e., as discussed 

above, when the person did not accommodate 

demand from the other party, respond to the other 

party’s interest in swaps or security-based swaps, 

solicit the other party, propose economic terms, 

intermediate between parties, provide liquidity, or 

engage in other dealing activities). See part II.A.2, 

supra. 

36See proposed CEA rule 1.3(ppp)(4)(ii); 

proposed Exchange Act rule 3a71–2(a). To the 

extent that the stated notional amount of a swap or 

security-based swap is leveraged or enhanced by its 

structure, the calculation shall be based on the 

effective notional amount of the swap or securitybased swap rather than on its stated notional 

amount. 

37We preliminarily believe that activity above 

this amount would be sufficient to warrant dealer 

registration to bring about the benefits of such 

registration. 

38Also, allowing offsets for collateral would 

result in a de minimis standard that could 

encompass positions of virtually unlimited size. 

39The term ‘‘special entity’’ encompasses: Federal 

agencies; States, State agencies and political 

subdivisions (including cities, counties and 

municipalities); ‘‘employee benefit plans’’ as 

defined under the Employee Retirement Income 

Security Act of 1974 (‘‘ERISA’’); ‘‘governmental 

plans’’ as defined under ERISA; and endowments. 

40See proposed CEA rule 1.3(ppp)(4)(ii); 

proposed Exchange Act rule 3a71–2(b). 

41See proposed CEA rule 1.3(ppp)(4)(iii); 

proposed Exchange Act rule 3a71–2(c). That these 

tests measure the entity’s activities over the prior 

12 months provides certainty. As of the end of each 

month, the entity will know whether it may qualify 

for the exemption during the following month. 

42Similarly, because all the de minimis factors 

must be satisfied, a person who enters into only a 

single swap or security-based swap, as a swap 

dealer, with a single counterparty could not qualify 

for the de minimis exemption if that swap or 

security-based swap exceeds the effective notional 

amount threshold. 

43For this purpose, an affiliated group would be 

defined as any group of entities that is under 

common control and that reports information or 

prepares its financial statements on a consolidated 

basis. 

44See proposed CEA rule 1.3(ppp)(4)(iv); 

proposed Exchange Act rule 3a71–2(d). 

45For these purposes only, an amendment to an 

existing swap or security-based swap would not 

need to be counted as a new swap or security-based 

swap if the underlying item is substantially the 

same as the original item. This may occur, for 

example, to reflect the effect of a corporate action 

such as a merger. An amendment would be counted 

as a new swap or security-based swap, however, to 

a de minimis quantity of dealing should 

be measured in relation to the level of 

the person’s other activities (or other 

swap or security-based swap activities). 

Aside from the fact that the statute does 

not explicitly call for a relative test, 

such an approach would lead to the 

result that larger and more active 

companies, which presumably would be 

more able to influence the swap 

markets, would be more likely to qualify 

for the exemption than smaller and less 

active companies. Also, a relative test 

not only would require a means of 

measuring the person’s dealing 

activities, but also would require a 

means of measuring the larger scope of 

activities to which its swap dealing or 

security-based swap dealing activities 

are to be compared, thus introducing 

unnecessary complexity to the 

exemption’s application. 

Our proposed factors for the de 

minimis exemption seek to focus the 

availability of the exemption toward 

entities for which registration would not 

be warranted from a regulatory point of 

view in light of the limited nature of 

their dealing activities. At the same 

time, we recognize that this focus does 

not appear to readily translate into 

objective criteria. Thus, while the 

proposed factors discussed below reflect 

our attempt to delimit the de minimis 

exemption appropriately, we recognize 

that a range of alternative approaches 

may be reasonable, and we are 

particularly interested in commenters’ 

suggestions as to the appropriate factors. 

The first proposed factor is that the 

aggregate effective notional amount, 

measured on a gross basis, of swaps or 

security-based swaps that an entity 

enters into over the prior 12 months in 

connection with its dealing activities 35

could not exceed $100 million.36 We 

understand that in general the notional 

size of a small swap or security-based 

swap is $5 million or less, and this 

proposed threshold would reflect 20 

instruments of that size. Given the 

customer protection issues raised by 

swaps and security-based swaps— 

including the risks that counterparties 

may not fully appreciate when entering 

into swaps or security-based swaps—we 

believe that this notional amount 

reflects a reasonable limit for identifying 

those entities that engage in a de 

minimis level of dealing activity.37 This 

standard would measure an entity’s 

quantity of dealing on a gross basis 

(without consideration of the market 

risk offsets associated with combining 

long and short positions) to reflect the 

entity’s overall amount of dealing 

activity. Similarly, the proposed 

notional threshold would not account 

for the amount of collateral held by or 

provided by the entity, nor other risk 

mitigating factors, in determining 

whether it engages in a de minimis 

quantity of dealing, given that dealer 

status focuses on an entity’s absolute 

level of activity, and is not directly 

based on the risks that an entity poses 

or faces.38

In addition, the aggregate effective 

notional amount of such swaps or 

security-based swaps, in which the 

person’s counterparty is a ‘‘special 

entity’’ (as that term is defined in CEA 

Section 4s(h)(2)(C) and Exchange Act 

Section 15F(h)(2)(C)),39 that an entity 

enters into over the prior 12 months 

could not exceed $25 million.40 The 

Dodd-Frank Act provided special 

protections to special entities in 

connection with swaps and securitybased swaps, and we preliminarily 

believe that this lower proposed 

threshold reasonably reflects the special 

protections afforded to those entities. 

In addition, to take advantage of the 

de minimis exemption, the proposed 

rule would provide that the entity could 

not have entered into swaps or securitybased swaps (as applicable) as a dealer 

with more than 15 counterparties, other 

than security-based swap dealers, over 

the prior 12 months.41 The 

Commissions preliminarily believe that 

an entity that enters into swaps or 

security-based swaps, in a dealer 

capacity, with a larger number of 

counterparties should be registered to 

help achieve Title VII’s orderly market 

goals, and thus cannot be said to engage 

in a de minimis quantity of dealing 

(even if the aggregate effective notional 

amount of the swaps or security-based 

swaps is less than the thresholds noted 

above).42 For purposes of determining 

the number of counterparties, we 

preliminarily believe that counterparties 

who are members of an affiliated group 

would generally count as one 

counterparty, given that the purpose of 

the limit is to measure the scope of 

dealer’s interaction with separate 

counterparties.43

Finally, the proposed rule would 

provide that, to take advantage of the de 

minimis exemption, the entity could not 

have entered into more than 20 swaps 

or security-based swaps (as applicable) 

as a dealer during the prior 12 months.44

As is the case for the limitation on the 

number of counterparties, the 

Commissions preliminarily believe that 

an entity that enters into a larger 

number of swaps or security-based 

swaps, in a dealer capacity, would, if 

registered, help achieve Title VII’s 

orderly market goals, and thus cannot be 

said to engage in a de minimis quantity 

of dealing. For these purposes, we 

would expect that each separate 

transaction the entity enters into under 

a swap or security-based swap master 

agreement in general would count as 

entering into a swap or security-based 

swap, but that an amendment of an 

existing swap or security-based swap in 

which the counterparty remained the 

same and the underlying item remained 

substantially the same would not count 

as a new swap or security based swap.45


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80181 

the extent that the change in the underlying item 

modifies the economic risk reflected by the swap 

or security-based swap. 

46The Exchange Act’s definition of ‘‘dealer’’ does 

not include a de minimis exemption. Thus, an 

entity that engages in dealing activity involving 

securities (other than security-based swaps with 

eligible contract participants) would be required to 

register as a ‘‘dealer’’ under the Exchange Act, and 

comply with the Exchange Act’s requirements 

applicable to dealers, absent some other exception 

or exemption from registration. 47See CEA section 1a(49)(A). 

The proposed rule would not 

distinguish between different types of 

swaps or security-based swaps into 

which entities may enter (e.g., rate 

swaps versus other commodity swaps, 

or credit default swaps versus equity 

swaps). The Commissions preliminarily 

do not believe that the ceiling for 

distinguishing de minimis dealing 

activities from other dealing activities 

appropriately turns upon the particular 

type of swap or security-based swap.46

The Commissions request comment 

on the proposed rule regarding the de 

minimis exemption. Commenters 

particularly are requested to address 

whether certain of the proposed factors 

should be modified or eliminated; for 

example, should the proposed $100 

million limit on annual notional swaps 

or security-based swaps entered into in 

a dealer capacity be raised or lowered to 

better implement the intended scope of 

the de minimis exemption—i.e., to 

exclude entities for which dealer 

regulation would not be warranted? 

Should we adopt different thresholds 

that would appropriately limit the 

exemption so it encompasses only those 

entities whose dealing activities are 

such that dealer regulation is not 

warranted? To what extent would 

certain entities be expected to reduce or 

otherwise adjust their dealing activity to 

fall within the scope of the de minimis 

exemption? Would there be any adverse 

implications for market participants if 

this happens? To what extent could the 

proposed factors potentially reduce 

dealing activity, and in doing so reduce 

the liquidity available in the swap or 

security-based swap market? 

Commenters also are requested to 

address whether the rule should seek to 

identify only certain types of 

counterparties with which a person 

could engage in dealing activities under 

the exemption. We also particularly 

request comment on the proposed $25 

million notional threshold for dealer 

transactions with ‘‘special entities,’’ 

including whether that proposed 

threshold should be raised or lowered, 

and whether an entity that enters into 

dealing transactions with ‘‘special 

entities’’ should be able to take 

advantage of the exemption at all. In 

addition, we request comment on 

whether the proposed threshold for 

transactions with ‘‘special entities’’ 

would provide a disincentive to dealers 

entering into transactions with such 

entities. 

Commenters further are requested to 

address whether the factors may 

appropriately account for the size of the 

swap or security-based swap activities 

compared to the size of the entity; how 

an entity’s swaps or security-based 

swaps with affiliated counterparties 

should be treated for purposes of the 

test; and whether the exemption’s 

factors should vary depending on the 

type of swap or security-based swap at 

issue. 

In addition, commenters are requested 

to address the significance of the fact 

that the statutory de minimis exemption 

specifically references transactions with 

or on behalf of a customer. Does that 

mean the exemption was intended to 

specifically address dealing activity as 

an accommodation to an entity’s 

customers? If so, should the exemption 

be conditioned on the presence of an 

existing relationship between the entity 

and the counterparty that does not 

entail swap or security-based swap 

dealing activity, and if so, which types 

of relationships should be treated as 

creating a ‘‘customer’’ relationship? 

Commenters also are requested to 

address whether the de minimis 

exemption should excuse an entity from 

having to comply with certain 

regulatory requirements imposed on 

swap dealers or security-based swap 

dealers, while also mandating 

compliance with other dealer 

requirements. In addition, commenters 

are requested to address whether, in lieu 

of the self-executing approach proposed 

here, the Commissions instead should 

require that entities which seek relief 

under this de minimis exemption must 

submit exemptive requests to the 

relevant agency for the agency’s 

consideration and action. Commenters 

further are requested to address whether 

the proposed notional threshold for the 

de minimis exception should be subject 

to a formula that permits automatic 

periodic adjustments to the threshold, 

such as to reflect changes in market size 

or in the size of typical contracts. 

C. Statutory Exclusion for Swaps in 

Connection With Originating a Loan 

The ‘‘swap dealer’’ definition excludes 

an insured depository institution (‘‘IDI’’) 

‘‘to the extent it offers to enter into a 

swap with a customer in connection 

with originating a loan with that 

customer.’’ 47 This exclusion does not 

appear in the definition of ‘‘securitybased swap dealer.’’ 

1. Comments Regarding the Exclusion 

for Swaps in Connection With Loans 

Three IDIs commented on this aspect 

of the definition, stating that the 

exclusion should encompass any swap 

entered into contemporaneously with a 

loan that is related to any of the 

borrower’s activities that affect the 

ability to repay the loan and can be 

hedged. Thus, in their view, the 

exclusion should cover exchange rate 

and physical commodity swaps in 

addition to interest rate swaps. The IDIs 

also said the exclusion should apply to 

amendments, restructurings and 

workouts of loans, and to lenders that 

act through a syndicate. 

Another commenter expressed similar 

views, and also asked for clarification 

whether the exclusion applies to all 

aspects of the definition, or if it applies 

only to whether a person is commonly 

known in the trade as a swap dealer. 

The CFTC preliminarily believes the 

exclusion applies to all aspects of the 

swap dealer definition. 

2. Proposed Rule Regarding the 

Exclusion for Swaps in Connection 

With Loans 

The CFTC preliminarily interprets the 

word ‘‘offer’’ in this exclusion to include 

scenarios where the IDI requires the 

customer to enter into a swap, or the 

customer asks the IDI to enter into a 

swap, specifically in connection with a 

loan made by that IDI. Also, the 

proposed rule provides that, in order to 

prevent evasion, the statutory exclusion 

does not apply where (i) The purpose of 

the swap is not linked to the financial 

terms of the loan; (ii) the IDI enters into 

a ‘‘sham’’ loan; or (iii) the purported 

‘‘loan’’ is actually a synthetic loan such 

as a loan credit default swap or loan 

total return swap. 

The proposed rule would apply the 

statutory exclusion only to swaps that 

are connected to the financial terms of 

the loan, such as, for example, its 

duration, interest rate, currency or 

principal amount. Although 

commenters urged that this exclusion be 

extended to other aspects of the lending 

relationship, we preliminarily believe 

that it would not be appropriate that 

this exclusion from the swap dealer 

definition encompass swaps that are 

connected to the borrower’s other 

business activities, even if the loan 

agreement requires that the borrower 

enter into such swaps or otherwise 

refers to them. We preliminarily believe 

that a broader reading of the exclusion 

could encompass all swap activity 


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80182 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

48The CFTC preliminarily believes that the 

proposed exclusion could be claimed by any IDI 

that participates in a loan through any means that 

involves a payment to a lender to take the place of 

that lender, including an ‘‘English style’’ 

participation. 

49See proposed CEA rule 1.3(ppp)(3); proposed 

Exchange Act rule 3a71–1(c). 

50For example, in order to efficiently impose the 

dealer requirements on only the person’s dealing 

activities, it may be necessary for the person to have 

separate books and records and a separate 

compliance regime for its dealing activities. 

51CEA section 1a(49)(B); Exchange Act section 

3(a)(71)(B). As discussed below, the Commissions 

preliminarily believe that there are four major 

categories of swaps and two major categories of 

security-based swaps. See part IV.A, infra. The 

designation as a swap dealer or security-based swap 

dealer may, for example, be limited in terms of 

these categories or in terms of particular activities 

of the person. 

between an IDI and its borrowers, which 

we do not think is intended. 

The origination of commercial loans 

is a complex process, and the CFTC 

preliminarily believes that this 

exclusion should be available to all IDIs 

that are a source of funds to a borrower. 

For example, all IDIs that are part of a 

loan syndicate providing a loan to a 

borrower could claim this exclusion 

with respect to swaps entered into with 

the borrower that are connected to the 

financial terms of the loan. Similarly, 

the proposed exclusion could be 

claimed with respect to such swaps 

entered into by any IDI that participates 

in or obtains a participation in such 

loan by means of a transfer or 

otherwise.48 Also, an IDI that is a source 

of funds for the refinancing of a loan 

(whether directly or through a 

syndicate, participation or otherwise) 

could claim the exclusion if it enters 

into a swap with the refinancing 

borrower. 

We emphasize that this proposed 

exclusion, by its statutory terms, is 

available only to IDIs. If an IDI were to 

transfer its participation in a loan to a 

non-IDI, then the non-IDI would not be 

able to claim this exclusion, regardless 

of the terms of the loan or the manner 

of the transfer. Similarly, a non-IDI that 

is part of a loan syndicate with IDIs 

would not be able to claim the 

exclusion. 

In sum, the proposed exclusion may 

be claimed by a person that meets the 

following three conditions: (i) The 

person is an IDI; (ii) the person is the 

source of funds to a borrower in 

connection with a loan (either directly 

or through syndication, participation, 

refinancing or otherwise); and (iii) the 

person enters into a swap with the 

borrower that is connected to the 

financial terms of the loan (so long as 

the loan is not a sham or a synthetic 

loan). 

The CFTC requests comment on the 

proposed rule relating to the statutory 

exclusion for swaps in connection with 

originating a loan, and in particular on 

whether this statutory exclusion should 

be extended beyond swaps that are 

connected to the financial terms of the 

loan, and if so, why. The CFTC also 

requests comment on whether this 

exclusion should apply only to swaps 

that are entered into contemporaneously 

with the IDI’s origination of the loan 

(and if so, how ‘‘contemporaneously’’ 

should be defined for this purpose), or 

whether this exclusion should also 

apply to swaps entered into during part 

or all of the duration of the loan. 

D. Designation as a Dealer for Certain 

Types, Classes, or Categories of Swaps, 

Security-Based Swaps, or Activities 

The statutory definitions include a 

provision stating that a person may be 

designated as a dealer for one or more 

types, classes or categories of swaps, 

security-based swaps, or activities 

without being considered a swap dealer 

or security-based swap dealer for other 

types, classes or categories of swaps, 

security-based swaps, or activities. This 

provision is permissive and does not 

require the Commissions to designate 

persons as dealers for only a limited set 

of types, classes or categories of swaps, 

security-based swaps, or activities. 

1. Comments Regarding Limited 

Designation as a Swap Dealer or 

Security-Based Swap Dealer 

One commenter stated that the 

Commissions should allow a person to 

register as a swap dealer or securitybased swap dealer for only a limited set 

of types, classes or categories of swaps 

or security-based swaps. Another 

commenter expressed the view that a 

person designated as a swap dealer or 

security-based swap dealer should be 

designated as such for all types of swaps 

or security-based swaps, respectively. 

2. Proposed Rule Regarding Limited 

Designation as a Swap Dealer or 

Security-Based Swap Dealer 

In general, the Commissions propose 

that a person that satisfies the definition 

of swap dealer or security-based swap 

dealer would be a dealer for all types, 

classes or categories of swaps or 

security-based swaps, or activities 

involving swaps or security-based 

swaps, in which the person engages.49

Thus, the person would be subject to all 

regulatory requirements applicable to 

dealers for all swaps or security-based 

swaps into which it enters. We propose 

this approach because it may be difficult 

for swap dealers and security-based 

swap dealers to separate their dealing 

activities from their other activities 

involving swaps or security-based 

swaps.50

The proposed rule also states, 

however, that the Commissions may 

provide for a person to be designated as 

a swap dealer or security-based swap 

dealer for only specified categories of 

swaps, security-based swaps, or 

activities, without being classified as a 

dealer for all categories.51 This proposed 

rule would afford persons an 

opportunity to seek, on an appropriate 

showing, a limited designation based on 

facts and circumstances applicable to 

their particular activities. The 

Commissions anticipate that a swap 

dealer could seek a limited designation 

at the same time as, or at a later time 

subsequent to, the person’s initial 

registration as a swap dealer. 

The CFTC understands that there may 

potentially be non-financial entities, 

such as physical commodity firms, that 

conduct swap dealing activity through a 

division of the entity, and not a 

separately-incorporated subsidiary. In 

these instances, the entity’s swap 

dealing activity would not be a core 

component of the entity’s overall 

business. If this type of entity registered 

as a swap dealer, the CFTC anticipates 

that certain swap dealer requirements 

would apply to the swap dealing 

activities of the division, but not 

necessarily to the swap activities of 

other parts of the entity. 

The Commissions request comment 

on the proposed rules regarding limited 

designation as a swap dealer or securitybased swap dealer. Commenters 

particularly are requested to address the 

circumstances in which such limited 

purpose designations would be 

appropriate, the factors that the 

Commissions should consider when 

addressing such requests, and the type 

of information requestors should 

provide in support of their request. For 

example, would it be appropriate to 

grant such limited purpose designations 

only to entities that do not otherwise 

fall within the definition of a financial 

entity, and whose dealing activity is 

below a defined threshold of the entity’s 

overall activity? At what level should 

the Commissions set such a threshold? 

Which of the requirements applicable to 

dealers should or should not apply to 

such entity’s non-dealing activities in 

swaps and security-based swaps? 

In addition, commenters are requested 

to address whether the Commissions 

should provide for limited purpose 

designations of swap dealers or securitybased swap dealers through some other 

mechanism as an alternative to, or in 


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52Such swaps and security-based swaps should 

be considered in this way only for purposes of 

determining whether a particular person is a swap 

dealer or security-based swap dealer and does not 

necessarily apply in the context of the Exchange 

Act’s general definition of ‘‘dealer.’’ The swaps and 

security-based swaps, moreover, would continue to 

be subject to all laws and requirements applicable 

to such swaps and security-based swaps. 

53See Dodd-Frank Act sections 721(b)(2), 

761(b)(3). For example, it would not be permissible 

for an entity that provides liquidity on one side of 

the market to use affiliated entities to provide 

liquidity on the other side in an attempt to avoid 

having to register as a swap or security-based swap 

dealer. 

addition to, case-by-case evaluations of 

individual applications. If so, what 

criteria and procedures would be 

appropriate for making limited purpose 

designations through this type of 

approach? Also, should the limited 

purpose designation apply on a 

provisional basis starting at the time 

that the entity makes an application for 

a limited purpose designation? 

Finally, commenters also are asked to 

address whether such limited purpose 

designations should be conditioned in 

any way, such as by the provision of 

information of the type that would be 

required with respect to an entity’s 

swaps or security-based swaps 

involving the particular category or 

activity for which they are not 

designated as a dealer. 

E. Certain Interpretative Issues 

1. Affiliate Issues 

We preliminarily believe that the 

word ‘‘person’’ in the swap dealer and 

security-based swap dealer definitions 

should be interpreted to mean that the 

designation applies with respect to a 

particular legal person. That is, for 

example, we would not view a trading 

desk or other discrete business unit that 

is not a separately organized legal 

person as a swap dealer; rather, the legal 

person of which it is a part would be the 

swap dealer. Also, an affiliated group of 

legal persons under common control 

could include more than one dealer. 

Within such a group, any legal person 

that engages in swap or security-based 

swap dealing activities would be a swap 

dealer or security-based swap dealer, as 

applicable. 

In determining whether a particular 

legal person is a swap dealer or securitybased swap dealer, we preliminarily 

believe it would be appropriate for the 

person to consider the economic reality 

of any swaps and security-based swaps 

it enters into with affiliates (i.e., legal 

persons under common control with the 

person at issue), including whether 

those swaps and security-based swaps 

simply represent an allocation of risk 

within a corporate group.52 Swaps and 

security-based swaps between persons 

under common control may not involve 

the interaction with unaffiliated persons 

that we believe is a hallmark of the 

elements of the definitions that refer to 

holding oneself out as a dealer or being 

commonly known as a dealer. To the 

extent, however, that an entity seeks to 

use transactions between persons under 

common control to avoid one of the 

dealer definitions, the Commissions 

have the authority to prohibit practices 

designed to evade the requirements 

applicable to swap dealers and securitybased swap dealers.53

The Commissions invite comment as 

to how the swap dealer and securitybased swap dealer definitions should be 

applied to members of an affiliated 

group. Commenters particularly are 

invited to address how the Commissions 

should interpret common control for 

these purposes, and whether this 

interpretation should be limited to 

wholly-owned affiliates. 

2. Application to Particular Swap 

Markets 

The swap markets are diverse and 

encompass a variety of situations in 

which parties enter into swaps with 

each other. We believe it is helpful to 

the understanding of the rule to discuss 

some of these situations, particularly 

those that have been raised by 

commenters, here. The situations 

discussed below include persons who 

enter into swaps as aggregators, as part 

of their participation in physical 

markets, or in connection with the 

generation and transmission of 

electricity. We invite comment as to 

what aspects of the parties’ conduct in 

these situations should, or should not, 

be considered swap dealing activities, 

and whether the parties involved in 

these situations are swap dealers. 

a. Aggregators 

Commenters explained that some 

persons enter into swaps with other 

parties in order to aggregate the swap 

positions of the other parties into a size 

that would be more amenable to 

entering into swaps in the larger swap 

market, or otherwise to make entering 

into such swaps more efficient. For 

example, certain cooperatives enter into 

swaps with smaller cooperatives, 

smaller businesses or their members in 

order to establish a position in a 

commodity that is large enough to be 

traded on a swap or futures market. 

Similarly, one smaller financial 

institution explained that it enters into 

swaps with counterparties whose swap 

positions would not be large enough to 

be of interest to larger financial 

institutions. This institution stated that 

it enters into offsetting swaps with 

larger financial institutions so that it is 

in a neutral position between the 

counterparties and the larger financial 

institutions. 

The result of these arrangements is 

that such persons engage in activities 

that are similar in many respects to 

those of a swap dealer as set out in the 

definition—the person enters into swaps 

to accommodate demand from other 

parties, it enters into swaps with a 

relatively large number of non-dealers, 

and it holds itself out as willing to enter 

into swaps. It may be that the swap 

dealing activities of these aggregators 

would not exceed the de minimis 

threshold, and therefore they would not 

be swap dealers. The CFTC, in 

particular, requests comment as to how 

the de minimis threshold would apply 

to such persons. If their activity would 

exceed the de minimis threshold set 

forth in the proposed rule, the 

Commissions request comment on the 

application of the swap dealer 

definition to their activity. 

b. Physical Market Participants 

The markets in physical commodities 

such as oil, natural gas, chemicals and 

metals are complex and varied. They 

involve a large number of market 

participants that, over time, have 

developed highly customized 

transactions and market practices that 

facilitate efficiencies in their market in 

unique ways. Some of these transactions 

would be encompassed by the statutory 

definition of ‘‘swap,’’ and some 

participants in these markets engage in 

swap dealing activities that are above 

the proposed de minimis threshold. The 

Commissions invite comment as to any 

different or additional factors that 

should be considered in applying the 

swap dealer definition to participants in 

these markets. 

c. Electricity Generation and 

Transmission 

The use of swaps in the generation 

and transmission of electricity is highly 

complex because electricity cannot be 

stored and therefore is generated, 

transmitted and used on a continuous, 

real-time basis. Also, the number and 

variety of participants in the electricity 

market is very large and some electricity 

services are provided as a public good 

rather than for profit. Nevertheless, 

some participants engage in swap 

dealing activities as described above 

that are above the de minimis threshold 

set forth in the proposed rule. The 

Commissions invite comment as to any 

different or additional factors that 

should be considered in applying the 


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54Public Law 106–554, 114 Stat. 2763 (Dec. 21, 

2000). 

55See CEA sections 2(d) (Excluded Derivative 

Transactions), 2(e) (Excluded Electronic Trading 

Facilities), 2(g) (Excluded Swap Transactions) and 

2(h) (Legal Certainty for Certain Transactions in 

Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). 

The CFMA also excluded swap agreements from the 

definitions of ‘‘security’’ in Section 3(a)(10) of the 

Exchange Act and Section 2(a)(1) of the Securities 

Act. See Section 3A of the Exchange Act, 15 U.S.C. 

78c–1, and Section 2A of the Securities Act, 15 

U.S.C. 77b–1 (both of which have been modified by 

the Dodd-Frank Act). The CFMA, however, 

provided that the SEC had antifraud authority over 

security-based swap agreements. 

56Section 723(a)(2) of the Dodd-Frank Act adds 

new subsection (e) to CEA section 2 (7 U.S.C. 2(e)). 

New CEA section 2(e) provides that ‘‘[i]t shall be 

unlawful for any person, other than an eligible 

contract participant, to enter into a swap unless the 

swap is entered into on, or subject to the rules of, 

a board of trade designated as a contract market 

under section 5.’’ 

57Section 763(e) of the Dodd-Frank Act adds 

paragraph (l) to Exchange Act section 6. New 

Exchange section 6(l) provides that ‘‘[i]t shall be 

unlawful for any person to effect a transaction in 

a security-based swap with or for a person that is 

not an eligible contract participant, unless such 

transaction is effected on a national securities 

exchange registered pursuant to subsection (b).’’ 

58The changes to the ECP definition made by the 

Dodd-Frank Act originated in the Administration’s 

‘‘White Paper’’ on financial regulatory reform. See 

Financial Regulatory Reform, A New Foundation: 

Rebuilding Financial Supervision and Regulation, 

available at http://www.financialstability.gov/docs/ 

regs/FinalReprot_web.pdf, at 48–49 (June 17, 2009) 

(‘‘Current law seeks to protect unsophisticated 

parties from entering into inappropriate derivatives 

transactions by limiting the types of counterparties 

that could participate in those markets. But the 

limits are not sufficiently stringent.’’). 

59The monetary component of ECP status for 

individuals remains the same under the amended 

ECP definition: More than $10 million (but now in 

discretionary investments, not in total assets), or $5 

million if the transactions for which ECP status is 

necessary are for risk management of an asset or 

liability the individual owns or incurs, or is 

reasonably likely to own or incur. 

60CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii), 

(ix), (x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii), 

(ix), (x)), as redesignated by Section 721(a)(9) of the 

Dodd-Frank Act. 

61CEA section 1a(18)(A)(v)(I) (7 U.S.C. 

1a(18)(A)(v)(I)), as redesignated by Section 721(a)(9) 

of the Dodd-Frank Act. 

62CEA section 1a(18)(A)(v)(III) (7 U.S.C. 

1a(18)(A)(v)(III)), as redesignated by Section 

721(a)(9) of the Dodd-Frank Act. 

63CEA section 1a(18)(A)(vi) (7 U.S.C. 

1a(18)(A)(vi)), as redesignated by Section 721(a)(9) 

of the Dodd-Frank Act. 

64CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C. 

1a(18)(A)(vii) and (xi), as redesignated by Section 

721(a)(9) of the Dodd-Frank Act. 

swap dealer definition to participants in 

the generation and transmission of 

electricity. Specifically, the 

Commissions invite comment on 

whether there are special 

considerations, including without 

limitation special considerations arising 

from section 201(f) of the Federal Power 

Act, related to non-profit, public power 

systems such as rural electric 

cooperatives and entities operating as 

political subdivisions of a State, and the 

applicability of the exemptive authority 

in section 722(f) of the Dodd-Frank Act 

to address those considerations. 

III. Amendments to Definition of 

Eligible Contract Participant 

A. Overview 

The Commodity Futures 

Modernization Act of 2000 (‘‘CFMA’’) 54

generally excluded or exempted 

transactions between eligible contract 

participants (‘‘ECPs’’) from most 

provisions of the CEA.55 Section 

723(a)(1)(A) of the Dodd-Frank Act 

repeals those exclusions and 

exemptions. ECP status remains 

important, however, because Section 

723(a)(2) of the Dodd-Frank Act renders 

it unlawful for a non-ECP to enter into 

a swap other than on, or subject to the 

rules of, a designated contract market 

(‘‘DCM’’).56 Section 763(e) of the DoddFrank Act also renders it unlawful for a 

non-ECP to enter into a security-based 

swap unless such transaction is effected 

on a national securities exchange 

registered pursuant to Section 6(b) of 

the Exchange Act.57 In addition, Section 

768(b) of the Dodd-Frank Act makes it 

unlawful for a non-ECP to enter into a 

security-based swap unless a 

registration statement is in effect. While 

this means that non-ECPs cannot enter 

into swaps on SEFs or on a bilateral, offexchange basis, it also opens swaps to 

non-ECPs, so long as the swaps are 

entered into on, or subject to the rules 

of, a DCM. Similarly, while non-ECPs 

cannot enter into security-based swaps 

unless the transaction is effected on a 

national securities exchange and the 

security-based swap has an effective 

registration statement, it also opens 

security-based swaps to non-ECPs. 

Congress also amended 58 the ECP 

definition in Section 721(a)(9) of the 

Dodd-Frank Act by: (1) Raising a 

threshold that governmental entities 

may use to qualify as ECPs, in certain 

situations, from $25 million in 

discretionary investments to $50 million 

in such investments; and (2) replacing 

the ‘‘total asset’’ standard for individuals 

to qualify as ECPs with a discretionary 

investment standard.59

B. Commenters’ Views 

The ECP definition elicited comment 

from nine commenters. The comments 

ranged from requests not to increase the 

monetary thresholds for governmental 

employee benefit plans in certain 

instances to suggestions to dramatically 

raise them across the board, and from 

requests not to change the definition in 

a way that would limit the commenter’s 

access to swaps to specific proposals to 

address such otherwise limited access. 

In the Dodd-Frank Act, Congress 

addressed aspects of the ECP definition 

that it found to be of particular concern 

regarding governmental entities and 

individuals. Otherwise, though, persons 

who qualified for exclusions or 

exemptions to enter into bilateral, offexchange swaps prior to the Dodd-Frank 

Act will still qualify to do so with 

respect to non-standardized swaps 

under the Dodd-Frank Act, with the 

exceptions discussed below. We have 

not identified any legislative history 

suggesting that Congress intended the 

Commissions to undertake a wholesale 

revision of the ECP definition. 

Accordingly, the Commissions are 

limiting the further definition of the 

term ECP to the discrete issues 

discussed below. 

C. New ECP categories 

The CEA definition of ECP generally 

is comprised of regulated persons; 60

entities defined as ECPs based on a total 

asset test (e.g., a corporation, 

partnership, proprietorship, 

organization, trust, or other entity with 

total assets exceeding $10 million) 61 or 

an alternative monetary test coupled 

with a non-monetary component (e.g., 

an entity with a net worth in excess of 

$1 million and engaging in businessrelated hedging; 62 or certain employee 

benefit plans, the investment decisions 

of which are made by one of four 

enumerated types of regulated 

entities 63); and certain governmental 

entities and individuals that meet 

defined thresholds.64

Persons in the new major swap 

participant, major security-based swap 

participant, swap dealer and securitybased swap dealer categories are likely 

to be among the most active and largest 

users of swaps and security-based 

swaps. Accordingly, the Commissions 

propose to further define the term ECP 

to include these new categories, which 

will permit such persons to enter into 

swaps and security-based swaps on 

SEFs and on a bilateral basis (where 

otherwise permitted under the DoddFrank Act and regulations thereunder). 

We seek comment on this proposed 

expansion of the ECP definition. 

D. Relationship Between Retail Foreign 

Currency and ECP Status in the Context 

of a Commodity Pool 

Prior to the Dodd-Frank Act, clause 

(A)(iv) of the ECP definition provided 

that a commodity pool was an ECP if the 

pool and its operator met certain 

requirements (i.e., the commodity pool 

has $5 million in total assets and is 

operated by a commodity pool operator 

regulated under the CEA or subject to 


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65CEA section 1a(12)(A)(iv) (7 U.S.C. 

1a(12)(A)(iv)). 

66 7 U.S.C. 2(c)(2)(B) and (C). See generally 

‘‘Regulation of Off-Exchange Retail Foreign 

Exchange Transactions and Intermediaries,’’ 75 FR 

55410 (Final Rule; Sept. 10, 2010) (discussing the 

new CFTC retail forex regulatory regime); 

‘‘Regulation of Off-Exchange Retail Foreign 

Exchange Transactions and Intermediaries,’’ 75 FR 

3282 (Proposed Rule; Jan. 20, 2010) (providing 

historical background on the regulation of retail 

forex transactions). 

67CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), 

as redesignated by Section 721(a)(9) of the DoddFrank Act. 

68 In particular, under CEA section 4s and 

Exchange Act section 15F, dealers and major 

participants in swaps or security-based swaps 

generally are subject to the same types of margin, 

capital, business conduct and certain other 

requirements, unless an exclusion applies. See CEA 

section 4s(h)(4), (5); Exchange Act section 15F(h)(4), 

(5). 

69As discussed below, the tests of the major 

participant definitions use terms—particularly 

‘‘systemically important,’’ ‘‘significantly impact the 

financial system’’ or ‘‘create substantial counterparty 

exposure’’—that denote a focus on entities that pose 

a high degree of risk through their swap and 

security-based swap activities. In addition, the link 

between the major participant definition and risk 

was highlighted during the Congressional debate on 

the statute. See 156 Cong. Rec. S5907 (daily ed. July 

15, 2010) (dialogue between Senators Hagen and 

Lincoln, discussing how the goal of the major 

participant definition was to ‘‘focus on risk factors 

that contributed to the recent financial crisis, such 

as excessive leverage, under-collateralization of 

swap positions, and a lack of information about the 

aggregate size of positions’’). 

70Also, neither major participant definition 

encompasses an entity that meets the respective 

swap dealer or security-based swap dealer 

definition. See CEA section 1a(33)(A); Exchange Act 

section 3(a)(67)(A)(i). 

foreign regulation), regardless of 

whether each pool participant was itself 

an ECP.65 Section 741(b)(10) of the 

Dodd-Frank Act amended clause (A)(iv) 

of the ECP definition to provide that a 

commodity pool engaging in retail 

foreign currency transactions of the type 

described in CEA sections 2(c)(2)(B) or 

2(c)(2)(C) ; 66 (‘‘retail forex’’ and such 

pools, ‘‘Retail Forex Pools’’) no longer 

qualifies as an ECP for those purposes 

if any participant in the pool is not 

independently an ECP. The 

Commissions believe that in some cases 

commodity pools unable to satisfy the 

conditions of clause (A)(iv) of the ECP 

definition may rely on clause (A)(v) to 

qualify as ECPs instead for purposes of 

retail forex. Clause (A)(v) of the ECP 

definition applies to business entities 

irrespective of their form of organization 

(i.e., corporations, partnerships, 

proprietorships, organizations, trusts 

and other entities), and contains a $1 

million net worth test where such an 

entity ‘‘enters into an agreement, 

contract, or transaction in connection 

with the conduct of the entity’s business 

or to manage the risk associated with an 

asset or liability owned or incurred or 

reasonably likely to be owned or 

incurred by the entity in the conduct of 

the entity’s business.’’ 67

The Commissions believe that 

permitting Retail Forex Pools with one 

or more non-ECP participants to achieve 

ECP status by relying on clause (A)(v) of 

the ECP definition would frustrate the 

intent of Congress in denying ECP status 

to Retail Forex Pools under clause 

(A)(iv). Consequently, the Commissions 

propose to further define the term ECP 

to preclude a Retail Forex Pool with one 

or more non-ECP participants from 

qualifying as an ECP by relying on 

clause (A)(v) of the ECP definition if 

such Retail Forex Pool is not an ECP 

due to the language added to clause 

(A)(iv) of the ECP definition by section 

741(b)(10) of the Dodd-Frank Act (i.e., 

because the pool contains one or more 

non-ECP participants). Because 

commodity pools can be structured in 

various ways and can have one or more 

feeder funds and/or pools, many with 

their own participants, the Commissions 

propose to preclude a Retail Forex Pool 

from being an ECP pursuant to clause 

(A)(iv) of the ECP definition if there is 

a non-ECP participant at any investment 

level (e.g., a participant in the pool itself 

(a direct participant), an investor or 

participant in a fund or pool that invests 

in the pool in question (an indirect 

participant), an investor or participant 

in a fund or pool that invests in that 

investor fund or pool (also an indirect 

participant), etc.). 

Similarly, the Commissions believe 

that some commodity pools unable to 

satisfy the total asset or regulated status 

components of clause (A)(iv) of the ECP 

definition may rely on clause (A)(v) to 

qualify as ECPs instead. The 

Commissions are of the view that a 

commodity pool that cannot satisfy the 

monetary and regulatory status 

conditions prescribed in clause (A)(iv) 

should not qualify as an ECP in reliance 

on clause (A)(v) of the ECP definition. 

Therefore, the Commissions propose to 

further define the term ECP to prevent 

such an entity from qualifying as an ECP 

pursuant to clause (A)(v) of the ECP 

definition. 

E. Request for comment 

The Commissions request comment 

on all aspects of the proposed 

amendments to the definition of 

‘‘eligible contract participant.’’ Are the 

proposed interpretations with respect to 

Retail Forex Pools and other commodity 

pools appropriate? Do entities described 

in the various enumerated ECP 

categories (other than commodity pools) 

rely on clause (A)(v) to qualify as ECPs? 

If so, should an entity that would be 

described in one of the clauses of 

paragraph (A) of the ECP definition, but 

cannot satisfy the conditions prescribed 

in that clause, be prohibited from 

relying on clause (A)(v) of the ECP 

definition? 

In addition, should the Commissions 

further narrow any or all of the ECP 

categories? Why or why not? If so, what 

additional conditions would be 

appropriate? Should the Commissions 

define the term ‘‘discretionary basis,’’ as 

requested by one commenter, either 

solely for purposes of clause (A)(vii) or 

clause (A)(xi), or for both clauses? 

Alternatively, should the Commissions 

add any additional categories of ECPs, 

such as the following categories 

suggested by commenters: Commercial 

real estate developers; energy or 

agricultural cooperatives or their 

members; or firms using swaps as 

hedges pursuant to the terms of the 

CFTC’s Swap Policy Statement? If so, 

which ones and why? 

IV. Definitions of ‘‘Major Swap 

Participant’’ and ‘‘Major Security-Based 

Swap Participant’’ 

The definitions of ‘‘major swap 

participant’’ and ‘‘major security-based 

swap participant’’ (also jointly referred 

to as the ‘‘major participant’’ definitions) 

respectively focus on the market 

impacts and risks associated with an 

entity’s swap and security-based swap 

positions. In this respect, the major 

participant definitions differ from the 

definitions of ‘‘swap dealer’’ and 

‘‘security-based swap dealer,’’ which 

focus on an entity’s activities and 

account for the amount or significance 

of those activities only in the context of 

the de minimis exception. 

Despite those differences in focus, 

persons that meet the major participant 

definitions in large part must follow the 

same statutory requirements that apply 

to swap dealers and security-based swap 

dealers.68 In this way, the statute 

applies comprehensive regulation to 

entities whose swap or security-based 

swap activities do not cause them to be 

dealers, but nonetheless could pose a 

high degree of risk to the U.S. financial 

system generally.69

The major participant definitions are 

similar in their key provisions, although 

one exception, as discussed below, is 

available only in connection with the 

‘‘major swap participant’’ definition. 

Both major participant definitions 

encompass persons that satisfy any of 

three alternative tests: 70

• The first test encompasses persons 

that maintain a ‘‘substantial position’’ in 

any of the ‘‘major’’ categories of swaps or 

security-based swaps, as those 

categories are determined by the CFTC 


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80186 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

71See CEA section 1a(33)(A)(i); Exchange Act 

section 3(a)(67)(A)(ii)(I). 

72See CEA section 1a(33)(A)(ii); Exchange Act 

section 3(a)(67)(A)(ii)(II). 

73See CEA section 1a(33)(A)(iii); Exchange Act 

section 3(a)(67)(A)(ii)(III). 

74See CEA Section 1a(33)(B); Exchange Act 

section 3(a)(67)(B). 

75See CEA section 1a(33)(C); Exchange Act 

section 3(a)(67)(C). 

76See CEA section 1a(33)(D). 

77 In light of the significant and novel issues 

raised by the major participant definitions, the 

Commissions recognize the importance of 

monitoring the swap and security-based swap 

markets following adoption of major participant 

rules. This will help us evaluate whether the rules 

appropriately reflect how market participants use 

these instruments, and will help us consider the 

impact of market evolution and the ways in which 

market participants may change their practices in 

response to the rules, so we may identify potential 

improvements to the rules or other actions to 

enhance enforcement of major participant 

regulation. 

78See CEA section 1a(33)(A)(i), (iii); Exchange 

Act section 3(a)(67)(a)(2)(i), (iii). One commenter 

suggested that we determine these categories by 

reference to the types of instruments specifically 

listed in the statutory definition of ‘‘swap.’’ See 

Northwestern Mutual letter (suggesting that, for 

regulatory consistency, each type of swap listed in 

the definition and options on each of those swaps 

should be considered to be an individual major 

category). The statutory definition of ‘‘swap’’ lists 22 

different types of swaps. 

79See proposed CEA rule 1.3(rrr). For the 

avoidance of doubt, the term ‘‘swap’’ as it is used 

in the definitions of the major swap categories in 

rule 1.3(rrr) has the meaning set forth in section 

1a(47) of the CEA and the rules promulgated 

thereunder. 

or SEC as applicable. This test excludes 

both ‘‘positions held for hedging or 

mitigating commercial risk,’’ and 

positions maintained by or contracts 

held by any employee benefit plan (as 

defined in paragraphs (3) and (32) of 

section 3 of ERISA (29 U.S.C. 1002)) for 

the primary purpose of hedging or 

mitigating risks directly associated with 

the operation of the plan.71

• The second test encompasses 

persons whose outstanding swaps or 

security-based swaps create ‘‘substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the United States banking 

system or financial markets.’’ 72

• The third test encompasses any 

‘‘financial entity’’ that is ‘‘highly 

leveraged relative to the amount of 

capital such entity holds and that is not 

subject to capital requirements 

established by an appropriate Federal 

banking agency’’ and that maintains a 

‘‘substantial position’’ in swaps or 

security-based swaps for any of the 

‘‘major’’ categories of swaps or securitybased swaps.73

The statute directs the CFTC or the 

SEC to define ‘‘substantial position’’ for 

the respective definition at the 

threshold that it determines to be 

‘‘prudent for the effective monitoring, 

management, and oversight of entities 

that are systemically important or can 

significantly impact the financial system 

of the United States.’’ The definitions 

further provide that when defining 

‘‘substantial position,’’ the CFTC or SEC 

‘‘shall consider the person’s relative 

position in uncleared as opposed to 

cleared [swaps or security-based swaps] 

and may take into consideration the 

value and quality of collateral held 

against counterparty exposures.’’ 74

Both major participant definitions 

provide that a person may be designated 

as a major participant for one or more 

categories of swaps or security-based 

swaps without being classified as a 

major participant for all classes of swaps 

or security-based swaps.75

Finally, the definition of ‘‘major swap 

participant’’—but not the definition of 

‘‘major security-based swap 

participant’’—includes an exception for 

any ‘‘entity whose primary business is 

providing financing, and uses 

derivatives for the purpose of hedging 

underlying commercial risks related to 

interest rate and foreign currency 

exposures, 90 percent or more of which 

arise from financing that facilitates the 

purchase or lease of products, 90 

percent or more of which are 

manufactured by the parent company or 

another subsidiary of the parent 

company.’’ 76

Although the two major participant 

definitions are similar, they address 

instruments that reflect different types 

of risks and that can be used by endusers and other market participants for 

different purposes. Interpretation of the 

definitions must appropriately account 

for those differences. 

The Commissions are proposing rules 

to further define the ‘‘major swap 

participant’’ and ‘‘major security-based 

swap participant’’ definitions, by 

specifically addressing: (a) The ‘‘major’’ 

categories of swaps or securities-based 

swaps; (b) the meaning of ‘‘substantial 

position’’; (c) the meaning of ‘‘hedging or 

mitigating commercial risk’’; (d) the 

meaning of ‘‘substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets’’; and (e) the meanings 

of ‘‘financial entity’’ and ‘‘highly 

leveraged.’’ We also are proposing rules 

to specify the use of a daily average 

methodology for identifying whether a 

person meets one of the major 

participant definitions, provide for a 

reevaluation period for certain entities 

that exceed the relevant daily average by 

a small amount, and provide for a 

minimum length of time before a person 

may no longer be deemed a major 

participant. 

We further propose that the CFTC or 

SEC may limit an entity’s designation as 

a major participant to only certain types, 

classes or categories of swaps or 

security-based swaps. We also address 

certain additional interpretive issues 

that commenters have raised. Finally, 

while the Commissions also are not 

proposing any exclusions from the 

major participant definitions, we are 

soliciting comment as to whether 

certain types of entities should be 

excluded from the definitions’ 

application.77

A. ‘‘Major’’ Categories of Swaps and 

Securities-Based Swaps 

The first and third tests of the 

statutory major participant definitions 

encompass entities that have a 

substantial position in a ‘‘major’’ 

category of swaps or security-based 

swaps. The Commissions are 

responsible for designating these 

‘‘major’’ categories.78

The Commissions propose to 

designate ‘‘major’’ categories of swaps 

and security-based swaps in a manner 

that reflects the risk profiles of these 

various instruments and the different 

purposes for which end-users make use 

of the various instruments. We 

preliminarily believe that it is important 

not to parse these ‘‘major’’ categories so 

finely as to base the ‘‘substantial 

position’’ thresholds on unduly narrow 

risks that would reduce those 

thresholds’ effectiveness as risk 

measures. The ‘‘major’’ categories will 

apply only for purposes of the major 

participant definitions and are not 

necessarily determinative with respect 

to any other provision of the DoddFrank Act or the regulations adopted 

thereunder. 

1. Major Categories of Swaps 

We propose to designate four ‘‘major’’ 

categories of swaps for purposes of the 

‘‘major swap participant’’ definition. The 

four categories are rate swaps, credit 

swaps, equity swaps and other 

commodity swaps.79 The first category 

would encompass any swap which is 

primarily based on one or more 

reference rates, such as swaps of 

payments determined by fixed and 

floating interest rates, currency 

exchange rates, inflation rates or other 

monetary rates. The second category 

would encompass any swap that is 

primarily based on instruments of 

indebtedness, including but not limited 

to any swap primarily based on one or 

more indices related to debt 

instruments, or any swap that is an 

index credit default swap or total return 


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80The term ‘‘commodity’’ as defined in Section 

1a(9) of the CEA, 7 U.S.C. 1a(9), and CFTC Rule 

§ 1.3(e), 17 CFR 1.3(e) includes interest rates, 

foreign exchange rates, and equity and debt indices 

as well as physical commodities. Thus, the fourth 

category of swaps is entitled ‘‘other commodity 

swaps’’ because it includes any swap not included 

in the other three categories. 

81This category does not encompass a securitybased swap that is based on an instrument of 

indebtedness solely in connection with the swap’s 

financing leg. 

82See proposed Exchange Act rule 3a67–2. 

83At the same time, we note that the distinctions 

between these proposed ‘‘major’’ categories of 

‘‘security-based swaps’’ arguably are less significant 

than the distinctions among the proposed major 

categories of ‘‘swaps’’ (such as, for example, the 

distinction between other commodity swaps and 

rate swaps). 

84See CEA section 1a(33)(B); Exchange Act 

section 3(a)(67)(B). 

85See letter from Timothy W. Cameron, Esq., 

Managing Director, SIFMA Asset Management 

Group, dated September 20, 2010 (‘‘SIFMA AMG 

letter’’) (suggesting a standard of $2.5 billion average 

exposure in any calendar quarter based on the 

entity’s entire portfolio of swaps and security-based 

swaps, other than foreign exchange swaps and 

forwards); letter from Gus Sauter, Chief Investment 

Officer, Vanguard, dated September 20, 2010 

(‘‘Vanguard letter’’) (suggesting that the applicable 

threshold be $500 million in uncollateralized 

exposure for any single major swap category or $1 

billion aggregate exposure across all major 

categories). 

86See letter from Jennifer J. Kalb, Associate 

General Counsel, Metropolitan Life Insurance 

Company, dated September 20, 2010 (‘‘MetLife 

letter’’) (suggesting that cleared trades be subject to 

a lesser ‘‘charge’’ for purposes of the substantial 

position calculation, or be excluded entirely). 

swap on one or more indices of debt 

instruments. The third category would 

encompass any swap that is primarily 

based on equity securities, such as any 

swap primarily based on one or more 

indices of equity securities, or any total 

return swap on one or more equity 

indices. The fourth category would 

encompass any swap not included in 

any of the first three categories. This 

fourth category would generally 

include, for example and not by way of 

limitation, any swap for which the 

primary underlying item is a physical 

commodity or the price or any other 

aspect of a physical commodity.80

The four major categories of swaps are 

intended to cover all swaps. Each swap 

would be in the category that most 

closely describes the primary item 

underlying the swap. If a swap is based 

on more than one underlying item of 

different types, the swap would be in 

the category that describes the 

underlying item that is likely to have 

the most significant effect on the 

economic return of the swap. The 

proposed categories are consistent with 

market statistics that distinguish 

between these general types of swaps, as 

well as market infrastructures that have 

been established for these types of 

swaps. 

We request comment on this proposed 

method of allocating swaps among 

‘‘major’’ categories. Commenters 

particularly are asked to address 

whether there are any types of swaps 

that would have unclear status under 

this proposal, as well as whether all 

swaps instead should be placed into a 

single ‘‘major’’ category for purposes of 

the ‘‘major swap participant’’ definition, 

or whether there should be additional 

‘‘major’’ categories of swaps. 

Commenters are also asked to address 

whether the rate swap category should 

be divided into two separate 

categories—one for swaps based on rates 

of exchange between different 

currencies, and another for swaps based 

on interest rates, inflation rates and 

other monetary rates—and if so, in 

which category cross-currency rate 

swaps should be included. Also, should 

the major swap category for other 

commodity swaps be divided into two 

separate categories—one for swaps 

based on agricultural commodities, and 

another for swaps based on all other 

commodities not included in the other 

categories? 

2. Major Categories of Security-Based 

Swaps 

We propose to designate two ‘‘major’’ 

categories of security-based swaps for 

purposes of the ‘‘major security-based 

swap definition.’’ The first category 

would encompass any security-based 

swap that is based, in whole or in part, 

on one or more instruments of 

indebtedness (including loans), or a 

credit event relating to one or more 

issuers or securities, including but not 

limited to any security-based swap that 

is a credit default swap, total return 

swap on one or more debt instruments, 

debt swap, debt index swap, or credit 

spread.81 The second category would 

encompass any other security-based 

swaps not included in the first category; 

this category would include, for 

example, equity swaps.82

The proposed categories reflect the 

fact that entities that transact in 

security-based swaps for nonspeculative purposes would be expected 

to use the respective instruments for 

different purposes. For example, swaps 

based on instruments of indebtedness, 

such as credit derivatives, can be used 

to hedge the risks associated with the 

default of a counterparty or debt 

obligation. Equity swaps can be used, 

among other ways, to hedge the risks 

associated with equity ownership or 

gain synthetic exposure to equities.83

The proposed categories also are 

consistent with market statistics that 

currently distinguish between those 

general types of security-based swaps, 

as well as market infrastructures, 

including separate trade warehouses, 

that have been established for credit 

default swaps and equity swaps. 

We request comment on this proposed 

method of allocating security-based 

swaps between two ‘‘major’’ categories. 

In particular, we request comment on 

whether there are any types of securitybased swaps that would have unclear 

status under this proposal, as well as 

whether all security-based swaps 

instead should be placed into a single 

‘‘major’’ category for purposes of the 

‘‘major security-based swap participant’’ 

definition, or whether there should be 

additional ‘‘major’’ categories of 

security-based swaps. 

B. ‘‘Substantial Position’’ 

As noted above, the Commissions are 

required to define the term ‘‘substantial 

position’’ as a threshold that is ‘‘prudent 

for the effective monitoring, 

management, and oversight of entities 

that are systemically important or can 

significantly impact the financial system 

of the United States.’’ 84 This raises two 

fundamental issues: (i) What types of 

measures should be used to identify the 

risks posed by an entity’s swap or 

security-based swap positions; and (ii) 

for each of those measures, how much 

risk should be required to evidence a 

‘‘substantial position’’? 

1. Commenters’ Views 

Commenters have expressed diverse 

views as to what should constitute a 

substantial position. A number of 

commenters suggested the use of a test 

based on the current uncollateralized 

mark-to-market exposure posed by an 

entity’s swap or security-based swap 

positions, after taking bilateral netting 

agreements into account. Two 

commenters suggested specific dollar 

amounts of uncollateralized exposure to 

use as the substantial position 

threshold.85 Several commenters 

expressed the view that positions 

subject to central clearing should be 

entirely excluded from the analysis, or 

at least should be discounted for 

purposes of the analysis.86

Some commenters opposed using the 

notional amount of swap or securitybased swap positions to set the 

threshold, stating that the notional 

amount is not indicative of the risks 

associated with a position. Some 

commenters similarly opposed using 

measures of swap or security-based 

swap volume to set the threshold, 


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80188 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

87But see letter from Christopher A. Klem, Ropes 

& Gray, dated September 2, 2010 (test should 

account for frequency of trading and frequency of 

trading with non-dealers). 

88See letter from Andrew Baker, Chief Executive 

Officer, Alternative Investment Management 

Association, dated September 24, 2010 (‘‘AIMA 

letter’’) (discussing possible methods of estimating 

the maximum risk of loss related to positions); letter 

from Warren Davis, Of Counsel, Sutherland Asbill 

& Brennan LLP on behalf of the Federal Home Loan 

Banks, dated September 20, 2010 (in addressing 

‘‘substantial counterparty exposure’’ test, noting the 

possibility of accounting for the potential exposure 

of a portfolio). 

89See letter from Edward J. Rosen, Cleary Gottlieb 

Steen & Hamilton LLP, dated September 21, 2010 

(‘‘Cleary letter’’) (suggesting that the threshold 

should be akin to the amount that is required for 

a non-financial entity to be designated as 

systemically important under Title I of the DoddFrank Act). 

Section 113 of the Dodd-Frank Act provides that 

the Financial Stability Oversight Council (‘‘FSOC’’) 

may determine that a non-bank financial company 

shall be supervised by the Federal Reserve Board, 

subject to prudential standards, if the FSOC 

‘‘determines that material financial distress at the 

U.S. nonbank financial company, or the nature, 

scope, size, scale, concentration, 

interconnectedness, or mix of the activities of the 

U.S. nonbank financial company, could pose a 

threat to the financial stability of the United States.’’ 

In making that determination, the FSOC is to 

consider: Leverage; off-balance sheet exposures; 

transactions and relationships with other significant 

non-bank financial companies and bank holding 

companies; importance as a source of credit and 

liquidity; extent to which assets are managed rather 

than owned; the nature, scope, size, scale, 

concentration, interconnectedness and mix of 

activities; presence of a primary financial regulator; 

assets and liabilities; and any other appropriate 

risk-related factors. 

90 In practice, however, this measure may 

underestimate the amount of risk that an entity 

poses to its counterparties, given that it may take 

multiple days to liquidate a defaulting entity’s swap 

or security-based swap positions, during which 

time prices may move against the defaulting entity. 

91See AIMA letter (‘‘An entity that has only a 

small number of counterparties may only affect a 

small number of entities directly, should it fail, but 

the impact could be significant if the position is 

large and the counterparty is a systemically 

important entity. A diversified exposure to multiple 

entities could affect more entities but is likely to be 

smaller and thus shares the losses in the industry 

and having less systemic impact.’’). 

contending that the number of trades 

does not reflect risk.87

A few commenters addressed the 

possibility that the threshold could take 

into account the potential future risks 

associated with a position, in addition 

to the risks associated with 

uncollateralized current exposure.88

Some commenters suggested that the 

threshold take into account the potential 

riskiness of the particular type of 

instrument at issue. Some commenters 

maintained that the threshold should 

take into account the number of 

counterparties an entity has, the size of 

an entity’s positions compared to the 

size of the market, the size of an entity’s 

swap or security-based swap positions 

compared to the entity’s ability to 

absorb losses of that magnitude, or the 

financial strength of an entity’s 

counterparties. Several commenters 

stated that the threshold should be 

based on an average measure over time, 

so that short-term spikes in measures 

such as exposure would not by 

themselves cause an entity to meet the 

major participant definitions. Some 

commenters suggested that the 

substantial position threshold should 

reflect an amount of ‘‘systemic risk.’’ 89

2. Proposed Substantial Position 

Thresholds 

The Commissions recognize that it is 

important for the substantial position 

thresholds to be set using objective 

numerical criteria. Objective criteria 

should permit regulators, market 

participants and entities that may be 

subject to the regulations to readily 

evaluate whether swap or security-based 

swap positions meet the thresholds, and 

should promote the predictable 

application and enforcement of the 

requirements governing major 

participants. 

In determining the substantial 

position thresholds—in light of what is 

‘‘prudent for the effective monitoring, 

management, and oversight’’ of entities 

that are systemically important or can 

significantly impact the U.S. financial 

system—the Commissions are mindful 

that tests based on current 

uncollateralized exposure and tests 

based on potential future exposure both 

have respective advantages and 

disadvantages. We thus are proposing 

tests that would account for both types 

of exposure. 

A test that focuses solely on the 

current uncollateralized exposure 

associated with an entity’s swap and 

security-based swap positions should 

provide a reasonable measure of the 

theoretical amount of potential risk that 

an entity would pose to its 

counterparties if the entity currently 

were to default.90 Such a test also 

should be relatively clear-cut for market 

entities to implement, and would be 

based on calculations that we expect 

that market entities would perform as a 

matter of course. 

At the same time, a focus solely on 

current uncollateralized exposure could 

be overly narrow by failing to identify 

risky entities until some time after they 

begin to pose the level of risk that 

should subject them to regulation as 

major participants. Because exposure 

can change significantly over short 

periods of time, and a swap or securitybased swap position that may pose large 

potential exposures nonetheless would 

often have a mark-to-market exposure of 

zero at inception, an entity’s positions 

may already pose significant risk to 

counterparties and to the market even 

before its uncollateralized mark-tomarket exposure increases up to the 

applicable threshold. A test that focuses 

solely on current uncollateralized 

exposure thus would not appear to be 

sufficient to satisfy the systemic 

importance standard required by the 

statute. 

Tests based on measures of potential 

future exposure—which would address 

an estimate of how much the value of 

a swap or security-based swap might 

change against an entity over the 

remaining life of the contract—could 

address the gap left by a current 

uncollateralized exposure test. Potential 

future exposure tests, however, would 

reflect only an estimate of that type of 

risk, and would only be as effective as 

the factors used by the test. 

While we have considered several 

other types of tests that could be used 

to determine the substantial position 

threshold, we preliminarily do not 

believe that the advantages of those tests 

justify their disadvantages. For example, 

while a threshold based on the number 

of an entity’s counterparties could help 

identify highly interconnected entities 

(a factor that some have argued is 

important for identifying an entity’s 

systemic risk), it also has been argued 

that a large number of counterparties 

could mean that the losses associated 

with that entity’s default would be 

divided and absorbed by many 

counterparties without broader market 

effects.91 While a threshold that is based 

on an entity’s financial strength would 

help account for the possibility of an 

entity’s default as well as the effects of 

such a default, it would not address 

swap-related risks to the market that are 

not directly linked to the entity’s 

default. In other words, an entity that 

has large out-of-the-money swap or 

security-based swap positions and faces 

a margin call may cause significant 

price movements in the swaps or 

security-based swaps and in the related 

reference entities or assets if the entity 

chooses to unwind its positions, even if 

the entity itself does not appear to 

present a large threat of default. These 

movements may be exacerbated if other 

entities have similar positions. 

Moreover, although substantial 

position thresholds based on the 

financial strength of an entity’s 

counterparties would help measure the 

potential that an entity’s default would 

have a broader impact, such thresholds 

could result in disparate results between 

two entities with identical positions, 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80189 

92See proposed CEA rule 1.3(sss)(2); proposed 

Exchange Act rule 3a67–3(b)(1). In other words, the 

test would measure the portion of the exposure that 

is not offset by the posting of collateral. If a position 

was collateralized only partially, the value of the 

collateral posted would be offset against the total 

exposure, and the test would measure the residual 

part of the exposure. We recognize that there may 

be operational delays between changes in exposure 

and the resulting exchanges of collateral, and in 

general we would not expect that operational delays 

associated with the daily exchange of collateral 

would be considered to lead to uncollateralized 

exposure for these purposes. 

As noted above, the statutory definitions require 

us to consider the presence of central clearing in 

setting the substantial position threshold. This test 

would account for the risk-mitigating effects of 

central clearing in that centrally cleared swaps and 

security-based swaps are subject to mark-to-market 

margining that would largely eliminate the 

uncollateralized exposure associated with a 

position, effectively resulting in cleared positions 

being excluded from the analysis. 

93See proposed CEA rule 1.3(sss)(2); proposed 

Exchange Act rule 3a67–3(b)(2). 

94 Depending on the particular circumstances of 

the swap or security-based swap, such collateral 

may be posted to a third-party custodian, directly 

to the counterparty, or in accordance with the rules 

of a derivatives clearing organization or clearing 

agency. 

95Consistent with industry practices, we would 

expect that entities may value exposure based on 

measures that take into account the amounts that 

would be payable if the transaction were 

terminated. Also, to the extent the valuation of 

collateral posted in connection with swaps or 

security-based swaps is subject to other rules or 

regulations, we would expect that the valuation of 

collateral for purposes of the major participant 

calculations would be consistent with those 

applicable rules. 

At the same time, we recognize that there can be 

disputes or uncertainty as to an entity’s exposure 

in connection with swap and security-based swap 

positions, and as to the valuation of the collateral 

it has posted in connection with those positions. In 

some circumstances this could lead to uncertainty 

as to whether the entity is a major participant. As 

addressed below, we are requesting comment as to 

the potential significance of these issues, and as to 

whether we should set forth additional guidance or 

mandate the use of specific standards with respect 

to these valuations. 

Also, it is important to recognize that while we 

expect that other regulatory requirements 

applicable to the valuation of swap or securitybased swap positions and collateral would be 

relevant to certain calculations relating to major 

participant status, our proposed rules would not be 

relevant for other purposes, such as in the context 

of capital and margin requirements. 

96Section 362(b)(17) of the United States 

Bankruptcy Code generally provides derivatives 

contracts with a safe harbor from the Bankruptcy 

Code’s automatic stay, thus allowing parties to 

these contracts to enforce their contractual rights, 

including those associated with netting and offsets, 

even after a counterparty has filed for bankruptcy. 

In addition, Section 210(c)(8)(A) of the DoddFrank Act reaffirms the enforceability of netting and 

offset provisions in certain derivatives contracts 

with insolvent counterparties that have been placed 

under the receivership of the Federal Deposit 

Insurance Corporation (‘‘FDIC’’). However, the 

Dodd-Frank Act also places certain limitations on 

the timing by which netting rights may be exercised 

when the FDIC has been appointed as the receiver 

of an insolvent counterparty. See Dodd-Frank Act 

section 210(c)(10)(B). 

97To the extent that the two counterparties 

maintain multiple netting agreements (e.g., separate 

agreements for dollar-denominated and eurodenominated instruments), the calculation would 

account only for the netting permitted under the 

netting agreement that is relevant to the swap or 

security-based swap at issue. 

98See proposed CEA rule 1.3(sss)(2)(iii)(A); 

proposed Exchange Act rule 3a67–3(b)(3)(A). As is 

the case for the proposed rules on valuation, the 

proposed rules regarding possible offsets of various 

positions are for purposes of determining major 

participant status only. Other rules proposed by the 

Commissions may address the extent to which, if 

any, persons such as dealers and major participants 

may offset positions for other purposes. 

99 If, for example, an entity was $X out of the 

money in connection with a security-based swap, 

but was $X in the money with the same 

counterparty in connection with a swap, there 

would be no economic need for the entities to 

exchange collateral in connection with those 

offsetting positions. A test that fails to account for 

Continued 

and also could encourage concentration 

of exposure or potential future exposure 

within a few counterparties. While tests 

that are based on the volume of an 

entity’s swaps or security-based swaps 

may be helpful in identifying significant 

swap or security-based swap activity, 

such tests would not directly be 

germane to the current or potential 

future exposure posed by an entity’s 

swap and security-based swap 

positions. Finally, while we have 

considered the feasibility of tests that 

take specific contract features into 

account (e.g., triggers that require the 

payment of mark-to-market margin if an 

entity’s credit rating is lowered), we 

preliminarily believe that simpler tests 

of exposure can more efficiently identify 

the risks associated with particular 

swap or security-based swap positions. 

After considering these alternatives, 

the Commissions are proposing two 

tests to define ‘‘substantial position.’’ 

One test would focus exclusively on an 

entity’s current uncollateralized 

exposure; the other would supplement a 

current uncollateralized exposure 

measure with an additional measure 

that estimates potential future exposure. 

A position that satisfies either test 

would be a ‘‘substantial position.’’ 

The Commissions, however, request 

comment on whether it would be 

appropriate to use other types of 

approaches for determining whether an 

entity has a substantial position—as an 

alternative to, or in addition to, the two 

proposed tests. 

a. Proposed Current Exposure Test 

The proposed first substantial 

position test, which would focus solely 

on current uncollateralized exposure, in 

general would set the substantial 

position threshold by reference to the 

sum of the uncollateralized current 

exposure, obtained by marking-tomarket using industry standard 

practices, arising from each of the 

person’s positions with negative value 

in each of the applicable ‘‘major’’ 

category of swaps or security-based 

swaps (other than positions excluded 

from consideration, such as positions 

for the purpose of ‘‘hedging or mitigating 

commercial risk’’).92

A person would apply this proposed 

substantial position test on a major 

category-by-major category basis, 

examining its positions with each 

counterparty with which the person has 

swaps or security-based swaps in the 

particular category. For each 

counterparty, the person would 

determine the dollar value of the 

aggregate current exposure arising from 

each of its swap or security-based swap 

positions with negative value (subject to 

the netting provisions described below) 

in that major category by marking-tomarket using industry standard 

practices, and deduct from that amount 

the aggregate value of the collateral the 

person has posted with respect to the 

swap or security-based swap positions. 

The aggregate uncollateralized outward 

exposure would be the sum of those 

uncollateralized amounts over all 

counterparties with which the person 

has entered into swaps or security-based 

swaps in the applicable major 

category.93

The proposed test would not 

prescribe any particular methodology 

for measuring current exposure or the 

value of collateral posted,94 and instead 

would provide that the method should 

be consistent with counterparty 

practices and industry practices 

generally.95

This proposed test would account for 

the risk mitigating effects of netting 

agreements 96 by permitting an entity to 

calculate its exposure on a net basis, by 

applying the terms of master netting 

agreements entered into between the 

entity and a single counterparty.97

When calculating the net exposure the 

entity may take into account offsetting 

positions with that particular 

counterparty involving swaps, securitybased swaps and securities financing 

transactions (consisting of securities 

lending and borrowing, securities 

margin lending and repurchase and 

reverse repurchase agreements) to the 

extent that is consistent with the offsets 

provided by the master netting 

agreement.98

The Commissions preliminarily 

believe that this approach is appropriate 

because it avoids identifying a 

position’s exposure as being 

‘‘uncollateralized’’ when there is no 

current counterparty risk associated 

with it due to offsets under a netting 

agreement with the counterparty.99 In 


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this netting of exposure could lead the entities to 

engage in needless offsetting exchanges of 

collateral. 

100See proposed CEA rule 1.3(sss)(2)(iii)(C); 

proposed Exchange Act rule 3a67–3(b)(2)(iii). While 

recognizing that offsetting positions of that type 

would reduce the market risk facing the entity, the 

offsets would not be expected to directly mitigate 

the risks that the entity’s counterparties would face 

if the entity were to default. 

101This issue does not arise to the extent that an 

entity’s net positions with a counterparty are fully 

collateralized. 

102 In other words, if an entity’s out-of-the-money 

rate swap positions have $W exposure, its out-ofthe-money other commodity swap positions have 

$X exposure, its out-of-the-money security-based 

swap positions have $Y exposure, and its other outof-the money positions covered by that netting 

agreement have $Z exposure, fractions of the 

collateral equal to W/(W+X+Y+Z) should be 

allocated to the rate swap positions, X/(W+X+Y+Z) 

to the other commodity swap positions and Y/ 

(W+X+Y+Z) to the security-based swap positions. A 

similar process should be used for allocating net 

out-of-the-money exposure across the categories of 

swaps and security-based swaps that have out-ofthe-money exposure when one or more categories 

are in-the-money. 

103See proposed CEA rule 1.3(sss)(1); proposed 

Exchange Act rule 3a67–3(a)(1). 

104 In this regard, the Commissions preliminarily 

believe that the ‘‘Tier 1’’ capital of major dealer 

banks provides relevant information about the 

ability of the financial system to absorb losses of a 

particular size. We note that, among U.S. banks that 

are dealers in credit derivatives, the six largest 

banks account for the vast majority of dealing 

activities. We understand that the most liquid ‘‘Tier 

1’’ regulatory capital for those six banks ranges from 

$14 billion to $113 billion. 

105 In other words, the proposed thresholds are 

intended to be low enough to provide for the 

appropriately early regulation of an entity whose 

swap or security-based swap positions have a 

reasonable potential of posing significant 

counterparty risks and risks to the market that stress 

the financial system, while being high enough that 

it would not unduly burden entities that are 

materially less likely to pose these types of risks. 

106For example, the proposed $1 billion 

threshold for swaps and security-based swaps 

would reflect a potential loss of $3 billion if three 

large swap or security-based swap entities were to 

fail close in time. That $3 billion could represent 

a significant impairment of the ability of some 

major dealers to absorb losses, as reflected by their 

Tier 1 capital. 

We also are mindful of the views expressed by 

the two commenters that suggested particular dollar 

values for the threshold. See note 85, supra. 

107See proposed CEA rule 1.3(sss)(4); proposed 

Exchange Act rule 3a67–3(d). 

calculating current uncollateralized 

exposure, however, the entity may not 

take into account the market risk offsets 

associated with holding positions with 

multiple counterparties.100 Also, the 

entity may not ‘‘double count’’ any offset 

or collateral—once any item of collateral 

or any position with positive value has 

been applied against current exposure, 

the same item cannot be applied for 

purposes of this test against any other 

exposure. 

The proposal to permit this type of 

netting, however, raises questions as to 

how an entity’s net out-of-the-money 

exposure with a counterparty, and the 

collateral posted with respect to its 

positions with the counterparty, should 

be allocated among swap positions, 

security-based swap positions and other 

positions specified in the rule.101 In 

particular, when an entity has not fully 

collateralized its net current exposure to 

a particular counterparty with which it 

has a netting agreement, there may be 

questions regarding how to attribute the 

net out-of-the-money positions and 

associated collateral to its swap or 

security-based swap positions. We 

preliminarily believe that an entity that 

has net uncollateralized exposure to a 

counterparty should, for purposes of the 

test, allocate that net uncollateralized 

exposure pro rata in a manner that 

reflects the exposure associated with 

each of its out-of-the-money swap 

positions, security-based swap positions 

and non-swap positions.102 This 

allocation would be intended to cause 

the measure of uncollateralized 

exposure connected with swaps or 

security-based swaps for purposes of the 

test to reasonably reflect the relative 

contribution of those instruments to an 

entity’s total overall uncollateralized 

exposure. 

For purposes of the definition of 

‘‘major swap participant,’’ the 

Commissions are proposing to set the 

current uncollateralized exposure 

threshold at a daily average of $1 billion 

in the applicable major category of 

swaps, except that the threshold for the 

rate swap category would be a daily 

average of $3 billion. For purposes of 

the definition of ‘‘major security-based 

swap participant,’’ this threshold would 

be based on a daily average of $1 billion 

in the applicable major category of 

security-based swaps.103 We 

preliminarily believe that these 

proposed thresholds are appropriate for 

identifying entities that, through their 

swap and security-based swap activities, 

have a significant potential to pose the 

systemic importance or risks to the U.S. 

financial system that the major 

participant definition and associated 

statutory requirements were intended to 

address, but we also recognize that it is 

possible that the appropriate threshold 

should be higher or lower. In proposing 

these specific thresholds, we have 

sought to take into account several 

factors: (i) The ability of the financial 

system to absorb losses of a particular 

size; 104 (ii) the appropriateness of 

setting ‘‘prudent’’ thresholds that are 

materially below the level that could 

cause significant losses to the financial 

system as it would not be appropriate 

for the substantial position test to 

encompass entities only after they pose 

significant risks to the market through 

their swap or security-based swap 

activity; 105 and (iii) the need to account 

for the possibility that multiple market 

participants may fail close in time, 

rather than focusing narrowly on the 

potential impact of a single participant’s 

default.106 Based on these factors, we 

preliminarily believe that the proposed 

substantial position thresholds would 

reasonably be expected to apply to 

entities that have the potential of 

satisfying the statutory criteria of 

systemic importance or significant 

impact to the U.S. financial system. As 

discussed below, however, we welcome 

comments on the appropriateness of the 

proposed threshold. 

These proposed thresholds would be 

evaluated by reference to a calculation 

of the mean of an entity’s 

uncollateralized exposure measured at 

the close of each business day, 

beginning on the first business day of 

each calendar quarter and continuing 

through the last business day of that 

quarter.107 In this regard, the 

Commissions have taken into account 

commenters’ concerns that an entity’s 

exposure should not be evaluated based 

on a single point in time, as short-term 

market fluctuations may not fairly 

reflect the risks of the entity’s positions. 

The use of a daily average approach 

should help address commenters’ 

concerns about the impact of short-term 

price fluctuations, and also help 

preclude the possibility that an entity 

may seek to use short-term transactions 

to distort the measure of exposure. 

The Commissions request comment 

on the proposed current 

uncollateralized exposure test. 

Commenters particularly are requested 

to address whether the proposed 

threshold amounts of current 

uncollateralized exposure are 

appropriate, and, if not, what alternative 

higher or lower threshold amounts 

would appropriately identify entities 

that pose the types of risks that the 

definition was intended to address. In 

this regard, commenters specifically are 

requested to address whether bank Tier 

1 capital provides a good indicative 

reference of the ability of major dealers 

to absorb losses of a particular size, or 

whether alternative reference points for 

the analysis (e.g., the size of the swap 

market or security-based swap market) 

would also be applied. Commenters are 

requested to address whether 

uncollateralized mark-to-market 

exposure is the appropriate way to 

measure current exposure, and if not, 

what alternative approach is more 

appropriate, and why. Commenters also 

are requested to address whether the 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80191 

proposed thresholds reasonably address 

the need to set the threshold at a 

prudent level so as to avoid the 

possibility that the substantial position 

test would encompass entities only after 

they pose significant risks to the market, 

whether the proposed thresholds 

reasonably address the possibility that 

multiple market entities could fail close 

in time, and whether the proposed 

thresholds reasonably address the fact 

that swap or security-based swap 

activities would comprise only part of 

the risks to the market posed by an 

entity. To what extent would this 

proposed definition of ‘‘substantial 

position’’ have an effect on the activities 

of entities that potentially may be 

deemed to be major participants? What 

impact could these types of effects have 

on liquidity, on risk-taking or riskreducing activities, or on other aspects 

of the relevant markets? 

Also, more fundamentally, we request 

comment on whether the substantial 

position analysis also should encompass 

a test that does not account for the 

collateral posted in connection with an 

entity’s exposure, given that tests that 

account for the posting of collateral 

would not encompass entities that have 

very large swap or security-based swap 

positions that are fully collateralized 

(either by the posting of bilateral 

collateral or by virtue of central 

clearing). In that light, should the 

analysis seek to capture entities that 

have very large positions in light of 

potential market disruptions such 

entities could cause, regardless of 

whether the positions are collateralized? 

Commenters further are requested to 

address whether such thresholds should 

also account for entities that have large 

in-the-money positions that may 

indicate their potential significance to 

the market. In this regard, commenters 

also are asked to address whether the 

thresholds should specifically address 

entities with large in-the-money 

positions that lead them to receive large 

amounts of collateral posted by their 

counterparties, particularly to the extent 

that such collateralized in-the-money 

positions could later turn and lead the 

entity to incur losses. 

In addition, commenters are requested 

to address whether and how it would be 

appropriate to adjust the threshold 

amounts over time, including whether 

these proposed current uncollateralized 

exposure thresholds should periodically 

be adjusted by formula to reflect 

changes in the ability of the market to 

absorb losses over time, or changes in 

other criteria over time. Commenters 

further are requested to address whether 

the test will be practical for potential 

major participants to use. Moreover, 

commenters are requested to address 

whether the proposed current exposure 

test should be modified to account for 

the risks associated with the expected 

time lag between an entity’s default and 

the liquidation of its swap or securitybased swap positions. 

Commenters also are requested to 

address whether we should set forth 

additional guidance or mandate the use 

of specific standards with respect to the 

measure of exposure or valuing 

collateral posted, or should specify 

particular procedures in the event of 

valuation disputes. What particular 

industry standard documentation and 

other methodologies could be used to 

measure exposure and value collateral? 

Also, how could regulatory 

requirements applicable to the valuation 

of collateral be relevant to the valuation 

of collateral for purposes of the major 

participant definitions? 

Commenters are invited to address 

whether the rule should provide that, in 

measuring their current uncollateralized 

exposure, entities must value collateral 

in a way that is at least as conservative 

as such collateral would be valued 

according to applicable haircuts or other 

adjustments dictated by applicable 

regulations. Commenters further are 

requested to address whether the test 

should exclude certain types of 

collateral that cannot readily be valued. 

Also, commenters are requested to 

address whether the proposed method 

of evaluation—the mean of an entity’s 

uncollateralized exposure measures at 

the close of each business day, 

beginning on the first business day of 

each calendar quarter and continuing 

through the last business day of that 

quarter—would be unduly burdensome 

or potentially subject to gaming or 

evasion. 

Should the proposed approach for 

measuring uncollateralized current 

exposure be amended or supplemented, 

such as by establishing requirements for 

how exposure should be measured or 

collateral should be valued in certain 

circumstances (e.g., requiring the 

valuation of certain types of collateral to 

be conservative during times of rapid 

price changes in the relevant asset 

class)? Should current exposure and 

collateral be required to be valued in 

accordance with US generally accepted 

accounting principles? Would 

measurement according to such 

principles differ in any respects from 

measurement under the proposal, and, if 

so, how? 

In addition, commenters are requested 

to address the proposed netting 

provisions of this test, including: 

whether the proposed test would 

reasonably permit the measure of 

uncollateralized exposure to account for 

bilateral netting agreements; whether 

additional types of positions should be 

included within the netting provisions; 

whether the proposal appropriately 

takes into account the netting of 

exposures and collateral involving 

positions in financial instruments other 

than swaps, security-based swaps and 

securities financing transactions and if 

so, whether any limitations to such 

offsetting would be necessary or 

appropriate; whether the netting 

provisions should accommodate 

offsetting positions involving the net 

equity balance in an entity’s securities 

account (e.g., free credit balances, other 

credit balances, and fully paid 

securities), and if so, whether any 

limitations to such offsetting would be 

necessary or appropriate; whether the 

netting provisions should accommodate 

offsets for exposures, or collateral 

connected with the positions that an 

entity has with the affiliate of a 

counterparty; and whether the proposed 

method of allocating the 

uncollateralized portion of exposures 

among the different types of financial 

instruments that are all subject to a 

single netting agreement is appropriate. 

Commenters also are requested to 

address whether the proposed current 

uncollateralized exposure test would 

pose significant monitoring burdens 

upon entities that have swap or 

security-based swap positions that are 

significant enough to potentially meet 

the current uncollateralized exposure 

threshold. Should we provide guidance 

as to policies and procedures that such 

an entity should be able to follow to 

demonstrate that it does not meet the 

applicable thresholds? 

b. Proposed Current Exposure Plus 

Potential Future Exposure test 

The second proposed test would 

account both for current 

uncollateralized exposure (as discussed 

above) and for the potential future 

exposure associated with swap or 

security-based swap positions in the 

applicable ‘‘major’’ category of swaps or 

security-based swaps. This additional 

test would allow the major participant 

analysis to take into account estimates 

of how the value of an entity’s swap or 

security-based swap positions may 

move against the entity over time. 

The potential future exposure portion 

of this proposed test would be based on 

an entity’s ‘‘aggregate potential outward 

exposure,’’ which would reflect the 

potential exposure of the entity’s swap 

or security-based swap positions in the 

applicable ‘‘major’’ category of swap or 

security-based swaps, subject to certain 

adjustments. Bank capital standards also 


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80192 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

108See 12 CFR part 3, app. C, section 32 (Office 

of the Comptroller of the Currency bank capital 

standards). 109For example, consistent with the bank 

standards, the multiplier for equity swaps would 

range from 0.06 for equity swaps of one year or less 

to 0.10 for equity swaps with a maturity of more 

than five years. See proposed Exchange Act rule 

3a67–3(c)(2)(i)(A). For security-based swaps based 

on the credit of a reference entity, the multiplier 

would be 0.1. 

The current bank capital standards contain a 

distinction based on whether the credit derivative 

is on ‘‘investment grade’’ or ‘‘non-investment grade’’ 

reference entities, providing a 0.1 multiplier for the 

former and a lower 0.05 multiplier for the latter. We 

preliminarily do not believe that a test that 

distinguishes among reference entities by reference 

to their credit ratings would be appropriate for 

purposes of these definitions, particularly in light 

of the fact that the Dodd-Frank Act mandates the 

substitution of credit ratings with other standards 

of creditworthiness in U.S. regulations. See DoddFrank Act section 939A. 

The multipliers in part will be a function of the 

remaining maturity of the swap or security-based 

swap. If the swap or security-based swap, however, 

is structured such that on specified dates the 

outstanding exposure is settled and the terms are 

reset so the market value is zero, the remaining 

maturity would equal the time until the next reset 

date. 

Although we recognize that these risk multipliers 

may suggest a lower than expected volatility of 

credit or equity derivatives of that duration, this 

may be offset by the fact that the proposed 

calculations of potential future exposure do not 

directly account for portfolio netting or collateral 

updates that could mitigate future exposure. We 

preliminarily believe that the use of these 

thresholds (and proposed related calculations) for 

purposes of identifying major participants are 

consistent with similar bank capital standards and 

are therefore suitable for use as an estimate of 

potential future exposure. We are also cognizant 

that requiring a more complete calculation of 

potential future exposure may be costly and 

burdensome for participants, especially those who 

would otherwise not meet the thresholds for major 

swap or security-based swap participant and would 

not have systems in place to perform a more 

complete calculation. 

110See proposed CEA rule 1.3(sss)(3)(ii); 

proposed Exchange Act rule 3a67–3(c)(2)(i)(B). For 

purposes of this rule, in the case of positions that 

represent the sale of an option on a swap or 

security-based swap (other than the sale of an 

option permitting the person exercising the option 

to purchase a credit default swap), we would view 

the effective notional amount of the option as being 

equal to the effective notional amount of the 

underlying swap or security-based swap, and we 

would view the duration used for purposes of the 

formula as being equal to the sum of the duration 

of the option and the duration of the underlying 

swap or security-based swap. 

111The analysis would exclude swap or securitybased swap positions that constitute the purchase 

of an option, such that the person has no additional 

payment obligations under the position, as well as 

other positions on which the person has prepaid or 

otherwise satisfied all of its payment obligations. 

See proposed Exchange Act rule 3a67–3(c)(2)(i)(C). 

For similar reasons, the potential outward 

exposure associated with a position by which a 

person buys credit protection using a credit default 

swap would be capped at the net present value of 

the unpaid premiums. See proposed CEA rule 

1.3(sss)(3)(ii)(A)(4); proposed Exchange Act rule 

3a67–3(c)(2)(i)(D). 

112 In particular, for swaps or security-based 

swaps subject to master netting agreements the 

potential exposure associated with the person’s 

swap or security-based swaps with each 

counterparty would equal a weighted average of the 

potential exposure in the applicable ‘‘major’’ 

category of swaps or security-based swaps with a 

particular counterparty as calculated without 

reference to netting, and that amount reduced by 

the ratio of net current replacement cost to gross 

current replacement cost of all swap and securitybased swap positions with that counterparty, 

consistent with the following equation: PNet = 0.4 

x PGross + 0.6 x NGR x PGross. 

Under this formula, PNet is the potential exposure 

in the applicable ‘‘major’’ category of swaps or 

security-based swaps adjusted for bilateral netting; 

PGross is the potential exposure in that category 

without adjustment for bilateral netting; and NGR 

is the ratio of net current replacement cost to gross 

current replacement cost. See proposed CEA rule 

1.3(sss)(3)(ii)(B); proposed Exchange Act rule 3a67– 

3(c)(2)(ii). 

The ‘‘NGR’’ ratio is intended to serve as a type of 

proxy for the impact of netting on potential future 

exposure, but does not serve as a precise indicator 

of future changes in net exposure relative to gross 

exposure, as the ratio and potential exposure can 

be influenced by many idiosyncratic properties of 

individual portfolios. See Basle Committee on 

Banking Supervision, ‘‘The Treatment of the Credit 

Risk Associated with Certain Off-Balance-Sheet 

Items’’ (July 1994). 

113For these purposes, a swap or security-based 

swap would be considered to be subject to daily 

mark-to-market margining if, and for as long as, the 

counterparties follow the daily practice of 

exchanging collateral to reflect changes in exposure 

(after taking into account any other positions 

addressed by a netting agreement between the 

parties). If a person is permitted to maintain an 

uncollateralized ‘‘threshold’’ amount under the 

agreement, that amount (regardless of actual 

exposure) would be considered current 

uncollateralized exposure for purposes of the test. 

Also, if the agreement provides for a minimum 

transfer amount in excess of $1 million, the entirety 

of that amount would be considered current 

uncollateralized exposure. See proposed CEA rule 

1.3(sss)(3)(iii)(B); proposed Exchange Act rule 

3a67–3(c)(3)(ii). 

In this way, the measure of potential future 

exposure would reflect for the risk mitigating 

benefits of daily margining, while specifically 

accounting for industry practices that limit those 

benefits. Of course, to take advantage of this 

adjustment it is not enough to the agreement to 

provide for daily mark-to-market margining—the 

parties must actually follow that practice. 

114See proposed CEA rule 1.3(sss)(3)(iii)(A); 

proposed Exchange Act rule 3a67–3(c)(3). 

115For example, the central counterparties that 

clear credit default swaps do not necessarily 

become the counterparties of their members’ 

customers (although even absent direct privity 

those central counterparties benefit customers by 

providing for protection of collateral they post as 

margin, and by providing procedures for the 

portability of the customer’s positions in the event 

of a dealer’s default). As a result, central clearing 

may not eliminate the counterparty risk that the 

customer poses to the dealer. Even then, however, 

required mark-to-market margining should help 

control that risk, and central clearing thus would 

be expected to reduce the likelihood that an entity’s 

default would lead to broader market impacts. 

make use of this type of test,108 and this 

proposal builds upon those standards 

but modifies them to focus on the risk 

that an entity poses to its counterparties 

(rather than on the risk that 

counterparties pose to an entity). In 

doing so, this proposal seeks to use a 

test that can be implemented by a range 

of market participants, and that can be 

expected to lead to reproducible results 

across market participants with 

identical swap or security-based swap 

portfolios, rather than relying on 

alternative tests (e.g., value at risk 

measures or stress testing 

methodologies) that may be costly for 

market participants to implement and 

that would not be expected to lead to 

reproducible results across participants. 

The exposure measures in general 

would be based on the total notional 

principal amount of those positions, 

adjusted by certain risk factors that 

reflect the type of swap or securitybased swap at issue and the duration of 

the position.109 For positions in which 

the stated notional amount is leveraged 

or enhanced by the particular structure, 

this calculation would be based on the 

position’s effective notional amount.110

At the same time, the proposed 

measures would contain adjustments for 

certain types of positions that pose 

relatively lower potential risks.111 In 

addition, the general risk-adjusted 

notional measures of potential future 

exposure would be reduced to reflect 

the risk mitigation effects of master 

netting agreements, in a manner 

consistent with bank capital 

standards.112

The proposed measures of potential 

future exposure would contain further 

downward adjustments to account for 

the risk mitigation effects of central 

clearing and mark-to-market margining. 

In particular, if the swap or securitybased swap positions are cleared by a 

registered clearing agency or subject to 

daily mark-to-market margining,113 the 

measures of potential future exposure 

would further be adjusted to equal 

twenty percent of the potential future 

exposure calculated using the 

methodology described above.114 The 

Commissions preliminarily believe that 

a significant downward adjustment 

would be appropriate because clearing 

and daily mark-to-market margining 

would be expected to reduce the 

potential future risks posed by an 

entity’s swap or security-based swap 

positions. Also, it is appropriate to 

incentivize the use of central clearing 

and daily mark-to-market margining as 

practices for helping to control risks. We 

are not proposing to entirely eliminate 

such cleared and margined positions 

from the analysis of potential future 

exposure, however, because clearing 

may not entirely eliminate the risks 

posed by an entity’s potential default,115

and daily mark-to-market margining 

would not eliminate the risks associated 

with large intra-day price movements. 

While the proposed amount of the 

adjustment seeks to balance these 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80193 

116See proposed Exchange Act rule 3a67–3(a)(2). 

117See notes 103 to 106, supra, and 

accompanying text. 

118Based on these thresholds, we preliminarily 

believe that only relatively few entities would 

regularly have to perform these potential future 

exposure calculations with regard to their securitybased swaps. See notes 181 and 182, infra, and 

accompanying text. 

competing factors, we recognize that 

alternative higher or lower downward 

adjustments may also be appropriate. 

For purposes of the ‘‘major swap 

participant’’ definition, the substantial 

position threshold would be $2 billion 

in daily average current uncollateralized 

exposure plus aggregate potential 

outward exposure in the applicable 

major swap category, except that the 

threshold for the rate swap category 

would be a daily average of $6 billion. 

For purposes of the ‘‘major securitybased swap participant’’ definition, the 

substantial position threshold would be 

$2 billion in daily average current 

uncollateralized exposure plus aggregate 

potential outward exposure in any 

major security-based swap category.116

These proposed amounts reflect the 

same factors discussed above in the 

context of the current uncollateralized 

exposure test,117 but are raised to reflect 

the fact that potential future exposure is 

a measure of potential risk over time, 

and hence is less likely to pose a direct, 

immediate impact on the markets than 

current measures of uncollateralized 

exposure. We recognize that alternative 

risk thresholds may also be appropriate, 

and we welcome comment on potential 

alternatives. 

In light of the amount of this 

threshold and the underlying risk 

adjustments, we preliminarily do not 

believe that an entity would need to 

calculate its potential future exposure 

for purposes of the test unless the entity 

has large notional positions. For 

example, in light of the proposed risk 

adjustment of 0.10 for credit derivatives, 

an entity that does not have any 

uncollateralized current exposure 

would have to have notional positions 

of at least $20 billion to potentially meet 

the $2 billion threshold, even before 

accounting for the discounts associated 

with netting agreements. If those swaps 

or security-based swaps are cleared or 

subject to mark-to-market margining, the 

additional 20 percent risk adjustment 

would mean that the entity without 

current uncollateralized exposure 

would have to have cleared notional 

positions of at least $100 billion to 

possibly meet that threshold.118

The Commissions request comment 

on this proposed use of a current 

exposure plus potential future exposure 

test to determine the substantial 

position threshold. Commenters 

particularly are requested to address the 

appropriateness of using potential 

exposure risk adjustments derived from 

bank capital rules; and the 

appropriateness of using bank capital 

methodologies for addressing positions 

subject to netting agreements. Also, 

should this test be supplemented by a 

test that accounts for the notional 

amount of an entity’s swap or securitybased swap positions without riskadjustments, to focus on entities that 

have very large swap or security-based 

swap positions? 

Commenters are requested to address 

whether the proposed threshold 

amounts for the proposed current 

exposure plus potential future exposure 

test are appropriate, and if not, what 

alternative threshold amounts would be 

more appropriate, and why. In addition, 

commenters are requested to address the 

proposed method of discounting the 

potential future exposure associated 

with cleared positions or positions 

subject to daily mark-to-market 

margining to equal 20 percent of what 

the measure of potential future exposure 

would be otherwise. Would a larger or 

smaller discount be appropriate? Is 

there data available that may assist with 

reaching the appropriate discount 

factor? Also, in that regard, should both 

sets of discounts be equal, or should 

cleared positions be subject to more of 

a discount than uncleared positions 

subject to daily mark-to-market 

margining? Commenters also are invited 

to address whether the proposed 

discounts for cleared positions or 

positions that are marked-to-market 

would make it unnecessary or 

duplicative for this test separately to 

account for netting agreements. Also, if 

an entity currently has posted excess 

collateral in connection with a position, 

should the amount of that current 

overcollateralization be deducted from 

its measure of potential future 

exposure? 

Commenters also are requested to 

address whether the proposed test in 

connection with purchases of credit 

protection—which would cap the 

measure of exposure at the net present 

value of unpaid premiums—would raise 

problems in implementation, and 

whether we should propose any 

particular discount rate to be used in 

conducting the calculation (and, if so, 

what discount rate should be 

appropriate). Also, should the measure 

of potential future exposure in 

connection with purchases of credit 

protection and options also account for 

collateral that a counterparty has posted 

in connection with an entity’s in-themoney positions, given that such 

collateralized in-the-money positions 

could later turn and cause losses to an 

entity? In addition, for positions that 

represent the sale of options on swaps 

or security-based swaps, would the 

effective notional amount of the option 

for purposes of the calculation properly 

be deemed to be the notional amount of 

the underlying instrument (or should 

the notional amount of the option vary 

based on the link between the changes 

in the value of the option and changes 

in the value of the underlying), and 

would the duration of the option 

properly be deemed to be the sum of the 

duration of the option and the duration 

of the underlying swap or securitybased swap? 

Commenters also are requested to 

address whether the risk adjustment for 

credit derivatives should reflect the 

riskiness of the underlying reference 

entity, and, if so, how should that be 

accomplished in a way that does not 

rely on the use of credit ratings. 

The proposed test of potential future 

exposure is based in part on the 

application of fixed multipliers to the 

notional amounts, or effective notional 

amounts, of swaps and security-based 

swaps. In this regard, commenters are 

invited to discuss whether there are 

alternative tests that would be more 

effective to determine potential future 

exposure or otherwise to supplement an 

uncollateralized current exposure test, 

and whether such alternative tests may 

be more effectively developed in the 

near future, when additional data 

regarding swap and security-based swap 

positions are likely to be available. In 

particular, commenters are requested to 

identify any tests based on nonproprietary risk models that could be 

uniformly applied by all potential major 

participants to measure potential future 

exposure. Commenters who propose 

alternative tests are asked to address 

how the tests would provide consistent 

results across different types of swaps 

and security-based swaps, including 

customized instruments, in the different 

major categories. Commenters are also 

invited to address, on the other hand, 

whether a single test based on 

uncollateralized current exposure (i.e., 

without any test of potential future 

exposure) would be adequate for 

identifying entities whose swap or 

security-based swap positions pose a 

relatively high degree of risk to 

counterparties and to the markets. In 

addition, commenters are invited to 

identify any tests or thresholds below 

which a party would be deemed not to 

be a major swap participant, without 

needing to calculate the exposure tests 

set forth in the proposed rule. 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80194 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

119See CEA section 1a(33)(A)(i)(I); Exchange Act 

section 3(a)(67)(A)(i)(I). 

120See, e.g., letter from Coalition for Derivatives 

End-Users, dated September 20, 2010 (discussing, 

inter alia, a supplier’s use of credit derivatives in 

connection with a cash receivable, and a company’s 

use of equity derivatives in connection with a stock 

repurchase program). 

121See Cleary letter (also urging inclusion of ‘‘all 

risks’’ arising in connection with a company’s 

business activities, including risks incidental to a 

company’s ordinary course of business). 

122See MetLife letter (addition of mitigation 

‘‘plainly indicates that this exclusion intends an 

expansive definition of hedging and can also 

encompass non-speculative derivatives positions 

used to manage economic risk, including 

potentially diversification and synthetic asset 

strategies, such as the conservative ‘replication’ 

strategy permitted under State insurance laws’’); 

letter from Joanne R. Medero, Managing Director, 

BlackRock, dated September 20, 2010 (addressing 

the parallel context of the exclusion for ERISA plan 

positions). 

123See CEA section 2(h)(7)(A); Exchange Act 

section 3C(g)(1)(B) (exception from mandatory 

clearing requirements when one or more 

counterparties are not ‘‘financial entities’’ and are 

using swaps or security-based swaps ‘‘to hedge or 

mitigate commercial risk’’). The definition of 

commercial risk here is for purposes of only the 

major participant definitions and, to the extent the 

interpretation is similar, for purposes of the enduser exception from the mandatory clearing 

requirement. The concept of commercial risk may 

be interpreted differently for other purposes under 

the CEA and the Exchange Act. 

124There is a technical difference in the way 

those provisions use the concept of hedging and 

mitigating commercial risk—in that the major 

participant definitions specifically refer to 

‘‘positions held for hedging and mitigating 

commercial risk’’ while the end-user exception 

refers to a counterparty that ‘‘is using [swaps or 

security-based swaps] to hedge or mitigate 

commercial risk.’’ That difference is consistent with 

the different language used in the two places 

(particularly the use of ‘‘substantial position’’ in the 

major participant definitions) and we do not see a 

reason why the use of the term in the context of 

the major participant definitions should be 

construed differently than its use in the comparable 

clearing exception. 

125The presence of the third major participant 

test suggests that financial entities generally may 

not be precluded from taking advantage of the 

hedging exclusion in the first test. The third test, 

which does not account for hedging, specifically 

applies to non-bank financial entities that are 

highly leveraged and have a substantial position in 

a major category of swaps or security-based swaps. 

That test would be redundant if the hedging 

exclusion in the first major participant test were 

entirely unavailable to financial entities. 

Also, had the statute intended the phrase ‘‘hedge 

or mitigate commercial risk’’ to apply only to 

activities of or positions held by non-financial 

entities, it would not have been necessary to 

include an additional provision in the statute 

generally restricting the availability of the clearing 

exception to non-financial entities. 

126The scope of the proposed exclusion is based 

on our understanding that when a swap or securitybased swap is used to hedge an entity’s commercial 

activities, the gains or losses associated with the 

swap or security-based swap itself will be offset by 

losses or gains in the entity’s commercial activities, 

and hence the risks posed by the swap or securitybased swap to counterparties or the industry 

generally will be mitigated. 

127We do not concur with the suggestion that the 

use of the word ‘‘mitigating’’ within the major 

participant definitions was intended to mean 

something significantly more than hedging. Other 

provisions of the Dodd-Frank Act appear to use the 

terms ‘‘hedging’’ and ‘‘mitigating’’ interchangeably; 

for example, certain provisions of the Dodd-Frank 

Act refer to ‘‘risk-mitigating hedging activities.’’ See 

Dodd-Frank Act section 619 (adding Section 13 to 

the Bank Holding Company Act of 1956); DoddFrank Act section 619 (adding Section 27B to the 

Securities Act of 1933). Title VII also refers to 

‘‘[h]edging and other similar risk mitigating 

activities.’’ Dodd-Frank Act section 716(d)(1). 

Commenters further are requested to 

address whether and how it would be 

appropriate to adjust the threshold 

amounts over time, including whether 

these proposed thresholds should 

periodically be adjusted by formula to 

reflect changes in the ability of the 

market to absorb losses over time, or 

changes in other criteria over time. In 

addition, commenters are requested to 

address whether the proposed use of a 

daily average measure for purposes of 

this test would be burdensome for 

potential major participants to 

implement, and, if so, how often should 

potential participants have to measure 

these amounts. Commenters also are 

requested to address whether any such 

tests should seek to reflect the 

maximum level of exposure associated 

with a position, rather than riskadjusted estimates of exposure proposed 

here. 

In addition, commenters are requested 

to address whether this proposed test 

would pose significant monitoring 

burdens upon entities that have swap or 

security-based swap positions that are 

significant enough to potentially meet 

the combined current uncollateralized 

exposure and potential future exposure 

test. Should we provide guidance as to 

policies and procedures that such an 

entity should be able to follow to be able 

to demonstrate that it does not meet the 

applicable thresholds? 

C. ‘‘Hedging or Mitigating Commercial 

Risk’’ 

The first test of the major participant 

definitions excludes positions held for 

‘‘hedging or mitigating commercial risk’’ 

from the substantial position 

analysis.119

Commenters took the position that 

this exclusion from the major 

participant definitions should 

encompass a variety of uses of swaps 

and security-based swaps to hedge risks 

faced by non-financial entities.120 Some 

commenters also suggested that the 

exclusion should be interpreted to 

address risks such as ‘‘balance sheet 

risk,’’ the ‘‘risk of under-diversification,’’ 

and hedges undertaken on a portfolio 

basis. Some commenters favored 

interpreting this exclusion to permit its 

use by insurers and banks. One 

commenter emphasized the need to 

avoid taking interpretations that would 

encourage commercial entities not to 

manage risks that they otherwise would 

manage.121 Commenters also took the 

position that the addition of the word 

‘‘mitigating’’ was intended to expand the 

exclusion beyond what would have 

been encompassed had only the term 

‘‘hedging’’ been used.122

1. Proposed Interpretation 

In interpreting the meaning of 

‘‘hedging or mitigating commercial risk’’ 

for purposes of the first test of the major 

participant definitions, the 

Commissions first note that virtually 

identical language is found in the DoddFrank provisions granting an exception 

from the mandatory clearing 

requirement to non-financial entities 

that are using swaps or security-based 

swaps to hedge or mitigate commercial 

risk.123 Because Congress used virtually 

identical language in both instances, the 

Commissions intend to interpret the 

phrase ‘‘hedging or mitigating 

commercial risk’’ with respect to the 

participant definitions in the same 

manner as the phrase ‘‘hedge or mitigate 

commercial risk’’ in the exception from 

the mandatory clearing requirement.124

The Commissions also note that 

although only non-financial entities that 

are using swaps or security-based swaps 

to hedge or mitigate commercial risk 

generally may qualify for the clearing 

exemption, no such statutory restriction 

applies with respect to the exclusion for 

hedging positions in the first major 

participant test. Accordingly, with 

respect to the first major participant test, 

it appears that positions established to 

hedge or mitigate commercial risk may 

qualify for the exclusion, regardless of 

the nature of the entity—i.e., whether a 

financial entity (including a bank) or a 

non-financial entity.125

In general, we are premising the 

proposed exclusion on the principle 

that swaps or security-based swaps 

necessary to the conduct or management 

of a person’s commercial activities 

should not be included in the 

calculation of a person’s substantial 

position.126 In this regard, the 

Commissions preliminarily believe that 

whether an activity is commercial 

should not be determined solely by the 

person’s organizational status as a forprofit company, a non-profit 

organization or a governmental entity. 

Rather, the determinative factor should 

be whether the underlying activity to 

which the swap relates is commercial in 

nature.127


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128We preliminarily believe that swap positions 

that are held for the purpose of speculation or 

trading are, for example, those positions that are 

held primarily to take an outright view on the 

direction of the market, including positions held for 

short term resale, or to obtain arbitrage profits. 

Swap positions that hedge other positions that 

themselves are held for the purpose of speculation 

or trading are also speculative or trading positions. 

We preliminarily believe that swap positions that 

are held for the purpose of investing are, for 

example, those positions that are held primarily to 

obtain an appreciation in value of the swap position 

itself, without regard to using the swap to hedge an 

underlying risk. In contrast, a swap position related 

to a non-swap investment (such as the purchase of 

an asset that a commercial enterprise will use to 

produce income or otherwise advance its 

commercial interests) may be a hedging position if 

it otherwise qualifies for the definition of hedging 

or mitigating commercial risk. 

129See proposed Exchange Act rule 3a67–4(a). 

The concept of ‘‘economically appropriate’’ already 

is found in rules under the CEA pertaining to the 

definition of ‘‘bona fide hedging’’ for purposes of an 

exemption from position limits. See CEA rule 

1.3(z). In the context of the definition of ‘‘major 

security-based swap participant,’’ we may take into 

account existing interpretations of that term under 

the CEA, but only to the extent that such 

interpretations would appropriately be applied to 

the use of security-based swaps for hedging. 

The SEC preliminarily plans to interpret the 

concept of ‘‘economically appropriate’’ based on 

whether a reasonably prudent person would 

consider the security-based swap to be appropriate 

for managing the identified commercial risk. The 

SEC also preliminarily believes that for a securitybased swap to be deemed ‘‘economically 

appropriate’’ in this context, it should not introduce 

any new material quantum of risks (i.e., it cannot 

reflect over-hedging that could reasonably have a 

speculative effect) and it should not introduce any 

basis risk or other new types of risk (other than the 

counterparty risk that is attendant to all securitybased swaps) more than reasonably necessary to 

manage the identified risk. 

130These hedging positions would include 

activities, such as the management of receivables, 

that arise out of the ordinary course of an entity’s 

commercial operations, including activities that are 

incidental to those operations. 

131See proposed Exchange Act rule 3a67–4(b)(1). 

For these purposes, we preliminarily believe that 

security-based swap positions that are held for the 

purpose of speculation or trading are those 

positions that are held intentionally for short-term 

resale and/or with the intent of benefiting from 

actual or expected short-term price movements or 

to lock in arbitrage profits, as well as security-based 

swap positions that hedge other positions that 

themselves are held for the purpose of speculation 

or trading. Thus, for example, positions that would 

be part of a ‘‘trading book’’ of an entity such as a 

bank would not constitute hedging positions that 

may be excluded for purposes of the first major 

participant test. 

132See proposed Exchange Act rule 3a67–4(b)(2). 

133See proposed Exchange Act rule 3a67–4(a)(3). 

The proposal particularly would require the person 

to: Identify and document the risks that are being 

reduced by the security-based swap position; 

establish and document a method of assessing the 

effectiveness of the security-based swap as a hedge; 

and regularly assess the effectiveness of the 

security-based swap as a hedge. 

We expect that market participants that have 

security-based swap activities significant enough 

that they may be major participants would already 

engage in risk assessment activities for their 

hedging positions, either formally or informally, 

and thus we do not believe that the proposed 

requirements would disrupt existing business 

practices. Instead, the proposal is intended to create 

standards that will allow market participants to 

confirm their compliance with the rule by 

formalizing risk assessment activities that should 

already be part of an effective hedging program. 

a. Proposed Exclusion in the ‘‘Major 

Swap Participant’’ Definition 

As a general matter, the CFTC 

preliminarily believes that whether a 

position hedges or mitigates commercial 

risk should be determined by the facts 

and circumstances at the time the swap 

is entered into, and should take into 

account the person’s overall hedging 

and risk mitigation strategies. At the 

same time, the swap position could not 

be held for a purpose that is in the 

nature of speculation, investing or 

trading. Although the line between 

speculation, investing or trading, on the 

one hand, and hedging, on the other, 

can at times be difficult to discern, the 

statute nonetheless requires such 

determinations.128 The CFTC expects 

that a person’s overall hedging and risk 

management strategies will help inform 

whether or not a particular position is 

properly considered to hedge or mitigate 

commercial risk. Although the 

definition includes swaps that are 

recognized as hedges for accounting 

purposes or as bona fide hedging for 

purposes of an exemption from position 

limits under the CEA, the swaps 

included within the proposed exclusion 

are not limited to those categories. 

Rather, the proposal covers swaps 

hedging or mitigating any of a person’s 

business risks, regardless of their status 

under accounting guidelines or the bona 

fide hedging exemption. 

The CFTC invites comment on 

whether swaps qualifying for the 

hedging or risk mitigation exclusion 

should be limited to swaps where the 

underlying hedged item is a nonfinancial commodity. Commenters may 

also address whether swaps subject to 

this exception should hedge or mitigate 

commercial risk on a single risk or an 

aggregate risk basis, and on a single 

entity or a consolidated basis. The CFTC 

also invites comment on whether risks 

such as the foreign exchange, currency, 

or interest rate risk relating to offshore 

affiliates, should be covered; whether 

industry-specific rules on hedging, or 

rules that apply only to certain 

categories of commodity or asset classes 

are appropriate at this time; whether 

swaps facilitating asset optimization or 

dynamic hedging should be included; 

and whether hedge effectiveness should 

be addressed. Commenters are requested 

to discuss both the policy and legal 

bases underlying their comments. 

b. Proposed Exclusion in the ‘‘Major 

Security-Based Swap Participant’’ 

Definition 

The proposed meaning of ‘‘hedging or 

mitigating commercial risk’’ for 

purposes of the ‘‘major security-based 

swap participant’’ definition would 

require that a security-based swap 

position be economically appropriate to 

the reduction of risks in the conduct 

and management of a commercial 

enterprise, where they arise from the 

potential change in the value of assets, 

liabilities and services connected with 

the ordinary course of business of the 

enterprise.129 This standard is intended 

to exclude from the first major 

participant test security-based swaps 

that pose limited risk to the market and 

to counterparties because the positions 

would be substantially related to 

offsetting risks from an entity’s 

commercial operations.130 The securitybased swaps included within the 

proposed rule would not be limited to 

those recognized as hedges for 

accounting purposes; rather, the 

proposal has been drafted to cover 

security-based swaps used in the 

broader range of transactions commonly 

referred to as economic hedges, 

regardless of their status under 

accounting guidelines. 

At the same time, the security-based 

swap position could not be held for a 

purpose that is in the nature of 

speculation or trading.131 In addition, 

the security-based swap position could 

not be held to hedge or mitigate the risk 

of another security-based swap position 

or swap position unless that other 

position itself is held for the purpose of 

hedging or mitigating commercial risk 

as defined by the rule or CEA rule 

1.3(ttt).132

We look forward to commenters’ 

views on whether the proposed 

standard strikes an appropriate balance 

in determining which positions may be 

excluded for purposes of the first major 

participant test. We recognize that there 

are other reasonable views as to what 

positions may appropriately be 

considered to be for the purposes of 

hedging or mitigating commercial risk. 

We also recognize the importance of 

providing as clear guidance as possible 

as to what is or is not a hedging position 

for these purposes. 

The proposal also would condition 

the entity’s ability to exclude these 

security-based swap positions on the 

entity engaging in certain specified 

activities related to documenting the 

underlying risks and assessing the 

effectiveness of the hedge in connection 

with the positions.133 These activities 

are intended to help ensure that 

positions excluded for purposes of the 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80196 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

134This condition does not mandate that an entity 

follow a particular set of procedures to take 

advantage of the exclusion. We would expect that 

an entity that already engages in these types of risk 

assessment procedures in connection with its 

existing business activities to be able to rely on 

those procedures to satisfy the condition. These 

conditions also could be satisfied by the entity’s use 

of a third-party to assist with these risk assessment 

activities. 

135The references here to customers and 

counterparties do not include swap or securitybased swap counterparties. 

136For example, under this proposal an entity 

may exclude from the first major participant test a 

security-based swap used to manage the credit risk 

posed by a customer’s default in connection with 

financing that an entity provides to that customer. 

The entity may not exclude an identical securitybased swap, however, if that security-based swap is 

used to hedge the credit risk associated with a 

second swap or security-based swap that itself is 

not for the purpose of hedging or mitigating 

commercial risk. 

first major participant test would not 

extend to positions that are not entered 

into to reduce or hedge commercial 

risks, or that at a later time no longer 

substantially serve to reduce or mitigate 

such risks.134

We preliminarily believe that this 

proposed approach would facilitate the 

following types of security-based swap 

positions: 

• Positions established to manage the 

risk posed by a customer’s, supplier’s or 

counterparty’s potential default in 

connection with: financing provided to 

a customer in connection with the sale 

of real property or a good, product or 

service; a customer’s lease of real 

property or a good, product or service; 

a customer’s agreement to purchase real 

property or a good, product or service in 

the future; or a supplier’s commitment 

to provide or sell a good, product or 

service in the future; 135

• Positions established to manage the 

risk posed by a financial counterparty 

(different from the counterparty to the 

hedging position at issue) in connection 

with a separate transaction (including a 

position involving a credit derivative, 

equity swap, other security-based swap, 

interest rate swap, commodity swap, 

foreign exchange swap or other swap, 

option, or future that itself is for the 

purpose of hedging or mitigating 

commercial risk pursuant to the rule or 

CEA rule 1.3(ttt)); 

• Positions established to manage 

equity or market risk associated with 

certain employee compensation plans, 

including the risk associated with 

market price variations in connection 

with stock-based compensation plans, 

such as deferred compensation plans 

and stock appreciation rights; 

• Positions established to manage 

equity market price risks connected 

with certain business combinations, 

such as a corporate merger or 

consolidation or similar plan or 

acquisition in which securities of a 

person are exchanged for securities of 

any other person (unless the sole 

purpose of the transaction is to change 

an issuer’s domicile solely within the 

United States), or a transfer of assets of 

a person to another person in 

consideration of the issuance of 

securities of such other person or any of 

its affiliates; 

• Positions established by a bank to 

manage counterparty risks in 

connection with loans the bank has 

made; and 

• Positions to close out or reduce any 

of those positions. 

2. Request for Comments 

We request comment on the proposed 

definition of ‘‘hedging or mitigating 

commercial risk’’ for purposes of both 

the ‘‘major swap participant’’ and the 

‘‘major security-based swap participant’’ 

definitions. Commenters particularly are 

requested to address whether the 

proposed definitions would adequately 

limit the types of swaps or securitybased swaps that are encompassed by 

the definition, such that the definitions 

do not encompass positions that serve 

speculative, trading or other nonhedging purposes. In this regard, do the 

proposed definitions appropriately 

exclude from the scope of the definition 

swaps and security-based swaps that 

would be less likely to pose risks to 

counterparties and the market, by virtue 

of gains or losses on those swaps being 

offset by losses or gains associated with 

an entity’s commercial operations? 

Commenters further are requested to 

address whether the proposed 

‘‘economically appropriate’’ standard 

would effectively limit the positions 

encompassed by the definition. If not, 

what alternative standards (e.g., 

standards derived from accounting 

principles) would more effectively 

identify hedging positions and 

distinguish those from positions held 

for other purposes? In that regard, is the 

concept of ‘‘economically appropriate’’ 

well-understood, and, if not, is there 

another concept that would more 

effectively delimit the nature of the 

relationship between the swap or 

security-based swap position and the 

risk being hedged or mitigated? Also, in 

the context of the definition of this term 

for purposes of security-based swaps, 

should existing interpretive guidance 

pertaining to the concept of 

‘‘economically appropriate’’ with respect 

to the CEA’s bona fide hedging 

exemption for position limits be 

considered, and, if so, to what extent? 

We further request comment on possible 

alternative approaches to the test 

identifying positions entered into for the 

purpose of hedging or mitigating 

commercial risk. For example, should 

the test require the entity excluding a 

position to have a reasonable basis to 

believe, and to actually believe, that the 

excluded swap would be a ‘‘highly 

effective,’’ ‘‘reasonably effective’’ or 

‘‘economically appropriate’’ hedge of a 

specified commercial risk? Should the 

test be generally identical to the 

proposed test, but with the substitution 

of the phrase ‘‘highly effective’’ or 

‘‘reasonably effective’’ (or another 

standard) for ‘‘economically 

appropriate’’? Should the test be based 

on accounting principles for hedging 

treatment (i.e., a quantitative test 

requiring the hedge to be within a 

certain band of effectiveness)? 

Commenters also are requested to 

address the proposed restrictions on 

positions in the nature of speculation or 

trading. Is it appropriate not to permit 

any speculative or trading positions 

from being deemed for the purpose of 

hedging or mitigating commercial risk? 

What would be the impact of such an 

interpretation on an entity’s risk 

mitigation practices? Also, is the 

dividing line between speculative and 

trading positions on the one hand, and 

positions eligible to be considered to be 

hedging positions on the other hand, 

sufficiently clear? Is such a line 

appropriately based on whether the 

position is intended to be held for the 

short-term versus long-term intent? 

Would some alternative criteria be 

preferable in terms of setting forth 

objective standards for identifying risk 

reducing hedging positions and 

distinguishing them from other 

positions? Also, would additional 

standards or other guidance be 

appropriate to help ensure that 

positions used in connection with 

speculative or trading purposes do not 

fall within the definition? 

We further request comment on the 

proposal that a swap or security-based 

swap would not fall within the 

definition of ‘‘hedging or mitigating 

commercial risk’’ if it is held to hedge 

or mitigate the risk of another swap or 

security-based swap, unless that other 

position itself is held for the purpose of 

hedging or mitigating commercial risk. 

One consequence of this approach 

might be that a particular swap or 

security-based swap hedging a 

particular type of risk would be 

included or excluded based solely on 

whether that risk arises from another 

swap or security-based swap or from a 

different type of transaction.136 Is this 

the appropriate approach? What would 

be the consequences of this approach for 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80197 

137See CEA section 1a(33)(A)(ii); Exchange Act 

section 3(a)(67)(A)(ii)(II). 

138See proposed CEA rule 1.3(uuu)(2); proposed 

Exchange Act rule 3a67–5(b)(1). 

different types of entities? How would 

the proposed approach affect the risk 

management practices of entities that 

are close to the proposed threshold? Is 

it appropriate to include both positions 

within the major participant 

calculations? If this general approach in 

the proposed rule were adopted, should 

there be any exceptions to the 

approach? What alternative approaches 

might be considered? For example, 

would it be appropriate to exclude a 

swap or security-based swap that hedges 

another swap or security-based swap 

from the calculation? What would be 

the advantages and disadvantages of this 

approach? 

Moreover, commenters are requested 

to address whether the definition 

should encompass a quantitative test 

that would limit the total value of swaps 

and security-based swaps that an entity 

may include under this rule to be no 

more than the total value of underlying 

risk identified by such entity. If so, what 

measurement should be used for 

determining an entity’s total value of 

swaps and security-based swaps and 

total value of underlying risk, and what 

methods or procedures should entities 

be required to follow when calculating 

and comparing the two values? 

In addition, commenters are requested 

to address whether the proposed 

procedural requirements, in the context 

of this definition for purposes of the 

‘‘major security-based swap participant’’ 

analysis, are appropriate. In this regard, 

commenters are requested to discuss 

whether there are any advantages or 

disadvantages to providing more 

specific procedural requirements; 

whether the proposed procedural 

requirements will alter business 

practices to the extent that a transition 

period is necessary before they are 

implemented; and whether specific 

guidance is required to address how the 

proposed procedural requirements will 

affect existing positions. In addition, 

commenters are requested to address 

whether the proposed procedural 

requirements should include a 

requirement to quantify the underlying 

risk and the effectiveness of the hedge, 

and whether such quantitative 

assessments would impose significant 

systems costs or other costs. Also, 

should an assessment of hedging 

effectiveness be required at all, in light 

of the costs that may be associated with 

such a requirement? 

More generally, would the proposed 

standards for identifying positions for 

the purpose of hedging or mitigating 

commercial risk suffice to allow a 

person holding a security-based swap 

position to identify and document the 

commercial risks that are being hedged 

or mitigated by that position, and if not, 

what additional requirements are 

needed? Should additional guidance be 

provided regarding whether 

components of risks (in assets, liabilities 

or services) or whether risks in 

portfolios (of assets, liabilities or 

services) may be identified as the 

commercial risks that are being hedged 

or mitigated by the position, and, if so, 

which components? Also, should 

additional guidance be provided with 

respect to the form of documentation or 

the elements of the hedging relationship 

that should be documented, and, if so, 

which elements? Moreover, if a swap or 

security-based swap that was hedging at 

inception were no longer to serve a 

hedging purpose over time, should it no 

longer fall within the definition of 

hedging or mitigating commercial risk? 

In addition, should the rule specify 

the frequency with which an entity 

should assess the effectiveness of the 

hedge? Also, should we provide 

additional guidance on the acceptable 

methods of assessing effectiveness? Is a 

qualitative assessment adequate to 

assess effectiveness or should a 

quantitative assessment also be 

required? Should the rule establish a 

level of offset between the position and 

the hedged risk, below which the 

position would not be considered to be 

effective at reducing risk, and, if so, 

what is the level of offset (or range of 

levels) below which the position should 

not be considered to be effective? Are 

there methods for assessing 

effectiveness that should not be 

permitted for these purposes? 

Commenters also are requested to 

address whether the proposal also 

should encompass certain activities in 

which an entity hedges an affiliate’s 

risks. 

We further request comment on how 

the definition should apply to hedging 

activities by financial entities. 

Commenters particularly are invited to 

address whether financial entities 

should be able to rely on this exclusion, 

or whether financial entities should face 

special limits in the context of this 

exclusion. Commenters further are 

requested to address how the proposed 

provisions excluding positions in the 

nature of speculation or trading from the 

definition would apply to activities by 

banks, including permissible trading 

activities by banks, and, in particular, 

whether it is appropriate to exclude 

positions that are part of an entity’s 

‘‘trading book.’’ 

Commenters also are requested to 

address the application of the proposal 

to registered investment companies, 

including whether additional guidance 

would be appropriate with respect to 

which uses of security-based swaps by 

registered investment companies would 

fall within the exclusion. 

D. ‘‘Substantial Counterparty Exposure’’ 

The second test of the major 

participant definitions addresses 

entities whose swaps and security-based 

swaps ‘‘create substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets.’’ 137 Unlike the first 

test of the major participant definitions, 

this test does not focus on positions in 

a ‘‘major’’ category of swaps or securitybased swaps. Also, unlike the first test, 

this test does not explicitly exclude 

hedging positions or certain ERISA plan 

positions from the analysis. 

Some commenters suggested that the 

second major participant definition test 

should be interpreted in a manner 

similar to the first test. Many 

commenters stated that the analysis 

should also reflect netting agreements 

and the posting of collateral. Some 

commenters stated that the test should 

exclude hedging positions, and cleared 

positions. 

We preliminarily believe that the 

second major participant definition 

test’s focus on the counterparty risk 

associated with an entity’s swap or 

security-based swap positions is similar 

enough to the ‘‘substantial position’’ 

risks embedded in the first test that the 

second test appropriately takes into 

account the same measures of current 

uncollateralized exposure and potential 

future exposure that are used in our 

proposal for the first test. For the second 

test, however, the thresholds must focus 

on the entirety of an entity’s swap 

positions or security-based swap 

positions, rather than on positions in 

any specific ‘‘major’’ category. In 

addition, this second test does not 

explicitly account for positions for 

hedging commercial risk or ERISA 

positions. 

Accordingly, these proposed 

calculations of substantial counterparty 

exposure would be performed in largely 

the same way as the calculation of 

substantial position in the first major 

participant definition tests, except that 

the amounts would be calculated by 

reference to all of the person’s swap or 

security-based swap positions, rather 

than by reference to a specific ‘‘major’’ 

category of such positions.138

For purposes of the ‘‘major swap 

participant’’ definition, the CFTC 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80198 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

139See proposed CEA rule 1.3(uuu)(1). 

140See proposed Exchange Act rule 3a67–5(a). 

141See notes 103 to 106 and 117, supra, and 

accompanying text. 

142Thus, these proposed thresholds in part would 

account for an entity that has large positions in 

more than one major category of swaps or securitybased swaps, but that does not meet the substantial 

position threshold for either. 

143Sections 721 and 761 of the Dodd-Frank Act 

add a definition of the term ‘‘appropriate Federal 

banking agency’’ in sections 1a and 3(a) of the CEA 

and the Exchange Act, respectively, 7 U.S.C. 1a(2), 

15 U.S.C. 78c(a)(72). The Commissions propose to 

refer to those statutory definitions for purposes of 

the rules. 

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

section 3C(g)(3)(A). 

145See Cleary letter (also addressing status of 

broker-dealers and futures commission merchants 

as part of the analysis). 

The circularity would result because, for 

purposes of the end-user clearing exception, 

‘‘financial entity’’ is defined to include swap 

dealers, security-based swap dealers, major swap 

participants, and major security-based swap 

participants. 

146See proposed CEA rule 1.3(vvv)(1); proposed 

Exchange Act rule 3a67–6(a). To avoid circularity, 

the meaning of ‘‘financial entity’’ for purposes of the 

‘‘major swap participant’’ definition would not 

encompass any ‘‘swap dealer’’ or ‘‘major swap 

participant’’ (but would encompass ‘‘security-based 

swaps dealers’’ and ‘‘major security-based swap 

participants’’). The meaning of ‘‘financial entity’’ for 

purposes of the ‘‘major security-based swap 

participant’’ definition would not encompass any 

‘‘security-based swap dealer’’ or ‘‘major securitybased swap participant (but would encompass 

‘‘swap dealers’’ and ‘‘major swap participants’’). For 

both definitions, ‘‘financial entity’’ would include 

any: commodity pool (as defined in section 1a(10) 

of the CEA); private fund (as defined in section 

202(a) of the Investment Advisers Act of 1940); 

employee benefit plan as defined in paragraphs (3) 

and (32) of section 3 of the Employee Retirement 

Income Security Act of 1974; and person 

predominantly engaged in activities that are in the 

business of banking or financial in nature (as 

defined in section 4(k) of the Bank Holding 

Company Act of 1956). 

147See letter from Robert Pickel, Executive Vice 

Chairman, International Swaps and Derivatives 

Association, Inc., dated September 20, 2010 

(suggesting that ‘‘leverage ratio limits to which 

banks and other regulated entities are subject would 

be unsuitably low for other enterprises’’); letter from 

Steve Martinie, Assistant General Counsel and 

Assistant Secretary, The Northwestern Mutual Life 

Insurance Company, dated September 20, 2010 

(‘‘Northwestern Mutual letter’’) (suggesting that 

financial firms require less cushion than other 

entities because financial firms are able to match 

their assets and liabilities more closely). 

148See Northwestern Mutual letter (suggesting 

that the Commissions recognize that liabilities such 

as bank deposits and insurance policy reserves are 

not leverage); Vanguard letter (suggesting that 

leverage should relate to debt financing and should 

not encompass potential leveraging effects posed by 

derivatives); SIFMA AMG letter (suggesting that the 

Commissions take into account the difference 

between non-recourse and recourse obligations, the 

difference between notional amounts payable and 

actual payable obligations, and the difference 

between actual financial obligations and leverage 

embedded in a derivative that affects returns but 

does not result in a payment obligation). 

proposes that the second major 

participant definition test be satisfied by 

a current uncollateralized exposure of 

$5 billion, or a combined current 

uncollateralized exposure and potential 

future exposure of $8 billion, across the 

entirety of an entity’s swap positions.139

For purposes of the ‘‘major securitybased swap participant’’ definition, the 

SEC proposes that the second test be 

satisfied by a current uncollateralized 

exposure of $2 billion, or a combined 

current uncollateralized exposure and 

potential future exposure of $4 billion, 

across the entirety of an entity’s 

security-based swap positions.140 We 

look forward to commenters’ views as to 

whether alternative thresholds would be 

more appropriate to achieve the 

statutory goals. 

These proposed thresholds in part are 

based on the same factors that underpin 

the proposed ‘‘substantial position’’ 

thresholds.141 The proposed thresholds, 

however, also reflect the fact that this 

test must account for an entity’s 

positions across four major swap 

categories or two major security-based 

swap categories.142 These proposed 

thresholds, moreover, have further been 

raised to reflect the fact that this second 

test (unlike the first major participant 

test) encompasses certain hedging 

positions that, in general, we would 

expect to pose fewer risks to 

counterparties and to the markets as a 

whole than positions that are not for 

purposes of hedging. 

We request comment on this proposal. 

Commenters particularly are requested 

to address whether the proposed use of 

current uncollateralized exposure and 

potential future exposure tests 

(including the parts of those tests that 

account for positions that are cleared or 

subject to mark-to-market margining) are 

appropriate, and whether the proposed 

thresholds are set at an appropriate 

level. Should the thresholds be higher 

or lower? If so, what alternative 

threshold amounts would be more 

appropriate, and why? Commenters also 

are requested to address whether the 

test should exclude commercial risk and 

ERISA hedging positions, on the 

grounds that those hedging positions 

may not raise the same degree of risk to 

counterparties as other swap or securitybased swap positions. Comments are 

also requested on whether the test of 

substantial counterparty exposure, given 

its focus on the systemic risks arising 

from the entirety of a person’s portfolio, 

should include a measure to take into 

account the person’s combined swap 

positions and security-based swap 

positions. 

E. ‘‘Financial Entity’’ and ‘‘Highly 

Leveraged’’ 

The third test of the major participant 

definitions addresses any ‘‘financial 

entity,’’ other than one subject to capital 

requirements established by an 

appropriate Federal banking agency,143

that is ‘‘highly leveraged relative to the 

amount of capital’’ the entity holds, and 

that maintains a substantial position in 

a ‘‘major’’ category of swaps or securitybased swaps. This test does not permit 

an exclusion for positions held for 

hedging. 

As discussed below, we are proposing 

specific definitions of the terms 

‘‘financial entity’’ and ‘‘highly 

leveraged.’’ In addition, we request 

comment on whether we should include 

additional regulators within the 

proposed interpretation of what is an 

appropriate Federal banking agency. 

1. Meaning of ‘‘financial entity’’ 

While the third major participant 

definition test does not explicitly define 

‘‘financial entity,’’ Title VII of the DoddFrank Act defines ‘‘financial entity’’ in 

the context of the end-user exception 

from mandatory clearing (an exception 

that generally is not available to those 

entities).144 Some commenters have 

pointed out that using that definition 

here would produce circular results.145

We preliminarily do not believe there 

is a basis to define ‘‘financial entity’’ for 

purposes of the major participant 

definitions in a way that materially 

differs from the definition used in the 

end-user exception from mandatory 

clearing. Using the same basic definition 

also would appear to be consistent with 

the statute’s intent to treat non-financial 

end-users differently than financial 

entities. Accordingly, other than 

technical changes to avoid circularity, 

we propose to use the same definition 

in the major participant definitions.146

Commenters are requested to address 

our proposed definition of ‘‘financial 

entity.’’ 

2. Meaning of ‘‘Highly Leveraged’’ 

Some commenters have stated that the 

term ‘‘highly leveraged’’ should be 

interpreted by looking at the leverage 

associated with other firms in an 

entity’s line of business, rather than by 

applying an across-the-board measure of 

leverage.147 One commenter suggested 

that higher leverage may be warranted 

for entities with a smaller capital base, 

and another commenter suggested that 

we look at analogous banking 

regulations rather than creating a new 

regime for measuring leverage. Some 

commenters suggested ways of 

addressing specific items for purposes 

of determining leverage.148

The Commissions recognize that 

traditional balance sheet measures of 

leverage have limitations as tools for 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80199 

149The Basel Committee on Banking Supervision 

recently proposed one method for calculating riskadjusted leverage in its Consultative Document 

entitled: ‘‘Strengthening the resilience of the 

banking sector’’ (Dec. 2009). This proposal would 

create a new leverage ratio based on a comparison 

of capital to total exposure. Total exposure for these 

purposes would be measured by, among other 

things, including the notional value of all written 

credit protection, severely limiting the recognition 

given to netting, and calculating the risks associated 

with off-balance sheet derivatives transactions, as 

measured by the current exposure method for 

calculating future risks outlined in Basel II. The 

Consultative Document drew over 150 comments 

from the international financial community, which 

included both those in support of, and those that 

questioned the inclusion of a risk-adjusted leverage 

ratio within the Basel framework. The Basel 

Committee on Banking Supervision expects to 

deliver a full package of reforms by the end of 2010, 

based on the Consultative Document released in 

December 2009 and comments received thereon. 

150See Dodd-Frank Act section 165(j)(1). 

151These entities would include those that 

submit periodic reports on a voluntary basis to the 

SEC, as well as those that are required to file 

periodic reports with the SEC. 

152 In this regard, we recognize that under 

Exchange Act rule 15c3–1, a broker-dealer may 

determine its required minimum net capital, among 

other ways, by applying a financial ratio that 

provides that its aggregate indebtedness shall not 

exceed 1500% of its net capital (i.e., a 15 to 1 

aggregate indebtedness to net capital ratio). 

Exchange Act Rule 17a–11 further requires that 

broker-dealers that use such method to establish 

their required minimum net capital must provide 

notice to regulators if their aggregate indebtedness 

exceeds 1200% of their net capital (i.e., a 12 to 1 

aggregate indebtedness to net capital ratio). We 

recognize that these measures, however, reflect a 

different ratio of total liabilities to equity; for 

example, the calculation of aggregate indebtedness 

in rule 15c3–1 excludes certain liabilities, and the 

calculation of net capital includes certain 

subordinated debt—meaning that these measures 

would respectively be equivalent to ratios higher 

than 15:1 or 12:1 when converted to a balance sheet 

ratio of liabilities to equity such as that used under 

the proposed rule. 

evaluating an entity’s ability to meet its 

obligations. In part this is because such 

measures of leverage do not directly 

account for the potential risks posed by 

specific instruments on the balance 

sheet, or financial instruments that are 

held off of an entity’s balance sheet (as 

may be the case with an entity’s swap 

and security-based swap positions). At 

the same time, we preliminarily do not 

believe that it is necessary to use more 

complex measures of risk-adjusted 

leverage here, particularly given that the 

third test in the major participant 

definitions already addresses those 

types of risks by considering whether an 

entity has a substantial position in a 

major category of swaps or securitybased swaps. We are also mindful of the 

costs that entities would face if forced 

to undertake a complex risk-adjusted 

leverage calculation, especially for 

entities that would not already be 

performing this type of analysis.149

Additionally, we preliminarily do not 

believe that it is necessary for the 

leverage standard to account for the 

degree of leverage associated with 

different types of financial entities. 

Although the third test of the major 

participant definitions does not define 

‘‘highly leveraged,’’ we note that 

Congress addressed the issue of leverage 

in Title I of the Dodd-Frank Act. There, 

Congress provided that the Board of 

Governors of the Federal Reserve 

System must require a bank holding 

company with total consolidated assets 

equal to or greater than $50 billion, or 

a nonbank financial company 

supervised by the Board of Governors, 

to maintain a debt to equity ratio of no 

more than 15 to 1 if the FSOC 

determines ‘‘that such company poses a 

grave threat to the financial stability of 

the United States and that the 

imposition of such requirement is 

necessary to mitigate the risk that such 

company poses to the financial stability 

of the United States.’’ 150

This requirement in Title I suggests 

potential alternative approaches to the 

definition of ‘‘highly leveraged’’ for 

purposes of the major participant 

definitions. On the one hand, the 15 to 

1 limit may represent an upper limit of 

acceptable leverage, indicating that the 

limit for the major participant 

definitions should be lower so as to 

create a buffer between entities at that 

upper limit and entities that are not 

highly leveraged. On the other hand, the 

Title 1 requirement, which applies only 

when the entity in question poses a 

‘‘grave threat’’ to financial stability, may 

indicate that the 15 to 1 leverage ratio 

is also the appropriate test of whether 

an entity poses the systemic risk 

concerns implicated by the major 

participant definitions. 

For these reasons, we propose two 

possible definitions of the point at 

which an entity would be ‘‘highly 

leveraged’’—either an entity would be 

‘‘highly leveraged’’ if the ratio of its total 

liabilities to equity is in excess of 8 to 

1, or an entity would be ‘‘highly 

leveraged’’ if the ratio of its total 

liabilities to equity is in excess of 15 to 

1. In either case, the determination 

would be measured at the close of 

business on the last business day of the 

applicable fiscal quarter. To promote 

consistent application of this leverage 

test, entities that file quarterly reports 

on Form 10–Q and annual reports on 

Form 10–K with the SEC would 

determine their total liabilities and 

equity based on the financial statements 

included with such filings.151 All other 

entities would calculate the value of 

total liabilities and equity consistent 

with the proper application of U.S. 

generally accepted accounting 

principles. 

We believe that the 15 to 1 ratio could 

be consistent with the use of that ratio 

in Title I, which, as noted above, 

provides that the 15 to 1 leverage ratio 

would be applied to a bank holding 

company or nonbank financial company 

subject to Title I as a maximum only if 

it is determined that the company poses 

a ‘‘grave threat’’ to financial stability. 

Commenters are requested to address 

whether the proposed 15 to 1 standard 

used in Title I suggests that a standard 

higher than 15 to 1 should be used here, 

given that the Title I standard is 

applicable only to large entities that also 

pose a ‘‘grave threat’’ to financial 

stability and thus may suggest that a 

higher standard is appropriate for 

entities that do not pose the same degree 

of threat. Alternatively, the 8 to 1 ratio 

could be consistent with the exemption 

in the third test of the major participant 

definitions for financial institutions that 

are subject to capital requirements set 

by the Federal banking agencies, as it is 

possible that financial institutions were 

specifically excluded from the third test 

based on the presumption that they 

generally are highly leveraged, and 

hence would have been covered by the 

third test if they were not expressly 

exempted. Based on our analysis of 

financial statements it appears that 

those institutions generally have 

leverage ratios of approximately 10 to 1, 

which may suggest that the ‘‘highly 

leveraged’’ threshold would have to be 

lower for those institutions to be 

potentially subject to the third test. 

Such an approach would help to ensure 

that the third test of the major 

participant definition applies to 

financial entities that are not subject to 

capital requirements set by the Federal 

banking agencies, but that have leverage 

ratios similar to institutions that are 

subject to those requirements. 

The Commissions request comment 

on the proposed alternative definitions 

of ‘‘highly leveraged.’’ Commenters 

particularly are requested to specifically 

address the relative merits of the 

proposed alternative 8 to 1 and 15 to 1 

standards, as well as other standards 

that they believe would be appropriate 

for these purposes.152

Commenters further are requested to 

address whether a risk-adjusted leverage 

ratio should be used, and, if so, how the 

ratio should be calculated (including 

whether particular items should be 

included or excluded when making this 

calculation), and whether a riskadjusted leverage ratio could be 

developed relying on measures already 


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80200 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

153For example, would adjustments akin to those 

discussed above in the context of broker-dealer net 

capital provide a more useful measure of leverage 

for these purposes? 

154See proposed CEA rule 1.3(qqq)(4)(i); 

proposed Exchange Act rule 3a67–7(a). The 

Commissions are proposing separate rules regarding 

the registration requirements and processes for 

major participants. 

155Commenters raised concerns over an entity 

qualifying as a major participant due to an unusual 

event. See, e.g., letter from American Benefits 

Council and Committee on the Investment of 

Employee Benefit Assets, dated September 20, 2010 

(stating that quirky volatility may affect the 

determinations). 

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

proposed Exchange Act rules 3a67–7(b). 

157See proposed CEA rule 1.3(qqq)(5); proposed 

Exchange Act rules 3a67–7(c)(1). 

158See Vanguard letter (suggesting that entities 

should remain in the status after qualification for 

an extended defined period such as one calendar 

year); AIMA letter (noting that recategorization of 

entities could be disruptive for entities’ business 

models and could be administratively burdensome 

for the Commissions). 

159See proposed CEA rule 1.3(qqq)(2); proposed 

Exchange Act rule 3a67–1(c). 

160CEA section 1a(33)(C); Exchange Act section 

3(a)(67)(C). 

calculated by entities as a matter of 

course.153 Commenters further are 

requested to address whether the 

leverage ratio should be revised to 

require that the amount of potential 

future exposure (as outlined in the 

‘‘substantial position’’ discussion above) 

be combined with total liabilities before 

such number is compared to equity for 

purposes of calculating the ratio, and, if 

so, whether the proposed ratios would 

still be appropriate; whether the rule 

should more specifically address issues 

as to how certain types of positions or 

liabilities should be accounted for when 

calculating leverage; whether the 

proposed timing of the measurement— 

the close of business on the last 

business day of the applicable fiscal 

quarter—would be potentially subject to 

gaming or evasion; and whether the rule 

text should particularly prescribe how 

separate categories of entities calculate 

leverage. 

F. Implementation Standard, 

Reevaluation Period and Minimum 

Duration of Status 

While the analysis of whether an 

entity is a major participant is backward 

looking, an entity that meets the criteria 

for being a major participant is required 

to register with the CFTC and/or the 

SEC, and comply with the requirements 

applicable to major participants. We 

recognize that these entities will need 

time to complete their applications for 

registration and to come into 

compliance with the applicable 

requirements. We thus propose that an 

unregistered entity that meets the major 

participant criteria as a result of its 

swap or security-based swap activities 

in a fiscal quarter would not be deemed 

to be a major participant until the earlier 

of the date on which it submits a 

complete application for registration 

pursuant to CEA Section 4s(b) or 

Exchange Act Section 15F(b), or two 

months after the end of that quarter.154

We preliminarily believe that this 

would provide entities with an 

appropriate amount of time to apply for 

registration and, with the time between 

the submission of an application and 

the effectiveness of the registration, to 

comply with the requirements 

applicable to major participants, 

without permitting undue delay. 

We also propose to provide a 

reevaluation for entities that meet one or 

more of the applicable major participant 

thresholds, but only by a modest 

amount.155 In particular, an 

unregistered entity that has met these 

criteria as a result of its swap or 

security-based swap activities in a fiscal 

quarter, but without exceeding any 

applicable threshold by more than 

twenty percent, would not immediately 

be subject to the timing requirements 

discussed above. Instead, that entity 

would become subject to those 

requirements if the entity exceeded any 

of the applicable daily average 

thresholds in the next fiscal quarter.156

We preliminarily believe this type of 

reevaluation period would avoid 

applying the major participant 

requirements to entities that meet the 

major participant criteria for only a 

short time due to unusual activity. 

In addition, we propose that any 

entity that is deemed to be a major 

participant would retain that status 

until such time that it does not exceed 

any of the applicable thresholds for four 

consecutive quarters after the entity 

becomes registered.157 Commentators 

raised concerns about the possibility of 

entities moving in and out of the status 

on a rapid basis,158 and we believe that 

this proposal appropriately addresses 

that concern in a way that would help 

promote the predictable application and 

enforcement of the requirements 

governing major participants. 

The Commissions request comment 

on these proposals. Commenters 

particularly are requested to address: 

Whether two months is an adequate 

amount of time for entities that have 

met the criteria to submit an application 

for registration; whether there is an 

adequate amount of time to make the 

necessary internal changes to come into 

compliance with the requirements 

applicable to major participants before 

being subject to those requirements as a 

result of a registration becoming 

effective; whether twenty percent is the 

appropriate threshold for applicability 

of the reevaluation period; whether 

there would be any risks arising from 

delaying registration as a major 

participant for an entity that exceeds the 

thresholds, but qualifies for the 

reevaluation period; and whether four 

consecutive quarters of not meeting the 

criteria for major participant status after 

registration is granted is the appropriate 

amount of time that a major participant 

should be required to stay in the status. 

In addition, we request comment on 

the appropriateness of the proposed 

reevaluation period. Commenters 

particularly are requested to address 

whether it is likely that unusual market 

conditions could cause an entity to 

exceed the proposed thresholds over the 

course of a quarter (based on a daily 

average) without generally raising the 

types of risks that the thresholds were 

intended to identify. Also, should the 

use of the reevaluation period be 

conditioned on requiring any entity 

relying on the reevaluation period to 

make a representation, or otherwise 

demonstrate, that it exceeded the 

threshold due to a one-time 

extraordinary event, and that it will be 

below the threshold at the next time of 

measurement? 

G. Limited Purpose Designations 

In general, a person that meets the 

definition of major participant will be 

considered to be a major participant 

with respect to all categories of swaps 

or security-based swaps, as applicable, 

and with regard to all activities 

involving those instruments.159 As 

discussed above, however, the statutory 

definitions provide that a person may be 

designated as a major participant for one 

or more categories of swaps or securitybased swaps without being classified as 

a major participant for all categories.160

Thus, as with the definitions of ‘‘swap 

dealer’’ and ‘‘security-based swap 

dealer,’’ we propose to provide that 

major participants who engage in 

significant activity with respect to only 

certain types, classes or categories of 

swaps or security-based swaps may 

apply for relief with respect to other 

types of swaps or security-based swaps 

from certain of the requirements that are 

applicable to major participants. The 

Commissions anticipate that a major 

participant could seek a limited 

designation at the same time as, or at a 

later time subsequent to, the person’s 

initial registration as a major 

participant. Because of the variety of 

situations in which major participants 


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161See Cleary letter (addressing welfare plans or 

entities holding assets of such plans, such as 

voluntary employee beneficiary associations, 

employer group trusts or bank-maintained 

collective trusts); see also letter from Jane Hamblen, 

State of Wisconsin Investment Board, dated 

September 20, 2010. 

162 In addition, a colloquy on the Senate floor 

addressed the status of managed accounts for 

purposes of the major participant definitions, 

particularly focusing on whether the analysis 

should ‘‘look at the aggregate positions of funds 

managed by asset managers or at the individual 

fund level?’’ In response, it was stated that, ‘‘[a]s a 

general rule, the CFTC and the SEC should look at 

each entity on an individual basis when 

determining its status as a major swap participant.’’ 

See 156 Cong. Rec. S5907 (daily ed. July 15, 2010) 

(colloquy between Senators Hagan and Lincoln). 

163See Dodd-Frank Act sections 721(b)(2), 

761(b)(3). 

164This guidance relates only to the application 

of the major participant definitions to managed 

accounts. It is not intended to apply to the 

treatment of managed accounts with respect to any 

other rules promulgated by the CFTC or SEC to 

implement Title VII of the Dodd-Frank Act or to any 

other applicable rules or requirements. 

may enter into swaps or security-based 

swaps, it is difficult to set out at this 

time the conditions, if any, which 

would allow a person to be designated 

as a major participant with respect to 

only certain types, classes or categories 

of swaps or security-based swaps. 

The Commissions request comment 

on the proposed rules regarding limited 

designation as a major participant. 

Commenters particularly are requested 

to address the circumstances in which 

such limited purpose designations 

would be appropriate, and to address 

the factors that the Commissions should 

consider when addressing such 

requests, and the type of information 

requestors should provide in support of 

their request. Commenters also are 

asked to address whether such limited 

purpose designations should be 

conditioned in any way, such as by the 

provision of information of the type that 

would be required with respect to an 

entity’s swaps or security-based swaps 

involving the particular category or 

activity for which they are not 

designated as a major participant. 

H. Additional Interpretive Issues 

Commenters have raised additional 

issues related to the major participant 

definitions. 

1. Exclusion for ERISA Plan Positions 

As discussed above, the first test of 

the major participant definitions 

excludes from the analysis ‘‘positions 

maintained by any employee benefit 

plan (or any contract held by such a 

plan) as defined in paragraphs (3) and 

(32) of section 3 of ERISA (29 U.S.C. 

1002) for the primary purpose of 

hedging or mitigating any risk directly 

associated with the operation of the 

plan.’’ Some commenters suggested that 

the exclusion should encompass 

activities such as portfolio rebalancing 

and diversification, and gaining 

exposure to alternative asset classes, 

and that this type of exclusion also 

should apply to certain other types of 

entities.161

We preliminarily do not believe that 

it is necessary to propose a rule to 

further define the scope of this 

exclusion. In this regard, we note that 

this ERISA plan exclusion, unlike the 

other exclusion in the first major 

participant test, is not limited to 

‘‘commercial’’ risk, which may be 

construed to mean that hedging by 

ERISA plans should be broadly 

excluded. 

While the Commissions are not 

proposing to make this type of exclusion 

available to additional types of entities, 

we request comment on whether we 

should do so. If so, what type of entities 

should receive this type of exclusion, 

and why do the concerns that led to the 

enactment of the major participant 

requirements in the Dodd-Frank Act not 

apply to such entities? 

2. Application of Major Participant 

Definitions to Managed Accounts 

Some commenters have stated that 

asset managers and investment advisers 

should not be deemed to be major 

participants by virtue of the swap and 

security-based swap positions held by 

the accounts they manage. These 

commenters have emphasized that asset 

managers and investment advisers are 

separate legal entities from the accounts 

that they administer, the accounts 

themselves are the counterparties to the 

swaps and security-based swaps, and 

managers and advisers do not maintain 

capital to support the trades of their 

clients. One commenter also expressed 

the view that the positions of individual 

accounts under the advisement of a 

single asset manager should not be 

aggregated for the purpose of the major 

participant definitions because different 

accounts managed by an asset manager 

may use the same positions for different 

purposes.162

Preliminarily, we do not believe that 

the major participant definitions should 

be construed to aggregate the accounts 

managed by asset managers or 

investment advisers to determine if the 

asset manager or investment adviser 

itself is a major participant. The major 

participant definitions apply to the 

entities that actually ‘‘maintain’’ 

substantial positions in swaps and 

security-based swaps or that have swaps 

or security-based swaps that create 

substantial counterparty exposure. The 

Commissions have the authority to 

adopt anti-evasion rules to address the 

possibility that persons who enter into 

swaps and security-based swaps may 

attempt to allocate the swaps and 

security-based swaps among different 

accounts (thereby attempting to treat 

such other accounts as the entity that 

has entered into the swaps or securitybased swaps) for the purpose of evading 

the regulations applicable to major 

participants.163 In addition, we note that 

since the major participant definitions 

focus on the entity that enters into 

swaps or security-based swaps, all of the 

managed positions of which a person is 

the beneficial owner are to be aggregated 

(along with such beneficial owner’s 

other positions) for purposes of 

determining whether such beneficial 

owner is a major participant.164

The Commissions request comment 

on the application of the major 

participant definitions to managed 

accounts. Commenters particularly are 

requested to address: whether 

additional guidance is necessary to 

address issues relating to the 

application of the major participant 

definition to managed accounts; 

whether there are areas of potential 

abuse, and if so, what they may be. 

Commenters further are requested to 

address whether the Commissions 

should adopt anti-evasion rules to 

address areas of potential abuse, and if 

so, how such rules should be crafted. 

In addition, commenters are requested 

to discuss any implementation concerns 

that may arise if the beneficial owner of 

a managed account meets one of the 

major participant definitions; for 

example, would the beneficial owner 

face any impediments in terms of 

identifying whether it falls within the 

major participant definitions? Also, 

what implementation issues would arise 

with respect to applying the major 

participant definitions to managed 

accounts and/or their beneficial owners 

if the accounts’ advisers or managers are 

not subject to regulation as major 

participants? 

3. Application of Major Participant 

Definitions to Positions of Affiliated 

Entities 

The issues discussed above with 

regard to managed accounts also are 

related to the separate issue of whether 

the major participant tests should, in 

some circumstances, aggregate the swap 

and security-based swap positions of 

entities that are affiliated. Absent that 

type of aggregation, an entity could seek 

to evade major participant status by 

allocating swap or security-based swap 


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80202 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

165Arguably, the basis for this type of attribution 

would be even stronger if the parent wholly owns 

the subsidiary. An attribution rule that only 

addresses 100 percent ownership situations, 

however, may readily be susceptible to gaming if 

the parent were to sell a very small interest in the 

subsidiary to another party. 

166 It may also be appropriate to address these 

issues in connection with the rule proposals 

addressing the substantive requirements applicable 

to major participants. 

167Such swaps and security-based swaps should 

be considered in this way only for purposes of 

determining whether a particular person is a major 

participant. The swaps and security-based swaps 

would continue to be subject to all laws and 

requirements applicable to such swaps and 

security-based swaps. 

168See letter from Karrie McMillan, General 

Counsel, Investment Company Institute, dated 

September 20, 2010 (registered investment 

companies should be excluded from the major 

participant (and dealer) definitions, or else the 

terms of the definitions should be interpreted to 

clarify that mutual funds generally will not be 

major participants). 

positions among a number of affiliated 

entities. 

In situations in which a parent is the 

majority owner of a subsidiary entity, 

we preliminarily believe that the major 

participant tests may appropriately 

aggregate the subsidiary’s swaps or 

security-based swaps at the parent for 

purposes of the substantial position 

analyses.165 Attributing those positions 

to a parent appears consistent with the 

concepts of ‘‘substantial position’’ and 

‘‘substantial counterparty exposure,’’ 

given that the parent would effectively 

be the beneficiary of the transaction. In 

those circumstances, however, there 

still may be questions as to whether the 

requirements applicable to major 

participants—e.g., capital, margin and 

business conduct—should be placed 

upon the parent or the subsidiary. We 

recognize that it may be appropriate at 

times to apply such requirements upon 

the subsidiary to the extent that the 

subsidiary is acting on behalf of the 

parent.166

Commenters particularly are invited 

to discuss when it would be appropriate 

to apply the major participant 

definitions to entities that are the 

majority owner of subsidiaries that enter 

into swaps or security-based swaps, or 

whether attribution of a subsidiary’s 

security-based swap positions is 

generally inappropriate. Also, to the 

extent this type of attribution is 

appropriate, to what extent should the 

subsidiary retain responsibilities for 

complying with the capital, margin, 

business conduct and other 

requirements applicable to major 

participants? 

Commenters further are requested to 

address whether the swaps or securitybased swaps of corporate subsidiaries in 

some circumstances should be 

attributed to an entity that itself is not 

the majority owner of the direct 

counterparty to a swap or security-based 

swap. Moreover, should this type of 

attribution apply when one entity 

controls another entity, and, if so, how 

should the concept of control be defined 

for these purposes? In addition, 

commenters are requested to address 

whether, as an alternative approach, this 

type of attribution would be appropriate 

specifically when a parent provides 

guarantees on behalf of its subsidiaries, 

or third parties provide guarantees on 

behalf of unaffiliated entities. 

Commenters further are requested to 

address any issues that would arise with 

regard to the effective implementation 

of the requirements applicable to major 

participants in the context of this type 

of attributions. 

4. Application of Major Participant 

Definitions to Inter-Affiliate Swaps and 

Security-Based Swaps 

Several commenters have suggested 

that swaps and security-based swaps 

between affiliated counterparties should 

not be considered within the analysis of 

whether an entity’s swap or securitybased swap positions cause it to be a 

major participant. Such inter-affiliate 

swaps and security-based swaps may be 

used to achieve various operational and 

internal efficiency objectives. 

The Commissions preliminarily 

believe that when a person analyzes its 

swap or security-based swap positions 

under the major participant definitions, 

it would be appropriate for the person 

to consider the economic reality of any 

swaps or security-based swaps it enters 

into with wholly owned affiliates, 

including whether the swaps and 

security-based swaps simply represent 

an allocation of risk within a corporate 

group.167 Such swaps and securitybased swaps among wholly-owned 

affiliates may not pose the exceptional 

risks to the U.S. financial system that 

are the basis for the major participant 

definitions. As discussed above in the 

context of managed accounts, however, 

an entity would not be able to evade the 

requirements applicable to major 

participants by allocating among 

multiple affiliates swap or securitybased swap positions of which it is the 

beneficial owner. 

The Commissions request comment 

on the treatment of inter-affiliate swaps 

and security-based swaps between 

wholly-owned affiliates of the same 

corporate parent in connection with the 

major participant definitions. 

Commenters also are requested to 

address whether similar interpretations 

should apply to swaps and securitybased swaps between entities within a 

consolidated group as determined in 

accordance with U.S. generally accepted 

accounting principles. Commenters 

further are requested to discuss whether 

the major participant definition should 

be interpreted to encompass an entity 

(including an affiliate of the named 

counterparty to the swap or securitybased swap) that provides a guarantee of 

the named counterparty’s obligations, 

either in the form of a guarantee or 

through some other form of credit 

support whereby the guarantor agrees to 

satisfy margin obligations of the named 

counterparty and/or periodic payment 

obligations of the named counterparty. 

5. Legacy Portfolios 

Some commenters have stated that 

certain entities that maintain legacy 

portfolios of credit default swaps that 

previously had been entered into in 

connection with the activities of 

monoline insurers and ‘‘credit derivative 

product companies’’ should not be 

considered major participants. The 

commenters argued that these entities 

would be unable to comply with the 

capital and margin requirements 

applicable to major participants, and 

that regulation as major participants is 

unnecessary given that the entities are 

not writing any additional swaps or 

security-based swaps. 

We request comment on whether the 

rules further defining major swap 

participant and major security-based 

swap participant should exclude such 

entities from the major participant 

definition if their swap and securitybased swap positions are limited to 

those types of legacy positions. The 

exclusion from the definition could be 

conditional, and any such excluded 

entity would be required to provide the 

Commissions with position information 

of the type that registered major 

participants would be required to 

provide. We invite comment on any 

other conditions that might be 

appropriate to an exclusion of such 

legacy portfolios from the major 

participant definitions. 

6. Potential Exclusions 

Some commenters stated that the 

major participant definitions should not 

be interpreted to apply to entities such 

as investment companies,168 ERISA 

plans, registered broker-dealers and/or 

registered futures commission 


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169See letter from The Swaps & Derivatives 

Marketing Ass’n, dated September 20, 2010 (certain 

hedged positions of broker-dealers and futures 

commission merchants with customers should not 

be considered as part of the substantial position 

analysis); Cleary letter (registered and wellcapitalized broker-dealers and futures commission 

merchants should not fall within the scope of the 

third major participant test). 

170See letter from Lee Ming Chua, General 

Counsel, Government of Singapore Investment 

Corp., dated September 20, 2010 (stating that the 

major participant definitions were not intended to 

apply to long-term financial investors); see also 

letter from Richard M. Whiting, The Financial 

Services Roundtable, dated September 20, 2010 

(major participant definitions should exclude firms 

that solely act as investors). 

171 5 U.S.C. 601 et seq. 

172 44 U.S.C. 3501 et seq. 

173 7 U.S.C. 19(a). 

merchants,169 and long-term investors 

such as sovereign wealth funds.170

These comments, and the rationale 

behind the comments, raise the issue of 

whether we should exclude, 

conditionally or unconditionally, 

certain types of entities from the major 

participant definitions, on the grounds 

that such entities do not present the 

risks that underpin the major 

participant definitions and/or to avoid 

duplication of existing regulation. While 

we are not proposing any such 

exclusions, we request comment as to 

whether we should exclude certain 

types of entities, including those noted 

above, as well as to entities subject to 

bank capital rules, State-regulated 

insurers, private and State pension 

plans, and registered derivatives 

clearing organizations or clearing 

agencies. 

Commenters particularly are 

requested to address whether such 

exclusions are necessary and 

appropriate in light of the proposed 

rules that would be applicable to major 

participants, whether any conditions 

would be appropriate for such 

exclusions, and whether modifying 

those proposed rules would more 

effectively address these issues than 

granting specific exclusions from the 

major participant definitions for specific 

types of entities. Commenters also are 

particularly requested to discuss 

whether banks should be excluded from 

the major participant definitions 

because of the regulation to which they 

already are subject. Commenters also are 

requested to discuss whether registered 

investment companies should be 

excluded from the major participant 

definitions because of the regulations to 

which they already are subject, and 

whether registered investment 

companies would be able to comply 

with capital and margin requirements 

applicable to major participants. 

Commenters also particularly are 

requested to address whether sovereign 

wealth funds or other entities linked to 

foreign governments should be excluded 

from the major participant definitions, 

particularly in light of the provisions of 

the Dodd-Frank Act governing its 

territorial reach, and whether the 

answer in part should be determined 

based on whether the entity’s 

obligations are backed by the full faith 

and credit of the foreign government. 

V. Administrative Law Matters—CEA 

Revisions (Definitions of ‘‘Swap Dealer’’ 

and ‘‘Major Swap Participant,’’ and 

Amendments to Definition of ‘‘Eligible 

Contract Participant’’) 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

requires that agencies consider whether 

the rules they propose will have a 

significant economic impact on a 

substantial number of small entities 

and, if so, provide a regulatory 

flexibility analysis respecting the 

impact.171 The rules proposed by the 

CFTC provide definitions that will 

largely be used in future rulemakings 

and which, by themselves, impose no 

significant new regulatory requirements. 

Accordingly, the Chairman, on behalf of 

the CFTC, hereby certifies pursuant to 5 

U.S.C. 605(b) that the proposed rules 

will not have a significant economic 

impact on a substantial number of small 

entities. 

B. Paperwork Reduction Act 

The proposed rule will not impose 

any new recordkeeping or information 

collection requirements, or other 

collections of information that require 

approval of the Office of Management 

and Budget under the Paperwork 

Reduction Act.172 The CFTC invites 

public comment on the accuracy of its 

estimate that no additional 

recordkeeping or information collection 

requirements or changes to existing 

collection requirements would result 

from the rules proposed herein. 

C. Cost-Benefit Analysis 

Section 15(a) of the CEA 173 requires 

the CFTC to consider the costs and 

benefits of its actions before issuing a 

rulemaking under the CEA. By its terms, 

Section 15(a) does not require the CFTC 

to quantify the costs and benefits of a 

rule or to determine whether the 

benefits of the rulemaking outweigh its 

costs; rather, it requires that the CFTC 

‘‘consider’’ the costs and benefits of its 

actions. Section 15(a) further specifies 

that the costs and benefits shall be 

evaluated in light of five broad areas of 

market and public concern: (1) 

Protection of market participants and 

the public; (2) efficiency, 

competitiveness, and financial integrity 

of futures markets; (3) price discovery; 

(4) sound risk management practices; 

and (5) other public interest 

considerations. The CFTC may in its 

discretion give greater weight to any one 

of the five enumerated areas and could 

in its discretion determine that, 

notwithstanding its costs, a particular 

rule is necessary or appropriate to 

protect the public interest or to 

effectuate any of the provisions or 

accomplish any of the purposes of the 

CEA. 

1. Summary of Proposed Requirements 

The proposed regulations would 

further define the terms ‘‘swap dealer,’’ 

‘‘eligible contract participant,’’ ‘‘major 

swap participant,’’ and related terms, 

including ‘‘substantial position’’ and 

‘‘substantial counterparty exposure.’’ 

The proposed regulations regarding 

eligible contract participants are 

clarifying changes that are not expected 

to have substantive effects on market 

participants. The proposed regulations 

further defining swap dealer and major 

swap participant are significant because 

any entity determined to be a swap 

dealer or major swap participant would 

be subject to registration, margin, 

capital, and business conduct 

requirements set forth in the DoddFrank Act, as those requirements are 

implemented in rules proposed or to be 

proposed by the CFTC. Those 

requirements will likely lead to 

compliance costs, capital holding costs, 

and margin posting costs, which have 

been or will be addressed in the CFTC’s 

proposals to implement those 

requirements. On the other hand, those 

requirements will likely lead to benefits 

in the form of increased market 

transparency, reduced counterparty risk 

and a lower incidence of systemic crises 

and other market failures. This 

discussion concerns the costs and 

benefits arising from the proposed 

definitional tests themselves, in terms of 

the burden on market participants to 

determine how the proposed definitions 

apply, and the benefits arising from the 

specificity of the proposals. 

2. Proposed Regulations Regarding 

‘‘Eligible Contract Participant’’ 

The proposal regarding ‘‘eligible 

contract participant’’ would provide that 

swap dealers and major swap 

participants would qualify as eligible 

contract participants. The CFTC 

believes this proposal is in line with the 

expectations of market participants and 

would impose virtually no costs while 

providing the benefit of greater 

certainty. The proposal would also 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80204 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

provide that certain commodity pools 

could not qualify as eligible contract 

participants under certain provisions 

specified in the proposal. The CFTC 

believes that this proposal clarifies the 

interpretation of this aspect of the 

eligible contract participant definition 

and would prevent the commodity 

pools from using a provision of the 

definition that was not intended to 

apply to the commodity pools. Thus, 

while the proposal would potentially 

impose some costs on the commodity 

pools that could no longer rely on 

certain provisions of the definition, 

benefits would arise from preventing the 

misinterpretation of the definition. 

3. Proposed Regulations Regarding 

‘‘Swap Dealer’’ 

The proposal regarding ‘‘swap dealer’’ 

would further define the term by 

providing that any person that engages 

in specified activities is a swap dealer. 

The proposal describes these activities 

qualitatively and in relatively general 

terms that apply in the same way to all 

parts of the swap markets. With regard 

to the de minimis exemption from the 

definition, the proposal sets out brightline quantitative tests to determine if a 

person’s swap dealing activity is de 

minimis. For the exclusion of swaps in 

connection with originating a loan by an 

insured depository institution, the 

proposal describes the scope of the 

exclusion qualitatively in terms that 

depend primarily on the terms of the 

swaps that would be eligible for the 

exclusion and the identity of the parties 

to the swap. Also, the proposal includes 

a voluntary process by which a swap 

dealer may request that the CFTC limit 

the swap dealer designation to certain 

aspects of the person’s activity. 

a. Costs 

The costs to a market participant from 

the proposed regulations further 

defining ‘‘swap dealer’’ would arise 

primarily from its need to review its 

activities and determine, as a qualitative 

matter, whether its activities are of the 

type described in the proposal. As its 

activities change from time to time, it 

would be necessary to repeat this 

review, and ongoing compliance costs 

may arise if the market participant 

determines that it should adapt its 

activities so as to not be encompassed 

by the definition. Because the proposed 

regulations are qualitative and on 

relatively general terms, there may be 

multiple interpretations of the general 

criteria by market participants. A market 

participant whose activities fall within 

the realm of those described in the 

proposal may have to incur the costs of 

a more focused review to determine 

whether or not it is encompassed by the 

definition. 

The proposal regarding the de 

minimis exemption, on the other hand, 

would impose lower costs because of 

the precise, quantitative nature of the 

proposed exemption. A market 

participant would incur only the cost of 

determining the applicable quantities, 

such as notional value, number of 

swaps, number of counterparties, and so 

forth set out in the proposal. The CFTC 

believes that relatively few market 

participants would have to determine 

whether the de minimis exemption 

applies to their activities, and there 

would be only a low number of 

instances where application of the 

quantitative tests would be uncertain. 

Similarly, the CFTC believes that 

insured depository institutions would 

incur relatively low costs to apply the 

proposed exclusion of swaps in 

connection with originating loans 

because the proposed criteria relate to 

matters in which the institution is 

directly involved. 

Last, the costs of the voluntary 

process for a request for a limited 

designation as a swap dealer are 

difficult to predict because they would 

depend on the complexity of the person 

making the request and the particular 

factors that are relevant to the limited 

designation. The CFTC believes that the 

person making the request would have 

broad discretion in determining how to 

do so and thereby could control the 

costs of the request to some extent. 

b. Benefits 

The benefits of the proposed 

regulations further defining ‘‘swap 

dealer’’ include that they set out a single 

set of criteria to be applied by all market 

participants. Thus, the proposed 

regulations create a level playing field 

that permits all market participants to 

determine, on an equal basis, which 

activities would potentially lead to 

designation as a swap dealer. The 

proposed regulations are set out in plain 

language terms that may be understood 

and applied by all market participants 

without relying on the technical 

expertise that may be required to 

implement more elaborate tests. The 

CFTC believes that the proposal can be 

fairly applied by substantially all market 

participants who could potentially be 

swap dealers. 

Regarding the proposals regarding the 

de minimis exemption and the 

exclusion of swaps in connection with 

the origination of loans, benefits arise 

from the relatively specific, quantitative 

nature of the proposals. Since these 

proposals are expected to be applied by 

relatively few market participants in 

limited situations, more detailed 

regulations are appropriate. The CFTC 

believes that these detailed criteria will 

permit market participants to make a 

relatively quick and low-cost 

determination of whether the exemption 

or exclusion apply. The proposal for 

requests for a limited swap dealer 

designation provides the benefit of 

flexibility to allow each market 

participant making this request to 

determine how to do so. 

4. Proposed Regulations Regarding 

‘‘Major Swap Participant’’ 

The proposal regarding ‘‘major swap 

participant’’ would further define the 

term by setting out quantitative 

thresholds against which a market 

participant would compare its swap 

activities to determine whether it is 

encompassed by the definition. The 

proposal would require that potential 

major swap participants analyze their 

swaps in detail to determine, for 

example, which of their swaps are 

subject to netting agreements or markto-market collateralization and the 

amount of collateral posted with respect 

to the swaps. The proposal includes a 

general, qualitative definition of the 

swaps that may be excluded from the 

comparison because they are used to 

‘‘hedge or mitigate commercial risk.’’ 

Like the swap dealer proposal, there is 

a voluntary process by which a major 

swap participant may request that the 

CFTC limit the major swap participant 

designation to certain aspects of the 

person’s activity. 

a. Costs 

The costs to a market participant from 

the proposed regulations further 

defining ‘‘major swap participant’’ 

would arise primarily from its need to 

analyze its swaps and determine 

whether it has a ‘‘substantial position’’ or 

‘‘substantial counterparty exposure’’ as 

defined in the proposal. The proposed 

rule defines potential future exposure 

by a factor of the dollar notational value 

of the swap. The Commission also 

considered market-based tests of 

potential future exposure such as 

margin requirements or other valuations 

of the outstanding position. The 

Commission decided in favor of a more 

easily implementable test rather than 

market-based criteria for potential future 

exposure, given that daily variation in 

market prices is captured by the current 

exposure calculation. The CFTC 

believes that because the proposed 

quantitative thresholds are high, only 

very few market participants would 

have to conduct a detailed analysis to 

determine whether they are 

encompassed by the proposed 


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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80205 

174Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601). 

175 44 U.S.C. 3501 et seq. 

176As noted previously, the concept of ‘‘hedging 

or mitigating commercial risk’’ also is found in the 

statutory provisions granting an exception to endusers from the mandatory clearing requirement in 

connection with swaps and security-based swaps. 

See CEA section 2(h)(7)(A); Exchange Act section 

3C(g)(1)(B) (exception from mandatory clearing 

requirements when one or more counterparties are 

not ‘‘financial entities’’ and are using swaps or 

security-based swaps ‘‘to hedge or mitigate 

commercial risk’’). If the proposed rule 3a67–4 

definition of ‘‘hedging or mitigating commercial 

risk’’ is used any future SEC rulemakings, including 

rulemaking with respect to the end-user exception, 

any necessary discussion of administrative law 

matters relating to the use of proposed rule 3a67– 

4 will be provided at that time. 

definition. The cost of the detailed 

analysis would vary for each market 

participant, depending on the particular 

characteristics of its swaps. Similarly, 

the costs to a market participant of 

determining whether it uses swaps to 

hedge or mitigate commercial risk 

would depend on how the market 

participant uses swaps. It is possible 

that for some market participants with 

complex positions in swaps, the costs of 

the analysis could be relatively high. 

As is the case for the similar proposal 

regarding swap dealers, the costs of the 

voluntary process for a request for a 

limited designation as a major swap 

participant are difficult to predict 

because they would depend on the 

complexity of the particular case. The 

CFTC believes that the person making 

the request would have broad discretion 

in determining how to do so and 

thereby could control the costs of the 

request to some extent. 

b. Benefits 

The benefits of the proposed 

regulations further defining ‘‘major swap 

participant’’ include that they set out a 

quantitative, bright-line test that can be 

applied at a relatively low cost. Also, 

the definition of ‘‘hedging or mitigating 

commercial risk’’ is stated in general 

terms that may be flexibly applied by 

potential major swap participants. In 

preparing this proposal, the CFTC 

considered other methods of defining 

‘‘major swap participant,’’ including 

multi-factor analyses, stress tests and 

adversary processes. The CFTC believes 

that these other methods would impose 

significantly higher costs for both the 

market participants that would have to 

apply them and for the CFTC (and, 

indirectly, the taxpayer), without 

providing additional benefits. The costs 

would result primarily from the need to 

retain qualified experts who would 

devote significant time and other 

resources to a detailed analysis of 

multiple aspects of the potential major 

swap participant’s swap positions. The 

benefits that could justify more costly 

proposals include reductions in 

arbitrary differences in results and 

greater consistency and predictability. 

However, other potential methods of 

further defining ‘‘major swap 

participant’’ do not appear likely to 

provide such benefits to an extent that 

would justify the higher costs. 

5. Request for Comment 

The CFTC invites public comment on 

its cost-benefit considerations. 

Commenters are also invited to submit 

any data or other information that they 

may have quantifying or qualifying the 

costs and benefits of the proposed rules 

with their comments. 

D. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996 (‘‘SBREFA’’) 174 the CFTC must 

advise the Office of Management and 

Budget as to whether the proposed rules 

constitute a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’ 

where, if adopted, it results or is likely 

to result in: (1) An annual effect on the 

economy of $100 million or more (either 

in the form of an increase or a decrease); 

(2) a major increase in costs or prices for 

consumers or individual industries; or 

(3) significant adverse effect on 

competition, investment or innovation. 

If a rule is ‘‘major,’’ its effectiveness will 

generally be delayed for 60 days 

pending Congressional review. We do 

not believe that any of the proposed 

rules, in their current form, would 

constitute a major rule. 

We request comment on the potential 

impact of the proposed rules on the 

economy on an annual basis, on the 

costs or prices for consumers or 

individual industries, and on 

competition, investment or innovation. 

Commenters are requested to provide 

empirical data and other factual support 

for their views to the extent possible. 

VI. Administrative Law Matters— 

Exchange Act Rules (Definitions of 

‘‘Security-Based Swap Dealer’’ and 

‘‘Major Security-Based Swap 

Participant’’) 

A. Paperwork Reduction Act Analysis 

Certain provisions of the proposed 

rules may impose new ‘‘collection of 

information’’ requirements within the 

meaning of the Paperwork Reduction 

Act of 1995 (‘‘PRA’’).175 The SEC has 

submitted them to the Office of 

Management and Budget (‘‘OMB’’) for 

review in accordance with 44 U.S.C. 

3507 and 5 CFR 1320.11. The title of the 

new collection of information is 

‘‘Procedural Requirements Associated 

with the Definition of ‘Hedging or 

Mitigating Commercial Risk.’’’ An 

agency may not conduct or sponsor, and 

a person is not required to respond to, 

a collection of information unless it 

displays a currently valid OMB control 

number. OMB has not yet assigned a 

control number to the new collection of 

information. 

1. Summary of Collection of Information 

Proposed Exchange Act rule 3a67–4 

would define the term ‘‘hedging or 

mitigating commercial risk.’’ 176

Security-based swap positions that meet 

this proposed definition would be 

excluded from the ‘‘substantial position’’ 

analysis under the first test of the 

proposed definition of major securitybased swap participant. 

For a security-based swap position to 

be held for the purpose of hedging or 

mitigating commercial risk under 

proposed rule 3a67–4, the person 

holding the position must satisfy several 

conditions, including the following: 

(i) The person must identify and 

document the risks that are being 

reduced by the security-based swap 

position; 

(ii) The person must establish and 

document a method of assessing the 

effectiveness of the security-based 

swaps as a hedge; and 

(iii) The person must regularly assess 

the effectiveness of the security-based 

swap as a hedge. 

2. Proposed Use of Information 

The collections of information in 

proposed rule 3a67–4 are designed to 

help prevent abuse of the exclusion and 

to help ensure that the exclusion is only 

available to those entities that are 

engaged in legitimate hedging or risk 

mitigating activities. 

3. Respondents 

The collections of information in 

proposed rule 3a67–4 would apply to 

those entities seeking to exclude the 

security-based swap positions held for 

hedging or mitigating commercial risk 

from the substantial position 

calculation. As discussed below in 

Section VI.B.4., based on the current 

market, we estimate that approximately 

10 entities have security-based swap 

positions of a magnitude that they could 

potentially reach the major securitybased swap participant thresholds. 

Accordingly, we estimate that 

approximately 10 entities would seek to 

avail themselves of the exclusion from 


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177Some entities follow these types of procedures 

so that their hedging transactions will qualify for 

hedge accounting treatment under generally 

accepted accounting principles, which requires 

procedures similar to those in proposed rule 3a67– 

4. Hedging relationships involving security-based 

swaps that qualify for the hedging or mitigating 

commercial risk exception in the proposed rule are 

not limited to those recognized as hedges for 

accounting purposes. We believe that all of the 

estimated 10 entities that have security-based swap 

positions of a magnitude that they could potentially 

be deemed to be major security-based swap 

participants already identify and document their 

risk management activities (including their 

security-based swap positions used to hedge or 

mitigate commercial risks) and assess the 

effectiveness of those activities as a matter of their 

ordinary business practice—even if they are not 

seeking hedge accounting treatment. 

the substantial position calculation for 

security-based swap positions held for 

hedging or mitigating commercial risk. 

4. Total Annual Reporting and 

Recordkeeping Burden 

We do not anticipate that the 

proposed collection of information in 

proposed rule 3a67–4 would cause the 

estimated 10 entities to incur any new 

costs. We believe that only highly 

sophisticated market participants would 

potentially meet the proposed 

thresholds for the major security-based 

swap participant designation and thus 

have a need to take advantage of the 

exclusion for positions held for hedging 

or mitigating commercial risk (and be 

required to meet the attendant 

collection requirements). We 

understand from our staff’s discussions 

with industry participants that the 

entities that have security-based swap 

positions and exposures of this 

magnitude currently create and 

maintain the documentation proposed 

to be required in rule 3a67–4, as part of 

their ordinary course business and risk 

management practices.177 Thus, we do 

not believe that any new burdens or 

costs will be imposed on the 

approximately 10 entities that may seek 

to use the exclusion. We therefore 

estimate the total annual reporting and 

recordkeeping burden associated with 

proposed rule 3a67–4 to be minimal. 

5. Collection of Information is 

Mandatory 

The collections of information in 

proposed rule 3a67–4 would be 

mandatory for those entities seeking to 

exclude positions they hold for hedging 

or mitigating commercial risk from the 

substantial position calculation. 

6. Confidentiality 

There is no proposed requirement that 

the collections of information in 

proposed rule 3a67–4 be provided to the 

SEC or a third party on a regular, 

ordinary course basis. In a situation 

where the SEC has obtained the 

information, the SEC would consider 

requests for confidential treatment on a 

case-by-case basis. 

7. Record Retention Period 

Proposed rule 3a67–4 does not 

contain a specific record retention 

requirement. Nonetheless, we would 

expect the approximately 10 entities 

that may seek to use the exclusion for 

positions held for hedging or mitigating 

commercial risk to maintain the records 

they create in connection with the 

exclusion. Because we understand from 

our staff’s discussions with industry 

participants that the entities that have 

security-based swap positions and 

exposures of this magnitude currently 

create and maintain the documentation 

proposed to be required in rule 3a67–4, 

as part of their ordinary course business 

and risk management practices, we do 

not expect any new burdens or costs 

will be imposed to maintain the records. 

8. Request for Comments 

The SEC invites comments on these 

estimates. Pursuant to 44 U.S.C. 

3506(c)(2)(B), the SEC requests 

comments in order to: (a) Evaluate 

whether the collection of information is 

necessary for the proper performance of 

our functions, including whether the 

information will have practical utility; 

(b) evaluate the accuracy of our estimate 

of the burden of the collection of 

information; (c) determine whether 

there are ways to enhance the quality, 

utility, and clarity of the information to 

be collected; and (d) evaluate whether 

there are ways to minimize the burden 

of the collection of information on those 

who respond, including through the use 

of automated collection techniques or 

other forms of information technology. 

Persons submitting comments on the 

collection of information requirements 

should direct them to the Office of 

Management and Budget, Attention: 

Desk Officer for the Securities and 

Exchange Commission, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, and should also 

send a copy of their comments to 

Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090, with reference to File No. 

S7–39–10. Requests for materials 

submitted to OMB by the SEC with 

regard to this collection of information 

should be in writing, with reference to 

File No. S7–39–10, and be submitted to 

the Securities and Exchange 

Commission, Records Management, 

Office of Filings and Information 

Services, 100 F Street, NE., Washington, 

DC 20549–1090. As OMB is required to 

make a decision concerning the 

collections of information between 30 

and 60 days after publication, a 

comment to OMB is best assured of 

having its full effect if OMB receives it 

within 30 days of publication. 

B. Consideration of Benefits and Costs 

1. Introduction 

The Dodd-Frank Act added 

definitions of ‘‘security-based swap 

dealer’’ and ‘‘major security-based swap 

participant’’ to the Exchange Act in 

conjunction with other provisions that 

require entities meeting either of those 

definitions to register with the SEC and 

to be subject to capital, margin, business 

conduct and certain other requirements. 

Consistent with the direction of the 

Dodd-Frank Act, the SEC is proposing 

rules to further define ‘‘major securitybased swap participant’’ along with 

additional terms used in that definition. 

The SEC also is proposing rules to 

further define ‘‘security-based swap 

dealer’’ and to set forth factors for 

determining the availability of the de 

minimis exception from that definition. 

We believe that these proposed rules are 

consistent with the purposes of the 

Dodd-Frank Act, and, as appropriate, set 

forth objective standards to facilitate 

market participants’ compliance with 

the amendments that the Dodd-Frank 

Act made to the Exchange Act. Market 

participants, however, may incur costs 

associated with certain of these 

proposed rules. 

The SEC believes that there would be 

two categories of potential costs. First, 

there would be costs associated with the 

regulatory requirements that would 

apply to a ‘‘security-based swap dealer’’ 

or a ‘‘major security-based swap 

participant’’ (e.g., the registration, 

margin, capital, and business conduct 

requirements that would be imposed on 

security-based swap dealers and major 

security-based swap participants). 

While the specific costs and benefits 

associated with these regulatory 

requirements are being addressed in the 

SEC’s proposals to implement those 

requirements, we recognize that the 

costs and benefits of these proposed 

definitions are directly linked to the 

costs and benefits of the requirements 

applicable to dealers and major 

participants. We welcome comment on 

the costs and benefits of these proposed 

definitions in that broader context. 

Second, there may be costs that 

entities incur in determining whether 

they qualify as a ‘‘security-based swap 

dealer’’ or a ‘‘major security-based swap 

participant’’ under the proposed 

definitional rules. These costs, along 


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178The specific costs associated with these 

regulatory requirements will be addressed in the 

SEC’s proposals to implement those requirements. 

179See Exchange Act section 3(a)(67)(C). 

180For example, distinguishing between 

categories of security-based swaps may cause some 

entities to incur additional costs to calculate their 

major security-based swap participant status with 

respect to each category. Similarly, categorization 

may affect whether an entity ultimately qualifies as 

a major security-based swap participant. 

181We believe that an estimate of an entity’s 

mark-to-market exposure associated with its 

security-based swap positions can be derived from 

the level of an entity’s notional positions. We 

recognize that the ratio of exposure to notional 

amount will vary by market participant and by 

position. We understand that mark-to-market 

exposures associated with credit derivative 

positions on average are equal to approximately 

three percent of an entity’s level of notional 

positions in credit derivatives. This estimate is 

based on second quarter 2010 U.S. bank market 

statistics involving credit derivatives, given that 

banks have credit derivative positions with gross 

positive fair value (which would equate to negative 

fair value for the banks’ counterparties) of $403 

billion, compared to total notional credit derivative 

positions of $13.9 trillion. See Office of the 

Comptroller of the Currency, ‘‘OCC’s Quarterly 

Report on Bank Trading and Derivatives Activities’’ 

(Second Quarter 2010) at 4 & Table 12. This data 

suggests that, on average, an entity would need to 

have notional credit derivative positions of roughly 

$33 billion to meet our proposed threshold for the 

first substantial position test, $1 billion in mark-tomarket exposure. 

We understand, based on our staff’s discussions 

with industry, that approximately 39 entities have 

Continued 

with the benefits associated with the 

proposed rules, are discussed below. 

2. Proposed Exchange Act rule 3a67–1— 

Definition of ‘‘Major Security-Based 

Swap Participant’’ 

Proposed Exchange Act rule 3a67–1 

would largely restate the statutory 

definition of ‘‘major security-based swap 

participant,’’ to consolidate the 

definition and related interpretations for 

ease of reference. 

A person that meets the definition of 

major security-based swap participant 

generally will be subject to the 

requirements applicable to major 

security-based swap participants 

without regard to the purpose for which 

it enters into a security-based swap, and 

without regard to the particular category 

of security-based swap.178 However, the 

statutory definitions provide that a 

person may be designated as a major 

security-based swap participant for one 

or more categories of security-based 

swaps or for particular activities 

without being classified as a major 

security-based swap participant for all 

categories or activities.179 Proposed rule 

3a67–1 would provide that a major 

security-based swap participant that 

engages in significant activity with 

respect to only certain types, classes or 

categories of security-based swaps or 

only in connection with specified 

activities, could obtain relief with 

respect to other types of security-based 

swaps from certain of the requirements 

that are applicable to major securitybased swap participants. The rule 

would have the benefit of implementing 

the statutory provision and providing 

that major security-based swap 

participants may obtain relief from the 

SEC. A person that seeks to be 

considered to be a major security-based 

swap participant only with respect to 

one category of security-based swaps, or 

only with respect to certain activities, 

would be expected to incur costs in 

connection with requesting an order 

from the SEC. However, any such costs 

would be voluntarily incurred by any 

person seeking to take advantage of that 

limited designation, and thus we 

preliminarily do believe that those costs 

would be attributable to the statute and 

not to this rule. 

3. Proposed Exchange Act Rule 3a67– 

2—‘‘Major’’ Categories of Security-Based 

Swaps 

Proposed Exchange Act rule 3a67–2 

would fulfill Congress’s mandate that 

the SEC designate ‘‘major’’ categories of 

security-based swaps by setting forth 

two such ‘‘major’’ categories—one 

consisting of credit derivatives and the 

other consisting of equity-swaps and 

other security-based swaps. We believe 

that these proposed categories would 

have the benefit of being consistent with 

the different ways in which those 

products are used, as well as market 

statistics and current market 

infrastructures (particularly the separate 

trade warehouses for credit default 

swaps and equity swaps). Although, as 

discussed below, this categorization is 

relevant to the ‘‘substantial position’’ 

tests of the ‘‘major security-based swap 

participant’’ definition, we believe that 

the categorization itself would not 

impose any costs on market 

participants. While the categorization 

may affect the costs that market 

participants will incur from particular 

statutory and regulatory requirements 

applicable to major security-based swap 

participants,180 those costs are being 

addressed in our proposals to 

implement those requirements. 

4. Proposed Exchange Act Rule 3a76– 

3—Definition of ‘‘Substantial Position’’ 

Proposed Exchange Act rule 3a67–3 

would define the term ‘‘substantial 

position,’’ which is used in the first and 

third tests of the definition of ‘‘major 

security-based swap participant.’’ The 

Dodd-Frank Act requires the SEC to 

define this term. We have proposed two 

tests for identifying the presence of a 

substantial position—one test based on 

a daily average measure of 

uncollateralized mark-to-market 

exposure, and one based on a daily 

average measure of combined 

uncollateralized mark-to-market 

exposure and potential future exposure. 

Both of these daily measures would be 

calculated and averaged over a calendar 

quarter. 

We believe that this proposed 

definition would have the benefit of 

providing objective criteria that 

reasonably would measure the risks 

associated with security-based swap 

positions, and reflect the counterparty 

risk and risk to the market factors that 

are embedded within the ‘‘major 

security-based swap participant’’ 

definition. We also believe that the 

proposed use of objective numerical 

criteria for the substantial position 

thresholds would promote the 

predictable application and enforcement 

of the requirements governing major 

security-based swap participants by 

permitting market participants to 

readily evaluate whether their securitybased swap positions meet the 

thresholds. 

The first ‘‘substantial position’’ test 

would encompass entities that have a 

daily average uncollateralized mark-tomarket exposure of $1 billion in a major 

category of security-based swaps. The 

second ‘‘substantial position’’ test would 

encompass entities that have a daily 

average combined uncollateralized 

mark-to-market exposure and potential 

future exposure of $2 billion. Potential 

future exposure would be measured, 

consistent with bank capital rules, 

largely by multiplying notional 

positions by risk factors. Additional 

adjustments would reflect netting 

agreements, the presence of central 

clearing and the presence of daily markto-market margining practices. 

As previously noted, there will be 

costs associated with the registration, 

margin, capital, business conduct, and 

other requirements that will be imposed 

on major security-based swap 

participants. Those costs are being 

addressed in the SEC’s rule proposals to 

implement those requirements. We also 

believe that there will be costs incurred 

by entities in determining whether they 

meet the definition of major securitybased swap participant. These costs are 

discussed below. 

Based on the current over-the-counter 

derivatives market, we estimate that no 

more than 10 entities that are not 

otherwise security-based swap dealers 

would have either uncollateralized 

mark-to-market positions 181 or 


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80208 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

credit default swap notional positions of roughly 

$33 billion or above. We understand that the large 

majority of those entities are banks or hedge funds 

(which we would expect to fully collateralize their 

positions with dealers as a matter of course). We 

further understand that banks, securities firms, and 

hedge funds typically collateralize most or all of 

their mark-to-market exposure to U.S. banks as a 

matter of practice. See OCC’s Quarterly Report on 

Bank Trading and Derivatives Activities (second 

quarter 2010) at 6. Therefore, it is not clear if any 

entities would have uncollateralized credit default 

swap positions near the proposed first substantial 

position threshold of $1 billion uncollateralized 

outward exposure. 

182The proposed risk multiplier of 0.1 for credit 

derivatives would require an entity to have a 

notional position of $20 billion in credit derivatives 

to reach the proposed $2 billion potential future 

exposure threshold (even before accounting for 

netting adjustments). The proposed additional 

multiplier of 0.2 for security-based swaps cleared 

by a registered clearing agency or subject to daily 

mark-to-market margining would mean that an 

entity with credit derivative positions that are 

cleared or subject to daily mark-to-market 

margining would need a notional position in credit 

derivatives of at least $100 billion to potentially 

reach the proposed $2 billion potential future 

exposure threshold. In this example, we are 

assuming an uncollateralized outward exposure of 

zero. 

We understand, based on our staff’s discussions 

with industry, that there are approximately 10 nondealer entities that have a notional position in 

credit derivatives of over $50 billion. 

183For each of the entities, we estimate that the 

initial programming would require the following 

levels of work from a Compliance Attorney, 

Compliance Manager, Programmer Analyst, Senior 

Internal Auditor, and Chief Financial Officer. The 

estimated contributions are as follows: 

approximately 2 hours of work from a Compliance 

Attorney to advise the entity’s compliance 

department on the legal requirements associated 

with the proposed tests; approximately 8 hours of 

work from a Compliance Manager to assist a 

Programmer Analyst in making the necessary 

changes to the entity’s existing automated system 

and to oversee and manage the entire programming 

process; approximately 40 hours of work from a 

Programmer Analyst to make the necessary 

programming changes to the existing automated 

system and to test the system; approximately 8 

hours of work from a Senior Internal Auditor to 

perform quality assurance to ensure that the 

automated system is properly performing the 

proposed tests; and approximately 3 hours of work 

from the entity’s Chief Financial Officer to monitor 

the process. We estimate that the hourly wage of a 

Compliance Attorney, Compliance Manager, 

Programmer Analyst, Senior Internal Auditor, and 

Chief Financial Officer would be approximately 

$291, $294, $190, $195, and $450, respectively. The 

$291/hour figure for a Compliance Attorney, the 

$294/hour figure for a Compliance Manager, the 

$190/hour figure for a Programmer Analyst, and the 

$195/hour figure for a Senior Internal Auditor are 

from SIFMA’s Management & Professional Earnings 

in the Securities Industry 2009, modified by SEC 

staff to account for an 1800-hour work-year and 

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits, and overhead. The $450/hour 

figure for a Chief Financial Officer is from http:// 

www.payscale.com, modified by SEC staff to 

account for an 1800-hour work-year and multiplied 

by 5.35 to account for bonuses, firm size, employee 

benefits, and overhead. See http:// 

www.payscale.com (last visited Nov. 1, 2010). 

184We anticipate that each entity would incur 

ongoing monitoring costs to evaluate their test 

results and to ensure that the tests are properly run. 

We estimate that each entity would have a Senior 

Internal Auditor spend approximately 4 hours each 

quarter (or a total of 16 hours annually) to perform 

this quality assurance. We also estimate that each 

entity would need a Compliance Attorney, a 

Compliance Manager, and its Chief Financial 

Officer to each spend approximately 1 hour each 

quarter (or a total of 4 hours annually) to monitor 

the entity’s test results and the entity’s status under 

the proposed rule. 

185The estimated one-time programming cost of 

approximately $13,444 per entity and $134,440 for 

all entities was calculated as follows: (Compliance 

Attorney at $291 per hour for 2 hours) + 

(Compliance Manager at $294 per hour for 8 hours) 

+ (Programmer Analyst at $190 per hour for 40 

hours) + (Senior Internal Auditor at $195 per hour 

for 8 hours) + (Chief Financial Officer at $450 per 

hour for 3 hours) × (10 entities) = $134,440. 

186The estimated ongoing monitoring cost of 

approximately $7,260 per year per entity and 

$72,600 per year for all entities was calculated as 

follows: (Senior Internal Auditor at $195 per hour 

for 16 hours) (Compliance Attorney at $291 per 

hour for 4 hours) + (Compliance Manager at $294 

per hour for 4 hours) + (Chief Financial Officer at 

$450 per hour for 4 hours) × (10 entities) = $72,600. 

combined uncollateralized current 

exposure and potential future exposure 

of a magnitude 182 that may rise close 

enough to the levels of our proposed 

thresholds to necessitate monitoring to 

determine whether they meet those 

thresholds. Additionally, we 

preliminarily believe that all of these 

approximately 10 entities currently 

maintain highly sophisticated financial 

operations in order to achieve the large 

security-based swap positions 

necessitating their use of the tests. 

We expect the costs associated with 

the proposed substantial position tests 

to be modest for these entities. We 

understand that the entities that have 

this magnitude of security-based swap 

positions already monitor and collect all 

of the data necessary for the proposed 

substantial position tests. Preliminarily, 

we understand that these entities 

already use automated systems to gauge 

their positions and exposures and assist 

in their risk management. Accordingly, 

we estimate that each of the entities 

would incur a one-time programming 

cost,183 as well as ongoing costs 

associated with the continuing use and 

monitoring of the testing.184 We 

estimate that the one-time programming 

cost would be approximately $13,444 

per entity, and $134,440 for all 

entities.185 We estimate that the annual 

ongoing costs would be approximately 

$7,260 per entity, and $72,600 for all 

entities.186

5. Proposed Exchange Act Rule 3a67– 

4—Definition of ‘‘Hedging or Mitigating 

Commercial Risk’’ 

Proposed Exchange Act rule 3a67–4 

would define the term ‘‘hedging or 

mitigating commercial risk.’’ Securitybased swap positions that meet that 

definition are excluded from the 

‘‘substantial position’’ analysis under the 

first test of the major participant 

definition. The proposed rule is 

intended to be objective and promote 

the predictable application and 

enforcement of the requirements 

governing major security-based swap 

participants. 

For a security-based swap position to 

be held for the purpose of hedging or 

mitigating commercial risk under 

proposed Exchange Act rule 3a67–4, the 

person holding the position must satisfy 

certain conditions: 

(i) The person must identify and 

document the risks that are being 

reduced by the security-based swap 

position; 

(ii) The person must establish and 

document a method of assessing the 

effectiveness of the security-based swap 

as a hedge; and 

(iii) The person must regularly assess 

the effectiveness of the security-based 

swap as a hedge. 

Proposed rule 3a67–4 would affect 

whether an entity will meet the 

definition of major security-based swap 

participant. The specific costs 

associated with these regulatory 

requirements are being addressed in the 

SEC’s proposals to implement those 

requirements. 

While we expect that there could be 

some potential costs associated with the 

procedural requirements of proposed 

rule 3a67–4, as described in Section 

VI.B.4., supra, we expect only highly 

sophisticated entities to hold securitybased swap positions of a magnitude 

that would require use of the proposed 

tests. Thus, we do not anticipate that 

these proposed procedural requirements 

would cause market participants to 

incur costs that they do not incur 

already as a matter of their ordinary 

business and risk management 

practices. Accordingly, we do not 

expect that the proposed definition of 

‘‘hedging or mitigating commercial risk’’ 

would impose any costs on the 

potentially affected entities beyond 

those already regularly incurred by 

these entities as a matter of course. 

6. Proposed Exchange Act Rule 3a67– 

5—Definition of ‘‘Substantial 

Counterparty Exposure That Could Have 

Serious Adverse Effects on The 

Financial Stability of The United States 

Banking System or Financial Markets’’ 

Proposed Exchange Act rule 3a67–5 

would define ‘‘substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets,’’ a term that 

comprises part of the second test of the 

‘‘major security-based swap participant’’ 

definition. This proposed rule would 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80209 

187As noted above, we recognize that major 

security-based swap participants will incur costs 

associated with the registration and termination of 

registration processes. These costs will be 

addressed in the SEC rule’s proposals to implement 

those requirements. 

188Based on our staff’s discussions with industry, 

we estimate that approximately 50 entities may be 

required to register as security-based swap dealers 

following implementation of these proposed rules. 

The specific costs associated with these regulatory 

requirements will be addressed in the SEC’s 

proposals to implement those requirements. 

189See Section 761(a)(6) of the Dodd-Frank Act. 

190See Section 15F(h)(2)(C) of the Exchange Act. 

parallel the ‘‘substantial position’’ 

analysis discussed above, but would 

examine an entity’s security-based swap 

positions as a whole (rather than 

focusing on a particular ‘‘major’’ 

category), and would not exclude 

certain hedging positions. Consistent 

with this broader scope, and the 

proposal that there be two ‘‘major’’ 

categories of security-based swaps, the 

thresholds used in this test would be 

two times the comparable ‘‘substantial 

position’’ thresholds. We believe that 

this approach reasonably would 

measure the counterparty exposure 

associated with the entirety of an 

entity’s security-based swap positions, 

consistent with the risk factors in the 

‘‘major security-based swap participant’’ 

definition. Additionally, we believe that 

the proposed definition would provide 

objective criteria and promote the 

predictable application and enforcement 

of the requirements governing major 

security-based swap participants by 

permitting market participants to 

readily evaluate whether their securitybased swap positions meet the proposed 

thresholds. 

We believe that the same 

approximately 10 entities would 

calculate their substantial counterparty 

exposure under this rule as would 

undertake the substantial position 

calculation under proposed rule 3a67–3. 

Given that the threshold for this 

proposed rule is derived from the 

calculations of substantial position that 

would be mandated by proposed rule 

3a67–3, we do not anticipate that it 

would create any costs outside of those 

already covered in the discussion of the 

estimated costs associated with the 

proposed definition of substantial 

position. 

7. Proposed Exchange Act Rule 3a67– 

6—Definitions of ‘‘Financial Entity’’ and 

‘‘Highly Leveraged’’ 

Proposed Exchange Act rule 3a67–6 

would define the terms ‘‘financial 

entity’’ and ‘‘highly leveraged,’’ both of 

which are used in the third test of the 

‘‘major security-based swap participant’’ 

definition. The proposed definition of 

‘‘financial entity’’ would be consistent 

with the use of that term in the Title VII 

exception from mandatory clearing for 

end-users of security-based swaps 

(subject to limited technical changes). 

One of the two alternative proposed 

definitions of ‘‘highly leveraged’’ would 

be consistent with a standard used in 

Title I of the Dodd-Frank Act, while the 

other alternative is based on an 

understanding of typical leverage ratios 

for certain financial entities. We believe 

that these proposed alternative 

standards would apply reasonable 

objective criteria to implement and 

further define the third test. 

Additionally, we believe that the 

proposed use of these objective 

definitions and numerical criteria 

would promote the predictable 

application and enforcement of the 

requirements governing major securitybased swap participants by permitting 

market participants to readily evaluate 

whether they meet the threshold for 

major security-based swap participant 

status. 

We do not believe that the proposed 

definition of ‘‘financial entity’’ would 

impose any significant costs on market 

entities, given the objective nature of the 

definition. We also do not believe that 

the proposed definition of ‘‘highly 

leveraged’’—a balance sheet test that 

would be based on the ratio of an 

entity’s liabilities and equity, and that, 

in the case of entities subject to public 

reporting requirements, could be 

derived from financial statements filed 

with the SEC—would impose any 

significant costs on entities that have 

security-based swap positions large 

enough to potentially meet the 

‘‘substantial position’’ requirement that 

is part of the third test. 

8. Proposed Exchange Act Rule 3a67– 

7—Timing Requirements, Reevaluation 

Period and Termination of Status 

Proposed Exchange Act rule 3a67–7 

would set forth methods for specifying 

when an entity that satisfies the tests 

specified within the definition of ‘‘major 

security-based swap participant’’ would 

be deemed to meet that definition. The 

proposed rule also would address the 

termination of an entity’s status as a 

major security-based swap participant. 

We believe that the proposed rule 

would set forth pragmatic standards for 

permitting entities that have securitybased swap positions that require 

registration to go through the 

registration process, and to terminate 

their status when appropriate. We 

believe that this proposed rule would 

impose no direct costs on market 

entities.187

9. Proposed Exchange Act Rule 3a71– 

1—Definition of ‘‘Security-Based Swap 

Dealer’’ 

Proposed Exchange Act rule 3a71–1 

largely would restate the statutory 

definition of ‘‘security-based swap 

dealer,’’ to consolidate the definition 

and related interpretations for market 

participants’ ease of reference. We are 

not proposing to further define the four 

specific tests set forth in the ‘‘securitybased swap dealer’’ definition. However, 

our release contains interpretive 

language that would have the benefit of 

providing additional legal certainty to 

market participants. While market 

participants would incur certain costs to 

analyze whether their security-based 

swap activities cause them to be on the 

‘‘dealer’’ side of the dealer-trader 

distinction (which would require them 

to register with the SEC and comply 

with the other requirements applicable 

to security-based swap dealers unless 

they can take advantage of the de 

minimis exception), these costs would 

be incurred because of the statutory 

change, rather than due to proposed rule 

3a71–1. The Dodd-Frank Act 

determined that persons that engage in 

dealing activities involving securitybased swaps should be subject to 

comprehensive regulation, and any such 

analytic costs arise from Congress’s 

determination to amend the Exchange 

Act.188

10. Proposed Exchange Act Rule 3a71– 

2—de Minimis Exception 

Proposed Exchange Act rule 3a71–2 

would set forth factors for determining 

whether a person that otherwise would 

be a security-based swap dealer can take 

advantage of the de minimis exception. 

The Dodd-Frank Act directed the SEC to 

promulgate these factors.189 The 

proposed factors would account for an 

entity’s annual notional security-based 

swap positions in a dealing capacity, its 

total notional security-based swap 

positions in a dealing capacity when the 

counterparty is a ‘‘special entity,’’ 190

and its total number of counterparties 

and security-based swaps as a dealer. 

We believe that these factors 

appropriately would focus on dealing 

activities that do not warrant an entity’s 

regulation as a security-based swap 

dealer. We also believe that these 

objective numerical criteria for the de 

minimis exception would promote the 

predictable application and enforcement 

of the de minimis exception from 

security-based swap dealer status. 

In general, we would expect a person 

that enters into security-based swaps in 

a dealing capacity would, as a matter of 

course, be aware of the notional amount 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80210 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

191 15 U.S.C. 78c(f). 

192 15 U.S.C. 78w(a)(2). 

of those positions, whether a particular 

counterparty is a ‘‘special entity,’’ and 

the total number of counterparties and 

security-based swaps it has in a dealer 

capacity. As a result, we believe that 

there would be no new costs incurred 

by entities in assessing the availability 

of the de minimis exception. Moreover, 

any costs associated with ensuring that 

a person can take advantage of the de 

minimis exception would be voluntarily 

incurred by entities that engage in 

dealing activities that seek to take 

advantage of the exception. 

11. Request for Comments 

The SEC requests comment on these 

estimated benefits and costs. 

Commenters particularly are requested 

to address: the accuracy of our estimate 

that there would be approximately 10 

entities in the market (that would not 

otherwise be security-based swap 

dealers) that would have security-based 

swap positions of a magnitude that may 

rise close enough to the levels of our 

proposed thresholds to necessitate 

monitoring to determine whether they 

meet those thresholds; the accuracy of 

our estimate that there would be 

approximately 50 entities in the market 

that may be required to register as 

security-based swap dealers following 

implementation of the proposed rules; 

the accuracy of our estimates of the 

costs associated with entities 

performing the proposed substantial 

position tests; whether the entities that 

have security-based swap positions that 

are significant enough to potentially 

meet one or more of the tests in the 

‘‘major security-based swap participant’’ 

definition would, as a matter of course, 

already have the data necessary to 

perform the two proposed substantial 

position tests, and if not, what 

additional data would they need and 

how much time and expense would 

gathering that data require; whether 

these same entities would, as a matter 

of course, already comply with the 

proposed procedural requirements 

associated with the exclusion for 

positions that are for the purpose of 

‘‘hedging or mitigating commercial risk;’’ 

and whether entities would change their 

behavior to avoid meeting the proposed 

definitions of ‘‘security-based swap 

dealer’’ or ‘‘major security-based swap 

participant,’’ and if so, what, if any, 

economic costs would be associated 

with such behavioral changes. 

In addition, and more generally, we 

request comment on the costs and 

benefits of these proposed definitions in 

the broader context of the substantive 

rules, including capital, margin and 

business conduct rules, applicable to 

dealers and major participants. 

Commenters particularly are requested 

to address whether the proposed scope 

of the dealer and major participant 

definitions are appropriate in light of 

the costs and benefits associated with 

those substantive rules. 

C. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition, and Capital 

Formation 

Section 3(f) of the Exchange Act 

requires the SEC, whenever it engages in 

rulemaking and is required to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, to consider whether the action 

would promote efficiency, competition, 

and capital formation.191 In addition, 

Section 23(a)(2) of the Exchange Act 192

requires the SEC, when adopting rules 

under the Exchange Act, to consider the 

impact such rules would have on 

competition. Section 23(a)(2) of the 

Exchange Act also prohibits the SEC 

from adopting any rule that would 

impose a burden on competition not 

necessary or appropriate in furtherance 

of the purposes of the Exchange Act. 

We preliminarily do not believe that 

the proposed rules would result in any 

burden on competition that is not 

necessary or appropriate in furtherance 

of the purposes of the Exchange Act. We 

are proposing rules to further define 

‘‘major security-based swap participant,’’ 

along with several terms used in that 

definition. We are also proposing rules 

to further define ‘‘security-based swap 

dealer’’ and to set forth factors for 

determining the availability of the de 

minimis exception from that definition. 

We believe that the proposed rules are 

consistent with the purposes of Title VII 

of the Dodd-Frank Act, and, as 

appropriate, set forth objective 

standards to facilitate market 

participants’ compliance with the 

amendments that Title VII of the DoddFrank Act made to the Exchange Act. 

These amendments mandate that the 

SEC regulate major security-based swap 

participants and security-based swap 

dealers, which include some, but not 

all, entities that enter into securitybased swaps. Although regulation of 

certain security-based swap market 

participants may result in competitive 

burdens to these entities when 

compared to unregulated security-based 

swap market participants, these burdens 

stem directly from Congress’s decision 

to impose regulation on a specified set 

of security-based swap market 

participants through the Dodd-Frank 

Act. 

While our decisions on how to further 

define the terms may have some effect 

on competition (e.g., our determinations 

regarding the proposed definition of 

substantial position will affect whether 

entities qualify as major security-based 

swap participants), we preliminarily do 

not believe that our decisions would 

impose additional competitive burdens 

on entities outside of those that 

Congress previously imposed through 

its decision in Title VII of the DoddFrank Act to regulate and differentiate 

security-based swap market 

participants. Moreover, we believe that 

defining substantial position will help 

provide market participants with legal 

certainty regarding their need to register 

as major security-based swap 

participants and is necessary and 

appropriate to implement the purposes 

of regulating security-based swap 

dealers and major security-based swap 

participants. 

We also preliminarily believe that the 

proposed rules would promote 

efficiency. We believe that the proposed 

rules would set forth clear objective 

standards to facilitate market 

participants’ compliance with the 

amendments that the Dodd-Frank Act 

made to the Exchange Act. Moreover, 

we believe that the proposed rules 

would promote the predictable 

application and enforcement of the 

Exchange Act. We also have considered 

what effect, if any, our proposed rules 

would have on capital formation. We 

preliminarily do not believe that our 

proposed rules would have a negative 

effect on capital formation. 

The SEC requests comment on the 

effect of the proposed rules on 

efficiency, competition, and capital 

formation. Commenters are particularly 

requested to address whether entities 

would change their behavior to avoid 

meeting the proposed definitions of 

‘‘security-based swap dealer’’ or ‘‘major 

security-based swap participant,’’ and if 

so, how. Commenters are also requested 

to address the effect, if any, that the 

proposed definitions of ‘‘substantial 

position,’’ ‘‘hedging or mitigating 

commercial risk,’’ ‘‘substantial 

counterparty exposure,’’ ‘‘financial 

entity,’’ or ‘‘highly leveraged,’’ or the 

proposed categories of security-based 

swaps would have on business 

decisions, trading behavior, transaction 

costs, or capital allocation. We also 

request comment on the effect, if any 

that the proposed de minimis exception 

to the definition of security-based swap 

dealer would have on business 

decisions, trading behavior, transaction 

costs, or capital allocation, and if so, 

how. Commenters are particularly 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80211 

193 5 U.S.C. 601 et seq. 

194 5 U.S.C. 603(a). 

195 5 U.S.C. 551 et seq. 

196Although Section 601(b) of the RFA defines 

the term ‘‘small entity,’’ the statute permits the 

Commissions to formulate their own definitions. 

The SEC has adopted definitions for the term small 

entity for the purposes of SEC rulemaking in 

accordance with the RFA. Those definitions, as 

relevant to this proposed rulemaking, are set forth 

in Rule 0–10, 17 CFR 240.0–10. See Securities 

Exchange Act Release No. 18451 (Jan. 28, 1982), 47 

FR 5215 (Feb. 4, 1982) (File No. AS–305). 

197See 5 U.S.C. 605(b). 

198See 17 CFR 240.0–10(a). 

199See 17 CFR 240.17a–5(d). 

200See 17 CFR 240.0–10(c). 

201See 13 CFR 121.201 (Subsector 522). 

202See id. at Subsector 522. 

203See id. at Subsector 523. 

204See id. at Subsector 524. 

205See id. at Subsector 525. 

encouraged to provide quantitative 

information to support their views. 

D. Consideration of Impact on the 

Economy 

For purposes of SBREFA, the SEC 

must advise the Office of Management 

and Budget as to whether the proposed 

rules constitute a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’ 

where, if adopted, it results or is likely 

to result in: (1) An annual effect on the 

economy of $100 million or more (either 

in the form of an increase or a decrease); 

(2) a major increase in costs or prices for 

consumers or individual industries; or 

(3) significant adverse effect on 

competition, investment or innovation. 

If a rule is ‘‘major,’’ its effectiveness will 

generally be delayed for 60 days 

pending Congressional review. We do 

not believe that any of the proposed 

rules, in their current form, would 

constitute a major rule. 

We request comment on the potential 

impact of the proposed rules on the 

economy on an annual basis, on the 

costs or prices for consumers or 

individual industries, and on 

competition, investment or innovation. 

Commenters are requested to provide 

empirical data and other factual support 

for their views to the extent possible. 

E. Regulatory Flexibility Act 

Certification 

The Regulatory Flexibility Act 

(‘‘RFA’’) 193 requires Federal agencies, in 

promulgating rules, to consider the 

impact of those rules on small entities. 

Section 603(a) 194 of the Administrative 

Procedure Act,195 as amended by the 

RFA, generally requires the SEC to 

undertake a regulatory flexibility 

analysis of all proposed rules, or 

proposed rule amendments, to 

determine the impact of such 

rulemaking on ‘‘small entities.’’ 196

Section 605(b) of the RFA provides that 

this requirement shall not apply to any 

proposed rule or proposed rule 

amendment, which if adopted, would 

not have a significant economic impact 

on a substantial number of small 

entities.197

For purposes of SEC rulemaking in 

connection with the RFA, a small entity 

includes: (i) When used with reference 

to an ‘‘issuer’’ or a ‘‘person,’’ other than 

an investment company, an ‘‘issuer’’ or 

‘‘person’’ that, on the last day of its most 

recent fiscal year, had total assets of $5 

million or less,198 or (ii) a broker-dealer 

with total capital (net worth plus 

subordinated liabilities) of less than 

$500,000 on the date in the prior fiscal 

year as of which its audited financial 

statements were prepared pursuant to 

Rule 17a–5(d) under the Exchange 

Act,199 or, if not required to file such 

statements, a broker-dealer with total 

capital (net worth plus subordinated 

liabilities) of less than $500,000 on the 

last day of the preceding fiscal year (or 

in the time that it has been in business, 

if shorter); and is not affiliated with any 

person (other than a natural person) that 

is not a small business or small 

organization.200 Under the standards 

adopted by the Small Business 

Administration, small entities in the 

finance and insurance industry include 

the following: (i) For entities engaged in 

credit intermediation and related 

activities, entities with $175 million or 

less in assets; 201 (ii) for entities engaged 

in non-depository credit intermediation 

and certain other activities, entities with 

$7 million or less in annual receipts; 202

(iii) for entities engaged in financial 

investments and related activities, 

entities with $7 million or less in 

annual receipts; 203 (iv) for insurance 

carriers and entities engaged in related 

activities, entities with $7 million or 

less in annual receipts; 204 and (v) for 

funds, trusts, and other financial 

vehicles, entities with $7 million or less 

in annual receipts.205

Based on feedback from industry 

participants about the security-based 

swap markets, the SEC preliminarily 

believes that entities that would qualify 

as security-based swap dealers and 

major security-based swap market 

participants, whether registered brokerdealers or not, exceed the thresholds 

defining ‘‘small entities’’ set out above. 

Thus, the SEC believes it is unlikely that 

the proposed rules would have a 

significant economic impact any small 

entity. 

For the foregoing reasons, the SEC 

certifies that the proposed rules would 

not have a significant economic impact 

on a substantial number of small entities 

for purposes of the RFA. 

The SEC encourages written 

comments regarding this certification. 

The SEC requests that commenters 

describe the nature of any impact on 

small entities and provide empirical 

data to illustrate the extent of the 

impact. 

VII. Statutory Basis and Rule Text 

List of Subjects 

17 CFR Part 1 

Definitions. 

17 CFR Part 240 

Reporting and recordkeeping 

requirements, Securities. 

Commodity Futures Trading 

Commission 

Text of Proposed Rules 

For the reasons stated in this release, 

the CFTC is proposing to amend 17 CFR 

part 1 as follows: 

PART 1—GENERAL REGULATIONS 

UNDER THE COMMODITY EXCHANGE 

ACT 

1. The authority citation for part 1 is 

revised to read as follows: 

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 

6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 

6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a–1, 

16, 16a, 19, 21, 23, and 24, as amended by 

Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, Pub. L. 

111–203, 124 Stat. 1376 (2010). 

2. Amend § 1.3 by: 

a. Adding paragraph (m); and 

b. As proposed to be amended at 75 

FR 63762, October 18, 2010, and 75 FR 

77576, December 13, 2010, adding (ppp) 

through (vvv) to read as follows: 

§ 1.3 Definitions 

* * * * * 

(m) Eligible contract participant. This 

term has the meaning set forth in 

Section 1a(18) of the Commodity 

Exchange Act, except that: 

(1) A major swap participant, as 

defined in Section 1a(33) of the 

Commodity Exchange Act and 

§ 1.3(qqq), is an eligible contract 

participant; 

(2) A swap dealer, as defined in 

Section 1a(49) of the Commodity 

Exchange Act and § 1.3(ppp), is an 

eligible contract participant; 

(3) A major security-based swap 

participant, as defined in Section 

3(a)(67) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(67)) and 

§ 240.3a67–1 of this title, is an eligible 

contract participant; 

(4) A security-based swap dealer, as 

defined in Section 3(a)(71) of the 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
80212 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

Securities and Exchange Act of 1934 (15 

U.S.C. 78c(a)(71)) and § 240.3a71–1 of 

this title, is an eligible contract 

participant; 

(5) A commodity pool with one or 

more direct or indirect participants that 

is not an eligible contract participant is 

not an eligible contract participant for 

purposes of Sections 2(c)(2)(B)(vi) and 

2(c)(2)(C)(vii) of the Commodity 

Exchange Act; and 

(6) A commodity pool that does not 

have total assets exceeding $5,000,000 

or that is not operated by a person 

described in clause (A)(iv)(II) of Section 

1a(18) of the Commodity Exchange Act 

is not an eligible contract participant 

pursuant to clause (A)(v) of such 

Section. 

* * * * * 

(ppp) Swap Dealer. (1) In general. The 

term ‘‘swap dealer’’ means any person 

who: 

(i) Holds itself out as a dealer in 

swaps; 

(ii) Makes a market in swaps; 

(iii) Regularly enters into swaps with 

counterparties as an ordinary course of 

business for its own account; or 

(iv) Engages in any activity causing it 

to be commonly known in the trade as 

a dealer or market maker in swaps. 

(2) Exception. The term ‘‘swap dealer’’ 

does not include a person that enters 

into swaps for such person’s own 

account, either individually or in a 

fiduciary capacity, but not as a part of 

regular business. 

(3) Scope. A person who is a swap 

dealer shall be deemed to be a swap 

dealer with respect to each swap it 

enters into, regardless of the category of 

the swap or the person’s activities in 

connection with the swap. However, if 

a person makes an application to limit 

its designation as a swap dealer to 

specified categories of swaps or 

specified activities of the person in 

connection with swaps, the Commission 

shall determine whether the person’s 

designation as a swap dealer shall be so 

limited. A person may make such 

application to limit its designation at 

the same time as, or at a later time 

subsequent to, the person’s initial 

registration as a swap dealer. 

(4) De minimis exception. A person 

shall not be deemed to be a swap dealer 

as a result of swap dealing activity 

involving counterparties that meets each 

of the following conditions: 

(i) The swap positions connected with 

those activities into which the person 

enters over the course of the 

immediately preceding 12 months have 

an aggregate gross notional amount of 

no more than $100 million, and have an 

aggregate gross notional amount of no 

more than $25 million with regard to 

swaps in which the counterparty is a 

‘‘special entity’’ (as that term is defined 

in Section 4s(h)(2)(C) of the Commodity 

Exchange Act). For purposes of this 

paragraph, if the stated notional amount 

of a swap is leveraged or enhanced by 

the structure of the swap, the 

calculation shall be based on the 

effective notional amount of the swap 

rather than on the stated notional 

amount. 

(ii) The person has not entered into 

swaps in connection with those 

activities with more than 15 

counterparties, other than swap dealers, 

over the course of the immediately 

preceding 12 months. In determining 

the number of counterparties, all 

counterparties that are members of a 

single group of persons under common 

control shall be considered to be a 

single counterparty. 

(iii) The person has not entered into 

more than 20 swaps in connection with 

those activities over the course of the 

immediately preceding 12 months. For 

purposes of this paragraph, each 

transaction entered into under a master 

agreement for swaps shall constitute a 

distinct swap, but entering into an 

amendment of an existing swap in 

which the counterparty to such swap 

remains the same and the item 

underlying such swap remains 

substantially the same shall not 

constitute entering into a swap. 

(5) Insured depository institution 

swaps in connection with originating 

loans to customers. Swaps entered into 

by an insured depository institution 

with a customer in connection with 

originating a loan with that customer 

shall not be considered in determining 

whether such person is a swap dealer. 

(i) A swap shall be considered to have 

been entered into in connection with 

originating a loan only if the rate, asset, 

liability or other notional item 

underlying such swap is, or is directly 

related to, a financial term of such loan. 

The financial terms of a loan include, 

without limitation, the loan’s duration, 

rate of interest, the currency or 

currencies in which it is made and its 

principal amount. 

(ii) An insured depository institution 

shall be considered to have originated a 

loan with a customer if the insured 

depository institution: 

(A) Directly transfers the loan amount 

to the customer; 

(B) Is a part of a syndicate of lenders 

that is the source of the loan amount 

that is transferred to the customer; 

(C) Purchases or receives a 

participation in the loan; or 

(D) Otherwise is the source of funds 

that are transferred to the customer 

pursuant to the loan or any refinancing 

of the loan. 

(iii) The term loan shall not include: 

(A) Any transaction that is a sham, 

whether or not intended to qualify for 

the exclusion from the definition of the 

term swap dealer in this rule; or 

(B) Any synthetic loan, including 

without limitation a loan credit default 

swap or loan total return swap. 

(qqq) Major Swap Participant. (1) In 

general. The term major swap 

participant means any person: 

(i) That is not a swap dealer; and 

(ii)(A) That maintains a substantial 

position in swaps for any of the major 

swap categories, excluding both 

positions held for hedging or mitigating 

commercial risk, and positions 

maintained by any employee benefit 

plan (or any contract held by such a 

plan) as defined in paragraphs (3) and 

(32) of Section 3 of the Employee 

Retirement Income Security Act of 1974 

(29 U.S.C. 1002) for the primary purpose 

of hedging or mitigating any risk 

directly associated with the operation of 

the plan; 

(B) Whose outstanding swaps create 

substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets; or 

(C) That is a financial entity that: 

(1) Is highly leveraged relative to the 

amount of capital such entity holds and 

that is not subject to capital 

requirements established by an 

appropriate Federal banking agency (as 

defined in Section 1a(2) of the 

Commodity Exchange Act); and 

(2) Maintains a substantial position in 

outstanding swaps in any major swap 

category. 

(2) Scope of designation. A person 

that is a major swap participant shall be 

deemed to be a major swap participant 

with respect to each swap it enters into, 

regardless of the category of the swap or 

the person’s activities in connection 

with the swap. However, if a person 

makes an application to limit its 

designation as a major swap participant 

to specified categories of swaps or 

specified activities of the person in 

connection with swaps, the Commission 

shall determine whether the person’s 

designation as a major swap participant 

shall be so limited. A person may make 

such application to limit its designation 

at the same time as, or at a later time 

subsequent to, the person’s initial 

registration as a major swap participant. 

(3) Timing requirements. A person 

that is not registered as a major swap 

participant, but that meets the criteria in 

this rule to be a major swap participant 

as a result of its swap activities in a 


emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 80213 

fiscal quarter, will not be deemed to be 

a major swap participant until the 

earlier of the date on which it submits 

a complete application for registration 

as a major swap participant or two 

months after the end of that quarter. 

(4) Reevaluation period. 

Notwithstanding paragraph (qqq)(3) of 

this section, if a person that is not 

registered as a major swap participant 

meets the criteria in this rule to be a 

major swap participant in a fiscal 

quarter, but does not exceed any 

applicable threshold by more than 

twenty percent in that quarter: 

(i) That person will not immediately 

be subject to the timing requirements 

specified in paragraph (qqq)(3) of this 

section; but 

(ii) That person will become subject to 

the timing requirements specified in 

paragraph (3) at the end of the next 

fiscal quarter if the person exceeds any 

of the applicable daily average 

thresholds in that next fiscal quarter. 

(5) Termination of status. A person 

that is deemed to be a major swap 

participant shall continue to be deemed 

a major swap participant until such time 

that its swap activities do not exceed 

any of the daily average thresholds set 

forth within this rule for four 

consecutive fiscal quarters after the date 

on which the person becomes registered 

as a major swap participant. 

(rrr) Category of swaps; major swap 

category. For purposes of Sections 

1a(33) and 1a(49) of the Commodity 

Exchange Act and §§ 1.3(ppp) and 

1.3(qqq), the terms major swap category, 

category of swaps and any similar terms 

mean any of the categories of swaps 

listed below. For the avoidance of 

doubt, the term swap as it is used in this 

§ 1.3(rrr) has the meaning set forth in 

Section 1a(47) of the Commodity 

Exchange Act and the rules thereunder. 

(1) Rate swaps. Any swap which is 

primarily based on one or more 

reference rates, including but not 

limited to any swap of payments 

determined by fixed and floating 

interest rates, currency exchange rates, 

inflation rates or other monetary rates, 

any foreign exchange swap, as defined 

in Section 1a(25) of the Commodity 

Exchange Act, and any foreign exchange 

option. 

(2) Credit swaps. Any swap that is 

primarily based on instruments of 

indebtedness, including but not limited 

to any swap primarily based on one or 

more broad-based indices related to debt 

instruments, and any swap that is an 

index credit default swap or total return 

swap on one or more indices of debt 

instruments. 

(3) Equity swaps. Any swap that is 

primarily based on equity securities, 

including but not limited to any swap 

based on one or more broad-based 

indices of equity securities and any total 

return swap on one or more equity 

indices. 

(4) Other commodity swaps. Any 

swap that is not included in the rate 

swap, credit swap or equity swap 

categories. 

(sss) Substantial position. (1) In 

general. For purposes of Section 1a(33) 

of the Commodity Exchange Act and 

§ 1.3(qqq), the term substantial position 

means swap positions, other than 

positions that are excluded from 

consideration, that equal or exceed any 

of the following thresholds in the 

specified major category of swaps: 

(i) For rate swaps: 

(A) $3 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $6 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(ii) For credit swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(iii) For equity swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(iv) For other commodity swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(2) Aggregate uncollateralized 

outward exposure. (i) In general. 

Aggregate uncollateralized outward 

exposure in general means the sum of 

the current exposure, obtained by 

marking-to-market using industry 

standard practices, of each of the 

person’s swap positions with negative 

value in a major swap category, less the 

value of the collateral the person has 

posted in connection with those 

positions. 

(ii) Calculation of aggregate 

uncollateralized outward exposure. In 

calculating this amount the person 

shall, with respect to each of its swap 

counterparties in a given major swap 

category: 

(A) Determine the dollar value of the 

aggregate current exposure arising from 

each of its swap positions with negative 

value (subject to the netting provisions 

described below) in that major category 

by marking-to-market using industry 

standard practices; and 

(B) Deduct from that dollar amount 

the aggregate value of the collateral the 

person has posted with respect to the 

swap positions. The aggregate 

uncollateralized outward exposure shall 

be the sum of those uncollateralized 

amounts across all of the person’s swap 

counterparties in the applicable major 

category. 

(iii) Relevance of netting agreements. 

(A) If the person has a master netting 

agreement in effect with a particular 

counterparty, the person may measure 

the current exposure arising from its 

swaps in any major category on a net 

basis, applying the terms of the 

agreement. Calculation of net exposure 

may take into account offsetting 

positions entered into with that 

particular counterparty involving swaps 

(in any swap category) as well as 

security-based swaps and securities 

financing transactions (consisting of 

securities lending and borrowing, 

securities margin lending and 

repurchase and reverse repurchase 

agreements), to the extent these are 

consistent with the offsets permitted by 

the master netting agreement. 

(B) Such adjustments may not take 

into account any offset associated with 

positions that the person has with 

separate counterparties. 

(3) Aggregate potential outward 

exposure. (i) In general. Aggregate 

potential outward exposure in any 

major swap category means the sum of: 

(A) The aggregate potential outward 

exposure for each of the person’s swap 

positions in a major swap category that 

are not subject to daily mark-to-market 

margining and are not cleared by a 

registered clearing agency or derivatives 

clearing organization, as calculated in 

accordance with paragraph (sss)(3)(ii); 

and 

(B) The aggregate potential outward 

exposure for each of the person’s swap 

positions in such major swap category 

that are subject to daily mark-to-market 

margining or are cleared by a registered 

clearing agency or derivatives clearing 

organization, as calculated in 

accordance with paragraph (sss)(3)(iii) 

of this section. 

(ii) Calculation of potential outward 

exposure for swaps that are not subject 

to daily mark-to-market margining and 

are not cleared by a registered clearing 


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80214 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

agency or derivatives clearing 

organization. (A) In general. (1) For 

positions in swaps that are not subject 

to daily mark-to-market margining and 

are not cleared by a registered clearing 

agency or a derivatives clearing 

organization, potential outward 

exposure equals the total notional 

principal amount of those positions, 

adjusted by the following multipliers on 

a position-by-position basis reflecting 

the type of swap. For any swap that 

does not appropriately fall within any of 

the specified categories, the ‘‘other 

commodities’’ conversion factors are to 

be used. If a swap is structured such 

that on specified dates any outstanding 

exposure is settled and the terms are 

reset so that the market value of the 

swap is zero, the remaining maturity 

equals the time until the next reset date. 

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

Residual maturity Interest rate Foreign exchange 

rate and gold 

Precious metals 

(except gold) Other commodities 

One year or less ...................................................... 0 .00 0 .01 0 .07 0 .10 

Over one to five years ............................................. 0 .005 0 .05 0 .07 0 .12 

Over five years ........................................................ 0 .015 0 .075 0 .08 0 .15 

Residual maturity Credit Equity 

One year or less .................................................................................................................................. 0 .10 0 .06 

Over one to five years ......................................................................................................................... 0 .10 0 .08 

Over five years .................................................................................................................................... 0 .10 0 .10 

(2) Use of effective notional amounts. 

If the stated notional amount on a 

position is leveraged or enhanced by the 

structure of the position, the calculation 

in paragraph (sss)(3)(ii)(A)(1) of this 

section shall be based on the effective 

notional amount of the position rather 

than on the stated notional amount. 

(3) Exclusion of certain positions. The 

calculation in paragraph 

(sss)(3)(ii)(A)(1) of this section shall 

exclude: 

(i) Positions that constitute the 

purchase of an option, such that the 

person has no additional payment 

obligations under the position; and 

(ii) Other positions for which the 

person has prepaid or otherwise 

satisfied all of its payment obligations. 

(4) Adjustment for certain positions. 

Notwithstanding paragraph 

(sss)(3)(ii)(A)(1) of this section, the 

potential outward exposure associated 

with a position by which a person buys 

credit protection using a credit default 

swap or index credit default swap is 

capped at the net present value of the 

unpaid premiums. 

(B) Adjustment for netting 

agreements. Notwithstanding paragraph 

(sss)(3)(ii)(A) of this section, for 

positions subject to master netting 

agreements the potential outward 

exposure associated with the person’s 

swaps with each counterparty equals a 

weighted average of the potential 

outward exposure for the person’s 

swaps with that counterparty as 

calculated under paragraph 

(sss)(3)(ii)(A), and that amount reduced 

by the ratio of net current exposure to 

gross current exposure, consistent with 

the following equation as calculated on 

a counterparty-by-counterparty basis: 

PNet = 0.4 * PGross + 0.6 * NGR * PGross

Note to paragraph (sss)(3)(ii)(B): PNet is the 

potential outward exposure, adjusted for 

bilateral netting, of the person’s swaps with 

a particular counterparty; PGross is that 

potential outward exposure without 

adjustment for bilateral netting; and NGR is 

the ratio of net current exposure to gross 

current exposure. 

(iii) Calculation of potential outward 

exposure for swaps that are subject to 

daily mark-to-market margining or are 

cleared by a registered clearing agency 

or derivatives clearing organization. For 

positions in swaps that are subject to 

daily mark-to-market margining or 

cleared by a registered clearing agency 

or derivatives clearing organization: 

(A) Potential outward exposure equals 

the potential exposure that would be 

attributed to such positions using the 

procedures in paragraph (sss)(3)(ii) of 

this section multiplied by 0.2. 

(B) For purposes of this calculation, a 

swap shall be considered to be subject 

to daily mark-to-market margining if, 

and for so long as, the counterparties 

follow the daily practice of exchanging 

collateral to reflect changes in the 

current exposure arising from the swap 

(after taking into account any other 

financial positions addressed by a 

netting agreement between the 

counterparties. If the person is 

permitted by agreement to maintain a 

threshold for which it is not required to 

post collateral, the total amount of that 

threshold (regardless of the actual 

exposure at any time) shall be added to 

the person’s aggregate uncollateralized 

outward exposure for purposes of 

paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or 

(iv)(B) of this section, as applicable. If 

the minimum transfer amount under the 

agreement is in excess of $1 million, the 

entirety of the minimum transfer 

amount shall be added to the person’s 

aggregate uncollateralized outward 

exposure for purposes of paragraph 

(sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B), as 

applicable. 

(4) Calculation of daily average. 

Measures of daily average aggregate 

uncollateralized outward exposure and 

daily average aggregate potential 

outward exposure shall equal the 

arithmetic mean of the applicable 

measure of exposure at the close of each 

business day, beginning the first 

business day of each calendar quarter 

and continuing through the last 

business day of that quarter. 

(ttt) Hedging or mitigating commercial 

risk. For purposes of Section 1a(33) of 

the Commodity Exchange Act and 

§ 1.3(qqq), a swap position shall be 

deemed to be held for the purpose of 

hedging or mitigating commercial risk 

when: 

(1) Such position: 

(i) Is economically appropriate to the 

reduction of risks in the conduct and 

management of a commercial enterprise, 

where the risks arise from: 

(A) The potential change in the value 

of assets that a person owns, produces, 

manufactures, processes, or 

merchandises or reasonably anticipates 

owning, producing, manufacturing, 

processing, or merchandising in the 

ordinary course of business of the 

enterprise; 

(B) The potential change in the value 

of liabilities that a person has incurred 

or reasonably anticipates incurring in 

the ordinary course of business of the 

enterprise; or 

(C) The potential change in the value 

of services that a person provides, 

purchases, or reasonably anticipates 


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providing or purchasing in the ordinary 

course of business of the enterprise; 

(D) The potential change in the value 

of assets, services, inputs, products, or 

commodities that a person owns, 

produces, manufactures, processes, 

merchandises, leases, or sells, or 

reasonably anticipates owning, 

producing, manufacturing, processing, 

merchandising, leasing, or selling in the 

ordinary course of business of the 

enterprise; 

(E) Any potential change in value 

related to any of the foregoing arising 

from foreign exchange rate movements 

associated with such assets, liabilities, 

services, inputs, products, or 

commodities; or 

(F) Any fluctuation in interest, 

currency, or foreign exchange rate 

exposures arising from a person’s 

current or anticipated assets or 

liabilities; or 

(ii) Qualifies as bona fide hedging for 

purposes of an exemption from position 

limits under the Commodity Exchange 

Act; or 

(iii) Qualifies for hedging treatment 

under Financial Accounting Standards 

Board Accounting Standards 

Codification Topic 815, Derivatives and 

Hedging (formerly known as Statement 

No. 133); and 

(2) Such position is: 

(i) Not held for a purpose that is in the 

nature of speculation, investing or 

trading; 

(ii) Not held to hedge or mitigate the 

risk of another swap or securities-based 

swap position, unless that other 

position itself is held for the purpose of 

hedging or mitigating commercial risk 

as defined by this rule or § 240.3a67–4 

of this title. 

(uuu) Substantial counterparty 

exposure. (1) In general. For purposes of 

Section 1a(33) of the Act and § 1.3(qqq), 

the phrase substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets means a swap 

position that satisfies either of the 

following thresholds: 

(i) $5 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(ii) $8 billion in: 

(A) Daily average aggregate 

uncollateralized outward exposure plus 

(B) Daily average aggregate potential 

outward exposure. 

(2) Calculation methodology. For 

these purposes, the terms ‘‘daily average 

aggregate uncollateralized outward 

exposure’’ and ‘‘daily average aggregate 

potential outward exposure’’ have the 

same meaning as in § 1.3(sss), except 

that these amounts shall be calculated 

by reference to all of the person’s swap 

positions, rather than by reference to a 

specific major swap category. 

(vvv) Financial entity; highly 

leveraged. (1) For purposes of Section 

1a(33) of the Commodity Exchange Act 

and § 1.3(qqq), the term ‘‘financial 

entity’’ means: 

(i) A security-based swap dealer; 

(ii) A major security-based swap 

participant; 

(iii) A commodity pool as defined in 

Section 1a(10) of the Commodity 

Exchange Act; 

(iv) A private fund as defined in 

Section 202(a) of the Investment 

Advisers Act of 1940 (15 U.S.C. 80b– 

2(a)); 

(v) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

Section 3 of the Employee Retirement 

Income Security Act of 1974 (29 U.S.C. 

1002); and 

(vi) A person predominantly engaged 

in activities that are in the business of 

banking or financial in nature, as 

defined in Section 4(k) of the Bank 

Holding Company Act of 1956. 

(2) For purposes of Section 1a(33) of 

the Commodity Exchange Act and 

§ 1.3(qqq), the term ‘‘highly leveraged’’ 

means the existence of a ratio of an 

entity’s total liabilities to equity in 

excess of [8 to 1 or 15 to 1] as measured 

at the close of business on the last 

business day of the applicable fiscal 

quarter. For this purpose, liabilities and 

equity should each be determined in 

accordance with U.S. generally accepted 

accounting principles. 

Securities and Exchange Commission 

Pursuant to the Exchange Act, 15 

U.S.C. 78a et seq., and particularly, 

Sections 3 and 23 thereof, and Sections 

712 and 761(b) of the Dodd-Frank Act, 

the SEC is proposing to adopt Rules 

3a67–1, 3a67–2, 3a67–3, 3a67–4, 3a67– 

5, 3a67–6, 3a67–7, 3a71–1, and 3a71–2 

under the Exchange Act. 

Text of Proposed Rules 

For the reasons stated in the 

preamble, the SEC is proposing to 

amend Title 17, Chapter II of the Code 

of the Federal Regulations as follows: 

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

1. The authority citation for part 240 

is amended by adding the following 

citation in numerical order: 

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 

77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 

78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78o– 

4, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, 

78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– 

3, 80b–4, 80b–11, and 7201 et seq., 18 U.S.C. 

1350; and 12 U.S.C. 5221(e)(3), unless 

otherwise noted. 

* * * * * 

Sections 3a67–1 through 3a67–7 and 

sections 3a71–1 and 3a71–2 are also issued 

under Pub. L. 111–203, §§ 712, 761(b), 124 

Stat. 1841 (2010). 

* * * * * 

2. Add §§ 240.3a67–1 through 

240.3a67–7 and §§ 240.3a71–1, 

240.3a71–2 to read as follows: 

* * * * * 

Sec. 

240.3a67 1—Definition of ‘‘Major Securitybased Swap Participant.’’ 

240.3a67 2—Categories of Security-based 

Swaps. 

240.3a67 3—Definition of ‘‘Substantial 

Position.’’ 

240.3a67 4—Definition of ‘‘Hedging or 

Mitigating Commercial Risk.’’ 

240.3a67 5—Definition of ‘‘Substantial 

Counterparty Exposure.’’ 

240.3a67 6—Definitions of ‘‘Financial 

Entity’’ and ‘‘Highly Leveraged.’’ 

240.3a67 7—Timing Requirements, 

Reevaluation Period, and Termination of 

Status. 

240.3a71 1—Definition of ‘‘Security-based 

Swap Dealer. 

240.3a71 2—De minimis Exception. 

* * * * * 

§ 240.3a67–1 Definition of ‘‘Major Securitybased Swap Participant.’’ 

(a) General. Major security-based 

swap participant means any person: 

(1) That is not a security-based swap 

dealer; and 

(2)(i) That maintains a substantial 

position in security-based swaps for any 

of the major security-based swap 

categories, excluding both positions 

held for hedging or mitigating 

commercial risk, and positions 

maintained by any employee benefit 

plan (or any contract held by such a 

plan) as defined in paragraphs (3) and 

(32) of section 3 of the Employee 

Retirement Income Security Act of 1974 

(29 U.S.C. 1002) for the primary purpose 

of hedging or mitigating any risk 

directly associated with the operation of 

the plan; 

(ii) Whose outstanding security-based 

swaps create substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets; or 

(iii) That is a financial entity that: 

(A) Is highly leveraged relative to the 

amount of capital such entity holds and 

that is not subject to capital 

requirements established by an 

appropriate Federal banking agency (as 

defined in 15 U.S.C. 78c(a)(72)); and 

(B) Maintains a substantial position in 

outstanding security-based swaps in any 

major security-based swap category. 


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(b) Scope of designation. A person 

that is a major security-based swap 

participant in general shall be deemed 

to be a major security-based swap 

participant with respect to each 

security-based swap it enters into, 

regardless of the category of the 

security-based swap or the person’s 

activities in connection with the 

security-based swap, unless the 

Commission limits the person’s 

designation as a major security-based 

swap participant to specified categories 

of security-based swaps or specified 

activities of the person in connection 

with security-based swaps. 

§ 240.3a67–2 Categories of Security-based 

Swaps. 

For purposes of sections 3(a)(67) and 

3(a)(71) of the Act, 15 U.S.C. 78c(a)(67) 

and 78c(a)(71), and the rules 

thereunder, the terms major securitybased swap category, category of 

security-based swaps and any similar 

terms mean either of the following 

categories of security-based swaps: 

(a) Security-based credit derivatives. 

Any security-based swap that is based, 

in whole or in part, on one or more 

instruments of indebtedness (including 

loans), or on a credit event relating to 

one or more issuers or securities, 

including but not limited to any 

security-based swap that is a credit 

default swap, total return swap on one 

or more debt instruments, debt swap, 

debt index swap, or credit spread. 

(b) Other security-based swaps. Any 

security-based swap not described in 

paragraph (a) of this section. 

§ 240.3a67–3 Definition of ‘‘Substantial 

Position.’’ 

(a) General. For purposes of section 

3(a)(67) of the Act, 15 U.S.C. 78c(a)(67), 

and § 240.3a67–1 of this chapter, the 

term substantial position means 

security-based swap positions, other 

than positions that are excluded from 

consideration, that equal or exceed 

either of the following thresholds in any 

major category of security-based swaps: 

(1) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(2) $2 billion in: 

(i) Daily average aggregate 

uncollateralized outward exposure; plus 

(ii) Daily average aggregate potential 

outward exposure. 

(b) Aggregate uncollateralized 

outward exposure. (1) General. 

Aggregate uncollateralized outward 

exposure in general means the sum of 

the current exposure, obtained by 

marking-to-market using industry 

standard practices, of each of the 

person’s security-based swap positions 

with negative value in a major securitybased swap category, less the value of 

the collateral the person has posted in 

connection with those positions. 

(2) Calculation of aggregate 

uncollateralized outward exposure. In 

calculating this amount the person 

shall, with respect to each of its 

security-based swap counterparties in a 

given major security-based swap 

category: 

(i) Determine the dollar value of the 

aggregate current exposure arising from 

each of its security-based swap 

positions with negative value (subject to 

the netting provisions described below) 

in that major category by marking-tomarket using industry standard 

practices; and 

(ii) Deduct from that dollar amount 

the aggregate value of the collateral the 

person has posted with respect to the 

security-based swap positions. The 

aggregate uncollateralized outward 

exposure shall be the sum of those 

uncollateralized amounts across all of 

the person’s security-based swap 

counterparties in the applicable major 

category. 

(3) Relevance of netting agreements. 

(i) If a person has a master netting 

agreement with a counterparty, the 

person may measure the current 

exposure arising from its security-based 

swaps in any major category on a net 

basis, applying the terms of the 

agreement. Calculation of net exposure 

may take into account offsetting 

positions entered into with that 

particular counterparty involving 

security-based swaps (in any swap 

category) as well as swaps and securities 

financing transactions (consisting of 

securities lending and borrowing, 

securities margin lending and 

repurchase and reverse repurchase 

agreements), to the extent these are 

consistent with the offsets permitted by 

the master netting agreement. 

(ii) Such adjustments may not take 

into account any offset associated with 

positions that the person has with 

separate counterparties. 

(c) Aggregate potential outward 

exposure. (1) General. Aggregate 

potential outward exposure means the 

sum of: 

(i) The aggregate potential outward 

exposure for each of the person’s 

security-based swap positions in a major 

security-based swap category that are 

not cleared by a registered clearing 

agency or subject to daily mark-tomarket margining, as calculated in 

accordance with paragraph (c)(2) of this 

section; and 

(ii) The aggregate potential outward 

exposure for each of the person’s 

security-based swap positions in a major 

security-based swap category that are 

cleared by a registered clearing agency 

or subject to daily mark-to-market 

margining, as calculated in accordance 

with paragraph (c)(3) of this section. 

(2) Calculation of potential outward 

exposure for security-based swaps that 

are not cleared by a registered clearing 

agency or subject to daily mark-tomarket margining. 

(i) General. (A)(1) For positions in 

security-based swaps that are not 

cleared by a registered clearing agency 

or subject to daily mark-to-market 

margining, potential outward exposure 

equals the total notional principal 

amount of those positions, multiplied 

by the following factors on a positionby-position basis reflecting the type of 

security-based swap. For any securitybased swap that is not of the ‘‘credit’’ or 

‘‘equity’’ type, the ‘‘other’’ conversion 

factors are to be used: 

Residual maturity Credit Equity Other 

One year or less ............................................................................................ 0 .10 0 .06 0 .10 

Over one to five years ................................................................................... 0 .10 0 .08 0 .12 

Over five years .............................................................................................. 0 .10 0 .10 0 .15 

(2) If a security-based swap is 

structured such that on specified dates 

any outstanding exposure is settled and 

the terms are reset so that the market 

value of the security-based swap is zero, 

the remaining maturity equals the time 

until the next reset date. 

(B) Use of effective notional amounts. 

If the stated notional amount on a 

position is leveraged or enhanced by the 

structure of the position, the calculation 

in paragraph (c)(2)(i)(A) of this section 

shall be based on the effective notional 

amount of the position rather than on 

the stated notional amount. 


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(C) Exclusion of certain positions. The 

calculation in paragraph (c)(2)(i)(A) of 

this section shall exclude: 

(1) Positions that constitute the 

purchase of an option, such that the 

person has no additional payment 

obligations under the position; and 

(2) Other positions for which the 

person has prepaid or otherwise 

satisfied all of its payment obligations. 

(D) Adjustment for certain positions. 

Notwithstanding paragraph (c)(2)(i)(A) 

of this section, the potential outward 

exposure associated with a position by 

which a person buys credit protection 

using a credit default swap is capped at 

the net present value of the unpaid 

premiums. 

(ii) Adjustment for netting 

agreements. Notwithstanding paragraph 

(c)(2)(i) of this section, for positions 

subject to master netting agreements the 

potential outward exposure associated 

with the person’s security-based swaps 

with each counterparty equals a 

weighted average of the potential 

outward exposure for the person’s 

security-based swaps with that 

counterparty as calculated under 

paragraph (c)(2)(i) of this section, and 

that amount reduced by the ratio of net 

current exposure to gross current 

exposure, consistent with the following 

equation as calculated on a 

counterparty-by-counterparty basis: 

PNet = 0.4 × PGross + 0.6 × NGR × PGross

Note to paragraph (c)(2)(ii). Where: PNet is 

the potential outward exposure, adjusted for 

bilateral netting, of the person’s securitybased swaps with a particular counterparty; 

PGross is that potential outward exposure 

without adjustment for bilateral netting; and 

NGR is the ratio of net current exposure to 

gross current exposure. 

(3) Calculation of potential outward 

exposure for security-based swaps that 

are cleared by a registered clearing 

agency or subject to daily mark-tomarket margining. For positions in 

security-based swaps that are cleared by 

a registered clearing agency or subject to 

daily mark-to-market margining: 

(i) Potential outward exposure equals 

the potential outward exposure that 

would be attributed to such positions 

using the procedures in paragraph (c)(2) 

of this section, multiplied by 0.2. 

(ii) For purposes of this calculation, a 

security-based swap shall be considered 

to be subject to daily mark-to-market 

margining if, and for as long as, the 

counterparties follow the daily practice 

of exchanging collateral to reflect 

changes in the current exposure arising 

from the security-based swap (after 

taking into account any other financial 

positions addressed by a netting 

agreement between the counterparties). 

If the person is permitted by agreement 

to maintain a threshold for which it is 

not required to post collateral, the total 

amount of that threshold (regardless of 

the actual exposure at any time) shall be 

added to the person’s aggregate 

uncollateralized outward exposure for 

purposes of paragraph (a)(2) of this 

section. If the minimum transfer amount 

under the agreement is in excess of $1 

million, the entirety of the minimum 

transfer amount shall be added to the 

person’s aggregate uncollateralized 

outward exposure for purposes of 

paragraph (a)(2) of this section. 

(d) Calculation of daily average. 

Measures of daily average aggregate 

uncollateralized outward exposure and 

daily average aggregate potential 

outward exposure shall equal the 

arithmetic mean of the applicable 

measure of exposure at the close of each 

business day, beginning the first 

business day of each calendar quarter 

and continuing through the last 

business day of that quarter. 

§ 240.3a67–4 Definition of ‘‘Hedging or 

Mitigating Commercial Risk.’’ 

For purposes of section 3(a)(67) of the 

Act, 15 U.S.C. 78c(a)(67), and 

§ 240.3a67–1 of this chapter, a securitybased swap position shall be deemed to 

be held for the purpose of hedging or 

mitigating commercial risk when: 

(a) Such position is economically 

appropriate to the reduction of risks that 

are associated with the present conduct 

and management of a commercial 

enterprise, or are reasonably expected to 

arise in the future conduct and 

management of the commercial 

enterprise, where such risks arise from: 

(1) The potential change in the value 

of assets that a person owns, produces, 

manufactures, processes, or 

merchandises or reasonably anticipates 

owning, producing, manufacturing, 

processing, or merchandising in the 

ordinary course of business of the 

enterprise; 

(2) The potential change in the value 

of liabilities that a person has incurred 

or reasonably anticipates incurring in 

the ordinary course of business of the 

enterprise; or 

(3) The potential change in the value 

of services that a person provides, 

purchases, or reasonably anticipates 

providing or purchasing in the ordinary 

course of business of the enterprise; 

(b) Such position is: 

(1) Not held for a purpose that is in 

the nature of speculation or trading; and 

(2) Not held to hedge or mitigate the 

risk of another security-based swap 

position or swap position, unless that 

other position itself is held for the 

purpose of hedging or mitigating 

commercial risk as defined by this 

section or 17 CFR 1.3(ttt); and 

(c) The person holding the position 

satisfies the following additional 

conditions: 

(1) The person identifies and 

documents the risks that are being 

reduced by the security-based swap 

position; 

(2) The person establishes and 

documents a method of assessing the 

effectiveness of the security-based swap 

as a hedge; and 

(3) The person regularly assesses the 

effectiveness of the security-based swap 

as a hedge. 

§ 240.3a67–5 Definition of ‘‘Substantial 

Counterparty Exposure.’’ 

(a) General. For purposes of section 

3(a)(67) of the Act, 15 U.S.C. 78c(a)(67), 

and § 240.3a67–1 of this chapter, the 

term substantial counterparty exposure 

that could have serious adverse effects 

on the financial stability of the United 

States banking system or financial 

markets means a security-based swap 

position that satisfies either of the 

following thresholds: 

(1) $2 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(2) $4 billion in: 

(i) Daily average aggregate 

uncollateralized outward exposure; plus 

(ii) Daily average aggregate potential 

outward exposure. 

(b) Calculation. For these purposes, 

daily average aggregate uncollateralized 

outward exposure and daily average 

aggregate potential outward exposure 

shall be calculated the same way as is 

prescribed in § 240.3a67–3 of this 

chapter, except that these amounts shall 

be calculated by reference to all of the 

person’s security-based swap positions, 

rather than by reference to a specific 

major security-based swap category. 

§ 240.3a67–6 Definitions of ‘‘Financial 

Entity’’ and ‘‘Highly Leveraged.’’ 

(a) For purposes of section 3(a)(67) of 

the Act, 15 U.S.C. 78c(a)(67), and 

§ 240.3a67–1 of this chapter, the term 

financial entity means: 

(1) A swap dealer; 

(2) A major swap participant; 

(3) A commodity pool as defined in 

section 1a(10) of the Commodity 

Exchange Act (7 U.S.C. 1a(10)); 

(4) A private fund as defined in 

section 202(a) of the Investment 

Advisers Act of 1940 (15 U.S.C. 80b– 

2(a)); 

(5) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

Income Security Act of 1974 (29 U.S.C. 

1002); and 


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80218 Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules 

(6) A person predominantly engaged 

in activities that are in the business of 

banking or financial in nature, as 

defined in section 4(k) of the Bank 

Holding Company Act of 1956 (12 

U.S.C. 1843k). 

(b) For purposes of section 3(a)(67) of 

the Act, 15 U.S.C. 78c(a)(67), and 

§ 240.3a67–1 of this chapter, the term 

highly leveraged means the existence of 

a ratio of an entity’s total liabilities to 

equity in excess of [8 to 1 or 15 to 1] 

as measured at the close of business on 

the last business day of the applicable 

fiscal quarter. For this purpose, 

liabilities and equity should each be 

determined in accordance with U.S. 

generally accepted accounting 

principles. 

§ 240.3a67–7 Timing Requirements, 

Reevaluation Period, and Termination of 

Status. 

(a) Timing requirements. A person 

that is not registered as a major securitybased swap participant, but that meets 

the criteria in § 240.3a67–1 of this 

chapter to be a major security-based 

swap participant as a result of its 

security-based swap activities in a fiscal 

quarter, will not be deemed to be a 

major security-based swap participant 

until the earlier of the date on which it 

submits a complete application for 

registration pursuant to 15 U.S.C. 78o– 

8 or two months after the end of that 

quarter. 

(b) Reevaluation period. 

Notwithstanding paragraph (a) of this 

section, if a person that is not registered 

as a major security-based swap 

participant meets the criteria in 

§ 240.3a67–1 of this chapter to be a 

major security-based swap participant 

in a fiscal quarter, but does not exceed 

any applicable threshold by more than 

twenty percent in that quarter: 

(1) That person will not immediately 

be subject to the timing requirements 

specified in paragraph (a) of this 

section; but 

(2) That person will become subject to 

the timing requirements specified in 

paragraph (a) of this section at the end 

of the next fiscal quarter if the person 

exceeds any of the applicable daily 

average thresholds in that next fiscal 

quarter. 

(c) Termination of status. A person 

that is deemed to be a major securitybased swap participant shall continue to 

be deemed a major security-based swap 

participant until such time that its 

security-based swap activities do not 

exceed any of the daily average 

thresholds set forth within § 240.3a67– 

1 of this chapter for four consecutive 

fiscal quarters after the date on which 

the person becomes registered as a 

major security-based swap participant. 

§ 240.3a71–1 Definition of ‘‘Security-based 

Swap Dealer.’’ 

(a) General. The term security-based 

swap dealer in general means any 

person who: 

(1) Holds itself out as a dealer in 

security-based swaps; 

(2) Makes a market in security-based 

swaps; 

(3) Regularly enters into securitybased swaps with counterparties as an 

ordinary course of business for its own 

account; or 

(4) Engages in any activity causing it 

to be commonly known in the trade as 

a dealer or market maker in securitybased swaps. 

(b) Exception. The term securitybased swap dealer does not include a 

person that enters into security-based 

swaps for such person’s own account, 

either individually or in a fiduciary 

capacity, but not as a part of regular 

business. 

(c) Scope of designation. A person 

that is a security-based swap dealer in 

general shall be deemed to be a securitybased swap dealer with respect to each 

security-based swap it enters into, 

regardless of the category of the 

security-based swap or the person’s 

activities in connection with the 

security-based swap, unless the 

Commission limits the person’s 

designation as a major security-based 

swap participant to specified categories 

of security-based swaps or specified 

activities of the person in connection 

with security-based swaps. 

§ 240.3a71–2 De minimis Exception. 

For purposes of section 3(a)(71) of the 

Act, 15 U.S.C. 78c(a)(71), and 

§ 240.3a71–1 of this chapter, a person 

shall not be deemed to be a securitybased swap dealer as a result of 

security-based swap dealing activity 

involving counterparties that meets each 

of the following conditions: 

(a) Notional amount of outstanding 

security-based swap positions. The 

security-based swap positions 

connected with those activities into 

which the person enters over the course 

of the immediately preceding 12 months 

have an aggregate gross notional amount 

of no more than $100 million and have 

an aggregate gross notional amount of 

no more than $25 million with regard to 

security-based swaps in which the 

counterparty is a ‘‘special entity’’ (as that 

term is defined in 15 U.S.C. 78o–8). For 

purposes of this paragraph (a), if the 

stated notional amount of a securitybased swap is leveraged or enhanced by 

the structure of the security-based swap, 

the calculation shall be based on the 

effective notional amount of the 

security-based swap rather than on the 

stated notional amount. 

(b) No more than 15 counterparties. 

The person does not enter into securitybased swaps in connection with those 

activities with more than 15 

counterparties, other than securitybased swap dealers, over the course of 

the immediately preceding 12 months. 

In determining the number of 

counterparties, all counterparties that 

are members of a single affiliated group 

shall be considered to be a single 

counterparty. 

(c) No more than 20 security-based 

swaps. The person has not entered into 

more than 20 security-based swaps in 

connection with those activities over the 

course of the immediately preceding 12 

months. For purposes of this paragraph, 

each transaction entered into under a 

master agreement for security-based 

swaps shall constitute a distinct 

security-based swap, but entering into 

an amendment of an existing securitybased swap in which the counterparty 

to such swap remains the same and the 

notional item underlying such securitybased swap remains substantially the 

same shall not constitute entering into 

a security-based swap. 

Dated: December 1, 2010. 

By the Commodity Futures Trading 

Commission. 

David A. Stawick, 

Secretary. 

Dated: December 7, 2010. 

By the Securities and Exchange 

Commission. 

Elizabeth M. Murphy, 

Secretary. 

Additional Statement by the 

Commodity Futures Trading 

Commission Regarding the Joint 

Proposed Rule Entitled ‘‘Further 

Definition of ‘Swap Dealer,’ ‘SecurityBased Swap Dealer,’ ‘Major Swap 

Participant,’ ‘Major Security-Based 

Swap Participant,’ and ‘Eligible 

Contract Participant.’’’ 

On this matter, Chairman Gensler and 

Commissioners Dunn and Chilton voted 

in the affirmative; Commissioners 

Sommers and O’Malia voted in the 

negative. 

[FR Doc. 2010–31130 Filed 12–20–10; 8:45 am] 

BILLING CODE 6351–01–P; 8011–01–P 


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