Vol. 77 Thursday, 

No. 139 July 19, 2012 

Part II 

Commodity Futures Trading Commission 

17 CFR Part 39 

End-User Exception to the Clearing Requirement for Swaps; Final Rule 


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42560 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

1See Section 2(h)(1)(A) of the CEA, 7 U.S.C. 

2(h)(1)(A). 

2See Section 2(h)(7)(A) of the CEA, 7 U.S.C. 

2(h)(7)(A). 

3 7 U.S.C. 2(h)(7)(F) and 7 U.S.C. 2(h)(4)(A). 

4See 75 FR 80747 (Dec. 23, 2010). 

5The comment file for the proposed rulemaking 

can be found on the Commission Web site, 

www.cftc.gov. 

6The Commission notes that the Securities and 

Exchange Commission has proposed regulations 

concerning an exception for end-users from clearing 

requirements applicable to security-based swaps. 

See 75 FR 79992 (Dec. 21, 2010). The Commission 

has reviewed the SEC’s proposal and consulted 

with SEC staff regarding the SEC’s proposal and this 

final rulemaking. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 39 

RIN 3038–AD10 

End-User Exception to the Clearing 

Requirement for Swaps 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final rule. 

SUMMARY: The Commodity Futures 

Trading Commission (Commission or 

CFTC) is adopting final regulations to 

implement certain provisions of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank 

Act). These regulations govern the 

exception to the clearing requirement 

available to swap counterparties 

meeting certain conditions under the 

Commodity Exchange Act (CEA), as 

amended by the Dodd-Frank Act. 

DATES: Effective September 17, 2012. 

FOR FURTHER INFORMATION CONTACT: Erik 

F. Remmler, Associate Director, 202– 

418–7630, eremmler@cftc.gov; or Eileen 

A. Donovan, Associate Director, 202– 

418–5096, edonovan@cftc.gov, Division 

of Clearing and Risk, Commodity 

Futures Trading Commission, Three 

Lafayette Centre, 1155 21st Street NW., 

Washington, DC 20581. 

SUPPLEMENTARY INFORMATION: 

I. Background 

The CEA, as amended by Title VII of 

the Dodd-Frank Act, establishes a 

comprehensive new regulatory 

framework for swaps. The CEA requires 

a swap: (1) To be cleared through a 

derivatives clearing organization (DCO) 

if the Commission has determined that 

the swap is required to be cleared, 

unless an exception to the clearing 

requirement applies; (2) to be reported 

to a swap data repository (SDR) or the 

Commission; and (3) if the swap is 

subject to a clearing requirement, to be 

executed on a designated contract 

market (DCM) or swap execution facility 

(SEF), unless no DCM or SEF has made 

the swap available to trade. 

Section 2(h)(1)(A) of the CEA 

establishes a clearing requirement for 

swaps, providing that ‘‘it shall be 

unlawful for any person to engage in a 

swap unless that person submits such 

swap for clearing to a [DCO] that is 

registered under [the CEA] or a [DCO] 

that is exempt from registration under 

[the CEA] if the swap is required to be 

cleared.’’ 1 However, Section 2(h)(7)(A) 

of the CEA provides that the clearing 

requirement of Section 2(h)(1)(A) shall 

not apply to a swap if one of the 

counterparties to the swap: ‘‘(i) Is not a 

financial entity; (ii) is using swaps to 

hedge or mitigate commercial risk; and 

(iii) notifies the Commission, in a 

manner set forth by the Commission, 

how it generally meets its financial 

obligations associated with entering into 

non-cleared swaps’’ (referred to 

hereinafter as the ‘‘end-user 

exception’’).2 The Commission is 

adopting § 39.6 herein to implement 

certain provisions of Section 2(h)(7). 

Accordingly, any swap that is required 

to be cleared by the Commission 

pursuant to Section 2(h)(2) of the CEA 

must be submitted to a DCO for clearing 

by the parties thereto unless the 

conditions of Section 2(h)(7)(A) and 

§ 39.6 are satisfied. 

Congress promulgated the end-user 

exception in Section 2h(7) of the CEA to 

permit non-financial companies to 

continue using non-cleared swaps to 

hedge risks associated with their 

underlying business, such as 

manufacturing, energy exploration, 

farming, transportation, or other 

commercial activities. Additionally, 

Section 2(h)(7)(F) gives the Commission 

the authority to prescribe rules (or 

interpretations of such rules) that may 

be necessary to prevent abuse of the 

end-user exception, and Section 

2(h)(4)(A) requires the Commission to 

prescribe rules as determined by the 

Commission to be necessary to prevent 

evasions of the clearing requirement.3

Regulation 39.6 implements Section 

2(h)(7) of the CEA by: (1) Establishing 

the criteria for determining whether a 

swap hedges or mitigates commercial 

risk for purposes of Section 

2(h)(7)(A)(ii); (2) specifying the 

information that counterparties must 

report to satisfy the notification 

requirement of Section 2(h)(7)(A)(iii); 

and (3) establishing an exemption for 

small financial institutions pursuant to 

Section 2(h)(7)(C)(ii) of the CEA. The 

rule also requires reporting of certain 

information that the Commission will 

use to monitor compliance with, and 

prevent abuse or evasion of, the enduser exception. 

On December 23, 2010, the 

Commission published for public 

comment a notice of proposed 

rulemaking (NPRM) for § 39.6.4 The 

Commission received approximately 

2,000 comment letters, approximately 

1,650 of which were form letters (cited 

herein as ‘‘Form Letters’’), and 

Commission staff participated in 

approximately 30 ex parte meetings and 

teleconferences concerning the 

rulemaking.5 The Commission 

considered each of these comments in 

formulating the final regulations, as 

discussed below.6

II. Comments on the Notice of Proposed 

Rulemaking 

A. Scope of the End-User Exception 

As proposed, § 39.6(a) would provide 

that a counterparty to a swap (an 

‘‘electing counterparty’’) may elect the 

end-user exception to the clearing 

requirement provided in Section 

2(h)(7)(A) of the CEA (i.e., the end-user 

exception) if the electing counterparty: 

(1) Is not a ‘‘financial entity’’ as defined 

in Section 2(h)(7)(C)(i) of the CEA; (2) is 

using the swap to hedge or mitigate 

commercial risk as defined in § 39.6(c); 

and (3) provides or causes to be 

provided to a SDR or, if no SDR is 

available, the Commission, the 

information specified in proposed 

§ 39.6(b). 

1. General Scope of Regulation 39.6(a) 

The Commission received a number 

of comments regarding the general 

scope of § 39.6(a). Commodity Markets 

Council (CMC) and Riverside Risk 

Advisors, LLC (Riverside) recommended 

that the end-user exception should be 

available to a wide variety of entities. 

According to CMC, many market 

participants rely on customized overthe-counter swaps because they have 

small volume transactions or there are 

no standardized contracts available to 

hedge their specific commercial risks. 

Riverside requested that the 

Commission allow all potential 

counterparties other than swap dealers 

or major swap participants (MSPs) to 

elect the end-user exception. 

In contrast, Idaho Petroleum 

Marketers & Convenience Store 

Association (IPM&CSA) stated that the 

end-user exception should be narrowly 

tailored to businesses that produce, 

refine, process, market, or consume 

underlying commodities and to 

counterparties transacting with nonfinancial counterparties. The Form 

Letters generally agreed with the scope 

of the proposed rule’s exception from 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42561 

7The Form Letters stated: 

‘‘The big banks and their allies * * * are calling 

for exemptions for a very broad array of companies 

from the clearing and margin requirements of the 

act. Dodd-Frank already contains an exception for 

legitimate end-users, such as airlines and farmers, 

who are doing commercial hedging as part of their 

business from clearing and exchange trading 

requirements. We must not broaden this narrow, 

commonsense exception to include financial and 

commercial institutions that want to gamble in the 

derivatives markets. Doing so would allow 

systemically important companies to enter into 

risky trades in a market with zero transparency and 

accountability.’’ 

8See, e.g., American Securitization Forum (ASF), 

American Public Gas Association (APGA), National 

Rural Utilities Cooperative Finance Corp. (CFC), 

Coalition of Physical Energy Companies (COPE), 

Dairy Farmers of America (DFA), EDF Trading 

North America, LLC (EDF Trading), Farm Credit 

Council (FCC), Garkane Energy Cooperative 

(Garkane), Government Finance Officers 

Association (GFOA), Kraft Foods, Inc. (Kraft), 

National Association of Regulatory Utility 

Commissioners (NARUC), National Council of State 

Housing Agencies (NCSHA), Not for Profit 

Electricity End-Users (NFPEEU), National Milk 

Producers Foundation (NMPF), and Pacific Gas and 

Electric Co. (PG&E). 

9An exemption for small financial institutions 

from the definition of ‘‘financial entity,’’ which 

Congress directed the Commission to consider in 

Section 2(h)(7)(C)(ii) of the CEA, is addressed in 

section II.D hereof. 

10Public Law 102–242, 105 Stat. 2236 (1991). 

11 12 U.S.C. 1841 et seq. 

12For this purpose, the Commission considers 

that the term ‘‘foreign government’’ includes KfW, 

which is a non-profit, public sector entity 

responsible to and owned by the federal and state 

authorities in Germany, mandated to serve a public 

purpose, and backed by an explicit, full statutory 

guarantee provided by the German federal 

government. 

13For this purpose, the Commission considers the 

Bank for International Settlements, in which the 

Federal Reserve and foreign central banks are 

members, to be a foreign central bank. See http:// 

www.bis.org/about/orggov.htm. 

14For this purpose, the Commission considers the 

‘‘international financial institutions’’ to be those 

institutions defined as such in 22 U.S.C. 262r(c)(2) 

and the institutions defined as ‘‘multilateral 

development banks’’ in the Proposal for the 

Regulation of the European Parliament and of the 

Council on OTC Derivative Transactions, Central 

Counterparties and Trade Repositories, Council of 

the European Union Final Compromise Text, 

Article 1(4a(a)) (March 19, 2012). There is overlap 

between the two definitions, but together they 

include the following institutions: The International 

Continued 

clearing for non-financial companies 

engaging in commercial hedging and 

expressed concern with broadening the 

rule to include financial institutions or 

non-commercial hedges.7

In response to the comments from 

CMC and Riverside seeking a broader 

end-user exception, the Commission 

notes that the exception to the clearing 

requirement provided by Section 

2(h)(7)(A) is based on the type of 

counterparty (e.g., the electing 

counterparty must not be a financial 

entity) and the type of risk hedged or 

mitigated (commercial risk). The 

Commission believes the general scope 

of the rule provides an appropriately 

flexible exception to the clearing 

requirement for commercial entities 

within the limits of these two 

parameters established in the CEA. In 

response to Riverside’s other comment, 

the Commission notes that Congress 

specifically required all financial 

entities as defined in Section 2(h)(7)(C) 

(with certain exceptions specifically 

identified in that section) to submit for 

clearing swaps that are subject to the 

clearing requirement. Therefore, the 

Commission is adopting § 39.6(a) largely 

as proposed, except for changes to 

clarify the rule language and to make it 

consistent with other provisions of the 

rule as finalized. 

2. Application of the End-User 

Exception to Certain Entities 

The Commission received a number 

of specific requests from commenters 

that the Commission determine that 

certain entities, or types of entities, are 

able to elect the end-user exception.8

The commenters asked for relief in one 

of two ways: (i) That the Commission 

provide an express exemption from the 

clearing requirement for such entity; or 

(ii) that the Commission determine that 

the specific entity in question is not a 

financial entity and is hedging 

commercial risk. 

Regulation 39.6(a), as adopted, sets 

forth the basic conditions that an entity 

must satisfy to elect the end-user 

exception. Except with respect to 

foreign governments, foreign central 

banks, international financial 

institutions, and state and local 

government entities as discussed below, 

the Commission is declining to 

determine at this time whether certain 

specific entities, or types of entities, are 

exempt from the clearing requirement or 

would qualify for the end-user 

exception based on their specific 

circumstances.9 This release addresses 

comments and questions that are 

generally applicable to the rule. Any 

exemptive or interpretive 

determinations based on the specific 

nature or circumstances of a particular 

entity can better be addressed on a caseby-case basis, with the benefit of all 

relevant facts and circumstances, 

through the interpretive or exemptive 

relief processes available for such 

purposes under the CEA and the 

Commission’s regulations. 

3. Definition of ‘‘Financial Entity’’ and 

‘‘Financial Institution’’ for Purposes of 

FDICIA 

The International Energy Credit 

Association (IECA) requested that the 

Commission clarify the meaning of 

‘‘financial entity’’ in the regulation. 

According to IECA, because of the 

implications of being labeled a 

‘‘financial entity’’ under the Dodd-Frank 

Act, an entity may be reluctant to 

represent that it is a ‘‘financial 

institution’’ for purposes of the Federal 

Deposit Insurance Corporation 

Improvement Act (FDICIA).10 IECA 

recommended that proposed § 39.6(a) be 

revised in part to state that a 

counterparty may elect the end-user 

exception if the electing counterparty 

(new language emphasized): ‘‘Is not a 

‘financial entity’ as defined in section 

2(h)(7)(C)(i) of the Act (determined 

without regard to whether such entity 

believes itself to be, or in fact 

constitutes, a ‘financial institution’ 

within the meaning of FDICIA).’’ 

The Commission declines to revise 

proposed § 39.6(a) as requested by IECA 

because ‘‘financial entity’’ and 

‘‘financial institution’’ are different 

terms referenced in different statutes. 

Interpreting the meaning and use of 

‘‘financial institution’’ under FDICIA is 

within the jurisdiction of the Federal 

Deposit Insurance Corporation. 

Accordingly, the Commission is not 

inclined to render a view on the 

meaning of that term. 

4. Status of Foreign Governments, 

Foreign Central Banks, and International 

Financial Institutions as ‘‘Financial 

Entities’’ 

The Commission received a comment 

from Milbank, Tweed, Hadley & McCloy 

LLP (Milbank) recommending that 

foreign governments and their agencies 

be excluded from the definition of 

‘‘financial entity.’’ Milbank cited central 

banks, treasury ministries, export 

agencies, and housing finance 

authorities as examples of agencies of 

foreign governments that could be 

affected. Milbank expressed concern 

that these entities might be treated as 

‘‘financial entities’’ that would not be 

permitted to use the end-user exception 

if, for example, they are viewed as 

‘‘predominately engaged in * * * 

activities that are financial in nature, as 

defined by Section 4(k) of the Bank 

Holding Company Act of 1956.’’ 11 In a 

separate letter, the World Bank 

commented that it should not be subject 

to the clearing requirement under 

Section 2(h)(1) of the CEA. 

The Commission recognizes that there 

are important public policy implications 

related to the application of the enduser exception, and the clearing 

requirement generally, to foreign 

governments,12 foreign central banks,13

and international financial 

institutions.14 The Commission expects 


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42562 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

Monetary Fund, International Bank for 

Reconstruction and Development, European Bank 

for Reconstruction and Development, International 

Development Association, International Finance 

Corporation, Multilateral Investment Guarantee 

Agency, African Development Bank, African 

Development Fund, Asian Development Bank, 

Inter-American Development Bank, Bank for 

Economic Cooperation and Development in the 

Middle East and North Africa, Inter-American 

Investment Corporation, Council of Europe 

Development Bank, Nordic Investment Bank, 

Caribbean Development Bank, European Investment 

Bank and European Investment Fund. (The 

International Bank for Reconstruction and 

Development, the International Finance 

Corporation and the Multilateral Investment 

Guarantee Agency are parts of the World Bank 

Group.) 

15See F. Hoffman-LaRoche, Ltd. v. Empagran 

S.A., 542 U.S. 155, 164 (2004), citing Murray v. 

Schooner Charming Betsy, 2 Cranch 64, 118, 2 L.Ed. 

208 (1804) (‘‘[A]n act of congress ought never to be 

construed to violate the law of nations if any other 

possible construction remains’’); Hartford Fire 

Insurance Co. v. California, 509 U.S. 764 (1993) 

(Scalia, J., dissenting). See also Restatement (Third) 

Foreign Relations Law § 403 (scope of a statutory 

grant of authority must be construed in the context 

of international law and comity including, as 

appropriate, the extent to which regulation is 

consistent with the traditions of the international 

system). 

16See, e.g., the International Organization and 

Immunities Act (22 U.S.C. 288) and the Foreign 

Sovereign Immunities Act (28 U.S.C. 1602). The 

United States has taken appropriate actions to 

implement international obligations with respect to 

such immunities and privileges. See, e.g., 

International Bank for Reconstruction and 

Development (the ‘‘World Bank’’) and International 

Monetary Fund (22 U.S.C. § 286g and 22 U.S.C. 

286h), the European Bank for Reconstruction and 

Development (22 U.S.C. 290l–6), the Multilateral 

Investment Guarantee Agency (22 U.S.C. 290k–10), 

the Africa Development Bank (22 U.S.C. 290i–8), 

the African Development Fund (22 U.S.C. 290g–7), 

the Asian Development Bank (22 U.S.C. 285g), the 

Inter-American Development Bank (22 U.S.C. 283g), 

the Bank for Economic Cooperation and 

Development in the Middle East and North Africa 

(22 U.S.C. 290o), and the Inter-American 

Investment Corporation (22 U.S.C. 283hh). See, e.g., 

CFTC Interpretative Letter regarding World Bank 

Group, dated October 30, 1991. ‘‘Based on the 

unique attributes and status of the World Bank 

Group as a multinational member agency, * * * the 

CFTC believes that the World Bank Group need not 

be treated as a U.S. person for purposes of 

application of the CFTC’s Part 30 rules.’’ See, also 

e.g., Board of Governors of the Federal Reserve 

approval of the application of BCI to acquire LITCO 

Bancorporation of New York, Inc., 68 Federal 

Reserve Bulletin 423 (1982) (the Bank Holding 

Company Act does not apply to foreign 

governments because they are not ‘‘companies’’ as 

such term is defined in the Bank Holding Company 

Act). 

17To the contrary, Section 752(a) of the DoddFrank Act directs the Commission to consult and 

coordinate with other regulators ‘‘on the 

establishment of consistent international standards 

with respect to the regulation (including fees) of 

swaps [and] swap entities. * * *’’ 

18The foregoing rationale and considerations do 

not, however, extend to sovereign wealth funds or 

similar entities due to the predominantly 

commercial nature of their activities. Accordingly, 

the Commission clarifies that sovereign wealth 

funds and similar entities are subject to Section 

2(h)(1) of the CEA. 

19The Commission is not convinced by NCHSA’s 

suggestion that Congress would have expressly 

included in the definition housing finance entities 

and other state and local government entities if it 

had intended for them to be ‘‘financial entities.’’ 

Congress did not list every type of entity that is a 

financial entity, but provided a catch-all definition 

in Section 2(h)(7)(C)(VIII) to capture various types 

of entities it did not specifically list. The reference 

to government employee benefit plans is part of 

Section 2(h)(7)(C)(VII), which includes various 

types of employee benefit plans specifically in the 

definition of ‘‘financial entity,’’ does not appear to 

have been intended as a singular identification of 

the only type of governmental entity that could be 

captured by the definition of ‘‘financial entity.’’ 

20 12 U.S.C. 24 (Seventh). 

that if any of the Federal Government, 

Federal Reserve Banks, or international 

financial institutions of which the 

United States is a member were to 

engage in swap transactions in foreign 

jurisdictions, the actions of those 

entities with respect to those 

transactions would not be subject to 

foreign regulation. However, if foreign 

governments, foreign central banks, or 

international financial institutions were 

subjected to regulation by the 

Commission in connection with their 

swap transactions, foreign regulators 

could treat the Federal Government, 

Federal Reserve Banks, or international 

financial institutions of which the 

United States is a member in a similar 

manner. The Commission notes that the 

Federal Reserve Banks and the Federal 

Government are not subject to the 

clearing requirement under the DoddFrank Act. 

Canons of statutory construction 

‘‘assume that legislators take account of 

the legitimate sovereign interests of 

other nations when they write American 

laws.’’ 15 In addition, international 

financial institutions operate with the 

benefit of certain privileges and 

immunities under U.S. law indicating 

that such entities may be viewed 

similarly under certain circumstances.16

There is nothing in the text or history 

of the swap-related provisions of Title 

VII of the Dodd-Frank Act to establish 

that Congress intended to deviate from 

these traditions of the international 

system by subjecting foreign 

governments, foreign central banks, or 

international financial institutions to 

the clearing requirement set forth in 

Section 2(h)(1) of the CEA.17

Given these considerations of comity 

and in keeping with the traditions of the 

international system, the Commission 

believes that foreign governments, 

foreign central banks, and international 

financial institutions should not be 

subject to Section 2(h)(1) of the CEA.18

Accordingly, it is not necessary to 

determine whether these entities are 

‘‘financial entities’’ under Section 

2(h)(7) of the CEA. 

The Commission notes, however, that 

if a foreign government, foreign central 

bank, or international financial 

institution enters into a non-cleared 

swap with a counterparty who is subject 

to the CEA and Commission regulations 

with regard to that transaction, then the 

counterparty still must comply with the 

CEA and Commission regulations as 

they pertain to non-cleared swaps. For 

example, the party must comply with 

the recordkeeping and reporting 

requirements under Parts 23 and 45 of 

the Commission’s regulations. 

5. Status of State and Local Government 

Entities as ‘‘Financial Entities’’ 

NCSHA recommended that the 

Commission explicitly provide that state 

and local governmental entities, 

specifically housing finance agencies, 

are not ‘‘financial entities’’ as defined in 

Section 2(h)(7) of CEA. In particular, 

NCSHA expressed concern regarding 

the applicability of Section 

2(h)(7)(C)(VIII), which provides that a 

person is a financial entity if the person 

is ‘‘predominantly engaged in activities 

that are in the business of banking, or 

in activities that are financial in nature, 

as defined in section 4(k) of the Bank 

Holding Company Act of 1956.’’ 

As an initial matter, the Commission 

notes that Congress did not expressly 

exclude state and local government 

entities from the ‘‘financial entity’’ 

definition. On the contrary, in Section 

2(h)(7)(C)(VII), Congress expressly 

included employee benefit plans of state 

and local governments in the ‘‘financial 

entity’’ definition, thereby prohibiting 

them from using the end-user 

exception.19 A per se exclusion for state 

and local government entities from the 

‘‘financial entity’’ definition is 

inappropriate. A state or local 

government entity’s swap activity may 

be commercial in nature and such entity 

may also meet the definition of a 

‘‘financial entity’’ in Section 2(h)(7)(C) 

of the CEA. Under such circumstances, 

the entity would be subject to 

compliance with the clearing 

requirement of Section 2(h)(1)(A). As an 

example, much like state and local 

government employee benefit plans that 

are expressly identified in Section 

2(h)(7)(C) as financial entities, other 

state or local government entities that 

act in the market in the same manner as 

private asset managers, such as local 

government investment pools, would 

need to comply. 

The ‘‘business of banking’’ is a term 

of art found in the National Bank Act 20

and is within the jurisdiction of, and 

therefore subject to interpretation by, 

the Office of the Comptroller of the 


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21Nationsbank of N.C., N.A. v. Variable Annuity 

Life Ins. Co., 513 U.S. 251, 258 & n.2 (1995). 

22The Commission notes that the definition of 

‘‘major swap participant’’ in Section 1a(33) of the 

CEA, in which the term ‘‘financial entity’’ is also 

used, does not include a provision that is similar 

to Section 2(h)(7)(D). In the absence of such a 

provision, the Commission has defined the term 

‘‘financial entity’’ in § 1.3(mmm)(1) for purposes of 

the ‘‘major swap participant’’ definition in Section 

1a(33) of the CEA and § 1.3(hhh), to exclude certain 

centralized hedging and treasury entities. See 77 FR 

30596 at 30750 (May 23, 2012). The Commission 

does not believe it would be appropriate to take a 

similar approach with respect to the end-user 

exception, however, because Section 2(h)(7)(D) 

specifically addresses when affiliates may be 

eligible for the end-user exception. 

Currency.21 Similarly, Section 4(k) of 

the Bank Holding Company Act is 

within the jurisdiction of, and therefore 

subject to interpretation by, the Board of 

Governors of the Federal Reserve 

System. Accordingly, the Commission is 

not inclined to interpret these 

provisions. However, even assuming 

that many state and local government 

entities may engage in some limited 

activities that are in the business of 

banking or are financial in nature as 

defined by Section 4(k), such activities 

are likely to be incidental, not primary, 

activities of those entities. Therefore, 

most state and local government entities 

are not likely to be ‘‘financial entities’’ 

under Section 2(h)(7)(C)(VIII), because 

they are not predominantly engaged in 

activities that are in the business of 

banking, or are financial in nature, as 

defined by Section 4(k) of the Bank 

Holding Company Act of 1956. Instead, 

most state and local government entities 

are ‘‘predominantly engaged’’ in other, 

non-banking and non-financial, 

activities related to their core public 

purposes and functions. Such entities 

therefore would not be ‘‘financial 

entities’’ by virtue of Section 

2(h)(7)(C)(VIII) of the CEA. 

Regarding NCHSA’s request for a 

specific determination for housing 

finance agencies, the Commission is not 

inclined to make such a determination 

without the opportunity to consider all 

relevant facts and circumstances. 

6. Affiliates 

Section 2(h)(7)(D)(i) of the CEA 

provides that an affiliate of a person that 

qualifies for the end-user exception 

(including affiliate entities 

predominantly engaged in providing 

financing for the purchase of the 

merchandise or manufactured goods of 

the person) may qualify for the 

exception only if the affiliate, acting on 

behalf of the person and as an agent, 

uses the swap to hedge or mitigate the 

commercial risk of the person or other 

affiliate of the person that is not a 

financial entity. The clear implication of 

this provision is that such an affiliate 

may elect the end-user exception, even 

if it is a financial entity, if the swap and 

the affiliate relationship otherwise 

comply with the requirements of 

Section 2(h)(7) and in particular, 

Section 2(h)(7)(D). Section 2(h)(7)(D)(ii), 

however, provides that this affiliate 

exception shall not apply to certain 

types of entities including, among 

others, swap dealers or MSPs. 

Shell Energy North America (US), L.P. 

(Shell) commented that, absent clear 

guidance by the Commission, potential 

electing counterparties that centralize 

their risk management through a 

hedging affiliate that is designated as a 

swap dealer or MSP may be unable to 

benefit from the end-user exception. As 

a result, many potential electing 

counterparties may need to restructure 

their businesses and risk management 

techniques, thereby losing the many 

benefits of centralized hedging. 

According to Shell, such a loss might 

require potential electing counterparties 

to take on additional risk or to transact 

with third parties. 

In response, the Commission notes 

that it lacks discretion in this regard 

because Congress specifically defined 

financial entities (which cannot use the 

end-user exception) to include swap 

dealers and MSPs, and Section 

2(h)(7)(D) specifically prohibits swap 

dealers or MSPs acting on behalf of 

affiliates from using that provision to 

elect the end-user exception.22

Similarly, Kraft, Philip Morris 

International, Inc. (Philip Morris), and 

Siemens Corp. (Siemens) commented 

that the Commission should exclude 

wholly-owned treasury subsidiaries of 

non-financial companies from the 

‘‘financial entity’’ definition, to the 

extent that they solely engage in swap 

transactions to hedge or mitigate the 

commercial risks of an entire corporate 

group. These commenters noted in 

particular that the treasury subsidiaries 

may be, or are likely to be, ‘‘financial 

entities’’ under Section 2(h)(7)(C)(VIII), 

because they are predominantly engaged 

in activities of a financial nature as 

defined in Section 4(k) of the Bank 

Holding Company Act. Siemens 

believes the Commission should amend 

the proposed rule to clarify that a 

financial entity acting as a ‘‘Treasury 

Affiliate’’ satisfies the statutory criteria 

for ‘‘acting on behalf of the person and 

as an agent,’’ as required by section 

2(h)(7)(D)(i) of the CEA. 

Here too, the Commission notes that 

Congress specifically defined ‘‘financial 

entity’’ for purposes of Section 2(h)(7) of 

the CEA, and proposed § 39.6(b)(2) 

(renumbered as § 39.6(a)(1)(i) in the 

final rule) simply adopts that definition. 

Likewise, Congress specifically set out 

in Section 2(h)(7)(D) who may qualify as 

an affiliate eligible for the end-user 

exception. The specificity with which 

Congress defines ‘‘financial entity’’ and 

sets out when affiliates, including 

affiliates that may be financial entities, 

may elect the end-user exception on 

behalf of an affiliate that is not a 

financial entity (i.e., the treasury 

affiliate would need to be ‘‘acting on 

behalf of the [other affiliate] and as 

agent’’), constrains the Commission’s 

discretion in this area. 

However, the Commission notes that 

it is important to distinguish where the 

treasury function operates in the 

corporate structure. Treasury affiliates 

that are separate legal entities and 

whose sole or primary function is to 

undertake activities that are financial in 

nature as defined under Section 4(k) of 

the Bank Holding Company Act are 

financial entities as defined in Section 

2(h)(7)(C)(VIII) of the CEA because they 

are ‘‘predominantly engaged’’ in such 

activities. If, on the other hand, the 

treasury function through which 

hedging or mitigating the commercial 

risks of an entire corporate group is 

undertaken by the parent or another 

corporate entity, and that parent or 

other entity is entering into swaps in its 

own name, then the application of the 

end-user exception to those swaps 

would be analyzed from the perspective 

of the parent or other corporate entity 

directly. 

For example, consider a parent 

company or other corporate entity 

predominantly engaged in 

manufacturing, agriculture, retailing, 

energy, or other non-‘‘financial entity’’ 

businesses and which is not one of the 

types of financial entities described in 

Sections 2(h)(7)(C)(I) through (VII). If 

that parent or other corporate entity 

enters into swaps with an affiliate that 

hedge or mitigate commercial risk of the 

affiliate, the affiliate may elect the enduser exception for those inter-affiliate 

swaps if the affiliate is not a financial 

entity. If the parent or other corporate 

entity then aggregates the commercial 

risks of those swaps with other risks of 

the commercial enterprise and hedges 

the aggregated commercial risk using a 

swap with a swap dealer, that entity 

may, in its own right, elect the end-user 

exception for that hedging swap. The 

parent or other corporate entity in the 

example is not a ‘‘financial entity’’ as 

defined in Section 2(h)(7)(C)(VIII) of the 

CEA, because that entity is 

‘‘predominantly engaged’’ in other, nonfinancial activities undertaken to fulfill 

its core commercial enterprise purpose. 

However, if the parent or other 


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23American Honda Finance Corp., John Deere 

Financial Services, Inc., Nissan North America, 

Inc., Toyota Financial Services, and Caterpillar 

Financial Services Corp. 

corporate entity, including, for example, 

a separately incorporated treasury 

affiliate, is a ‘‘financial entity,’’ then that 

entity cannot elect the end-user 

exception unless one of the specific 

affiliate provisions of the statute, 

Section 2(h)(7)(C)(iii) or Section 

2(h)(7)(D), apply. 

CFC recommended that the 

Commission clarify that the definition 

of ‘‘an affiliate of a person’’ includes a 

nonprofit, tax-exempt cooperative of 

which the person is a member and 

which is not a depository institution. 

Section 2(h)(7)(D)(ii) of the CEA lists 

certain types of entities that do not 

qualify as affiliates able to elect the enduser exception. The Commission 

declines to determine at this time 

whether specific types of entities would 

qualify as affiliates able to elect the enduser exception because such 

determinations are best made on a caseby-case basis with the benefit of all 

relevant facts and circumstances. 

Cravath, Swaine, and Moore, LLP 

(Cravath), EDF Trading, The Prudential 

Insurance Company of America 

(Prudential), and Working Group of 

Commercial Energy Firms (WGCEF) 

commented that the Commission should 

provide an explicit exemption from 

clearing and notification requirements 

for inter-affiliate swaps, i.e., swaps 

between companies that are part of a 

single group of affiliated companies. EEI 

& EPSA recommended that the 

Commission clarify in the regulatory 

text that ‘‘acting on behalf of the person 

and as an agent’’ to hedge or mitigate 

commercial risk includes inter-affiliate 

transactions. 

As a general matter, the Commission 

notes that Congress did not treat interaffiliate swaps differently from other 

swaps in Section 2(h)(7) of the CEA. 

Accordingly, the fact that a swap is 

between two affiliates would not change 

the analysis of whether one of the 

parties to the swap can elect the enduser exception. If one of the affiliates is 

not a financial entity and is using the 

swap to hedge or mitigate commercial 

risk, even if the other affiliate is a 

financial entity, the non-financial entity 

affiliate may elect the end-user 

exception and neither affiliate needs to 

clear the swap. However, whether the 

Commission should provide general 

clearing relief for inter-affiliate swaps 

for which the statutory requirements of 

the end-user exception are not satisfied 

is outside the scope of this rulemaking. 

Notwithstanding the foregoing, the 

Commission acknowledges that 

commenters have raised issues 

regarding inter-affiliate swaps that 

warrant further review and the 

Commission is considering other 

options regarding these issues. 

7. Captive Finance Companies 

Section 2(h)(7)(C)(iii) of the CEA 

provides that the definition of ‘‘financial 

entity’’ in Section 2(h)(7)(C)(i) of the 

CEA ‘‘shall not include an 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.’’ In connection with 

this ‘‘captive finance company’’ 

exception, the U.S. Chamber of 

Commerce and the Coalition for 

Derivatives End Users (CDEU) requested 

that the Commission interpret the 

phrase ‘‘90 percent or more of which are 

manufactured by the parent company or 

another subsidiary of the parent 

company’’ to include component parts, 

attachments, systems, and other 

products that may be manufactured by 

others, but sold together with the 

company’s products as well as 

attachments and labor costs that are 

incidental to the primary purchase. 

The Commission believes that the 

captive finance company exception 

must be interpreted in a manner 

consistent with the plain language of the 

statute. As a result, a person that seeks 

to fall within the captive finance 

company exception must be in the 

‘‘primary business’’ of providing 

financing of purchases or leases from its 

parent company or subsidiaries thereof. 

Consistent with this requirement, the 

Commission states that the captive 

finance company exception can be 

applied when this financing activity 

finances the purchase or lease of 

products sold by the parent company or 

its subsidiaries in a broad sense, 

including service, labor, component 

parts, and attachments that are related 

to the products. 

A group of captive finance companies 

or affiliates of captive finance 

companies (the ‘‘Captive Finance 

Companies’’) 23 asked the Commission 

to create a simple test to determine 

whether an entity qualifies for the 

captive finance company exception and 

to clarify whether the two ‘‘90 percent’’ 

prongs should be read separately or 

together. The Commission believes the 

test is set out plainly in the statute and 

only allows for limited interpretation. 

As to the two prongs, the Commission 

interprets them separately. That is, 

90 percent or more of the interest rate 

and currency exposures for which the 

captive finance company is using 

derivatives to hedge the related 

underlying commercial risks must arise 

from financing that facilitates the 

purchase or lease of products. Ninety 

percent or more of the products, the 

purchase or sale of which are being 

facilitated by the financing, must be 

manufactured by the parent company or 

its subsidiary. An entity must satisfy 

both prongs in order to be eligible for 

the captive finance company exception. 

The Captive Finance Companies 

expressed concern that the Commission 

would require a product, in order to 

qualify as ‘‘manufactured’’ by the parent 

company or a subsidiary, to have 

90 percent or more of its components 

manufactured by the parent company or 

subsidiary. The Commission requires 

only that the final product being 

purchased or sold, regardless of its 

components, be manufactured by the 

parent company or subsidiary in order 

to qualify. 

The Captive Finance Companies also 

asked the Commission whether the 

‘‘financing that facilitates the purchase 

or lease of products’’ should be 

measured on a single-entity or 

consolidated basis that includes the 

entity’s consolidated subsidiaries. They 

recommended that it be measured on a 

consolidated basis to prevent an entity 

that is a part of a larger group of entities 

from using corporate structures to 

manipulate the outcome and because 

most entities manage the reporting of 

their finance and leasing portfolios on 

that basis. The Commission agrees that 

the financing should be measured on a 

consolidated basis. 

Further, the Captive Finance 

Companies discussed the ways in which 

a captive finance company might 

‘‘facilitate’’ the purchase or lease of the 

parent company’s and subsidiaries’ 

products. For example, a captive finance 

company for an engine manufacturer 

may finance the sale of a boat that 

includes the manufacturer’s engine in 

order to facilitate the sale of the engine, 

even if the boat itself were 

manufactured by a different company. 

As a second example, a captive finance 

company may provide working capital 

and related financing to a dealer that 

sells the parent company’s products, 

even though such financing is not 

directly related to the sale of products. 

The Commission agrees that the word 

‘‘facilitates’’ as used in Section 

2(h)(7)(C)(iii) should be interpreted 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42565 

24 In addition, Section 2(h)(4)(A) requires the 

Commission to prescribe rules as determined by the 

Commission to be necessary to prevent evasion of 

the clearing requirements. 

25See, e.g., American Bankers Association (ABA), 

American Gas Association (AGA), APGA, American 

Petroleum Institute (API), Air Transport Association 

(ATA), CDEU, COPE, Cravath, EDF Trading, Edison 

Electric Institute (EEI), EEI and Electric Power 

Supply Association (EEI & EPSA), Encana 

Marketing (USA) Inc. (EMUS), IECA, Independent 

Petroleum Association (IPA), National Council of 

Farmer Cooperatives (NCFC), NCSHA, National 

Energy Marketers Association (NEMA), Natural Gas 

Supply Association (NGSA), NMPF, Noble Energy, 

Inc. (Noble), National Rural Electric Cooperative 

Association (NRECA), Peabody Energy Corp. 

(Peabody), Retail Energy Supply Association 

(RESA), San Diego Gas and Electric Co. (SDG&E), 

Shell, Swap Financial Group, LLC (SFG), WGCEF, 

and WSPP, Inc. (WSPP). 

26See, e.g., ABA, AGA, API, ATA, CDEU, CFI 

Industries, Inc. (CFI), Hess Corp. (Hess), NCFC, 

NCSHA, NFPEEU, Noble, Peabody, SDG&E, Shell, 

and WGCEF. 

27 Id. 

28See, e.g., APGA, COPE, Cravath, EDF Trading, 

EEI & EPSA, EMUS, Hess, IECA, IPA, NCSHA, 

NMPF, Petroleum Marketers Association of 

America and New England Fuel Institute (PMAA & 

NEFI), RESA, and SFG. 

29The Commission’s Part 43 rules on real-time 

public reporting of swap transaction data also 

require the reporting counterparty to indicate 

election of the end-user exception on a swap-byswap basis. See 77 FR 1182 at 1250 (Jan. 9, 2012). 

Indication of the election of the end-user exception 

will be publicly disseminated as required in Part 

43, but the additional information required under 

§ 39.6(b) will not be. 

broadly to include financing that may 

indirectly help to facilitate the purchase 

or lease of products. 

CFC commented that it should be 

viewed as a captive finance subsidiary 

of the entities that own it in a 

cooperative structure. CFC also 

discussed whether the captive finance 

company exception should be available 

when it provides financing to its 

member-owners to support their general 

business activities, rather than to 

finance purchases from its memberowners. The Commission is declining to 

determine at this time whether specific 

entities would qualify for the captive 

finance company exception because 

such determinations are best made on a 

case-by-case basis with the benefit of all 

relevant facts and circumstances. 

B. Reporting Requirements 

Section 2(h)(7)(A)(iii) of the CEA 

requires that, for the end-user exception 

to apply, one of the counterparties to the 

swap must notify ‘‘the Commission in a 

manner set forth by the Commission 

how it generally meets its financial 

obligations associated with entering into 

non-cleared swaps.’’ Section 2(h)(7)(F) 

of the CEA allows the Commission to 

‘‘prescribe such rules or issue 

interpretations of the rules as the 

Commission determines to be necessary 

to prevent abuse’’ of the end-user 

exception and to ‘‘request information 

from those persons claiming the clearing 

exception as necessary to prevent 

abuse.’’ 24

Proposed § 39.6(b) would implement 

Section 2(h)(7)(A)(iii) by requiring one 

of the counterparties (the ‘‘reporting 

counterparty’’) to provide, or cause to be 

provided, to a registered SDR, or if no 

registered SDR is available, to the 

Commission, information about how the 

electing counterparty generally expects 

to meet its financial obligations 

associated with the non-cleared swap. 

In addition, proposed § 39.6(b) would 

require the reporting counterparty to 

provide certain information that the 

Commission will use to monitor 

compliance with, and prevent abuse of, 

the end-user exception. The reporting 

counterparty would be required to 

provide the information at the time the 

electing counterparty elects the end-user 

exception. 

1. Frequency of Reporting 

The Commission received numerous 

comments suggesting that reporting of 

the information specified under 

proposed § 39.6(b) for each swap 

transaction would be burdensome.25 A 

number of commenters recommended 

that the Commission permit entities to 

report some or all of the required items 

on an annual or periodic basis with 

updates for any material changes.26

According to these commenters, an 

annual or periodic filing would provide 

sufficient notice to the Commission 

because the reasons for which each 

entity enters into hedge transactions, 

and the manner in which each entity 

generally meets its financial obligations 

associated with those transactions, do 

not change materially on a frequent 

basis.27 Several commenters believe that 

a one-time filing of some or all of the 

required items should suffice.28

Hess suggested that, instead of 

imposing additional reporting 

requirements, the Commission could 

prevent abuse of the end-user exception 

by requiring electing counterparties to 

represent that they satisfy the 

requirements of Sections 2(h)(7) and 2(j) 

of the CEA in swap contracts that they 

elect not to clear. EEI & EPSA also 

recommended that if the Commission 

were to require swap-by-swap reporting, 

it should adopt a flexible requirement 

that establishes reasonable time frames 

for reporting. ATA recommended that 

the Commission streamline the notice 

requirement by providing that notice 

may be satisfied on a one-time basis as 

part of the ISDA master agreement. 

IECA recommended that the rule be 

revised to state that if more than one, 

but less than all, parties to a swap are 

electing counterparties, the information 

specified in proposed § 39.6(b) shall be 

provided with respect to each of the 

electing counterparties. According to 

IECA, if all parties to a swap are electing 

counterparties, no report should be 

required. 

NMPF requested that the Commission 

simplify the reporting requirements, 

especially for those smaller hedgers for 

whom the typical reporting 

requirements would be burdensome, 

and exempt agricultural swaps between 

non-financial counterparties from all or 

most reporting requirements. Federal 

Home Loan Banks (FHL Banks) 

commented that certain non-financial 

entities should have no reporting 

obligation. 

As proposed, the swap-by-swap 

reporting frequency for all information 

to be reported may impose unnecessary 

burdens, and therefore the Commission 

is revising proposed § 39.6(b) to require 

only swap-by-swap reporting of the 

election of the end-user exception and 

the identity of the electing counterparty 

to the swap. The other information for 

which proposed § 39.6(b) would have 

required reporting on a swap-by-swap 

basis does not have to be reported for 

each swap if the electing counterparty 

has previously provided the information 

in an annual filing. 

In practice, the reporting counterparty 

will be required to check at least three 

boxes for each swap for which the enduser exception is elected, indicating: (1) 

The election of the exception; (2) which 

party is the electing counterparty; and 

(3) whether the electing counterparty 

has already provided the additional 

required information through an annual 

filing. If the third box is checked ‘‘no,’’ 

the reporting counterparty will have to 

provide the additional required 

information for that swap. The 

Commission is requiring certain 

information on a swap-by-swap basis so 

it can verify that the end-user exception 

is being elected in compliance with the 

CEA and Commission regulations.29 In 

addition, if a counterparty is eligible to 

claim the end-user exception for one 

asset class but not another (for example, 

if the counterparty is a swap dealer 

granted limited designation by the 

Commission pursuant to § 1.3(ggg)(3)), 

the Commission must be able to 

distinguish those swaps for which the 

counterparty may legitimately claim the 

end-user exception from those for which 

it cannot. The Commission does not 

believe this reporting requirement will 

impose a significant burden on parties 

because other detailed information for 

every swap must be reported under 


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30See, e.g., Sections 4(g) and 4(r) of the CEA; and 

Part 45 of the Commission’s regulations. 

31The Commission believes that the cost of 

establishing an additional reporting alternative is 

unlikely to be significant because the SDR and the 

Commission may do so in conjunction with 

establishing numerous other reporting processes, 

such as those required by the Commission’s Part 43 

rules on real-time public reporting of swap 

transaction data (77 FR 1182 (Jan. 9, 2012)). 

32See 77 FR 2136 at 2207 (Jan. 13, 2012) (Swap 

Data Recordkeeping and Reporting Requirements; 

final rule). 

other provisions of the CEA and 

Commission regulations.30

The Commission agrees with 

commenters that an annual filing for the 

remaining information will provide 

sufficient notice to the Commission 

because the general reasons for which 

electing counterparties enter into hedge 

transactions, and the manner in which 

they generally meet their financial 

obligations for those transactions, do not 

change frequently. While this approach 

may impose additional costs on SDRs 

and the Commission because each will 

have to establish and maintain two 

reporting alternatives,31 the 

Commission believes that this approach 

will impose lower costs on the swap 

parties than they would incur if all 

information were required to be 

reported on a swap-by-swap basis. 

Accordingly, § 39.6(b) is being revised 

to permit the following information to 

be reported on a swap-by-swap or an 

annual basis: (1) Whether the electing 

counterparty is a financial entity or a 

finance affiliate (i.e., is a financial entity 

electing the end-user exception by 

virtue of Sections 2(h)(7)(C)(ii) or (iii) or 

2(h)(7)(D) of the CEA); (2) whether the 

swap hedges or mitigates commercial 

risk (the annual filing will state that the 

electing counterparty will only elect the 

end-user exception for swaps that hedge 

or mitigate commercial risk); (3) how 

the electing counterparty generally 

expects to meet its financial obligations; 

and (4) information related to whether 

the electing counterparty is an issuer of 

securities with board approval to not 

clear the swaps for which the end-user 

exception is elected. 

The Commission has determined not 

to grant any exemptions to the § 39.6(b) 

reporting requirements at this time 

because any such determinations 

require a consideration of all relevant 

facts and circumstances. The modified 

reporting requirements should reduce 

some of the burdens cited by the 

commenters and given the low reporting 

burden under the rule and the general 

swap-by-swap reporting requirements in 

other regulations (e.g., Part 45), the 

Commission does not believe that a 

special, lesser reporting requirement for 

smaller parties or certain types of swaps 

is consistent with the statute. The 

Commission believes it would not be 

appropriate to require contract 

representations instead of reporting, or 

eliminate all or some reporting 

requirements for certain types of 

electing counterparties, because Section 

2(h)(7)(A)(iii) of the CEA specifically 

requires notification to the Commission. 

Finally, the information required under 

§ 39.6(b) will help to prevent abuse of 

the end-user exception by allowing the 

Commission to track when the 

exception is elected and who is electing 

it. 

2. Identifying the Reporting 

Counterparty 

As noted above, proposed § 39.6(b) 

would require one of the counterparties 

to the swap to act as the ‘‘reporting 

counterparty.’’ WSPP requested that the 

Commission clarify who the reporting 

counterparty is. WSPP noted that the 

Commission indicated in the NPRM that 

the reporting counterparty would be 

determined in accordance with the 

swap data recordkeeping and reporting 

rules and that if one of the 

counterparties is an MSP or swap 

dealer, then that entity would be the 

reporting counterparty. WSPP further 

noted that proposed § 39.6 itself would 

not impose such a requirement, and 

recommended that the Commission 

either cross-reference the relevant swap 

reporting rules in § 39.6 or define 

‘‘reporting counterparty’’ for purposes of 

§ 39.6. WSPP also requested 

clarification as to how two electing 

counterparties in an electing 

counterparty-to-electing counterparty 

transaction would determine which 

counterparty is the reporting 

counterparty, and whether the reporting 

counterparty would provide information 

on both electing counterparties at the 

same time. 

The Commission notes that § 45.8 of 

its swap data recordkeeping and 

reporting rules sets out how the 

determination of which counterparty is 

the reporting counterparty for a swap is 

to be made.32 The Commission is 

revising § 39.6(b) to include a reference 

to § 45.8. 

3. Reporting Methods 

As noted above, proposed § 39.6(b) 

would require the reporting 

counterparty to provide or cause to be 

provided to a registered SDR, or if no 

registered SDR is available, to the 

Commission, the information set forth 

in that paragraph. CFI recommended 

that the Commission revise the 

proposed rule to permit an electing 

counterparty to summarize or submit 

copies of ISDA agreements and credit 

support agreements to the Commission 

to demonstrate how the electing 

counterparty generally meets its 

financial obligations related to noncleared swaps. Similarly, EDF Trading 

stated that for transactions where 

neither party is a swap dealer or MSP, 

the Commission should provide an 

alternative to SDR reporting, such as the 

opportunity to submit hard copy 

records. 

Better Markets, Inc. (Better Markets) 

recommended that the Commission 

require electing counterparties to report 

directly to the Commission, in addition 

to an SDR. According to Better Markets, 

this would ensure that the Commission 

receives complete and timely 

information regarding reliance upon the 

end-user exception. Hess requested that 

the Commission permit electing 

counterparties who are not swap dealers 

or MSPs to report directly to an SDR or 

the Commission, rather than rely on a 

swap dealer or MSP counterparty to 

report. Hess commented that such a 

requirement would be more efficient 

and reliable. 

The Commission has determined not 

to revise § 39.6(b) in response to these 

comments. As discussed further in the 

considerations of costs and benefits in 

Section III hereof, the Commission 

believes that adopting alternative 

approaches to reporting is unnecessary, 

unduly burdensome, and may 

complicate data management and 

review. In response to Hess’ comment, 

the Commission notes that, as 

previously discussed, the final rule has 

been revised to permit electing 

counterparties to report much of the 

information required by the rule directly 

to an SDR or the Commission on an 

annual basis. For the information 

required to be reported on a swap-byswap basis, the reporting counterparty 

must be determined in accordance with 

§ 45.8. 

In the NPRM, the Commission stated 

that a reporting counterparty would 

provide the information required by 

proposed § 39.6(b) via a ‘‘check-thebox’’ approach and asked whether such 

an approach would be appropriate. 

EMUS, IECA, National Grain and 

Feed Association (NGFA), and WSPP 

commented that a check-the-box 

approach is sufficient to collect the 

information required. IECA 

recommended that the Commission 

specify the check-the-box system in the 

rule text. 

In contrast, Professor Michael 

Greenberger commented that a checkthe-box approach is inadequate. 

According to Professor Greenberger, this 


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approach will almost certainly be 

unreliable because the Commission will 

not have the necessary information to 

monitor and prevent potential abuse of 

the end-user exception. 

EMUS expressed concern that 

different reporting counterparties could 

provide the same information to a 

registered SDR in different formats. It 

recommended that the Commission 

adopt a yes-or-no schema for each of the 

items set forth in proposed § 39.6(b)(1)– 

(6). According to EMUS, such a system 

would standardize reporting, which 

would provide more useful information. 

EMUS also commented that a 

standardized submission format would 

reduce costs and facilitate reporting for 

electing counterparties. 

The Commission is satisfied that a 

check-the-box approach is an 

appropriate method to collect the 

information that the Commission 

requires to exercise regulatory oversight 

and that it mitigates the costs of 

compliance for the electing and 

reporting counterparties. In addition, a 

check-the-box approach provides a 

standardized data collection method for 

voluminous amounts of data, which will 

facilitate effective review by the 

Commission. It would be inefficient for 

the Commission to monitor and analyze 

a large volume of unique data points 

from a potentially wide range of electing 

counterparties. 

The final rule itself does not specify 

the exact format for reporting purposes 

because the Commission’s Part 45 rules 

establish the reporting requirements for 

all swap data, including the information 

required under § 39.6. 

4. Reporting of Inter-Affiliate or 

Cooperative-to-Member Swaps 

A few commenters raised issues 

regarding reporting of swaps between 

particular types of counterparties. Shell 

requested that the Commission clarify 

that swaps between affiliates need not 

be reported because such reporting for 

inter-affiliate swaps provides no useful 

information to the Commission and 

would be burdensome. 

NCFC requested clarification 

regarding who provides the financial 

obligation information in a transaction 

between a cooperative and its members 

(such as producers or elevators) or 

customers (e.g., an electing 

counterparty-to-electing counterparty 

transaction). NCFC also questioned 

whether an SDR or the Commission will 

accept the data for transactions that 

cooperatives enter into with their 

members and customers and whether 

the Commission has the resources to 

accept such data. 

In response to Shell’s comment, the 

Commission notes that, although 

Congress expressly addressed in Section 

2(h)(7)(D) of the CEA when an affiliate 

executing a swap on behalf of another 

affiliate may qualify for the end-user 

exception, Congress did not exempt 

such inter-affiliate swaps from the 

reporting requirements. Because interaffiliate swaps must be reported, the 

parties also must provide the 

information required under § 39.6(b) so 

that the Commission will know why a 

swap that would otherwise be subject to 

clearing is not being cleared. In 

response to NCFC’s request for 

clarification as to who provides the 

financial obligation information for 

cooperative-to-member swaps, the 

Commission notes that the reporting 

counterparty in such electing 

counterparty-to-electing counterparty 

transactions is to be determined in 

accordance with § 45.8, as previously 

discussed. 

5. Finance Affiliates 

As previously noted, Section 

2(h)(7)(C)(iii) of the CEA provides that 

the definition of ‘‘financial entity’’ 

‘‘shall not include an 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.’’ Section 2(h)(7)(D)(i) 

of the CEA provides that an affiliate of 

a person that qualifies for the end-user 

exception also may qualify for the 

exception but only if the affiliate, acting 

on behalf of the person and as an agent, 

uses the swap to hedge or mitigate the 

commercial risk of the person or other 

affiliate of the person that is not a 

financial entity. Section 2(h)(7)(D)(ii) 

identifies certain types of financial 

entities that cannot act as an affiliate 

electing counterparty on behalf of 

another person under Section 

2(h)(7)(D)(i), indicating that financial 

entities that are not identified in Section 

2(h)(7)(D)(ii) may do so. Proposed 

§ 39.6(b)(3) would implement these 

provisions and require the reporting 

counterparty to report, or cause to be 

reported, whether the electing 

counterparty is a ‘‘finance affiliate’’, i.e., 

a financial entity electing the end-user 

exception by virtue of Section 

2(h)(7)(C)(iii) or 2(h)(7)(D) of the CEA. 

EMUS requested that the Commission 

clarify whether the reporting 

counterparty must report that the 

electing counterparty is an affiliate of 

another person qualifying for the enduser exception under Section 

2(h)(7)(D)(i) of the CEA or a finance 

affiliate of such a person. According to 

EMUS, the NPRM indicated that the 

notification requirement would apply to 

all affiliates, while the rule text 

indicated a notification requirement 

would apply only to finance affiliates. 

In response to EMUS, the Commission 

is revising § 39.6(b)(3) (renumbered in 

the final rule as § 39.6(b)(1)(iii)(A)(1)) to 

clarify that the notification requirement 

only applies to financial entities acting 

as affiliates. While identification of 

financial entities acting as affiliates is 

important because they are an exception 

to the prohibition on financial entities 

electing the end-user exception, the 

Commission does not believe that 

identification of non-financial entities 

acting as agents for affiliated entities is 

necessary. Similarly, the Commission is 

further revising this provision to add a 

requirement for electing counterparties 

to report whether they are ‘‘financial 

entities’’ as defined in Section 

2(h)(7)(C)(i) of the CEA that are 

nevertheless exempt from the definition 

of ‘‘financial entity’’ as described in 

§ 39.6(d). But for the exemption 

provided in § 39.6(d), such entities 

would be prohibited from electing the 

end-user exception (the exemption in 

§ 39.6(d) is discussed in Section D 

below). 

6. Reporting How an Electing 

Counterparty Generally Meets Financial 

Obligations Associated With NonCleared Swaps 

As noted above, Section 2(h)(7)(A)(iii) 

of the CEA requires that the 

Commission be notified as to how an 

electing counterparty generally meets its 

financial obligations associated with 

entering into non-cleared swaps. 

Proposed § 39.6(b)(5) would implement 

this provision. 

NGSA recommended that the 

Commission modify the language of its 

proposed rule to be identical to the 

statutory language—namely, that the 

words ‘‘expects to meet’’ and ‘‘swap’’ in 

proposed § 39.6(b)(5) should be replaced 

with the words ‘‘meets’’ and ‘‘swaps,’’ 

respectively. 

CFC recommended that the 

information contained in the notice 

should be general enough to encompass 

all transactions of an electing 

counterparty, and the notice should 

contain information as to how entities 

meet the obligations of multiple types of 

non-cleared swaps, not individual 

swaps. 

CDEU and EMUS commented that the 

information the Commission proposed 


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42568 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

33See, e.g., Americans for Financial Reform 

(AFR), American Federation of State, County and 

Municipal Employees (AFSCME), Better Markets, 

PMAA & NEFI, and Professor Greenberger. 

to collect is sufficient. According to 

CDEU, any additional information on 

meeting obligations would be nonstandardized information that is not 

easily captured and reportable in a 

systematic fashion. CDEU commented 

that non-financial counterparties do not 

pose systemic risk and it is not clear 

how the reporting of more information 

on meeting financial obligations 

comports with the legislative intent of 

the Dodd-Frank Act. 

Several commenters recommended 

that the Commission collect 

substantially more information, 

including specific information such as 

the types of collateral the electing 

counterparty will use to satisfy its 

financial obligations, the exact collateral 

terms and arrangements, and the 

contractual terms and provisions.33

The Commission is modifying 

proposed § 39.6(b)(5) (renumbered in 

the final rule as § 39.6(b)(1)(iii)(C)) to 

read as follows: ‘‘How the electing 

counterparty generally meets its 

financial obligations associated with 

entering into non-cleared swaps by 

identifying one or more of the following 

categories, as applicable. * * *’’ The 

Commission believes this revision more 

accurately reflects the Dodd-Frank Act’s 

intent that an electing counterparty 

must demonstrate how it ‘‘generally 

meets its financial obligations’’ 

(emphasis added) with respect to noncleared swaps. Furthermore, the 

Commission is declining to modify 

proposed § 39.6(b)(5) to require 

reporting of additional, specific 

information because the statute only 

requires the electing counterparty to 

provide notice of how it ‘‘generally 

meets its financial obligations.’’ The 

Commission believes that the 

information required by the regulation 

will enable the Commission to exercise 

its regulatory oversight in an efficient 

and effective manner given the wide 

variety of different types of swaps and 

swap hedging strategies used by 

commercial entities. 

7. How a Counterparty Meets Its 

Financial Obligations 

Proposed § 39.6(b)(5)(i) through (v) 

would set forth categories of means by 

which an electing counterparty could 

generally meet its financial obligations 

associated with non-cleared swaps. 

The National Rural Electric 

Cooperative Association (NRECA) asked 

the Commission to confirm that, in 

representing which swaps are secured 

by collateral, the counterparty should 

check the box under proposed 

§ 39.6(b)(5)(ii) only if all or any portion 

of the financial obligations associated 

with the reported swap are secured by 

collateral that has been pledged to the 

swap counterparty at the time the swap 

is entered into. NRECA also asked 

whether that counterparty should check 

the box under proposed § 39.6(b)(5)(i) 

only if the obligations associated with 

the reported swap are to be secured in 

the future by collateral that is to be, or 

may in the future be, pledged to the 

swap counterparty pursuant to a master 

agreement or other credit support 

agreement applicable to the swap. 

NRECA also asked whether proposed 

§ 39.6(b)(5)(i) is the appropriate box to 

check when the counterparties have in 

place collateralization arrangements 

subject to agreed-upon unsecured credit 

thresholds. 

NRECA asked how a reporting 

counterparty may satisfy proposed 

§ 39.6(b)(5) where the financial 

obligations are not satisfied by any of 

the collateral set forth under proposed 

§ 39.6(b)(5)(i) through (iii) and the 

electing counterparty ‘‘intends to 

generally meet its financial obligations 

associated with non-cleared swaps’’ by 

managing its commercial risks 

prudently, offsetting its obligations 

under its non-cleared swaps against 

those commercial risks and, for a notfor-profit electricity provider, passing 

through its costs and benefits of hedging 

to its retail energy customers during the 

time period(s) for which a swap hedges 

or mitigates commercial risk. NRECA 

asked the Commission to clarify 

whether such a reporting counterparty 

should check the box for proposed 

§ 39.6(b)(iv) or (v). NRECA also asked 

whether the financial resources must be 

‘‘available’’ for purposes of proposed 

§ 39.6(b) at the time the swap is 

executed or by the time the swap is 

expected to settle and hedge or mitigate 

the commercial risk. 

In response to NRECA’s comments, 

the Commission is modifying the text of 

proposed § 39.6(b)(5)(i)–(v) (renumbered 

in the final rule as § 39.6(b)(1)(iii)(C)(1) 

through (5)) to provide greater clarity as 

follows (new language emphasized): 

‘‘(1) A written credit support agreement; 

(2) Pledged or segregated assets 

(including posting or receiving margin 

pursuant to a credit support agreement 

or otherwise); (3) A written third-party 

guarantee; (4) The electing 

counterparty’s available financial 

resources; or (5) Means other than those 

described in paragraphs (b)(1)(iii)(C)(1), 

(2), (3) or (4) of this section * * *.’’ 

In response to the comment regarding 

reporting of multiple sources, the 

Commission believes the word ‘‘solely’’ 

in proposed § 39.6(b)(5)(iv) may have 

created some uncertainty and has 

deleted this word from the final rule 

text. The NPRM stated that parties are 

required to check multiple boxes if 

multiple sources of financial resources 

may be used. For clarity, the 

Commission is modifying the text of 

proposed § 39.6(b)(5) (renumbered as 

§ 39.6(b)(1)(iii)(C)) to expressly require 

the checking of all applicable categories. 

In the example provided by NRECA, 

where the parties have a credit support 

arrangement subject to a threshold, the 

reporting counterparty would check one 

or more of the following: (1) Proposed 

§ 39.6(b)(5)(i) if the credit support 

arrangement is subject to a credit 

support agreement; (2) proposed 

§ 39.6(b)(5)(ii) if the credit support 

arrangement provided for pledging or 

segregating assets; and (3) proposed 

§ 39.6(b)(5)(iv) if the electing 

counterparty will use available financial 

resources to cover any amount up to the 

threshold listed in the credit support 

agreement. 

Finally, the Commission believes that 

NRECA’s example, where no collateral 

is used to satisfy obligations, falls 

squarely in proposed § 39.6(b)(5)(iv). 

The rule only requires that the electing 

counterparty identify how it generally 

meets its financial obligations with 

regard to uncleared swaps. 

8. Board Approval for SEC Filers 

Under Section 2(j) of the CEA, 

exemptions from the requirements of 

Section 2(h)(1) to clear a swap and 

Section 2(h)(8) to execute a swap 

through a board of trade or SEF are 

available to a counterparty that is an 

issuer of securities that are registered 

under Section 12 of the Securities 

Exchange Act of 1934 or that is required 

to file reports pursuant to Section 15(d) 

of the Securities Exchange Act of 1934 

(an ‘‘SEC Filer’’), but only if an 

appropriate committee of the issuer’s 

board or governing body has reviewed 

and approved the decision to enter into 

swaps that are subject to such 

exemptions. Proposed § 39.6(b)(6) 

would implement this provision and 

require an SEC Filer to report, on a 

swap-by-swap basis, whether an 

appropriate committee of its board of 

directors (or equivalent body) has 

reviewed and approved the decision not 

to clear the swap subject to the clearing 

requirement. 

A number of commenters interpreted 

proposed § 39.6(b)(6) as requiring an 

SEC Filer’s board of directors to approve 

each decision to not clear a swap (i.e., 

to grant approval on a swap-by-swap 

basis) and commented that Section 2(j) 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42569 

34See, e.g., AGA, API, CDEU, COPE, Cravath, EEI 

& EPSA, EMUS, EPSA, IECA, NFPEEU, NGSA, 

NRECA, Mr. Steve Quinlivan, RESA, SDG&E, 

WGCEF, and WSPP. 

35See, e.g., AGA, COPE, Cravath, EEI, EMUS, 

Hess, IECA, NGSA, NREC, NYCBA, Mr. Quinlivan, 

SDG&E, and WSPP. 

36See, e.g., ATA, COPE, EMUS, SDG&E, and 

WGCEF. 

37See, e.g., AGA, API, ATA, Cope, Cravath, EEI, 

EEI & EPSA, Hess, NFPEEU, NRECA, NYCBA, 

NGSA, Mr. Quinlivan, SDG&E, and WGCEF. 

38Footnote 18 of the NPRM stated: ‘‘For example, 

a board resolution or an amendment to a board 

committee’s charter could expressly authorize such 

committee to review and approve decisions of the 

electing person not to clear the swap being 

reported. In turn, such board committee could 

adopt policies and procedures to review and 

approve decisions not to clear swaps, on a periodic 

basis or subject to other conditions determined to 

be satisfactory to the board committee.’’ 75 FR at 

80750. 

39See, e.g., AGA, EEI, EMUS, Hess, NEMA, and 

SDG&E. 40See 75 FR at 80750 n. 16. 

of the Dodd-Frank Act does not impose 

such a requirement.34 COPE noted that 

companies generally do not engage in 

transaction-specific board actions. 

According to most of these 

commenters, swap-by-swap board 

approval would impose excessive costs 

and burdens on companies.35 AGA 

stated that a requirement that a board 

convene, review, and approve each and 

every decision to enter into a noncleared swap transaction would be so 

administratively burdensome as to 

preclude its use. 

Several commenters remarked that 

boards should be given broad discretion 

over their hedging strategies and how 

they choose to authorize entering into 

non-cleared swaps.36 Commenters also 

recommended that companies should be 

able to delegate board approval to the 

appropriate board, committee, or 

corporate official on a general or 

‘‘blanket’’ basis for either all swaps or 

various categories of swaps.37 For 

example, COPE recommended that the 

Commission revise proposed 

§ 39.6(b)(6)(ii) to state that a board or 

committee may authorize the company 

to adopt a policy which grants general 

and continuing authority to enter into 

one or more swaps which are not 

cleared, and that specific approval is not 

required before entering into each and 

every swap. NGSA and the Committee 

on Futures and Derivatives Regulation 

of the New York City Bar Association 

(NYCBA) commented that the 

Commission should clarify footnote 

18 38 of the NPRM and revise proposed 

§ 39.6(b)(6)(ii) by replacing the words 

‘‘the decision not to clear the swap’’ 

with the words ‘‘the decision not to 

clear such swaps.’’ 

Cravath commented that the 

requirements should be flexible enough 

such that companies are able to manage 

and supervise their non-cleared swaps 

in a manner that is consistent with their 

existing governance policies. 

On the other hand, Better Markets 

suggested imposing additional 

disclosure requirements on the 

companies, including specific 

justification for why each swap is not 

cleared. Better Markets also 

recommended that the SEC Filer’s CEO 

and CFO be required to certify that they 

have conducted a substantive review of 

the board committee’s action and 

decision not to clear the swaps. 

The Commission believes that Section 

2(j) of the Dodd-Frank Act does not 

require board approval of each decision 

by an SEC Filer to enter into a swap that 

is exempt from the clearing 

requirement. As noted above, Section 

2(j) of the CEA states that exemptions 

from Sections 2(h)(1) and 2(h)(8) (i.e., 

the clearing and trade execution 

requirements) shall be available to an 

SEC Filer ‘‘only if an appropriate 

committee of the [SEC Filer]’s board or 

governing body has reviewed and 

approved its decision to enter into 

swaps that are subject to such 

exemptions.’’ The Commission 

interprets this language to allow board 

approval on a general basis. To remove 

any ambiguity, the Commission is 

modifying proposed § 39.6(b)(6)(ii) 

(renumbered as § 39.6(b)(1)(iii)(D)(2)) to 

read as follows: ‘‘Whether an 

appropriate committee of that 

counterparty’s board of directors (or 

equivalent body) has reviewed and 

approved the decision to enter into 

swaps that are exempt from the 

requirements of sections 2(h)(1) and 

2(h)(8) of the Act.’’ This change allows 

for board approval on a general, as 

opposed to swap-by-swap, basis. Also, 

the reference to both Sections 2(h)(1) 

and 2(h)(8) makes clear that the board 

must have approved the decision to 

enter into swaps that are neither cleared 

nor executed on a DCM or SEF, as 

required by Section 2(j). 

Commenters also discussed how 

frequently the counterparty should be 

required to provide notice that the board 

has approved use of the end-user 

exception and how frequently the board 

must renew its approval. A number of 

commenters suggested that an annual 

certification of board approval of a 

general hedging policy would be 

sufficient.39 NRECA stated that annual 

certification should be sufficient unless 

there is an intervening material change 

in the board approval information 

previously submitted. AGA commented 

that the Commission should be satisfied 

if the company’s officers and/or risk 

committee annually reports to the board 

to ensure that the board remains 

informed of hedging activities. Hess, 

NRECA, and Shell commented that 

boards or board-appointed committees 

should be able to approve swaps on a 

periodic basis for either several months 

or years. IECA recommended that board 

approval be required whenever a 

company enters into a new ISDA 

agreement for swap transactions. 

EEI and RESA recommended a onetime notice that the board has approved 

the use of the end-user exception. 

WGCEF commented that companies 

should be able to adopt a single 

continuing resolution approving any 

decision to use the end-user exception. 

Peabody agreed that a single 

determination by a committee, which 

would only be revisited as the 

committee deems necessary, is 

appropriate. 

As noted above, the Commission has 

revised proposed § 39.6(b)(6) so that 

entities have the option to report board 

approval information annually or on a 

swap-by-swap basis. The Commission 

would expect an SEC Filer’s board to set 

appropriate policies governing the SEC 

Filer’s use of swaps subject to the enduser exception and to review those 

policies at least annually and, as 

appropriate, more often upon a 

triggering event (e.g., a new hedging 

strategy is to be implemented that was 

not contemplated in the original board 

approval). 

A number of commenters requested 

that the Commission clarify some of the 

terms used in proposed § 39.6(b)(6)(ii). 

NYCBA requested clarification as to 

what constitutes an ‘‘appropriate 

committee’’ for purposes of reviewing 

and approving the decision not to clear 

a swap. AGA asked the Commission to 

confirm that if a utility is a subsidiary 

of an SEC Filer, then the subsidiary’s 

board committee would authorize the 

swap, not the board of the SEC Filer. 

IECA recommended that the rule be 

revised to expressly provide that 

approval must be given by the board of 

the transacting entity, not the board of 

an affiliate. Finally, EMUS requested 

clarification as to the meaning of ‘‘issuer 

of securities.’’ 

The Commission considers a 

committee to be appropriate if it is 

specifically authorized to review and 

approve the SEC Filer’s decision to 

enter into swaps.40 The SEC Filer’s 

board would have reasonable discretion 

to determine the appropriate committee 

for approving decisions on swaps for its 

subsidiaries or affiliates. 


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42570 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

41See 75 FR 79992 at 79996 n. 34 (Dec. 21, 2010) 

(End-User Exception to Mandatory Clearing of 

Security-Based Swaps). 

42See, e.g., Cravath, EMUS, IECA, NCFC, NGSA 

& NCGA, NRECA, and Peabody. 

43See 76 FR 6715 at 6726 (Feb. 8, 2011) (Swap 

Trading Relationship Documentation Requirements 

for Swap Dealers and Major Swap Participants). 

44Unlike proposed § 23.505, this provision does 

not include a requirement to ‘‘obtain 

documentation.’’ This is because proposed § 23.505 

applies only to swap dealers and MSPs, whereas the 

reporting counterparty under § 39.6 may be a nonswap dealer/MSP. Such entities are less likely to 

have standardized documentation compliance 

systems in place and therefore obtaining 

documentation may be burdensome. To reduce this 

burden, the Commission has determined to provide 

greater flexibility in this rule. 

45See 77 FR 2136 at 2210 (Jan. 13, 2012) (Swap 

Data Recordkeeping and Reporting Requirements; 

final rule). 

In response to the comment regarding 

the meaning of ‘‘issuer of securities,’’ 

the Commission notes that Section 2(j) 

of the CEA refers to an ‘‘an issuer of 

securities that are registered under 

section 12 of the Securities Exchange 

Act of 1934 (15 U.S.C. 78l) or that is 

required to file reports pursuant to 

section 15(d) of the Securities Exchange 

Act of 1934 (15 U.S.C. 78o).’’ The SEC 

has stated that, for purposes of its 

proposed rule governing the end-user 

exception to mandatory clearing of 

security-based swaps, ‘‘a counterparty 

invoking the end-user clearing 

exception is considered by the [SEC] to 

be an issuer of securities registered 

under Exchange Act Section 12 or 

required to file reports pursuant to 

Exchange Act Section 15(d) if it is 

controlled by a person that is an issuer 

of securities registered under Exchange 

Act Section 12 or required to file reports 

pursuant to Exchange Act Section 

15(d).’’ 41 The Commission is 

interpreting this term in the same 

manner as the SEC. 

9. Liability for Reporting 

Several commenters recommended 

that the Commission provide a safe 

harbor from liability for firms who 

report on behalf of other firms.42 These 

commenters expressed concern that the 

proposed regulations may not protect 

the electing counterparty from potential 

liability if the reporting counterparty 

misreports information regarding the 

electing counterparty. These 

commenters also expressed concern that 

a swap dealer or MSP may be liable if 

the electing counterparty provides the 

swap dealer or MSP with false 

information and the swap dealer or MSP 

then provides the false information to 

an SDR or the Commission. NGSA, 

CDEU, and RESA commented that the 

Commission should authorize a 

reporting entity to rely on the written 

representations or affirmations of the 

electing counterparty. NCFC stated that 

the Commission should not require a 

reporting firm to verify the information 

provided by the electing counterparty. 

In the event that a reporting 

counterparty incorrectly reports a swap, 

CDEU recommended that the 

Commission provide a procedure to 

cure a notice failure. 

The Commission notes that proposed 

§ 23.505 addresses obtaining and 

reporting end-user exception 

information by swap dealers and 

MSPs.43 Under that proposed rule, 

‘‘[e]ach swap dealer and major swap 

participant shall obtain documentation 

sufficient to provide a reasonable basis 

on which to believe that its counterparty 

meets the statutory conditions required 

for an exception from a mandatory 

clearing requirement, as defined in 

section 2(h)(7) of the Act and § 39.6 of 

this chapter.’’ 

To provide greater clarification for the 

end-user exception, the Commission is 

modifying § 39.6 to add § 39.6(b)(3), 

which states: ‘‘Each reporting 

counterparty shall have a reasonable 

basis to believe that the electing 

counterparty meets the requirements for 

an exception to the clearing requirement 

under section 2(h)(7) of the Act and this 

section.’’ 44 The Commission believes 

that establishing this explicit standard 

will give reporting counterparties 

greater clarity as to how to comply with 

the requirements of the rule and will 

help prevent abuse of the end-user 

exception. What constitutes a 

‘‘reasonable basis to believe’’ will 

depend on the applicable facts and 

circumstances. For example, a reporting 

counterparty that has a long-standing 

business relationship with the electing 

counterparty and knows that the 

electing counterparty is doing the same 

repetitive swap trades for the same 

commercial risk hedging purposes may 

be able to rely on its due diligence for 

the initial swap in the series and not 

need to re-establish the due diligence 

for every subsequent swap trade. As a 

further example, it may be reasonable in 

many circumstances for the reporting 

counterparty to rely on appropriate 

representations from the electing 

counterparty. On the other hand, if the 

reporting counterparty has a reasonable 

basis to believe that the representations 

of the electing counterparty are not 

accurate for a particular swap being 

considered, then the reporting 

counterparty may not reasonably rely on 

those representations for that swap. 

In response to comments concerning 

the liability of electing counterparties 

that are dependent on reporting 

counterparties to fulfill the reporting 

requirements of the rule, the electing 

counterparty is entitled to rely on 

reasonable representations by the 

reporting counterparty that the 

notification information has been 

properly transmitted. In such 

circumstances, the electing counterparty 

would not be subject to adverse 

consequences and the swap will not be 

deemed ineligible for the end-user 

exception for failure of the reporting 

counterparty to properly report the 

information. 

Regarding CDEU’s comment on 

correcting information later determined 

to have been reported incorrectly, the 

Commission notes that its swap data 

recordkeeping and reporting rules 

address this issue for reported 

information generally in § 45.14.45

10. Commission Approval for Use of the 

End-User Exception 

NCSHA requested that the 

Commission clarify how the notification 

and reporting requirements of § 39.6 

will affect the approval process for 

eligible counterparties electing the enduser exception. According to NCSHA, it 

is unclear whether the Commission will 

deny a counterparty the right to elect 

the end-user exception on the basis of 

‘‘insufficiently meeting the 

Commission’s notification and reporting 

requirements.’’ NCSHA does not believe 

the Commission has the authority to 

reject eligible counterparties from 

electing the end-user exception on the 

basis of a failure to meet the 

Commission reporting or notification 

standards. However, if the Commission 

determines that it has that authority, 

NCSHA requested that the Commission 

provide a detailed list of the criteria it 

deems as necessary for a counterparty to 

sufficiently meet the CEA’s notification 

and reporting requirements. 

The Commission notes that § 39.6 

does not include a process for approving 

a counterparty’s election of the end-user 

exception, but a potential electing 

counterparty must meet the notification 

and reporting requirements in order to 

be eligible to elect the exception. 

C. Hedging or Mitigating Commercial 

Risk 

Section 2(h)(7)(A)(2) of the CEA 

provides that a swap shall not be subject 

to the clearing requirement if, among 

other things, one of the counterparties to 

the swap ‘‘is using swaps to hedge or 

mitigate commercial risk * * *.’’ 

Proposed § 39.6(c) provides potential 

electing counterparties with criteria for 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42571 

46The phrase ‘‘hedge or mitigate commercial 

risk’’ was also the subject of joint rulemaking by the 

Commission and the SEC for purposes of the ‘‘major 

swap participant’’ definition under Section 1a(33) 

of the CEA. The overlap of that joint rulemaking 

and § 39.6(c) is addressed in Section II.C.11 below. 

47See, e.g., CDEU, API, APGA, EEI & EPSA, Kraft, 

CMC, Milbank, and Philip Morris. 

48See, e.g., AFR, AFSCME, WDM, IPM&CSA, East 

Coast Petroleum (ECP), Pennsylvania Petroleum 

Marketers and Convenience Store Association 

(PPMCSA), Commodity Markets Oversight Coalition 

(CMOC), Fuel Merchants of New Jersey (FMNJ), 

Georgia Oilmen’s Association (GOA), Skylands 

Energy Service, Inc. (Skylands), Weiss, Edward M. 

Minicozzi, Medford Heating (Medford), Tobin, 

Sullivan, Fay & Grunebaum, and Form Letters. 

49See, e.g., CMOC, ECP, FMNJ, IPM&CSA, 

Medford, General Utilities, Inc., PPMCSA, and 

Skylands. 

50See, e.g., Independent Community Bankers of 

America (ICBA), COPE, Peabody, WSPP, and 

SIFMA. 

51See, e.g., WDM, IPM&CSA, ECP, PPMCSA, 

CMOC, FMNJ, GOA, Skylands, General Utilities, 

Inc., Medford, and Ms. Roselyn Devlin. 

52See, e.g., Skylands, FMNJ, General Utilities, 

Inc., Cochrans, ECP, and Medford. 

53Proposed § 39.6(c)(1)(i)(E) addressed similar 

financial risks arising from rate ‘‘movements’’ rather 

than ‘‘exposures.’’ However, the text of proposed 

§ 39.6(c)(1)(i)(E) inadvertently referred only to 

foreign exchange rates. Accordingly, the final rule 

text has been revised to include interest and 

currency rates to be consistent with 

§ 39.6(c)(1)(i)(F). 

determining whether a swap hedges or 

mitigates commercial risk.46

1. Breadth of the Criteria 

As noted in the NPRM, the criteria for 

what constitutes hedging or mitigating 

commercial risk in proposed § 39.6(c) 

are generally designed to allow a wide 

variety of potential electing 

counterparties to structure their swaps 

in a manner that fits their particular 

businesses while also providing 

guidance and a measure of certainty in 

discerning the line between swaps used 

for hedging or mitigating commercial 

risk and swaps used for other purposes. 

Many commenters supported a broad 

set of criteria that would provide 

entities with sufficient flexibility to 

accommodate different risk mitigation 

strategies.47 EEI & EPSA stated that a 

limited set of criteria (particularly with 

regard to hedging financial risks, as 

discussed in Section II.C.2 below) 

would prevent non-financial entities 

from effectively hedging risks associated 

with significant parts of their 

commercial businesses and could 

conflict with Section 737 of the DoddFrank Act (which concerns position 

limits). CDEU recommended that 

commercial risk be construed more 

broadly to incorporate all risks 

associated with an entity’s operations, 

including, but not limited to, interest 

rate risk, currency risk, credit risk, 

equity price risk, and risks arising from 

the purchase, ownership, production, 

storage, sale, financing, or 

transportation of commodities. 

Conversely, other commenters 

suggested that the Commission should 

construe commercial risk more 

narrowly.48 A number of commenters 

recommended that the definition of 

‘‘commercial risk’’ be narrowly tailored 

to apply only to those entities whose 

business activities expose them to risk 

from physical commodity price 

fluctuations.49 According to these 

commenters, ‘‘commercial risk’’ should 

not include risks that are purely 

financial in nature. AFR expressed 

concern that the proposed rule 

construes commercial risk too broadly 

and would provide little direction as to 

whether a swap position is hedging or 

mitigating commercial risk. In AFR’s 

view, any business risks might qualify 

under the proposed regulations. AFR 

recommended that the Commission 

provide a narrower, prescriptive 

definition. 

The Commission has determined that 

the criteria described in proposed 

§ 39.6(c) should not change except for 

certain limited changes specifically 

discussed below. The Commission 

believes that by limiting the end-user 

exception to swaps that hedge or 

mitigate commercial risk, Congress 

made clear that it did not intend the 

exception to be applicable for all types 

of risk. Given the wide variety of 

potential electing counterparties, swaps, 

and hedging scenarios, the Commission 

believes that the rule strikes an 

appropriate balance between providing 

flexibility for entities to qualify for the 

end-user exception and clarity on the 

limits of the exception. 

2. Treatment of Commodity Risks and 

Financial Risks 

Proposed § 39.6(c) sets out criteria for 

hedging certain financial risks such as 

interest, currency, or foreign exchange 

rate risks. The Commission asked in the 

NPRM whether the rule should only 

apply to swaps involving non-financial 

commodities. 

Several commenters noted that nonfinancial entities regularly hedge 

financial risks related to their business 

operations and that limiting the rule to 

risks related to non-financial 

commodities would be unduly 

restrictive.50 In contrast, other 

commenters stated that the rule should 

be limited to risks related to physical 

commodity price fluctuations and the 

principal business of the electing 

counterparty and should not include 

purely financial risks.51 Some 

commenters expressed the view that the 

end-user exception should be limited so 

that it can only be used in direct 

proportion to the electing counterparty’s 

physical holdings.52 These commenters 

believe this approach would prevent an 

entity that is engaged in commercial 

activity from claiming the end-user 

exception for risks that are not 

commercial. AFSCME expressed 

concern about including foreign 

exchange hedging because foreign 

exchange transactions are alleged to be 

regularly abused and manipulated. 

The Commission declines to revise 

proposed § 39.6 to exclude hedging of 

commercial ‘‘financial’’ risks from the 

end-user exception. The Commission 

believes that an entity that may elect the 

end-user exception can be subject to 

financial risks related to its commercial 

activities and that these risks can 

constitute commercial risks. For 

example, a change in interest rate risk 

on a non-financial entity’s debt incurred 

for commercial business operations 

(e.g., to fund the purchase of inputs or 

to build a factory for the entity) can 

constitute commercial risk. As a further 

example, § 39.6(c)(1)(i)(F) addresses the 

risk of a change in interest, currency or 

foreign exchange risk exposures arising 

from a person’s current or anticipated 

assets or liabilities in the ordinary 

course of business.53

Furthermore, the Commission does 

not believe the end-user exception was 

intended to apply only to physical 

commodity hedging. The Commission 

notes that the Dodd-Frank Act did not 

limit the end-user exception to physical 

position hedging. However, the 

Commission acknowledges the concern 

of commenters that allowing the enduser exception to be used for financial 

risk hedging might increase the 

potential for abuse of the exception. The 

Commission emphasizes that the use by 

non-financial entities of the end-user 

exception for financial risk hedging or 

mitigation must be an incidental part of 

(i.e., not central to) the electing 

counterparty’s business and must fully 

qualify under all other applicable 

provisions of the CEA and § 39.6. The 

Commission will monitor the use of the 

end-user exception, particularly when it 

is used for hedging financial risks. If the 

Commission finds that the end-user 

exception is being abused in this regard, 

it will take appropriate action. 

3. Facts and Circumstances Test 

The Commission noted in the NPRM 

that it preliminarily believed that 

whether a position is used to hedge or 

mitigate commercial risk should be 

determined by the facts and 

circumstances existing at the time the 


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54See, e.g., CDEU, Peabody, Philip Morris, EDF 

Trading, Kraft, NRECA, and AFSCME. 

55Hedge effectiveness testing is discussed in 

further detail below in section II.C.9. 

56See, e.g., SIFMA, SIFMA MFP, SFG, Milbank, 

NCHSA, and WSPP. 

57Based on the language of some of the 

comments, it appears that part of this concern may 

arise from the use of the phrase ‘‘commercial 

enterprise’’ in the proposed rule. That phrase is 

used to be consistent with existing § 1.3(z) of the 

Commission’s regulations, which identifies 

activities that qualify as hedging in the futures 

markets. 

58The exception to this approach is with respect 

to financial entities, which are defined in Section 

2(h)(7)(C) of the CEA based on who they are or what 

they do generally. Financial entities are prohibited 

from electing the end-user exception under Section 

2(h)(7)(A)(i) of the CEA. 

59 In the alternative to meeting the requirements 

of § 39.6(c)(1)(i), a swap executed by an electing 

counterparty may also be eligible for the end-user 

exception if the swap qualifies as a bona fide hedge 

for purposes of an exception from position limits 

under the CEA as provided in § 39.6(c)(1)(ii), or if 

it qualifies for hedging treatment under FASB 

Accounting Standards Codification Topic 815 or 

under GASB Statement 53 as provided in 

§ 39.6(c)(1)(iii). Consequently, the universe of 

swaps that can qualify for the exception is broader 

than the universe of swaps that qualify as bona fide 

hedges for purposes of an exception from position 

limits under the CEA as provided in § 39.6(c)(1)(ii). 

swap is entered into, and should take 

into account the person’s overall 

hedging and risk mitigation strategies. 

A number of commenters generally 

agreed with the Commission’s 

preliminary view.54 EDF Trading 

suggested that such an approach is the 

only commercially practical way to 

implement the rule. NRECA commented 

that the Commission should make clear 

in its rules that it will not second-guess 

the decision of an electing counterparty 

to enter into the swap and the decisions 

related to the terms of the swap for 

which the end-user exception is elected, 

and should not provide for review of 

such commercial risk management 

decisions with the benefit of hindsight. 

The Commission confirms that 

counterparties should look to the facts 

and circumstances that exist at the time 

the swap is executed to determine 

whether a swap satisfies the criteria for 

hedging or mitigating commercial risk 

as set forth in the final rule. In response 

to NRECA’s comment, the Commission 

does not believe it is necessary to 

expressly set forth the facts and 

circumstances test in § 39.6. The 

Commission notes that nothing in § 39.6 

would require ongoing reporting or 

testing of a swap’s hedge effectiveness.55

The Commission further notes, 

however, that it may review whether the 

election of the end-user exception was 

made in compliance with the CEA and 

the Commission’s regulations at the 

time such election was made. 

4. Commercial Status of the Electing 

Counterparty 

The Commission received a number 

of comments on whether ‘‘commercial’’ 

refers to (i) the underlying activity being 

hedged or (ii) the nature of the general 

activities of the entity claiming the enduser exception. CDEU, ICBA, WSPP, 

and the Securities Industry and 

Financial Markets Association (SIFMA) 

agreed with the Commission’s general 

view expressed in the NPRM that the 

determinant of whether a risk is 

‘‘commercial’’ should be based on the 

underlying activity to which the swap 

relates and not the general nature of the 

electing counterparty’s activities. A 

number of commenters requested that, 

to avoid any uncertainty, the rule 

language clarify that governmental and 

non-profit entities can incur commercial 

risks (such as interest rate risk 

associated with debt).56 Similarly, 

Norges Bank Investment Management 

asked the Commission to confirm that 

use of the word ‘‘commercial’’ does not 

preclude foreign central banks and other 

sovereign entities from relying on the 

end-user exception.57

In response to a question asked in the 

NPRM, ICBA commented that 

agricultural cooperatives and non-profit, 

governmental, or municipal entities 

should not receive any special 

considerations. ICBA reasoned that 

adding further gradations or special 

considerations could create competitive 

disadvantages for other entities. ICBA 

further noted that the Dodd-Frank Act 

contemplates special treatment under 

the end-user exception only for small 

financial institutions and accordingly, 

special treatment for other types of 

entities might contravene Congressional 

intent. 

In response to these comments, the 

Commission confirms that the 

determination of whether the risk being 

hedged or mitigated is ‘‘commercial’’ 

will be based on the underlying activity 

to which the risk relates, not on the type 

of entity claiming the end-user 

exception.58 The Commission confirms 

that this distinction applies to all 

potential electing counterparties 

including governmental entities, both 

domestic and foreign, and non-profit 

entities. Their status as governmental or 

non-profit entities does not control the 

determination of whether they are 

hedging or mitigating ‘‘commercial’’ 

risk. Rather, that determination will 

depend on the nature of the underlying 

activity to which the risk being hedged 

or mitigated relates. 

Finally, the Commission believes that 

any additional language adding further 

gradations or special considerations in 

this regard could create confusion or 

unintended distinctions among different 

types of entities. 

5. ‘‘Economically Appropriate’’ 

Standard 

Under proposed § 39.6(c)(1)(i), a swap 

is used to hedge or mitigate commercial 

risk if the swap is ‘‘economically 

appropriate’’ to the reduction of any of 

six different categories of commercial 

risk listed in that section.59 Kraft 

commented that the ‘‘economically 

appropriate’’ standard should not be 

further defined because ‘‘bright-line’’ 

definitions or limitations will result in 

less effective hedges and increased 

costs. 

Better Markets expressed concern that 

the proposed ‘‘economically 

appropriate’’ standard may allow the 

end-user exception to be elected for 

swaps that do not hedge commercial 

risk precisely. Better Markets 

recommended that the Commission 

adopt a ‘‘congruence’’ standard that 

Better Markets believes fits the statutory 

language better. The ‘‘congruence’’ 

standard would require each risk in the 

swap to be congruent with a 

corresponding commercial risk being 

hedged. 

On the other hand, SFG believes the 

‘‘economically appropriate’’ standard is 

too narrow and should be replaced with 

a ‘‘management or reduction of risks’’ 

standard. 

The Commission is adopting the 

‘‘economically appropriate’’ standard as 

proposed. The Commission believes that 

this standard will help interested parties 

distinguish those swaps that hedge or 

mitigate commercial risks from those 

that do not, thereby reducing regulatory 

uncertainty and helping prevent abuse 

of Section 2(h)(7) of the CEA. The facts 

and circumstances will determine 

whether the swap is economically 

appropriate to hedge or mitigate 

commercial risks. While the 

Commission acknowledges that this 

standard leaves room for judgment in its 

application, the Commission believes 

this flexible approach is needed given 

the wide variety of swaps, potential 

electing counterparties, and hedging 

strategies to which the rule applies. The 

Commission believes the ‘‘economically 

appropriate’’ standard, together with the 

identification of the six different 

categories of permissible commercial 

risks listed in proposed § 39.6(c)(1)(i), is 

specific enough, when reasonably 

applied, to determine whether a swap is 

being used to hedge or mitigate 

commercial risk. 

The Commission is not adopting a 

‘‘congruence’’ standard because it 


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60See, e.g., BG Americas & Global LNG (BG LNG), 

Peabody, Philip Morris, Form Letters, and Cravath. 

61See, e.g., Hess, WGCEF, EPSA, and Peabody. 

believes the standard, which would 

require that each component risk of the 

swap be congruent with each risk being 

hedged, may be too restrictive and 

difficult to apply given the range of 

potential electing counterparties, types 

of swaps, and hedging strategies. Nor is 

the Commission adopting a 

‘‘management or reduction of risks’’ 

standard. SFG’s recommendation does 

not explain what risk ‘‘management’’ 

means. Furthermore, the Commission is 

concerned that a standard based on 

‘‘management’’ of risks may be overly 

inclusive and could apply to any swap 

that changes risk levels, including 

swaps that increase risk contrary to the 

goals of the Dodd-Frank Act. 

6. Hedging Treatment Under 

Accounting Standards 

Under proposed § 39.6(c)(1)(iii), a 

swap may be deemed to hedge or 

mitigate commercial risk if the swap 

qualifies for hedging treatment under 

Financial Accounting Standards Board 

(FASB) Accounting Standards 

Codification Topic 815. Professor 

Greenberger commented that 

transactions that meet the definition of 

hedging under accounting standards 

should qualify as commercial hedges. 

SIFMA, SIFMA’s Municipal Financial 

Products Committee (SIFMA MFP), and 

GFOA asked that the Commission revise 

the proposed rule to include swaps that 

qualify for hedging treatment under the 

Governmental Accounting Standards 

Board (GASB) Statement 53, Accounting 

and Financial Reporting for Derivative 

Instruments (Statement 53). Statement 

53 is the accounting standard for 

establishing a bona fide hedge under the 

GASB accounting standards used by 

many local government entities in the 

United States. Although different from 

the FASB accounting standard for 

hedging treatment, Statement 53 is 

similar in effect. 

The Commission agrees that entities 

that use GASB accounting standards 

should be able to use Statement 53 to 

demonstrate that a swap hedges or 

mitigates commercial risk in the same 

way that the FASB hedging standard is 

used. Accordingly, the Commission is 

revising proposed § 39.6(c)(1)(iii) to 

include swaps that qualify for hedging 

treatment under Statement 53. 

7. Speculation, Investing, or Trading 

Under proposed § 39.6(c)(2)(i), a swap 

does not hedge or mitigate commercial 

risk if it is used for a purpose that is in 

the nature of ‘‘speculation, investing, or 

trading.’’ Commenters expressed 

different views on whether swaps held 

for speculative, investing, or trading 

purposes should qualify as hedging or 

mitigating commercial risk and whether 

it is practical for the Commission to 

include the limitation in the rule. The 

Commission also received a number of 

comments that addressed application of 

the proposed limitation specifically to 

physical commodity swaps. 

A number of commenters agreed that 

swaps which are used for one or more 

of the purposes of speculation, trading 

or investing should not qualify for the 

end-user exception.60 Philip Morris 

commented that the proposed criteria 

for hedging or mitigating commercial 

risk sufficiently encompass swaps 

legitimately used to hedge commercial 

risks, while excluding those used for 

speculation, trading, or other nonhedging purposes. The Form Letters 

supported the general concept of this 

limitation, noting that the ‘‘common 

sense’’ exception for end users should 

not be broadened to allow institutions to 

‘‘gamble’’ in the derivatives markets. 

AFR agreed with the Commission’s 

approach as explained in footnote 23 of 

the NPRM, but also expressed concern 

that the proposed rule may be too 

flexible and could create a loophole for 

speculators claiming to be hedging 

commercial risk when in fact they are 

not. 

Several commenters suggested 

revising the proposed rule to limit the 

possibility that the provision would be 

applied in an overly restrictive manner. 

IECA recommended that the words 

‘‘investing or trading’’ be eliminated 

from § 39.6(c)(2)(i). IECA believes that, 

because swaps are ‘‘traded’’ and can 

appear on an entity’s balance sheet, it is 

inappropriate to prohibit swaps used for 

investing or trading purposes. Vitol, Inc. 

(Vitol) expressed concern that excluding 

speculative or trading activities might 

preclude commercial firms that 

merchandise commodities or act as 

intermediaries in the supply chain from 

treating such positions as hedging or 

mitigating their commercial risk. 

Commenters expressed particular 

concern that the term ‘‘trading’’ could 

be interpreted to include entering and 

exiting swap positions used to hedge or 

mitigate commercial risk and therefore 

such swaps would be ineligible for the 

end-user exception.61 For example, 

WGCEF commented that a ‘‘trading’’ 

position held in anticipation of a 

potential price increase should qualify 

as hedging commercial risk, but under 

the proposed rule it could be interpreted 

as a ‘‘trading’’ position and not qualify 

for the end-user exception. 

Similarly, BG LNG, API, and WGCEF 

believe, based on their reading of 

footnote 23 of the NPRM, that certain 

swaps entered into for the purpose of 

hedging physical market positions could 

be excluded. According to BG LNG and 

EPSA, any rule that prohibits the enduser exception from being applied 

generally to swaps that hedge physical 

market positions because they are 

classified as ‘‘trading’’ positions or 

‘‘speculative’’ positions would have 

serious, adverse consequences to 

physical markets for energy and other 

commodities. Also in reference to 

footnote 23 in the NPRM, WGCEF and 

BG LNG commented that many swaps 

that represent ‘‘arbitrage’’ positions are 

themselves hedges of commercial risk 

and not the type of speculative swaps 

that should be denied the end-user 

exception. BG LNG further commented 

that the unwinding or offsetting of such 

swaps should not change their 

characterization as ‘‘hedging or 

mitigating commercial risk.’’ 

API, EPSA, and WGCEF 

recommended that the Commission 

clarify that swap positions that hedge 

other speculative or trading swap 

positions are also speculative or trading 

positions, unless such swap positions 

hedge physical commodity positions. 

Cravath and Riverside commented 

that ‘‘investments’’ should be deleted 

from the limitation, noting that certain 

swaps that hedge or mitigate 

commercial risks specified in the rule 

may be treated as investments for 

accounting or other purposes. 

Finally, WGCEF noted that ‘‘trading,’’ 

‘‘speculation,’’ and ‘‘investing’’ were not 

defined in the proposed rule or the CEA. 

The Commission is adopting 

§ 39.6(c)(2)(i) as proposed. While the 

line between hedging or mitigating 

commercial risk and other uses of swaps 

can be difficult to discern at times, the 

Dodd-Frank Act nonetheless requires 

such determinations to be made. The 

Commission believes that explicitly 

prohibiting the end-user exception for 

swaps entered into for the purpose of 

speculating, investing, or trading, as 

opposed to swaps used for the purpose 

of hedging or mitigating commercial 

risk, will help entities to understand the 

limits of hedging or mitigating 

commercial risk for purposes of § 39.6 

and will help prevent abuse of the 

exception. 

The Commission believes that the 

meaning of § 39.6(c)(2)(i) is apparent 

when read in the overall context of 

§ 39.6(c), which addresses the 

requirement in Section 2(h)(7)(A)(ii) of 

the CEA that the electing counterparty 

be using the swap to hedge or mitigate 

commercial risk. This requirement 


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62The Commission further clarifies that 

merchandising activity in the physical marketing 

channel qualifies as commercial activity, consistent 

with the Commission’s longstanding bona fide 

hedging exemption to speculative position limits. 

See § 1.3(ttt)(1)(ii). 

63See, e.g., Susquehanna Bancshares, Inc., The 

Private Bank and Trust Company, Commerce Bank, 

Atlantic Capital Bank, Trustmark, Webster Bank, 

UMB Bank, Chatham Financial, and Wintrust. 

focuses on the purpose for which the 

potential electing counterparty is using 

the swap. Swaps executed for the 

purpose of speculating, investing, or 

trading are not being used to hedge or 

mitigate commercial risk. Such 

positions are, generally speaking, being 

executed primarily for the purpose of 

taking an outright view on market 

direction or to obtain an appreciation in 

value of the swap position itself and not 

primarily for hedging or mitigating 

underlying commercial risks. For 

example, swap positions held primarily 

for the purpose of generating profits 

directly upon closeout of the swap, and 

not to hedge or mitigate underlying 

commercial risk, are speculative or 

serve as investments. Further, as an 

alternative example, swaps executed for 

the purpose of offsetting potential future 

increases in the price of inputs that the 

entity reasonably expects to purchase 

for its commercial activities serve to 

hedge a commercial risk. 

As noted above, several commenters 

expressed concern regarding the 

inclusion of ‘‘trading’’ in § 39.6(c)(2)(i). 

In the context of the rule, ‘‘trading’’ is 

not used to mean simply buying and 

selling. Rather, a party is using a swap 

for the purpose of trading under the rule 

in this context when the party is 

entering and exiting swap positions for 

purposes that have little or no 

connection to hedging or mitigating 

commercial risks incurred in the 

ordinary course of business. ‘‘Trading,’’ 

as used in § 39.6(c)(2)(i), therefore 

would not include simply the act of 

entering into or exiting swaps if the 

swaps are used for the purpose of 

hedging or mitigating commercial risks 

incurred in the ordinary course of 

business.62

The Commission acknowledges that 

some swaps that may be characterized 

as ‘‘arbitrage’’ transactions in certain 

contexts may also reduce commercial 

risks enumerated in § 39.6(c)(1). The 

discussion in footnote 23 of the NPRM 

was intended to clarify that swaps are 

speculative for purposes of the rule if 

entered into principally and directly for 

profit and not principally to hedge or 

mitigate commercial risk. The reference 

to ‘‘arbitrage profits’’ in footnote 23 was 

intended to provide an example of what 

is commonly a speculative swap, not to 

characterize all arbitrage swaps as 

speculative. 

The Commission is not revising 

§ 39.6(c)(2)(i) to provide an express 

exception for swaps related to physical 

commodity positions. Swaps related to 

physical positions are not always 

hedging or mitigating commercial risk. 

For example, a swap related to physical 

positions may be a speculative position 

taking an outright view of the 

underlying commodity market. In 

limiting the end-user exception to 

swaps that hedge or mitigate 

commercial risk, Congress did not 

provide an exception from that 

limitation for swaps related to physical 

positions. 

The Commission also notes that some 

commenters may have interpreted the 

proposed rule as prohibiting an entity 

that claims the end-user exception with 

respect to certain swaps from entering 

into other swaps for the purpose of 

speculation, investing, or trading. The 

Commission reiterates that a party’s 

ability to elect the end-user exception 

for a particular swap is a function of the 

purpose of the particular swap in 

question. The fact that a party enters 

into other unrelated swaps for the 

purpose of speculating, investing, or 

trading will have no effect on the 

counterparty’s assessment of whether its 

other swaps meet the requirements of 

the rule. 

8. Swaps Hedging Other Swaps 

Under proposed § 39.6(c)(2)(ii), a 

swap that hedges or mitigates the risk of 

another swap or security-based swap 

may qualify as hedging or mitigating 

commercial risk only if the underlying 

swap or security-based swap itself is 

used to hedge or mitigate commercial 

risk. 

Professor Greenberger generally 

agreed with the limitation in the 

proposed rule and recommended that 

the limitation be extended to all swaps 

hedging other swaps. In his view, 

hedges of other hedging swaps are 

inherently speculative and should not 

be allowed under the end-user 

exception. 

Reval.com, Inc. (Reval) suggested that 

swap transactions that are executed on 

a ‘‘matched book’’ basis with swaps that 

are excepted from the clearing 

requirement should also be eligible for 

the clearing end-user exception. Several 

small or regional financial entities 

commented that swaps executed on a 

matched book or back-to-back basis with 

swap dealers, which hedge swaps 

executed with non-financial entities 

who themselves are using the swaps to 

hedge commercial risks, should get the 

benefit of the end-user exception.63

The Commission considered whether 

a swap that hedges another swap that 

itself is used to hedge or mitigate 

commercial risk could qualify for the 

end-user exception. The Commission 

determined that such a swap could 

qualify if it in fact hedges or mitigates 

commercial risk for a party entering into 

the swap. In connection therewith, the 

Commission has determined that 

‘‘matched book’’ or ‘‘back-to-back’’ 

swaps that hedge or mitigate risks of 

other swaps may qualify for the enduser exception if the swap is used to 

reduce risks in the conduct and 

management of a commercial enterprise 

as set forth in § 39.6(c)(1) and the ‘‘other 

swap’’ itself qualifies for the end-user 

exception. This is why § 39.6(c)(2)(ii) 

provides that a swap that hedges or 

mitigates the risk of another swap or 

security-based swap may qualify as 

hedging or mitigating commercial risk, 

so long as the underlying swap or 

security-based swap itself is used to 

hedge or mitigate commercial risk. This 

provision allows successive swaps in a 

chain of back-to-back swaps to qualify 

for the end-user exception if the first 

underlying swap qualifies for the 

exception, and each such successive 

swap is used by a party to that 

successive swap that qualifies for the 

end-user exception to hedge or mitigate 

commercial risk. This result is only 

applicable to entities that could 

otherwise qualify for the end-user 

exception. Accordingly, in a chain of 

qualifying swaps involving only 

qualifying entities, if the ‘‘last’’ 

qualifying entity in the chain hedges its 

qualifying swap (its ‘‘underlying swap’’) 

by entering into a qualifying swap with 

a non-qualifying financial entity (its 

‘‘hedging swap’’), then although the 

qualifying entity can elect to use the 

end-user exception with respect to its 

hedging swap, that financial entity 

cannot elect the end-user exception for 

any further swap used by that financial 

entity to hedge or mitigate its position. 

In effect, the chain is then broken. 

Reval’s comment indicates that the 

text of proposed § 39.6(c)(2) may be 

unclear. When the wording of proposed 

§ 39.6(c) is read as a whole, the 

proposed rule provides that a swap 

qualifies for the end-user exception if it 

meets one of the conditions stated in 

proposed § 39.6(c)(1) and if, as stated in 

proposed § 39.6(c)(2), the swap is (i) not 

held for a speculative, investing, or 

trading purpose, or (ii) not hedging 

another swap unless that swap itself is 

held for hedging purposes. Accordingly, 

the literal text of proposed § 39.6(c)(2) 

could be interpreted to permit a swap to 

qualify for the end-user exception if the 


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64 75 FR at 80752 (footnote omitted). 

65The Commission notes that in the definition of 

‘‘hedge or mitigate commercial risk’’ proposed by 

the Commission for purposes of defining ‘‘major 

swap participant’’ under Section 1a(33) of the CEA, 

there was no conjunction between clauses (i) and 

(ii). See Further Definition of ‘‘Swap Dealer,’’ 

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

Participant,’’ ‘‘Major Security-Based Swap 

Participant’’ and ‘‘Eligible Contract Participant,’’ 75 

FR 80174, 80214, 80217 (Dec. 21, 2010) (proposed 

§ 1.3(ttt)(2)). However, the Commission added the 

conjunction in the final definition. See 77 FR 30596 

at 30750 (May 23, 2012) (final § 1.3(kkk)(2)). 

66See section II.C.9 herein. 

67See, e.g., EEI & EPSA, ATA, WGCEF, RESA, 

Peabody, Kraft, and American Public Power 

Association & Large Public Power Council. 

68See, e.g., ATA, APGA, Cravath, EDF Trading, 

and Kraft. 

69Regarding commenters’ queries about dynamic 

hedging, which WGCEF described as the ability to 

modify the hedging structure related to physical 

assets or positions when relevant pricing 

relationships applicable to that asset change, the 

Commission notes that qualification as bona fide 

hedging does not require that hedges, once entered 

into, must remain static. The Commission 

recognizes that entities may update their hedges 

periodically when pricing relationships or other 

market factors applicable to the hedges change. 

swap is not hedging another swap (i.e., 

if the second clause is satisfied), even if 

the swap is itself held for a speculative, 

investing, or trading purpose (i.e., if the 

first clause is not satisfied). 

The NPRM stated that ‘‘[p]roposed 

§ 39.6(c)(2) further provides, however, 

that a swap is disqualified from the enduser exception if it is held for a 

speculative, investing, or trading 

purpose, or if it hedges another swap 

unless that swap itself is held for 

hedging purposes.’’ 64 In other words, 

proposed § 39.6(c)(2) provides that a 

swap would be disqualified from the 

end-user exception if either of two 

conditions were true: If the swap is held 

for a speculative, investing, or trading 

purpose, or if the swap hedges another 

swap unless that swap itself is held for 

hedging or mitigating purposes. 

Accordingly, the Commission is 

revising the text of § 39.6(c)(2) to clarify 

the rule text in accordance with the 

intended purpose by replacing the 

conjunction ‘‘or’’ between clauses (i) 

and (ii) in § 39.6(c)(2) with the 

conjunction ‘‘and.’’ 65 This clarifies that, 

in order to qualify for the end-user 

exception, the swap must not be used 

for the purposes stated in § 39.6(c)(2)(i), 

and it must not be used for the purposes 

stated in § 39.6(c)(2)(ii). The final rule 

adopted by the Commission includes 

this change. 

In response to Professor Greenberger’s 

comment, the Commission does not 

believe that a swap that hedges an 

existing hedge is always speculative. 

The CEA does not require that the enduser exception be available only if the 

swap is a perfect or exact hedge. A swap 

originally designed to hedge commercial 

risk in compliance with the criteria of 

the rule may, over time, no longer fully 

serve its original hedging purpose. For 

example, if the underlying commercial 

risk hedged by the original swap or 

security-based swap no longer exists or 

changes as a result of changing market 

conditions or changes in the business 

needs of the electing counterparty, the 

risk now posed by the original swap or 

security-based swap itself is like other 

commercial risks that arose in the 

ordinary course of business because that 

swap originated as a hedge of 

commercial risk. Accordingly, as the 

Commission has stated that the entities 

shall evaluate the facts and 

circumstances existing at the time a 

hedge position is initiated 66 when 

electing the end-user exception, the 

entity should have the option to elect 

the end-user exception for swaps that 

hedge or mitigate risks created by the 

original swap or security-based swap, 

even if the original risk hedged no 

longer exists or has changed. 

9. Portfolio and Dynamic Hedging, and 

Hedge Effectiveness Testing 

In the NPRM, the Commission asked 

whether the end-user exception should 

apply to swaps that hedge or mitigate 

commercial risk on a single-risk basis or 

an aggregate-risk basis or to swaps that 

facilitate dynamic hedging. The 

Commission also asked whether hedge 

effectiveness should be addressed. 

A number of commenters stated that 

portfolio hedging and dynamic hedging 

may hedge or mitigate commercial risk, 

and are commonly used by certain 

potential electing counterparties, and 

therefore the hedging techniques should 

be eligible for the end-user exception.67

WGCEF, Shell, and ATA noted that 

commercial firms in the physical energy 

and other markets often hedge 

underlying physical assets and related 

positions on a portfolio or aggregate 

basis and also may dynamically hedge. 

WGCEF stated that in such cases it 

would be impracticable to have one-toone matching of each swap to a specific 

physical transaction or asset for 

purposes of complying with the enduser exception. EEI & EPSA and WGCEF 

commented that excluding hedging of 

commercial risks on a portfolio basis or 

dynamic hedging could introduce 

uncertainty and limit the ability of nonfinancial entities to effectively manage 

their commercial risks. 

Regarding hedge effectiveness, a 

number of commenters stated that it is 

important for entities to know at the 

time a transaction is executed whether 

the end-user exception applies. 

According to these commenters, an 

effectiveness test should not be used 

because it can only determine whether 

the swap appropriately hedges or 

mitigates commercial risk at the time of 

the test and not at the time of swap 

execution.68 EDF Trading suggested that 

‘‘reasonable efforts to hedge commercial 

risks’’ should be considered hedging. 

EDF Trading noted that tracking and 

analyzing the hedging or mitigating 

characteristics of a swap after its 

inception would be difficult because the 

hedging value of a swap fluctuates over 

time and is subject to market forces. 

EDF Trading further noted that such 

uncertain market fluctuations are the 

principal reason for entering into 

hedging transactions in the first place. 

EDF Trading believes that requiring an 

ongoing, periodic assessment of a 

hedge’s effectiveness or purpose would 

be burdensome for commercial entities 

and would do little to reduce systemic 

risk. 

CFI suggested that a requirement to 

report the related risk being hedged, 

which would be necessary to test hedge 

effectiveness, would impose an 

unnecessary burden on electing 

counterparties. In contrast, Better 

Markets and PMAA & NEFI commented 

that entities should be required to 

disclose what specific risks they are 

hedging and how the swap hedges those 

risks so that regulators can police the 

end-user exception. Furthermore, Better 

Markets stated that entities should have 

to certify that excepted swaps are not 

entered into for speculation either in 

whole or in part. 

The Commission has determined that 

a swap that facilitates portfolio hedging 

or dynamic hedging may be eligible for 

the end-user exception if that swap 

hedges or mitigates commercial risk. 

The Commission acknowledges that 

portfolio hedging and dynamic 

hedging 69 can be economically 

appropriate to hedge or mitigate 

commercial risk, depending on the 

relevant facts and circumstances. 

The Commission has also determined 

that parties will not be required to 

demonstrate hedge effectiveness or 

engage in periodic hedge effectiveness 

testing. The Commission agrees with 

commenters that entities need to know 

whether the swap is eligible for the enduser exception at the time it is executed 

and should not be subject to second 

guessing if subsequent hedge 

effectiveness testing finds that the swap 

does not, over time, hedge the intended 

risk as such ineffectiveness may be 

beyond the control of the electing 

counterparty. Furthermore, the 

Commission believes that such a 


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70 77 FR 30596 at 30750 (May 23, 2012). 

71See, e.g., ABA, COPE, EMUS, ICBA, Reval, FHL 

Banks, Philip Morris, and EDF Trading. 

requirement could potentially add costs 

and burdens with potentially limited 

added benefit. 

Finally, the Commission has 

determined not to require entities to 

document and report the risk being 

hedged. The Commission believes that 

such a requirement would create a large 

volume of unique data that would be 

difficult to meaningfully review. 

Although the Commission has 

determined not to modify § 39.6 to 

address portfolio hedging or dynamic 

hedging at this time, the Commission 

recognizes that the end-user exception 

could be more easily abused in these 

contexts. The Commission intends to 

monitor use of the end-user exception 

and if such abuse becomes prevalent, it 

may impose appropriate hedge 

identification and/or hedge 

effectiveness testing or reporting 

requirements. 

10. Swap-by-Swap or Swap Portfolio 

Approach 

In a comment submitted prior to 

publication of the NPRM, NYCBA 

requested clarification as to whether all 

swaps entered into by a party, or only 

a certain percentage of the party’s swap 

portfolio, must hedge or mitigate 

commercial risk for the party to qualify 

for the end-user exception. In proposed 

§ 39.6, whether a commercial risk is 

being hedged or mitigated would be 

determined for each swap, not for all or 

a portion of a party’s swap portfolio. 

As noted above, Section 2(h)(7)(A)(ii) 

of the CEA provides that a swap shall 

not be subject to the clearing 

requirement if, among other things, one 

of the counterparties to the swap ‘‘is 

using swaps to hedge or mitigate 

commercial risk * * *.’’ The 

Commission does not believe that 

Congress intended this language to 

automatically apply to all swaps—no 

matter how numerous and no matter 

what their purpose—used by an entity 

that uses some swaps to hedge or 

mitigate commercial risk. Such an 

interpretation would extend the enduser exception beyond its purpose of 

facilitating the use of swaps for hedging 

or mitigating commercial risk. 

Conversely, the statutory language does 

not clearly limit the end-user exception 

to entities that use swaps solely to 

hedge or mitigate commercial risk. 

Implementation of Section 2(h)(7)(A)(ii) 

thus requires the Commission to 

determine how the provision should be 

applied to entities that use swaps to 

hedge or mitigate commercial risk but 

also for other purposes. 

Broadly speaking, there are two 

possible ways to do this: Either on a 

swap-by-swap basis or based on an 

entity’s overall portfolio of swaps. The 

former approach has a number of 

important advantages and the 

Commission therefore is adopting the 

swap-by-swap approach as proposed. 

This approach is consistent with the 

swap-by-swap clearing requirement in 

Section 2(h)(1) of the CEA. The portfolio 

approach would present numerous 

issues that would be difficult to 

overcome or would render the end-user 

exception less effective for achieving the 

stated goals of the Dodd-Frank Act. For 

example, if the Commission required 

that a certain minimum percentage of a 

party’s swaps must hedge or mitigate 

commercial risk, the end-user exception 

would be unavailable to parties who do 

not reach the minimum threshold. This 

could prevent a large number of nonfinancial entities from using the enduser exception at all. It is unlikely that 

Congress intended such a result. In 

addition, if the Commission required a 

high percentage of a party’s swap 

portfolio to hedge or mitigate 

commercial risk, potential electing 

counterparties could be more inclined 

to abuse the end-user exception and 

evade clearing by classifying nonhedging swaps as hedges to meet the 

threshold set forth in the rule. Another 

concern is that, if a party’s swap 

portfolio satisfied the percentage 

requirement, the party could elect the 

end-user exception for all swaps, 

including swaps that do not hedge or 

mitigate commercial risk, thereby 

undermining the systemic risk 

reduction benefits of the clearing 

requirement. A swap-by-swap approach 

is thus consistent with Section 

2(h)(7)(F), which authorizes the 

Commission to prescribe rules to 

prevent abuse of the end-user exception 

to the clearing requirement, and Section 

2(h)(4)(A), which directs the 

Commission to prescribe rules as 

determined by the Commission to be 

necessary to prevent evasions of the 

clearing requirement. 

The Commission also believes the 

percentage approach would be difficult 

to apply as a rule. In addition to 

determining whether each swap hedges 

or mitigates commercial risk to calculate 

a swap portfolio percentage, each such 

entity would need to repeatedly 

measure and report portfolio hedging 

percentages to maintain compliance. A 

percentage-of-portfolio test could lead to 

significant regulatory uncertainty given 

the difficulty of measuring the 

percentage of swaps that hedge or 

mitigate commercial risk over time as 

the portfolio changes. 

11. Consistency Across Commission 

Regulations 

The Commission asked in the NPRM 

whether the criteria for hedging or 

mitigating commercial risk should be 

consistent across all Commission 

regulations. Section 1a(33) of the CEA, 

which defines ‘‘major swap 

participant,’’ provides for an exclusion 

of certain swap positions held for 

‘‘hedging or mitigating commercial risk’’ 

from the determination of whether an 

entity maintains a substantial position 

in swaps. For purposes of Section 1a(33) 

and the Commission’s definition of 

‘‘major swap participant’’ in § 1.3(hhh), 

the Commission has adopted § 1.3(kkk) 

to provide criteria for what constitutes 

‘‘hedging or mitigating commercial 

risk.’’ 70

A number of commenters 

recommended that the criteria for 

hedging or mitigating commercial risk 

be consistent across all Commission 

regulations. These commenters do not 

believe it is appropriate to have 

different hedging criteria under the 

‘‘major swap participant’’ definition and 

end-user exception.71 The ABA 

recommended that the Commission 

cross-reference the hedging criteria used 

in the ‘‘major swap participant’’ 

definition rather than include separate 

but identical criteria in the end-user 

exception to avoid the possibility of 

inadvertent or inconsistent amendments 

and interpretations. 

The ‘‘hedging or mitigating 

commercial risk’’ criteria set forth in 

§ 1.3(kkk) and § 39.6(c) are consistent. 

The Commission has determined that 

the criteria will remain as consistent as 

possible to facilitate consistent 

interpretation across the CEA and 

Commission regulations. However, 

application of the phrase ‘‘hedging or 

mitigating commercial risk’’ serves 

similar, but different purposes in the 

two rules. In addition, while the ‘‘major 

swap participant’’ definition allows for 

application of the criteria to financial 

entities, pursuant to the limitations in 

Section 3(h)(7)(C) of the CEA, the enduser exception does not. Accordingly, 

there is a reasonable possibility that the 

Commission may determine that the two 

criteria should be modified in different 

ways in the future. Therefore, the 

Commission has determined to publish 

the criteria in separate rules rather than 

incorporate them by reference. 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42577 

72See, e.g., CUNA, FHL Banks, 19 Small Banks, 

MBCA, Frost, FTNF, ICBA, PCBB, and Reval. 

73See, e.g., ICBA, 19 Small Banks, MBCA, FCC, 

Chatham, FTNF, Trustmark, UMB, Webster Bank, 

and Wintrust. 

74Chatham indicated that Section 2(h)(7)(C)(ii) 

institutions will spend between $2,500 and $25,000 

in legal fees related to reviewing and negotiating 

clearing-related documentation, and a Section 

2(h)(7)(C)(ii) institution will spend a minimum of 

between $75,000 and $125,000 per year on fees paid 

to each FCM with which it maintains a relationship. 

Webster Bank corroborated these numbers and also 

noted that a Section 2(h)(7)(C)(ii) institution will 

incur additional costs from DCO fees, which vary 

based on collateral delivered. 

75See, e.g., ABA, FCC, Frost, FTNF, MBCA, 

Devlin, FHL Banks, 19 Small Banks, Susquehanna 

Bancshares, Inc., The Private Bank and Trust 

Company, Commerce Bank, Atlantic Capital Bank, 

Trustmark, Webster Bank, UMB Bank, Chatham 

Financial, and Wintrust. 

76ABA, Susquehanna Bancshares, Inc., The 

Private Bank and Trust Company, Commerce Bank, 

Atlantic Capital Bank, Trustmark, Webster Bank, 

UMB Bank, Chatham Financial, and Wintrust. 

D. Exemption of Small Banks, Savings 

Associations, Farm Credit System 

Institutions, and Credit Unions From the 

Definition of ‘‘Financial Entity’’ 

Section 2(h)(7)(C)(ii) of the CEA 

provides that the Commission ‘‘shall 

consider whether to exempt from the 

definition of ‘financial entity’ small 

banks, savings associations, farm credit 

system institutions and credit unions 

including: 

(I) Depository institutions with total 

assets of $10,000,000,000 or less; 

(II) Farm credit system institutions 

with total assets of $10,000,000,000 or 

less; or 

(III) Credit unions with total assets of 

$10,000,000,000 or less.’’ 

For purposes of this discussion, all 

banks, savings associations, farm credit 

system institutions, and credit unions, 

regardless of size, are referred to as 

‘‘Section 2(h)(7)(C)(ii) institutions’’ and 

the subgroup of Section 2(h)(7)(C)(ii) 

institutions that are eligible for 

exemption from the ‘‘financial entity’’ 

definition are collectively referred to as 

‘‘small financial institutions’’ or ‘‘SFIs.’’ 

In the NPRM, the Commission 

requested comment regarding the 

appropriateness, breadth, risk issues, 

and limits of an exemption for Section 

2(h)(7)(C)(ii) institutions. The 

Commission also asked whether there 

are appropriate measures for 

determining whether a Section 

2(h)(7)(C)(ii) institution qualifies as a 

small financial institution other than the 

$10 billion or less total assets test 

referenced in the CEA. 

A number of commenters supported 

defining SFIs broadly,72 but AFR stated 

that only those small banks that engage 

in de minimis swap activity should be 

exempted. CII opposed extending the 

end-user exception to small Section 

2(h)(7)(C)(ii) institutions because doing 

so ‘‘would help preserve a hole in the 

oversight and regulation of derivatives 

that would likely be exploited to the 

detriment of the capital markets.’’ 

A number of commenters 73

recommended that the Commission 

provide an exemption for SFIs because 

most small Section 2(h)(7)(C)(ii) 

institutions only offer swaps to 

customers in connection with loans for 

the customers’ commercial business 

activities, and the related swaps hedge 

interest rate risk. These commenters 

noted that such swaps are not 

speculative in nature and are generally 

low risk. The small Section 2(h)(7)(C)(ii) 

institutions then enter into swaps with 

other financial institutions, often on a 

matched or back-to-back swap basis, to 

hedge the underlying risk of those 

customer swaps. According to these 

commenters, such matched or back-toback swaps pose less risk to the small 

Section 2(h)(7)(C)(ii) institutions. For 

example, MBCA commented that 

‘‘[small Section 2(h)(7)(C)(ii) 

institutions] participate in the swaps 

markets for purposes of hedging interest 

rate risk on their balance sheets and 

offering swaps in connection with loans 

as a means to deliver long-term fixed 

rate financing to commercial 

borrowers.’’ Also, these commenters 

noted that the swaps are often secured 

by assets funded by the loans and those 

assets are not liquid. The lack of 

liquidity of the security means that the 

small Section 2(h)(7)(C)(ii) institutions 

cannot simply pass on the security to a 

DCO as collateral for the matched swaps 

and must fund the collateral posted to 

DCOs in other ways. 

Commenters also claimed that 

requiring small Section 2(h)(7)(C)(ii) 

institutions to clear swaps would 

impose inordinate costs on them. 

Chatham and Webster Bank noted that 

the fees charged by futures commission 

merchants to clear swaps could be 

significant for Section 2(h)(7)(C)(ii) 

institutions that are ineligible for the 

end-user exception and did not 

previously clear their swaps, especially 

those institutions that transact only a 

small number of swaps. They indicated 

that these fees generally take the form of 

a fixed minimum monthly fee, plus a 

‘‘ticket’’ fee that varies with the volume 

of swap transactions processed.74 ABA 

and ICBA commented that if small 

Section 2(h)(7)(C)(ii) institutions have to 

incur high fixed costs for clearing, they 

might refrain from entering into swaps 

to avoid having to incur such costs. 

ABA and 19 Small Banks commented 

that Section 2(h)(7)(C)(ii) institutions 

should be exempted because applicable 

banking regulations and guidance 

require banks to establish internal risk 

management policies and procedures for 

all operations and activities, including, 

in some cases, for swap transactions. 

ABA also noted that banks are limited 

by the banking regulations applicable to 

them as to the amount of credit they can 

extend to each individual or entity to a 

specified percentage of capital and 

reserves. 

FCC recommended that the 

Commission adopt rules that would 

permit farm credit system (FCS) 

associations and banks to exercise the 

end-user exception. FCC noted that FCS 

associations have, on average, total 

assets under $10 billion, and that FCS 

banks may have total assets exceeding 

$10 billion. According to FCC, these 

FCS institutions are cooperatives owned 

by their members, and a major function 

of each cooperative is to act on behalf 

of its members in the financial markets. 

FCC further noted that the members of 

these cooperatives are generally either 

non-financial entities or small financial 

institutions. FCC reasoned that, because 

an FCS cooperative essentially is taking 

the place of its members to face the 

larger financial markets on behalf of the 

members, the end-user exception that 

would be available to the cooperative’s 

members should pass through to the 

cooperative. In addition, FCC noted that 

the Farm Credit Administration 

effectively regulates FCS institutions; 

FCS institutions only enter into safe, 

non-speculative swaps primarily related 

to member loans backed by collateral; 

and, unlike large banks, the FCS 

institutions are not as interconnected 

with other financial entities. 

Regarding the criteria for determining 

whether a Section 2(h)(7)(C)(ii) 

institution is eligible for the exemption, 

a number of commenters recommended 

that the Commission allow institutions 

with more than $10 billion in assets to 

qualify for the exemption.75 FCC 

commented that Congress provided the 

Commission with the authority to 

exempt financial institutions with more 

than $10 billion in assets. A number of 

commenters 76 suggested raising the 

threshold to $30 billion or higher. Frost, 

FTN, and MBCA recommended a $50 

billion threshold. 19 Small Banks 

recommended that institutions with 

assets less than $50 billion and with 

uncollateralized exposure less than $1 

billion should qualify for the 

exemption. These commenters 

suggested that historically, the swap 

activity of financial institutions with 

these higher asset levels is only a small 

percentage of the total swaps market 


emcdonald on DSK67QTVN1PROD with RULES2
42578 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

77The Commission notes that if a Section 

2(h)(7)(C)(ii) institution, regardless of its size, 

executes a swap with a customer/counterparty who 

properly elects the end-user exception for that 

swap, then neither the customer/counterparty nor 

the Section 2(h)(7)(C)(ii) institution needs to clear 

its position in that swap. 

78See Section III.E hereof for information on the 

volume of swaps executed by Section 2(h)(7)(C)(ii) 

institutions. 

79As noted by the 19 Small Banks in their 

comment letter, ‘‘it is important to note that an SFI 

would not be exempt from clearing and trading for 

any speculative trades. Indeed, SFIs would have to 

meet the same conditions required for the end-user 

exception to mandatory clearing of swaps under 

Proposed Rule 39.6.’’ 

80The Commission’s $10 billion threshold is in 

harmony with the SEC’s proposed approach to 

exempt SFIs from clearing security-based swaps 

that are subject to mandatory clearing. 75 FR 79992 

at 80011 (Dec. 21, 2010). 

81See, e.g., Section 165 of the Dodd-Frank Act. 

(‘‘In order to prevent or mitigate risks to the 

financial stability of the United States that could 

arise from the material financial distress or failure, 

or ongoing activities, of large, interconnected 

financial institutions, the Board of Governors shall, 

on its own or pursuant to recommendations by the 

Council under section 115, establish prudential 

standards for nonbank financial companies 

supervised by the Board of Governors and bank 

holding companies with total consolidated assets 

equal to or greater than $50,000,000,000.’’) 

82Furthermore, although not determinative as to 

what is ‘‘small,’’ the Commission is concerned that 

if Section 2(h)(7)(C)(ii) institutions with assets 

greater than $10 billion can avail themselves of the 

exemption, these larger institutions, which have 

and therefore exempting them would 

not pose risk to the market or the 

financial system. 

FHL Banks commented that the $10 

billion asset level should be the baseline 

for the exemption. For Section 

2(h)(7)(C)(ii) institutions with more 

assets, FHL Banks recommended that 

the Commission establish objective 

criteria for the exemption based on the 

risk that the institution poses to the U.S. 

financial system. For example, FHL 

Banks suggested that the Commission 

could look to the institution’s current 

uncollateralized exposure as well as its 

potential future exposure. 

Similarly, FCC commented that the 

systemic risk created by derivatives is 

not a function of an institution’s asset 

size, but a function of the type and 

amount of derivative activity after 

netting offsetting positions and 

collateral. According to FCC, small 

institutions that enter into many risky 

trades pose greater risk to the financial 

system than larger institutions that 

carefully manage their derivatives 

portfolios. Accordingly, FCC 

recommended that the Commission 

focus on risk instead of asset size and 

recommended defining ‘‘financial 

entity’’ to mean entities with current 

uncollateralized exposure and potential 

future exposure of $3 billion in rate 

swaps and $1 billion in other major 

swap categories. FCC noted that such 

entities could be required to report 

compliance with the risk-based 

exposure test when electing the enduser exception. Similarly, CUNA 

recommended that the Commission 

should only allow entities with at least 

$10 billion in assets and that engage in 

a ‘‘significant volume’’ of swaps to 

qualify for the exemption. 

The Commission is adopting § 39.6(d) 

to provide an exemption from the 

definition of ‘‘financial entity’’ for small 

Section 2(h)(7)(C)(ii) institutions. The 

Commission acknowledges that small 

Section 2(h)(7)(C)(ii) institutions, which 

tend to serve smaller, local markets, are 

well situated to provide swaps to the 

customers in their markets for the 

purpose of hedging commercial risk. 

The Commission also acknowledges that 

historically, as indicated by 

commenters, a large portion of the 

swaps executed by small Section 

2(h)(7)(C)(ii) institutions with customers 

likely hedge interest rate risk associated 

with commercial loans. Many of these 

loans and the related swaps are not 

secured by cash or other highly liquid 

collateral, but by less liquid assets of the 

customer such as the property or 

inventory purchased with the loan 

proceeds. Based on the comments 

received, it appears that small Section 

2(h)(7)(C)(ii) institutions typically hedge 

customer swaps by entering into 

matching swaps in the swap market, 

and if those matched swaps had to be 

cleared, the small Section 2(h)(7)(C)(ii) 

institutions would have to post margin 

to satisfy the requirements of the 

DCOs.77 This arrangement could raise 

the costs for small Section 2(h)(7)(C)(ii) 

institutions of hedging the risks related 

to these types of customer swaps to the 

extent they need to fund the cost of the 

margin posted. In addition, the 

Commission acknowledges that some 

small Section 2(h)(7)(C)(ii) institutions 

may incur initial and annual fixed 

clearing fees and other expenses that 

may be incrementally higher relative to 

the small number of swaps they execute 

over a given period of time. Lastly, 

given the relatively low notional volume 

swap books held by small Section 

2(h)(7)(C)(ii) institutions 78 and the 

commercial customer purposes these 

swaps satisfy, the Commission believes 

that swaps executed by small Section 

2(h)(7)(C)(ii) institutions are what 

Congress was considering when it 

directed the Commission to consider an 

exemption from the ‘‘financial entity’’ 

definition for small financial 

institutions in Section 2(h)(7)(C)(ii) of 

the CEA. Accordingly, the Commission 

believes that it is appropriate to exempt 

small Section 2(h)(7)(C)(ii) institutions 

from the definition of ‘‘financial entity’’ 

in Section 2(h)(7)(C), thereby permitting 

small Section 2(h)(7)(C)(ii) institutions 

to elect not to clear swaps that are 

otherwise eligible for the end-user 

exception.79

Having determined that an exemption 

for small Section 2(h)(7)(C)(ii) 

institutions is appropriate, the 

Commission considered the comments 

received regarding whether to use the 

$10 billion total assets threshold 

identified in Section 2(h)(7)(C)(ii) of the 

CEA for determining what is a ‘‘small’’ 

Section 2(h)(7)(C)(ii) institution, or 

whether to use another test. The 

Commission has determined to limit the 

exemption to Section 2(h)(7)(C)(ii) 

institutions with $10 billion in total 

assets or less.80 The Commission 

acknowledges that the $10 billion level 

is not required by the CEA. However, 

the Commission also believes that by 

specifically identifying that asset level 

three times, once for each type of 

Section 2(h)(7)(C)(ii) institution, 

Congress expressed its clear intent that 

the Commission should base its 

consideration of what is a ‘‘small’’ 

institution on the $10 billion asset level. 

The Commission therefore believes that 

it is appropriate to use the $10 billion 

level absent strong and convincing facts 

or circumstances supporting alternative 

measures. 

The Commission believes that it 

would be inappropriate to exempt 

Section 2(h)(7)(C)(ii) institutions with 

substantially higher total asset amounts, 

such as the $30 billion, $50 billion, or 

higher levels recommended by several 

commenters. Congress has identified 

large financial institutions as more 

likely to cause systemic risk and has 

directed prudential regulators to 

consider prudential standards for 

‘‘large’’ institutions having assets of $50 

billion or more.81 Although $30 billion 

in assets is less than the $50 billion 

level identified by Congress as being 

indicative of ‘‘large’’ financial 

institutions, $30 billion is three times 

greater than the $10 billion level 

identified by Congress in Section 

2(h)(7)(C)(ii) as indicative of a ‘‘small’’ 

financial institution that should have 

the benefit of the exemption. While 

some commenters asserted that Section 

2(h)(7)(C)(ii) institutions with assets in 

excess of $10 billion have commonly 

executed swaps with customers for the 

same purposes that smaller institutions 

do, and that these institutions pose less 

risk to the financial system than much 

larger institutions, these commenters 

did not provide specific data applicable 

to institutions with $10 billion or more 

of assets that would confirm these 

assertions.82 Accordingly, commenters 


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greater capabilities than institutions with less than 

$10 billion of assets, are more likely to increase 

their swap activities at the regional or national level 

using the commercial advantage that the exemption 

will provide. Accordingly, it is possible that the 

amount of swap activity of these larger institutions 

could increase significantly over time if the 

exemption were available to them. 

83Asset level data for banks and savings 

associations is available at fdic.gov, and for credit 

unions at ncua.gov. Data for farm credit system 

institutions was provided to the Commission by the 

Farm Credit Administration. 

84 In mid-2010, the most recent period for which 

Section 2(h)(7)(C)(ii) institution swap data could be 

obtained, approximately 1,015 Section 2(h)(7)(C)(ii) 

institutions had outstanding swap exposure. Of 

those institutions, 138 had total assets over $10 

billion and 876 had total assets below $10 billion. 

85For example, if the SFIs internally net large 

numbers of customer trades and then partially 

hedge the aggregate risk, or use hedging swaps 

based on interest rates or durations that do not 

match the customer swaps precisely, basis risk 

could be created that could become significant in 

another financial crisis. 

did not provide strong and convincing 

evidence that an asset level higher than 

$10 billion would be more appropriate 

than the $10 billion or less test for 

distinguishing ‘‘small’’ Section 

2(h)(7)(C)(ii) institutions from others. 

As a basic check on how many 

institutions could use the exemption at 

the $10 billion total assets level, the 

Commission looked at how many 

Section 2(h)(7)(C)(ii) institutions had 

total assets less than $10 billion and 

how many had more. Approximately 

14,700 Section 2(h)(7)(C)(ii) institutions 

were operating in the United States as 

of December 31, 2011. Of those, 

approximately 120 had total assets 

greater than $10 billion.83 The 

remaining 14,580 institutions had less 

than $10 billion in total assets. In other 

words, about 99 percent of banks, 

savings associations, farm credit system 

institutions, and credit unions will 

qualify as SFIs using the $10 billion or 

less test.84 While this data did not 

influence the Commission’s 

consideration of what constitutes a 

‘‘small’’ Section 2(h)(7)(C)(ii) 

institution, it indicates that a high 

number of Section 2(h)(7)(C)(ii) 

institutions would be able to use the 

exemption for their hedging swap 

activities. 

The Commission also considered 

whether it should adopt an alternative 

or additional uncollateralized exposure 

test, as recommended by some 

commenters. As noted above, several 

commenters recommended defining 

financial institutions that can use the 

exemption based on whether an 

institution’s current and potential future 

uncollateralized swap exposure exceeds 

a certain threshold. Commenters 

suggested $1 billion or $3 billion as 

acceptable levels of uncollateralized 

exposure. 

The Commission determined that an 

uncollateralized exposure test is not 

consistent with the statutory language of 

Section 2(h)(7)(C) of the CEA or the 

reasons for including a central clearing 

requirement in the Dodd-Frank Act. The 

Commission takes particular note of the 

fact that in Section 2(h)(7)(C)(ii), 

Congress focused exclusively on the size 

of the entity, based on total amount of 

assets, for measuring whether a 

financial institution should be exempt 

from the ‘‘financial entity’’ definition. 

Congress did not direct the Commission 

to consider whether uncollateralized 

risk exposure should be used for this 

purpose. Furthermore, it is not readily 

apparent how even full collateralization 

of exposure on a bilateral basis is an 

effective substitute for required clearing 

in the event of a severe financial shock 

such as occurred in 2008. 

Commenters did not establish how an 

uncollateralized exposure test would be 

consistent with a definition of ‘‘small’’ 

financial institutions. An 

uncollateralized exposure test based on 

an entity’s current and potential future 

exposure from swaps is not linked to the 

size of the financial institution or its 

significance to the financial system. For 

example, an uncollateralized exposure 

test allowing up to $1 billion in 

uncollateralized exposure could allow 

institutions with over $100 billion in 

assets to qualify as ‘‘small.’’ The 

Commission does not believe such a 

definition would be consistent with the 

intent of allowing an exemption for 

‘‘small’’ Section 2(h)(7)(C)(ii) 

institutions from the clearing 

requirement. Had Congress intended 

such a result, it would have directed the 

Commission to consider exempting 

‘‘low-risk’’ institutions. 

In addition, the entity-by-entity 

uncollateralized exposure tests 

proposed by commenters may not 

capture the different risks non-cleared 

swaps may pose to the financial system. 

Any such test would need to carefully 

consider risk factors that the clearing 

requirement under the Dodd-Frank Act 

addresses, including opaque, non-public 

risk transference among market 

participants; buildup of risks in 

individual entities (such as the swap 

dealers with whom Section 2(h)(7)(C)(ii) 

institutions generally hedge swap 

exposure); effective measurement of risk 

in ever changing markets; and effective 

risk management frameworks for 

extreme market conditions. In this 

regard, the Commission does not believe 

that an entity-by-entity uncollateralized 

exposure test would account for: 

systemic risks that could arise if many 

Section 2(h)(7)(C)(ii) institutions are 

executing non-cleared swaps with only 

one swap dealer that fails, thereby 

concentrating uncleared counterparty 

risk; whether the Section 2(h)(7)(C)(ii) 

institutions hedging trades are creating 

other risks because they cannot 

perfectly match the risks being 

hedged; 85 rapidly changing market 

conditions; or a systemic liquidity 

freeze. 

These risks are mitigated through 

central clearing. DCOs set margin levels 

and recalculate and collect margin 

amounts daily (sometimes intra-daily) 

based on changing market conditions. 

DCOs also use established and tested 

processes to swiftly calculate and cover 

losses resulting from a counterparty 

default, rapidly closing out or 

transferring the defaulted positions, and 

using the liquid collateral posted as 

margin by the defaulting party (plus 

other liquid assets available to the DCO, 

if necessary) to satisfy any losses 

incurred by the DCO in connection with 

the default. In this way, DCOs are able 

to make whole the market participants 

using its clearing services, 

notwithstanding a default by a member 

that may otherwise have been a 

counterparty to many of those market 

participants on a bilateral trading basis. 

As such, a swap clearing requirement 

protects the financial system from the 

risks that attend to the 

interconnectedness of the financial 

system. The interconnectedness of 

financial institutions, particularly large 

institutions, means that severe shocks to 

the financial system, such as occurred 

in late 2008, can cause liquidity to dry 

up in a matter of days or change the 

perceived credit quality of institutions 

overnight, vastly increasing their capital 

requirements. Such rapid changes can 

cause entities, particularly in the 

banking system, to fail with little or no 

forewarning. Notably, these risks are not 

necessarily ameliorated by a test that 

looks at uncollateralized exposure, 

because in the event of a severe 

financial shock, even swaps that are 

fully collateralized at the mark-tomarket value on one day can fall into 

default the next as credit conditions 

change rapidly. In such event, the nondefaulting counterparties become 

exposed to losses that accumulate 

rapidly, which in turn can lead to their 

default. 

Because the comments have not 

demonstrated why the Commission 

should interpret ‘‘small’’ to mean ‘‘lowrisk’’ based upon an uncollateralized 

exposure calculus, and why such a 

calculus is an adequate substitute for 

the benefits provided by required 

clearing, the Commission declines to 


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42580 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

86 7 U.S.C. 4(c)(6). 

87The six RTO/ISOs are California Independent 

System Operator Corporation, Electric Reliability 

Council of Texas, Inc., ISO New England Inc., 

Midwest Independent Transmission System 

Operator, Inc., New York Independent System 

Operator, Inc., and PJM Interconnection, L.L.C. 

88See 76 FR 58186 (Sept. 20, 2011) (Swap 

Transaction Compliance and Implementation 

Schedule: Clearing and Trade Execution 

Requirements under Section 2(h) of the CEA). 

adopt an uncollateralized exposure test 

at this time. 

With regard to FCC’s comments 

regarding FCS institutions, the 

Commission notes that if any such 

institution has total assets equal to or 

less than $10 billion, then it is a small 

financial institution that can elect the 

end-user exception. However, for those 

FCS institutions with assets greater than 

$10 billion, Section 2(h)(7)(C)(ii) of the 

CEA does not provide special 

consideration for cooperatives that meet 

the definition of ‘‘financial entity’’ and 

therefore the asset size limit applies to 

them. 

The Commission recognizes that 

cooperatives exist to serve their member 

owners. The Commission further 

recognizes that, as described above, 

some cooperatives represent their 

members in the financial markets, and 

the members of some of these 

cooperatives are entities that could elect 

the end-user exception if acting alone. 

Accordingly, the Commission may 

consider providing exemptive relief for 

financial cooperatives through a 

separate action under its authority in 

Section 4(c) of the CEA. 

E. Additional Considerations 

1. Consultation With Other Regulatory 

Agencies; Jurisdictional Issues 

Staff of the Federal Energy Regulatory 

Commission (FERC Staff) commented 

that ‘‘the CFTC should interpret and 

apply the CEA as amended by DoddFrank to ensure that CFTC jurisdiction 

and FERC jurisdiction do not overlap.’’ 

FERC Staff believes that, due to FERC’s 

existing comprehensive regulation, 

‘‘Dodd-Frank terms should be 

interpreted as not applying to any 

contract or instrument traded in an 

RTO/ISO market pursuant to a FERC 

accepted or approved rate schedule or 

tariff. Applying Dodd-Frank swaps 

regulation to RTOs/ISOs is not only 

unnecessary but also potentially 

harmful.’’ 

PG&E and SDG&E recommended that 

the Commission consult and coordinate 

with other regulatory agencies and state 

commissions (such as FERC and the 

California Public Utilities Commission 

(CPUC)) to assure regulatory consistency 

and comparability to the extent that 

hedging activities are already regulated. 

They noted that the costs and burdens 

associated with duplicative or 

inconsistent regulation would be passed 

through to ratepayers. As an example, 

PG&E noted that in certain instances, 

the CPUC may direct PG&E, as part of 

their obligation to serve customer load, 

to perform hedging on behalf of third 

parties, or assist municipalities in 

making decisions about hedging 

transactions. In such cases where the 

utility is directed to engage in certain 

derivative transactions by the CPUC, 

PG&E commented that these activities 

should be exempt from Commission 

regulation. 

Finally, NRECA stated that the 

Commission should create a 

‘‘Commission-lite’’ regime for nonfinancial entities that are already subject 

to regulation by energy or 

environmental federal agencies and do 

not have the infrastructure/personnel of 

financial entities. 

The Commission has determined not 

to revise § 39.6 in response to these 

comments. The Commission does not 

believe the commenters have identified 

a conflict between § 39.6 and other 

regulations. Regulation 39.6 would not 

prevent entities from entering into 

swaps that do not hedge commercial 

risk; it would only identify when a swap 

may be excepted from the clearing 

requirement in accordance with the 

CEA. Accordingly, if other regulators 

require an entity to enter into swaps that 

do not hedge commercial risk, these 

entities can still execute those swaps 

and clear them as required under the 

CEA. However, the Commission 

recognizes that conflict between 

regulatory regimes may arise and the 

Commission plans to consult with other 

regulators as appropriate. 

Regarding the FERC comment, the 

Commission notes that Section 722(f) of 

the Dodd-Frank Act 86 provides that the 

Commission may exempt transactions 

entered into pursuant to, inter alia, a 

tariff approved by FERC or the Public 

Utility Commission of Texas (which 

would include RTO/ISO transactions) if 

the Commission determines that such 

an exemption would be consistent with 

the public interest and the purposes of 

the CEA. Six RTO/ISOs 87 have 

submitted a petition for an order of 

exemption pursuant to Section 722(f) of 

the Dodd-Frank Act. The Commission 

intends to act on this petition 

expeditiously. 

Regarding FCC’s comment, Section 

2(h)(7)(C)(ii) of the CEA expressly 

provides the Commission with the 

authority to exempt certain farm credit 

system institutions from the definition 

of ‘‘financial entity’’ along with other 

SFIs. Such exemptive authority would 

be unnecessary if the clearing 

requirement was not intended to apply 

to farm credit system institutions. 

2. Implementation and Compliance 

The Committee on Capital Markets 

Regulation (CCMR) and CME Group, 

Inc. (CME) recommended that the enduser exception be finalized early in the 

establishment of the clearing 

requirement process. CME commented 

that the end-user exception should be 

finalized early so companies know who 

will be subject to the clearing 

requirement. 

Other commenters, including EEI & 

EPSA, Shell, EDF Trading, EEI, and 

CDEU, recommended that the 

implementation deadline for the DoddFrank Act be extended. EDF Trading 

and EEI recommended that the 

Commission allow a one-year 

‘‘transition period’’ following the 

effective date of the Dodd-Frank Act to 

allow entities to comply with the new 

end-user exception regulations. 

Finally, a number of commenters 

recommended that the Commission 

delay the § 39.6 reporting requirements. 

ATA recommended that the 

Commission key implementation of the 

end-user notification regime to the time 

when SDRs become operational. COPE 

suggested that the reporting requirement 

not be enforced until reporting systems 

have been largely standardized to avoid 

the development of multiple, bespoke 

software programs or systems for 

compliance. NEMA noted that 

significant terms have not been defined 

and that an overly aggressive 

compliance schedule could force many 

of its members out of the market for 

financial products because of their 

concern of being treated as a financial 

entity. NEMA also commented that 

parties must have sufficient time to 

make the requisite investment in 

information technology systems and to 

develop compliance plans. 

The Commission has determined that 

§ 39.6 will become effective 60 days 

after publication in the Federal 

Register. However, the Commission 

notes that compliance with § 39.6 will 

not be necessary or possible until swaps 

become subject to the clearing 

requirement. The Commission’s 

proposed compliance and 

implementation schedule for the 

clearing requirement gives non-financial 

entities a minimum of 270 days to 

comply after the Commission issues a 

clearing requirement determination for a 

swap or group, category, type or class of 

swaps.88 Moreover, the Commission has 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42581 

89As previously noted, this section states: ‘‘It 

shall be unlawful for any person to engage in a 

swap unless that person submits such swap for 

clearing to a [DCO] that is registered under this Act 

or a [DCO] that is exempt from registration under 

[the CEA] if the swap is required to be cleared.’’ 

90See Section 2(h)(2) of the CEA, 7 U.S.C. 2(h)(2). 

91When a bilateral swap is moved into clearing, 

the clearinghouse becomes the counterparty to each 

of the original participants in the swap. This 

standardizes counterparty risk for the original swap 

participants in that they each bear the same risk 

attributable to facing the clearinghouse as 

counterparty. In addition, clearing mitigates 

counterparty risk to the extent that the 

clearinghouse is a more creditworthy counterparty 

relative to those that each participant in the trade 

might have otherwise faced. Clearinghouses have 

demonstrated resilience in the face of past market 

stress. Most recently, they remained financially 

sound and effectively settled positions in the midst 

of turbulent events in 2007–2008 that threatened 

the financial health and stability of many other 

types of entities. 

92See CEA 2(h)(7)(C)(ii). 

stated that no such clearing requirement 

determinations will become effective 

until the Commission adopts certain 

related rules. 

3. Revocation of Election of the EndUser Exception 

IECA recommended that the 

Commission establish regulations that 

would make an election not to clear a 

swap irrevocable without the consent of 

both parties. 

The Commission notes that Section 

2(h)(7)(B) of the CEA provides that the 

application of the end-user exception is 

solely at the discretion of the 

counterparty to the swap that meets the 

conditions set forth in Section 

2(h)(7)(A). Section 2(h)(7) does not 

address, however, whether the electing 

counterparty may revoke its election 

and choose to clear the swap. The 

Commission believes that any decision 

to change the clearing status of the swap 

after it is entered into is a contractual 

matter between the two parties. 

III. Consideration of Costs and Benefits 

A. Introduction 

The regulations being adopted herein 

interpret and establish qualifying 

criteria for the end-user exception 

provided in Section 2(h)(7) of the CEA 

from the clearing requirement 

established in Section 2(h)(1)(A) of the 

CEA, as amended by the Dodd-Frank 

Act. An understanding of the costs and 

benefits of the end-user exception 

requires background understanding of 

the Section 2(h)(1)(A) clearing 

requirement.89

Prior to the passage of the Dodd-Frank 

Act, swap transactions were not 

required to be cleared. In the wake of 

the financial crisis of 2008, Congress 

adopted the Dodd-Frank Act, which, 

among other things, requires the 

Commission to determine whether a 

particular swap, or group, category, type 

or class of swaps, shall be required to 

be cleared.90 Specifically, Section 

723(a)(3) of the Dodd-Frank Act 

amended Section 2(h)(1)(A) of the CEA 

to make it ‘‘unlawful for any person to 

engage in a swap unless that person 

submits such swap for clearing to a 

derivatives clearing organization that is 

registered under [the CEA] or a 

derivatives clearing organization that is 

exempt from registration under [the 

CEA] if the swap is required to be 

cleared.’’ This clearing requirement is 

designed to reduce counterparty risk 

associated with swaps and, in turn, 

mitigate the potential systemic impact 

of such risk and reduce the likelihood 

for swaps to cause or exacerbate 

instability in the financial system.91 It 

reflects a fundamental premise of the 

Dodd-Frank Act: The use of properly 

regulated and functioning central 

clearing can reduce systemic risk. 

Notwithstanding the benefits of 

clearing, Section 2(h)(7) of the CEA 

provides for the end-user exception if 

one of the swap counterparties: ‘‘(i) Is 

not a financial entity; (ii) is using swaps 

to hedge or mitigate commercial risk; 

and (iii) notifies the Commission, in a 

manner set forth by the Commission, 

how it generally meets its financial 

obligations associated with entering into 

non-cleared swaps.’’ Section 

2(h)(7)(C)(ii) directs the Commission to 

consider making the end-user exception 

available to small banks, savings 

associations, credit unions, and farm 

credit institutions, including those 

institutions with total assets of $10 

billion or less, through an exemption 

from the statutory definition of 

‘‘financial entity.’’ 92 As noted above in 

section D hereof, for purposes of this 

final release, all banks, savings 

associations, farm credit system 

institutions, and credit unions, 

regardless of size, are referred to as 

‘‘Section 2(h)(7)(C)(ii) institutions’’ and 

the subgroup of Section 2(h)(7)(C)(ii) 

institutions that are eligible for 

exemption from the ‘‘financial entity’’ 

definition are collectively referred to as 

‘‘small financial institutions’’ or ‘‘SFIs.’’ 

In this final rulemaking, the 

Commission is adopting rules 

implementing the end-user exception. 

More specifically, the final rules: (1) 

Specify the content and manner to effect 

the required Commission notification 

(i.e., the reporting requirements); (2) 

establish the criteria for determining 

whether a swap is ‘‘hedging or 

mitigating commercial risk’’; and (3) 

exclude SFIs from the definition of 

‘‘financial entity’’ for purposes of 

Section 2(h)(7)(A)(i) of the CEA, making 

it possible for them to avail themselves 

of the end-user exception. It is the costs 

and benefits of this rulemaking that the 

Commission considers in the discussion 

that follows. 

Important to the Commission’s 

consideration of costs and benefits is 

that this rulemaking is permissive—that 

is, the election of the end-user exception 

is at the discretion of the counterparty 

to the swap that meets the requisite 

conditions set forth in the statute and 

the final rule. In addition, except for the 

reporting required for those electing the 

end-user exception set forth in § 39.6(b), 

the final rule imposes no substantive 

obligations on the electing parties. 

Rather, the final rule largely clarifies the 

statute it implements and provides 

specific criteria for certain key terms in 

the statute including ‘‘financial entity’’ 

and ‘‘hedging or mitigating commercial 

risk.’’ 

This notice also provides statutory 

interpretation and guidance to potential 

electing counterparties as to whether 

they are, for example, a ‘‘financial 

entity.’’ Although that term is defined in 

statute, the Commission’s response to 

comments regarding application of the 

definition to certain types of entities 

should yield a substantial, if 

unquantifiable, benefit by providing 

clarity and reducing uncertainty about a 

market participant’s status for purposes 

of determining the availability of the 

end-user exception. The added clarity 

provided by the Commission’s statutory 

interpretation and guidance, although 

beyond the scope of the Commission’s 

obligation to consider the costs and 

benefits of its regulations or orders 

under Section 15(a) of the CEA, should 

nevertheless promote greater confidence 

and integrity in the market. 

In the NPRM, the Commission asked 

for public comment on the costs and 

benefits of the proposed regulations, 

and specifically invited comments on 

whether: (1) It would be difficult or 

prohibitively expensive for persons to 

report the information required under 

the proposed rule; (2) there are more 

feasible and cost effective ways for the 

Commission to receive notification 

regarding the use of the end-user 

exception; (3) the Commission should 

consider requiring electing 

counterparties to report additional types 

of information; (4) collecting notice 

information regarding use of the enduser exception through SDRs would 

create significantly greater burdens for 

some parties to swaps compared to 

others; and (5) the Commission should 


emcdonald on DSK67QTVN1PROD with RULES2
42582 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

93See 75 FR at 80750–80751. 

94 Id. at 80754. 

95See, e.g., sections II.B.1, 6, 7, 8, and 9 and 

II.C.6. 

96 7 U.S.C. 19(a). 

97See Section 2(h)(7)(A)(iii) of the CEA. 

98See Section 2(h)(7)(A)(ii) of the CEA. 

extend the end-user exception to SFIs.93

The Commission also asked for 

commenters to provide an explanation 

for any preferred alternative and data to 

support their comments.94

The Commission received numerous 

comments addressing various cost and 

benefit considerations of the proposed 

rule and sought to promulgate a final 

rule that will help swap market 

participants apply the end-user 

exception in a uniform and accurate 

manner, balance the tradeoff of costs 

and benefits associated with the 

exemption, and minimize reporting 

burdens on market participants who 

elect the exception while still providing 

the Commission the information that it 

needs to monitor the markets and use of 

the exception by market participants. 

The Commission adopted a number of 

the alternatives posed by commenters, 

particularly with regard to the final 

rule’s reporting requirements.95

Informed by commenters, the 

discussion below considers the rule’s 

costs and benefits as well as alternatives 

to the rule. The discussion concludes 

with a consideration of the rule’s costs 

and benefits in light of the five factors 

specified in Section 15(a) of the CEA. 

B. Requirement To Consider the Costs 

and Benefits of the Commission’s Action 

Under Section 15(a) of the CEA 

Section 15(a) of the CEA 96 requires 

the Commission to consider the costs 

and benefits of its actions before 

promulgating a regulation under the 

CEA or issuing certain orders. Section 

15(a) further specifies that the costs and 

benefits shall be evaluated in light of 

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 

Commission considers the costs and 

benefits resulting from its discretionary 

determinations with respect to the 

Section 15(a) factors. 

In the sections that follow, the 

Commission considers the costs and 

benefits of final § 39.6, namely: (1) The 

costs and benefits of the reporting 

requirements; and (2) the costs and 

benefits of the established criteria for 

determining whether a swap hedges or 

mitigates commercial risk for purposes 

of Section 2(h)(7)(A)(ii). The former is in 

large part amenable to quantification, 

but the latter is not due to a lack of data 

about the manner in which swaps are 

currently being used to hedge or 

mitigate commercial risk and the 

economic terms thereof. Nevertheless, 

the Commission provides qualitative 

consideration of the costs and benefits 

of its approach to establishing criteria 

for determining whether a swap hedges 

or mitigates commercial risk. Finally, as 

required by Sections 2(h)(7)(C)(ii) and 

15(a) of the CEA, the Commission 

considers the costs and benefits of 

exempting SFIs with total assets of $10 

billion or less from the definition of 

‘‘financial entity.’’ 

The costs and benefits of the 

Commission’s action in this rulemaking 

are measured against the level of costs 

and benefits that would exist absent this 

rulemaking. With respect to each of this 

rulemaking’s three elements this is as 

follows: 

• Establishing the reporting 

requirements. The requirement that 

counterparties availing themselves of 

the end-user exception provide 

notification to the Commission remains 

a statutory requisite to invoke the 

exemption, albeit one that is not selfexecuting.97 Thus, the foundation 

against which this rulemaking’s costs 

and benefits are measured is the 

minimum notification that the 

Commission could prescribe to meet the 

statutory requirement. 

• The ‘‘hedge or mitigate commercial 

risk’’ element. Absent this rulemaking, 

‘‘hedging or mitigating commercial risk’’ 

remains a statutory requisite to invoke 

the end-user exception.98 This 

rulemaking clarifies the Commission’s 

interpretation of the term for purposes 

of implementing and enforcing the 

CEA’s statutory requirements. Thus, the 

foundation against which this 

rulemaking’s costs and benefits are 

measured is the statutory requirement 

standing alone without the clarification 

that the rulemaking provides. 

• Excluding qualifying SFIs from the 

definition of ‘‘financial entity.’’ Absent 

this rulemaking, all financial entities as 

defined in Section 2(h)(7)(C) of the CEA, 

including all SFIs, are statutorily 

disqualified from the end-user 

exception pursuant to Section 

2(h)(7)(A)(i) of the CEA, which specifies 

that to qualify for the end-user 

exception the counterparty must not be 

a financial entity. Thus, the foundation 

against which this rulemaking’s costs 

and benefits are measured is the 

statutory requirement that SFIs, as 

financial entities, remain subject to the 

clearing requirement of Section 

2(h)(1)(A) of the CEA. 

Additionally, with respect to the 

second and third elements, the 

Commission considers the rulemaking’s 

costs and benefits relative to alternatives 

besides that of abstaining from action. In 

the case of articulating reporting 

requirements, which is statutorily 

required, the Commission considers the 

rulemaking’s costs and benefits relative 

to prescribing the minimum obligation. 

As discussed in more detail below, 

the Commission is able to estimate 

certain reporting costs. The dollar 

estimates are offered as ranges with 

upper and lower bounds, which is 

necessary to accommodate the 

uncertainty that surrounds them. The 

Commission notes that the most likely 

outcome with respect to each estimate is 

a cost above the lower bound and below 

the upper bound. The costs and benefits 

associated with compliance with the 

Commission’s interpretation of the term 

‘‘hedging or mitigating commercial 

risk,’’ as well as those that result from 

the exemption for SFIs, however, are not 

readily susceptible to meaningful 

quantification because the requisite data 

is not available. 

For example, to reasonably estimate 

quantifiable costs and benefits of 

compliance with this rule’s 

interpretation of ‘‘hedging or mitigating 

commercial risk,’’ relative to 

alternatives, the Commission would 

need sufficient information to determine 

what swaps would be or would not be 

eligible for the end-user exception 

under different approaches considered 

by the Commission. This would require 

the Commission to identify a 

representative sample of market 

participants and collect detailed 

proprietary information regarding each 

swap position currently on their books, 

as well as the economic terms of the 

swap transactions entered into by those 

entities over a certain period of time. 

The Commission would also need 

detailed information regarding each 

sample member’s business practices, 

current assets, anticipated acquisition or 

disposition of assets, and other financial 

positions related to their commercial 

operations to determine what swaps are 

‘‘hedging or mitigating commercial risk’’ 

under various approaches considered by 

the Commission. 

To estimate the costs and benefits 

related to the exemption for SFIs, the 

Commission would need similar 

information regarding SFIs, including 

detailed information regarding the swap 

positions and activities of those entities 

and sufficient knowledge of their 

business models, as well as their current 

and future assets, to determine what 


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99See, e.g., Cravath, AGA, APGA, SFG, Noble, 

NCHSA, API, CDEU, Shell, SDG & E, Peabody, FHL 

Banks, NRECA, WSPP, IPA, COPE, WGCEF, EDF 

Trading, Hess, EEI & EPSA, API, IECA, and NMPF. 

swaps constitute ‘‘hedging or mitigating 

commercial risk.’’ Again, the data 

necessary to calculate such estimates is 

largely proprietary, not available to the 

Commission, and was not provided by 

commenters. Notwithstanding these 

limitations, the Commission identifies 

and considers the costs and benefits of 

these aspects of the rule in qualitative 

terms. 

C. Reporting Requirements 

1. Introduction 

Under Section 2(h)(7)(A)(iii) of the 

CEA, a condition to electing the enduser exception is that the electing 

counterparty ‘‘notifies the Commission 

in a manner set forth by the Commission 

how it generally meets its financial 

obligations associated with entering into 

non-cleared swaps.’’ Regulation 39.6(b) 

provides a mechanism for such 

reporting to the Commission and also 

requires the reporting counterparty to 

report that the end-user exception is 

being elected, who the electing 

counterparty is, and that the swap 

hedges or mitigates commercial risk. In 

addition, Section 2(j) of the CEA 

provides that any exception to the 

clearing requirement of Section 2(h)(1) 

of the CEA and the trading requirement 

of Section 2(h)(8) of the CEA are only 

available to an SEC Filer if the decision 

to enter into swaps subject to such 

exceptions has been reviewed by an 

appropriate committee of the governing 

body of the SEC Filer. Regulation 

39.6(b)(1)(iii)(D)(2) would require 

reporting of confirmation by the SEC 

Filer that such review has occurred. The 

information reported under § 39.6(b) is 

needed for the Commission to be able to 

determine when the end-user exception 

is being used and to monitor 

compliance with the exception. 

In the NPRM, the Commission 

contemplated swap-by-swap reporting 

of all the information required. As 

described below, the Commission 

received comments in response 

suggesting that the reporting 

requirements were burdensome and that 

less costly options may be available. In 

response to those comments, the 

Commission has made changes to the 

final rule that allow an electing 

counterparty to report certain 

information on an annual basis and to 

clarify that SEC Filers can obtain 

general approval of the end-user 

exception. The Commission believes 

that these changes will create significant 

cost reductions and benefits for electing 

and reporting counterparties, as 

described below. In addition, as 

described in more detail in Section 

II.B.3 above, the Commission has 

confirmed that the simple ‘‘check-thebox’’ reporting mechanism proposed in 

the NPRM may be used. A number of 

commenters agreed that this mechanism 

would greatly minimize the reporting 

burden and would provide standardized 

information that will be easily 

reviewable for regulatory purposes. 

The discussion below of the rule’s 

reporting requirements is divided into 

three parts. The first part covers the 

reporting requirements under the rule 

generally, the second addresses the SEC 

Filer reporting requirements, and the 

third provides specific cost estimates. 

Consideration of alternatives is 

incorporated within the first two parts. 

2. Reporting Generally 

In the NPRM, the Commission 

contemplated requiring the reporting 

counterparty to provide all information 

required under the rule on a swap-byswap basis. The Commission received 

comments that swap-by-swap reporting 

of all information required to be 

reported under the rule could be more 

burdensome than necessary and that 

other alternatives are available, such as 

annual or other periodic reporting, 

submission of contracts or contract 

summaries, separate reduced reporting 

requirements for certain small entities, 

or reliance on contract representations 

by electing counterparties instead of 

reporting.99

After consideration of these 

comments, the Commission believes 

that certain information required to be 

reported by § 39.6(b) could be reported 

on an annual basis without significantly 

compromising its value to the 

Commission and the public, and that 

such an approach is likely to be more 

cost-effective. Therefore, in response to 

these comments, the Commission 

revised the rule to require reporting of 

the following for each swap for which 

the end-user exception is elected: (1) 

That the election of the exception is 

being made; (2) which party is the 

electing counterparty; and (3) certain 

information specific to the electing 

counterparty unless that information 

has already been provided by the 

electing counterparty through an annual 

filing. The third set of information 

comprises data that is likely to remain 

relatively constant for many electing 

counterparties and therefore can be 

reported less frequently. 

In making this change in the final 

rule, the Commission believes that 

allowing the third set of information to 

be reported on either a swap-by-swap 

basis or on an annual basis is likely to 

mitigate reporting costs from the solely 

swap-by-swap approach proposed in the 

NPRM because entities will be able to 

select the most cost-effective option. 

As an estimate of cost savings, the 

Commission expects that the annual 

report will take approximately 30 

minutes to 90 minutes to complete, but 

then that information will not have to be 

reported on a swap-by-swap basis, 

generating incremental savings of one to 

five minutes per transaction. The 

Commission does not have adequate 

data to estimate these costs in the 

aggregate. However, the Commission 

believes that the number of swap 

transactions subject to this rule is likely 

to be quite large, and therefore, the 

aggregate savings of one to five minutes 

per transaction could be significant. 

Also, the approach has benefits for 

market participants generally in that the 

form of data provided to the 

Commission will enable it to exercise its 

regulatory oversight in an efficient and 

effective manner given the wide variety 

of different types of swaps and swap 

hedging strategies used by potential 

electing counterparties. Lastly, 

standardized reports make it more 

feasible for the Commission to conduct 

periodic auditing, which will be less 

costly to regulators than examining on 

a case-by-case basis possibly 

unstructured financial data or different 

contract security provisions submitted 

by electing counterparties. 

The Commission considered the other 

reporting frequency and mechanism 

alternatives proposed in the comments, 

but other than the annual reporting 

option provided in § 39.6(b)(2) of the 

rule, determined not to adopt them for 

several reasons. First, as mentioned 

above, Section 2(h)(7)(A) of the CEA 

requires an electing counterparty to 

notify the Commission how the 

counterparty meets its financial 

obligations associated with entering into 

non-cleared swaps as a condition to 

electing the end-user exception. 

Accordingly, the requirement to report 

some information is statutory and 

beyond the discretion of the 

Commission. Second, for swaps that are 

subject to the clearing requirement but 

are not being cleared, the Commission 

needs notice that the end-user exception 

is being elected and certain other 

information to assess compliance with 

Sections 2(h)(1) and (2)(h)(7) of the CEA 

and § 39.6. Third, delivery of 

agreements to the Commission would be 

almost as burdensome as the check-thebox approach (and in some cases more 

so) and would provide information in 

non-standard formats that would be 


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100See 77 FR 2136 at 2207 (Jan. 13, 2012) (Swap 

Data Recordkeeping and Reporting Requirements; 

final rule). 

101See, e.g., AFR, AFSCME, Better Markets, 

PMAA & NEFI, and Professor Greenberger. 

102See, e.g., Hess, EEI & EPSA, NGSA, CDEU, 

EMUS, SDG & E, WGCEF, Mr. Quinlivan, Cravath, 

AGA, EMUS, COPE, NYCBA, Shell, ATA, Noble, 

WSPP, IPA, Hess, IECA, EEI, PMAA & NEFI, CDEU, 

and NYCBA. 

difficult to review for regulatory 

purposes. Standardized data, on the 

other hand, will facilitate effective 

review by the Commission. Fourth, 

given the low reporting burden under 

these rules and the general swap-byswap reporting requirements in other 

regulations (e.g., Part 45), the 

Commission does not believe that a 

special, lesser reporting requirement for 

smaller parties would result in a 

materially lower burden while still 

maintaining compliance with the CEA. 

And last, the Commission believes that 

the check-the-box reporting method, 

and addition of the annual reporting 

option described above (together with 

the fact that various other information 

will already be reported for each swap 

pursuant to other provisions of the CEA 

and other regulations promulgated 

thereunder), minimize the reporting 

burden. 

EDF Trading, API, MarkitSERV, and 

COPE raised another concern about the 

costs of reporting. They commented that 

some potential electing counterparties 

may bear costs in order to implement 

new reporting systems to comply with 

the reporting requirements. The 

Commission notes that electing 

counterparties will only incur such 

costs if they engage in swaps with other 

electing counterparties. If the electing 

counterparty enters into swaps with a 

swap dealer or a major swap participant, 

the swap dealer or major swap 

participant will be the reporting 

counterparty.100 Based on historical 

experience, the Commission believes 

that electing counterparties will 

generally enter into swaps with swap 

dealers and major swap participants, 

and therefore will not be responsible for 

reporting the swap-by-swap information 

required in this rule. Moreover, even in 

the absence of this rule, if electing 

counterparties entered into swaps with 

one another they would be required to 

implement reporting systems in order to 

meet other swap-by-swap reporting 

requirements in the CEA and 

Commission regulations promulgated 

thereunder. Therefore, the Commission 

believes that the large majority of costs 

to implement reporting systems are 

properly recognized as the result of 

swap-by-swap reporting requirements 

that are beyond the scope of this rule. 

Accordingly, this rule will only result in 

costs to modify those reporting systems 

in order to provide the additional 

information required by this rule. 

NGSA, NRECA, IECA, and EEI 

recommended that the Commission 

provide a safe harbor from liability for 

firms who report on behalf of the 

electing counterparty. The Commission 

expects that if the electing counterparty 

has not filed an annual report to provide 

the information required in 

§ 39.6(b)(1)(iii), the reporting 

counterparty may choose to conduct 

some measure of due diligence in order 

to develop a reasonable basis for 

believing that the information it reports 

on behalf of the electing counterparty is 

accurate and the swap is eligible for the 

end-user exception. These costs are 

likely to vary depending on the number 

of electing counterparties with whom 

each reporting counterparty transacts, 

and the amount of due diligence that 

they choose to conduct, which can vary 

substantially depending on whether the 

electing counterparty has done an 

annual filing, the number of swaps the 

reporting counterparty executes within 

a year, and how well the reporting party 

already knows the electing 

counterparty’s financial strategies and 

policies. The Commission does not 

believe that there is sufficient data to 

estimate the burden hours that will 

result from this requirement, but 

believes that: (1) The cost is likely to be 

relatively low; and (2) such information 

will frequently be collected along with 

other information the reporting 

counterparty will gather from the 

electing counterparty as part of the 

process of executing the swap and 

reporting other details required by the 

CEA and Commission regulations. 

Moreover, it is important to consider 

these costs in light of the benefits 

achieved by the requirement. The 

Commission believes that the 

‘‘reasonable basis’’ standard is likely to 

deter abuse of the end-user exception, 

which could mitigate risks and costs 

that market participants and the public 

might otherwise face. If the end-user 

exception were abused, it would lead to 

reduced clearing and counterparty 

protection. If such abuse became 

widespread, it could also reduce the 

ability of clearinghouses to mitigate the 

transfer of financial instability among 

counterparties, thereby increasing risks 

to the public. 

Some commenters favored requiring 

more information regarding the types of 

collateral, exact collateral terms and 

arrangements, and swap contractual 

terms and provisions.101 The 

Commission determined not to require 

additional information because, on the 

one hand, the information would be 

costly for counterparties to provide and 

on the other, any such requirement 

would provide little benefit because it 

would be difficult to capture much of 

this information in a parameterized 

form, making it challenging to review 

the information in a systematic way. 

According to EMUS, the NPRM 

indicated that the notification 

requirement would apply to all 

affiliates, while the rule text indicated a 

notification requirement would apply 

only to finance affiliates. In response to 

EMUS, the Commission is revising 

proposed § 39.6(b)(3) to clarify that the 

notification requirement only applies to 

financial entities acting as affiliates. The 

Commission is also adding a 

requirement that electing counterparties 

report whether they are ‘‘financial 

entities’’ as defined in Section 

2(h)(7)(C)(i) of the CEA that are 

nevertheless exempt from the definition 

of ‘‘financial entity’’ as described in 

§ 39.6(d). For entities affected by these 

provisions, the total impact is the 

removal or addition of one check-box 

when reporting. 

3. SEC Filers 

In accordance with Section 2(j) of the 

CEA, the proposed rule required a 

committee of the board of directors (or 

equivalent body) of an SEC Filer to 

approve the decision not to clear the 

swap for which the end-user exception 

would be elected. The Commission 

received comments that requiring swapby-swap board approval would impose 

excess costs and burdens on SEC 

Filers.102 The Commission determined 

that any additional benefit of a swap-byswap approval, as compared to a more 

general approval, was insufficient to 

justify such an approach and 

accordingly, has revised the final rule to 

only require reporting (in the annual or 

swap-by-swap filing) whether such 

committee has generally approved 

entering into swaps subject to an 

exception to the clearing and trading 

requirements. The Commission believes 

this change will mitigate the potential 

burdens commenters raised by allowing 

such committees to provide blanket or 

more limited approvals for the end-user 

exception on a periodic basis as they 

deem appropriate for such approval and 

in a manner that may be consistent with 

general corporate practice. At the same 

time, the reporting requirement, while 

limited, still confirms that a committee 

of the governing board of the SEC Filer 

using the end-user exception has 


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103As discussed above, the statute itself requires 

some level of reporting. Absent an ability to 

demarcate between the minimum reporting that the 

statute would require and that resulting from this 

rule, the Commission has estimated the costs 

attributable to this rule from a base of zero, 

recognizing that the costs attributable to its 

discretion in this action must necessarily start from 

some higher base. Accordingly the costs attributable 

to the Commission’s action in this rulemaking are 

necessarily something below the estimates 

provided. Also, because the statute requires some 

reporting, the Commission has not articulated 

separate benefits attributable to this rulemaking. 

However, to the extent benefits distinguish this rule 

from considered alternatives, they are considered in 

the preceding discussion. 

104All salaries in these calculations are taken 

from the 2010 SIFMA Report on Management and 

Professional Earnings in the Securities Industry. 

Annual wages were converted to hourly wages 

assuming 2,000 work hours per year (40 hours per 

week for 50 weeks), and then multiplying by 5.35 

to account for bonuses, firm size, employee benefits 

and overhead. The remaining calculations used in 

these cost-benefit considerations are also derived 

from this source and modified in the same manner. 

In addition, for each range of aggregate costs 

presented in this discussion, the lower bound 

would be the aggregate cost if every relevant entity 

experienced the minimum per entity cost, and the 

upper bound would be the aggregate cost if every 

relevant entity experienced the maximum per entity 

cost. It is highly improbable that every entity would 

experience either the minimum or the maximum 

per entity cost, and as a consequence, the actual 

aggregate cost to market participants is likely to lie 

somewhere in the midst of each range that has been 

estimated in this section. 

considered such exceptions as required 

by Section 2(j) of the CEA. 

4. Cost Estimates 103

The Commission lacks data to 

estimate the precise number of nonfinancial entities that may be eligible for 

the end-user exception, and therefore 

cannot estimate total reporting costs 

with great accuracy. However, for 

informational purposes, the 

Commission has endeavored, where 

feasible, to estimate quantifiable costs. It 

has done so by using assumptions to 

define what it believes to be reasonable 

parameters for various uncertainties. At 

times, as noted with more specificity in 

the discussion that follows, the 

uncertainties are such that costs are 

reasonably estimable only within a wide 

range. For the purposes of these 

estimates, the Commission assumes a 

total of 30,000 electing counterparties 

(which includes SFIs), and that 

approximately 1,000 of them will 

function as reporting counterparties in 

any given year. The Commission further 

estimates that approximately 125 swap 

dealers and major swap participants 

will function as reporting counterparties 

for swaps for which the end-use 

exception is elected each year. All of 

these reporting counterparties likely 

will need to modify their reporting 

systems in order to accommodate the 

additional data fields required by this 

rule. The Commission estimates that 

those modifications will create a onetime expense of approximately one to 

ten burden hours per entity, for a total 

of approximately 1,125 to 11,250 burden 

hours. The hourly wage for a senior 

programmer is $292, which means that 

the aggregate one-time cost for 

modifying reporting systems is likely to 

be between $328,811 and $3,288,110.104

Furthermore, the 29,000 electing 

counterparties who do not function as 

reporting counterparties may, at certain 

times, need to communicate information 

to their respective reporting 

counterparties in order to facilitate 

reporting. That information may 

include, among other things, whether 

the electing counterparty has filed an 

annual report pursuant to § 39.6(b)(2) 

and information to facilitate any due 

diligence that the reporting counterparty 

may conduct. These costs will likely 

vary substantially depending on the 

number of different reporting 

counterparties with whom an electing 

counterparty conducts transactions, 

how frequently the electing 

counterparty enters into swaps, whether 

the electing counterparty undertakes an 

annual filing, and the due diligence that 

the reporting counterparty chooses to 

conduct. Therefore, the Commission 

believes that it is very difficult to 

estimate these costs reliably at this time. 

However, the Commission has 

endeavored to do so given the concerns 

commenters expressed about relying on 

other parties to provide information and 

to report the information. Accordingly, 

the Commission estimates that nonreporting electing counterparties will 

incur between five minutes and ten 

hours of annual burden hours. The 

hourly wage for a compliance attorney 

is $320, which means that the annual 

per entity cost for communicating 

information to the reporting 

counterparty is likely to be between $27 

and $3,210. Given the unknowns 

associated with this cost estimate noted 

above, the Commission does not believe 

this wide range can be narrowed at this 

time. 

Also, the Commission estimates that 

approximately two-thirds of electing 

counterparties (or 20,000 electing 

counterparties) will choose to file an 

annual report pursuant to § 39.6(b)(2). 

The annual filing option was added in 

the final rule and therefore an estimate 

of costs related thereto was not included 

in the NPRM. The annual filing option 

will reduce reporting costs overall 

because it is less costly than swap-byswap reporting. The Commission 

estimates that it will take an average of 

30 minutes to 90 minutes to complete 

and submit this filing, for an aggregate 

total of 10,000 to 30,000 burden hours. 

The average hourly wage for a 

compliance attorney is $320, which 

means that the aggregate annual cost for 

submitting the annual report is likely to 

be approximately $3,200,000 to 

$9,600,000. Other costs and benefits 

associated with the rule’s reporting 

requirements cannot be monetized at 

this time because the Commission lacks 

adequate information to do so. 

The rule requires reporting of the 

following for each swap for which the 

end-user exception is elected: (1) That 

the election of the exception is being 

made; (2) which party is the electing 

counterparty; and (3) certain 

information specific to the electing 

counterparty unless that information 

has already been provided by the 

electing counterparty through an annual 

filing. The third set of information 

comprises data that is likely to remain 

relatively constant for many electing 

counterparties and therefore can be 

reported either on a transaction-bytransaction basis or through an annual 

report that is updated as necessary. 

As a recurring expense, the reporting 

counterparty will have to report the 

information required in § 39.6(b)(1)(i) 

and (ii) for each swap and the 

information required in § 39.6(b)(1)(iii) 

for each swap only if the electing 

counterparty has not filed an annual 

report. To comply with § 39.6(b)(1)(i) 

and (ii), the reporting counterparty will 

be required to check one box indicating 

the end-user exception is being elected 

and complete one field identifying the 

electing counterparty. The Commission 

expects that this information will be 

entered into the appropriate reporting 

system concurrently with additional 

information that is required under the 

CEA and other Commission regulations 

promulgated thereunder. Therefore, 

each reporting counterparty is likely to 

spend 15 seconds to two minutes per 

transaction in incremental time entering 

the swap-by-swap information that is 

required in § 39.6(b)(1)(i) and (ii) into 

the reporting system. Regarding the 

§ 39.6(b)(1)(iii) information, the 

Commission expects that, for the first 

swap conducted involving a particular 

electing counterparty, it will take 

approximately 30 minutes to 90 minutes 

to collect and submit the information 

required and then approximately one to 

five minutes to collect and submit this 

information for subsequent transactions 

with that same counterparty. The 

Commission does not have sufficient 

data to estimate the number of swaps 

that will be subject to this rule, so it is 

not possible to estimate these costs in 

the aggregate. 


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105 In either case, costs and benefits are not 

readily quantifiable. Such quantification would 

require data and information that the Commission 

does not possess nor have at its disposal. This 

includes data regarding the number, characteristics, 

and notional value of swaps that are impacted by 

these decisions, as well as information about the 

required margin for the swaps if they are cleared 

or not cleared, the type and amount of collateral 

that counterparties require for the swaps, estimates 

for the affected firms of the cost of capital used to 

post margin, and pricing for cleared swaps and noncleared swaps. 

106 In the alternative to meeting the requirements 

of § 39.6(c)(1)(i), a swap executed by an electing 

counterparty may also be eligible for the end-user 

exception if the swap qualifies as a bona fide hedge 

for purposes of an exception from position limits 

under the CEA as provided in § 39.6(c)(1)(ii), or if 

it qualifies for hedging treatment under FASB 

Accounting Standards Codification Topic 815 or 

under GASB Statement 53 as provided in 

§ 39.6(c)(1)(iii). No comments raised cost/benefit 

issues regarding these two bases for electing the 

end-user exception other than supporting the 

benefits offered by including these additional 

alternatives. 

107The Commission agrees with Kraft that ‘‘[a]ny 

bright-line definition or exclusion, such as those 

previously discussed, would infringe on a swap 

counterparty’s ability to effectively hedge or 

mitigate its commercial risk. * * *’’ 

108See, e.g., Kraft, RESA, WGCEF, Peabody, 

NRECA, American Public Power Association & 

Large Public Power Council, and EEI & EPSA. 109See section II.C.5 above. 110See, e.g., Tobin, Sullivan, Fay & Grunebaum, 

CMOC, Skylands, IPM & CSA, and FMNJ. 

D. Hedging or Mitigating Commercial 

Risk 

1. Introduction 

Regulation 39.6(c) provides a broad 

set of criteria for determining what 

constitutes hedging or mitigating 

commercial risk for the end-user 

exception to apply. The Commission’s 

flexible set of criteria allows 

counterparties to use the end-user 

exception when appropriate given their 

specific circumstances. At the same 

time, the criteria are designed to prevent 

abuse of the end-user exception, which 

would hinder one of the primary goals 

of the Dodd-Frank Act: Moving swaps 

into central clearing, thereby reducing 

counterparty risk and its potential to 

create instability in the financial system. 

Congress prescribed ‘‘hedging or 

mitigating commercial risk’’ as a 

condition for applying the end-user 

exception, without providing further 

statutory definition of its meaning. The 

Commission is exercising its discretion 

to do so. Thus, relative to the statutory 

requirement, the costs and benefits of 

the rule are those attributable to 

clarifying the Commission’s 

understanding of the term for 

implementation and enforcement 

purposes rather than implementing and 

enforcing the condition without 

clarifying its interpretation. Relative to 

other alternatives that the Commission 

could have selected, the costs or 

benefits of the rule are generally a 

function of whether the Commission 

adopts a more- or less-inclusive 

approach in articulating what 

constitutes hedging or mitigating 

commercial risk for purposes of the enduser exception relative to the 

theoretically optimal level that Congress 

presumably intended the statutory 

language to effect.105 In addition, a 

potential electing counterparty will 

incur some costs in applying the 

standard set forth in the rule to 

determine whether a specific swap 

qualifies as hedging or mitigating 

commercial risk. Each category— 

clarification costs and benefits, 

inclusion costs and benefits, and 

determination costs—is discussed 

below. 

2. Clarification Costs and Benefits 

As stated above, even in the absence 

of this rulemaking, ‘‘hedging or 

mitigating commercial risk’’ is a 

necessary condition for being eligible to 

claim the end-user exception with 

respect to a particular swap. By 

clarifying the Commission’s 

interpretation of this term, this rule 

provides market participants with the 

benefit of greater regulatory certainty, 

which will reduce costs associated with, 

for example, legal opinions to interpret 

the term or the costs of foregoing the 

end-user exception to which market 

participants might otherwise be entitled. 

3. Inclusion Costs and Benefits 

Regulation 39.6(c)(1)(i) identifies six 

possible sources of commercial risk and 

sets forth an ‘‘economically 

appropriate’’ standard for assessing the 

correspondence between a given swap 

and the commercial risk that it hedges 

or mitigates.106

As noted above, the Commission has 

determined not to provide a bright-line 

definition of ‘‘economically 

appropriate’’ to allow greater flexibility 

in application of the standard. The 

Commission cannot anticipate and 

account for all of the types of potential 

electing counterparties, swaps, and 

strategies that might be used to hedge or 

mitigate commercial risk, so a brightline approach not allowing for judgment 

and consideration of all relevant facts 

and circumstances would likely lead to 

outcomes in some circumstances that 

inappropriately include or exclude 

certain swaps from the end-user 

exception, particularly with respect to 

custom swaps and unique hedging 

strategies.107 Therefore, the Commission 

did not adopt alternatives that relied on 

a bright-line approach. 

In addition, the Commission 

described the six categories of 

commercial risk in a way that it believes 

are inclusive of the many different types 

of commercial risk that can be hedged 

or mitigated. At the same time, by 

delineating specific types of commercial 

risk that can be hedged or mitigated for 

the end-user exception to apply, the 

Commission has created boundaries that 

provide greater clarity for application of 

the exception and prevent abuse or 

evasion of the exception thereby 

reducing the costs that can result from 

uncertainty or abuse or evasion. 

The Commission has determined that 

alternative approaches proposed by 

commenters that are significantly more 

or less inclusive assign undue weight to 

various costs and benefits that increase 

or decrease with varying degrees of 

inclusiveness. The ‘‘management or 

reduction of risks’’ standard proposed 

by SFG would create the possibility that 

swaps could be excepted from clearing 

when they are merely being used to 

‘‘manage’’ risks. That approach would 

be contrary to the statute because it 

could include swaps that are used to 

increase risk rather than to hedge or 

mitigate commercial risks. On the other 

hand, as explained above in Section 

II.C.5, the ‘‘congruence’’ standard 

proposed by Better Markets would 

require ‘‘an exact match’’ between each 

component of commercial risk being 

hedged and the swap that hedges it. 

However, a hedge does not have to be 

economically perfect in order to reduce 

rather than increase risk. Moreover, 

commenters emphasized the prevalence 

and necessity of dynamic hedging 

strategies, which continually rebalance 

hedges in light of changes or anticipated 

changes in underlying positions and 

their alignment with the hedges that 

offset their risk.108 In light of this, the 

Commission believes that the additional 

costs created by a ‘‘congruence 

standard’’ would not be justified by its 

benefits and therefore has not adopted 

that alternative.109

Several commenters suggested that 

excluding swaps that hedge or mitigate 

financial risks would prevent abuse of 

the end-user exception by making the 

exception unavailable for speculative 

swaps.110 However, as stated above, the 

Commission acknowledges that there 

are various financial risks that may be 

commercial risks for potential electing 

counterparties. Section 2(h)(7) of the 

CEA clearly allows swaps used by 

qualifying entities to hedge or mitigate 

commercial risks to be excepted out of 

the clearing requirement. The 


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111See section II.C.7 above. 

112Entities will also have to determine whether 

or not they are financial entities according to 

Section 2(h)(7)(C) of the CEA. Such costs result 

from the requirements of the Dodd-Frank Act and 

therefore do not arise as a result of the exercise of 

discretion by the Commission. 

113See Section II.D. 

114Asset level data for banks and savings 

associations is available at fdic.gov, and credit 

unions at ncua.gov. Data for farm credit system 

institutions was provided to the Commission by the 

Farm Credit Administration. 

115 In mid-2010, the most recent period for which 

Section 2(h)(7)(C)(ii) institution swap data could be 

obtained, approximately 1,015 Section 2(h)(7)(C)(ii) 

institutions had outstanding swap exposure. Of 

those institutions, 138 had total assets over $10 

billion and 876 had total assets below $10 billion. 

Commission believes that imposing 

such a limitation on using the end-user 

exception for financial swaps without 

consideration of whether they in fact do 

hedge or mitigate commercial risk 

would be inconsistent with the statute, 

and therefore has not adopted that 

alternative and accordingly, this 

alternative is beyond the reach of 

consideration under Section 15(a) of the 

CEA. 

Various commenters suggested that 

§ 39.6(c)(2)(i), which prohibits use of the 

end-user exception for swaps used for 

the purpose of speculation, trading, and 

investing, would prevent use of the 

exception for swaps that hedge or 

mitigate commercial risk.111 Some of 

these comments also indicate that the 

meaning of ‘‘speculation, trading or 

investing’’ is unclear, which could 

cause some regulatory uncertainty, 

leading participants to refrain from 

electing the end-user exception in 

appropriate circumstances or to avoid 

entering into some swaps that hedge or 

mitigate commercial risk altogether. 

The Commission has addressed these 

concerns by clarifying how 

§ 39.6(c)(2)(i) is to be applied in the 

context of the entire rule. As explained 

in greater detail in section II.C.7 above, 

the focus of the limitation is on the 

purpose of the swap for the potential 

electing counterparty, i.e., if it is 

principally used for hedging or 

mitigating commercial risk as 

characterized in the rule, then the enduser exception may be elected 

notwithstanding how the swap may 

otherwise be characterized, but if it is 

used for speculative, trading or 

investing purposes with little or no 

intent to hedge or mitigate commercial 

risk, then the end-user exception is not 

available. Accordingly, the Commission 

believes that this provision, if applied as 

intended, provides a benefit to market 

participants by clarifying the 

circumstances under which they may 

claim the end-user exception in 

accordance with the general 

requirement in Section 2(h)(7)(A)(ii) of 

the CEA that the swap must ‘‘hedge or 

mitigate commercial risk’’. 

4. Determination Costs 

To avail themselves of the end-user 

exception, potential electing 

counterparties must determine whether 

the specific swap in question is being 

used to ‘‘hedge or mitigate commercial 

risk’’ under the rule.112 The 

Commission expects that entities will 

incur direct costs in the form of 

personnel hours devoted to analyzing 

this question. The cost of determining 

whether a specific swap is being used to 

‘‘hedge or mitigate commercial risk’’ 

will depend on the nature of the entity’s 

hedging activities in the relevant 

situation. Some entities will incur 

relatively few costs in confirming that 

they are hedging or mitigating 

commercial risk. Others will incur little 

or no cost confirming that they are not 

covered by the definition. However, for 

some entities, especially those that use 

swaps to hedge in a variety of ways and 

circumstances, the determination could 

be more complex and may require that 

personnel with financial and legal 

expertise review the circumstances of 

the entity’s swap activities to make the 

determination of whether the swap in 

question is being used to hedge or 

mitigate commercial risk. 

Notably, entities would incur 

determination costs regardless of the 

terms of the rule, because they must in 

any event interpret the statutory 

definition to determine whether they, 

and the swap in question, are eligible. 

Thus, at a minimum, a significant 

portion of the costs discussed here are 

attributable to the inclusion in the 

Dodd-Frank Act of a restriction on 

eligible swaps to those that ‘‘hedge or 

mitigate commercial risk,’’ and not from 

any aspect of this rule. Indeed, the final 

rule mitigates these costs by providing 

guidance about the application of the 

statutory requirements. 

The time and resources that must be 

expended by an entity on this exercise 

will vary considerably depending on a 

number of factors, including (1) whether 

the entity in question must determine 

whether it is a financial entity; (2) the 

number and diversity of swaps executed 

by the entity; and (3) the complexity of 

the swap strategies being used by the 

entity. The Commission did not receive 

any comments quantifying the costs that 

an entity may incur in making these 

determinations. The Commission 

believes that, for most entities and 

swaps, making the determinations 

necessary will involve little or no cost 

because the nature of the electing 

counterparty and the use of the swaps 

in the context of the rule will be readily 

apparent. The Commission also 

recognizes that for some swaps and 

entities that have mixed purposes or 

that have unique characteristics, there 

will be determination costs; and in 

limited cases, such costs could be 

significant. However, it is not possible 

to estimate such costs for the entire 

market because the Commission does 

not have available to it detailed data for 

the swap market that would be needed 

to make such an estimate and also 

because such determinations are highly 

fact specific and can vary substantially 

from one swap to the next. 

E. Exemption for Small Financial 

Institutions 

Section 2(h)(7)(C)(ii) of the CEA 

directs the Commission to consider 

exempting small banks, savings 

associations, farm credit institutions, 

and credit unions with $10 billion or 

less in total assets from the definition of 

‘‘financial entity.’’ As discussed above, 

the Commission is adopting such an 

exemption in § 39.6(d).113 The 

Commission notes that as of December 

31, 2011, there were approximately 

14,700 Section 2(h)(7)(C)(ii) institutions 

operating in the United States. Of those 

institutions, approximately 120 of them 

had total assets greater than $10 billion, 

while the remaining 14,580 institutions 

had less than $10 billion in total assets 

making them SFIs that could elect the 

end-user exception when using swaps to 

hedge or mitigate commercial risk.114 In 

other words, about 99 percent of banks, 

savings associations, farm credit system 

institutions, and credit unions will 

qualify as SFIs using the $10 billion 

level.115 In addition, analysis conducted 

by the Commission suggests that 99 

percent of Section 2(h)(7)(C)(ii) 

institutions with less than $10 billion in 

total assets that had open swap 

positions had gross notional swap books 

of $2 billion or less. While this data did 

not influence the Commission’s 

consideration of what constitutes a 

‘‘small’’ Section 2(h)(7)(C)(ii) 

institution, it does indicate how many 

institutions may benefit from the 

exemption as adopted by the 

Commission. 

Commenters suggested alternative 

approaches to the exemption for SFIs, 

such as asset test thresholds above $10 

billion, or a test that focuses on 

uncollateralized exposure. However, 

commenters did not provide sufficient 

quantitative or qualitative evidence to 

persuade the Commission that a 

threshold greater than $10 billion in 


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116See, e.g., NGSA, Reval, RESA, NRECA, IECA, 

and EEI. 

assets would provide benefits that 

justify any corresponding costs. In the 

absence of compelling evidence for a 

threshold other than that which was 

suggested by Congress, the Commission 

has adopted the threshold identified in 

the statute. 

F. Consideration of Section 15(a) 

Factors 

1. Protection of Market Participants and 

the Public 

The reporting requirements help to 

discourage abuse of the end-user 

exception by requiring electing 

counterparties to provide, or cause to be 

provided, information to the 

Commission that demonstrates 

compliance with the legal conditions for 

using the exception. This helps protect 

market participants and the public. If 

the end-user exception were abused or 

evaded (i.e., if entities wrongfully 

avoided clearing and trading on an 

exchange swaps that were required to be 

cleared and traded), market participants 

would be exposed to additional 

counterparty risk. Moreover, the public 

could be exposed to systemic risk, and 

the costs associated with large-scale 

financial system failure, if large 

aggregate positions of non-cleared, 

speculative swaps were to accumulate 

in systemically important institutions. 

Although reporting counterparties 

will incur reporting costs, the rule seeks 

to minimize these costs and provide 

flexibility as to the frequency at which 

the information is reported. The 

Commission has promulgated rules that 

require electing counterparties to 

provide, or cause to be provided, the 

limited information needed to 

effectively regulate the end-user 

exception and meet the statutory 

requirements. In addition, certain 

reporting requirements may be satisfied 

by submitting the required information 

on a swap-by-swap or annual basis. This 

enables entities to adopt reporting 

practices that reduce their reporting 

costs without compromising the 

Commission’s ability to regulate the 

market. 

The rules also help to protect market 

participants and the public because they 

permit boards of SEC Filers to approve 

swaps on a swap-by-swap or more 

general basis. The Commission believes 

that either basis is sufficient to ensure 

that members of the board are aware 

that the end-user exception may be 

elected and to ensure that such an 

election has been appropriately 

considered at the top of the corporate 

responsibility hierarchy. The 

Commission recognizes that swap-byswap approval might reduce risk to 

market participants and the public to a 

somewhat greater degree than general 

approval, but it agrees with commenters 

that any such incremental improvement 

does not warrant the additional burden. 

The ‘‘reasonable basis’’ standard 

required of reporting counterparties is 

likely to create some costs for market 

participants who are reporting 

entities.116 The Commission expects 

that if a reporting counterparty is not 

the electing counterparty and is 

reporting all information on a swap-byswap basis, reporting counterparties 

may choose to conduct some due 

diligence in order to verify that their 

counterparty and the swap meet the 

requirements for eligibility. However, 

the Commission expects that most 

reporting entities are likely to know 

their customers, which will mitigate any 

costs associated with due diligence. 

Moreover, these costs must be 

considered in light of the benefits of 

such a requirement, namely enhanced 

compliance with clearing requirements, 

which serves to protect public interests, 

as well as the competitiveness and 

integrity of swap markets. 

Finally, as described above, the 

‘‘economically appropriate’’ hedging 

standard, together with the six types of 

commercial risk and specific safe 

harbors for hedging or mitigating risk 

that are recognized in the rule, mitigates 

the risk that market participants could 

abuse the exception or evade the 

clearing requirement, which could 

increase counterparty risk and 

potentially harm market participants 

and the public. 

2. Efficiency, Competitiveness, and 

Financial Integrity of Swap Markets 

Section 2(h)(8) of the CEA provides 

that swaps that are subject to the 

clearing requirement shall be executed 

on a board of trade or swap execution 

facility unless no such board or facility 

makes the swap available for trading. 

Preventing abuse of the end-user 

exception promotes exchange trading as 

intended by the Dodd-Frank Act by 

ensuring that more swaps that are 

supposed to be cleared are in fact 

cleared. This is likely to increase 

liquidity for these swaps, which should 

promote competitiveness by increasing 

the number of market participants that 

offer certain swaps in any one place. It 

should also enhance the efficiency of 

swap markets by reducing the amount of 

time that market participants must 

spend looking for willing counterparties 

and receiving actionable quotes for such 

swaps. 

Certain provisions of this rule, such as 

the information required to be reported, 

the requirement for board approval, and 

the requirement that reporting entities 

gather sufficient information to have a 

reasonable basis for concluding that 

their counterparty is eligible for the enduser exception, will discourage abuse of 

the exception, thereby promoting the 

financial integrity of swap markets and 

financial markets as a whole. Market 

participants should have confidence 

that swaps that are not being used to 

hedge or mitigate commercial risk will 

be cleared. 

3. Price Discovery 

As described in greater detail above in 

Section III.C.1, the Commission believes 

that the rule reduces the potential for 

abuse or evasion (which could result in 

reduced exchange trading and therefore 

reduced price discovery) while also 

giving effect to the statutory 

requirement to create an exception from 

clearing for non-financial entities and 

SFIs using swaps to hedge or mitigate 

commercial risk. To the extent that 

reducing abuse or evasion results in 

greater liquidity on boards of trade and 

swap execution facilities, it promotes 

improved price discovery. 

4. Sound Risk Management Practices 

The Commission believes that the rule 

will lead to sound risk management 

practices. By requiring that swaps be 

‘‘economically appropriate’’ to the 

reduction of the commercial risks that 

they hedge or mitigate, the rule helps to 

ensure that changes in the value of noncleared swaps that otherwise would be 

subject to clearing are largely offset by 

changes in the value of assets or 

liabilities that electing counterparties 

have or reasonably expect to have (e.g., 

future changes in variable interest rates, 

foreign exchange rates, or the price of 

commodities). The offset should 

partially or fully ensure that the electing 

counterparty has sufficient resources to 

meet the financial commitments 

incumbent on them by virtue of their 

hedging positions. 

Electing counterparties may be 

exposed to certain financial risks in the 

course of ordinary business, such as the 

risk of exchange rate fluctuations related 

to foreign transactions and interest rate 

risk that could impact a potential 

electing counterparty’s cost of debt 

incurred for commercial business 

purposes. The rule promotes sound risk 

management practices by mitigating the 

cost of collateral for entities to use 

swaps to hedge these types of financial 

risks related to their commercial 

activities. 


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117 5 U.S.C. 601 et seq. 

118See 66 FR 20740 at 20743 (Apr. 25, 2001) 

(regarding ECPs) and 75 FR 80898 at 80926 (Dec. 

23, 2010) (regarding SDRs). 

119 44 U.S.C. 3501 et seq. 

For SEC Filers, the governing board or 

equivalent body is directly responsible 

to shareholders for the financial 

condition and performance of the firm, 

and also has access to information that 

would give them a comprehensive 

picture of the company’s financial 

condition and risk management 

strategies. Therefore, any oversight they 

provide to the firm’s risk management 

strategies is likely to encourage sound 

practices. However, the requirement 

contemplated in the NPRM that boards 

approve decisions to exempt swaps 

from clearing on a swap-by-swap basis 

could have been difficult for some firms 

to operationalize, and therefore could 

have undermined a firm’s ability to 

implement risk management strategies 

that take advantage of the end-user 

exception. In other words, there is a 

tradeoff between the risk management 

benefits associated with more direct and 

intimate board oversight, and the risk 

management costs of the same. The 

Commission believes that the addition 

of the option to approve use of the enduser exception on a broad basis, rather 

than swap by swap, effectively balances 

these concerns, retaining direct board 

involvement in the firm’s decision to 

exercise the exemption, but in a manner 

that does not hinder the firm’s ability to 

operationalize their risk management 

strategies. 

5. Other Public Interest Considerations 

For purposes of determining whether 

a swap hedges or mitigates commercial 

risk, the rule includes swaps that 

qualify for hedging treatment under 

Statement 53, Accounting and Financial 

Reporting for Derivative Instruments, 

issued by GASB. This change in the 

final rule expands the range of swaps 

that state and local government entities 

can except from the clearing 

requirement to provide a safe harbor for 

swaps that are bona fide hedges under 

Statement 53. As a consequence, the 

change helps to ensure that U.S. local 

governmental entities who use what are 

definitively hedging swaps under 

accounting standards are able to take 

advantage of the end-user exception for 

such purposes. 

In addition, the Commission provides 

guidance in Section II.A.4 that foreign 

governments, foreign central banks and 

certain international financial 

institutions will not be subject to the 

clearing requirements of Section 2(h)(1) 

of the CEA as a matter of comity. This 

guidance is in the public interest 

because it is premised on the 

expectation that foreign regulators will 

reciprocate and provide similar relief to 

the Federal Government, the Federal 

Reserve Banks of the United States and 

the international financial institutions 

of which the United States is a member. 

IV. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act (RFA) 

requires federal agencies, in 

promulgating regulations, to consider 

whether those regulations will have a 

significant economic impact on a 

substantial number of small entities 

and, if so, provide a regulatory 

flexibility analysis respecting the 

impact.117 As noted in the NPRM, the 

regulations adopted herein would affect 

eligible contract participants (ECPs) and 

SDRs. The Commission has previously 

determined that neither ECPs nor SDRs 

are small entities for purposes of the 

RFA.118 Accordingly, the Chairman, on 

behalf of the Commission, certified in 

the NPRM pursuant to 5 U.S.C. 605(b) 

that these regulations will not have a 

significant economic impact on a 

substantial number of small entities. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(PRA) 119 imposes certain requirements 

on Federal agencies (including the 

Commission) in connection with 

conducting or sponsoring any collection 

of information as defined by the PRA. 

An agency may not conduct or sponsor, 

and a person is not required to respond 

to, a collection of information unless it 

displays a currently valid control 

number. This rulemaking imposes new 

collection of information requirements 

within the meaning of the PRA. 

Accordingly, the Commission requested 

and the Office of Management and 

Budget (OMB) assigned a control 

number for the new collection of 

information: OMB control number 

3038–0085. The Commission has 

submitted this final rule along with 

supporting documentation for OMB’s 

review. Responses to this collection of 

information will be mandatory. 

The Commission will protect 

proprietary information according to the 

Freedom of Information Act and 17 CFR 

part 145, ‘‘Commission Records and 

Information.’’ In addition, section 

8(a)(1) of the CEA strictly prohibits the 

Commission, unless specifically 

authorized by the CEA, from making 

public ‘‘data and information that 

would separately disclose the business 

transactions or market positions of any 

person and trade secrets or names of 

customers.’’ The Commission is also 

required to protect certain information 

contained in a government system of 

records according to the Privacy Act of 

1974, 5 U.S.C. 552a. 

1. Information Provided by Reporting 

Entities/Persons 

Regulation 39.6 will require an 

electing counterparty to provide or 

cause to be provided certain information 

about the swap to a registered SDR or, 

if no registered SDR is available to 

receive the information, the 

Commission in the form and manner 

specified by the Commission. The 

reporting will occur only once at the 

beginning of the swap life cycle. If one 

of the counterparties to the swap is a 

swap dealer or a major swap participant, 

the electing counterparty would cause 

such information to be reported by that 

swap dealer or major swap participant. 

The electing counterparty would act as 

the reporting counterparty only if its 

counterparty is not a swap dealer or a 

major swap participant. 

As noted in the NPRM, the 

Commission estimates that there are 

approximately 30,000 non-financial 

entities that are counterparties to a swap 

in a given year. Of those entities, the 

Commission estimates that the majority 

will not be required to report under 

Regulation 39.6 because their 

counterparty will be a swap dealer or 

major swap participant. In that case, as 

described above, the swap dealer or 

major swap participant will be required 

to report on behalf of the electing 

counterparty. Also, the reporting under 

Regulation 39.6 is only required to be 

made one time for each swap, with no 

further notifications or other reporting 

required in subsequent years. Reducing 

the number of annual potential electing 

counterparties by these factors, the 

Commission estimates that there are 

approximately 1,000 electing 

counterparties who will be required to 

report in a given year. The Commission 

estimates that the report will require 

between 10 minutes and one hour of 

burden, per electing counterparty per 

year. The number of burden hours per 

electing counterparty may vary 

depending on various factors, such as 

the number of swaps entered into by 

that electing counterparty in the given 

year. Therefore, the number of estimated 

aggregate annual burden hours is 

between 167 and 1,000 hours. 

2. Information Collection Comments 

The Commission received a comment 

from the Electric Trade Associations 

stating that the Commission 

rulemakings under the Dodd-Frank Act 

constitute an accumulation of 

interrelated regulatory burdens and 


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42590 Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 

costs on nonfinancial small entities and 

the Commission should conduct a 

comprehensive analysis under the PRA 

and other statutes. However, the 

comment did not specifically address 

this rulemaking. 

List of Subjects in 17 CFR Part 39 

Business and industry, Reporting 

requirements, Swaps. 

For the reasons stated in the 

preamble, amend 17 CFR part 39 as 

follows: 

PART 39—DERIVATIVES CLEARING 

ORGANIZATIONS 

■ 1. The authority citation for part 39 is 

revised to read as follows: 

Authority: 7 U.S.C. 2 and 7a–1 as 

amended by Pub. L. 111–203, 124 Stat. 1376. 

■ 2. Add § 39.6 to read as follows: 

§ 39.6 Exceptions to the clearing 

requirement. 

(a) Non-financial entities. (1) A 

counterparty to a swap may elect the 

exception to the clearing requirement 

under section 2(h)(7)(A) of the Act if the 

counterparty: 

(i) Is not a ‘‘financial entity’’ as 

defined in section 2(h)(7)(C)(i) of the 

Act; 

(ii) Is using the swap to hedge or 

mitigate commercial risk as provided in 

paragraph (c) of this section; and 

(iii) Provides, or causes to be 

provided, the information specified in 

paragraph (b) of this section to a 

registered swap data repository or, if no 

registered swap data repository is 

available to receive the information 

from the reporting counterparty, to the 

Commission. A counterparty that 

satisfies the criteria in this paragraph 

(a)(1) and elects the exception is an 

‘‘electing counterparty.’’ 

(2) If there is more than one electing 

counterparty to a swap, the information 

specified in paragraph (b) of this section 

shall be provided with respect to each 

of the electing counterparties. 

(b) Reporting. (1) When a 

counterparty elects the exception to the 

clearing requirement under section 

2(h)(7)(A) of the Act, one of the 

counterparties to the swap (the 

‘‘reporting counterparty,’’ as determined 

in accordance with § 45.8 of this part) 

shall provide, or cause to be provided, 

the following information to a registered 

swap data repository or, if no registered 

swap data repository is available to 

receive the information from the 

reporting counterparty, to the 

Commission, in the form and manner 

specified by the Commission: 

(i) Notice of the election of the 

exception; 

(ii) The identity of the electing 

counterparty to the swap; and 

(iii) The following information, unless 

such information has previously been 

provided by the electing counterparty in 

a current annual filing pursuant to 

paragraph (b)(2) of this section: 

(A) Whether the electing counterparty 

is a ‘‘financial entity’’ as defined in 

section 2(h)(7)(C)(i) of the Act, and if the 

electing counterparty is a financial 

entity, whether it is: 

(1) Electing the exception in 

accordance with section 2(h)(7)(C)(iii) or 

section 2(h)(7)(D) of the Act; or 

(2) Exempt from the definition of 

‘‘financial entity’’ as described in 

paragraph (d) of this section; 

(B) Whether the swap or swaps for 

which the electing counterparty is 

electing the exception are used by the 

electing counterparty to hedge or 

mitigate commercial risk as provided in 

paragraph (c) of this section; 

(C) How the electing counterparty 

generally meets its financial obligations 

associated with entering into noncleared swaps by identifying one or 

more of the following categories, as 

applicable: 

(1) A written credit support 

agreement; 

(2) Pledged or segregated assets 

(including posting or receiving margin 

pursuant to a credit support agreement 

or otherwise); 

(3) A written third-party guarantee; 

(4) The electing counterparty’s 

available financial resources; or 

(5) Means other than those described 

in paragraphs (b)(1)(iii)(C)(1), (2), (3), or 

(4) of this section; and 

(D) Whether the electing counterparty 

is an entity that is an issuer of securities 

registered under section 12 of, or is 

required to file reports under section 

15(d) of, the Securities Exchange Act of 

1934, and if so: 

(1) The relevant SEC Central Index 

Key number for that counterparty; and 

(2) Whether an appropriate committee 

of that counterparty’s board of directors 

(or equivalent body) has reviewed and 

approved the decision to enter into 

swaps that are exempt from the 

requirements of sections 2(h)(1) and 

2(h)(8) of the Act. 

(2) An entity that qualifies for an 

exception to the clearing requirement 

under this section may report the 

information listed in paragraph 

(b)(1)(iii) of this section annually in 

anticipation of electing the exception for 

one or more swaps. Any such reporting 

under this paragraph shall be effective 

for purposes of paragraph (b)(1)(iii) of 

this section for swaps entered into by 

the entity for 365 days following the 

date of such reporting. During such 

period, the entity shall amend such 

information as necessary to reflect any 

material changes to the information 

reported. 

(3) Each reporting counterparty shall 

have a reasonable basis to believe that 

the electing counterparty meets the 

requirements for an exception to the 

clearing requirement under this section. 

(c) Hedging or mitigating commercial 

risk. For purposes of section 

2(h)(7)(A)(ii) of the Act and paragraph 

(b)(1)(iii)(B) of this section, a swap is 

used to hedge or mitigate commercial 

risk if: 

(1) Such swap: 

(i) Is economically appropriate to the 

reduction of risks in the conduct and 

management of a commercial enterprise, 

where the risks arise from: 

(A) The potential change in the value 

of assets that a person owns, produces, 

manufactures, processes, or 

merchandises or reasonably anticipates 

owning, producing, manufacturing, 

processing, or merchandising in the 

ordinary course of business of the 

enterprise; 

(B) The potential change in the value 

of liabilities that a person has incurred 

or reasonably anticipates incurring in 

the ordinary course of business of the 

enterprise; 

(C) The potential change in the value 

of services that a person provides, 

purchases, or reasonably anticipates 

providing or purchasing in the ordinary 

course of business of the enterprise; 

(D) The potential change in the value 

of assets, services, inputs, products, or 

commodities that a person owns, 

produces, manufactures, processes, 

merchandises, leases, or sells, or 

reasonably anticipates owning, 

producing, manufacturing, processing, 

merchandising, leasing, or selling in the 

ordinary course of business of the 

enterprise; 

(E) Any potential change in value 

related to any of the foregoing arising 

from interest, currency, or foreign 

exchange rate movements associated 

with such assets, liabilities, services, 

inputs, products, or commodities; or 

(F) Any fluctuation in interest, 

currency, or foreign exchange rate 

exposures arising from a person’s 

current or anticipated assets or 

liabilities; or 

(ii) Qualifies as bona fide hedging for 

purposes of an exemption from position 

limits under the Act; or 

(iii) Qualifies for hedging treatment 

under: 

(A) Financial Accounting Standards 

Board Accounting Standards 

Codification Topic 815, Derivatives and 

Hedging (formerly known as Statement 

No. 133); or 


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Federal Register / Vol. 77, No. 139 / Thursday, July 19, 2012 / Rules and Regulations 42591 

(B) Governmental Accounting 

Standards Board Statement 53, 

Accounting and Financial Reporting for 

Derivative Instruments; and 

(2) Such swap is: 

(i) Not used for a purpose that is in 

the nature of speculation, investing, or 

trading; and 

(ii) Not used to hedge or mitigate the 

risk of another swap or security-based 

swap position, unless that other 

position itself is used to hedge or 

mitigate commercial risk as defined by 

this rule or § 240.3a67–4 of this title. 

(d) For purposes of section 2(h)(7)(A) 

of the Act, a person that is a ‘‘financial 

entity’’ solely because of section 

2(h)(7)(C)(i)(VIII) shall be exempt from 

the definition of ‘‘financial entity’’ if 

such person: 

(i) Is organized as a bank, as defined 

in section 3(a) of the Federal Deposit 

Insurance Act, the deposits of which are 

insured by the Federal Deposit 

Insurance Corporation; a savings 

association, as defined in section 3(b) of 

the Federal Deposit Insurance Act, the 

deposits of which are insured by the 

Federal Deposit Insurance Corporation; 

a farm credit system institution 

chartered under the Farm Credit Act of 

1971; or an insured Federal credit union 

or State-chartered credit union under 

the Federal Credit Union Act; and 

(ii) Has total assets of $10,000,000,000 

or less on the last day of such person’s 

most recent fiscal year. 

Issued in Washington, DC, on July 10, 

2012, by the Commission. 

David A. Stawick, 

Secretary of the Commission. 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendices to End-User Exception to 

Mandatory Clearing of Swaps— 

Commission Voting Summary and 

Statements of Commissioners 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Sommers, Chilton, O’Malia 

and Wetjen voted in the affirmative; no 

Commissioner voted in the negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the final rule on the end-user 

exception to the clearing requirement for 

swaps. One of the primary goals of the DoddFrank Wall Street Reform and Consumer 

Protection Act (Dodd-Frank Act) was to 

lower risk to the interconnected financial 

system by requiring standardized swaps 

between financial entities to be cleared. 

Congress provided that non-financial 

entities, such as farmers, ranchers, 

manufacturers and other end-users, should 

be able to choose whether or not to clear 

those swaps that hedge or mitigate 

commercial risks. The Commission’s final 

rule implements this exception for nonfinancial entities, establishing criteria for 

hedging or mitigating commercial risk and 

imposing minimal reporting requirements for 

those swaps that come under the end-user 

exception. The final rule benefited from 

significant public input, including requiring 

that most of the information be reported 

annually, rather than transaction by 

transaction as had been proposed. 

In the Dodd-Frank Act, Congress also 

directed the Commission to consider 

exempting from the definition of ‘‘financial 

entity’’ small financial institutions with total 

assets of $10 billion or less, thus making 

them eligible for the end-user exception. 

After considering the comments received on 

the end-user exception proposal, the 

Commission is exempting small financial 

institutions, including small banks, savings 

associations, farm credit system institutions 

and credit unions, at the $10 billion total 

asset level, as identified by Congress. 

[FR Doc. 2012–17291 Filed 7–18–12; 8:45 am] 

BILLING CODE 6351–01–P 


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