Vol. 77 Tuesday, 

No. 152 August 7, 2012 

Part II 

Commodity Futures Trading Commission 

17 CFR Part 50 

Clearing Requirement Determination Under Section 2(h) of the CEA; 

Proposed Rule 

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47170 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

1 17 CFR 145.9. Commission regulations referred 

to herein are found on the Commission’s Web site. 

2On October 3, 2008, President Bush signed the 

Emergency Economic Stabilization Act of 2008, 

which was principally designed to allow the U.S. 

Department of the Treasury and other government 

agencies to take action to restore liquidity and 

stability to the U.S. financial system (e.g., the 

Troubled Asset Relief Program—also known as 

TARP—under which the U.S. Department of the 

Treasury was authorized to purchase up to $700 

billion of troubled assets that weighed down the 

balance sheets of U.S. financial institutions). See 

Public Law 110–343, 122 Stat. 3765 (2008). 

3See Financial Crisis Inquiry Commission, ‘‘The 

Financial Crisis Inquiry Report: Final Report of the 

National Commission on the Causes of the 

Financial and Economic Crisis in the United 

States,’’ Jan. 2011, at xxviii, available at http://

www.gpo.gov/fdsys/pkg/GPO–FCIC/pdf/GPO–

FCIC.pdf. 

4See id. at 386. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 50 

RIN 3038–AD86 

Clearing Requirement Determination 

Under Section 2(h) of the CEA 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: The Commodity Futures 

Trading Commission (Commission or 

CFTC) is proposing regulations to 

establish a clearing requirement under 

new section 2(h)(1)(A) of the 

Commodity Exchange Act (CEA or Act), 

enacted under Title VII of the DoddFrank Wall Street Reform and Consumer 

Protection Act (Dodd-Frank Act). The 

regulations would require that certain 

classes of credit default swaps (CDS) 

and interest rate swaps (IRS), described 

herein, be cleared by a derivatives 

clearing organization (DCO) registered 

with the Commission. The Commission 

also is proposing regulations to prevent 

evasion of the clearing requirement and 

related provisions. 

DATES: Comments must be received on 

or before September 6, 2012. 

ADDRESSES: You may submit comments, 

identified by RIN number 3038–AD86, 

by any of the following methods: 

• The agency’s Web site, at http:// 

comments.cftc.gov. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: David A. Stawick, Secretary of 

the Commission, Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street NW., 

Washington, DC 20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

Please submit your comments using 

only one method. 

All comments must be submitted in 

English, or if not, accompanied by an 

English translation. Comments will be 

posted as received to http:// 

www.cftc.gov. You should submit only 

information that you wish to make 

available publicly. If you wish the 

Commission to consider information 

that you believe is exempt from 

disclosure under the Freedom of 

Information Act, a petition for 

confidential treatment of the exempt 

information may be submitted according 

to the procedures established in § 145.9 

of the Commission’s regulations.1

The Commission reserves the right, 

but shall have no obligation, to review, 

pre-screen, filter, redact, refuse or 

remove any or all of your submission 

from http://www.cftc.gov that it may 

deem to be inappropriate for 

publication, such as obscene language. 

All submissions that have been redacted 

or removed that contain comments on 

the merits of the rulemaking will be 

retained in the public comment file and 

will be considered as required under the 

Administrative Procedure Act and other 

applicable laws, and may be accessible 

under the Freedom of Information Act. 

FOR FURTHER INFORMATION CONTACT: 

Sarah E. Josephson, Deputy Director, 

202–418–5684, sjosephson@cftc.gov; 

Brian O’Keefe, Associate Director, 202– 

418–5658, bokeefe@cftc.gov; or Erik 

Remmler, Associate Director, 202–418– 

7630, eremmler@cftc.gov, Division of 

Clearing and Risk, Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street NW., 

Washington, DC 20581. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Background 

A. Financial Crisis 

B. Central Role of Clearing in the DoddFrank Act 

C. G–20 and International Commitments on 

Clearing 

D. Overview of Section 2(h) and § 39.5 

E. Submissions From DCOs 

II. Review of Swap Submissions 

A. General Description of Information 

Considered 

B. Commission Processes for Review and 

Surveillance of DCOs 

C. Credit Default Swaps 

D. Proposed Determination Analysis for 

Credit Default Swaps 

E. Interest Rate Swaps 

F. Proposed Determination Analysis for 

Interest Rate Swaps 

III. Proposed Rule 

A. Proposed § 50.1 Definitions 

B. Proposed § 50.2 Treatment of Swaps 

Subject to a Clearing Requirement 

C. Proposed § 50.3 Notice to the Public 

D. Proposed § 50.4 Classes of Swaps 

Required To Be Cleared 

E. Proposed § 50.5 Clearing Transition 

Rules 

F. Proposed § 50.6 Delegation of 

Authority 

G. Proposed § 50.10 Prevention of 

Evasion of the Clearing Requirement and 

Abuse of an Exception or Exemption to 

the Clearing Requirement 

IV. Implementation 

V. Cost Benefit Considerations 

A. Statutory and Regulatory Background 

B. Overview of Swap Clearing 

C. Consideration of the Costs and Benefits 

of the Commission’s Action 

D. Costs and Benefits of the Rule as 

Compared to Alternatives 

E. Section 15(a) Factors 

VI. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 

I. Background 

A. Financial Crisis 

In the fall of 2008, a series of large 

financial institution failures triggered a 

financial and economic crisis that 

threatened to freeze U.S. and global 

credit markets. As a result of these 

failures, unprecedented governmental 

intervention was required to ensure the 

stability of the U.S. financial system.2

These failures revealed the vulnerability 

of the U.S. financial system and 

economy to wide-spread systemic risk 

resulting from, among other things, poor 

risk management practices of financial 

firms and the lack of supervisory 

oversight for a financial institution as a 

whole.3

The financial crisis also illustrated the 

significant risks that an uncleared, overthe-counter (OTC) derivatives market 

can pose to the financial system. As the 

Financial Crisis Inquiry Commission 

explained: 

The scale and nature of the [OTC] 

derivatives market created significant 

systemic risk throughout the financial system 

and helped fuel the panic in the fall of 2008: 

millions of contracts in this opaque and 

deregulated market created interconnections 

among a vast web of financial institutions 

through counterparty credit risk, thus 

exposing the system to a contagion of 

spreading losses and defaults.4

Certain OTC derivatives, such as CDS, 

played a prominent role during the 

crisis. According to a white paper by the 

U.S. Department of the Treasury, ‘‘the 

sheer volume of these [CDS] contracts 

overwhelmed some firms that had 

promised to provide payment of the 

CDS and left institutions with losses 

that they believed they had been 

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5 Financial Regulatory Reform: A New 

Foundation, June 2009, available at: http://

www.treasury.gov/initiatives/Documents/Final

Report_web.pdf and cited in S. Rep. 111–176 at 29– 

30 (Apr. 30, 2010). 

6Adam Davidson, ‘‘How AIG fell apart,’’ Reuters, 

Sept. 18, 2008, available at http://www.reuters.com/ 

article/2008/09/18/us-how-aig-fell-apartidUSMAR85972720080918. 

7Hugh Son, ‘‘AIG’s Trustees Shun ‘Shadow 

Board,’ Seek Directors,’’ Bloomberg, May 13, 2009, 

available at http://www.bloomberg.com/apps/

news?pid=newsarchive&sid=aaog3i4yUopo&

refer=us. 

8The President’s Working Group on Financial 

Markets, ‘‘Policy Statements on Financial Market 

Developments,’’ Mar. 2008, available at http://

www.treasury.gov/resource-center/fin-mkts/ 

Documents/pwgpolicystatemktturmoil_

03122008.pdf. 

9 ISDA, ISDA Margin Survey, 2009, available at 

http://www.isda.org/c_and_a/pdf/ISDA–MarginSurvey-2009.pdf. 

10The TED spread measures the difference in 

yield between three-month Eurodollars as 

represented by London Interbank Offered Rate 

(LIBOR), and three-month Treasury Bills. LIBOR 

contains credit risk while T-bills do not. As the 

spread got larger, it meant that lenders demanded 

more return to compensate for credit risk then they 

would need if they loaned the money to the U.S. 

Department of the Treasury without any credit risk. 

11The U.S. Financial Crisis: Credit Crunch and 

Yield Spreads, by James R. Barth et al., page 5, 

available at: http://apeaweb.org/confer/bei08/

papers/blp.pdf. 

12See Federal Reserve Bank of New York, Press 

Release, ‘‘New York Fed Welcomes Further 

Industry Commitments on Over-the-Counter 

Derivatives,’’ Oct. 31, 2008, available at http://

www.newyorkfed.org/newsevents/news/markets/

2008/an081031.html, which references documents 

prepared by market participants describing the 

importance of clearing. See also Ciara Linnane and 

Karen Brettell, ‘‘NY Federal Reserve pushes for 

central CDS counterparty,’’ Reuters, Oct. 6, 2008, 

available at http://www.reuters.com/article/2008/

10/06/cds-regulation-idUSN0655208920081006. 

13The Commission has proposed rules that would 

establish a separate process for determining 

whether a swap has been made ‘‘available to trade’’ 

by a DCM or SEF. Those rules, and any 

determinations made under those rules, will be 

finalized separately from the proposed clearing 

requirements discussed herein. See Process for a 

Designated Contract Market or Swap Execution 

Facility to Make a Swap Available to Trade Under 

Section 2(h)(8) of the Commodity Exchange Act, 76 

FR 77728 (Dec. 14, 2011). 

14S. Rep. 111–176, at 32 (April 30, 2010). See 

also Letter from Senators Christopher Dodd and 

Blanche Lincoln to Congressmen Barney Frank and 

Collin Peterson (June 30, 2010) (‘‘Congress 

determined that clearing is at the heart of reform— 

bringing transactions and counterparties into a 

robust, conservative, and transparent risk 

management framework.’’). 

15S. Rep. 111–176, at 33. 

protected against.’’ 5 In particular, AIG 

reportedly issued uncleared CDS 

transactions covering more than $440 

billion in bonds, leaving it with 

obligations that it could not cover as a 

result of changed market conditions.6

As a result of AIG’s CDS exposure, the 

Federal government bailed out the firm 

with over $180 billion of taxpayer 

money in order to prevent AIG’s failure 

and a possible contagion event in the 

broader economy.7

More broadly, the President’s 

Working Group (PWG) on Financial 

Policy noted shortcomings in the OTC 

derivative markets as a whole during the 

crisis. The PWG identified the need for 

an improved integrated operational 

structure supporting OTC derivatives, 

specifically highlighting the need for an 

enhanced ability to manage 

counterparty risk through ‘‘netting and 

collateral agreements by promoting 

portfolio reconciliation and accurate 

valuation of trades.’’ 8 These issues were 

exposed in part by the surge in 

collateral required between 

counterparties during 2008, when the 

International Swaps and Derivatives 

Association (ISDA) reported an 86% 

increase in the collateral in use for OTC 

derivatives, indicating not only the 

increase in risk, but also circumstances 

in which positions may not have been 

collateralized.9

With only limited checks on the 

amount of risk that a market participant 

could incur, great uncertainty was 

created among market participants. A 

market participant did not know the 

extent of its counterparty’s exposure, 

whether its counterparty was 

appropriately hedged, or if its 

counterparty was dangerously exposed 

to adverse market movements. Without 

central clearing, a market participant 

bore the risk that its counterparty would 

not fulfill its payment obligations 

pursuant to a swap’s terms 

(counterparty credit risk). As the 

financial crisis deepened, this risk made 

market participants wary of trading with 

each other. As a result, markets quickly 

became illiquid and trading volumes 

plummeted. The dramatic increase in 

‘‘TED spreads’’ evidenced this 

mistrust.10 These spreads increased 

from a long-term average of 

approximately 30 basis points to 464 

basis points.11

The failure to adequately collateralize 

the risk exposures posed by OTC 

derivatives, along with the contagion 

effects of the vast web of counterparty 

credit risk, led many to conclude that 

OTC derivatives should be centrally 

cleared. For instance, in 2008, the 

Federal Reserve Bank of New York 

(FRBNY) began encouraging market 

participants to establish a central 

counterparty to clear CDS.12 For several 

years prior, the FRBNY had led a 

targeted effort to enhance operational 

efficiency and performance in the OTC 

derivatives market by increasing 

automation in processing and by 

promoting sound back office practices, 

such as timely confirmation of trades 

and portfolio reconciliation. Beginning 

with CDS in 2008, the FRBNY and other 

primary supervisors of OTC derivatives 

dealers increasingly focused on central 

clearing as a means of mitigating 

counterparty credit risk and lowering 

systemic risk to the markets as a whole. 

Both regulators and market participants 

alike recognized that risk exposures 

would have been monitored, measured, 

and collateralized through the process 

of central clearing. 

B. Central Role of Clearing in the DoddFrank Act 

Recognizing the peril that the U.S. 

financial system faced during the 

financial crisis, Congress and the 

President came together to pass the 

Dodd-Frank Act in 2010. Title VII of the 

Dodd-Frank Act establishes a 

comprehensive new regulatory 

framework for swaps, and the 

requirement that swaps be cleared by 

DCOs is one of the cornerstones of that 

reform. The CEA, as amended by Title 

VII, now requires a swap: (1) To be 

cleared through a DCO if the 

Commission has determined that the 

swap, or group, category, type, or class 

of 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.13

Clearing is at the heart of the DoddFrank financial reform. According to the 

Senate Report:14

As a key element of reducing systemic risk 

and protecting taxpayers in the future, 

protections must include comprehensive 

regulation and rules for how the OTC 

derivatives market operates. Increasing the 

use of central clearinghouses, exchanges, 

appropriate margining, capital requirements, 

and reporting will provide safeguards for 

American taxpayers and the financial system 

as a whole. 

The Commission believes that a 

clearing requirement will reduce 

counterparty credit risk and provide an 

organized mechanism for collateralizing 

the risk exposures posed by swaps. 

According to the Senate Report:15

With appropriate collateral and margin 

requirements, a central clearing organization 

can substantially reduce counterparty risk 

and provide an organized mechanism for 

clearing transactions. * * * While large 

losses are to be expected in derivatives 

trading, if those positions are fully margined 

there will be no loss to counterparties and 

the overall financial system and none of the 

uncertainty about potential exposures that 

contributed to the panic in 2008. 

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16See ‘‘Implementing OTC Derivatives Market 

Reforms,’’ Financial Stability Board, Oct. 25, 2010, 

available at http://www.financialstabilityboard.org/ 

publications/r_101025.pdf. 

17OTC Derivatives Working Group, ‘‘OTC 

Derivatives Market Reforms: Third Progress Report 

on Implementation,’’ Financial Stability Board, June 

15, 2012, available at http://www.financialstability

board.org/publications/r_120615.pdf. 

18 IOSCO’s report, published in February 2012, is 

available at https://www.iosco.org/library/pubdocs/ 

pdf/IOSCOPD374.pdf. 

19See 76 FR 44464 (July 26, 2011); 17 CFR 39.5. 

20See section 2(h) of the CEA. A clearing 

requirement determination also may be initiated by 

the Commission. Section 2(h)(2)(A)(i) of the CEA 

requires the Commission on an ongoing basis to 

‘‘review each swap, or any group, category, type, or 

class of swaps to make a determination as to 

whether the swap, category, type or class of swaps 

should be required to be cleared.’’ As previously 

noted, the Commission intends to consider swaps 

submitted by DCOs prior to undertaking any 

Commission-initiated reviews. 

21The letter made it clear that DCOs should 

submit both pre-enactment swaps and swaps for 

which DCOs have initiated clearing since 

enactment of the Dodd-Frank Act. Pre-enactment 

swaps refer to those swaps that DCOs were 

accepting for clearing as of July 21, 2010, the date 

of enactment of the Dodd-Frank Act. 

22Other swaps submissions were received from 

Kansas City Board of Trade (KCBT) and the Natural 

Gas Exchange (NGX). KCBT and NGX do not accept 

any CDS or IRS for clearing. 

23The Commission will consider all other swaps 

submitted under § 39.5(b) as soon as possible after 

this proposal is published. These other swaps 

include certain CDS that were submitted to the 

Commission subsequent to the initial February 2012 

submissions discussed above. If the Commission 

determines that additional swaps should be 

required to be cleared such determination likely 

will be proposed as a new class under proposed 

§ 50.4, as discussed below. 

Notably, Congress did not focus on just 

one asset class, such as CDS; rather, 

Congress determined that all swaps that 

a DCO plans to accept for clearing must 

be submitted to the Commission for a 

determination as to whether or not those 

swaps are required to be cleared 

pursuant to section 2(h)(2)(D) of the 

CEA. 

C. G–20 and International Commitments 

on Clearing 

The financial crisis generated 

international consensus on the need to 

strengthen financial regulation by 

improving transparency, mitigating 

systemic risk, and protecting against 

market abuse. As a result of the 

widespread recognition that 

transactions in the OTC derivatives 

market increased risk and uncertainty in 

the economy and became a significant 

contributor to the financial crisis, a 

series of policy initiatives were 

undertaken to better regulate the 

financial markets. 

In September 2009, leaders of the 

Group of 20 (G–20)—whose 

membership includes the United States, 

the European Union, and 18 other 

countries—agreed that: (1) OTC 

derivatives contracts should be reported 

to trade repositories; (2) all standardized 

OTC derivatives contracts should be 

cleared through central counterparties 

and traded on exchanges or electronic 

trading platforms, where appropriate, by 

the end of 2012; and (3) non-centrally 

cleared contracts should be subject to 

higher capital requirements. 

In June 2010, the G–20 leaders 

reaffirmed their commitment to achieve 

these goals. In its October 2010 report 

on Implementing OTC Derivatives 

Market Reforms (the October 2010 

Report), the Financial Stability Board 

(FSB) made twenty-one 

recommendations addressing practical 

issues that authorities may encounter in 

implementing the G–20 leaders’ 

commitments.16 The G–20 leaders again 

reaffirmed their commitments at the 

November 2011 Summit, including the 

end-2012 deadline. The FSB has issued 

three implementation progress reports. 

The most recent report urged 

jurisdictions to push forward 

aggressively to meet the G–20 end-2012 

deadline in as many reform areas as 

possible. On mandatory clearing, the 

report observed that ‘‘[j]urisdictions 

now have much of the information they 

requested in order to make informed 

decisions on the appropriate legislation 

and regulations to achieve the end-2012 

commitment to centrally clear all 

standardised OTC derivatives.’’ 17

Specifically with regard to required 

clearing, the Technical Committee of the 

International Organization of Securities 

Commissions (IOSCO) has published a 

final report, Requirements for 

Mandatory Clearing, outlining 

recommendations that regulators should 

follow to carry out the G–20’s goal of 

requiring standardized swaps to be 

cleared.18

D. Overview of Section 2(h) and § 39.5 

The Commission has promulgated 

§ 39.5 of its regulations to implement 

procedural aspects section 2(h) of the 

CEA.19 Regulation 39.5 establishes 

procedures for: (1) Determining the 

eligibility of a DCO to clear swaps; (2) 

the submission of swaps by a DCO to 

the Commission for a clearing 

requirement determination; (3) 

Commission initiated reviews of swaps; 

and (4) the staying of a clearing 

requirement. 

This determination and rule proposed 

today would require that certain swaps 

submitted by Commission-registered 

DCOs are required to be cleared under 

section 2(h) of the CEA. Under section 

2(h)(1)(A), ‘‘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.’’ 20

A clearing requirement determination 

may be initiated by a swap submission. 

Section 2(h)(2)(B)(i) of the CEA requires 

a DCO to ‘‘submit to the Commission 

each swap, or any group, category, type 

or class of swaps that it plans to accept 

for clearing, and provide notice to its 

members of the submission.’’ In 

addition under section 2(h)(2)(B)(ii) of 

the CEA, ‘‘[a]ny swap or group, 

category, type, or class of swaps listed 

for clearing by a [DCO] as of the date of 

enactment shall be considered 

submitted to the Commission.’’ 

E. Submissions From DCOs 

On February 1, 2012, Commission 

staff sent a letter requesting that DCOs 

submit all swaps that they were 

accepting for clearing as of that date, 

pursuant to § 39.5.21 The Commission 

received submissions relating to CDS 

and IRS clearing from: the International 

Derivatives Clearinghouse Group (IDCH) 

on February 17, 2012; the CME Group 

(CME), ICE Clear Credit, ICE Clear 

Europe, each dated February 22, 2012, 

and a submission from LCH.Clearnet 

Limited (LCH) on February 24, 2012.22

This proposal’s clearing requirement 

determination would cover certain CDS 

and IRS currently being cleared by a 

DCO. The Commission intends 

subsequently to consider other swaps 

submitted by DCOs, such as 

agricultural, energy, and equity indices. 

The decision to focus on CDS and IRS 

in the initial clearing requirement 

determination is a function of both the 

market importance of these swaps and 

the fact that they already are widely 

cleared. In order to move the largest 

number of swaps to required clearing in 

its initial determination, the 

Commission believes that it is prudent 

to focus on those swaps that have the 

highest market shares and market 

impact. Further, for these swaps there is 

already a blueprint for clearing and 

appropriate risk management. CDS and 

IRS fit these considerations and 

therefore are well suited for required 

clearing consideration.23

Significantly, market participants 

have recommended that the 

Commission take this approach. In their 

joint comment letter to the 

Commission’s proposed Compliance 

and Implementation Schedule for the 

clearing requirement, the Futures 

Industry Association (FIA), ISDA, and 

the Securities Industry and Financial 

Markets Association (SIFMA) opined 

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24FIA/ISDA/SIFMA comment letter to the Notice 

of Proposed Rulemaking, Swap Transaction 

Compliance and Implementation Schedule: 

Clearing and Trade Execution Requirements under 

Section 2(h) of the CEA, 76 FR 58186 (Sept. 20, 

2011). This comment letter is available on the 

Commission’s Web site at: http://

comments.cftc.gov/PublicComments/Comment

List.aspx?id=1093&ctl00_ctl00_cphContentMain_

MainContent_gvCommentListChangePage=2. 

25On July 28, 2011, Commissioner O’Malia 

released a letter seeking public comment on the 

manner in which the Commission should determine 

(i) which swaps would be subject to the clearing 

requirement and (ii) whether to grant a stay of a 

clearing requirement. Commissioner O’Malia’s 

letter, as well as AIMA’s letter, are available on the 

Commission’s Web site at: http://www.cftc.gov/

About/Commissioners/ScottDOMalia/reviewof

swaps. 

26Bank of International Settlements (BIS) data, 

December 2011, available at http://www.bis.org/

statistics/otcder/dt1920a.pdf. 

27 Id.; LCH data. 

28BIS data, December 2011, available at http://

www.bis.org/statistics/otcder/dt1920a.pdf. 

29 Id. 

30 ICE Clear Credit data, as of the April 26, 2012 

clearing cycle. 

31See responses to Commissioner O’Malia’s letter 

of June 28, 2011 requesting input on the clearing 

determination available on the Commission’s Web 

site, available at http://www.cftc.gov/About/ 

Commissioners/ScottDOMalia/reviewofswaps. 

32See comment file for Swap Transaction 

Compliance and Implementation Schedule: 

Clearing and Trade Execution Requirements under 

Section 2(h) of the CEA, 76 FR 58186 (Sept. 20, 

2011), available at http://comments.cftc.gov/ 

PublicComments/CommentList.aspx?id=1093. 

33See comment file for Process for Review of 

Swaps for Mandatory Clearing, 75 FR 67277 (Nov. 

2, 2010), available at http://comments.cftc.gov/ 

PublicComments/CommentList.aspx?id=890. 

that CDS and IRS should be required to 

be cleared first because they are already 

being cleared.24 FIA, ISDA, and SIFMA 

commented further that it would make 

sense for the Commission to require 

commodity and equity swaps to be 

cleared later because fewer of these 

swaps are currently being cleared. 

Similarly, the letter sent by the 

Alternative Investment Management 

Association (AIMA) in response to 

Commissioner O’Malia’s request for 

comment concerning the 

implementation of the clearing 

requirement 25 argues that the 

Commission should first review those 

swaps currently being cleared and then 

swaps that currently trade in large 

numbers. 

IRS accounts for about $500 trillion of 

the $650 trillion global OTC swaps 

market, in notional dollars—the highest 

market share of any class of swaps.26

LCH claims to clear about $302 trillion 

of those—meaning that, in notional 

terms, LCH clears approximately 60% of 

the IRS market.27 While CDS indices do 

not have as prominent a market share as 

IRS, CDS indices are capable of having 

a sizeable market impact, as they did 

during the 2008 financial crisis. Overall, 

the CDS marketplace has almost $29 

trillion in notional outstanding across 

both single and multi-name products.28

CDS on standardized indices accounts 

for about $10 trillion of the global OTC 

market in notional dollar amount 

outstanding.29 Since March 2009, the 

ICE Clear Credit and ICE Clear Europe 

have combined to clear over $30 trillion 

in gross notional for all CDS.30 Because 

of the market shares and market impacts 

of these swaps, and because these swaps 

are currently being cleared, the 

Commission decided to review CDS and 

IRS in its initial clearing requirement 

determination. The Commission 

recognizes that while this is an 

appropriate basis for this initial 

proposal, swap clearing is likely to 

evolve and clearing requirement 

determinations made at later times may 

be based on a variety of other factors 

beyond the extent to which the swaps 

in question are already being cleared. 

II. Review of Swap Submissions 

A. General Description of Information 

Considered 

The Commission reviewed each of the 

submissions in detail. Based on these 

submissions, the Commission was able 

to consider the ability of an individual 

DCO to clear a given swap, as well as 

to consider the information supplied 

cumulatively across all submissions for 

a given swap. The analysis included 

reviews of the DCOs’ existing rule 

frameworks and their risk management 

policies. The Commission relied on 

industry data as available, such as 

publicly available Depository Trust and 

Clearing Corporation (DTCC) data from 

the Trade Information Warehouse (TIW) 

on CDS transactions. Other publicly 

available data sources, such as data from 

the Bank of International Settlements 

(BIS) on the OTC derivatives markets 

are analyzed and cited throughout this 

notice of proposed rulemaking. The 

Commission also was able to review 

letters from market participants directly 

related to the clearing requirement.31

Other market input on the clearing 

requirement could be taken from 

comments received with regard to rules 

relating to the proposed Swap 

Transaction Compliance and 

Implementation Schedule: Clearing and 

Trade Execution Requirements under 

Section 2(h) of the CEA 32 and the 

Process for Review of Swaps for 

Mandatory Clearing.33 This notice of 

proposed rulemaking also reflects 

consultation with the staff of the 

Securities and Exchange Commission 

(SEC), prudential regulators, and 

international regulatory authorities. As 

§ 39.5 provides for a 30-day comment 

period for any clearing determination, 

the final clearing requirement will be 

informed by public feedback. 

B. Commission Processes for Review 

and Surveillance of DCOs 

i. Part 39 Regulations Set Forth 

Standards for Compliance 

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

provides that the Commission shall 

review whether the submissions are 

consistent with section 5b(c)(2) of the 

CEA. Section 5b(c)(2) of the CEA sets 

forth eighteen core principles with 

which DCOs must comply to be 

registered and to maintain registration. 

The core principles address numerous 

issues, including financial resources, 

participant and product eligibility, risk 

management, settlement procedures, 

default management, system safeguards, 

reporting, recordkeeping, public 

information, and legal risk. 

All of the DCOs that submitted swaps 

for review are registered with the 

Commission and their submissions 

identify swaps that they are already 

clearing. Consequently, the Commission 

has been reviewing and monitoring 

compliance by the DCOs with the core 

principles for the submitted swaps. For 

purposes of reviewing whether the 

submissions are consistent with section 

5b(c)(2) of the CEA, the Commission 

will rely on both the information 

received in the submissions themselves 

and on its ongoing review and risk 

surveillance programs. These processes 

are summarized below to provide a 

better understanding of the information 

the Commission uses in its review of 

consistency of the submissions with the 

core principles. The Commission 

believes this overview is particularly 

helpful for this rulemaking because the 

clearing requirement proposed herein is 

the first such undertaking by the 

Commission under the provisions of the 

Dodd-Frank Act. 

The primary objective of the CFTC 

supervisory program is to ensure 

compliance with applicable provisions 

of the CEA and implementing 

regulations, and in particular, the core 

principles applicable to DCOs. A 

primary concern of the program is to 

monitor and mitigate potential risks that 

can arise in derivatives clearing 

activities for the DCO, its members, and 

entities using the DCO’s services. 

Accordingly, the CFTC supervisory 

program takes a risk-based approach. 

In addition to the core principles set 

forth in section 5b(c)(2) of the CEA, 

section 5c(c) of the CEA governs the 

procedures for review and approval of 

new products, new rules, and rule 

amendments submitted to the 

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34See section 6c of the CEA. 

35See section 6b of the CEA. 

36See section 5e of the CEA. 

37 In the case of CME and ICE Clear Europe, the 

submissions also included other swaps beyond 

those in the CDS and IRS categories. These 

submissions, including a description of the specific 

swaps covered, are available at http://www.cftc.gov/ 

IndustryOversight/IndustryFilings/index.htm. 

38Available at: http://www.cmegroup.com/ 

market-regulation/rule-filings.html and https:// 

www.theice.com/publicdocs/regulatory_filings/ 

ICEClearCredit_022212.pdf. ICE Clear Europe did 

not provide a link to its relevant Web page. 

Commission by DCOs. Part 39 of the 

CFTC’s regulations implements sections 

5b and 5c(c) of the CEA by establishing 

specific requirements for compliance 

with the core principles as well as 

procedures for registration, for 

implementing DCO rules, and for 

clearing new products. Part 40 of the 

CFTC’s regulations sets forth additional 

provisions applicable to a DCO’s 

submission of rule amendments and 

new products to the CFTC. 

The Commission has means to enforce 

compliance, including the 

Commission’s ability to sue the DCO in 

federal court for civil monetary 

penalties,34 issue a cease and desist 

order,35 or suspend or revoke the 

registration of the DCO.36 In addition, 

any deficiencies or other compliance 

issues observed during ongoing 

monitoring or an examination are 

frequently communicated to the DCO 

and various measures are used by the 

Commission to ensure that the DCO 

appropriately addresses such issues, 

including escalating communications 

within the DCO management and 

requiring the DCO to demonstrate, in 

writing, timely correction of such 

issues. 

ii. Initial Registration Application 

Review and Periodic In-Depth Reviews 

Section 5b of the CEA requires a DCO 

to register with the Commission. In 

order to do so, an organization must 

submit an application demonstrating 

that it complies with the core 

principles. During the review period, 

the Commission generally conducts an 

on-site review of the prospective DCO’s 

facilities, asks a series of questions, and 

reviews all documentation received. 

The Commission may ask the applicant 

to make changes to its rules to comply 

with the CEA and the Commission’s 

regulations. 

After registration, the Commission 

conducts examinations of DCOs to 

determine whether the DCO is in 

compliance with the CEA and 

Commission regulations. The 

examination consists of a planning 

phase where staff reviews information 

the Commission has on hand to 

determine whether the information 

raises specific issues and to develop an 

examination plan. The examination 

team participates in a series of meetings 

with the DCO at its facility. Commission 

staff also communicates with relevant 

DCO staff, including senior 

management, and reviews 

documentation. Data produced by the 

DCO is independently tested. Finally, 

when relevant, walk-through testing is 

conducted for key DCO processes. 

iii. Commission Daily Risk Surveillance 

Commission risk surveillance staff 

monitors the risks posed to and by 

DCOs, clearing members, and market 

participants, including market risk, 

liquidity risk, credit risk, and 

concentration risk. This analysis 

includes reviews of daily, large trader 

reporting data obtained from market 

participants, clearing members, and 

DCOs, which is available at the trader, 

clearing member, and DCO levels. 

Relevant margin and financial resources 

information is also included within the 

analysis. 

Commission staff regularly conducts 

back-testing to review margin coverage 

at the product level and follows up with 

the relevant DCO regarding any 

exceptional results. Independent stress 

testing of portfolios is conducted on a 

daily, weekly, and ad hoc basis. The 

independent stress tests may lead to 

individual trader reviews and/or futures 

commission merchant (FCM) risk 

reviews to gain a deeper understanding 

of a trading strategy, risk philosophy, 

risk controls and mitigants, and 

financial resources at the trader and/or 

FCM level. The traders and FCMs that 

have a higher risk profile are then 

reviewed during the Commission’s onsite review of a DCO’s risk management 

procedures. 

C. Credit Default Swaps 

i. Submissions Provided Information per 

§ 39.5 

Pursuant to § 39.5, the Commission 

received filings with respect to CDS 

from CME, ICE Clear Credit, and ICE 

Clear Europe.37 The CME and ICE Clear 

Credit submissions included the CDS 

that each clear on North American 

corporate indices, covering various 

tenors and series. The ICE Clear Europe 

submission includes, among other 

swaps, the CDS contracts on European 

corporate indices that they clear, with 

information on each of the different 

tenors and series. Each of the 

submissions contained information 

relating to the five statutory factors set 

forth in section 2(h)(2)(D) of the CEA 

and other information required under 

§ 39.5. 

CME, ICE Clear Credit, and ICE Clear 

Europe provided notice of their § 39.5 

swap submissions to their members by 

posting their submissions on their 

respective Web sites.38 The submissions 

also are published on the Commission’s 

Web site. 

Regulation 39.5(b)(3)(viii) also directs 

a DCO’s submission to include a 

summary of any views on the 

submission expressed by members. 

CME’s submission did not address this. 

In their submissions, ICE Clear Credit 

and ICE Clear Europe stated that neither 

has solicited nor received any 

comments to date and will notify the 

Commission of any such comments. The 

Commission expects that DCOs will 

provide any feedback they receive 

regarding their submissions to the 

Commission for consideration. 

ii. Background on Market 

A credit default swap is a bilateral 

contract that allows the counterparties 

to trade or hedge the risk that an 

underlying entity will default—in most 

cases, either a corporate or a sovereign 

borrower. The protection buyer makes a 

quarterly premium payment until a predefined credit event occurs or until the 

swap agreement matures. In return, the 

protection seller assumes the financial 

loss in case the reference borrower 

becomes insolvent or an underlying 

security defaults. In addition to such 

‘‘single name’’ CDS described above, the 

market also developed CDS to cover 

multi-name baskets of entities. While 

these baskets can be specifically created 

by the parties in a bespoke swap 

transaction, the large majority of multiname baskets are based on both 

standardized indices and standardized 

swap agreements. These index CDS can 

cover up to 125 reference entities. Each 

of these entities may be weighted 

equally within the index or have 

different weightings depending on the 

terms of the specific index. Unlike a 

single name CDS, these contracts 

generally continue until the swap 

agreement reaches its scheduled 

termination date. Under the contract, 

the protection seller would assume the 

financial loss associated with, and make 

payment to the protection buyer on, 

each of the individual entities in the 

index that suffers a credit event until 

the swap’s maturity. Those entities 

suffering a credit event would be 

removed from the index. The swap 

would continue on the remaining 

names, with the protection buyer 

making reduced quarterly premium 

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39See BIS data, available at http://www.bis.org/ 

statistics/otcder/dt1920a.pdf. 

40S&P/ISDA have, for example, co-branded 

additional indices for use in the CDS marketplace. 

These indices cover similar classes of reference 

entities as the Markit indices. To date, however, the 

use of these indices by market participants has been 

limited. With insufficient data regarding 

outstanding notional amounts and trading volumes, 

the Commission does not believe it appropriate to 

include these indices in the mandatory clearing 

determination. To the extent other providers 

establish indices with demonstrable open interest, 

trading volumes and pricing sources, the 

Commission will consider them for inclusion either 

within the current proposed classes of swaps, or 

within a separate class of swaps. Exclusion for the 

proposed classes only means that the CDS on such 

indices are not subject to a clearing requirement, 

and has no other impact on the use of such indices 

by market participants. 

41The term ‘‘reference entities’’ refers to those 

entities that form the basis of an index. For the 

indices discussed in this proposal, all of the 

reference entities are corporate entities. For 

example, when one of those corporate entities 

declares bankruptcy, it may trigger a credit event 

under the terms of the index. A credit event also 

may be declared when a reference entity fails to pay 

on an outstanding debt. 42See www.dtcc.com. Data as of May 21, 2012. 

43 ISDA’s Big Bang Protocol in April 2009, in 

addition to providing the ‘‘hardwiring’’ necessary 

for Auction Settlement and the establishment of the 

Credit Derivatives Determination Committees, also 

created a new standardized North American 

corporate CDS contract with fixed scheduled 

termination dates, fixed payment and accrual dates, 

and standardized coupons. See http:// 

www.isda.org/companies/auctionhardwiring/ 

auctionhardwiring.html. 

payments based upon the now smaller 

index covered by the swap. 

The most recent BIS study39 found 

that, as of December 2011, the size of 

the overall CDS marketplace exceeded 

$28.6 trillion in notional amount 

outstanding. Of that amount, $11.8 

trillion was in multi-name CDS 

agreements. Within this sub-category of 

CDS, CDS on indices accounted for 

more than 89% of the total notional 

amount outstanding. This continues a 

trend as CDS on standardized indices 

have seen increasing volumes relative to 

other multi-name instruments such as 

synthetic collateralized debt obligations 

and other bespoke products. 

Multiple providers have established 

CDS indices to be used by market 

participants. These providers typically 

establish an index’s constituents, as 

well as standard terms and tenors. They 

also may provide on-going pricing 

services for their indices. The CDS 

indices owned and managed by Markit 

have the dominant market share within 

this class of CDS. There are other 

providers of CDS indices, though to 

date, those indices have not been widely 

used. Currently none of the indices are 

the basis for any CDS cleared by a 

DCO.40 The Markit CDX family of 

indices is the standard North American 

credit default swap family of indices, 

with the primary corporate indices 

being the CDX North American 

Investment Grade (consisting of 125 

investment grade corporate reference 

entities 41) (CDX.NA.IG) and the CDX 

North American High Yield (consisting 

of 100 high yield corporate reference 

entities) (CDX.NA.HY). The standard 

currency for CDS on these indices is the 

U.S. dollar. 

Additionally, Markit owns and 

manages the iTraxx indices covering 

reference entities in the European and 

Asia/Pacific markets. The primary 

indices for the European markets are the 

iTraxx Europe which covers 125 

European investment grade corporate 

reference entities, the iTraxx Europe 

Crossover covering 50 European high 

yield reference entities and the iTraxx 

Europe High Volatility, which is a 30- 

entity subset of the European 

investment grade index. These indices 

are generally denominated in euro. 

Beyond those discussed above, Markit 

provides more granular indices covering 

specific corporate sectors in both the 

United States and Europe. Markit also 

provides indices that cover noncorporate reference entities, including 

indices of sovereign reference entities 

from around the world, U.S. municipal 

issuers and structured finance issuers. 

Some of the sector specific CDS, 

particularly those based on indices in 

the iTraxx family have significant 

volumes. For example, the iTraxx 

Europe Senior Financials referencing 

European financial institutions has over 

$13 billion in net notional and 3,711 

open contracts for Series 17 according to 

DTCC data.42 Those contracts are not 

currently cleared by a DCO and thus 

have not been submitted to the 

Commission. Therefore, these contracts 

are not being considered as part of the 

proposed clearing requirement 

determination discussed herein. To the 

extent these contracts were to be cleared 

by a DCO in the future, the DCO would 

be required to submit those contracts to 

the Commission for review pursuant to 

§ 39.5. If those contracts were not 

cleared by any DCO, they may still be 

subject to a Commission-initiated 

review pursuant to § 39.5(c) in the 

future. 

As administrator of these indices, 

Markit reviews the composition of 

underlying reference entities in the 

indices every six months. Once Markit 

establishes the constituents to be 

included within the indices, a new 

series of the respective index is created. 

Additionally, each time one of the 

reference entities within an index 

suffers a credit event, a new version of 

an existing series of the index is created. 

In addition to the series and version 

variations that may exist on the index, 

the parties can choose the tenor of the 

CDS on a given index. While the 5-year 

tenor is the most common, and therefore 

most liquid, other standard tenors may 

include 1-, 2-, 3-, 7-, and 10-year swaps. 

Beyond these administrative 

functions, Markit, in conjunction with 

ISDA, has established standardized 

transaction terms and legal 

documentation in the form of standard 

terms supplements and confirmations 

for their indices. In the vast majority of 

cases, transactions using the indices are 

executed using these standard terms, 

although the indices also may be used 

in connection with non-standard 

transactions. A particular CDS index 

agreement will only be eligible to be 

cleared by a DCO to the extent the 

agreement is based upon the standard 

terms. Consistent with the movement of 

the CDS market to standardized 

contracts and spreads, cleared contracts 

all use standardized spreads of 100 or 

500 basis points on the cost of 

protection, with the use of the upfront 

payments to accurately capture the cost 

of the credit protection on the indices.43

The CDS cleared by CME, ICE Clear 

Credit, and ICE Clear Europe that were 

submitted to the Commission are 

standardized contracts providing credit 

protection on an untranched basis, 

meaning that settlement is not limited to 

a specific range of losses upon the 

occurrence of credit events among the 

reference entities included within an 

index. Besides single name CDS, these 

untranched CDS on indices are the only 

type of CDS being cleared by these 

DCOs. Other swaps like credit index 

tranches, options, and first- or Nth-todefault baskets on these indices are not 

currently cleared. 

Both CME and ICE Clear Credit have 

submitted standard untranched CDS on 

the CDX.NA.IG and the CDX.NA.HY 

indices that they clear. CME offers the 

CDX.NA.IG at the 3-, 5-, 7- and 10-year 

tenors for each series going back to 

Series 9 for those contracts that have not 

reached their termination date. For the 

North American high yield index, CME 

offers clearing for Series 11 and each 

subsequent series at the 5-year tenure. 

ICE Clear Credit offers CDX.NA.IG 

Series 8 and all subsequent series of that 

index that are still outstanding at the 5- 

and 10-year tenors. Additionally, Series 

8 to Series 10 are cleared at the 7-year 

tenor. For the high yield index, ICE 

Clear Credit clears all series from the 

current series through the CDX.NA.HY 

Series 9 at the 5-year tenor. 

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44 Generally the market for all CDS is driven by 

dealers. Recent estimates found that about 74% of 

CDS trading takes place among 20 dealer-banks 

worldwide, according to data from DTCC., which 

runs a central registry for credit derivatives. See 

http://www.bloomberg.com/news/2011-11-01/ 

selling-more-insurance-on-shaky-european-debtraises-risk-for-u-s-banks.html. 

45The term ‘‘on-the-run’’ refers to current series 

of an index, while older series are referred to ‘‘offthe-run.’’ Each six months when a new series is 

created (or ‘‘rolls’’ using market terminology), the 

new series is considered the ‘‘on-the-run’’ index, 

and all others are considered ‘‘off-the-run.’’ 

46Clearing rules generally provide for a 

mechanism for DCOs to levy fines against clearing 

members for failure to submit accurate prices across 

the full term structure for a given product. 

47The theoretical spread/price of the index may 

be calculated by looking at the spread/price of each 

of the individual constituents in the index, though 

this may not account for the actual demand to buy 

or sell protection based on the index itself. 

48Such single name CDS are defined as ‘‘securitybased swaps’’ under section 721(a) of the DoddFrank Act. 

49See BIS data, available at http://www.bis.org/ 

statistics/otcder/dt1920a.pdf. 

50See ICE Clear Credit’s petitions to the 

Commission and SEC, dated October 4, 2011. The 

petition to the Commission is available at http:// 

www.cftc.gov/stellent/groups/public/ 

@rulesandproducts/documents/ifdocs/ 

iceclearcredit100411public.pdf. 

In addition to these indices, ICE Clear 

Credit has also cleared the CDX North 

American Investment Grade High 

Volatility (consisting 30 names from the 

CDX.NA.IG) (CDX.NA.IG.HVOL). ICE 

Clear Credit is not however clearing 

Series 18, the most recently established 

series of the CDX.NA.IG.HVOL or Series 

17, given the limited trading volumes 

for this swap. ICE Clear Credit only 

clears the CDX.NA.IG.HVOL for Series 9 

through Series 16, and only at the 5-year 

tenor. 

ICE Clear Europe, another registered 

DCO, made a submission covering the 

index CDS that it clears. Similar to the 

other submissions, the contracts that 

ICE Clear Europe clears are focused on 

corporate reference entities, though in 

this case, the entities are based in 

Europe. Also, similar to the CME and 

ICE Clear Credit submissions, the swaps 

cleared by ICE Clear Europe are indices 

owned and administered by Markit. ICE 

Clear Europe clears the eurodenominated contracts referencing the 

iTraxx Europe, the iTraxx Europe 

Crossover, and the iTraxx Europe High 

Volatility. For the iTraxx Europe and 

Crossover, ICE Clear Europe clears 

outstanding contracts in the Series 7 

and 8, respectively, through the current 

series. For the High Volatility index, ICE 

Clear Europe clears outstanding 

contracts in the Series 9 through the 

current series. In terms of tenors, ICE 

Clear Europe clears the 5-year tenor for 

all swaps, as well as the 10-year tenor 

for the iTraxx Europe index. 

Based upon those portions of the 

CME, ICE Clear Credit, and ICE Clear 

Europe swap submissions relating to the 

cleared CDS contracts discussed above, 

as well as the analysis conducted by the 

Commission pursuant to § 39.5(b) and 

set forth below, the Commission is 

reviewing the following classes of swaps 

for purposes of the clearing 

requirement. 

iii. CDS Trading and Risk Management 

The indices were created in the mid2000s. Parties to these OTC contracts 

could use the indices to express their 

bullish or bearish sentiments on credit 

as an asset class, or to actively manage 

their credit exposures.44 As 

standardized contracts and indices, they 

had increased liquidity and were 

cheaper and easier to enter into than a 

customized transaction. Following the 

financial crisis, the popularity of such 

bespoke transactions like synthetic 

collateral debt obligations decreased 

and the standardized indices continued 

to grow. 

Markit licenses its indices to market 

making financial institutions. 

Notwithstanding that these contracts 

trade as OTC products, the 

standardization of the contracts has 

allowed for them to be completed and 

confirmed electronically by a number of 

service providers. The 5-year tenor is 

the most liquid of the tenors. Similarly, 

the current ‘‘on-the-run’’ series tend to 

see the most liquidity, while the older 

‘‘off-the-run’’ series tend to see less 

liquidity.45 Many investors exit 

positions in an existing series when a 

new series ‘‘rolls,’’ explaining increased 

liquidity in the ‘‘on-the-run’’ series. As 

noted above, the pricing for the contract 

is generally set at a standardized rate of 

100 or 500 basis points, with upfront 

payments exchanged to compensate for 

the actual price of the credit protection 

being provided. 

For the DCOs clearing these swaps, 

the key factors in managing the risk of 

CDS portfolios that they clear are 

changes in the price of the swaps, the 

idiosyncratic risk related to the default 

of a reference entity, and the liquidity 

risk associated with unwinding a 

portfolio of a defaulting clearing 

member. While differing in the specific 

margin methodologies, each of the DCOs 

uses methodologies designed to capture 

99% of potential portfolio losses over a 

five-day period. The DCOs will stress 

CDS portfolios with shifts both up and 

down in the price of the CDS, as well 

as with changes to the slope of the term 

structure of the CDS pricing curve. 

Idiosyncratic risk will be captured by a 

‘‘jump-to-default’’ analysis in which 

widely held reference entities are 

assumed to default with limited or no 

recovery. Liquidity risk seeks to capture 

the cost of liquidating a portfolio, with 

assumed higher costs associated with 

concentrated portfolios. 

The DCOs conduct end-of-day 

settlement on the CDS, using prices 

submitted by clearing members that 

hold a cleared position in that swap. 

According to DCO rules, the submitted 

prices may be traded against, such that 

members are incentivized to submit 

accurate pricing data. The DCOs analyze 

the submitted data to remove any 

outliers.46 The DCOs then calculate a 

composite spread or price by 

aggregating all the prices individually 

submitted, after deleting the outliers.47

The more liquid a particular swap, the 

more price submissions will be made. 

In the event of a default of a clearing 

member, the DCOs have the ability to 

conduct an auction for other members to 

bid on all or a portion of the defaulting 

member’s portfolio of CDS positions. To 

the extent that the DCO was unable to 

sell the entire portfolio, the clearing 

rules require the non-defaulting clearing 

members to accept an apportionment of 

such portfolio if required by the DCO. 

To the extent the market for a swap is 

more liquid, the chances for a successful 

auction would likely be increased. 

Further, to the extent an auction is 

unsuccessful, a more liquid market 

would give the clearing member 

receiving such an apportionment a 

better opportunity to successfully sell or 

otherwise offset the risk associated with 

the CDS it accepted. 

In addition to the CDS indices, ICE 

Clear Credit and ICE Clear Europe also 

offer single name CDS 48 for clearing. Of 

the $29 trillion in CDS notional 

outstanding, approximately $17 trillion 

is in single name swaps according to the 

latest market survey of BIS.49 As part of 

their margining methodology, DCOs are 

seeking approval to offer portfolio 

margining for the single name CDS and 

the CDS indices held within a given 

portfolio.50 Given that the single name 

reference entities will likely also be 

constituents of a given index within a 

portfolio, the Commission generally 

believes that such portfolio margining 

initiatives are consistent with the sound 

risk management policies for DCOs that 

are required under § 39.13(g)(4). 

Moreover, DCOs such as ICE Clear 

Credit already use margining 

methodologies that provide for 

appropriate portfolio margining 

treatment with regard to clearing 

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51See ICE Clear Credit’s certification to the 

Commission, dated as of November 25, 2011. The 

certification is available at http://www.cftc.gov/ stellent/groups/public/@rulesandproducts/ 

documents/ifdocs/rul112511icecc001.pdf. 

members’ proprietary positions.51 The 

Commission is committed to working 

toward establishing similar portfolio 

margining programs for DCOs clearing 

customer positions in CDS indices and 

single name CDS. 

iv. CDS Classes Based on Key 

Specifications 

Under § 39.5, the decision of the 

Commission to require that a group, 

category, type, or class of swaps be 

required to be cleared is informed by a 

number of factors. As an initial matter, 

the Commission looks to the 

submissions of the DCO themselves 

with regard to the swaps they submit. 

After analyzing the key attributes of the 

swaps submitted, the Commission is 

proposing to establish two classes of 

CDS subject to the clearing requirement. 

The first class is based on the North 

American untranched indices and the 

second class is based on the European 

untranched indices. 

Given the different markets that the 

CDS indices cover, the different 

currencies and other logistical 

differences in how the CDS markets and 

documentation work, the Commission 

believes this is an appropriate basis for 

separate classes. In the case of the 

submissions received to date, the U.S. 

dollar-denominated CDS covering North 

America corporate credits would be a 

separate class of CDS from a eurodenominated CDS referencing European 

obligations. 

The nature of the underlying 

reference entities for the CDS serve to 

establish the another specification. Each 

index referenced was a broad-based 

pool of corporate entities. These indices 

included both investment grade and 

high yield corporate entities and they 

were not limited by a specific sector 

type. The data available for corporate 

CDS transactions, including the CDS 

indices, is substantial. As new swaps 

are cleared and considered by class, the 

nature of the underlying index will 

continue to be a factor in the 

establishment of such classes. 

As noted above, the regional 

differences in the way CDS indices are 

traded and cleared warrant a separate 

specification based upon common 

market standards established within the 

regions. Beyond different currencies, the 

key terms of the underlying CDS, 

including the relevant credit events, 

may differ with direct impact on the 

clearing and risk management of these 

products by DCOs. 

The actual indices included within a 

class are also specified. As only certain 

indices for a type of reference entity 

may have significant trading volumes 

and be cleared within a particular 

region, it is necessary to identify those 

specific indices within the classes. 

The classes are also being defined by 

particular tenors for the various indices 

included within the class. Given varying 

outstanding notional amounts and 

trading volumes on different tenors of 

existing indices, the Commission has 

analyzed the impact of including all or 

only select tenors within a given class. 

In addition, applicable series are 

identified within each tenor so that 

market participants can identify 

whether a particular series of given 

index is required to be cleared. 

Finally, the nature of the CDS itself 

referencing the underlying indices will 

be a factor as well. Each of the 

submissions dealt only with untranched 

CDS on the indices. There is a 

significant market for tranched swaps 

using the indices, where parties to the 

CDS contract agree to address only a 

certain range of losses along the entire 

loss distribution curve. Other swaps 

such as first or ‘‘Nth’’ to default baskets, 

and options, also exist on the indices. 

v. Identification of Specifications 

The Commission is proposing two 

classes of CDS contracts subject to the 

clearing requirement. The first class 

would be untranched CDS contracts 

referencing corporate entities in North 

America via Markit’s CDX.NA.IG and 

CDX.NA.HY indices. The second class 

would include untranched CDS 

referencing European corporate entities 

via Markit’s iTraxx Europe, iTraxx 

Europe Crossover and iTraxx Europe 

High Volatility. The following table sets 

forth the specific specifications of each 

class: 

TABLE 1 

North American Untranched CDS Indices Class 

Specification 

1. Reference Entities ...................... Corporate. 

2. Region ......................................... North America. 

3. Indices ......................................... CDX.NA.IG. 

CDX.NA.HY. 

4. Tenor ........................................... CDX.NA.IG: 3Y, 5Y, 7Y, 10Y. 

CDX.NA.HY: 5Y. 

5. Applicable Series ........................ CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current Series. 

CDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current Series. 

CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current Series. 

CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current Series. 

CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current Series. 

6. Tranched ..................................... No. 

European Untranched CDS Indices Class 

Specification 

1. Reference Entities ...................... Corporate. 

2. Region ......................................... Europe. 

3. Indices ......................................... iTraxx Europe. 

iTraxx Europe Crossover. 

iTraxx Europe HiVol. 

4. Tenor ........................................... iTraxx Europe: 5Y, 10Y. 

iTraxx Europe Crossover: 5Y. 

iTraxx Europe HiVol: 5Y. 

5. Applicable Series ........................ iTraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current Series. 

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52To the extent other vendors successfully 

develop similar indices, the Commission would 

conduct the analysis required by § 39.5, either on 

its own initiative or based on a DCO submission. 

If based on that analysis the Commission issued a 

clearing requirement determination, it is likely that 

such indices would be considered to be part of an 

existing class of CDS that are required to be cleared. 53See www.dtcc.com. Data as of May 21, 2012. 

TABLE 1—Continued 

iTraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current Series. 

iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series. 

iTraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including the current Series. 

6. Tranched ..................................... No. 

The Commission is proposing to 

separate the classes of corporate swaps 

between the North American contracts 

and European contracts. The 

Commission believes that indices based 

on other types of entities would be 

viewed as a separate class and would be 

subject to a separate determination by 

the Commission. For example, given the 

differences that exist with regard to 

volumes and risk management of 

indices based on sovereign issuers, it is 

likely that such CDS would represent 

their own class of swaps. Similarly, to 

the extent indices from other regions 

were submitted by a DCO, it is likely 

that the Commission would take the 

view that they are part of their own 

class of swaps as well. 

The Commission believes it 

appropriate to define the classes of 

swaps as untranched CDS contracts 

referencing the broad-based corporate 

indices of Markit. These corporate 

indices have the most net notional 

outstanding, the most trading volumes, 

and the best available pricing. The risk 

management frameworks for the 

corporate index swaps are the most 

well-established, and have the most 

available data in terms of CDS spreads 

and corporate default studies for 

analysis of the underlying constituents 

of the indices. Agreements based on 

these indices also are widely accepted 

and use standardized terms.52

Both of the CDS classes presented 

herein assume that the relevant CDS 

agreement will use the standardized 

terms established by Markit/ISDA with 

regard to the specific index and be 

denominated in a currency that is 

accepted for clearing by DCOs. To the 

extent that a CDS agreement on an index 

listed within the classification is not 

accepted for clearing by any DCO 

because it uses non-standard terms or is 

denominated in a currency that makes 

it ineligible for clearing, that CDS would 

not be subject to the requirement that it 

be cleared, notwithstanding that the 

CDS is based on such index. 

With regard to the specific indices, 

the Commission has not included the 

CDX.NA.IG.HVOL within the North 

American swap class. While older series 

of this swap were cleared at the 5-year 

tenor by ICE Clear Credit, neither of the 

two most recent series has been cleared, 

given the lack of trading volume in this 

swap. The swap is not offered for 

clearing by CME. To the extent that any 

DCO decides to clear future series of 

this particular indice, it would need to 

be submitted pursuant to § 39.5, at 

which time, the Commission would be 

able to revisit the profile of the 

underlying index and determine 

whether swap contracts associated with 

this index should be subject to a 

clearing requirement. 

ICE Clear Europe continues to clear 

the iTraxx Europe High Volatility 

through the current series at the 5-year 

tenor, notwithstanding declines in the 

volume for the recent series. Overall, the 

outstanding notional amounts and 

trading volumes are substantially less 

than those of the other iTraxx swaps. 

Recent DTCC data indicates that the 

gross notional amounts on contracts on 

the iTraxx Europe High Volatility index 

was $1.8 billion, representing less than 

1% of those volumes for the European 

investment grade index and 

approximately 2.5% of the European 

high yield index for the same series.53

Notwithstanding the relatively small 

volumes, the Commission is proposing 

to include the iTraxx Europe High 

Volatility index within the class of 

European corporate indices subject to 

required clearing at this time. Because 

the current on-the-run series of this 

particular index is cleared, unlike the 

similar North American contract, the 

Commission believes the contract 

should be included within the class of 

European corporate swaps that is 

required to be cleared. 

With regard to tenors, Markit, as 

administrator of the indices, publishes 

the initial spreads on the roll for each 

of the tenors offered for a given indice. 

For the CDX.NA.IG, it publishes spreads 

for the 1-, 2-, 3-, 5-, 7-, and 10-year 

tenors. For the CDX.NA.HY, the spreads 

are set for the 3-, 5-, 7-, and 10-year 

tenors. For the iTraxx Europe, Crossover 

and High Volatility, spreads are 

similarly set for the 3-, 5-, 7-, and 10- 

year tenors. 

Notwithstanding these various tenor 

offerings, the 5-year tenor for all indices 

is by far the most liquid tenor in the 

CDS marketplace. As a result, each DCO 

clears the 5-year tenor of the CDS index 

swaps that they clear. CME additionally 

offers clearing for 3-, 7-, and 10-year 

tenors on the CDX.NA.IG. ICE Clear 

Credit offers clearing on the 10-year 

tenor for the North American 

investment grade swap in addition to 

the 5-year contract. In the past, ICE 

Clear Credit has cleared the 7-year tenor 

of that index, but has not offered that 

tenor since Series 10. For the iTraxx 

indices, ICE Clear Europe offers the 10- 

year tenor on the investment grade 

index, in addition to the 5-year tenor. 

Based upon its analysis of the § 39.5 

factors, the Commission is proposing 

that each of the 3-, 5-, 7-, and 10-year 

tenors be included within the class of 

swaps subject to the clearing 

requirement determination for 

CDX.NA.IG. While the DCO 

submissions indicate varying degrees of 

trading volumes among the indices at 

tenors other than the 5-year tenor, there 

are clearly large notional volumes and 

trading activity across the products as a 

whole. The risk management 

frameworks and methodologies 

employed by the DCOs should not be 

substantially impacted or can be 

adjusted to accommodate additional 

tenors. The remaining factors should be 

unchanged. 

The Commission is proposing to 

exclude the 1- and 2-year tenors of the 

CDX.NA.IG from the class at this point. 

The Commission would like to see more 

data on the volumes of these tenors. 

Importantly, these tenors of swaps have 

not been submitted to the Commission 

by a DCO, so the Commission could 

review them when submitted by a DCO 

or on its own initiative pursuant to the 

§ 39.5(c). Because many investors use 

the 5-year tenor to take a view on credit 

as an asset class, and then exit the 

position when the new index rolls 

rather than hold a less liquid position in 

an off-the-run swap, the Commission is 

concerned that those seeking to avoid 

clearing may shift to the 1- or 2-year 

tenor to take a position on credit. The 

Commission will monitor volumes in 

the swaps at these tenors and evaluate 

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54After its initial submission, ICE Clear Credit 

added the CDX.NA.HY, Series 15, 3-year contract to 

its list of CDS contracts eligible for clearing. The 

Commission has reviewed this contract, but is not 

including this particular contract within its 

proposed determination. The Commission will 

monitor volumes in the product at these tenors and 

evaluate whether a change in the class of swaps to 

include additional tenors is warranted. 

55As discussed in further detail below, the 

clearing requirement would not require existing 

swaps in the older series to be cleared. The 

requirement is prospective, only requiring newly 

executed swaps in these older series to be cleared. 

whether a change in the class of swaps 

to include these tenors is warranted. 

With regard to the CDX.NA.HY, the 

Commission’s proposal will be limited 

to the 5-year tenor, the predominant 

tenor in this contract.54 Similarly, the 

Commission’s proposal with regard to 

the iTraxx indices will capture only 

those tenors that are currently offered 

for clearing—the 5- and 10-year tenors 

for the iTraxx Europe, and the 5-year 

tenors for the iTraxx Crossover and the 

iTraxx High Volatility. 

The Commission’s proposed clearing 

determination will be limited to only 

those series of a given index, which are 

currently being cleared. Therefore, no 

swaps referencing a series prior to 

Series 8 for the CDX.NA.IG and 

CDX.NA.HY would be required to be 

cleared. For the iTraxx Europe and 

iTraxx Europe Crossover, no contracts 

referencing a series prior to Series 7 

would be required to be cleared, and in 

the case of the iTraxx Europe High 

Volatility, no series prior to Series 9 

would be required to be cleared.55

Further, to the extent that any 

contract is of a tenor such that it is 

scheduled to terminate prior to July 1, 

2013, such contract would not be part 

of this proposed clearing determination. 

Given the implementation periods 

provided for under § 50.25, discussed 

below in Section IV, the Commission 

does not want to create a situation 

where certain market participants 

would be required to clear a contract 

based upon their status under the 

implementation provisions, but other 

parties would never be required to clear 

that same contract before its scheduled 

termination. 

The Commission also is proposing 

that the classes be limited to untranched 

CDS agreements on the aforementioned 

indices where the contract covers the 

entire index loss distribution of the 

index and settlement is not linked to a 

specified number of defaults. Tranched 

swaps, first- or ‘‘Nth’’ to-default, 

options, or any other product variations 

on these indices are excluded from 

these classes. These other swaps based 

on the indices, such as tranches, have 

very different profiles in terms of the 

§ 39.5 analysis. Besides very different 

notional and trading volumes, the risk 

management processes and operations 

may be significantly different. The 

Commission believes it appropriate to 

consider tranched swaps and other 

variations on the indices as outside of 

the classes of swaps proposed herein. 

Such swaps, if submitted, likely would 

be viewed as a separate class. 

D. Proposed Determinations Analysis 

for Credit Default Swaps 

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

requires the Commission to review 

whether a swap submission under 

section 2(h)(2)(B) is consistent with 

section 5b(c)(2) of the CEA. Section 

2(h)(2)(D)(ii) of the CEA also requires 

the Commission to consider five factors 

in a determination based on a 

Commission initiated review or a swap 

submission: (1) The existence of 

significant outstanding notional 

exposures, trading liquidity, and 

adequate pricing data; (2) the 

availability of rule framework, capacity, 

operational expertise and resources, and 

credit support infrastructure to clear the 

contract on terms that are consistent 

with the material terms and trading 

conventions on which the contract is 

then traded; (3) the effect on the 

mitigation of systemic risk, taking into 

account the size of the market for such 

contract and the resources of the DCO 

available to clear the contract; (4) the 

effect on competition, including 

appropriate fees and charges applied to 

clearing; and (5) the existence of 

reasonable legal certainty in the event of 

the insolvency of the relevant DCO or 

one or more of its clearing members 

with regard to the treatment of customer 

and swap counterparty positions, funds, 

and property. 

i. Consistency With Core Principles for 

Derivatives Clearing Organizations 

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

requires the Commission to review 

whether a submission is consistent with 

the core principles for DCOs. Each of 

the DCO submissions relating to CDS 

provided data to support the 

Commission’s analysis of the five factors 

under section 2(h)(2)(D) of the CEA. The 

Commission also was able to call upon 

independent analysis conducted with 

regard to CDS market, as well as its 

knowledge and reviews of the registered 

DCOs’ operations and risk management 

processes, covering items such as 

product selection criteria, pricing 

sources, participant eligibility, and 

other relevant rules. The discussion of 

all of these factors is set forth below. 

The swaps submitted by CME, ICE 

Clear Credit, and ICE Clear Europe 

pursuant to § 39.5(b) are currently being 

cleared by those organizations. As 

discussed above, the risk management, 

rules, and operations used by each DCO 

to clear these swaps are subject to 

review by the Commission risk 

management, legal, and examinations 

staff on an on-going basis. 

Additionally, each of the DCOs has 

established procedures for the review of 

any new swaps offered for clearing. 

Before the indices referenced herein 

were accepted for clearing by any of the 

DCOs, they were subject to review by 

the risk management functions of those 

organizations. Such analysis generally 

focuses on the ability to risk manage 

positions in the potential swaps and on 

any specific operational issues that may 

arise from the clearing of such swaps. In 

the case of the former, this involves 

ensuring that adequate pricing data is 

available, both historically and on a 

‘‘going forward’’ basis, such that a 

margining methodology could be 

established, back-tested, and used on an 

on-going basis. Operational issues may 

include analysis of additional contract 

terms for new swaps that may require 

different settlement procedures. Each of 

the contracts submitted by CME, ICE 

Clear Credit, and ICE Clear Europe and 

discussed herein has undergone an 

internal review process by the 

respective DCO and has been 

determined to be within their product 

eligibility standards. 

As part of their rule frameworks, each 

of the DCOs also maintains participant 

eligibility requirements. On April 20, 

2012, CME filed its amended rule 

concerning CDS Clearing Member 

Obligations and Qualifications (Rule 

8H04). Pursuant to the amended rule, 

published to comply with Commission 

Regulation 39.12(a)(2), a CDS clearing 

member would have to maintain at least 

$50 million of capital. The amended 

rule would also require a CDS clearing 

member’s minimum capital requirement 

to be ‘‘scalable’’ to the risks it poses. 

Further, CME already has client clearing 

available for its CDS index contracts. 

Similarly, on March 23, 2012, ICE 

Clear Credit filed its amended Rule 

201(b) to incorporate the $50 million 

minimum capital requirement for 

clearing members. ICE Clear Credit also 

has client clearing available for its CDX 

index contracts. 

ICE Clear Europe has adopted similar 

rules to comply with § 39.12(a)(2), and 

has instituted changes to its rules to 

permit client clearing of its iTraxx 

contracts. 

In their submissions, CME and ICE 

Clear Credit enclosed their risk 

management procedures. In its 

submission, ICE Clear Europe references 

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56Based on Commission data for registered DCOs 

as of May 10, 2012. 

57See http://www.cmegroup.com/clearing/cmeclearing-overview/safeguards.html for data 

regarding CME’s guaranty fund, as of May 10, 2012; 

https://www.theice.com/clear_credit.jhtml for data 

on the size of ICE Clear Credit’s guaranty fund; and 

https://www.theice.com/clear_europe_cds.jhtml for 

data on the size of ICE Clear Europe’s guaranty fund 

for CDS, as of May 10, 2012. 

58Many DCOs also have rules allowing for an 

assessment of the remaining clearing members in 

the event of a default. 

59Based on data published on www.markit.com 

as of May 23, 2012. 

its risk management procedures, which 

it had previously submitted to the 

Commission in connection with its 

application to register as a DCO. As part 

of its risk management and examination 

functions, the Commission reviews each 

DCO’s risk management procedures, 

including its margining methodologies. 

ICE Clear Credit uses a multi-factor 

model to margin the indices discussed 

herein, as well as single name CDS. The 

margining methodology is designed to 

capture the risk of movements in credit 

spreads, liquidation costs, jump-todefault risk for those names on which 

credit protection has been sold, large 

position concentration risks, interest 

rate sensitivity, and basis risk associated 

with offsetting index derived single 

names and opposite ‘‘outright’’ single 

names. These factors are similarly used 

by ICE Clear Europe to calculate the 

margining requirements for their iTraxx 

swap listings and the underlying single 

name constituents. The CME’s CDS 

model also weighs a number of factors 

to calculate the initial margin for a 

portfolio of CDS positions. These 

include macro-economic risk factors, 

such as movements associated with 

systematic risk resulting in large shifts 

in credit spreads across a portfolio, 

shifts in credit spreads based on tenors 

and changes in relative spreads between 

investment grade and high yield 

spreads. Additional factors include 

specific sector risks, the idiosyncratic 

risk of extreme moves in particular 

reference entities and the liquidity risk 

associated with unwinding the 

portfolio. In all cases, the methodologies 

are designed to protect against any 5- 

day move in the value of the given CDS 

portfolio, with a 99% confidence level. 

In addition to initial margin, each of 

the clearinghouses collects variation 

margin on a daily basis to capture 

changes in the mark-to-market value of 

the positions. To do this, the 

clearinghouses calculate end-of-day 

settlement prices using clearing member 

price submissions for cleared swaps. 

Each of the clearinghouses maintains 

processes for ensuring the quality of 

member price submissions, including 

the ability to compel trades at quoted 

prices on a random basis and to enforce 

fines on incomplete or incorrect 

submissions. ICE Clear Credit and ICE 

Clear Europe also use Markit services 

for CDX and iTraxx submissions. CME 

uses other third party data providers for 

pricing support as necessary on its 

cleared CDS products. 

In addition to the end-of-day 

settlement, each of the clearinghouses 

monitors positions throughout the day 

and maintains the ability to require 

margin on an intraday basis. Triggers 

may be set based upon the erosion of 

margin to a specific level or a call may 

be made at the discretion of the 

clearinghouse. When necessary, DCOs 

apply concentration charges to a 

clearing member’s house or customer 

account in order to address situations 

where the DCO believes a given position 

may be under-collateralized because the 

size of the position relative to the size 

of the market may increase the cost of 

liquidating the position. 

In addition to the initial margin and 

variation margin collected by each DCO, 

each of the clearinghouses maintains a 

separate guaranty fund for its CDS 

clearing business. Using a combination 

of factors from their margining 

methodologies, positions are stressed to 

replicate extreme but plausible market 

conditions. Using these stressed results, 

each of the clearinghouses sizes its 

guaranty fund to cover the positions of 

its two largest debtor clearing members. 

Clearing members are required to 

contribute to the guaranty fund based on 

their relative positions. 

To the extent a clearing member was 

unable to meet a margin call, or 

otherwise violated clearinghouse rules, 

each of the clearinghouses has the 

ability to find a clearing member in 

default. In such cases, each of the 

clearinghouses has established 

procedures by which it attempts to 

minimize the risk associated with a 

defaulting member’s positions. A 

clearinghouse would activate its default 

committee, seconding traders from 

clearing participants, to work to 

partition the portfolio for sale and for 

hedging purposes. The clearinghouse 

would then conduct an auction among 

its clearing participants for the sale of 

the portfolio. To the extent certain 

positions were unsold, each of the 

clearinghouses has the ability to allocate 

such positions to the remaining clearing 

members. 

While other resources of the 

clearinghouse would be available in the 

event of a default of a clearing member, 

including clearinghouse contributions, 

the initial margin and guaranty fund 

contributions make up the primary 

financial resources of the 

clearinghouses. In total, CFTC-registered 

DCOs are currently holding more than 

$20 billion in aggregate in initial margin 

to cover cleared CDS positions.56

Additionally, publicly available data 

shows that CME’s CDS guaranty fund 

has approximately $629 million; ICE 

Clear Credit has a guaranty fund equal 

to $4.4 billion; and ICE Clear Europe has 

a guaranty fund Ö2.7 billion for its CDS 

business.57 In addition to the guaranty 

fund contributions made by clearing 

members, each of the clearinghouses 

also makes contributions to their 

respective funds, ranging in amounts 

from $50 to $100 million.58

Based upon the Commission’s ongoing risk management and rule 

reviews, and its annual examinations of 

the DCOs, the Commission believes that 

the submissions of CME, ICE Clear 

Credit, and ICE Clear Europe are 

consistent with section 5b(c)(2) of the 

CEA and the related Commission 

regulations. In analyzing the CDS 

products submissions discussed herein, 

the Commission does not believe that a 

clearing determination with regard to 

the specified CDS products would be 

inconsistent with CME, ICE Clear 

Credit, or ICE Clear Europe’s continued 

ability to maintain such compliance 

with the DCO core principles. 

ii. Consideration of the Five Statutory 

Factors for Clearing Requirement 

Determinations 

a. Outstanding Notional Exposures, 

Trading Liquidity, and Adequate Pricing 

Data 

Section 2(h)(2)(D)(ii)(I) of the CEA 

requires the Commission to take into 

account the existence of outstanding 

notional exposures, trading liquidity, 

and adequate pricing data. As discussed 

earlier, the most recent BIS data has 

shown significant growth in the use of 

CDS on index products, with notional 

amounts growing by 40% over the most 

recent annual reporting period. Overall, 

CDS on index products account for 37% 

of all notional amounts of CDS contracts 

outstanding, with over $10 trillion in 

notional outstanding. 

The predominant provider of CDS 

indices is Markit. Markit has indices 

covering corporate and sovereign 

entities, among others, in the United 

States, Europe, and Asia. Recent Markit 

data shows daily transaction volumes of 

1,561 transactions using its licensed 

family of CDX indices, and 1,266 daily 

transactions using its European iTraxx 

index swaps.59 Further, it shows a 

rolling monthly average of $663 billion 

in gross notional amount for the CDX 

family of indices and Ö499 billion for 

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60 Data available at www.dtcc.com. In 2006, DTCC 

began providing warehouse services for confirmed 

CDS trades through its Trade Information 

Warehouse (TIW). With the commitment of global 

market participants in 2009 to ensure that all OTC 

derivatives trades are recorded by a central 

repository, TIW has become a global repository for 

all CDS trades. With all major market participants 

submitting their trades to the TIW, it is estimated 

that 98% of all CDS trades are included within the 

warehouse, making it the primary source of CDS 

transaction data. 

the iTraxx family. Nearly all of the CDX 

contracts and volumes come from 

indices that would be subject to the 

proposed clearing requirement 

determination. For the iTraxx, more 

than 79% of those daily contract 

volumes and 82% of the daily gross 

notional volumes come from the iTraxx 

investment grade and high yield indices 

contemplated by the proposed clearing 

requirement determination. 

One point highlighted by this data, 

however, is the declining trading 

liquidity in the off-the-run series that 

can occur. Of the volumes noted by 

Markit, nearly 60% was in the current 

on-the-run series, as compared to all 

other outstanding series combined. The 

submissions of ICE Clear Credit, ICE 

Clear Europe, and CME also note the 

decline in average weekly gross notional 

amounts and contracts for benchmark 

tenors for off-the-run indices. The 

decline however can be more 

precipitous among older off-the-run 

indices. While many market factors can 

contribute to the actual volumes for a 

specific off-the-run contract, subject to 

certain exceptions, the trend is generally 

toward lower volumes. 

Set forth below is a table of data taken 

from DTCC as of May 22, 2012, 

highlighting the net notional amounts 

and outstanding contracts across all 

tenors available for each series in the 

proposed determination.60

BILLING CODE 6351–01–P 

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Notwithstanding the declining 

volumes that occur when an index is no 

longer on-the-run, the Commission does 

not believe that is sufficient reason to 

exclude the older series from the classes 

of CDS. As the DTCC data indicates, 

there are still significant volumes of 

outstanding notional amounts in each of 

these series. From the perspective of the 

clearinghouse, the risk management of 

the older series of swaps should not 

provide significant additional 

challenges. With the significant notional 

and contract volumes still outstanding 

at DTCC, many clearing members 

already have these positions on their 

books and are meeting their risk 

management requirements, even in the 

face of declining trading volumes. 

Finally, while the volumes may decline, 

the data included in the submissions 

indicates that volume still does exist, 

and parties should be able trade as 

necessary. Additionally, as discussed 

further below, the clearing requirement 

would apply only to new swaps 

executed in the off-the-run indices. 

Given the contract and notional 

volumes listed above, there is adequate 

data available on pricing. The pricing 

for the CDS on these indices is fairly 

consistent across clearinghouses. The 

clearinghouses generally require a 

clearing member with open interest in a 

particular index to provide a price on 

that index for end of day settlement 

purposes. After applying a process to 

remove clear outliers, a composite price 

is calculated using the remaining prices. 

To ensure the integrity of the 

submissions, clearing members’ prices 

may be ‘‘actionable,’’ meaning that they 

may form the basis of an actual trade 

that the member will be forced to enter. 

Clearinghouses also have compliance 

programs that may result in fines for 

clearing members that fail to submit 

accurate pricing data. 

Beyond clearing member submissions, 

there are a number of third-party 

vendors that provide pricing services on 

these swaps. Third-party vendors 

typically source their data from a 

broader range of dealers. The data 

includes both direct contributions as 

well as feeds to automated trading 

systems. This data is reviewed for 

outliers and aggregated for distribution. 


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61See the June 2, 2009 letter to The Honorable 

William C. Dudley, President of the Federal Reserve 

Bank of New York, available at http:// 

www.newyorkfed.org/newsevents/news/markets/ 

2009/060209letter.pdf. 

62Available at: http://occ.treas.gov/topics/capitalmarkets/financial-markets/trading/derivatives/ 

dq311.pdf. 

63See U.S. Department of Justice and the Federal 

Trade Commission, Horizontal Merger Guidelines 

[hereinafter ‘‘Horizontal Merger Guidelines’’] at 

§ 1(Aug. 19, 2010), available at http://www.justice.

gov/atr/public/guidelines/hmg-2010.pdf. 

b. Availability of Rule Framework, 

Capacity, Operational Expertise and 

Resources, and Credit Support 

Infrastructure 

Section 2(h)(2)(D)(ii)(II) of the CEA 

requires the Commission to take into 

account the availability of rule 

framework, capacity, operational 

expertise and resources, and credit 

support infrastructure to clear the 

contract on terms that are consistent 

with the material terms and trading 

conventions on which the contract is 

then traded. The Commission 

preliminarily has determined that this 

factor is satisfied by each of CME, ICE 

Clear Credit, and ICE Clear Europe. 

CME, ICE Clear Credit, and ICE Clear 

Europe, respectively, currently are 

clearing the swaps each submitted 

under § 39.5. As such, they have 

developed respective rule frameworks, 

capacity, operational expertise and 

resources, and credit support 

infrastructure to clear the contracts on 

terms that are consistent with the 

material terms and trading conventions 

on which the contracts currently are 

trading. The Commission believes that 

these are scalable and that CME, ICE 

Clear Credit, and ICE Clear Europe 

would be able to risk manage the 

additional swaps that might be 

submitted due to the clearing 

requirement determination. 

Following the financial crisis, the 

major market participants committed in 

2009 to the substantial reforms to the 

OTC derivatives markets.61 Among the 

commitments from CDS dealers and buy 

side participants was to actively engage 

with central counterparties to broaden 

the range of cleared swaps and market 

participants. These changes were in 

addition to those generated through 

organizations like ISDA and their 

protocols impacting CDS. For broadly 

traded swaps like the CDS indices, the 

ultimate impact of these initiatives was 

operational platforms, rule frameworks, 

and other infrastructure initiatives that 

replicated the bilateral market and 

supported the move of these CDS to a 

centrally cleared environment. In this 

way, the CDS clearing services offered 

by DCOs, including CME, ICE Clear 

Credit, and ICE Clear Europe, were 

designed to be cleared in a manner that 

is consistent with the material terms 

and trading conventions of a bilateral, 

uncleared market. 

In addition, CME, ICE Clear Credit, 

and ICE Clear Europe are registered 

DCOs. To be registered as such, CME, 

ICE Clear Credit, and ICE Clear Europe 

have, on an on-going basis, 

demonstrated to the Commission that 

they are each in compliance with the 

core principles set forth in the CEA and 

Commission regulations, as discussed 

above. As a general matter, any DCO 

that does not have the rule framework, 

capacity, operational expertise and 

resources, and credit support 

infrastructure to clear the swaps that are 

subject to mandatory clearing is not in 

compliance with the core principles or 

the Commission regulations 

promulgating these principles. 

The Commission requests comment 

on all aspects of this factor, including 

whether or not commenters agree that 

an applicant’s status as a registered DCO 

is sufficient for meeting the factor’s 

requirements. 

c. Effect on the Mitigation of Systemic 

Risk 

Section 2(h)(2)(D)(ii)(III) of the CEA 

requires the Commission to take into 

account the effect on the mitigation of 

systemic risk, taking into account the 

size of the market for such contract and 

the resources of the DCO available to 

clear the contract. The Commission 

agrees with the § 39.5 swap submissions 

of the CME, ICE Clear Credit, and ICE 

Clear Europe that requiring certain 

classes of CDS to be cleared would 

reduce systemic risk in this sector of the 

swaps market. As CME noted, the 2008 

financial crisis demonstrated the 

potential for systemic risk arising from 

the interconnectedness of OTC 

derivatives market participants and the 

limited transparency of bilateral, i.e. 

uncleared, counterparty relationships. 

According to the Quarterly Report 

(Third Quarter 2011) on Bank Trading 

and Derivatives Activities of the Office 

of the Comptroller of the Currency (OCC 

Report),62 CDS index products account 

for a significant percentage of the 

notional value of swaps positions held 

by financial institutions. According to 

ICE Clear Credit, the CDS indices it 

offers for clearing are among the most 

actively traded swaps with the largest 

pre-clearing outstanding positions, and 

ICE Clear Credit’s clearing members are 

among the most active market 

participants. ICE Clear Credit also noted 

that its clearing members clear a 

significant portion of their clearingeligible portfolio. 

Clearing the CDS indices subject to 

this proposal will reduce systemic risk 

in the following ways: Mitigating 

counterparty credit risk because the 

DCO would become the buyer to every 

seller of CDS indices subject to this 

proposal and vice versa; providing 

counterparties with daily mark-tomarket valuations and exchange of 

variation margin pursuant to a risk 

management framework; posting initial 

margin with the clearinghouse in order 

to cover potential future exposures in 

the event of a default; achieving 

multilateral netting, which substantially 

reduces the number and notional 

amount of outstanding bilateral 

positions; reducing swap counterparties’ 

operational burden by consolidating 

collateral management and cash flows; 

and eliminating the need for novations 

or tear-ups because clearing members 

may offset opposing positions. 

As discussed previously, the 

clearinghouses collect substantial 

amounts of collateral in the form of 

initial margin and guaranty fund 

contributions to cover potential losses 

on CDS portfolios. The methodologies 

for calculating these amounts are based 

on covering 5-day price movements on 

a portfolio with a 99% confidence level 

for initial margin, and longer liquidation 

periods and higher confidence levels 

under ‘‘extreme but plausible’’ 

conditions in the case of guaranty fund 

requirements. Beyond these financial 

resources, the clearinghouses have in 

place established risk monitoring 

processes, system safeguards, and 

default management procedures, which 

are subject to testing and review, to 

address potential systemic shocks to the 

financial markets. 

The Commission requests comment 

on all aspects of this factor, including 

the risk mitigation associated with 

proposed clearing determination. 

d. Effect on Competition 

Section 2(h)(2)(D)(ii)(IV) of the CEA 

requires the Commission to take into 

account the effect on competition, 

including appropriate fees and charges 

applied to clearing. Of particular 

concern to the Commission is whether 

this proposed determination would 

harm competition by creating, 

enhancing, or entrenching market power 

in an affected product or service market, 

or facilitating the exercise of market 

power.63 Under U.S. Department of 

Justice guidelines, market power is 

viewed as the ability ‘‘to raise price 

[including clearing fees and charges], 

reduce output, diminish innovation, or 

otherwise harm customers as a result of 

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47184 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

64 Id.; see also U.S. Department of Justice (DOJ) 

and the Federal Trade Commission (FTC), Antitrust 

Guidelines for Collaborations Among Competitors 

at § 1.2 (April 2000), available at http:// 

www.ftc.gov/os/2000/04/ftcdojguidelines.pdf (‘‘The 

central question is whether the relevant agreement 

likely harms competition by increasing the ability 

or incentive profitably to raise price above or 

reduce output, quality, service, or innovation below 

what likely would prevail in the absence of the 

relevant agreement’’). 

65 Included among these could be a separate 

product market for CDS indices licensing. 

66The federal antitrust agencies, the DOJ and 

FTC, use the ‘‘hypothetical monopolist test’’ as a 

tool for defining antitrust markets for competition 

analysis purposes. The test ‘‘identif[ies] a set of 

products that are reasonably interchangeable with 

a product,’’ and thus deemed to reside in the same 

relevant antitrust product or service market. ‘‘[T]he 

test requires that a hypothetical profit-maximizing 

firm, not subject to price regulation, that was the 

only present and future seller of those products 

(‘hypothetical monopolist’) likely would impose at 

least a small but significant and non-transitory 

increase in price (‘SSNIP’) on at least one product 

in the market.’’ In most cases, a SSNIP of five 

percent is posited. If consumers would respond to 

the hypothesized SSNIP by substituting alternatives 

to a significant degree to render it unprofitable, 

those alternative products/services are included 

within the relevant market. This methodological 

exercise is repeated until it has been determined 

that consumers have no further interchangeable 

products/services available to them. Horizontal 

Merger Guidelines at § 4.1. 

67See id. 

68 In other words, the Commission questions that, 

faced with a five percent non-transitory increase in 

the price of clearing the identified CDS classes, 

including fees and other charges, that the parties to 

these CDS transactions would forego clearing in 

sufficient volume to render the price increase 

unprofitable. 

69Stated another way, competitive or potentially 

competitive CDS indices other than Markit, or for 

Markit CDS tenors other than those subject to this 

proposal, may offer a reasonably interchangeable 

substitute for cleared transactions in the proposed 

classes proposed, particularly if the price of 

clearing the required classes increased five percent. 

70That said, the Commission recognizes that (1) 

to the extent the clearing services market for the 

CDS subject to this proposal, after foreclosing 

uncleared swaps, would be limited to a 

concentrated few participants with highly aligned 

incentives, and (2) the clearing services market is 

insulated from new competitive entry through 

barriers—e.g., high sunk capital cost requirements; 

high switching costs to transition from embedded, 

incumbents; and access restrictions, the proposed 

diminished competitive constraints or 

incentives.’’ 64

The Commission has identified the 

following putative product and service 

markets as potentially affected by this 

proposed clearing determination: A 

DCO service market encompassing those 

clearinghouses that currently (or with 

relative ease in the future could) clear 

the CDS subject to this proposal, and a 

CDS product market or markets 

encompassing the CDS that are subject 

to this determination.65 Without 

defining the precise contours of these 

markets at this time,66 the Commission 

recognizes that, depending on the 

interplay of several factors, this 

proposed swap determination 

potentially could impact competition 

within the affected markets. Of 

particular importance to whether any 

impact is, overall, positive or negative, 

is: (1) Whether the demand for these 

clearing services and swaps is 

sufficiently elastic that a small but 

significant increase above competitive 

levels would prove unprofitable because 

users of the CDS products and DCO 

clearing services would substitute other 

products/clearing services co-existing in 

the same market(s), and (2) the potential 

for new entry into these markets. The 

availability of substitute products/ 

clearing services to compete with those 

encompassed by this proposed 

determination, and the likelihood of 

timely, sufficient new entry in the event 

prices do increase above competitive 

levels, each operate independently to 

constrain anticompetitive behavior. 

Any competitive import would likely 

stem from the fact that proposed 

determination would (1) remove the 

alternative of not clearing the CDS 

subject to this proposal, and/or (2) 

single out Markit indices and certain 

tenors for determination. The proposed 

determination would not specify what 

CDS products (or products that compete 

with the proposed CDS classes) may or 

may not be offered, traded, or 

voluntarily cleared; or who may or may 

not compete to provide clearing services 

for the CDS subject to this proposal (as 

well as those not required to be cleared). 

With respect to the first potential area 

of competitive import, to the extent that 

parties to the CDS subject to this 

proposal consider clearing the 

transactions reasonably interchangeable 

with not clearing them, the proposed 

determination would eliminate at least 

one competitive substitute within the 

clearinghouse services market for the 

CDS subject to this proposal. Given the 

risk-mitigation purpose and benefit of 

migration to voluntary CDS clearing, 

however, the Commission sees some 

basis to doubt that, under the 

‘‘hypothetical monopolist’’ 

methodology,67 counterparties to 

cleared swaps would consider the 

alternative of not clearing CDS under 

this proposal as a reasonable substitute 

to a degree sufficient that they should be 

viewed as populating the same relevant 

market.68 And, if the alternative of not 

clearing the proposed classes of CDS 

falls outside of the relevant services 

market that includes clearing, the 

proposed clearing determination should 

not impact competition in the clearing 

services market. The Commission 

requests comment on the extent to 

which foregoing clearing is considered 

reasonably interchangeable with 

clearing the CDS subject to this proposal 

and, in particular, if parties transacting 

cleared swaps in these classes would 

forego clearing if clearinghouses raised 

the price of clearing five percent. The 

Commission also requests comment on 

whether a different percentage than five 

percent should be used. 

Moreover, even if cleared and noncleared transactions in the proposed 

CDS clearing requirement are now 

within the same relevant market, 

removing the uncleared option through 

this proposed rulemaking is not 

determinative of negative competitive 

impact. Other factors—including the 

availability of other substitutes within 

the market or potential for new entry 

into the market—may constrain market 

power. 

The Commission recognizes that 

currently no DCO clears CDS indices 

licensed by any other provider than 

Markit, suggesting the possibility that 

currently the clearing service market 

may be limited to the three providers 

(CME, ICE Clear Credit, and ICE Clear 

Europe) now clearing CDS indices 

licensed by Markit. This could be 

indicative, but is not dispositive, of 

whether a concentrated clearing services 

market susceptible to exercises of 

market power exists. The possibility 

remains that uncleared transactions on 

other indices, as well as cleared and 

uncleared transactions on Markit 

indices of tenors not included within 

the proposed determination, may also 

populate the affected clearing services 

market to constrain CME, ICE Clear 

Credit, and ICE Clear Europe from 

exercising market power.69 The 

Commission requests comment on the 

extent to which uncleared transactions 

on non-Markit indices, and cleared and 

uncleared transactions on Markit 

indices of tenors not included within 

the proposed determination, are 

considered reasonably interchangeable 

with clearing the CDS subject to this 

proposal; and, in particular, if parties 

transacting cleared CDS subject to this 

proposal would substitute uncleared 

transactions on non-Markit indices and/ 

or transactions on Markit CDS tenors 

not subject to this proposal if 

clearinghouses raised the price of 

clearing the CDS required to be cleared 

five percent. 

Additionally, the potential for new 

entry may constrain market power in an 

otherwise concentrated clearing services 

market. The Commission does not 

foresee that the proposed determination 

constructs barriers that would deter or 

impede new entry into a clearing 

services market.70 Indeed, there is some 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47185 

determination could have a negative competitive 

impact by increasing market concentration. 71See, e.g., Horizontal Merger Guidelines at § 9.2 

(entry likely if it would be profitable which is in 

part a function of ‘‘the output level the entrant is 

likely to obtain’’). 

72The Commission observes that an FCM or DCO 

also may be subject to resolution under Title II of 

the Dodd-Frank Act to the extent it would qualify 

as covered financial company (as defined in section 

201(a)(8) of the Dodd-Frank Act). 

73 If an FCM is also registered as a broker-dealer, 

certain issues related to its insolvency proceeding 

would also be governed by the Securities Investor 

Protection Act. 

74Claims seeking payment for the administration 

of customer property would share this priority. 

basis to expect that the determination 

could foster an environment conducive 

to new entry. For example, the proposed 

clearing determinations, and the 

prospect that more may follow, is likely 

to reinforce, if not encourage, growth in 

demand for clearing services. Demand 

growth, in turn, can enhance the sales 

opportunity, a condition hospitable to 

new entry.71 Further, this proposed 

determination may increase the 

incentive of competing indices 

providers (for illustration purposes, 

Standard & Poor’s) to support a new 

clearing services entrant through some 

form of partnership or other 

sponsorship effort. The Commission 

requests comment on the extent to 

which (1) entry barriers currently do or 

do not exist with respect to a clearing 

services market for the identified CDS 

classes; (2) the proposed determinations 

may lessen or increase these barriers; 

and (3) the proposed determinations 

otherwise may encourage, discourage, 

facilitate, and/or dampen new entry into 

the market. 

Also, while the proposed rule does 

single out Markit indices and certain 

CDS tenors for required clearing, for 

reasons similar to those discussed 

above, this does not foreclose 

competition from CDS on other indices 

or tenors, and may in fact encourage it. 

For example, the Commission 

anticipates that an attempt by Markit to 

increase indices licensing fees would 

present a competitive opportunity for 

current and potential future indices 

providers to capture market share and/ 

or entrants to leverage from market 

entry. The Commission requests 

comment on the extent to which 

competition in identified Markit CDS 

product markets may be impacted, 

including any expected impact on the 

price of Markit indices licenses, cost of 

swaps in the required classes, and entry 

conditions. 

In addition to what is noted above, 

the Commission requests comment, and 

quantifiable data, on whether the 

required clearing of any or all of these 

swaps will create conditions that create, 

increase, or facilitate an exercise of (1) 

clearing services market power in CME, 

ICE Clear Credit, ICE Clear Europe, and/ 

or any other clearing service market 

participant, including conditions that 

would dampen competition for clearing 

services and/or increase the cost of 

clearing services, and/or (2) market 

power in any product markets for 

Markit indices and CDS tenors, 

including conditions that would 

dampen competition for these product 

markets and/or increase the cost of CDS 

involving the proposed clearing 

requirement. The Commission seeks 

comment, and quantifiable data, on the 

likely cost increases associated with 

clearing, particularly those fees and 

charges imposed by DCOs, and the 

effects of such increases on 

counterparties currently participating in 

the market. The Commission also seeks 

comment regarding the effect of 

competition on risk management by 

DCOs. The Commission welcomes 

comment on any other aspect of this 

factor. 

e. Legal Certainty in the Event of the 

Insolvency 

Section 2(h)(2)(D)(ii)(V) of the CEA 

requires the Commission to take into 

account the existence of reasonable legal 

certainty in the event of the insolvency 

of the relevant DCO or one or more of 

its clearing members with regard to the 

treatment of customer and swap 

counterparty positions, funds, and 

property. The Commission is proposing 

this clearing requirement based on its 

view that there is reasonable legal 

certainty with regard to the treatment of 

customer and swap counterparty 

positions, funds, and property in 

connection with cleared swaps, namely 

the CDS indices subject to this proposal, 

in the event of the insolvency of the 

relevant DCO (CME, ICE Clear Credit, or 

ICE Clear Europe) or one or more of the 

DCO’s clearing members. 

The Commission concludes that, in 

the case of a clearing member 

insolvency at CME or ICE Clear Credit, 

subchapter IV of Chapter 7 of the U.S. 

Bankruptcy Code (11 U.S.C. 761–767) 

and Part 190 of the Commission’s 

regulations would govern the treatment 

of customer positions.72 Pursuant to 

section 4d(f) of the CEA, a clearing 

member accepting funds from a 

customer to margin a cleared swap, 

must be a registered FCM. Pursuant to 

11 U.S.C. 761–767 and Part 190 of the 

Commission’s regulations, the 

customer’s CDS positions, carried by the 

insolvent FCM, would be deemed 

‘‘commodity contracts.’’ 73 As a result, 

neither a clearing member’s bankruptcy 

nor any order of a bankruptcy court 

could prevent either CME or ICE Clear 

Credit from closing out/liquidating such 

positions. However, customers of 

clearing members would have priority 

over all other claimants with respect to 

customer funds that had been held by 

the defaulting clearing member to 

margin swaps, such as the customers’ 

positions in CDS indices subject to this 

proposal.74 Thus, customer claims 

would have priority over proprietary 

claims and general creditor claims. 

Customer funds would be distributed to 

swaps customers, including CDS 

customers, in accordance with 

Commission regulations and section 

766(h) of the Bankruptcy Code. 

Moreover, the Bankruptcy Code and the 

Commission’s rules thereunder (in 

particular 11 U.S.C. 764(b) and 17 CFR 

190.06) permit the transfer of customer 

positions and collateral to solvent 

clearing members. 

Similarly, 11 U.S.C. 761–767 and Part 

190 would govern the bankruptcy of a 

DCO, in conjunction with DCO rules 

providing for the termination of 

outstanding contracts and/or return of 

remaining clearing member and 

customer property to clearing members. 

With regard to ICE Clear Europe, the 

Commission understands that the 

default of a clearing member of ICE 

Clear Europe would be governed by the 

rules of that DCO. ICE Clear Europe, a 

DCO based in the United Kingdom, has 

represented that under English law its 

rules would supersede English 

insolvency laws. Under its rules, ICE 

Clear Europe would be permitted to 

close out and/or transfer positions of a 

defaulting clearing member that is an 

FCM pursuant to the U.S. Bankruptcy 

Code and Part 190 of the Commission’s 

regulations. According to ICE Clear 

Europe’s submission, the insolvency of 

ICE Clear Europe itself would be 

governed by both English insolvency 

law and Part 190. 

ICE Clear Europe has obtained legal 

opinions that support the existence of 

such legal certainty in relation to the 

protection of customer and swap 

counterparty positions, funds, and 

property in the event of the insolvency 

of one or more of its clearing members. 

In addition, ICE Clear Europe has 

obtained a legal opinion from U.S. 

counsel regarding compliance with the 

protections afforded to FCM customers 

under New York law. 

The Commission requests comment 

on its conclusions with regard to legal 

certainty in the event of an insolvency 

of CME, ICE Clear Credit, ICE Clear 

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75BIS, OTC Derivatives Market Activity in the 

First Half of 2011, November 2011, Table 1 

[hereinafter ‘‘BIS data’’]. The BIS data provides the 

broadest market-wide estimates of interest rate 

swap activity available to the Commission. 

76 Id. 

77Federal Reserve Bank of New York Staff 

Reports, ‘‘An Analysis of OTC Interest Rate 

Derivatives Transactions: Implications for Public 

Reporting’’ (March 2012) at 3 [hereinafter ‘‘NY Fed 

Analysis’’], available at http://www.newyorkfed.org/ 

research/staff_reports/sr557.pdf. 

78The IRS submissions received by the 

Commission are available at http://www.cftc.gov/ 

IndustryOversight/IndustryFilings/index.htm. 

Submission materials marked by the submitting 

DCO for confidential treatment pursuant to 

§§ 39.5(b)(5) and 145.9(d) are not available for 

public review. 

Europe, or one of such DCOs’ clearing 

members. 

Request for Comment 

The Commission requests comment 

on all aspects of the proposed classes of 

CDS to be included within the clearing 

requirement and the proposed 

determination. The Commission may 

consider alternatives to the proposed 

CDS classes and is requesting comment 

on the following questions: 

• Should the Commission include all 

tenors, such as the 1- or 2-year tenor for 

Markit indices, for each index included 

within the class, notwithstanding the 

fact that those are tenors not currently 

cleared by a DCO? Will market 

participants be incentivized to use such 

contracts to avoid the clearing 

requirement? 

• Should the Commission limit its 

determination to the most liquid tenors 

of the CDX.NA.IG such as the 5- and 10- 

year tenors, and exclude other tenors 

such as the 3- and 7-year tenors, which 

are less liquid? 

• Is the Commission correct in 

believing that risk management 

frameworks and methodologies 

supporting existing cleared offerings can 

be adjusted to address additional tenors 

with limited changes? 

• Should the Commission structure 

its clearing requirement such that 

indices that become older off-the-run 

indices are no longer subject to the 

requirement? In such a proposal, how 

should the Commission treat those offthe-run indices, such CDX.NA.IG Series 

9, that have remained extremely active 

notwithstanding being off-the-run? 

Should the Commission establish some 

type of threshold of trading to exclude 

off-the-run indices from the 

requirement? How would the 

Commission construct a rule to indicate 

that an off-the-run index is no longer 

subject to clearing? 

• To the extent off-the-run indices 

were excluded from the clearing 

requirement, would market participants 

be incentivized to trade in older off-therun indices, as opposed to current onthe-run indices? 

• The CDS indices proposed to be 

included within the clearing 

requirement are currently offered by 

DCOs and are among the most liquid 

CDS. Is there any factor within the five 

statutory that do not support inclusion 

with the clearing requirement? Are there 

other factors outside of those five factors 

with regard to these particular offerings 

that weigh against inclusion in a 

clearing determination? 

E. Interest Rate Swaps 

i. Introduction 

Interest rate swaps are agreements 

wherein counterparties agree to 

exchange payments based on a series of 

cash flows over a specified period of 

time typically calculated using two 

different rates multiplied by a notional 

amount. As of June 2011, the BIS 

estimated that over $500 trillion in 

notional amount of single currency 

interest rate swaps were outstanding 75

representing 75 to 80%of the total 

estimated notional amount of 

derivatives outstanding.76 Based on 

these factors and on the swap 

submissions received under § 39.5(b), 

the Commission believes that interest 

rate swaps represent a substantial 

portion of the swaps market and warrant 

consideration by the Commission for 

required clearing. 

The Commission’s consideration of 

the interest rate swap submissions (IRS 

submissions) is presented in two parts. 

The first part, this Section II.E, 

discusses the Commission’s rationale for 

determining how to classify and define 

the interest rate swaps identified in the 

DCO submissions to be considered for 

the clearing requirement. The second 

part, Section II.F, presents the 

Commission’s consideration of the IRS 

submissions in accordance with section 

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

Unlike certain CDS or futures 

contracts, there are a large number of 

different, variable contract 

specifications available and used in 

interest rate swap transactions. As an 

indication of this variability, the 

Commission notes that over 10,500 

different combinations of significant 

interest rate swap terms were identified 

for trades executed in a single three 

month period in 2010.77 This variability 

creates a challenge for DCOs to specify 

the interest rate swaps for which 

clearing services are available and for 

the Commission to define what kinds of 

interest rate swaps will be subject to the 

clearing requirement. Notwithstanding 

this variability in swap terms, parties 

generally seek common economic 

results when entering into interest rate 

swaps, and there are common contract 

definitions and conventions that make 

classifying and clearing interest rate 

swaps possible. Identifying and 

analyzing these commonalities is 

necessary for effective classification of 

the swaps that will be subject to a 

proposed clearing requirement 

determination for interest rate swaps. 

Accordingly, a summary of the DCO 

submissions received by the 

Commission is followed by a discussion 

of how interest rate swaps are traded 

and risk managed and an analysis of the 

primary interest rate swap classes that 

are cleared and the product 

specifications used to identify interest 

rate swap products within each class. 

Thereafter, in Section II.F the 

Commission considers each of the 

interest rate swap classes and the 

primary specifications that are 

identified in the IRS submissions using 

the five factors identified in section 

2(h)(2)(D) of the CEA to determine 

which interest rate swaps shall be 

required to be cleared. 

ii. Submissions Received 

The Commission received 

submissions from three DCOs eligible to 

clear interest rate swaps (IRS 

submissions): LCH.Clearnet Limited 

(LCH), the clearing division of the 

Chicago Mercantile Exchange Inc. 

(CME), and International Derivatives 

Clearinghouse, LLC (IDCH).78

The following table summarizes the 

interest rate swap classes and significant 

specifications identified in the IRS 

submissions as currently available for 

clearing by each DCO. The classes and 

swap specifications are described in 

more detail below. 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47187 

79 In this proposal, currencies are identified either 

by their full name or by the three letter ISO 

currency designation for the currency. 

80LCH letter, dated February 24, 2012, at 1, 

stating that the market share percentage estimate is 

based upon BIS statistics and SwapClear volumes 

as of January 31, 2012. 

81These specifications can be found on LCH’s 

Web site at http://www.lchclearnet.com/Images/ 

General%20Regulations_tcm6-43737.pdf. 

82See ‘‘ODSG data’’ described below. The ODSG 

data set, while the broadest available providing 

trade-by-trade details, is limited in that it excludes 

trades that needed to be manually confirmed or that 

did not include a G14 Dealer. 

TABLE 3—INTEREST RATE SWAP SUBMISSIONS SUMMARY

LCH CME IDCH 

Swap Classes .............. Fixed-to-floating, basis, forward rate agreements (FRAs), overnight index swaps (OIS).Fixed-to-floating .............................................. Fixed-to-floating, 

basis, FRAs, OIS. 

Currencies 79 ................ USD, EUR, GBP, JPY, AUD, CAD, CHF, 

SEK, CZK, DKK, HKD, HUF, NOK, NZD, 

PLN, SGD, and ZAR.

USD, EUR, GBP, JPY, CAD, and CHF .......... USD. 

Rate Indexes ............... For Fixed-to-floating, basis, FRAs: LIBOR in 

seven currencies, BBR–BBSW, BA–CDOR, 

PRIBOR, CIBOR–DKNA13, CIBOR2– 

DKNA13, EURIBOR–Telerate, EURIBOR– 

Reuters, HIBOR–HIBOR, HIBOR–HKAB, 

HIBOR–ISDC, BUBOR–Reuters, NIBOR, 

BBR–FRA, BBR–Telerate, PLN–WIBOR, 

PLZ–WIBOR, STIBOR, SOR–Reuters, 

JIBAR.

USD–LIBOR, CAD–BA, CHF–LIBOR, GBP– 

LIBOR, JPY–LIBOR, and EURIBOR.

USD–LIBOR. 

For OIS: FEDFUNDS, SONIA, EONIA, TOIS.

Maximum Stated Termination Dates.For Fixed-to-floating, basis, FRAs: USD, 

EUR, and GBP out to 50 years, AUD, 

CAD, CHF, SEK and JPY out to 30 years 

and the remaining nine currencies out to 

10 years.

USD, EUR, GBP out to 50 years, and CAD, 

JPY, CHF, AUD out to 30 years.

For Fixed-to-floating: 

30 years. 

For OIS: USD, EUR, GBP, and CHF out to 

two years.

......................................................................... For OIS, and FRAs: 

two years. 

Each of the IRS submissions provided 

information specified under § 39.5(b) for 

such swap submissions or provided 

references to Web sites or other sources 

for such information, including, for 

example, information previously 

provided to the Commission for other 

purposes. Each submitter also has 

described how it provided notice to its 

members as required by 

§ 39.5(b)(3)(viii). 

LCH has been clearing OTC interest 

rate swaps since 1999 through its 

SwapClear service. In its IRS 

submission, LCH indicates that it clears 

more than 50% of the interest rate swap 

market by notional amount.80 As of its 

submission date, February 24, 2012, 

LCH reported that it had cleared and 

held outstanding about one million 

trades with an aggregate notional 

amount over $283 trillion. LCH 

accepted for clearing fixed-to-floating 

and basis swaps in seventeen currencies 

(including variable notional swaps in 

three currencies), overnight index swaps 

in four currencies, and forward rate 

agreements in 10 currencies. Swaps 

accepted for clearing must have certain 

product specifications identified by 

LCH, which help it administer clearing 

and manage risk appropriately.81 Of the 

three interest rate swap submitters, LCH 

has been clearing the longest, clears the 

broadest range of interest rate swaps, 

and clears the largest portion of the 

interest rate swap market at this time. 

As of March 2011, LCH implemented 

client clearing in both Europe and the 

U.S. Prior to that date, both parties to a 

swap had to be LCH members to be able 

to clear a swap with LCH. 

CME began clearing interest rate 

swaps on October 18, 2010. CME’s IRS 

submission indicates that CME is 

currently clearing fixed-to-floating 

swaps in six currencies with an 

identified set of product specifications 

and has open interest in three 

currencies. In its submission, CME 

recommended a clearing requirement 

determination for all non-option interest 

rate swaps denominated in a currency 

cleared by any qualified DCO. 

In September 2010, IDCH amended its 

rule book to provide for clearing interest 

rate swaps. IDCH is eligible to clear U.S. 

dollar denominated fixed-to-floating 

swaps, overnight index swaps, and 

forward rate agreements, which have 

certain product specifications as 

identified in its submission. IDCH had 

no outstanding cleared positions for 

these swaps as of the date of this 

proposal. 

Furthermore, the interest rate swaps 

identified in the three IRS submissions 

are all single currency swaps with no 

optionality, as defined by the applicable 

DCO. 

iii. Interest Rate Swap Market 

Conventions and Risk Management 

Unlike certain CDS for which highly 

standardized terms have been 

developed, or futures, the terms of 

which are set by the exchanges, interest 

rate swaps are broad in scope and 

present a wide range of variable product 

classes and product specifications 

within each class. A data set of interest 

rate swaps electronically recorded over 

a three month period in 2010 by 14 large 

dealers for which one of those dealers 

was a party to each swap, contained 

over 10,500 different combinations of 

product classes, currencies, tenors, and 

forward periods.82 The data set also 

included eight different general product 

classes (e.g., fixed-to-floating, basis, 

forward rate agreements, swaptions, 

etc.), 28 currencies, 53 different rate 

indexes, and stated termination dates 

from one month to 55 years. In addition, 

dozens of different contract term 

conventions were identified. 

Notwithstanding the large variety of 

contracts, there are commonalities that 

make it possible to categorize interest 

rate swaps for clearing purposes. Firstly, 

the vast majority of interest rate swaps 

use the ISDA definitions and contract 

conventions that allow market 

participants to agree quickly on 

common terms for each transaction. In 

fact, the three DCOs clearing interest 

rate swaps all use ISDA definitions in 

their product specifications. 

Secondly, counterparties enter into 

swaps to achieve particular economic 

results. While the results desired may 

differ in small ways depending on each 

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83These are sometimes also referred to as 

‘‘types,’’ ‘‘categories,’’ or ‘‘groups.’’ For purposes of 

this determination, the Commission is using the 

term ‘‘class,’’ in order to be consistent with the 

approach taken by the European Securities and 

Markets Authority (ESMA) in its Discussion Paper, 

‘‘Draft Technical Standards for the Regulation on 

OTC Derivatives, CCPs, and Trade Repositories,’’ 

(Feb. 16, 2012), available at http:// 

www.esma.europa.eu/system/files/2012-95.pdf. It is 

also noted that other categorizations are sometimes 

used for certain purposes. However, these four 

classes are common terms used by the DCOs and 

are common terms used in industry taxonomies. 

84See, e.g., ISDA Swap Taxonomies, available at 

http://www2.isda.org/identifiers-and-otctaxonomies/; Financial Products Markup Language, 

available at http://www.fpml.org/; and the NY Fed 

Analysis. 

85See below for a discussion of available market 

sources. 

86After putting on these hedging positions, the 

DCO has the time needed to address any residual 

risk of the defaulted portfolio through auctioning 

off the defaulted portfolio together with the hedging 

transactions. 

87See LCH IRS submission, at 4. 

counterparty’s specific circumstances 

and goals, there are certain common 

swap conventions that are used to 

identify and achieve commonly desired 

economic results when entering into 

interest rate swaps. For example, a party 

that is trying to hedge variable interest 

rate risk may enter into a fixed rate to 

floating rate swap, or a party that is 

seeking to fix interest rates for periods 

in the future may enter into a forward 

rate agreement. 

The IRS submissions classify interest 

rate swaps on this basis by identifying 

commonly known classes of swaps that 

they clear including: fixed rate to 

floating rate swaps, that are sometimes 

referred to as plain vanilla swaps (fixedto-floating swaps); floating rate to 

floating rate swaps, also referred to as 

basis swaps (basis swaps); overnight 

index swaps (OIS); and forward rate 

agreements (FRAs).83 These class terms 

are also being used in industry efforts to 

develop a taxonomy for interest rate 

swaps.84

Furthermore, within these general 

classes, certain specifications such as 

currency, reference interest rate index, 

and stated termination date (also 

referred to as maturity date), are 

essential for defining the economic 

result that will be achieved. For 

example, a party located in the United 

States who seeks to hedge interest rate 

risk that is in U.S. dollars will most 

likely enter into a U.S. dollar swap as 

opposed to a swap in different currency. 

The party will also enter into a swap 

whose interest rate index correlates with 

the floating rate the party is trying to 

hedge and will specify a termination 

date that coincides with when the 

subject interest rate risk terminates. 

Each of the IRS submissions naturally 

use these common specifications when 

identifying the swaps that the DCO 

clears. Within each of those 

specifications, there are common terms 

used by the DCOs, which allows for 

further classification of the full range of 

interest rate swaps that are executed. 

Accordingly, while there are a wide 

variety of interest rate swaps when 

taking into account all possible contract 

specifications, certain specifications are 

commonly used by the DCOs and 

market participants. This allows for the 

identification of classes of swaps and 

primary specifications within each class 

that reflect the economic goals market 

participants seek to achieve and that are 

based on market conventions used by 

the DCOs to define which interest rate 

swap products they will clear. For 

example, fixed-to-floating swaps 

comprise roughly 50% of interest rate 

swaps, U.S. dollar denominated swaps 

account for approximately 35% of the 

total outstanding notional amount of 

swaps, and U.S. dollar LIBOR is the 

floating rate index used for 

approximately 80% of U.S. dollar swaps 

traded.85

The DCOs also risk manage interest 

rate swaps collectively on a portfolio 

basis rather than on a transaction or 

product specific basis. All three DCOs 

primarily assess risk at the portfoliolevel. In other words, when looking at 

the risk posed by an interest rate swap 

portfolio, DCOs do not assess the risk of 

any one particular swap or swap class 

within the portfolio. Instead, the DCOs 

analyze the cumulative risk of a 

position’s components. This concept of 

risk aggregation is also used within the 

context of the DCOs’ margining 

methodologies. All three DCOs use 

margin methodologies based on 

portfolio margining as opposed to 

margining individual swaps or swap 

categories and subsequently developing 

offsets and charges across different 

swaps or classes of swaps. 

By looking at risk on a portfolio basis, 

the DCOs take into account how swaps 

with different attributes, such as 

underlying currency, stated termination 

dates, underlying floating rate indexes, 

swap classes, etc., are correlated and 

thus can offset risk across attributes. 

This is possible because, although 

individual transactions may have 

unique contract terms, given the 

commonalities of transactions as 

discussed above, swap portfolios can be 

risk managed on a cumulative value 

basis taking into account correlations 

among the cleared swaps. Consequently, 

DCOs can be expected to fairly, rapidly, 

and efficiently manage the risk of 

interest rate swaps in a default scenario 

through a small number of large hedging 

transactions that hedge large numbers of 

similarly correlated positions held by 

the defaulting party.86 As such, liquidity 

for specific, individual swaps is not the 

focus of DCOs from a risk management 

perspective. Rather, liquidity is viewed 

as a function of whether a portfolio of 

swaps has common specifications that 

are determinative of the economics of 

the swaps in the portfolio such that a 

DCO can price and risk manage the 

portfolio through block hedging and 

auctions in a default situation. 

A real life example of how this works 

is provided by LCH’s management of the 

Lehman Brothers cleared interest rate 

swap portfolio following Lehman’s 

bankruptcy in September 2008. Upon 

Lehman’s default, LCH needed to risk 

manage a portfolio of approximately 

66,000 interest rate swaps, which it 

hedged with approximately 100 new 

trades in less than five days. Once LCH 

executed these initial hedges, it was left 

with a relatively risk neutral portfolio. 

However, some risk still remained given 

that the hedges did not match the 

original trades exactly. Once the 

portfolio was hedged, LCH asked 

clearing members to price and bid on 

all, or subdivided portions, of the 

original Lehman portfolio with the 

hedging trades. For example, clearing 

members with live open positions in 

U.S. dollar swaps were asked to bid for 

the relatively hedged U.S. dollar 

portfolio. Through the bidding process, 

LCH was able to hedge and auction off 

all risk related to Lehman’s interest rate 

swap portfolio existing at the time of its 

bankruptcy and only used 

approximately 35% of the initial margin 

Lehman had posted.87

iv. Interest Rate Swap Classification for 

Clearing Requirement Determinations 

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

provides that the Commission ‘‘shall 

review each swap, or any group, 

category, type, or class of swaps to make 

a determination as to whether’’ any 

thereof shall be required to be cleared. 

In reviewing the IRS submissions, the 

Commission has considered whether its 

clearing requirement determination 

should address individual swaps, or 

categories, types, classes, or other 

groups of swaps. 

Based on the market conventions as 

discussed above, and the DCO 

recommendations in the IRS 

submissions, the Commission is 

proposing a clearing requirement for 

four classes of interest rate swaps: fixedto-floating swaps, basis swaps, OIS, and 

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88LCH clears all four classes of swap products; 

IDCH is eligible to clear fixed-to-floating swaps, 

OIS, and FRAs; and CME clears fixed-to-floating 

swaps. 89TriOptima data, as of March 16, 2012. See 

Section II.F below for a description of the 

TriOptima Data. The TriOptima data provides 

information on nine other classes of swaps, none of 

which is included in the IRS submissions. Notably, 

one other type, swaptions, exceeded FRAs and basis 

swaps in terms of number of transactions completed 

in the sample. On a notional amount basis, 

swaptions represented less than half the notional 

amount of FRAs traded and a little less than the 

notional amount of basis swaps. Regardless, 

because swaptions are not being cleared by any 

DCOs at this time, they are not being considered in 

this proposal. 

90By contract, the two parties to an OTC swap 

often (but not always) agree that only one payment 

is due and owing on each payment date equal to 

the net positive amount equal to the excess amount 

of the larger amount due from one party over the 

smaller amount due from the other party. For 

cleared swaps, generally speaking, the amount 

payable to or by a party on any given day is 

determined based on the aggregate net amount due 

from or owed to the party for all of its positions that 

are cleared. 

FRAs. According to the IRS 

submissions, LCH offers all four classes 

for clearing, IDCH offers three of them 

for clearing, and CME offers one of them 

for clearing.88

These four classes represent a 

substantial portion of the interest rate 

swap market. The following table 

provides an indication of the 

outstanding positions in each class. 

TABLE 4—INTEREST RATE SWAPS NOTIONAL AND TRADE COUNT BY CLASS 89

Swap class 

Notional 

amount 

(USD BNs) 

Gross 

notional 

percent of 

total 

Total trade 

count 

Total trade 

count 

percent of 

total 

Fixed-to-Floating .............................................................................................. $299,818 52 3,239,092 75 

FRA .................................................................................................................. 67,145 12 202,888 5 

OIS ................................................................................................................... 43,634 8 109,704 3 

Basis ................................................................................................................ 27,593 5 119,683 3 

Other ................................................................................................................ 132,162 23 617,637 14 

Total .......................................................................................................... 570,352 100 4,289,004 100 

At this time, there are no standard 

definitions in federal statutes or existing 

Commission regulations for these 

interest rate swap classes. In addition, 

while various class definitions are used 

in the derivatives literature, there are no 

commonly used definitions in the 

market. Accordingly, for purposes of 

discussing the clearing requirement 

determination in this proposal, the 

Commission has developed the 

following class definitions based on 

information provided by the submitting 

DCOs and market conventions. 

To define the four interest rate swap 

classes in a manner that works across all 

three DCOs making IRS submissions 

and for the interest rate swap market 

generally, it is useful first to summarize 

how interest rate swaps work. As noted 

above, in an interest rate swap, the 

parties exchange payments based on a 

series of cash flows over a specified 

period of time calculated using two 

different interest rates multiplied by a 

notional amount. One party to the swap 

agrees to pay the amount equal to one 

of the interest rates specified multiplied 

by the notional amount and the other 

party agrees to pay the amount equal to 

the other interest rate specified times 

the notional amount.90 Each such 

payment stream is typically referred to 

as one ‘‘leg’’ or ‘‘side’’ of the swap 

transaction. 

Using this background, the four 

classes of swaps are defined as follows, 

for purposes of this proposal: 

1. ‘‘Fixed-to-floating swap’’: A swap 

in which the payment or payments 

owed for one leg of the swap is 

calculated using a fixed rate and the 

payment or payments owed for the other 

leg are calculated using a floating rate. 

2. ‘‘Floating-to-floating swap’’ or 

‘‘basis swap’’: A swap in which the 

payments for both legs are calculated 

using floating rates. 

3. ‘‘Forward Rate Agreement’’ or 

‘‘FRA’’: A swap in which payments are 

exchanged on a pre-determined date for 

a single specified period and one leg of 

the swap is calculated using a fixed rate 

and the other leg is calculated using a 

floating rate that is set on a predetermined date. 

4. ‘‘Overnight indexed swap’’ or 

‘‘OIS’’: A swap for which one leg of the 

swap is calculated using a fixed rate and 

the other leg is calculated using a 

floating rate based on a daily overnight 

rate. 

The LCH and CME IRS submissions 

addressed issues of classification for 

purposes of the interest rate swap 

clearing requirement. In its submission, 

LCH discussed the classification of 

interest rate swaps and recommended 

establishing clearing requirements for 

classes of interest rate swaps. LCH 

stated: 

We believe that it is counterproductive to 

define every single attribute and combination 

that could be found in an [interest rate] swap, 

and furthermore it would always be possible 

to create additional attributes that would 

move a swap outside of the mandate. We do 

not believe that the Commission should 

define the almost limitless combination of 

swap attributes currently used by the market. 

We recommend defining a subset of easily 

identifiable features that determine a swap 

subject to mandatory clearing if that swap is 

cleared by a registered DCO that satisfies the 

five factors in the Act and the Commission’s 

regulations. 

More specifically, LCH recommended 

that the Commission use the following 

specifications to classify interest rate 

swaps for purposes of making a clearing 

determination: (i) Swap class (i.e., what 

the two legs of the swap are (fixed-tofloating, basis, OIS, etc.)), (ii) floating 

rate definitions used, (iii) the currency 

in which the notional and payment 

amounts are specified, (iv) stated final 

term of the swap (also known as 

maturity), (v) notional structure over the 

life of the swap (constant, amortizing, 

roller coaster, etc.), (vi) floating rate 

frequency, (vii) whether optionality is 

included, and (viii) whether a single 

currency or more than one currency is 

used for denominating payments and 

notional amount. In effect, LCH 

recommended the use of a set of basic 

product specifications to identify and 

describe each class of swaps subject to 

the clearing requirement. 

CME recommended a clearing 

determination for all non-option interest 

rate swaps denominated in a currency 

cleared by any qualified DCO. CME’s 

request is similar to LCH’s 

recommendation in that CME identifies 

currency and optionality as factors to 

consider. In addition, CME’s request 

focuses on defining swaps subject to the 

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91LCH IRS submission, at 6. 

92 In addition, as noted by LCH, a product-byproduct requirement may be evaded more easily 

because the specifications of a particular swap 

contract would need to match the specifications of 

each product subject to a clearing requirement. The 

clearing requirement could be evaded by adding, 

deleting, or modifying one or more of the contract’s 

specifications, including minor specifications that 

have little or no impact on the economics of the 

swap. By using a class-based approach that allows 

for ranges of contract specifications established by 

the DCOs within each class, the Commission is 

reducing the potential for evasion in accordance 

with section 2(h)(4)(A) of the CEA, which directs 

the Commission to prescribe rules necessary to 

prevent evasion of the clearing requirements. 

93The term ‘‘conditional notional amount’’ refers 

to notional amounts that can change over the term 

of a swap based on a condition established by the 

parties upon execution such that the notional 

amount of the swap is not a known number or 

schedule of numbers, but may change based on the 

occurrence of some future event. This term does not 

include what are commonly referred to as 

‘‘amortizing’’ or ‘‘roller coaster’’ notional amounts 

for which the notional amount changes over the 

term of the swap based on a schedule of notional 

amounts known at the time the swap is executed. 

Furthermore, it would not include a swap 

containing early termination events or other terms 

that could result in an early termination of the swap 

if a DCO clears the swap with those terms. 

94As noted above, the notional amount of the 

swap is a critical element to pricing every swap 

because it is the amount by which the interest rate 

for each leg is multiplied by to calculate the 

payment streams for each counterparty. However, 

the notional amount is not really a specification 

that differentiates one class of swaps from another 

clearing requirement in a manner that 

can be used by all DCOs and not by 

reference to a specific DCO. IDCH did 

not recommend a particular approach 

for structuring the clearing 

determination. 

The Commission agrees with the 

general approach suggested by LCH and 

is proposing to establish a clearing 

requirement for classes of swaps, rather 

than for individual swap products. 

As an alternative, the Commission 

considered whether to establish clearing 

requirements on a product-by-product 

basis. Such a determination would need 

to identify the multitude of legal 

specifications of each product that 

would be subject to the clearing 

requirement. Although the industry uses 

standardized definitions and 

conventions, the product descriptions 

would be lengthy and require 

counterparties to compare all of the 

legal terms of their particular swap 

against the terms of the many different 

swaps that would be included in a 

clearing requirement. In this regard, 

LCH stated that the clearing requirement 

‘‘would be sub-optimal for the overall 

market if participants are forced to read 

pages of rules to decipher whether or 

not a swap is required to be cleared, or 

to have to make complex and time 

consuming decisions at the point of 

execution.’’ 91 The Commission shares 

this view and believes that for interest 

rate swaps, a product-by-product 

determination could be unnecessarily 

burdensome for market participants in 

trying to assess whether each swap 

transaction is subject to the 

requirement. A class-based approach 

would allow market participants to 

determine quickly whether they need to 

submit their swap to a DCO for clearing 

by checking initially whether the swap 

has the basic specifications that define 

each class subject to the clearing 

requirement.92

A product-by-product designation 

also would be difficult to administer 

because the Commission would be 

required to consider each and every 

product submitted. On the other hand, 

designating classes of interest rate 

swaps for the clearing requirement 

provides a cost effective, workable 

method for the Commission to review 

new swap products that DCOs will 

submit for clearing determinations on a 

going forward basis without undertaking 

a full Commission review of each and 

every swap product. For each new 

swap, or group, class, type, or category 

of swap submitted, the DCO can identify 

whether it believes the submission falls 

within a class of swaps already subject 

to the clearing requirement. For such 

swaps, as described in greater detail 

below, the Commission is proposing to 

delegate to the Director of the Division 

of Clearing and Risk, with the 

consultation of the General Counsel, the 

authority to confirm whether the swap 

fits within the identified class and is 

therefore subject to the clearing 

requirement. In this way, DCOs will not 

be required to submit lengthy 

submissions, and the Commission need 

not review swaps that are already part 

of a class of swaps that the Commission 

has determined are subject to a clearing 

requirement pursuant to section 2(h)(2) 

of the CEA. Only swaps that are in a 

new swap class that has not previously 

been reviewed, because it contains one 

or more class level specifications that 

are not contained within a class that has 

previously been reviewed, would be 

subject to full Commission review. 

Request for Comment 

The Commission invites comment on 

the interest rate swaps class definitions. 

• Are the definitions in harmony with 

industry practice? 

• Should the Commission establish a 

clearing requirement for classes of 

swaps or for individual swap products? 

• Would a product-by-product 

determination impose a greater burden 

on market participants than the 

proposed class-based approach? 

v. Interest Rate Swap Specifications 

After consideration of the IRS 

submissions received, the practical 

considerations of classifying swaps as 

described in the preceding section, the 

portfolio-based risk management 

approaches used by DCOs, and existing 

market practice for classifying and 

trading swap products based on 

common economic results, the 

Commission has analyzed the IRS 

submissions received pursuant to 

section 2(h)(2)(D) of the CEA and § 39.5, 

and is proposing to classify the interest 

rates swaps submitted using the 

following affirmative specifications for 

each class: (i) Currency in which the 

notional and payment amounts are 

specified; (ii) rates referenced for each 

leg of the swap; and (iii) stated 

termination date of the swap. The 

Commission also is proposing three 

‘‘negative’’ specifications for each class: 

(i) No optionality (as specified by the 

DCOs); (ii) no dual currencies; and (iii) 

no conditional notional amounts.93

The Commission has chosen these 

three affirmative specifications because 

it believes that they are fundamental 

specifications used by counterparties to 

determine the economic result of a swap 

transaction for each party. 

Counterparties enter into swaps to 

achieve particular economic results. For 

example, counterparties may enter into 

interest rate swaps to hedge an 

economic risk, to facilitate a purchase, 

or to take a view on the future direction 

of an interest rate. The counterparties 

enter into a swap that they believe will 

best achieve their desired economic 

result at a reasonable cost. 

The classes of swaps reflect general 

categories of desired economic results. 

As noted above, the IRS submissions 

identified four different classes of swap 

contracts that are being cleared at this 

time: Fixed-to-floating swaps, basis 

swaps, OIS, and FRAs. These classes of 

interest rates swaps reflect industry 

categorization and allow counterparties 

to achieve a particular economic result. 

For example, a fixed-to-floating swap 

may be used by a counterparty to hedge 

interest rate risk related to bonds it has 

issued or which it owns. Because the 

categorization of interest rate swaps into 

one of these basic classes reflects 

fundamental characteristics of a 

particular swap, counterparties can 

immediately assess whether a particular 

swap they are considering might be of 

a class that is subject to required 

clearing. 

All three submitters also identified 

currency as a specification for 

distinguishing swaps that are subject to 

clearing.94 A swap that requires 

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because every swap has a notional amount. By 

contrast, the currency in which the notional and 

payment amounts are specified does distinguish 

one class of swaps from others. 

95For example, parties seeking to hedge interest 

rate risk in connection with bonds or to invest 

funds using swaps are more likely to enter into 

swaps that designate the same currency in which 

the bonds are payable or that the funds to be 

invested are held. 

96Although hedging an economic risk expected to 

remain outstanding for ten years with a matching 

ten year swap may generally be the most efficient 

and precise approach, the Commission recognizes 

that parties may achieve a similar result by using 

swaps with different stated termination dates. 

However, such substitution generally provides a 

less precise hedge. 

97Each DCO identifies the standard term or range 

of terms it will accept for each specification. 

Accordingly, swap counterparties can review the 

DCO’s product specifications to determine whether 

a swap will satisfy the DCO’s requirements for these 

specifications. Additionally, DCOs are likely to 

develop a screening mechanism by which a party 

can enter the terms of a specific swap and 

determine whether the DCO will clear it. It is also 

likely that third-party vendors will develop or are 

developing similar screeners to apply to multiple 

DCOs. If counterparties want to enter into a swap 

that is in a class subject to required clearing and 

no DCO will clear the swap because it has other 

specifications that the DCOs will not accept, then 

the parties can still enter into that transaction on 

an uncleared basis. 

98LCH recommended in its submission that 

floating rate tenor (also known as frequency) also 

be a class level specification and the Commission 

acknowledges that floating rate tenor can, in some 

cases, be a fundamental specification for achieving 

the economic benefits of an interest rate swap. 

However, it is the Commission’s preliminary view 

that floating rate tenor is more akin to the other 

non-class specifications in that it is not 

fundamental to all economic results that may be 

Continued 

calculation or payment in a currency 

different than the currency of the related 

underlying purposes of the swap would 

introduce currency risk.95 Thus, the 

currency designated for the swap is a 

basic factor in precisely achieving the 

economic results of the swap desired by 

each party. For example, if a party 

wants to hedge a commercial business 

risk denominated in dollars, then the 

party is likely to enter into a swap 

calculated and payable in dollars. 

Entering into a swap in a currency that 

is different from the currency in which 

the risk to be hedged is denominated 

would unnecessarily introduce currency 

risk and reduce the effectiveness of the 

swap. 

The swaps listed by all three DCOs in 

their IRS submissions all identified the 

interest rates used for each leg of the 

swap as a basic term that defines the 

swap. The rates are basic determinants 

of the economic value of each stream of 

payments of an interest rate swap. It is 

therefore an important determinant for 

achieving each party’s desired economic 

result. For example, if a party wants to 

hedge a loan obligation for which the 

interest rate is based on the London 

Interbank Offered Rate (commonly 

referred to as LIBOR), then the party can 

accurately hedge that risk by entering 

into a swap for which it receives LIBOR 

to offset its variable LIBOR risk. Using 

a different variable rate index would 

unnecessarily add basis risk to the swap 

and inhibit the party’s desired result of 

hedging the risk inherent in changes in 

LIBOR over the life of its loan. 

Finally, the stated termination date, or 

maturity, of a swap is a basic 

specification for establishing the value 

of a swap transaction because interest 

rate swaps are based on an exchange of 

payments over a specified period of 

time ending on the stated termination 

date. The value of a swap at any one 

point in time depends in part on the 

value of each payment stream over the 

remaining life of the swap. For example, 

if a party wants to hedge variable 

interest rate risk for bonds it has issued 

that mature in ten years, it will 

generally enter into a swap with a stated 

termination date that matches the final 

maturity date of the bonds being 

hedged.96 To terminate the swap prior 

to such date would result in only a 

partial hedge and to execute a swap 

with a stated termination date that is 

later than the final bond maturity date 

would simply create exposed rate risk 

during the extended period beyond the 

final maturity date of the bonds. 

As a general matter, the four classdefining specifications identified by the 

Commission are used by all three 

submitters when identifying the swaps 

they clear. By using these basic 

specifications to identify the swaps 

subject to the clearing requirement, 

counterparties contemplating entering 

into a swap can determine quickly as a 

threshold matter whether the particular 

swap may be subject to a clearing 

requirement. If the swap has the basic 

specifications of a class of swaps subject 

to a clearing requirement, the parties 

will know that they need to verify 

whether a DCO will clear that particular 

swap. This will reduce the burden on 

swap counterparties related to 

determining whether a particular swap 

may be subject to the clearing 

requirement. 

The Commission also considered 

whether to define classes of swaps on 

the basis of other product specifications. 

Other potential specifications are 

numerous because of the nearly 

limitless alternative interest rate swaps 

that are theoretically possible. These 

alternative specifications fall into two 

general categories: Specifications that 

are commonly used to address 

mechanical issues for most swaps, and 

specifications that are less common and 

address idiosyncratic issues related to 

the particular needs of a counterparty. 

Examples of specifications that are 

commonly used to address mechanical 

issues for most swaps considered by the 

Commission include: Floating rate reset 

tenors, floating rate reset dates, 

reference city for business days, 

business day convention, day count 

fraction, spread added or subtracted 

from the variable rate, compounding 

method, effective date, averaging 

method, payment dates, period end 

dates, upfront payments, and consent to 

legal jurisdiction. These specifications 

are specifically identified for most swap 

transactions executed today. While 

these specifications may affect the value 

of the swap in a mechanical way, they 

are not, generally speaking, fundamental 

to determining the economic result the 

parties are trying to achieve. For 

example, the day count fraction selected 

affects calculation periods and therefore 

the amounts payable for each payment 

period. However, the parties, and the 

DCOs, can make mechanical 

adjustments to period pricing at the 

time a swap is cleared based on the day 

count fraction alternative selected by 

the parties and the day count fraction 

does not drive the economic result the 

parties are trying to achieve. 

Furthermore, DCOs can provide 

clearing for the standard alternatives of 

each of these specifications without 

affecting risk management. Using the 

same day count fraction example, LCH 

will accept U.S. dollar-LIBOR trades for 

clearing with nine alternative day count 

fractions based on the common day 

count fractions used in the market.97

While this specification, and other 

specifications of this kind, may affect 

the amounts owed on a swap, they can 

be accounted for mechanically in the 

payment amount calculations and do 

not change the substantive economic 

result the parties want to achieve. 

Examples of the latter are special 

representations added to address 

particular legal issues, unique 

termination events, special fees, and 

conditions tied to events specific to the 

parties. None of the DCOs clear interest 

rate swaps with terms in the second 

group. Accordingly, such specifications 

are not included in the classes of swaps 

subject to the clearing requirement 

proposed by this rule, and the 

Commission considered only the first 

group of more common specifications 

that are identified by the submitting 

DCOs in their product specifications. 

In short, the Commission recognizes 

that these other specifications may have 

an effect on the economic result to be 

achieved with the swap.98 However, it 

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considered by parties when contemplating a swap 

and it is a specification for which the DCOs can 

fairly easily offer all of the standard tenors that 

parties may consider. 

believes that counterparties may 

account for the effects of such 

specifications with adjustments to other 

specifications or in the price of the 

swap. Furthermore, DCOs account for 

various alternatives or range of 

alternatives for these terms without 

impairing risk management. Finally, as 

described above in more detail, 

including these specifications in the 

description of the swaps subject to a 

clearing requirement could increase the 

burden on counterparties when 

checking whether a swap may be subject 

to required clearing. Accordingly, the 

Commission has determined not to 

include other, non-class defining 

specifications in the swap class 

definition. 

The Commission also considered 

whether there are product specifications 

that the Commission should explicitly 

exclude from the initial clearing 

requirement determination. In this 

regard, the Commission considered 

swaps with optionality, multiple 

currency swaps, and swaps with 

conditional notional amounts. The 

Commission determined that these three 

specifications should be included as socalled ‘‘negative’’ specifications. 

Optionality and swaps referencing 

more than one currency for calculation 

or payment purposes, raise concerns 

regarding adequate pricing measures 

and consistency across swap contracts 

that make them difficult for DCOs to 

effectively risk manage. LCH, CME, and 

IDCH currently do not clear interest rate 

swaps with such specifications. 

Furthermore, LCH and CME indicated 

that interest rate swaps with optionality 

or that reference multiple currencies 

should not be included for 

consideration of a clearing requirement 

at this time. LCH noted that, at this 

time, there is a lack of reliable market 

data and no market consensus on 

valuation models for swaps with these 

specifications, which significantly 

impairs a DCO’s ability to set margin 

levels effectively for such products. 

Given these factors, the Commission is 

proposing to exclude swaps with 

optionality or that reference multiple 

currencies from this clearing 

requirement determination. 

Finally, LCH recommended that the 

Commission exclude from the clearing 

requirement swaps whose notional 

amount over the term of the swap is 

conditional, and therefore, at the time of 

execution, cannot be definitively 

identified by a number or schedule of 

numbers for the term of the swap. For 

example, the parties may agree to a 

formula for calculating the notional 

amount based on an index or the 

occurrence of future events such as 

prepayments on a pool of mortgages. 

The IRS submissions indicated that all 

three submitters would clear swaps with 

constant notional amounts through the 

final termination date. LCH also clears 

amortizing and roller coaster notional 

schedules for certain classes of swaps so 

long as the notional amounts for the 

contract are known at the time the swap 

is cleared. None of the DCOs clears 

swaps for which the notional amount 

throughout the term of the swap is not 

specifically known at the time the swap 

is executed. The Commission 

understands that conditional notional 

amount swaps are, at this time, difficult 

for DCOs to price effectively and risk 

manage. Accordingly, while this may 

change over time if certain market 

conventions develop in this area, 

conditional notional amount swaps 

cannot be subject to the clearing 

requirement determination. 

To reach a determination as to which 

interest rate swaps shall be subject to 

the clearing requirement, the 

Commission will consider in the 

following section the IRS submissions 

received pursuant to section 2(h)(2)(D) 

of the CEA and § 39.5 within the 

framework of the classes and 

specifications identified. In summary, 

the Commission will consider four 

classes of interest rate swaps for the 

clearing requirement: Fixed-to-floating 

swaps, basis swaps, FRAs, and OIS. 

Within each class, the Commission will 

further consider the following product 

specifications to define which swaps 

shall be required to be cleared: 

Currency, floating rate indexes 

referenced, stated termination dates, use 

of dual currencies, optionality, and 

notional amount certainty. 

Request for Comments 

• The Commission invites comment 

on the six principle swap specifications 

identified by the Commission as being 

used by counterparties to determine the 

economic result of a swap transaction 

within each class. 

• Should more specifications be 

added? If so, what are they and how are 

they fundamental to determining the 

economic result of a swap? Should any 

of the specifications be eliminated? 

F. Proposed Determination Analysis for 

Interest Rate Swaps 

i. Consistency With Core Principles for 

Derivatives Clearing Organizations 

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

requires the Commission to review 

whether a swap submission is 

consistent with the core principles for 

DCOs in making its clearing 

determination. LCH, CME, and IDCH 

already clear all swaps identified in 

their respective IRS submissions and 

therefore each is subject to the 

Commission’s review and surveillance 

procedures summarized above. 

Accordingly, the three DCOs already are 

required to comply with the core 

principles set forth in section 5b(c)(2) of 

the CEA with respect to the swaps being 

considered by the Commission for the 

clearing requirement. 

To monitor compliance, the 

Commission has conducted periodic 

examinations of LCH, CME, and IDCH. 

During an examination, the Commission 

requests certain data regarding cleared 

transactions, fund transfers, margin 

requirement calculations, risk 

management testing and other issues 

that is provided as of a specific review 

date. In this manner, the Commission 

gets a snap-shot of information that the 

Commission staff uses to reconcile 

selected accounts and other 

information. Subsequently, the 

Commission goes onsite, typically for 

several days, to interview relevant 

parties and to test whether various 

policies and procedures established by 

the DCOs in their respective rule books 

comply with the CEA’s core principles 

for DCOs and other regulatory 

requirements. 

As discussed above, following the 

review of data and the onsite visits, the 

Commission undertakes extensive 

analysis and discusses any questions 

and potential deficiencies with staff and 

management of the DCO to address any 

deficiencies and improvements that can 

be implemented by the DCO. To ensure 

that the DCOs are in compliance with 

the core principles, a detailed analysis 

is done to assess the DCO’s policies and 

procedures regarding pricing, 

margining, back-testing, and their IRS 

portfolio risk management procedures. 

Furthermore, the Commission assesses 

the DCOs’ procedures and policies 

regarding: (1) Onboarding new clearing 

members; (2) establishing the financial 

resources available to the DCOs and 

testing the sufficiency of those 

resources; and (3) assessing the default 

management and settlement procedures. 

More specifically, the DCOs give the 

Commission documentation that details 

relevant official policies and 

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99The only exception is IDCH. At this time, RSG 

does not actively monitor the risk posed by IDCH 

and its participants because IDCH does not have 

any open interest. 

100See Bank of England, ‘‘Thoughts on 

Determining Central Clearing Eligibility of OTC 

Derivatives,’’ Financial Stability Paper No. 14, 

March 2012, at 11, available at http:// 

www.bankofengland.co.uk/publications/ 

Documents/fsr/fs_paper14.pdf. 

101All DCOs are required to begin providing daily 

trade-by-trade data to the Commission as of 

November 8, 2012. CME also provided some 

information in this area, but because CME clears a 

small set of interest rate swaps for a relatively short 

period of time, CME’s data is considered too limited 

to provide any indication of the complete interest 

rate swap market. The Commission recognizes that 

the LCH data also has limited value for its 

consideration of the first factor because it includes 

only cleared swaps, and not uncleared swaps. 

However, because LCH clears a large portion of the 

swaps products it offers clearing for (based on 

available information, LCH has cleared 

approximately 50 to 90 percent of the dealer open 

interest in the different interest rate swap products 

that it clears), its data provides some indication of 

the possible notional exposures and liquidity in the 

products submitted by LCH that the Commission is 

considering. Given the limitations on other 

available data, the Commission believes it is useful 

to consider the LCH data along with the marketwide BIS data, ODSG data, and TriOptima data. 

102The TriOptima data does not indicate how 

many trades are new for each reporting period 

rather than carry-over trades from the prior period. 

Accordingly, it is not possible to determine the 

amount of new trading activity from one reporting 

period to the next. 

103NY Fed Analysis at 6. 

procedures. The DCOs also provide 

evidence (such as margining, pricing 

data, and back-testing results) that 

confirms that the policies and 

methodologies are effective. Finally, the 

Commission goes onsite to the DCOs 

and interviews relevant parties and 

observes the procedures real-time to 

confirm that the DCOs are in effect 

following their stated policies. 

Additionally, the Commission, if 

feasible, will independently verify the 

analysis of any data provided by the 

DCOs. 

The Commission’s Risk Surveillance 

Group (RSG) conducts daily risk 

management surveillance of all DCOs.99

If any issues arise, the RSG and the 

DCOs work in concert to understand 

and quickly address those issues. CME, 

LCH, and IDCH have worked 

collaboratively with the Commission in 

this regard and have provided accessible 

points of contact within the DCOs’ 

respective organizations to expedite 

information flow. 

All three submitting DCOs have 

asserted that they are capable of 

maintaining compliance with the core 

principles following a clearing 

requirement determination for the 

swaps that they clear, and the 

Commission has no reason to believe 

such assertions are not accurate at this 

time. The Commission does not believe 

that subjecting any of the interest rates 

swaps identified in the IRS submissions 

to a clearing requirement would alter 

compliance by the respective DCOs with 

the core principles. Accordingly, the 

Commission believes that each of the 

IRS submissions are consistent with 

section 5b(c)(2) of the CEA. 

Request for Comment 

• The Commission requests comment 

on whether the proposed interest rate 

swaps clearing requirement 

determination would alter any DCO’s 

ability to comply with the DCO core 

principles. 

ii. Consideration of the Five Statutory 

Factors for Clearing Requirement 

Determinations 

As explained above, section 

2(h)(2)(D)(ii) of the CEA identifies five 

factors the Commission shall take into 

account in making a clearing 

requirement determination. The process 

for submission and review of swaps for 

a clearing requirement determination is 

further detailed in § 39.5. This section 

provides the Commission’s 

consideration of the five factors in the 

context of the requirements of § 39.5 for 

interest rate swaps. 

a. Outstanding Notional Exposures, 

Trading Liquidity, and Adequate Pricing 

Data 

Section 2(h)(2)(D)(ii)(I) of the CEA 

requires the Commission to take into 

account the existence of outstanding 

notional exposures, trading liquidity, 

and adequate pricing data. For purposes 

of this factor, the Commission 

considered the market data regarding 

outstanding notional amounts, trade 

liquidity, and pricing. Unlike CDS for 

which substantially all of the trading 

data has been collected and is stored in 

one place, there is no single data source 

for notional exposures and trading 

liquidity for the entire interest rate swap 

market.100 However, the Commission 

considered several sources of data on 

the interest rate swap market that 

collectively provides the information 

the Commission needs to make a 

clearing requirement determination. The 

data sources considered include: general 

quarterly estimates published by the 

Bank for International Settlements (BIS 

data); market data published weekly by 

TriOptima (TriOptima data) covering 

swap trade information submitted 

voluntarily by 14 large derivatives 

dealers (G14 Dealers); trade-by-trade 

data provided voluntarily by the G14 

Dealers to the OTC Derivatives 

Supervisors Group for a three month 

period between June and August 2010 

(ODSG data); and trade-by-trade data 

provided by LCH for the first calendar 

quarter of 2012 and summary cleared 

swap open interest information (LCH 

data).101 The G14 Dealers and LCH 

trade-by-trade data was provided to the 

Commission on a confidential basis and 

consent was granted for publication of 

the summary information in this 

proposal. 

Each of these data sources has a 

number of limitations that are important 

to understand when considering the 

data. The following is a brief discussion 

of these limitations and how the data 

sets, when considered together, provide 

a more complete picture of outstanding 

notional amounts, trade liquidity, and 

pricing for the Commission’s 

consideration of the swaps submitted. 

The BIS data set covers the largest 

portion of the interest rate swap market 

over time and therefore is useful for 

reaching general conclusions regarding 

full market size and longer term market 

trends. However, the BIS data provides 

only summary information that is not 

granular enough to inform the clearing 

requirement considerations at the 

proposed class level. 

TriOptima’s data set updates are 

published weekly and provide more 

detail than the BIS data covering most 

of the class level specifications 

considered by the Commission. The 

TriOptima data is limited to the extent 

it only contains information gathered by 

TriOptima and therefore does not 

include all OTC interest rate swaps. 

Also, the TriOptima data shows 

outstanding notional and trade numbers 

as of a set date and does not provide an 

indication of trade liquidity over 

time.102

The ODSG data provided detailed 

information on a trade-by-trade basis, 

thereby providing sufficient information 

for class-level consideration. This 

information is useful for considering 

trading liquidity. However, the ODSG 

data set is limited in several ways that 

can skew analysis of the data. The 

ODSG data covered transactions 

confirmed on the MarkitWire platform, 

a trade confirmation service offered by 

MarkitSERV, between June 1, 2010 and 

August 31, 2010, where at least one 

party was a G14 Dealer. The dataset 

does not include transactions that took 

place between two non-G14 Dealer 

parties, with such parties representing 

an estimated 11% of the notional 

volume activity in MarkitSERV.103 The 

number of non-G14 Dealer swap trades 

that are not entered on MakitSERV has 

not been estimated and could be 

significant. The omission of certain 

classes of participants and trades in the 

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104 Id. at 6. 105 Id. at 5. 

106The NY Fed Analysis noted that for the ODSG 

interest rate swap data set the number and volume 

of non-price-forming trades were significantly 

greater than the number and volume of trades that 

were new economic activity. NY Fed Analysis, 

at 8. 

107BIS data. 

108This row excludes FRAs and options. 

sample will bias transaction and 

notional volume statistics downward. It 

may also distort the proportions of 

products seen relative to each other. 

The ODSG dataset also does not 

include transactions that were manually 

confirmed either by choice or necessity. 

It is estimated that the data set 

represents roughly 78% of G14 Dealer 

interest rate transaction activity.104 The 

three-month time frame in 2010 also 

introduces limitations into analysis of 

the data set. This time frame 

represented a period in the midst of 

historically low central bank interest 

rate policy across major currencies and 

novel liquidity measures taken in 

response to the 2008 financial crisis. 

The short period also could be affected 

by seasonal patterns, and the possibility 

exists that the markets have 

fundamentally changed since the data 

was gathered. The lack of manually 

confirmed trades in the data suggests an 

overrepresentation of standardized 

transactions such as OIS and plain 

vanilla interest rate swaps and 

underrepresentation of non-standard 

classes such as exotics and basis swaps. 

For instance, exotic product structures 

not eligible for electronic matching are 

estimated to make up 2% of the OTC 

interest rate derivative market.105

The LCH data provides summary data 

on outstanding notional amounts for 

different classes of swaps and the first 

quarter 2012 data provide detailed 

information on a trade-by-trade basis 

thereby providing sufficient information 

for class-level consideration. The LCH 

data is limited in that it only includes 

swaps cleared by LCH. It is noted, 

however, that LCH has cleared about 

50% of the interest rate swap market 

and higher levels of certain kinds of 

swaps indicating a reasonably high 

inclusion rate. This data set also has the 

advantage of being more current than 

the ODSG data and BIS data and is 

specific to the swaps that are under 

consideration in this Commission 

determination. 

The TriOptima data and ODSG data 

are both based, in large part, on data 

provided by the G14 Dealers. 

Additionally, the TriOptima data is 

published by TriOptima in formats that, 

for the class specifications considered 

by the Commission, can be analyzed in 

a manner similar to the analysis of the 

ODSG data. In fact, the Commission has 

found the TriOptima data and the ODSG 

data to be complementary in some ways. 

The TriOptima data is current and 

provides fairly detailed information 

about the gross notional amounts and 

total trade numbers for each class 

specification considered in this 

proposal. However, the TriOptima data 

does not provide enough information to 

assess periodic trade liquidity for each 

specification. Because the ODSG data is 

provided on a trade-by-trade basis, the 

Commission and other regulators have 

been able to make more granular 

assessments of this information, 

particularly for purposes of considering 

trading liquidity. Accordingly, although 

the ODSG data is nearly two years old, 

it is useful for confirming whether 

observations based on the current 

TriOptima data are consistent with 

historical trends and also to indicate 

trading liquidity. 

For this proposal, the Commission is 

considering only the swaps identified in 

the DCOs’ IRS submissions. 

Accordingly, where possible, the 

Commission presents and discusses 

only the data for swaps identified in the 

submissions. For example, although the 

ODSG data identifies twenty-eight 

different currencies in which swaps 

were traded during the period covered 

by the data set, only the seventeen 

currencies identified in the submissions 

were considered. In addition, the ODSG 

data shows all transactions recorded on 

MarkitServ including not only new, 

price-forming transactions, but also 

administrative transactions such as 

amendments, assignments, compression 

trades, and internal, inter-affiliate trades 

that may not be price forming.106

Because the Commission is considering 

notional amounts and trading liquidity, 

non-price-forming trades have been 

removed from the ODSG data presented 

below. 

The following analysis of interest rate 

swap data is presented based on the four 

swap classes and class specifications 

discussed above. This information is 

used by the Commission to determine 

whether there exists significant 

outstanding notional amounts, trading 

liquidity, and pricing data to include 

each class and specification identified 

in the IRS submissions. 

1. Interest Rate Swap Class 

The Commission first considered data 

relevant to the different interest rate 

swap classes included in the IRS 

submissions starting with the BIS data. 

TABLE 5—BANK FOR INTERNATIONAL SETTLEMENTS INTEREST RATE SWAPS OUTSTANDING NOTIONAL BY CLASS 107

[Amounts in billions of U.S. dollars] 

June 2009 Dec. 2009 June 2010 Dec. 2010 June 2011 Dec. 2011 

All Derivatives .......................................... $594,553 $603,900 $582,685 $601,046 $706,884 $647,762 

Interest Rate Swaps 108 ........................... 341,903 349,288 347,508 364,377 441,201 402,611 

FRAs ........................................................ 46,812 51,779 56,242 51,587 55,747 50,576 

Options ..................................................... 48,513 48,808 48,081 49,295 56,291 50,911 

Total interest rate swaps .................. 437,228 449,875 451,831 465,260 553,240 504,098 

The BIS data shows only notional 

amounts for three large categories: 

FRAs, swaps with options, and other 

interest rate swaps. It does not provide 

information on daily trading liquidity or 

break out other kinds of interest rate 

swaps such as basis swaps, OIS, or 

inflation swaps. 

However, the BIS data is useful in 

providing certain big picture 

information. It indicates that interest 

rate swaps in total constitute nearly 

80% of the derivatives market and 

interest rate swap notional amounts 

generally increased for all three kinds of 

swaps between 2008 and 2011. 

Additionally, all three classes of swaps 

identified by the BIS data have 

substantial notional amounts 

outstanding. As of December 2011, 

FRAs had about $50.5 trillion 

outstanding, options had about $51 

trillion outstanding, and other interest 

rate swaps had about $403 trillion 

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109TriOptima data, as of March 16, 2012. The 

TriOptima data provides information on nine other 

classes of swaps, none of which is included in the 

submissions. Notably, one other type, swaptions, 

exceeded FRAs and basis swaps in terms of number 

of transactions completed in the sample. On a 

notional amount basis, swaptions represented less 

than half the notional amount of FRAs traded and 

a little less than the notional amount of basis swaps. 

Regardless, because swaptions were not included in 

the list of swaps cleared in the IRS submissions, 

swaptions are not being considered for the clearing 

requirement determination because no DCO is 

clearing swaptions at this time. 110NY Fed Analysis at 7. The ODSG data 

includes swaps entered into between June and 

August, 2010 as voluntarily reported by the G14 

Dealers. The ODSG data provides information on 

other classes of swaps, none of which is included 

in the submissions. 

111The data covers swaps cleared by LCH during 

the first calendar quarter, 2012. Total Notional 

Outstanding Cleared is as of March 31, 2012. 

outstanding. Furthermore, the BIS data 

shows that over the three year period 

covered in Table 5, total interest rate 

swaps reported grew by about 15%. 

Given this information, none of the 

kinds of swaps identified by the BIS 

should be eliminated from 

consideration by the Commission for a 

clearing requirement based on the BIS 

data alone. However, the BIS data does 

not provide enough detail to reach 

further determinations regarding the 

swaps identified in the IRS submissions. 

TABLE 6—TRIOPTIMA DATA INTEREST RATE SWAPS OUTSTANDING NOTIONAL AND TRADE COUNT BY CLASS 109

Swap class 

Notional 

amount 

(USD BNs) 

Percent of total 

notional 

Total trade 

count 

Percent of 

total trade 

count 

Fixed-to-Floating ............................................................................................ $299,818 52 3,239,092 75 

FRA ................................................................................................................ 67,145 12 202,888 5 

OIS ................................................................................................................. 43,634 8 109,704 3 

Basis Swap .................................................................................................... 27,593 5 119,683 3 

Other .............................................................................................................. 132,162 23 617,637 14 

Total ........................................................................................................ 570,352 100 .00 4,289,004 100 

TABLE 7—ODSG DATA INTEREST RATE SWAPS TRADING ACTIVITY BY CLASS 110

Swap class 

Notional 

amount traded 

in quarter 

(USD BNs) 

Trade count in 

quarter 

Average 

weekly 

notional traded 

(USD BNs) 

Average 

weekly 

number of 

trades 

Fixed-to-Floating .............................................................................................. $15,858 123,337 $1,201 9,344 

OIS ................................................................................................................... 16,563 12,792 1,255 969 

FRA .................................................................................................................. 6,931 5,936 525 450 

Basis Swap ...................................................................................................... 2,307 3,173 175 240 

Other ................................................................................................................ 2,820 16,073 214 1,218 

Total .......................................................................................................... 44,479 161,311 3,370 12,221 

The TriOptima data and the ODSG 

data identify notional amounts and 

trade counts for all four classes of swaps 

identified in the IRS submissions. 

Outstanding notional amounts are 

provided in the TriOptima data and BIS 

data. Trading liquidity as an indication 

of how effectively DCOs can risk 

manage a portfolio of swaps can be 

evidenced in several ways. The data 

available for this purpose includes total 

notional amount outstanding, total 

number of swaps outstanding, and the 

average number of transactions over a 

given period of time. The TriOptima 

data indicates liquidity through the total 

notional amount outstanding and total 

number of trades outstanding at a given 

time. The ODSG data provides an 

indication of liquidity in terms of the 

number of trades during the calendar 

quarter covered by the data and the 

average weekly number of trades during 

the period. 

The TriOptima data shows that all 

four classes have significant outstanding 

notional amounts with basis swaps 

being the lowest at about $27.6 trillion 

and the highest being fixed-to-floating 

swaps at $288.8 trillion. Total trade 

counts for each type are also significant 

with the lowest being 109,704 for OIS 

and the highest being fixed-to-floating 

swaps at 3,239,092. The ODSG data 

confirms these observations historically. 

The average number of swap trades 

per week for each class of swaps is 

shown in the last column of Table 7. 

According to the ODSG data set, basis 

swaps were traded at the lowest 

frequency compared to the other three 

classes at 240 times on average each 

week during the ODSG data period. 

Because the ODSG data is from the 

summer of 2010 and gross notional 

amounts and trading activity in interest 

rate swaps have both increased 

generally, the Commission believes that 

trading activity has likely increased for 

all classes. 

TABLE 8—LCH DATA INTEREST RATE SWAPS NOTIONAL OUTSTANDING AND TRADE COUNT CLEARED BY CLASSES 111

Swap class 

Notional 

cleared 

in Quarter 

(USD BNs) 

Number of 

swaps cleared 

in quarter 

Average 

weekly 

notional traded 

(USD BNs) 

Average 

weekly 

number of 

trades 

Total notional 

outstanding 

(USD BNs) 

Fixed-to-Floating .................................................................. $17,022 117,780 $1,309 9,060 $226,016 

FRA ...................................................................................... 11,271 31,630 867 2,433 27,707 

OIS ....................................................................................... 8,731 6,848 672 527 36,510 

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112Percentages are calculated based on total 

notional amount cleared by LCH divided by total 

notional outstanding as reported by TriOptima. The 

TriOptima data is used because it is the most 

current data set that provides data broken out 

according to the classes currently being cleared. 

113LCH started clearing FRAs in December 2011 

and cleared volumes have increased significantly 

each month since the start date. 

114BIS data. 

115To some extent, such decreases may have 

resulted from increased trade compression exercises 

during the subsequent reporting period. 

116TriOptima data, as of March 16, 2012. 

TABLE 8—LCH DATA INTEREST RATE SWAPS NOTIONAL OUTSTANDING AND TRADE COUNT CLEARED BY CLASSES 111— 

Continued 

Swap class 

Notional 

cleared 

in Quarter 

(USD BNs) 

Number of 

swaps cleared 

in quarter 

Average 

weekly 

notional traded 

(USD BNs) 

Average 

weekly 

number of 

trades 

Total notional 

outstanding 

(USD BNs) 

Basis .................................................................................... 1,610 2,940 124 226 11,378 

Total .............................................................................. 38,634 159,198 2,972 12,246 301,612 

The LCH data generally confirms the 

assessment of market-wide data. There 

is substantial outstanding notional 

volumes and trade liquidity for each of 

the four classes already being cleared at 

LCH. 

LCH cleared the following percentage 

of each class of swap as reported by 

TriOptima: 112

• 75% of the Fixed-to-Floating swaps, 

• 41% of FRAs,113

• 84% of OIS, and 

• 41% of Basis Swaps. 

Accordingly, a substantial portion of 

each class is already being cleared 

voluntarily. 

Swap Class Conclusion 

The Commission concludes that the 

four classes of swaps currently being 

cleared have significant outstanding 

notional amounts and trading liquidity. 

The Commission further notes that a 

substantial percentage of each of the 

four classes is already cleared by DCOs. 

2. Currency 

As discussed above in Section II.E, 

the currency in which the notional and 

payment amounts are specified is a 

primary product specification and all 

four data sources provide interest rate 

swap data by currency. 

TABLE 9—BANK FOR INTERNATIONAL SETTLEMENTS: INTEREST RATE SWAPS NOTIONAL BY CURRENCY 114

(Amounts Outstanding in Billions of U.S. Dollars) 

June 2009 Dec 2009 June 2010 Dec 2010 June 2011 Dec 2011 

EUR .......................................................... $160,668 $175,790 $161,515 $177,831 $219,094 $184,702 

USD .......................................................... 154,174 153,373 164,119 151,583 170,623 161,864 

JPY ........................................................... 57,452 53,855 55,395 59,509 65,491 66,819 

GBP .......................................................... 32,591 34,257 36,219 37,813 50,109 43,367 

CAD .......................................................... 3,227 3,427 4,411 4,247 6,905 6,397 

SEK .......................................................... 5,294 4,696 4,461 5,098 5,832 5,844 

CHF .......................................................... 4,713 4,807 4,650 5,114 6,170 5,395 

Other ........................................................ 19,108 19,669 21,061 24,064 29,017 29,709 

All Currencies ........................................... 437,228 449,875 451,831 465,260 553,240 504,098 

The BIS data addresses seven of the 

seventeen currencies identified in the 

submissions individually. All seven 

currencies have substantial outstanding 

notional amounts as of December 2011, 

ranging from nearly $5.4 trillion for the 

Swiss franc to about $185 trillion in 

euro. Although several currencies 

showed decreases in total notional 

outstanding from one reporting period 

to the next, most such decreases were 

around ten percent or less, and, after 

such decreases, total notional amounts 

for those currencies generally 

rebounded.115 For all currencies, the 

outstanding notional amounts were 

higher at the end of the most recent 

three-year period as compared to the 

beginning of the period. 

The Commission believes that the BIS 

data supports the conclusion that there 

exists significant outstanding notional 

amounts in each currency identified in 

the BIS data and that there is no 

indication that notional amounts in 

those currencies are decreasing at a rate 

that would warrant elimination of those 

currencies from consideration for a 

clearing requirement. 

TABLE 10—TRIOPTIMA DATA INTEREST RATE SWAPS OUTSTANDING NOTIONAL AND TRADE COUNT BY CURRENCY 116

Currency 

Notional 

amount 

(USD BNs 

Eqv.) 

Percent of 

total notional 

Total trade 

count 

Percent of 

total trade 

count 

Euro ................................................................................................................. $176,481 36 1,115,504 28 

US Dollar ......................................................................................................... 175,777 35 1,300,862 33 

Yen ................................................................................................................... 64,083 13 568,871 14 

British Pound ................................................................................................... 43,337 9 419,611 11 

Other 117 ........................................................................................................... 36,4905 7 536,887 14

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117Thirteen other currencies are cleared by LCH: 

AUD, CHF, SEK, CAD, ZAR, NZD, NOK, HKD, PLN, 

SGD, HUF, DKK, and CZK. 

118The ODSG data includes swaps entered into 

between June and August 2010 as voluntarily 

reported by the G14 Dealers. 

119 Includes the 13 other currencies cleared by 

LCH identified in its IRS submission. The ODSG 

data identified an additional 11 other currencies 

that were not cleared by any of the submitters. 

120TriOptima data, as of March 16, 2012. 

121The data covers swaps cleared by LCH during 

the first calendar quarter, 2012. Total Notional 

Outstanding is as of March 31, 2012. 

122The TriOptima data is used for this calculation 

because it is the most current data set that provides 

data broken out according to the classes currently 

being cleared. 

TABLE 10—TRIOPTIMA DATA INTEREST RATE SWAPS OUTSTANDING NOTIONAL AND TRADE COUNT BY CURRENCY 116— 

Continued 

Currency 

Notional 

amount 

(USD BNs 

Eqv.) 

Percent of 

total notional 

Total trade 

count 

Percent of 

total trade 

count 

Total .......................................................................................................... 496,168 100 3,941,735 100 

TABLE 11—ODSG DATA INTEREST RATE SWAPS NOTIONAL TRADING ACTIVITY BY CURRENCY 118

Currency 

Notional 

traded 

in quarter 

(USD BNs) 

Trade count in 

quarter 

Average 

weekly 

notional traded 

(USD BNs) 

Average 

weekly 

number of 

trades 

EUR ................................................................................................................. $18,410 45,114 $1,395 3,418 

USD ................................................................................................................. 11,013 48,876 834 3,703 

GBP ................................................................................................................. 7,248 16,282 549 1,233 

JPY .................................................................................................................. 4,263 18,799 323 1,424 

Other 119 ........................................................................................................... 3,048 20,412 231 1,546 

Total .......................................................................................................... 43,982 149,483 3,332 11,324 

The TriOptima data shows that total 

outstanding notional amounts as of 

March 16, 2012, ranged from $400 

billion for Czech koruna to over $176 

trillion notional amount for euros.120

While there may be sufficient 

outstanding notional amounts in all 

seventeen currencies, the Commission 

takes note that there is a clear 

demarcation between the four 

currencies with the highest outstanding 

notional amounts: euro, U.S. dollar, 

British pound, and yen, and all other 

currencies. As Table 10 shows, the four 

top currencies range from about 9% to 

36% of the total notional amount of all 

interest rate swaps outstanding and 

11%to 33% of the total number of 

trades. The remaining currencies range 

from about 2% down to 0.1% of the 

total notional amount traded and 3% 

down to 0.2%of total number of trades. 

In fact, the four major currencies 

accounted for about 93% of the total 

notional amount outstanding in the 

TriOptima data set. 

The ODSG data provides an 

indication of trading liquidity in terms 

of average weekly notional amount 

traded and number of new trades 

completed during the period covered by 

the data set. Of the four major 

currencies, Japanese yen had the lowest 

weekly average notional at $323 billion 

and the British pound had the lowest 

average number of trades each week at 

1,233. 

The TriOptima data provides an 

overall, more current view of trades 

outstanding, which provides a broader 

picture of the trading potential for each 

currency for purposes of DCO risk 

management. As of March 16, 2012, all 

but one of the seventeen currencies had 

outstanding trade counts in excess of 

14,000 with the exception being the 

Danish krone at 6,849. Again, the four 

highest currencies by trade count: euro, 

U.S. dollar, British pound, and yen, 

accounted for about 85% of the total 

number of trades recorded and 

outstanding at the time the data was 

collected. 

TABLE 12—LCH DATA INTEREST RATE SWAPS NOTIONAL OUTSTANDING AND TRADE COUNT CLEARED BY CURRENCY 121

Currency 

Notional cleared 

in quarter 

(USD BNs) 

Number of 

swaps cleared 

in quarter 

Average weekly 

notional traded 

(USD BNs) 

Average weekly 

number of 

trades 

Total notional 

outstanding 

(USD BNs) 

EUR .................................................................. $19,207 61,039 $1,477 4,695 $115,695 

USD .................................................................. 12,111 51,710 932 3,978 107,734 

GBP .................................................................. 2,801 12,976 216 998 25,339 

JPY ................................................................... 2,799 12,374 215 952 37,696 

Other ................................................................ 1,716 21,099 132 1,623 15,146 

Total .......................................................... 38,634 159,198 2,972 12,246 301,612 

The LCH data shows that the relative 

notional amount and number of swaps 

in each currency cleared is generally 

correlated with the notional amount and 

number of swaps of each currency 

reported by the more general market 

data sets. As a percentage of the total 

notional amount outstanding as 

reported by TriOptima, LCH cleared the 

following percentages: 122

• 66% of euro, 

• 61% of U.S. dollars, 

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123The ODSG data includes swaps entered into 

between June and August, 2010 as voluntarily 

reported by the G14 Dealers. This table includes 

only rate indexes used for the G4 currencies and 

that are cleared by LCH. 

124 ‘‘Eur-Euribor’’ category includes both EurEuribor-Reuters and Eur-Euribor-Telerate, which 

are both cleared by LCH. 

* ‘‘EONIA’’, ‘‘SONIA’’, and ‘‘FedFunds’’ are 

floating rate indexes used to calculate OIS amounts 

only. The other indexes listed in the table are used 

for fixed-to-floating swaps, basis swaps, and FRAs. 

125The data includes swaps cleared by LCH 

during the first calendar quarter, 2012. 

• 58% of British pounds, 

• 59% of Japanese yen, and 

• 42% of other currencies. 

Of the interest rate swaps identifying 

U.S. dollars, euro, British pounds or yen 

as the applicable currency, significantly 

more than half are already being cleared 

by LCH. While the level of clearing of 

other currencies is, on a combined basis 

reasonably high at 42%, the 

Commission notes the level is 

noticeably lower than the percentage of 

swaps being cleared for the top four 

currencies. 

Currency Specification Conclusion 

The Commission believes that all of 

the data sets demonstrate the existence 

of significant outstanding notional 

amounts and trading liquidity in the 

seventeen currencies identified in the 

submissions. However, the Commission 

notes that swaps using the four 

currencies with the highest outstanding 

notional amounts and trade frequency: 

euro, U.S. dollar, British pound, and 

yen, account for an outsized portion of 

both notional amounts outstanding and 

trading volumes. Furthermore, the 

Commission notes that these four 

currencies are already being cleared 

more than the other currencies 

generally. 

While it is important that this 

determination include a substantial 

portion of the interest rate swaps traded 

to have a substantive, beneficial impact 

on systemic risk, the Commission also 

recognizes that the proposed rule is the 

Commission’s first swap clearing 

requirement determination. As noted in 

the phased implementation rules for the 

clearing requirement, the Commission 

believes that introducing too much 

required clearing too quickly could 

unnecessarily increase the burden of the 

clearing requirement on market 

participants. In recognition of these 

considerations, the Commission will 

focus the remainder of this initial 

clearing requirement determination 

analysis on swaps referencing the four 

most heavily traded currencies. The 

Commission notes that the decision not 

to include the other thirteen currencies 

at this time does not limit the 

Commission’s authority to reconsider 

required clearing of those currencies in 

the future. 

The Commission requests comment 

on whether any of the other thirteen 

currencies identified above should be 

included in the initial clearing 

requirement determination for interest 

rate swaps. 

3. Floating Rate Index Referenced 

The ODSG data and LCH data provide 

an indication of the rate indices used on 

a transaction-by-transaction basis. Rate 

indexes are currency specific. However, 

the BIS data and the TriOptima data do 

not provide information on the different 

rate indices referenced in interest rate 

swaps. The following tables present 

trading activity data for each rate index 

identified in the IRS submissions as 

being cleared for each of the four 

currencies the Commission is proposing 

to include in the clearing requirement 

determination. 

TABLE 13—ODSG DATA INTEREST RATE SWAPS TRADING ACTIVITY BY RATE INDEX 123

Rate Index 

Notional traded 

in quarter 

(USD BNs) 

Trade count 

for quarter 

Average weekly 

notional traded 

(USD BNs) 

Average weekly 

number of 

trades 

EUR–EURIBOR 124 .................................................................. $9,366 38,213 $710 2,895 

USD–LIBOR ............................................................................. 9,080 46,620 688 3,532 

EUR–EONIA * .......................................................................... 9,022 6,496 684 492 

GBP–SONIA * .......................................................................... 4,934 2,011 374 152 

JPY–LIBOR .............................................................................. 4,015 18,491 304 1,401 

GBP–LIBOR ............................................................................. 2,296 12,417 174 941 

USD–FedFunds * ..................................................................... 1,887 1,951 143 148 

EUR–LIBOR ............................................................................. 1 5 0 0 

Total .................................................................................. 40,602 126,204 3,076 9,561 

TABLE 14—LCH DATA INTEREST RATE SWAPS NOTIONAL OUTSTANDING AND TRADE COUNT BY RATE INDEX125

Rate index (by currency) 

Notional cleared 

in quarter 

(USD BNs) 

Number of swaps 

cleared in 

quarter 

Average weekly 

notional traded 

(USD BNs) 

Average weekly 

number of 

trades 

EURO 

EURIBOR ......................................................................... $13,444 57,157 $1,034 4,397 

EONIA ............................................................................... 5,763 3,882 443 299 

US Dollar 

LIBOR ............................................................................... 10,905 50,197 839 3,861 

FEDFUND ......................................................................... 1,206 1,513 93 116 

GBP 

LIBOR ............................................................................... 1,067 11,550 82 888 

SONIA ............................................................................... 1,734 1,426 134 110 

Yen 

LIBOR ............................................................................... 2,799 12,374 215 952 

Other Indexes .......................................................................... 1,716 21,099 132 1,623 

Total ........................................................................... 38,634 159,198 2,972 12,246 

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126British pound-SONIA has about the same 

number of trades and per week trading average as 

Fedfunds, but has a higher outstanding notional 

amount at $1.734 trillion. 

127The ‘‘swap curve’’ is the term generally used 

by market participants for interest rate swap pricing 

and is similar to, and is sometimes established, in 

part, based on, ‘‘yield curves’’ used for pricing 

bonds. 

128Other factors, such as convexity, may also be 

taken into account in determining the appropriate 

hedge ratio between the initial swap and the other 

swaps used to hedge its exposure. 

129For further discussion of the use of portfolio 

risk management by DCOs, see the discussion of 

interest rate swap market conventions and risk 

management in Section II.E above. 

The ODSG data shows minimal 

activity for EUR–LIBOR with about 1 

billion of notional amount and five 

trades made for the three-month period 

in 2010 that the ODSG data covers. 

EUR–LIBOR does not appear on the 

LCH data table because, although swaps 

referencing that index can be cleared at 

LCH, LCH had no open interest for that 

index as of March 31, 2012. Given the 

minimal notional amounts and trade 

liquidity for the EUR–LIBOR index, the 

Commission has determined not to 

include EUR–LIBOR under the clearing 

requirement. 

The other rate indexes all show 

significant notional amounts and 

trading liquidity. The rates with the 

least activity, the U.S. dollar Fedfund 

index and British pound-LIBOR index, 

each have over one trillion dollars in 

notional outstanding already cleared at 

LCH and on a weekly basis, $93 billion 

and $82 billion in notional amount, 

respectively, were cleared per week on 

average. In terms of number of trades 

cleared at LCH, swaps referencing 

Fedfunds were cleared on average 116 

times per week and swaps referencing 

British pound-LIBOR were cleared 888 

times per week on average. All of the 

other indices currently cleared have 

similar or substantially higher number 

of trades and notional amounts 

cleared.126

The rate indexes used for OTC 

interest rate swaps and the interest rate 

swaps identified for clearing by the 

DCOs reference not only the generic 

index, but a reference definition for the 

index such as the ISDA definition or 

Reuters definition. These reference 

definitions refer to the generic index 

and in addition, typically identify 

specifically where the calculating party 

shall look up the index and sometimes 

at what time the calculating party shall 

look up the index for calculation 

purposes. Additionally, these reference 

indices provide a standard alternative if 

the index is not available from the 

designated source at the designated 

time. While the Commission recognizes 

the importance of these features of the 

reference definitions and that each 

swap, both cleared and uncleared, 

should have these features, such 

features need not be included in the 

index rate specification for the 

Commission’s clearing requirement 

determination because they are not 

definitive for the economic result 

achieved. Rather, the generic index 

itself is. If the parties to a swap identify 

a specific reference definition for an 

index, they need only confirm whether 

the DCO accepts that reference 

definition. If it does not, then the swap 

in question is not accepted for clearing 

and it is not subject to the clearing 

requirement. 

Rate Index Specification Conclusion 

The Commission concludes that with 

the exception of the EURO–LIBOR 

index, all of the rate indexes identified 

in the IRS submissions have significant 

outstanding notional amounts and 

trading liquidity. The Commission 

further notes that significant notional 

amounts of these rate indexes are 

already cleared by DCOs. 

4. Stated Termination Dates 

Stated termination date (sometimes 

referred to as ‘‘maturities’’) data is often 

presented by aggregating stated 

termination dates for swaps into 

specified term periods or ‘‘buckets.’’ 

The IRS submissions show that the 

DCOs have been clearing interest rate 

swaps with final termination dates out 

to at least ten years for all seventeen 

currencies and out to 50 years for some 

classes and currencies cleared. 

The use of maturity buckets eases the 

discussion of the range of termination 

dates. As the tables below show, interest 

rate swaps can be multi-year contracts 

with termination dates out to fifty years 

or more depending on the class and 

currency of the swap. Also, stated 

termination dates can fall on any day of 

the year. Given this continuum of 

termination dates, the DCOs have 

indicated that they manage the cleared 

swap portfolio risk using a swap 

curve.127 Swap curves are also used by 

market participants to price interest rate 

swaps. By pricing swaps in this way, the 

economic results of an interest rate 

swap can be fairly closely 

approximated, and therefore hedged, 

using two or more other swaps with 

different maturities principally by 

matching the weighted average duration 

of those swaps with the duration of the 

swap being hedged.128 In the same 

manner, a large portfolio of interest rate 

swaps can be hedged fairly closely with 

a small number of hedging swaps that 

have the same duration as the entire 

portfolio or subsets of related swaps 

within the portfolio. In effect, for DCO 

risk management purposes, the 

termination dates of interest rate swaps 

are assessed based on how they affect 

the overall duration aspects of the 

portfolio of swaps cleared.129

Accordingly, the primary determination 

with respect to the stated termination 

date specification is, for each class and 

currency, at what point, if any, along the 

continuum of swap maturities is there 

insufficient notional outstanding and 

trading liquidity to structure the swap 

curve effectively for DCO risk 

management purposes. 

The TriOptima data provided 

sufficient detail to discern notional 

amounts and trade counts only for each 

swap class. The ODSG data provided 

sufficient detail to discern notional 

amounts and trade counts only for each 

currency. The LCH data provided 

enough detail for both swap class and 

currency. 

Regarding maturity buckets, the BIS 

data only provides information for 

interest rate swaps in three periods: up 

to one year, between one year and five 

years, and more than five years. Because 

the BIS data does not provide granular 

detail beyond the five year maturity 

date, it does not provide enough detail 

to inform the Commission’s 

determination regarding the IRS 

submissions under consideration. 

Accordingly, the BIS data was not 

considered for the stated termination 

date specification. 

TABLE 15—TRIOPTIMA DATA INTEREST RATE SWAPS NOTIONAL BY MATURITY PERIOD AND CLASS 130

[U.S. dollar equivalent in billions] 

Product type Maturity 

0≤2 years 

Maturity 

2≤5 years 

Maturity 

5≤10 years 

Maturity 

10≤20 years 

Maturity 

20≤30 years 

Maturity 

30+ Years 

Fixed-to-Floating: 

—Notional ......................................... $118,523 $80,101 $66,049 $19,872 $13,207 $2,067 

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47200 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

130TriOptima data, as of March 16, 2012. 

131The data covers swaps cleared by LCH during 

the first calendar quarter, 2012. 

132The ODSG data includes swaps entered into 

between June and August, 2010 as voluntarily 

reported by the G14 Dealers. Only currencies and 

swap classes identified in the IRS submissions are 

included. 

TABLE 15—TRIOPTIMA DATA INTEREST RATE SWAPS NOTIONAL BY MATURITY PERIOD AND CLASS130—Continued 

[U.S. dollar equivalent in billions] 

Product type Maturity 

0≤2 years 

Maturity 

2≤5 years 

Maturity 

5≤10 years 

Maturity 

10≤20 years 

Maturity 

20≤30 years 

Maturity 

30+ Years 

—Trade Count .................................. 823,434 890,622 908,880 303,927 270,074 42,155 

FRA: 

—Notional ......................................... $66,040 $1,060 $45 $0 $0 $0 

—Trade Count .................................. 201,164 1,646 78 0 0 0 

OIS: 

—Notional ......................................... $41,783 $1,450 $258 $64 $74 $4 

—Trade Count .................................. 77,982 26,067 3,740 1,376 510 29 

Basis Swap: 

—Notional ......................................... $17,324 $6,032 $2,633 $950 $561 $94 

—Trade Count .................................. 39,632 34,080 24,590 12,638 8,197 546 

TABLE 16—LCH DATA: INTEREST RATE SWAPS NOTIONAL OUTSTANDING CLEARED BY MATURITY PERIOD AND CLASS131

[U.S. dollar equivalent in billions] 

Product type Maturity 

0≤2 years 

Maturity 

2≤5 years 

Maturity 

5≤10 years 

Maturity 

10≤20 years 

Maturity 

20≤30 years 

Maturity 

30≤50 years 

Fixed-to-Floating: 

—Notional ......................................... $7,773 $4,448 $3,569 $747 $463 $52 

—Trade Count .................................. 22,431 34,930 40,086 8,551 10,701 1,127 

FRA: 

—Notional ......................................... $11,184 $0 $0 $0 $0 $0 

—Trade Count .................................. 31,584 0 0 0 0 0 

OIS: 

—Notional ......................................... $8,714 $0 $0 $0 $0 $0 

—Trade Count .................................. 6,848 0 0 0 0 0 

Basis Swap: 

—Notional ......................................... $1,423 $129 $37 $14 $5 $1 

—Trade Count .................................. 1,485 736 394 226 84 15 

The TriOptima data and LCH data 

presented above is useful in considering 

the distribution of final termination 

dates based on swap class. For fixed-tofloating swaps and basis swaps, there 

was significant outstanding notional 

amounts and number of trades for all 

maturity buckets. 

For FRAs, the TriOptima data shows 

a steep drop off after two years, 

although there is still over $1 trillion 

dollars of outstanding notional amount 

in the 2≤5 year bucket and 1,646 trades. 

The notional amount outstanding falls 

below $50 billion after the five year 

maturity. The LCH data shows 

substantial outstanding notional 

amounts out to two years and none 

thereafter. The IRS submissions provide 

that the DCOs do not clear FRAs with 

payment dates beyond three years. 

Accordingly, the Commission need not 

consider FRAs with maturities beyond 

three years until such time as a DCO 

submits such swaps for clearing. 

For OIS, the TriOptima data shows 

notional amounts for all maturity 

buckets, but the drop off was steep 

beyond two years. After ten years, 

outstanding notional amounts drop 

below $100 billion for each maturity 

bucket. The LCH data shows no 

outstanding notional amounts cleared 

beyond two years. The IRS submissions 

provide that the DCOs do not accept for 

clearing OIS swaps beyond two years. 

Accordingly, the Commission is not 

considering OIS swaps beyond two 

years in this clearing requirement 

determination. 

TABLE 17—ODSG DATA: INTEREST RATE SWAPS TRADING ACTIVITY BY MATURITY PERIOD AND CURRENCY 132

[U.S. dollar equivalent in billions] 

Currency Maturity 

0≤2 years 

Maturity 

2≤5 years 

Maturity 

5≤10 years 

Maturity 

10≤20 years 

Maturity 

20≤30 years 

Maturity 

30≤50 years 

EUR .......................................................... $14,596 $1,699 $1,510 $447 $287 $34 

USD .......................................................... 6,796 1,991 1,999 247 220 5 

GBP .......................................................... 6,521 348 263 72 54 17 

JPY ........................................................... 2,970 782 448 91 16 0 

Other ........................................................ 2,597 325 142 16 3 0 

Total .................................................. 33,480 5,143 4,362 872 580 56 

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133The data covers swaps cleared by LCH during 

the first calendar quarter, 2012. 

TABLE 18—LCH DATA INTEREST RATE SWAPS NOTIONAL OUTSTANDING CLEARED BY MATURITY PERIOD AND

CURRENCY 133

[U.S. Dollar Equivalent in Billions] 

Currency Maturity 

0≤2 years 

Maturity 

2≤5 years 

Maturity 

5≤10 years 

Maturity 

10≤20 years 

Maturity 

20≤30 years 

Maturity 

30≤50 years 

EUR .......................................................... $14,697 $1,922 $1,759 $477 $269 $35 

USD .......................................................... 8,850 1,796 1,176 154 133 2 

GBP .......................................................... 2,143 256 268 59 51 16 

JPY ........................................................... 2,204 254 262 56 12 0 

Other ........................................................ 1,200 349 141 13 3 0 

Total .................................................. 29,094 4,577 3,606 760 468 53 

The ODSG data and LCH data in the 

two preceding tables show notional 

amounts traded for maturity buckets by 

currency. As shown, there were traded 

and cleared notional amounts for euro, 

U.S. dollars and British pounds out to 

the 30 to 50 year bucket and for yen out 

to the twenty to thirty year bucket. The 

LCH data confirms that substantial 

notional amounts of euros, U.S. dollars 

and British pounds are being cleared out 

to fifty years and yen out to 30 years. 

Stated Termination Date Specification 

Conclusion 

For the classes of swaps, the 

TriOptima data show that there is 

significant outstanding notional 

amounts and number of trades out to 50 

years for fixed-to-floating swaps and 

basis swaps, out to three years for OIS, 

and out to two years for FRAs. With 

respect to currencies, the ODSG data set 

and LCH data show significant 

outstanding notional amounts and 

number of trades out to 50 years for U.S. 

dollars, euros, and British pounds and 

out to 30 years for yen. 

5. Adequate Pricing Data 

In reaching its proposed 

determination, the Commission also is 

taking into account the adequacy of the 

pricing data for the four classes of 

interest rate swaps. LCH submits there 

is adequate pricing data for its risk and 

default management. It explains that its 

risk and default management is based 

on the following factors under normal 

and stressed conditions: 

• Outstanding notional, by maturity 

bucket and currency; 

• Number of participants with live 

open positions, by maturity bucket and 

currency; 

• Notional throughput of the market, 

by maturity bucket and currency; 

• Size tradable by maturity bucket 

that would not adjust the market price; 

• Number of potential direct clearing 

members clearing the products that are 

part of the mutualized default fund and 

default management process; 

• Interplay between on-the-run and 

off-the-run contracts; and 

• Product messaging components and 

structure. 

LCH carries out a fire drill of its 

default management procedures and 

readiness twice a year. According to 

LCH, the fire drill presents an 

opportunity to further benchmark 

market liquidity and behavior and for 

models and assumptions to be 

recalibrated based on practitioner input. 

LCH also tests liquidity assumptions 

from the outset when developing 

clearing capabilities for a new product 

and thereafter, on a daily basis. This 

testing informs how LCH develops and 

modifies its risk management 

framework to provide adequate risk 

coverage in compliance with the core 

principles applicable to DCOs. Based on 

this framework, LCH contends that there 

is adequate pricing data for the swaps 

offered for clearing. 

IDCH submits that there is adequate 

pricing data to produce the IDCHgenerated discount curve (the IDCH 

Curve). IDCH values each open position 

at the end of each trading day by 

valuing each leg of the cash flows of the 

contract (fixed and floating) according 

to discount factors produced by the 

IDCH Curve. The IDCH Curve is a zerocoupon yield curve that is updated on 

a continual basis and includes a 

composite of swap rates. IDCH generates 

a unique IDCH Curve for each reference 

rate that is available for clearing and 

calibrates each of these IDCH Curves to 

the discount curve to value at-market 

instruments at par. 

CME publicly represents that its 

interest rate swap valuations are fully 

transparent and rely on pricing inputs 

obtained from wire service feeds. 

Further, CME uses conventional pricing 

methodologies, including OIS 

discounting, to produce its zero coupon 

curve. In addition, customers are 

provided with direct access to daily 

reports showing curve inputs, daily 

discount factors, and valuations for each 

cleared swap position. 

It is also worth noting that those 

interest rate swaps that are the subject 

of this proposal are capable of being 

priced off of deep and liquid debt 

markets. Because of the stability of 

access to pricing data from these 

markets, the pricing data for non-exotic 

interest rate swaps that are currently 

being cleared is generally viewed as 

non-controversial. 

Based on consideration of the existence 

of significant outstanding notional 

exposures, trading liquidity, and 

adequate pricing data, the Commission 

preliminarily has determined to include 

interest rate swaps with the following 

specifications in the clearing 

requirement rule. 

TABLE 19—INTEREST RATE SWAP DETERMINATION

Fixed-to-Floating Swap Class 

Specification 

1. Currency ........................................ U.S. Dollar (USD) ......... Euro (EUR) ................... Sterling (GBP) ............... Yen (JPY). 

2. Floating Rate Indexes ................... LIBOR ........................... EURIBOR ...................... LIBOR ........................... LIBOR. 

3. Stated Termination Date Range ... 28 days to 50 years ...... 28 days to 50 years ...... 28 days to 50 years ...... 28 days to 30 years. 

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TABLE 19—INTEREST RATE SWAP DETERMINATION—Continued 

4. Optionality ...................................... No ................................. No ................................. No ................................. No. 

5. Dual Currencies ............................. No ................................. No ................................. No ................................. No. 

6. Conditional Notional Amounts ....... No ................................. No ................................. No ................................. No. 

Basis Swap Class 

Specification 

1. Currency ........................................ U.S. Dollar (USD) ......... Euro (EUR) ................... Sterling (GBP) ............... Yen (JPY). 

2. Floating Rate Indexes ................... LIBOR ........................... EURIBOR ...................... LIBOR ........................... LIBOR. 

3. Stated Termination Date Range ... 28 days to 50 years ...... 28 days to 50 years ...... 28 days to 50 years ...... 28 days to 30 years. 

4. Optionality ...................................... No ................................. No ................................. No ................................. No. 

5. Dual Currencies ............................. No ................................. No ................................. No ................................. No. 

6. Conditional Notional Amounts ....... No ................................. No ................................. No ................................. No. 

Forward Rate Agreement Class 

Specification 

1. Currency ........................................ U.S. Dollar (USD) ......... Euro (EUR) ................... Sterling (GBP) ............... Yen (JPY). 

2. Floating Rate Indexes ................... LIBOR ........................... EURIBOR ...................... LIBOR ........................... LIBOR. 

3. Stated Termination Date Range ... 3 days to 3 years .......... 3 days to 3 years .......... 3 days to 3 years .......... 3 days to 3 years. 

4. Optionality ...................................... No ................................. No ................................. No ................................. No. 

5. Dual Currencies ............................. No ................................. No ................................. No ................................. No. 

6. Conditional Notional Amounts ....... No ................................. No ................................. No ................................. No. 

Overnight Index Swap Class 

Specification 

1. Currency ........................................ U.S. Dollar (USD) ......... Euro (EUR) ................... Sterling (GBP)..

2. Floating Rate Indexes ................... FedFunds ...................... EONIA ........................... SONIA..

3. Stated Termination Date Range ... 7 days to 2 years .......... 7 days to 2 years .......... 7 days to 2 years..

4. Optionality ...................................... No ................................. No ................................. No..

5. Dual Currencies ............................. No ................................. No ................................. No..

6. Conditional Notional Amounts ....... No ................................. No ................................. No..

Request for Comments 

• Should the Commission consider 

other data to determine whether there 

are outstanding notional exposures, 

trading liquidity, or adequate pricing 

data to support the proposed clearing 

requirements? If so, please provide or 

identify any additional data that may 

assist the Commission in this regard. 

• Do the four classes of interest rate 

swaps that would be subject to the 

proposed clearing requirement have 

significant outstanding notional 

amounts and trading liquidity? 

• Should the Commission include the 

other thirteen currencies currently being 

cleared in its initial clearing 

requirement determination? 

• Should the Commission include 

stated termination dates that are shorter 

than those that are listed, particularly 

for the fixed-to-floating and basis 

swaps? 

• If the option in an interest rate 

swaption is exercised and not cash 

settled, should the resulting swap be 

subject to the clearing requirement if it 

meets the specifications included in the 

proposed clearing requirement? 

• Is there adequate pricing data for 

DCO risk and default management of the 

interest rate swaps that would be subject 

to the proposed rule? 

b. Availability of Rule Framework, 

Capacity, Operational Expertise and 

Resources, and Credit Support 

Infrastructure 

Section 2(h)(2)(D)(ii)(II) of the CEA 

requires the Commission to take into 

account the availability of rule 

framework, capacity, operational 

expertise and resources, and credit 

support infrastructure to clear the 

proposed classes of swaps on terms that 

are consistent with the material terms 

and trading conventions on which they 

are now traded. The Commission 

believes that LCH, CME, and IDCH have 

developed rule frameworks, capacity, 

operational expertise and resources, and 

credit support infrastructure to clear the 

interest rate swaps they currently clear 

on terms that are consistent with the 

material terms and trading conventions 

on which those swaps are being traded. 

The Commission notes that LCH already 

clears more than half the global interest 

rate swaps in the four proposed classes 

of the clearing requirement and that 

CME and IDCH also already clear the 

more commonly traded swaps under 

this clearing requirement proposal. 

Importantly, the Commission notes 

that the three DCOs each developed 

their interest rate swap clearing 

offerings in conjunction with market 

participants and in response to the 

specific needs of the marketplace. In 

this manner, the clearing services of 

each DCO are designed to be consistent 

with the material terms and trading 

conventions of a bilateral, uncleared 

market. 

LCH submits that it has the capability 

and expertise to not only manage the 

risks inherent in the current book of 

interest rate swaps cleared, but also the 

capability to manage the increased 

volume that the clearing requirement for 

all of its currently clearable products 

could generate. LCH states that its 

clearing model seamlessly allows 

interest rate swaps to be cleared on 

identical terms for both new and 

existing, bilateral OTC swaps. Existing 

bilateral swaps are regularly back 

loaded into LCH’s cleared swaps book. 

In order to be able to securely risk 

manage, and technologically and 

operationally process this volume of 

trades and diversity of underlying 

product (i.e., all of the unique 

underlying features of every single 

swap), LCH has developed operational 

models, controls, and risk algorithms to 

ensure that it can process trades, and is 

capable of calculating the level of risk 

it has with any counterparty—both 

direct clearing members and their 

customers. LCH believes its SwapClear 

service is proof that the interest rate 

swap market and all of its features can 

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be safely cleared with the right systems, 

controls, risk management, operational 

framework, and expertise, and it points 

to the orderly and successful close out 

of the Lehman Brothers International 

Europe’s interest rate swap portfolio. 

LCH notes that in so doing, no other 

clearing member or clearing member’s 

customer was harmed and, less than 

half of the defaulter’s initial margin was 

used. 

CME’s submission cites to its rule 

books to demonstrate the availability of 

rule framework, capacity, operational 

expertise and resources, and credit 

support infrastructure to clear qualified, 

interest rate swap contracts on terms 

that are consistent with the material 

terms and trading conventions on which 

the contracts are then traded. 

IDCH submits that its rule book 

provides a rule framework for clearing 

members and customers of clearing 

members to clear U.S. dollar interest 

rate swaps on terms that are consistent 

with the material terms and trading 

conventions on which they would trade 

interest rate swaps and forward rate 

agreements in the OTC market. The 

IDCH rule book also sets forth clearing 

member criteria and obligations, and 

descriptions of the clearing process, the 

settlement process (including the 

collection of performance bond and 

protection of customer collateral), and 

the default process. 

IDCH also claims that it has the 

capacity, operational expertise and 

resources, and credit support 

infrastructure to clear U.S. dollar 

interest rate swaps on terms that are 

consistent with the material terms and 

trading conventions on which interest 

rate swaps and forward rate agreements 

are traded in the OTC market. IDCH 

states that it has the financial capacity 

to clear such swaps as demonstrated by 

the financial resources backing its 

obligations under the cleared contracts, 

which includes initial margin posted by 

clearing members (for their proprietary 

account and customer accounts), 

guaranty fund deposits posted by 

clearing members, and assessment 

powers against clearing members. IDCH 

notes that it has been registered as a 

DCO since 2008 and has dedicated 

tremendous resources to developing its 

operational capacity to clear interest 

rate swaps. It claims that the capacity of 

the IDCH clearing systems is scalable 

and has been tested to manage the 

anticipated volume of interest rate 

contracts. IDCH also says that its 

clearing systems presently have the 

capacity to manage the clearing of up to 

220,000 contracts with 550 value-at-risk 

(VaR) scenarios being used for portfolio 

revaluation. The architecture of the 

systems is designed to be scalable with 

hardware and has been tested to manage 

the clearing of up to two million interest 

rate swaps using the same 550 VaR 

scenarios for revaluation. 

Having taken into account the three 

DCOs’ availability of rule framework, 

capacity, operational expertise and 

resources, and credit support 

infrastructure, the Commission is 

proposing the determination and rules 

described below. 

Request for Comments 

• The Commission requests comment 

on all aspects of this factor, including 

whether or not commenters agree that 

the three DCOs clearing interest rate 

swaps can satisfy the factor’s 

requirements. 

• Has the Commission sufficiently 

taken into account the three DCOs’ 

availability of rule framework, capacity, 

operational expertise and resources, and 

credit support infrastructure? Are there 

additional or alternative considerations 

that should be reviewed by the 

Commission? 

c. Effect on the Mitigation of Systemic 

Risk 

Section 2(h)(2)(D)(ii)(III) of the CEA 

requires the Commission to take into 

account the effect on the mitigation of 

systemic risk, taking into account the 

size of the market for such contract and 

the resources of the DCO available to 

clear the contract. CME, LCH, and IDCH 

submit that subjecting interest rate 

swaps to central clearing would help 

mitigate systemic risk. As noted above, 

the Commission believes that the market 

for these swaps is significant and 

mitigating counterparty risk through 

clearing likely would reduce systemic 

risk in that market and in the industry, 

generally. 

According to LCH, if all clearable 

swaps are required to be cleared, the 

inevitable result will be a less disparate 

marketplace from a systemic risk 

perspective. CME submits that the 2008 

financial crisis demonstrated the 

potential for systemic risk arising from 

the interconnectedness of OTC 

derivatives market participants and 

submits that centralized clearing will 

reduce systemic risk. 

IDCH submits that, given the 

tremendous size of the interest rate 

derivatives market, the potential 

mitigation of systemic risk through 

centralized clearing of interest rate 

swaps is significant. IDCH argues that 

clearing such swaps brings the risk 

mitigation and collateral and 

operational efficiency afforded to 

cleared and exchange-traded futures 

contracts to bilaterally negotiated OTC 

interest rate derivatives. The submission 

of interest rate swaps for clearing affords 

the parties the credit, risk management, 

capital, and operational benefits of 

central counterparty clearing of such 

transactions, and facilitates collateral 

efficiency. Cleared swaps allow market 

participants to free up counterparty 

credit lines that would otherwise be 

committed to open bilateral contracts. 

Additionally, according to IDCH, an 

efficient system for centralized clearing 

allows parties to mitigate the risk of a 

bilateral OTC derivative. Instead of 

holding offsetting positions with 

different counterparties and being 

exposed to the risk of each counterparty, 

a party may enter into an economically 

offsetting position that is cleared. 

Although the positions are not offset, 

the initial margin requirement will be 

reduced to close to zero. To eliminate 

risk without using centralized clearing, 

the party must enter into a tear-up 

agreement with the counterparty, or 

enter into a novation. 

While the clearing requirement would 

remove a large portion of the 

interconnectedness of current OTC 

markets that leads to systemic risk, the 

Commission notes that central clearing, 

by its very nature, concentrates risk in 

a handful of entities. However, the 

Commission observes that central 

clearing was developed and designed to 

handle such concentration of risk. 

LCH has extensive experience risk 

managing very large volumes of interest 

rate swaps; as noted above, it is believed 

that about half of the interest rate swaps 

are cleared by LCH. CME submits that 

it has the necessary resources available 

to clear the swaps that are the subject of 

its submission. The Commission notes 

that CME or its predecessors have 

cleared futures since 1898 and is the 

largest futures clearinghouse in the 

world. CME has not defaulted during 

that time. IDCH submits that the IDCH 

framework provides IDCH with scalable 

financial resources sufficient to clear a 

large volume of interest rate swaps. 

Accordingly, the Commission believes 

that LCH, CME, and IDCH would be able 

to manage the risk posed by clearing 

swaps that are required to be cleared. In 

addition, the Commission believes that 

the central clearing of the interest rate 

swaps that are the subject of this 

proposal would serve to mitigate 

counterparty credit risk thereby having 

a positive effect on the reducing 

systemic risk. Having taken into account 

the effect on the mitigation of systemic 

risk, the Commission is proposing the 

determination and rules described 

below. 

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47204 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

134See Section II.D above for more detailed 

discussion. 

135 In other words, the Commission questions 

that, faced with an assumed five percent nontransitory increase in the price of clearing the 

identified interest rate swaps, including fees and 

other charges, that the parties to these interest rate 

swap transactions would forego clearing in 

sufficient volume to render the price increase 

unprofitable. 

136That said, the Commission recognizes that (1) 

to the extent the clearing services market for the 

interest rate swaps identified in this proposal, after 

foreclosing uncleared swaps, would be limited to a 

concentrated few participants with highly aligned 

incentives, and (2) the clearing services market is 

insulated from new competitive entry through 

barriers—e.g., high sunk capital cost requirements; 

high switching costs to transition from embedded, 

incumbents; and access restrictions—the proposed 

determination could have a negative competitive 

impact by increasing market concentration. 

137See, e.g., Horizontal Merger Guidelines at § 9.2 

(entry likely if it would be profitable which is in 

part a function of ‘‘the output level the entrant is 

likely to obtain’’). 

Request for Comments 

• Would the proposed clearing 

requirement reduce systemic risk? 

• Would the proposed clearing 

requirement increase the risk to LCH, 

CME, or IDCH? If so, please explain 

why. 

• Are LCH, CME, and IDCH capable 

of handling any increased risk that 

would result from the proposed clearing 

requirement? 

d. Effect on Competition 

Section 2(h)(2)(D)(ii)(IV) of the CEA 

requires the Commission to take into 

account the effect on competition, 

including appropriate fees and charges 

applied to clearing. As discussed above, 

of particular concern to the Commission 

is whether this proposed determination 

would harm competition by creating, 

enhancing, or entrenching market power 

in an affected product or service market, 

or facilitating the exercise of market 

power. Market power is viewed as the 

ability to raise price, including clearing 

fees and charges, reduce output, 

diminish innovation, or otherwise harm 

customers as a result of diminished 

competitive constraints or incentives.134

The Commission has identified one 

putative service market as potentially 

affected by this proposed clearing 

determination: A DCO service market 

encompassing those clearinghouses that 

currently (or with relative ease in the 

future could) clear the interest rate 

swaps subject to this proposal. Without 

defining the precise contours of this 

market at this time, the Commission 

recognizes that, depending on the 

interplay of several factors, this 

proposed clearing requirement 

potentially could impact competition 

within the affected market. Of particular 

importance to whether any impact is, 

overall, positive or negative, is: (1) 

Whether the demand for these clearing 

services and swaps is sufficiently elastic 

that a small but significant increase 

above competitive levels would prove 

unprofitable because users of the 

interest rate swap products and DCO 

clearing services would substitute other 

clearing services co-existing in the same 

market(s); and (2) the potential for new 

entry into this market. The availability 

of substitute clearing services to 

compete with those encompassed by 

this proposed determination, and the 

likelihood of timely, sufficient new 

entry in the event prices do increase 

above competitive levels, each operate 

independently to constrain 

anticompetitive behavior. 

Any competitive import would likely 

stem from the fact that the proposed 

determination would remove the 

alternative of not clearing for interest 

rate swaps subject to this proposal. The 

proposed determination would not 

specify who may or may not compete to 

provide clearing services for the interest 

rate swaps subject to this proposal (as 

well as those not required to be cleared). 

To the extent that parties to interest 

rate swaps subject to this proposal 

consider clearing the swaps reasonably 

interchangeable with not clearing them, 

the proposed determination would 

eliminate at least one competitive 

substitute within the clearinghouse 

services market for the interest rate 

swaps identified in this proposal. Given 

the risk-mitigation purpose and benefit 

of migration to voluntary interest rate 

swap clearing, however, the 

Commission sees some basis to doubt 

that counterparties to cleared swaps 

would consider the alternative of not 

clearing interest rate swaps subject to 

this proposal as a reasonable substitute 

to a degree sufficient that they should be 

viewed as populating the same relevant 

market.135 Furthermore, if the 

alternative of not clearing the interest 

rate swaps subject to this proposal falls 

outside of the relevant services market 

that includes clearing, the proposed 

clearing determination should not 

impact competition in the clearing 

services market. The Commission 

requests comment on the extent to 

which foregoing clearing is considered 

reasonably interchangeable with 

clearing the interest rate swaps subject 

to this proposal and, in particular, if 

parties transacting interest rate swaps 

subject to this proposal would forego 

clearing if clearinghouses raised the 

price of clearing five percent. The 

Commission also requests comment on 

whether a different percentage than five 

percent should be used. 

Moreover, even if cleared and noncleared transactions of the type subject 

to this proposal are now within the 

same relevant market, removing the 

uncleared option through this proposed 

rulemaking is not determinative of 

negative competitive impact. Other 

factors—including the availability of 

other substitutes within the market or 

potential for new entry into the 

market—may constrain market power. 

Additionally, the potential for new 

entry may constrain market power in an 

otherwise concentrated clearing services 

market. The Commission does not 

foresee that the proposed determination 

constructs barriers that would deter or 

impede new entry into a clearing 

services market.136 Indeed, there is 

some basis to expect that the 

determination could foster an 

environment conducive to new entry. 

For example, the proposed clearing 

determinations, and the prospect that 

more may follow, is likely to reinforce, 

if not encourage, growth in demand for 

clearing services. Demand growth, in 

turn, can enhance the sales opportunity, 

a condition hospitable to new entry.137

The Commission requests comment on 

the extent to which: (1) Entry barriers 

currently do or do not exist with respect 

to a clearing services market for the 

interest rate swaps subject to this 

proposal; (2) the proposed 

determinations may lessen or increase 

these barriers; and (3) the proposed 

determinations otherwise may 

encourage, discourage, facilitate, and/or 

dampen new entry into the market. 

Request for Comments 

In addition to what is noted above, 

the Commission requests comment, and 

quantifiable data, on whether the 

required clearing of any or all of these 

swaps will create conditions that create, 

increase, or facilitate an exercise of: (1) 

Clearing services market power in LCH, 

CME, and IDCH, and/or any other 

clearing service market participant, 

including conditions that would 

dampen competition for clearing 

services and/or increase the cost of 

clearing services; and/or (2) market 

power in any product markets for 

interest rate swaps, including 

conditions that would dampen 

competition for these product markets 

and/or increase the cost of interest rate 

swaps involving the interest rate swaps 

identified in this proposal. The 

Commission seeks comment, and 

quantifiable data, on the likely cost 

increases associated with clearing, 

particularly those fees and charges 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47205 

138The Commission observes that an FCM or 

DCO also may be subject to resolution under Title 

II of the Dodd-Frank Act to the extent it would 

qualify as covered financial company (as defined in 

section 201(a)(8) of the Dodd-Frank Act). 

139 If an FCM is also registered as a broker-dealer, 

certain issues related to its insolvency proceeding 

would also be governed by the Securities Investor 

Protection Act. 

140Claims seeking payment for the administration 

of customer property would share this priority. 

141Section 2(h)(2)(D)(iii) of the CEA. 

142See 17 CFR 43.2, Real-Time Public Reporting 

of Swap Transaction Data, 77 FR 1182, 1243–44 

(Jan. 9, 2012); and 17 CFR 45.3, Swap Data 

Recordkeeping and Reporting Requirements, 77 FR 

2136, 2199–2200 (Jan. 13, 2012). 

imposed by DCOs, and the effects of 

such increases on counterparties 

currently participating in the market. 

The Commission also seeks comment 

regarding the effect of competition on 

DCO risk management. The Commission 

also welcomes comment on any other 

aspect of this factor. 

e. Legal Certainty in the Event of the 

Insolvency 

Section 2(h)(2)(D)(ii)(V) of the CEA 

requires the Commission to take into 

account the existence of reasonable legal 

certainty in the event of the insolvency 

of the relevant DCO or one or more of 

its clearing members with regard to the 

treatment of customer and swap 

counterparty positions, funds, and 

property. The Commission is proposing 

this clearing requirement based on its 

view that there is reasonable legal 

certainty with regard to the treatment of 

customer and swap counterparty 

positions, funds, and property in 

connection with cleared swaps, namely 

the interest rate swaps subject to this 

proposal, in the event of the insolvency 

of the relevant DCO (CME, LCH, or 

IDCH) or one or more of the DCO’s 

clearing members. 

The Commission concludes that, in 

the case of a clearing member 

insolvency at CME or IDCH, subchapter 

IV of Chapter 7 of the U.S. Bankruptcy 

Code (11 U.S.C. 761–767) and Part 190 

of the Commission’s regulations would 

govern the treatment of customer 

positions.138 Pursuant to section 4d(f) of 

the CEA, a clearing member accepting 

funds from a customer to margin a 

cleared swap, must be a registered FCM. 

Pursuant to 11 U.S.C. 761–767 and Part 

190 of the Commission’s regulations, the 

customer’s interest rate swap positions, 

carried by the insolvent FCM, would be 

deemed ‘‘commodity contracts.’’ 139 As a 

result, neither a clearing member’s 

bankruptcy nor any order of a 

bankruptcy court could prevent either 

CME or IDCH from closing out/ 

liquidating such positions. However, 

customers of clearing members would 

have priority over all other claimants 

with respect to customer funds that had 

been held by the defaulting clearing 

member to margin swaps, such as the 

interest rate swaps subject to this 

proposal.140 Thus, customer claims 

would have priority over proprietary 

claims and general creditor claims. 

Customer funds would be distributed to 

swap customers, including interest rate 

swap customers, in accordance with 

Commission regulations and section 

766(h) of the Bankruptcy Code. 

Moreover, the Bankruptcy Code and the 

Commission’s rules thereunder (in 

particular 11 U.S.C. 764(b) and 17 CFR 

190.06) permit the transfer of customer 

positions and collateral to solvent 

clearing members. 

Similarly, 11 U.S.C. 761–767 and Part 

190 would govern the bankruptcy of a 

DCO, in conjunction with DCO rules 

providing for the termination of 

outstanding contracts and/or return of 

remaining clearing member and 

customer property to clearing members. 

With regard to LCH, the Commission 

understands that the default of a 

clearing member of LCH would be 

governed by the rules of that DCO. LCH, 

a DCO based in the United Kingdom, 

has represented that under English law 

its rules would supersede English 

insolvency laws. Under its rules, LCH 

would be permitted to close out and/or 

transfer positions of a defaulting 

clearing member that is an FCM 

pursuant to the U.S. Bankruptcy Code 

and Part 190 of the Commission’s 

regulations. According to LCH’s 

submission, the insolvency of LCH itself 

would be governed by both English 

insolvency law and Part 190. 

LCH has obtained legal opinions that 

support the existence of such legal 

certainty in relation to the protection of 

customer and swap counterparty 

positions, funds, and property in the 

event of the insolvency of one or more 

of its clearing members. In addition, 

LCH has obtained a legal opinion from 

U.S. counsel regarding compliance with 

the protections afforded to FCM 

customers under New York law. 

Request for Comments 

The Commission invites comment 

regarding whether there is reasonable 

legal certainty in the event of an 

insolvency of a DCO or one or more of 

its clearing members with regard to the 

treatment of customer and swap 

counterparty positions, funds, and 

property. 

III. Proposed Rule 

The Commission is proposing the 

following rules under section 2(h)(2), as 

well as its authority under sections 

5b(c)(2)(L) and 8a(5) of the CEA. In 

issuing a determination regarding 

whether a swap or class of swaps is 

required to be cleared, ‘‘the Commission 

may require such terms and conditions 

to the requirement as the Commission 

determines to be appropriate.’’ 141

A. Proposed § 50.1 Definitions 

Proposed § 50.1 sets forth two defined 

terms: ‘‘business day’’ and ‘‘day of 

execution.’’ The definition of business 

day would exclude Saturdays, Sundays, 

and legal holidays. This definition is 

being proposed as a means of addressing 

situations where executing 

counterparties are located in different 

time zones. It is intended to avoid 

difficulties associated with end-of-day 

trading by deeming swaps executed 

after 4:00pm, or on a day other than a 

business day, to have been executed on 

the immediately succeeding business 

day. The Commission recognizes that 

market participants should not be 

required to maintain back-office 

operations 24 hours a day or 7 days a 

week in order to meet the proposed 

deadline for submitting swaps that are 

required to be cleared to a DCO. The 

Commission also is attempting to be 

sensitive to possible concerns about 

timeframes that may discourage trade 

execution late in the day. To account for 

time-zone issues, the ‘‘day of execution’’ 

has been defined to be the calendar day 

of the party to the swap that ends latest, 

giving the parties the maximum amount 

of time to subject their swaps to a DCO 

while still requiring such submission on 

a same-day basis. 

B. Proposed § 50.2 Treatment of Swaps 

Subject to a Clearing Requirement 

Proposed § 50.2(a) would require all 

persons, other than those who elect the 

exception for non-financial entities in 

accordance with § 39.6, to submit a 

swap that is part of the class described 

in § 50.4 for clearing by a DCO as soon 

as technologically practicable and no 

later than the end of the day of 

execution. The objective of this 

provision is to ensure that swaps subject 

to a clearing requirement are submitted 

to DCOs for clearing in a timely manner. 

The Commission notes that this 

proposal regarding timing of submission 

to a DCO is consistent with the real-time 

public reporting rules and the rules 

mandating deadlines for the reporting of 

swap data to SDRs, both of which use 

‘‘as soon as technologically practicable’’ 

as the applicable standard.142

For purposes of this rule, the 

Commission clarifies that submission of 

a swap by a market participant to its 

FCM clearing member would be deemed 

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47206 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

143Customer Clearing Documentation, Timing of 

Acceptance for Clearing, and Clearing Member Risk 

Management, 77 FR 21278, 21307 (Apr. 9, 2012). 

144Section 2(h)(4) of the CEA, 7 U.S.C. 2(h)(4). 

145Section 2(h)(7)(F) of the CEA, 7 U.S.C. 

2(h)(7)(F). 

146Section 8a(5) of the CEA, 7 U.S.C. 12a(5). 

to meet the requirements for submitting 

the swap to a DCO. Once a customer 

submits a swap to its FCM, the 

timeliness considerations are governed 

by other straight-through-processing 

rules recently finalized by the 

Commission.143 Under § 1.74(a), FCMs 

that are clearing members of DCOs shall 

coordinate with DCOs to establish 

systems that enable the FCM or DCO to 

accept or reject each trade submitted for 

clearing by a customer of the FCM as 

quickly as would be technologically 

practicable if fully automated systems 

were used. Similarly, under § 1.74(b), 

FCM clearing members must accept or 

reject each trade submitted to it by a 

customer as quickly as would be 

technologically practicable if fully 

automated systems were used. Those 

market participants that clear on their 

own behalf would be required to submit 

their swaps to a DCO directly and 

pursuant to the proposed timeframe. 

Proposed § 50.2(b) would require 

persons subject to § 50.2(a) to undertake 

reasonable efforts to determine whether 

a swap is required to be cleared. The 

Commission would consider such 

reasonable efforts to include checking 

the Commission’s Web site or the DCO’s 

Web site for verification of whether a 

swap is required to be cleared. 

Similarly, market participants could 

consult third-party service providers for 

such verification. This reasonable efforts 

standard is intended to provide market 

participants with clarity as to what is 

expected of them when they enter into 

a swap that has the specifications of one 

of the classes identified in proposed 

§ 50.4. 

Ideally, DCOs will design and develop 

systems that will enable market 

participants and trading platforms to 

check whether or not their swap is 

subject to a clearing requirement and be 

provided with an answer within 

seconds (or faster). This technology 

would provide a single-stop solution for 

the market with regard to checking 

eligibility under a required clearing 

regime. 

C. Proposed § 50.3 Notice to the Public 

Proposed § 50.3(a) would require each 

DCO to post on its Web site a list of all 

swaps that it will accept for clearing and 

clearly indicate which of those swaps 

the Commission has determined are 

required to be cleared pursuant to part 

50 of the Commission’s regulations and 

section 2(h)(1) of the CEA. The 

proposed rule builds upon the 

requirements of § 39.21(c)(1), which 

requires each DCO to disclose publicly 

information concerning the terms and 

conditions of each contract, agreement, 

and transaction cleared and settled by 

the DCO. Proposed § 50.3(b) would 

require the Commission to post on its 

Web site a list of those swaps it has 

determined are required to be cleared 

and all DCOs that are eligible to clear 

such classes of swaps. The Commission 

believes that this will provide market 

participants with sufficient notice 

regarding which swaps are subject to a 

clearing requirement. 

D. Proposed § 50.4 Classes of Swaps 

Required To Be Cleared 

As discussed at length above, 

proposed § 50.4 sets forth the classes of 

interest rate swaps and CDS that the 

Commission has determined are 

required to be cleared. Proposed 

§ 50.4(a) includes a table listing those 

types of interest rate swaps the 

Commission would require to be 

cleared; proposed § 50.4(b) includes a 

table listing those types of CDS indices 

the Commission would require to be 

cleared. The Commission believes that 

this format provides market participants 

with a clear understanding of which 

swaps are required to be cleared. By 

using basic specifications to identify the 

swaps subject to the clearing 

requirement, counterparties 

contemplating entering into a swap can 

determine quickly as a threshold matter 

whether or not the particular swap may 

be subject to a clearing requirement. If 

the swap has the basic specifications of 

a class of swaps determined to be 

subject to a clearing requirement, the 

parties will know that they need to 

verify whether a DCO will clear that 

particular swap. This will reduce the 

burden on swap counterparties related 

to determining whether a particular 

swap may be subject to the clearing 

requirement. 

E. Proposed § 50.5 Clearing Transition 

Rules 

Proposed § 50.5 would codify section 

2(h)(6) of the CEA. Under proposed 

§ 50.5(a), swaps that are part of a class 

described in § 50.4 but were entered 

into before the enactment of the DoddFrank Act would be exempt from 

clearing so long as the swap is reported 

to an SDR pursuant to § 44.02 and 

section 2(h)(5)(A) of the CEA. Similarly, 

under proposed § 50.5(b), swaps entered 

into after the enactment of the DoddFrank Act but before the application of 

the clearing requirement would be 

exempt from the clearing requirement if 

reported pursuant to § 44.03 and section 

2(h)(5)(B) of the Act. 

F. Proposed § 50.6 Delegation of 

Authority 

Proposed § 50.6(a) would delegate to 

the Director of the Division of Clearing 

and Risk, or the Director’s designee, 

with the consultation of the General 

Counsel or the General Counsel’s 

designee, the authority to determine 

whether a swap falls within a class of 

swaps described in § 50.4 and to 

communicate such a determination to 

the relevant DCOs. The Commission 

believes that the Division of Clearing 

and Risk has the requisite expertise to 

make such a determination and that the 

most expeditious way for the 

marketplace to be apprised of a such a 

determination would be for the Division 

of Clearing and Risk to make the 

determination itself and to 

communicate it directly to the relevant 

DCOs. 

Swaps that contain the specifications 

described in § 50.4 would be presumed 

to fall within a class of swaps already 

subject to a clearing requirement. In this 

manner, the Commission hopes to 

facilitate DCOs’ ability to add new 

swaps to particular classes without 

undue burden. 

G. Proposed § 50.10 Prevention of 

Evasion of the Clearing Requirement 

and Abuse of an Exception or 

Exemption to the Clearing Requirement 

The Commission is proposing § 50.10 

to prevent evasion of the clearing 

requirement and prevent abuse of any 

exemption or exception to the clearing 

requirement under the Commission’s 

new rulemaking authority provided in 

the Dodd-Frank Act amendments to 

sections 2(h)(4)(A) 144 (Prevention of 

Evasion) and 2(h)(7)(F) 145 (Abuse of the 

End-User Exception) of the CEA and 

under the Commission’s existing 

rulemaking authority in section 8a(5) 146

(General Rulemaking Authority) of the 

CEA. Proposed § 50.10 would prohibit 

(a) evasions of the requirements of 

section 2(h), (b) abuse of the end-user 

exception to the clearing requirement, 

and (c) abuse of any exemption or 

exception to the requirements of section 

2(h), including any exemption or 

exception that the Commission may 

provide by rule, regulation, or order. 

Section 2(h) of the CEA provides two 

express rulemaking provisions 

specifically addressing prevention of 

evasion and prevention of abuse of the 

clearing requirement. Section 2(h)(4)(A) 

states that the Commission shall 

prescribe rules and issue interpretations 

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147Section 6(e)(4)–(5) of the CEA, 7 U.S.C. 9a(4)– 

(5). 

148Section 9(a)(6) of the CEA, 7 U.S.C. 13(a)(6). 

149For example, it would be a violation of 

proposed § 50.10(a) for a SEF to knowingly or 

recklessly evade or participate in or facilitate an 

evasion of the trade execution requirement under 

section 2(h)(8). 

150Section 2(h)(1)(A) of the CEA, 7 U.S.C. 

2(h)(1)(A). 

151See End-User Exception to the Clearing 

Requirement for Swaps, adopted by the 

Commission on July 10, 2012, available at 

www.cftc.gov. 

152Examples described in the guidance are 

illustrative and not exhaustive of the transactions, 

instruments, or entities that could be considered 

evasive. In considering whether a transaction, 

instrument, or entity is evasive, the Commission 

will consider the facts and circumstances of each 

situation. 

153See Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap 

Agreement’’; Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping, Section VII, adopted by 

the Commission on July 10, 2012, available at 

www.cftc.gov. 

of rules as determined by the 

Commission to be necessary to prevent 

evasions of the clearing requirements 

under section 2(h) of the CEA. Section 

2(h)(7)(F) provides that the Commission 

may prescribe such rules or issue 

interpretations of the rules as the 

Commission determines to be necessary 

to prevent abuse of the exceptions to the 

clearing requirement. The Commission 

preliminarily views evasion of the 

clearing requirement and abuse of an 

exemption or exception to the clearing 

requirement, including the end-user 

exception, to be related concepts and 

are informed by new enforcement 

authority under the Dodd-Frank Act, 

which added new sections 6(e)(4)–(5) 147

and 9(a)(6) 148 to CEA. 

Proposed § 50.10(a) would make it 

unlawful for any person to knowingly or 

recklessly evade, participate in, or 

facilitate an evasion of any of the 

requirements of section 2(h) of the CEA. 

Proposed § 50.10(a) is informed by and 

consistent with section 6(e)(4) and (5) of 

the CEA, which states that any DCO, SD, 

or MSP that ‘‘knowingly or recklessly 

evades or participates in or facilitates an 

evasion of the requirements of section 

2(h) shall be liable for a civil monetary 

penalty in twice the amount otherwise 

available for a violation of section 2(h).’’ 

Proposed § 50.10(a), however, would 

apply to any person. In addition, 

proposed § 50.10(a) would apply to any 

requirement under section 2(h) of the 

CEA or any Commission rule or 

regulation promulgated thereunder. 

These requirements include the clearing 

requirement under section 2(h)(1), 

reporting of data under section 2(h)(5), 

and the trade execution requirement 

under section 2(h)(8), among other 

requirements.149

The Commission notes, however, that 

section 2(h)(1)(A) 150 of the CEA 

provides that it ‘‘shall be unlawful for 

any person to engage in a swap unless 

that person submits such swap for 

clearing’’ to a DCO if the swap is 

required to be cleared. Unlike the 

knowing or reckless standard under 

proposed § 50.10(a), section 2(h)(1)(A) 

imposes a non-scienter standard on 

swap market participants. Therefore, 

any person engaged in a swap that is 

required to be cleared under section 2(h) 

and proposed Part 50 of the 

Commission’s Regulations, and such 

person did not submit the swap for 

clearing, absent an exemption or 

exception, would be subject to a 

Commission enforcement action 

regardless of whether the person 

knowingly or recklessly failed to submit 

the swap for clearing. 

Proposed § 50.10(b) makes it unlawful 

for any person to abuse the end-user 

exception to the clearing requirement as 

provided under section 2(h)(7) of the 

CEA and § 39.6.151 Proposed § 50.10(b) 

is adopted under the authority in both 

section 2(h)(4)(A) and section 2(h)(7)(F). 

The Commission preliminarily believes 

that an abuse of the end-user exception 

to the clearing requirement may also, 

depending on the facts and 

circumstances, be an evasion of the 

requirements of section 2(h). The 

Commission’s view is informed by 

section 9(a)(6) of the CEA, which crossreferences both the prevention of 

evasion authority in section 2(h)(4) and 

prevention of abuse of the exception to 

the clearing requirement in section 

2(h)(7)(F). Section 9(a)(6) states that it 

‘‘shall be a felony punishable by a fine 

of not more than $1,000,000 or 

imprisonment for not more than 10 

years, or both, together with the costs of 

prosecution, for * * * [a]ny person to 

abuse the end user clearing exemption 

under section 2(h)(4), as determined by 

the Commission.’’ Therefore, the 

Commission is proposing to interpret a 

violation of section 9(a)(6) of the CEA to 

also be a violation of proposed 

§ 50.10(b). 

Proposed § 50.10(c) makes it unlawful 

for any person to abuse any exemption 

or exception to the requirements of 

section 2(h) of the CEA, including any 

exemption or exception, as the 

Commission may provide by rule, 

regulation, or order. This provision is 

informed by the Dodd-Frank Act 

amendments in section 2(h)(4)(A) to 

prescribe rules necessary to prevent 

evasions of the clearing requirements, 

section 2(h)(7)(F) to prescribe rules 

necessary to prevent abuse of the 

exceptions to the clearing requirements, 

and the Commission’s general 

rulemaking authority in section 8a(5) to 

promulgate rules that, in the judgment 

of the Commission, are reasonably 

necessary to accomplish any purposes 

of the CEA. Therefore, the Commission 

preliminarily believes that proposed 

§ 50.10(c) is necessary to prevent abuses 

of any exemption or exception to the 

requirements of section 2(h). 

The Commission believes a 

‘‘principles-based’’ approach to 

proposed § 50.10 is appropriate. The 

Commission is not proposing to provide 

a bright-line test of non-evasive or 

abusive conduct, because such an 

approach may be a roadmap for 

engaging in evasive or abusive conduct 

or activities. Nevertheless, the 

Commission is proposing additional 

guidance regarding evasion and abuse in 

order to provide clarity to market 

participants.152

The Commission proposes to interpret 

these rules in a manner similar to its 

interpretation of the anti-evasion rules 

that it recently adopted in its 

rulemaking to further define the term 

swap.153 The Commission proposes to 

determine on a case-by-case basis, 

whether particular transactions or other 

activities constitute an evasion of the 

requirements of section 2(h) of the CEA 

or the regulations promulgated 

thereunder or an abuse of any 

exemption or exception to the 

requirements of section 2(h). Each such 

transaction or activity would be 

evaluated on a case-by-case basis with 

consideration given to all the facts and 

circumstances. 

Similar to its approach in the rules 

further defining the term ‘‘swap,’’ the 

Commission proposes that it would not 

consider transactions or other activities 

structured in a manner solely motivated 

by a legitimate business purpose to 

constitute evasion or abuse. 

Additionally, when determining 

whether particular conduct is an 

evasion of the requirements of section 

2(h) or an abuse of any exemptions or 

exceptions to those requirements, the 

Commission will consider the extent to 

which the conduct involves deceit, 

deception, or other unlawful or 

illegitimate activity. 

The Commission recognizes that 

market participants may engage in 

conduct or activities, such as structuring 

a transaction in a particular way, for 

legitimate business purposes, without 

any intention to evade the requirements 

of section 2(h) of the CEA or abuse any 

exemptions or exceptions thereunder. 

Thus, in evaluating whether a person 

has evaded such requirements or abused 

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154See section 2(a)(13)(G) of the CEA, 7 U.S.C. 

2(a)(13)(G), and section 4r(a)(1) of the CEA, 7 U.S.C. 

6r(a)(1). 

155See End-User Exception to the Clearing 

Requirement for Swaps, adopted by the 

Commission on July 10, 2012, available at 

www.cftc.gov. 

156Section 6(c)(2) of the CEA, 7 U.S.C. 9(c)(2). 

157Section 9(a)(4) of the CEA, 7 U.S.C. 13(a)(4). 

See also section 9(a)(3) of the CEA, 7 U.S.C. 

13(a)(3). 

158The Commission proposed a compliance 

schedule for the clearing requirement in September 

2011, 76 FR 58186 (Sept. 20, 2011), and is finalizing 

17 CFR 50.25 concurrently. 

159 Dodd-Frank Wall Street Reform and Consumer 

Protection Act, Public Law 111–203, 124 Stat. 1376 

(2010). 

160This section states: ‘‘It shall be 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 this 

Act or a derivatives clearing organization that is 

exempt from registration under this Act if the swap 

is required to be cleared.’’ 

an exemption or exception, the 

Commission proposes to consider the 

extent to which a person has a 

legitimate business purpose in 

connection with the relevant conduct or 

activities. This proposed analytical 

method will be useful in the overall 

analysis of potentially knowingly or 

recklessly evasive conduct or abusive 

conduct. The Commission proposes to 

view legitimate business purpose 

considerations on a case-by-case basis in 

conjunction with all other relevant facts 

and circumstances. 

Moreover, the Commission recognizes 

that it is possible that a person 

intending to evade the requirements of 

section 2(h) or abuse an exemption or 

exception thereunder may attempt to 

justify its actions by claiming that such 

actions are legitimate business practices 

in its industry. Therefore, the 

Commission proposes to retain the 

flexibility, via an analysis of all relevant 

facts and circumstances, to confirm not 

only the legitimacy of the business 

purpose of those actions but whether 

the actions could still be determined to 

be evasive or abusive. Because market 

participants engage in conduct and 

activities, such as structuring 

transactions and instruments, in a 

particular way for various reasons, it is 

essential that all relevant facts and 

circumstances be considered, including 

legitimate business purposes, before 

reaching any conclusion as to evasion or 

abuse. 

When determining whether a 

particular activity constitutes an evasion 

of the requirements of section 2(h) or an 

abuse of any exemption or exception to 

such requirements, the Commission 

proposes to consider the extent to which 

the activity involves deceit, deception, 

or other unlawful or illegitimate 

activity. The Commission believes that 

although it is likely that fraud, deceit, or 

unlawful activity will be present where 

evasion or abuse has occurred, these 

factors are not prerequisites to finding a 

violation of proposed rule § 50.10. 

Rather, fraud, deceit, or unlawful 

activity is one circumstance the 

Commission proposes to consider when 

evaluating a person’s conduct or 

activities. 

Finally, when considering all the 

relevant facts and circumstances under 

a potential violation of proposed rule 

§ 50.10, the Commission would not 

consider the form, label, or written 

documentation of any relevant 

agreement, contract or transaction to be 

dispositive. This approach is intended 

to prevent evasion and abuse through 

clever draftsmanship of a form, label, or 

other written documentation. Therefore, 

the Commission proposes to look 

beyond the form of the agreement, 

contract or transaction to examine its 

actual substance and purpose to prevent 

any evasion or abuse through clever 

draftsmanship. 

In addition to the prohibitions under 

proposed § 50.10, the Commission notes 

that additional provisions of the CEA 

may also be applicable to evasive or 

abusive practices. For example, the 

Commission notes that swaps, whether 

cleared or uncleared, must be reported 

to a registered SDR, or if no SDR will 

accept the swap, to the Commission.154

In that regard, the Commission has 

proposed that to be eligible to qualify 

for certain exceptions or to be able to 

rely on certain exemptions, at least one 

party to the swap must report certain 

information to an SDR or to the 

Commission. Regulation 39.6(b)(4), for 

example, requires at least one party to 

a swap that has elected to use the enduser exception to the clearing 

requirement to report whether the swap 

is used to hedge or mitigate commercial 

risk.155

Considering this regulatory regime, 

certain evasive or abusive practices, 

such as making false statements or 

submission in connection with the 

clearing requirement, may also violate 

other provisions of the CEA. For 

example, section 6(c)(2) 156 of the CEA, 

which makes it unlawful for any person 

to make any false or misleading 

statement of material fact to the 

Commission, including in any report 

filed with the Commission or any other 

information relating to a swap. 

Furthermore, section 9(a)(4) 157 of the 

CEA makes it a felony for any person to 

willfully falsify a material fact, make 

any false or fraudulent statements or 

representations, or make or use any false 

writing or document or fraudulent 

statement or entry to an SDR. Thus, the 

Commission may bring enforcement 

actions under proposed § 50.10, section 

6(c)(2), and section 9(a)(4), among other 

statutory provisions and rules, to 

prevent evasions of the requirements of 

section 2(h) and abuses of any 

exemption or exception to such 

requirements. 

Request for Comment 

The Commission requests comment 

on all aspects of the proposed rules and 

specifically on: 

• Should the Commission clarify in 

the proposed rules that the clearing 

requirement applies to all new swaps 

and all changes in the ownership of a 

swap, such as assignment, novation, 

exchange, transfer, or conveyance? 

• Is proposed § 50.10 and the 

guidance set forth in this section 

sufficient to address concerns of evasion 

of the requirements of section 2(h) or an 

abuse of any exemption or exception to 

such requirements? Is further guidance 

necessary? If so, what further guidance 

would be appropriate? 

• Should the Commission prohibit 

certain specific practices that would be 

evasions of the requirements of section 

2(h)? 

• Should the Commission prohibit 

certain specific practices that would be 

an abuse of the end-user exception? 

• Should the Commission prohibit 

certain specific practices that would be 

an abuse of any other exemption or 

exception to the requirements of section 

2(h)? 

IV. Implementation 

The Commission is proposing to 

require compliance with the clearing 

requirement for the classes of swaps 

identified in proposed § 50.4 according 

to the compliance schedule contained in 

§ 50.25.158 Under this schedule, 

compliance with the clearing 

requirement will be phased by type of 

market participant entering into a swap 

subject to the clearing requirement. 

V. Cost Benefit Considerations 

A. Statutory and Regulatory Background 

The regulations contained in this 

proposal identify certain classes of 

swaps that are required to be cleared 

pursuant to the Dodd-Frank Act’s 159

clearing requirement incorporated 

within amended section 2(h)(1)(A) of 

the CEA.160 This clearing requirement is 

designed to standardize and reduce 

counterparty risk associated with swaps, 

and, in turn, mitigate the potential 

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161 76 FR 44464 (July 26, 2011). 

162See § 39.5(b), § 39.5(c). Under section 

2(h)(2)(B)(ii) of the CEA, ‘‘[a]ny swap or group, 

category, type, or class of swaps listed for clearing 

by a [DCO] as of the date of enactment shall be 

considered submitted to the Commission.’’ 

163Section 2(h)(2)(D) of the CEA and § 39.5(b)(ii). 

164 Data provided to the Commission by LCH. 

165See http://www.lchclearnet.com/swaps/ 

volumes/. 

166See http://www.cmegroup.com/trading/

interest-rates/cleared-otc/index.html#data and 

http://www.trioptima.com/repository/historicalreports.html. 

167See Federal Reserve Bank of New York, Press 

Release, ‘‘New York Fed Welcomes Further 

Industry Commitments on Over-the-Counter 

Derivatives,’’ Oct. 31, 2008, available at http://www.

newyorkfed.org/newsevents/news/markets/2008/

an081031.html, which references documents 

prepared by market participants describing the 

importance of clearing. See also Ciara Linnane and 

Karen Brettell, ‘‘NY Federal Reserve pushes for 

central CDS counterparty,’’ Reuters, Oct. 6, 2008, 

available at http://www.reuters.com/article/2008/

10/06/cds-regulation-idUSN0655208920081006. 

168Based on Commission data for registered 

DCOs as of May 10, 2012. 

systemic impact of such risks and 

reduce the likelihood for swaps to cause 

or exacerbate instability in the financial 

system. It reflects a fundamental 

premise of the Dodd-Frank Act: the use 

of properly functioning central clearing 

can reduce systemic risk. 

Regulation 39.5 provides an outline 

for the Commission’s review of swaps 

for required clearing.161 Regulation 39.5 

allows the Commission to review swaps 

submitted by DCOs or those swaps that 

the Commission opts to review on its 

own initiative.162 Under section 

2(h)(2)(D) of the CEA, in reviewing 

swaps for required clearing, the 

Commission must take into account the 

following factors: (1) Significant 

outstanding notional exposures, trading 

liquidity and adequate pricing data, (2) 

the availability of rule framework, 

capacity, operational expertise and 

credit support infrastructure, (3) the 

effect on the mitigation of systemic risk, 

(4) the effect on competition and (5) the 

existence of reasonable legal certainty in 

the event of the insolvency of the DCO 

or one or more of its clearing 

members.163 Regulation 39.5 also directs 

DCOs to provide to the Commission 

other information, such as product 

specifications, participant eligibility 

standards, pricing sources, risk 

management procedures, a description 

of the manner in which the DCO has 

provided notice of the submission to its 

members and any additional 

information requested by the 

Commission. This information is 

designed to assist the Commission in 

identifying those swaps that are 

required to be cleared. 

B. Overview of Swap Clearing 

i. How Clearing Reduces Risk 

When a bilateral swap is cleared, 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—i.e., the 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 

the original swap participants. 

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. 

Given the variety of effective 

clearinghouse tools to monitor and 

manage counterparty risk, the 

Commission believes that DCOs will 

continue to be some of the most 

creditworthy counterparties in the swap 

markets. These tools include the 

contractual right to: (1) Collect initial 

and variation margin associated with 

outstanding swap positions; (2) mark 

positions to market regularly (usually 

one or more times per day) and issue 

margin calls whenever the margin in a 

customer’s account has dropped below 

predetermined levels set by the DCO; (3) 

adjust the amount of margin that is 

required to be held against swap 

positions in light of changing market 

circumstances, such as increased 

volatility in the underlying product; and 

(4) close out the swap positions of a 

customer that does not meet margin 

calls within a specified period of time. 

Moreover, in the event that a clearing 

member defaults on their obligations to 

the DCO, the latter has a number of 

remedies to manage associated risks, 

including transferring the swap 

positions of the defaulted member, and 

covering any losses that may have 

accrued with the defaulting member’s 

margin on deposit. In order to transfer 

the swap positions of a defaulting 

member and manage the risk of those 

positions while doing so, the DCO has 

the ability to: (1) Hedge the portfolio of 

positions of the defaulting member to 

limit future losses; (2) partition the 

portfolio into smaller pieces; (3) auction 

off the pieces of the portfolio, together 

with their corresponding hedges, to 

other members of the DCO; and (4) 

allocate any remaining positions to 

members of the DCO. In order to cover 

the losses associated with such a 

default, the DCO would typically draw 

from (in order): (1) The initial margin 

posted by the defaulting member; (2) the 

guaranty fund contribution of the 

defaulting member; (3) the DCO’s own 

capital contribution; (4) the guaranty 

fund contribution of non-defaulting 

members; and (5) an assessment on the 

non-defaulting members. These 

mutualized risk mitigation capabilities 

are largely unique to clearinghouses, 

and help to ensure that they remain 

solvent and creditworthy swap 

counterparties even when dealing with 

defaults by their members or other 

challenging market circumstances. 

ii. Movement of Swaps Into Clearing 

There is significant evidence that 

some parts of the OTC swap markets 

(the IRS and CDS markets in particular) 

have been migrating into clearing over 

the last few years in response to natural 

market incentives as well as in 

anticipation of the Dodd-Frank Act’s 

clearing requirement. LCH Clearnet 

data, for example, shows that the 

outstanding volume of interest rate 

swaps cleared by LCH has grown 

steadily since at least November 2007, 

as has the monthly registration of new 

trade sides. Data provided to the 

Commission shows that the notional 

amount of cleared IRS is approximately 

$72 trillion as of January 2007, and just 

over $236 trillion in September 2010, an 

increase of 228% in three and a half 

years.164 Together, those facts indicate 

increased demand for LCH clearing 

services related to interest rate swaps, a 

portion of which preceded the DoddFrank Act.165 Data available through 

CME and TriOptima indicate similar 

patterns of growing demand for interest 

rate swap clearing services, though their 

publically available data does not 

provide a picture of demand prior to the 

passage of the Dodd-Frank Act.166

In addition to IRS clearing, major CDS 

market participants are clearing their 

CDS indices and single names in 

significant volumes. As explained 

above, in 2008, the Federal Reserve 

Bank of New York (FRBNY) began 

encouraging market participants to 

establish a central counterparty to clear 

CDS.167 In the past four years, CDS 

clearing has grown significantly. In 

total, CFTC-registered DCOs are 

currently holding more than $20 billion 

in aggregate in initial margin to cover 

cleared CDS positions.168 Additionally, 

publicly available data shows that 

CME’s CDS guaranty fund has 

approximately $629 million; ICE Clear 

Credit has a guaranty fund equal to $4.4 

billion; and ICE Clear Europe has a 

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47210 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

169See http://www.cmegroup.com/clearing/cmeclearing-overview/safeguards.html for data 

regarding CME’s guaranty fund, as of May 10, 2012; 

https://www.theice.com/clear_credit.jhtml for data 

on the size of ICE Clear Credit’s guaranty fund; and 

https://www.theice.com/clear_europe_cds.jhtml for 

data on the size of ICE Clear Europe’s guaranty fund 

for CDS, as of May 10, 2012. 

170 ‘‘Has OTC Energy Clearing Finally Taken 

Off?’’ in Markets 03, a publication from FIA 

available at: http://www.futuresindustry.org/ 

downloads/Outlook/OTCenergy.pdf. See also, 

‘‘Energy: An example for regulators to study,’’ 

Financial Times, Nov 3, 2011, available at http:// 

www.ft.com/intl/cms/s/0/c5bfba26-fb3e-11e0-8df6- 

00144feab49a.html#axzz1zkpvIkJd. 

171CME Group, ‘‘Stepping Out of Uncertainty,’’ 

(2009), available at http://www.cmegroup.com/ 

company/history/magazine/Summer2009/ 

steppingout.html. 

172 It is also possible that some market 

participants would respond to the proposed rule’s 

requirement that certain types of swaps be cleared 

by decreasing their use of such swaps. This 

possibility contributes to the uncertainty regarding 

how the proposed rule will affect the quantity of 

swaps that are cleared. 

guaranty fund Ö2.7 billion for its CDS 

business.169

Notably, the move toward central 

clearing has been particularly 

pronounced during times of crisis, as 

market participants have voluntarily 

used central clearing as a way of 

protecting against counterparty credit 

risk. The bankruptcy of Enron, in 2001, 

led to the emergence of clearing for OTC 

energy swaps in the United States. After 

Enron’s failure, many counterparties to 

energy swaps realized the benefits of 

substituting the creditworthiness of a 

clearing house for that of their bilateral 

counterparties. Much of the impetus for 

moving OTC energy swaps into clearing 

resulted from the credit crisis that 

developed following Enron’s 

collapse.170 According, to CME, its 

ClearPort service ‘‘filled a major void in 

the aftermath of the Enron collapse, 

particularly in the OTC market for 

natural gas, which was left without a 

central OTC marketplace.’’ 171

iii. The Clearing Requirement and Role 

of the Commission 

In the Dodd-Frank Act, Congress 

directed that clearing shift from a 

voluntary practice to a mandatory 

practice for certain swaps and gave the 

Commission responsibility for 

determining which swaps would be 

required to be cleared. Therefore, the 

costs and benefits of required clearing 

are attributable, in part, to the Act itself, 

and, in part, to Commission action, 

taking the form of an exercise of 

discretion to determine which swaps are 

required to be cleared. Because the 

requirements of the Dodd-Frank Act and 

the discretion of the Commission 

operate in concert in this way, it is 

impossible to distinguish precisely 

between those costs and benefits that 

result from the Dodd-Frank Act’s 

clearing requirement, considered in the 

abstract, and those that result from the 

Commission’s determinations that 

particular types of swaps will be 

required to be cleared. Also, because 

voluntary clearing of swaps has 

increased over past years (may be due 

in part to anticipation of the clearing 

requirement to be imposed under the 

Dodd-Frank Act, but may also be due in 

part to a realization of the benefits of 

clearing after the financial crisis), it is 

impossible to determine precisely the 

extent to which any increased use of 

clearing would result from statutory or 

regulatory requirements, as compared to 

swap market participants’ desires to use 

clearing to obtain its risk-reducing 

benefits.172

The Commission also recognizes that 

there might not be a linear relationship 

between the quantity of swaps that are 

cleared (whether measured by number 

of swaps, the notional value of swaps or 

some other measure of swap quantity, 

such as the exposure resulting from the 

swaps) and the costs and benefits 

resulting from clearing. For example, if 

the Commission were to assume that the 

proposed rule would result in a 

doubling of the quantity of a certain 

type of swap that is cleared, it would 

not necessarily be the case that the costs 

and benefits of clearing that type of 

swap would double. Rather, the 

relationship could be non-linear for a 

variety of reasons (such as variations 

among the users of that type of swap). 

In fact, it may be reasonable to assume 

that where the costs of clearing are 

relatively low and the benefits are 

relatively high, market participants 

already voluntarily clear swaps even in 

the absence of a clearing requirement. 

The Commission requests comment on 

the relationship between the 

requirement that the swaps identified in 

the proposal be cleared and the costs 

and benefits of that requirement, 

including on whether that relationship 

is linear or non-linear. 

For all these reasons, the Commission 

has determined that the costs and 

benefits related to the required clearing 

of the classes of IRS and CDS subject to 

this proposal are attributable, in part to 

(1) Congress’s stated goal of reducing 

systemic risk by, among other things, 

requiring clearing of swaps and (2) the 

Commission’s discretion in selecting 

swaps or classes of swaps in order to 

achieve those ends. The Commission 

will discuss the costs and benefits of the 

overall move from voluntary clearing to 

required clearing for the swaps subject 

to this proposal. 

The Commission requests comment 

on this assumption, and in particular on 

the extent to which swap market 

participants’ use of clearing results from 

a regulatory requirement that specific 

swaps be cleared (i.e., the rules 

proposed here), the Dodd-Frank Act’s 

general clearing requirement, or other 

motivations for the use of clearing, 

including, among other things, 

independent business reasons and 

incentives from other regulators, such as 

prudential authorities. 

C. Consideration of the Costs and 

Benefits of the Commission’s Action 

i. CEA Section 15(a) 

Section 15(a) of the CEA 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 the 

following 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. 

Accordingly, the Commission considers 

the costs and benefits resulting from its 

own discretionary determinations with 

respect to the section 15(a) factors. 

In the sections that follow the 

Commission considers: (1) Costs and 

benefits of required clearing for the 

classes of swaps identified in this 

proposal; (2) alternatives contemplated 

by the commission and their costs and 

benefits relative to the approach 

proposed herein; (3) the impact of 

required clearing for the proposed 

classes of swaps on the 15(a) factors. 

ii. Costs and Benefits of Required 

Clearing Under the Proposal 

In order to clear swaps in the classes 

identified in this proposal, certain 

market participants are likely to face 

certain startup and ongoing costs 

relating to technology and 

infrastructure, new or updated legal 

agreements, ongoing fees from service 

providers, and costs related to 

collateralization of their positions. The 

per-entity costs related to changes in 

technology, infrastructure, and legal 

agreements are likely to vary widely, 

depending on each market participant’s 

existing technology infrastructure, legal 

agreements, operations, and anticipated 

needs in each of these areas. For market 

participants that already use clearing, 

some of these costs may be expected to 

be lower, while the opposite would 

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173For example, the PEW Economic Policy Group 

estimates total costs of the acute stage of the crisis 

for U.S. interests were approximately $12.04 

trillion, including lost GDP, wages, real estate 

wealth, equity wealth, and fiscal costs. Their 

estimates include $7.4 trillion in losses in the 

equity markets between June 2008 and March 2009, 

but do not include subsequent gains in equity 

markets that restored markets to their mid-2008 

levels by the end of 2009. In addition, their 

calculations do not include continued declines in 

real estate markets subsequent to March 2009. See 

Pew Economic Policy Group, ‘‘The Cost of the 

Financial Crisis: The Impact of the September 2008 

Economic Collapse,’’ March 2010. The IMF 

estimated that the cost to the banking sector of the 

financial crisis through 2010 was approximately 

$2.2 trillion and reported a range of estimates for 

total cost to the taxpayer of GSE bailouts that 

ranged from $160 billion (Office of Management 

and Budget, February 2010) to $500 billion 

(Barclays Capital, December 2009). See IMF, 

‘‘Global Financial Stability Report: Responding to 

the Financial Crisis and Measuring Systemic 

Risks,’’ October 2010. Both studies acknowledge 

that the estimates are subject to uncertainties. 

174See Chatham Financial letter at 2, available at 

http://comments.cftc.gov/PublicComments/ 

ViewComment.aspx?id=58077 and Webster Bank 

letter at 3, available at http://comments.cftc.gov/ 

PublicComments/ViewComment.aspx?id=58076. 

likely be true for market participants 

that begin to use clearing only because 

of the requirement. The costs of 

collateralization, on the other hand, are 

likely to vary depending on whether an 

entity is subject to capital requirements 

or not, and the differential between the 

cost of capital for the assets they uses as 

collateral, and the returns they realize 

on those assets. Commenters are 

requested to address the extent to which 

factors such as these will affect the costs 

of clearing for various market 

participants. 

There are also significant benefits 

associated with increased clearing, 

including reducing and standardizing 

counterparty risk, increased 

transparency, and easier access to the 

swap markets. These effects together 

will contribute significantly to the 

stability and efficiency of the financial 

system. It is impossible, at this point, to 

quantify these benefits with any degree 

of precision. The Commission notes, 

however, that the extraordinary 

financial system turbulence of 2008 has 

had profound and long-lasting adverse 

effects on the real economy, and 

therefore reducing systemic risk 

provides significant, if unquantifiable, 

benefits.173 Also, as is the case for the 

costs related to clearing, these benefits 

would be relatively less to the extent 

that market participants are already 

using clearing in the absence of a 

requirement. Commenters are requested 

to address this aspect of the analysis as 

well. 

a. Technology, Infrastructure, and Legal 

Costs 

With respect to technology, for market 

participants that already use swap 

clearing or transact in futures, many of 

the backend requirements for 

technology that supports cleared swaps 

are likely to be quite similar, and 

therefore necessary changes to those 

systems are likely to require a relatively 

lower costs. Market participants that are 

not currently using clearing for swaps or 

transacting in futures, however, may 

need to implement appropriate 

middleware to connect with an FCM 

that will clear their transactions. 

Similarly for legal fees, the costs 

related to clearing the swaps that are 

subject to the proposed clearing 

requirement are likely to vary widely 

depending on whether market 

participants already use clearing or 

transact in futures. For those market 

participants that have not already 

engaged an FCM, it has been estimated 

that smaller financial institutions will 

spend between $2,500 and $25,000 

reviewing and negotiating legal 

agreements when establishing a new 

business relationship with an FCM.174

The Commission does not have 

information necessary to confirm these 

estimates or determine to what degree 

these estimates would apply to larger 

entities establishing a relationship with 

an FCM. In addition, the Commission 

does not have information to determine 

costs associated with entities that 

already have established relationships 

with one or more FCMs but need to 

revise those agreements. In all cases 

such costs are likely to depend 

significantly on the specific business 

needs of each entity and therefore are 

expected to vary widely among market 

participants. 

In addition, the Commission is 

exercising the anti-evasion rulemaking 

authority granted to it by the DoddFrank Act. Generally, proposed rule 

§ 50.10 states that it is unlawful for any 

person to knowingly or recklessly evade 

or participate in or facilitate an evasion 

of the requirements of section 2(h) of the 

CEA, to abuse the exception to the 

clearing requirement as provided under 

section 2(h)(7) of the CEA and 

Commission rule § 39.6, or to abuse any 

exemption or exception to the 

requirements of section 2(h) of the CEA, 

including any exemption or exception 

as the Commission may provide by rule, 

regulation, or order. 

Although proposed rule § 50.10 does 

not set forth a bright line test to define 

evasion or abuse, the proposed rule is 

expected to help ensure that would-be 

evaders cannot engage in conduct or 

activities that constitute an evasion of 

the requirements of section 2(h) or an 

abuse of any exemption or exception to 

such requirements. The Commission 

also proposes guidance as to how it 

would determine if such evasion or 

abuse has occurred, while at the same 

time preserving the Commission’s 

ability to determine, on a case-by-case 

basis, with consideration given to all the 

facts and circumstances, that other types 

of transactions or activities constitute an 

evasion or abuse under proposed 

§ 50.10. 

The Commission proposes that 

participants in the markets should 

already have policies and procedures in 

place to ensure that their employees, 

affiliates, and agents will refrain from 

engaging in activities, including 

devising transactions, for the purpose of 

evading, or in reckless disregard of, the 

requirements of section 2(h) of the CEA 

and Commission rules and regulations 

promulgated thereunder or to abuse any 

exemption or exception to such 

requirements. Given that the proposed 

rule imposes no affirmative duties (i.e., 

reporting or recordkeeping), it is 

unlikely that it will impose any 

additional ongoing costs beyond the 

pre-existing costs associated with 

ensuring that the firm is not engaging in 

unlawful conduct. In that regard, the 

Commission believes that it will not be 

necessary for firms that currently have 

adequate compliance programs to hire 

additional staff or significantly upgrade 

their systems to comply with the 

proposed rule. Firms may, however, 

incur some one-time costs such as costs 

associated with training traders and staff 

on the proposed rule. In addition, 

market participants may incur costs 

when deciding whether particular 

conduct or activity could be construed 

as being an evasion of the requirements 

of section 2(h) or an abuse of any 

exemption or exception to such 

requirements. However, the proposed 

rules and proposed guidance explain 

what constitutes evasive or abusive 

conduct, which should serve to mitigate 

such costs. 

The Commission requests comment, 

including any quantifiable data and 

analysis, on the changes that market 

participants will have to make to their 

technological and legal infrastructures 

in order to clear the swaps that are 

subject to the proposed clearing 

requirement. How many market 

participants may have to establish new 

relationships with FCMs, or 

significantly upgrade those 

relationships? What updates to legal 

documentation are necessary, if any, for 

entities that already have an existing 

FCM relationship? If commenting on 

this subject, please clarify whether the 

comment relates to market participants 

that currently transact in: (1) Uncleared 

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47212 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

175See CME pricing charts at: http:// 

www.cmegroup.com/trading/cds/files/CDSFees.pdf; 

http://www.cmegroup.com/trading/interest-rates/

files/CME-IRS-Customer-Fee.pdf; 

and http://www.cmegroup.com/trading/interestrates/files/CME-IRS-Self-Clearing-Fee.pdf 

[hereinafter ‘‘CME Pricing Charts’’]. 176See LCH pricing for clearing services related 

to OTC IRS at: http://www.lchclearnet.com/swaps/ 

swapclear_for_clearing_members/fees.asp. 177See ICE Clear Credit fees for CDS at: 

https://www.theice.com/publicdocs/clear_credit/

circulars/ICEClearCredit%20Fee%20Schedule%20

Notice_FINAL.pdf. 178See CME Pricing Charts. 179See id. 

180See LCH pricing for clearing services related 

to OTC IRS at: http://www.lchclearnet.com/swaps/ 

swapclear_for_clearing_members/fees.asp. 

181See letters from Chatham and Webster Bank. 

182There also is a possibility that the numbers 

calculated above under-estimate the amount of 

additional initial margin that will need to be posted 

under a required clearing regime for IRS and CDS. 

For instance, there may be numerous market 

participants with directional portfolios that will be 

unable to benefit from margin offsets. However, the 

Commission continues to believe that its estimates 

are more likely to overstate the required additional 

margin. 

183The total amount of initial margin on deposit 

at CME for IRS is $5 billion, but for purposes of this 

estimate, the Commission is not including that 

amount. 

swaps without margin agreements; (2) 

uncleared swaps with margin 

agreements; (3) cleared swaps; and/or 

(4) futures. If possible, please quantify 

costs and the specific platforms being 

implemented, or changes being made to 

existing platforms. 

b. Ongoing Costs Related to FCMs and 

Other Service Providers 

In addition to costs associated with 

technological and legal infrastructure, 

market participants transacting in swaps 

subject to the proposed clearing 

requirement will bear ongoing costs 

associated with fees charged by FCMs. 

Regarding fees, DCOs typically charge 

FCMs an initial transaction fee for each 

of the FCM’s customers’ IRS that are 

cleared, as well as an annual 

maintenance fee for each of their 

customers’ open positions. Not 

including customer-specific and volume 

discounts, the transaction fees for IRS at 

the CME range from $1 to $24 per 

million notional amount for IRS and the 

maintenance fees are $2 per year per 

million notional amount for open 

positions.175 LCH transaction fees for 

IRS range from $1–$20 per million 

notional amount, and the maintenance 

fee ranges from $5–$20 per swap per 

month, depending on the number of 

outstanding swap positions that an 

entity has with the clearinghouse.176 For 

CDS, ICE Clear Credit charges an initial 

transaction fee of $6 per million 

notional amount. There is no 

maintenance fee charged by ICE for 

maintaining open CDS positions.177

FCMs will also bear additional fees 

with respect to their house accounts at 

the DCO to the extent that they clear 

more swaps due to the clearing 

requirement. For example, for IRS that 

they clear through CME, clearing 

members are charged a transaction fee 

that ranges from $0.75 to $18.00 per 

million notional, depending on the 

transaction maturity.178 Members, 

however, are not charged annual 

maintenance fees for their open house 

positions.179 For CDS, clearing members 

at ICE Clear Credit are charged $5 per 

transaction per million notional and 

there is no maintenance fee.180

As discussed above, it is difficult to 

predict precisely how the proposed 

requirement to clear the classes of 

swaps covered by this proposed rule 

will increase the use of swap clearing, 

as compared to the use of clearing that 

would occur in the absence of the 

requirement. However, the Commission 

expects that application of the clearing 

requirement to the swaps covered by the 

proposed rule will generally increase 

the use of clearing, leading to the 

ongoing transaction costs noted above. 

In addition, the Commission 

understands that FCM customers that 

only transact in swaps occasionally are 

typically required to pay a monthly or 

annual fee to each FCM that ranges from 

$75,000 to $125,000 per year.181 Again, 

although it is impossible to predict 

precisely how many FCM customers 

would be subject to such fees based on 

the proposed clearing requirement for 

CDS and IRS, the Commission expects 

that some market participants that 

previously did not use clearing would 

be subject to the requirements of the 

proposed rule. 

The Commission requests comment 

on whether the cited fee information is 

accurate and typical, as well as, the 

extent to which such fees are expected 

to result from the requirement to clear 

the classes of swaps subject to the 

proposed rule. Comment is also 

requested on whether the increased use 

of clearing that may result is expected 

to change such fees, and if so, how. The 

Commission also requests additional 

comment, data, and analysis regarding 

the fee structures of FCMs in general, 

and in particular as they relate to the 

clearing of the types of swaps covered 

by the proposed rule. Specifically, the 

Commission requests comment on the 

following: 

• Do the fees described above 

typically include fees charged by the 

DCO to the FCM for the FCM customer’s 

swap positions? 

• Do FCMs typically charge a similar 

fee to customers that are more active in 

trading swaps, and are such fees are 

generally greater, lesser, or similar to the 

fees charged to less active institutions? 

• Do such maintenance fees exist for 

larger customers, and if so, 

approximately how much charged? 

c. Costs Related to Collateralization of 

Cleared Swap Positions 

As mentioned above, market 

participants that enter into the classes of 

swaps covered by the proposed rule will 

be required to post collateral at the 

DCO. Of course, the incremental cost of 

collateral resulting from the application 

of the proposed clearing requirement 

depends on the extent to which such 

swaps are already being cleared (even in 

the absence of the requirement) or 

otherwise collateralized. The 

incremental cost also depends on 

whether such swaps are, if not 

collateralized, priced to include implicit 

contingent liabilities and counterparty 

risk born by the counterparty to the 

swap. 

A conservative approach would be to 

assume that the swaps that would be 

covered by the proposed clearing 

requirement currently are uncleared, 

completely uncollateralized, and not 

priced to include implicit contingent 

liabilities and counterparty risk born by 

the counterparty. In this case, 

imposition of the clearing requirement 

for those types of swaps would create 

additional costs due to: (1) The spread 

between cost of capital and returns on 

that capital for assets posted to meet 

initial margin for the entire term of the 

swap; and (2) the spread between cost 

of capital and returns on that capital for 

assets posted to meet the variation 

margin to the extent a party is ‘‘out of 

the money’’ on each swap. Under the 

assumptions mentioned above, if every 

IRS and CDS that is not currently 

cleared were moved into clearing, the 

maximum additional initial margin that 

would need to be posted is 

approximately $19.2 billion for IRS and 

$53 billion for CDS. However, for the 

reasons described below, these numbers 

likely overestimate the amount of 

additional initial margin that would 

need to be posted.182

The Commission calculated its 

estimated additional initial margin 

amounts based on the following 

assumptions. According to 

representations made to the 

Commission by LCH, they clear 

approximately 51% of the IRS market. 

The total amount of initial margin on 

deposit at LCH for IRS is approximately 

$20 billion.183 Therefore, if all 

remaining IRS were moved into 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47213 

184The total amount of initial margin on deposit 

only includes those amounts reported to the 

Commission by registered DCOs. Other 

clearinghouses, such as LCH.Clearnet.SA, clear the 

indices included in the proposed determination, 

however, the relative size of the open interest in the 

relevant CDS indices is substantially smaller than 

each of the DCOs included in this calculation. 

185BIS estimates that the gross notional value of 

outstanding CDS contracts is $28.6 trillion, and that 

$10.5 trillion of that is index related CDS. See BIS 

data, available at http://www.bis.org/statistics/ 

otcder/dt21.pdf. 

186 ISDA has estimated that 14.5% of the indexbased CDS market is currently being cleared, 

whereas the total outstanding notional at CME, ICE 

Clear Europe, and ICE Clear Credit represents 

approximately 7.5% of the global index-based CDS 

market estimated by BIS. Such a discrepancy would 

be expected if one or more of the following 

occurred: (1) If ISDA overestimated the percentage 

of the index-based CDS that is currently being 

cleared; (2) if BIS overestimated the size of the 

global index-based swap market; (3) if a significant 

amount of compression occurs as index-based CDS 

are moved into clearing; and/or (4) if a significant 

portion of the cleared index-based CDS market is 

held at clearinghouses other than CME, ICE Clear 

Europe, and ICE Clear Credit. The Commission 

believes that the compression of CDS positions 

moving into clearing is the most likely explanation, 

and therefore has used the ISDA estimate. However, 

the Commission also requests comment from the 

public regarding the accuracy of ISDA and BIS 

estimates regarding index-based CDS markets, and 

requests from the public any additional data for 

purposes of determining with greater certainty how 

much of the index-based CDS market is currently 

being cleared. 

187Both estimates assume that additional IRS 

brought into clearing would have similar margin 

requirements per unit of notional to those IRS that 

are already in clearing, and assumes that additional 

CDS brought into clearing would have similar 

margin requirements per unit of notional to those 

CDS that are already being cleared. These 

assumptions, in turn, imply similar levels of 

liquidity, compression, netting, and similar tenors 

for the swaps that are currently cleared and those 

that are not. While the Commission recognizes that 

these factors are not likely to be identical among 

both groups of products, adequate information to 

quantify the impact of each of these possible 

differences between the two groups of swaps on the 

amount of additional collateral that would have to 

be posted is not available. 

188See Cross-Border Application of Certain 

Swaps Provisions of the Commodity Exchange Act, 

77 FR 41213 (July 12, 2012). 

189See ISDA Margin Survey 2012, at 15, available 

at: http://www2.isda.org/functional-areas/research/ 

surveys/margin-surveys/. Although it is unclear 

exactly how many of the derivatives covered by this 

survey are swaps, it is reasonable to assume that a 

large part of them are. 

190This estimate, however, does not adjust for 

double counting of collateral assets. The same 

survey reports that as much as 91.1% of cash used 

as collateral and 43.8% of securities used as 

collateral are being reused, and therefore are 

counted two or more times in the ISDA survey. See 

ISDA Margin Survey 2012, at 20 and 11, 

respectively. 

191The NERA study is available at: http:// 

comments.cftc.gov/PublicComments/ 

ViewComment.aspx?id=50037 and their comments 

defending their cost of capital are available in their 

letter at http://comments.cftc.gov/PublicComments/ 

ViewComment.aspx?id=57015. 

192This aspect of the NERA study has been 

described in greater detail by MIT professors John 

Parsons and Antonio Mello, available at: http:// 

bettingthebusiness.com/2012/01/22/phantom-coststo-the-swap-dealer-designation-and-otc-reform/ and 

http://bettingthebusiness.com/2012/03/19/neradoubles-down/. 

clearing, approximately $19.2 billion 

($20B/0.51¥$20B = 19.2B) would have 

to be posted in initial margin. 

Similarly, the initial margin related to 

CDS currently on deposit at CME, ICE 

Clear Credit, and ICE Clear Europe is 

approximately $21.4 billion.184 This 

amount includes initial margin based on 

both index-based CDS and single-name 

CDS positions. BIS data indicates that 

approximately 36.6% of the CDS market 

comprises index-based CDS.185 If we 

assume that approximately 36.6% of the 

overall portfolio-based CDS margin (i.e., 

CDS indices and single-name CDS 

margined together) currently held by 

DCOs for CDS positions is related to 

index-based CDS, and then add any 

margin held by DCOs attributable solely 

to index-based CDS, we can estimate 

that approximately $9.0 billion in 

margin currently held by those DCOs is 

related to index-based CDS. ISDA data 

indicates that 14.5% of the index-based 

CDS market is currently cleared.186

Therefore, if the entire index-based CDS 

market moved into clearing, $53 billion 

($9.0/.145¥$9.0 = $53) in initial margin 

would have to be posted at DCOs.187

Again, it is highly probable that these 

estimates significantly overstate the 

amount of additional capital that would 

be posted for a number of reasons 

described below. 

First, this analysis assumes that every 

IRS and index-based CDS not currently 

cleared is brought into clearing under 

the proposed rule. However, in this rule 

the Commission has proposed required 

clearing only for certain classes of IRS 

and CDS, and not for all IRS and CDS. 

Therefore, there will still be certain 

types of IRS, such as those related to the 

thirteen additional currencies cleared by 

LCH, that are not required to be cleared. 

Moreover, the clearing requirement will 

apply only to new swap transactions 

whereas market estimates include 

legacy transactions. 

In addition, non-financial entities 

entering into swaps for the purpose of 

hedging or mitigating commercial risk 

are not required to use clearing under 

section 2(h)(7) of the CEA. As a 

consequence, many entities will not be 

required to clear, even when entering 

into IRS or CDS that are otherwise 

required to be cleared. Third, some IRS 

and CDS involve cross-border 

transactions to which the Commission’s 

clearing requirement will not apply.188

Fourth, collateral is already posted with 

respect to many non-cleared IRS and 

CDS. ISDA conducted a recent survey 

which reported that 93.4% of all trades 

involving credit derivatives, and 78.1% 

of all trades involving fixed income 

derivatives are subject to collateral 

agreements.189 Moreover, ISDA 

estimated that the aggregate amount of 

collateral in circulation in the noncleared OTC derivatives market at the 

end of 2011 was approximately $3.6 

trillion.190

In any case, it is reasonable to assume 

that the requirement to clear the swaps 

covered by the proposed rule will result 

in increased use of clearing and 

increased posting of collateral with 

respect to such swaps. To calculate the 

additional collateral cost to market 

participants, we must estimate the 

difference between the cost of capital for 

the additional collateral and the returns 

on that capital. In comments regarding 

other Commission rules, commenters 

have often taken the view that the 

difference between the cost and returns 

on capital for funds that are used as 

collateral is substantial. 

In a study commissioned by the 

Working Group of Commercial Energy 

Firms, for example, NERA used an 

estimate of 13.08% for the pre-tax 

weighted average cost of capital for the 

firm, and an estimate of 3.49% for the 

pre-tax yield on collateral, for a 

difference as 9.59% which NERA used 

as the net pre-tax cost of collateral.191

However, these estimates use the 

borrowing costs for the entire firm, but 

only consider the returns on capital for 

one part of the firm, when determining 

the spread between the two. The result 

is an over-stated difference, and 

therefore a higher cost associated with 

collateral than would result if the costs 

of capital and returns of capital were 

compared on a consistent basis.192

However, the Commission notes that 

this cost is not only likely overstated, 

for the reasons mentioned above, but 

that it also may not be a new cost. 

Rather, it is a displacement of a cost that 

is embedded in uncleared, 

uncollateralized swaps. Entering into a 

swap is costly for any market 

participant because of the default risk 

posed by its counterparty, whether the 

counterparty is a DCO, swap dealer, or 

other market participant. When a market 

participant faces the DCO, the DCO 

accounts for that counterparty risk by 

requiring collateral to be posted, and the 

cost of capital for the collateral is part 

of the cost that is necessary in order to 

maintain the swap position. When a 

market participant faces a dealer or 

other counterparty in an uncleared 

swap, however, the uncleared swap 

contains an implicit line of credit upon 

which the market participant effectively 

draws when its swap position is out of 

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47214 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

193Mello, Antonio S., and John E. Parsons, 

‘‘Margins, Liquidity, and the Cost of Hedging.’’ MIT 

Center for Energy and Environmental Policy 

Research, May 2012, available at http:// 

dspace.mit.edu/bitstream/handle/1721.1/70896/ 

2012–005.pdf?sequence=1. 

194See id., Mello and Parsons state in their paper, 

‘‘Hedging is costly. But the real source of the cost 

is not the margin posted, but the underlying credit 

risk that motivates counterparties to demand that 

margin be posted.’’ Id. at 12. They go on to 

demonstrate that, ‘‘To a first approximation, the 

cost charged for the non-margined swap must be 

equal to the cost of funding the margin account. 

This follows from the fact that the non-margined 

swap just includes funding of the margin account 

as an embedded feature of the package.’’ Id. at 15– 

16. 

195 In order to calculate the size of their guaranty 

funds, clearinghouses for swaps generally stress 

their clearing members’ portfolios under a number 

of extreme, but plausible, scenarios in order to 

identify the two clearing members with the largest 

losses. The resulting loss calculation of those two 

clearing members is used to size the guaranty fund. 

Once that amount is established, the clearinghouse 

will require contributions of all clearing members 

based on their relative ‘‘losses’’ under the stress 

scenarios. Assuming that the portfolios of new 

clearing members and new customers do not alter 

the overall sizing of the guaranty fund, but that the 

new clearing members are making contributions to 

the guaranty fund based on their relative potential 

losses, the overall guaranty fund contribution for 

existing clearing members may decrease. 

196BIS data, December 2011, available at: 

http://www.bis.org/statistics/derstats.htm. 

the money. Counterparties charge for 

this implicit line of credit in the spread 

they offer on uncollateralized, uncleared 

swaps. It can be shown that the cash 

flows of an uncollateralized swap (i.e., 

a swap with an implicit line of credit) 

are, over time, substantially equivalent 

to the cash flows of a collateralized 

swap with an explicit line of credit.193

And because the counterparty risk 

created by the implicit line of credit is 

the same as the counterparty risk that 

would result from an explicit line of 

credit provided to the same market 

participant, to a first order 

approximation, the charge for each 

should be the same as well.194 This 

means that the cost of capital for 

additional collateral posted as a 

consequence of requiring 

uncollateralized swaps to be cleared 

does not introduce an additional cost, 

but rather takes a cost that is implicit in 

an uncleared, uncollateralized swap and 

makes it explicit. This observation 

applies to capital costs associated with 

both initial margin and variation 

margin. 

The Commission invites further 

comment regarding the total amount of 

additional collateral that would be 

posted due to required clearing of the 

classes of swaps designated in this 

proposal. Furthermore, the Commission 

invites comment regarding the cost of 

capital and returns on capital for that 

collateral, as well as on the cost of the 

implicit line of credit embedded in 

uncleared, uncollateralized swaps. The 

Commission, in particular, welcomes 

any quantifiable data and analysis that 

commenters are willing to share 

regarding these subjects. 

Another impact of the proposed rule 

may be that financial institutions are 

required to hold additional capital with 

respect to their swap positions pursuant 

to prudential regulatory capital 

requirements. Basel III standards are 

designed to incentivize central clearing 

of derivatives by applying a lower 

capital weighting to them than for 

similar uncleared derivatives positions. 

Therefore, the Commission expects that 

the capital that financial institutions are 

required to hold is likely to be reduced 

as a consequence of their increased use 

of swap clearing. The Commission 

invites comment on the effects of 

required clearing on the capital 

requirements for financial institutions. 

To the extent possible, please quantify 

the relevant costs and benefits and 

explain the effect of the relevant capital 

standards. 

In addition, operational costs may 

result from the collateral requirements 

that apply to the proposed clearing 

requirement. With uncleared swaps, 

counterparties may agree not to collect 

variation margin until certain thresholds 

of exposure are reached, thus reducing 

or perhaps entirely eliminating the need 

to exchange variation margin as 

exposure changes. DCOs, on the other 

hand, collect and pay variation margin 

on a daily basis and sometimes more 

frequently. As a consequence, increased 

required clearing may increase certain 

operational costs associated with 

moving variation margin to and from the 

DCO. On the other hand, increased 

clearing is also likely to lead to benefits 

from reduced operational costs related 

to valuation disputes, as parties to 

cleared swaps agree to abide by the 

DCO’s valuation procedures. To the 

extent that the requirement to clear the 

types of swaps covered by the proposed 

rule leads to increased use of clearing, 

these costs and benefits are likely to 

result. The Commission invites further 

comment regarding the costs and 

benefits associated with operational 

differences related to the 

collateralization of uncleared versus 

cleared swaps. 

Increases in clearing as a result of the 

proposed clearing requirement also may 

result in additional costs for clearing 

members in the form of guaranty fund 

contributions. However, it also may be 

that increased clearing of swaps would 

decrease guaranty fund contributions for 

certain clearing members. Market 

participants that currently transact 

swaps bilaterally and do not clear such 

swaps must either become clearing 

members of an appropriate DCO or 

submit such swaps for clearing through 

an existing clearing member, once the 

clearing requirement applies to such 

swaps. A party that chooses to become 

a clearing member of a DCO must make 

a guaranty fund contribution. A party 

that chooses to clear swaps through an 

existing clearing member may have a 

share of the clearing member’s guaranty 

fund contribution passed along to it in 

the form of fees. While the addition of 

new clearing members and new 

customers for existing clearing members 

may result in existing clearing members 

experiencing an increase in their 

guaranty fund requirements, it should 

be noted that if (1) new clearing 

members are not among the two clearing 

members used to calculate the guaranty 

fund and (2) any new customers trading 

through a clearing member do not 

increase the size of uncollateralized 

risks at either of the two clearing 

members used to calculate the guaranty 

fund, all else held constant, existing 

clearing members may experience a 

decrease in their guaranty fund 

requirement.195

d. Benefits of Clearing 

As noted above, the benefits of swap 

clearing, in general, are significant. 

Thus, to the extent that the proposed 

clearing requirement for certain classes 

of IRS and CDS leads to increased use 

of clearing, these benefits are likely to 

result. As is the case for the costs noted 

above, it is impossible to predict the 

precise extent to which the use of 

clearing will increase as a result of the 

proposed rule, and therefore the benefits 

of the proposed rule cannot be precisely 

quantified. But the Commission believes 

that the benefits of increased clearing 

resulting from the proposed rule will be 

significant, because the classes of swaps 

required to be cleared by the proposed 

rule represent a substantial portion of 

the total swap markets. Currently 

outstanding IRS and CDS indices have 

notional amounts of about $504 trillion 

and $10.4 trillion, respectively, which is 

a substantial part of the $648 trillion 

notional global swaps market.196 As 

noted above, the proposed rule requires 

that only certain classes of IRS and CDS 

indices be cleared, but such classes 

likely represent the most common 

swaps within those overall asset classes, 

and therefore are likely to constitute a 

relatively large portion of those asset 

classes. By requiring these particular 

swaps to be cleared, the benefits of 

clearing are expected to be realized 

across a relatively large portion of the 

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197See proposed § 50.2(a). 198See Client Clearing Documentation, Timing of 

Acceptance for Clearing, and Clearing Member Risk 

Management, 77 FR 21278 (Apr. 9, 2012). 199The Commission notes that if a market 

participant executed a swap that is required to be 

cleared on a SEF or DCM, then that market 

participant will be deemed to have met their 

obligation to submit the swap to a DCO because of 

the straight-through processing rules previously 

adopted by the Commission. 

200BIS data, June 2011, available at http:// 

www.bis.org/publ/otc_hy1111.pdf. 

201See id. 

202See id. 

market. The Commission requests 

comment on whether such benefits will 

result from the proposed rule and, if so, 

the expected magnitude of such 

benefits. 

The proposed rule’s requirement that 

certain classes of swaps be cleared is 

expected to increase the number of 

swaps in which market participants will 

face a DCO, and therefore, will face a 

highly creditworthy counterparty. DCOs 

are some of the most creditworthy 

counterparties in the swap market 

because they have at their disposal a 

number of risk management tools that 

enable them to manage counterparty 

risk effectively. Those tools include 

contractual rights that enable them to 

use margin to manage current and 

potential future exposure, to close out 

and transfer defaulting positions while 

minimizing losses that result from such 

defaults, and to protect solvency during 

the default of one or more members 

through a waterfall of financial 

contributions from which they can 

draw, as outlined above. Also, clearing 

protects swap users from the risk of 

having to share in loss mutualization 

among FCMs if one DCO member 

defaults and such measures are 

necessary. 

This proposed rule requires that 

classes of swaps that are required to be 

cleared must be submitted to clearing 

‘‘as soon as technologically practicable 

after execution, but in any event by the 

end of the day of execution.’’ 197 This 

conforms to the requirements 

established in the recently finalized rule 

regarding timing of acceptance for 

clearing,198 which is designed to 

promote rapid submission of these 

swaps for clearing and reduce the 

unnecessary counterparty risk that can 

develop between the time of execution 

and submission to clearing.199

The Commission expects that the 

requirement for rapid submission, 

processing, and acceptance or rejection 

of swaps for clearing will be beneficial 

in several respects. It is important to 

note that when two parties enter into a 

bilateral swap with the intention of 

clearing it, each party bears 

counterparty risk until the swap is 

cleared. Once the swap is cleared, the 

clearinghouse becomes the counterparty 

to each of the original parties, which 

minimizes and standardizes 

counterparty risk. 

Where swaps of the type covered by 

the proposed rule are not executed on 

an exchange, the proposed rule should 

significantly reduce the amount of time 

needed to process them. Although costs 

associated with latency-period 

counterparty credit risk cannot be 

completely eliminated in this context, 

the rules will reduce the need to 

discriminate among potential 

counterparties in off-exchange swaps, as 

well as the potential costs associated 

with rejected swaps. By reducing the 

counterparty risk that could otherwise 

develop during the latency period, these 

rules promote a market in which all 

eligible market participants have access 

to counterparties willing to trade on 

terms that approximate the best 

available terms in the market. This may 

improve price discovery and promote 

market integrity. 

In addition, absent proposed § 50.10 

and related interpretations, certain risks 

could increase in a manner that the 

Commission would not be able to 

measure accurately. Proposed § 50.10 

and related interpretations are expected 

to bring the appropriate scope of swaps 

within the requirements of section 2(h), 

which will facilitate the achievement of 

the benefits of swap clearing and trade 

execution, among others. Activity 

conducted solely for a legitimate 

business purpose, absent other indicia 

of evasion or abuse, would not 

constitute a violation of proposed 

§ 50.10 as described in the 

Commission’s proposed interpretation. 

D. Costs and Benefits of the Proposed 

Rule as Compared to Alternatives 

The Commission’s proposal to apply 

the clearing requirement initially to 

certain CDS and IRS is a function of 

both the market importance of these 

products and the fact that they already 

are widely cleared. In order to move the 

largest number of swaps to required 

clearing in its initial determination, the 

Commission believes that it is prudent 

to focus on swaps that are widely used 

and for which there is already a 

blueprint for clearing and appropriate 

risk management. CDS and IRS that 

match these factors are therefore well 

suited for required clearing. 

As noted above, IRS with a notional 

amount of $504 trillion are currently 

outstanding—the highest proportion of 

the $648 trillion global swaps market of 

any class of swaps.200 CDS indices with 

a notional amount of about $10.4 trillion 

are currently outstanding.201 While CDS 

indices do not have as prominent a 

share of the entire swaps market as IRS, 

uncleared CDS is capable of having a 

sizeable market impact, as it did during 

the 2008 financial crisis. In addition, 

many of the swaps within each of the 

classes proposed for required clearing 

are already cleared by one or more 

clearinghouses. LCH claims to clear IRS 

with a notional amount of about $284 

trillion—meaning that, in notional 

terms, LCH clears 51% of the interest 

rate swap market.202 The swap market 

has made a smooth transition into 

clearing CDS on its own initiative. As a 

result, DCOs, FCMs, and many market 

participants already have experience 

clearing the types of swaps that have 

been proposed for required clearing. 

The Commission expects, therefore, that 

DCOs and FCMs are equipped to handle 

the increases in volume and outstanding 

notional amount in these swaps that is 

likely to be cleared as the result of the 

proposed rule. Because of the wide use 

of these swaps and their importance to 

the market, and because these swaps are 

already cleared safely, the Commission 

is proposing to subject certain types of 

IRS and CDS to the initial clearing 

requirement. 

The Commission is proposing certain 

key specifications for CDS and IRS that 

will inform whether a particular swaps 

falls within one of the classes of swaps 

that are required to be cleared. The two 

classes of CDS that are required to be 

cleared are (1) U.S. dollar-denominated 

CDS covering North America corporate 

credits and (2) euro-denominated CDS 

referencing European obligations. The 

four classes of IRS required to be cleared 

are (1) fixed-to-floating swaps, (2) basis 

swaps, (3) OIS, and (4) FRAs. 

Regarding CDS, the Commission has 

outlined three key specifications 

comprising (1) region and nature of 

reference entity, (2) the nature of the 

CDS itself, and (3) tenor. Each of these 

specifications will assist market 

participants in determining whether a 

swap falls within the CDS classes of 

swaps required to be cleared. For the 

first, a distinguishing characteristic is 

whether the reference entity is in North 

American or European and whether it is 

one of Markit’s CDX.NA.IG, 

CDX.NA.HY, iTraxx Europe, iTraxx 

Europe Crossover and iTraxx Europe 

High Volatility indices. The second key 

specification relates to whether the CDS 

is tranched or untranched. The classes 

that are required to be cleared include 

only untranched CDS where the 

contract covers the entire index loss 

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47216 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

203As noted in Section II.E above, mechanical 

specifications include characteristics such as 

floating rate reset tenors, reference city for business 

days, business day convention, and others that have 

some small impact on valuation but that do not 

fundamentally alter the economic consequence of 

the swap for the parties that enter into it. 

distribution of the indice and settlement 

is not linked to a specified number of 

defaults. Tranched swaps, first- or 

‘‘Nth’’ to-default, options, or any other 

product variations on these indices are 

excluded from these classes. Finally, the 

third key specification entails whether a 

swap falls within a tenor, specific to an 

index, that is required to be cleared. The 

Commission has determined that each 

of the 3-, 5-, 7-, and 10-year tenors be 

included within the class of swaps 

subject to the clearing requirement 

determination for CDX.NA.IG; the 5- 

year tenor be included for CDX.NA.HY; 

each of the 5- and 10-year for ITraxx 

Europe; the 5-year for ITraxx Europe 

Crossover; and, the 5-year for ITraxx 

Europe High Volatility. In addition, it 

should be noted that only certain series 

will be viewed as required to be cleared. 

The Commission had a number of 

alternatives to that proposed. First, the 

Commission could have used a 

narrower or broader group of reference 

entities. For example, the Commission 

has not included the CDX.NA.IG.HVOL 

within the North American swap class. 

While doing so would have increased 

the number of swaps required to be 

cleared, the Commission questions 

whether there is sufficient liquidity to 

justify required clearing at this time 

given that the recent series of 

CDX.NA.IG.HVOL have not been 

cleared by ICE (and are not offered at all 

by CME). 

The Commission could also have 

endeavored to include tranched CDS. 

The Commission recognizes that there is 

a significant market for tranched swaps 

using the indices. In these transactions, 

parties to the CDS contract agree to 

address only a certain range of losses 

along the entire loss distribution curve. 

Other swaps such as first or ‘‘Nth’’ to 

default baskets, and options, also exist 

on the indices. However, these swaps 

are not being cleared currently and were 

not submitted by a DCO for 

consideration under § 39.5. 

Regarding tenor, the Commission 

could have included more of those 

offered within the classes of swaps 

required to be cleared. For example, the 

CDX.NA.IG has 1- and 2-year tenors and 

the CDX.NA.HY, has 3-, 7-, and 10-year 

tenors that have not been included 

among the specified tenors. The iTraxx 

Europe has 3- and 7-year tenors and the 

Crossover and High Volatility each have 

3-, 7-, and 10-year tenors that have not 

been included. In addition, the 

Commission could have included all 

series of active indices. The concern, 

regarding both tenors and series, is that 

certain tenors and series have lower 

liquidity and may be difficult for a DCO 

to adequately risk manage. While 

including more tenors and series would 

have increased the volume of swaps 

required to be cleared to some degree, 

the Commission proposes that doing so 

may have raised costs for DCOs and 

other market participants and been less 

desirable relative to the factors 

established in § 39.5. 

With regard to IRS, as mentioned 

above, the Commission is proposing a 

clearing requirement for four classes of 

interest rate swaps: fixed-to-floating 

swaps, basis swaps, OIS, and FRAs. 

Within those four classes, the 

Commission is proposing three 

affirmative specifications for each class 

((i) Currency used for in which the 

notional and payment amounts are 

specified, (ii) rates referenced for each 

leg of the swap, and (iii) stated 

termination date of the swap) and three 

‘‘negative’’ specifications for each class 

((i) No optionality (as specified by the 

DCOs); (ii) no dual currencies; and (iii) 

no conditional notional amounts). 

The Commission considered whether 

to establish clearing requirements on a 

product-by-product basis. Such a 

determination would need to identify 

the multitude of legal specifications of 

each product that would be subject to 

the clearing requirement. Although the 

industry uses standardized definitions 

and conventions, the product 

descriptions would be lengthy and 

require counterparties to compare all of 

the legal terms of their particular swap 

against the terms of the many different 

swaps that would be included in a 

clearing requirement. The Commission 

believes that for interest rate swaps, a 

product-by-product determination could 

be unnecessarily burdensome for market 

participants in trying to assess whether 

each swap transaction is subject to the 

requirement. A class-based approach 

would allow market participants to 

determine quickly whether they need to 

submit their swap to a DCO for clearing 

by checking initially whether the swap 

has the basic specifications that define 

each class subject to the clearing 

requirement. 

As an alternative to the classes 

selected, LCH recommended that the 

Commission use the following 

specifications to classify interest rate 

swaps for purposes of making a clearing 

determination: (i) Swap class (i.e., what 

the two legs of the swap are (fixed-tofloating, basis, OIS, etc.)), (ii) floating 

rate definitions used, (iii) the currency 

designated for swap calculations and 

payments, (iv) stated final term of the 

swap (also known as maturity), (v) 

notional structure over the life of the 

swap (constant, amortizing, roller 

coaster, etc.), (vi) floating rate 

frequency, (vii) whether optionality is 

included, and (viii) whether a single 

currency or more than one currency is 

used for denominating payments and 

notional amount. CME recommended a 

clearing determination for all nonoption interest rate swaps denominated 

in a currency cleared by any qualified 

DCO. 

These alternative specifications fall 

into two general categories: 

specifications that are commonly used 

to address mechanical issues for most 

swaps, and specifications that are less 

common and address idiosyncratic 

issues related to the particular needs of 

a counterparty. Examples of the latter 

are special representations added to 

address particular legal issues, unique 

termination events, special fees, and 

conditions tied to events specific to the 

parties. None of the DCOs clear interest 

rate swaps with terms in the second 

group. As for mechanical specifications, 

while the Commission recognizes that 

such specifications may affect the value 

of the swap, such specifications are not, 

generally speaking, fundamental to 

determining the economic result the 

parties are trying to achieve.203 The 

Commission has proposed the three 

affirmative specifications described 

above because it believes that they are 

fundamental specifications used by 

counterparties to determine the 

economic result of a swap transaction 

for each party. 

The Commission also could have 

avoided the negative specifications for 

IRS, which would have had the effect of 

potentially including more IRS swaps 

within the universe of those required to 

be cleared. However, the Commission 

believes that swaps with optionality, 

multiple currency swaps, and swaps 

with conditional notional amounts raise 

concerns regarding adequate pricing 

measures and consistency across swap 

contracts. Such contingencies make 

them difficult for DCOs to effectively 

risk manage. Additionally, at this time, 

no DCO is offering them for clearing. 

Another alternative considered by the 

Commission, but not proposed, was that 

of stating the clearing requirement in 

terms of a particular type of swap, rather 

than using broad characteristics to 

describe the type of swaps for which 

clearing would be required. For 

example, rather than requiring that all 

IRS that meet the six specifications in 

proposed § 50.4(a) be cleared, the rule 

could have specified that only certain 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47217 

204For instance, in the example noted above, 

swaps with a term of five years and one day would 

not be required to be cleared. 

205For instance, the Commission decided not to 

include CDX.NA.IG.HiVOL from the proposed 

determination given the lack of volume in the 

current on-the-run and recent off-the-run series. In 

addition, CME currently does not clear any HiVOL 

contracts, and ICE Clear Credit no longer clears the 

most recent series. 

206As discussed in Section II.C and II.E above, 

DCOs offering clearing for CDS and IRS have 

established extensive risk management practices, 

which focus on the protection of market 

participants. See also Sections II.D and II.F for a 

discussion of the effect on the mitigation of 

systemic risk in the CDS market and in the IRS 

market, as well as the protection of market 

participants during insolvency events at either the 

clearing member or DCO level. 

207See Sections II.D and II.F above for a further 

discussion of how DCOs obtain adequate pricing 

data for the CDS and IRS that they clear. Based on 

this pricing data, valuation disputes are minimized, 

if not eliminated for cleared swaps. 

sub-types of those IRS—such as all such 

IRS with a term of five years—are 

required to be cleared. Such an 

approach might permit the Commission 

to account for variation in liquidity and 

outstanding notional values among 

different sub-types of swap, and thereby 

focus the clearing requirement on very 

particular swaps to account for these 

differences within the same general 

class. Also, generally speaking, limiting 

the clearing requirement to fewer swaps 

could reduce some costs associated with 

clearing. 

However, this advantage was weighed 

against an important disadvantage of 

this approach. A highly focused clearing 

requirement could increase the ability 

for market participants to replicate the 

economic results of a swap that is 

required to be cleared by substituting a 

swap not required to be cleared; this 

greater latitude for clearing avoidance, 

in turn, could increase systemic risk and 

dampen the beneficial effects of clearing 

noted above.204 Under the approach 

proposed by the Commission, all swaps 

that fall within identified classes are 

covered by the clearing requirement, 

which reduces the risk of such 

avoidance and the associated reduction 

of benefits. Moreover, stating the 

clearing requirement in more general 

terms reduces the costs associated with 

determining whether or not a particular 

swap is subject to the clearing 

requirement. 

The Commission invites comment on 

the costs and benefits of identifying 

classes of swaps for clearing in a more 

focused or more general manner. If 

possible, please quantify costs and 

benefits that result either from the 

approach proposed by the Commission 

or from alternatives that you believe the 

Commission should consider. 

The Commission also considered 

proposing required clearing for all 

seventeen currencies of IRS that are 

currently offered for clearing, but 

decided instead to propose required 

clearing at this time for IRS in four 

currencies (EUR, USD, GBP, and JPY). 

The Commission recognizes that 

requiring IRS in all seventeen currencies 

submitted by LCH Clearnet to be cleared 

would provide the benefit of some 

incremental reduction in overall 

counterparty, and thus systemic, risk 

attendant to clearing a greater portion of 

IRS. However, as noted above, the 

Commission proposes that initiating the 

clearing requirement in a measured 

manner with respect to IRS in the four 

specified currencies familiar to many 

market participants is the preferable 

approach at this time because it would 

give market participants an opportunity 

to identify and address any operational 

challenges related to required clearing. 

Moreover, the currencies included in 

the proposed classes constitute 

approximately 93% of cleared IRS, 

which suggests that significant 

reductions in counterparty risk and 

gains in systemic protection will be 

accomplished by limiting the clearing 

determination to them. 

Similarly, the Commission considered 

requiring clearing of all CDS that are 

currently being cleared, but decided not 

to include, in the initial clearing 

requirement, certain types of CDS that 

have a less significant role in the current 

market.205

The Commission invites further 

comment on its decision-making with 

regard to the classes of IRS and CDS that 

would be required to be cleared. 

Commenters are also invited to submit 

any data or other information that they 

may have quantifying or qualifying the 

costs and benefits of the proposal with 

their comment letters. 

E. Section 15(a) Factors 

As noted above, the requirement to 

clear the classes of swaps covered by the 

proposed rule is expected to result in 

increased use of clearing, although it is 

impossible to quantify with certainty 

the extent of that increase. Thus, this 

section discusses the expected results 

from an overall increase in the use of 

swap clearing in terms of the factors set 

forth in section 15(a) of the CEA. 

i. Protection of Market Participants and 

the Public 

As described above, required clearing 

of the classes of swaps identified in this 

proposed rule is expected to reduce 

counterparty risk for market participants 

that clear those swaps because they will 

face the DCO rather than another market 

participant that lacks the full array of 

risk management tools that the DCO has 

at its disposal. This also reduces 

uncertainty in times of market stress 

because market participants facing a 

DCO are less concerned with the impact 

of such stress on the solvency of their 

counterparty for cleared trades. 

By proposing to require clearing of 

certain classes of swaps, all of which are 

already available for clearing, the 

Commission expects to encourage a 

smooth transition by creating an 

opportunity for market participants to 

work out challenges related to required 

clearing of swaps while operating in 

familiar terrain. More specifically, the 

DCOs will clear an increased volume of 

swaps that they already understand and 

have experience managing. Similarly, 

FCMs likely will realize increased 

customer and transaction volume as the 

result of the requirement, but will not 

have to simultaneously learn how to 

operationalize clearing for new types of 

swaps. And the experience of FCMs 

with these products is also likely to 

benefit customers that are new to 

clearing, as the FCM guides them 

through initial experiences with cleared 

swaps.206

In addition, uncleared swaps subject 

to collateral agreements can be the 

subject of valuation disputes. These 

valuation disputes sometimes require 

several months, or longer, to resolve. 

Uncollateralized exposure can grow 

significantly during that time, leaving 

one of the two parties exposed to 

counterparty risk that was intended to 

be covered through a collateral 

agreement. DCOs reduce valuation 

disputes for cleared swaps as well as the 

risk that uncollateralized exposure can 

develop and accumulate during the time 

when such a dispute would have 

otherwise occurred, thus providing 

additional protection to market 

participants who transact in swaps that 

are required to be cleared.207

As far as costs are concerned, market 

participants that do not currently have 

established clearing relationships with 

an FCM will have to set up and 

maintain such a relationship in order to 

clear swaps that are required to be 

cleared. As discussed above, market 

participants that conduct a limited 

number of swaps per year will likely be 

required to pay monthly or annual fees 

that FCM’s charge to maintain both the 

relationship and outstanding swap 

positions belonging to the customer. In 

addition, the FCM is likely to pass along 

fees charged by the DCO for establishing 

and maintaining open positions. 

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47218 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

208See Section II.C and II.E. 

209See Chen, K., et al. ‘‘An Analysis of CDS 

Transactions: Implications for Public Reporting,’’ 

September 2011, Federal Reserve Bank of New York 

Staff Reports, at 14, available at http:// 

www.newyorkfed.org/research/staff_reports/ 

sr517.pdf. 

210As discussed in Sections II.C and II.E above, 

sound risk management practices are critical for all 

DCOs, especially those offering clearing for CDS 

and IRS. In the discussion above, the Commission 

considered whether each DCO submission under 

review was consistent with the core principles for 

DCOs. In particular, the Commission considered the 

DCO submissions in light of Core Principle D, 

which relates to risk management. See also Sections 

II.D and II.F for a discussion of the effect on the 

mitigation of systemic risk in the CDS market and 

in the IRS market, as well as the protection of 

market participants during insolvency events at 

either the clearing member or DCO level. 

211A list of the G20 commitments made in 

Pittsburgh can be found at: http:// 

www.g20.utoronto.ca/analysis/commitments-09- 

pittsburgh.html. 

212See 5 U.S.C. 601 et seq. 

213To the extent that this rulemaking affects 

DCMs, DCOs, or FCMs, the Commission has 

previously determined that DCMs, DCOs, and FCMs 

are not small entities for purposes of the RFA. See, 

respectively and as indicated, 47 FR 18618, 18619, 

ii. Efficiency, Competitiveness, and 

Financial Integrity of Swap Markets 

Swap clearing, in general, is expected 

to reduce uncertainty regarding 

counterparty risk in times of market 

stress and promote liquidity and 

efficiency during those times. Increased 

liquidity promotes the ability of market 

participants to limit losses by exiting 

positions effectively when necessary in 

order to manage risk during a time of 

market stress. 

In addition, to the extent that 

positions move from facing multiple 

counterparties in the bilateral market to 

being run through a smaller number of 

clearinghouses, clearing facilitates 

increased netting. This reduces the 

amount of collateral that a party must 

post in margin accounts. 

As discussed in Sections II.D and II.F 

above, in setting forth this proposal, the 

Commission took into account a number 

of specific factors that relate to the 

financial integrity of the swap markets. 

Specifically, the discussion above 

includes an assessment of whether the 

DCOs clearing CDS and IRS have the 

rule framework, capacity, operational 

expertise and resources, and credit 

support infrastructure to clear CDS and 

IRS on terms that are consistent with the 

material terms and trading conventions 

on which the contract is then traded. 

The proposal also considered the 

resources of DCOs to handle additional 

clearing, as well as the existence of 

reasonable legal certainty in the event of 

a clearing member or DCO 

insolvency.208

As discussed above, bilateral swaps 

create counterparty risk that may lead 

market participants to discriminate 

among potential counterparties based on 

their creditworthiness. Such 

discrimination is expensive and time 

consuming insofar as market 

participants must conduct due diligence 

in order to evaluate a potential 

counterparty’s creditworthiness. 

Requiring certain types of swaps to be 

cleared reduces the number of 

transactions for which such due 

diligence is necessary, thereby 

contributing to the efficiency of the 

swap markets. 

In proposing a clearing requirement 

for both CDS and IRS, the Commission 

must consider the effect on competition, 

including appropriate fees and charges 

applied to clearing. As discussed in 

more detail in Sections II.D and II.F 

above, there are a number of potential 

outcomes that may result from required 

clearing. Some of these outcomes may 

impose costs, such as if a DCO 

possessed market power and exercised 

that power in an anticompetitive 

manner, and some of the outcomes 

would be positive, such as if the 

clearing requirement facilitated a 

stronger entry-opportunity for 

competitors. 

As far as costs are concerned, the 

markets for some swaps within the 

classes that are proposed to be required 

to be cleared may be less liquid than 

others. All other things being equal, 

swaps for which the markets are less 

liquid have the potential to develop 

larger current uncollateralized 

exposures after a default on a cleared 

position, and therefore will require 

posting of relatively greater amounts of 

initial margin. 

iii. Price Discovery 

Clearing, in general, encourages better 

price discovery because it eliminates the 

importance of counterparty 

creditworthiness in pricing swaps 

cleared through a given DCO. That is, by 

making the counterparty 

creditworthiness of all swaps of a 

certain type essentially the same, prices 

should reflect factors related to the 

terms of the swap, rather than the 

idiosyncratic risk posed by the entities 

trading it.209

As discussed in sections II.D and II.F 

above, DCOs obtain adequate pricing 

data for the CDS and IRS that they clear. 

Each DCO establishes a rule framework 

for its pricing methodology and 

rigorously tests its pricing models to 

ensure that the cornerstone of its risk 

management regime is as sound as 

possible. 

iv. Sound Risk Management Practices 

If a firm enters into swaps to hedge 

certain positions and then the 

counterparty to those swaps defaults 

unexpectedly, the firm could be left 

with large outstanding exposures. As 

stated above, when a swap is cleared the 

DCO becomes the counterparty facing 

each of the two original participants in 

the swap. This standardizes and reduces 

counterparty risk for each of the two 

original participants. To the extent that 

a market participant’s hedges comprise 

swaps that are required to be cleared, 

the requirement enhances their risk 

management practices by reducing their 

counterparty risk. 

In addition, from systemic 

perspective, required clearing reduces 

the complexity of unwinding/ 

transferring swap positions from large 

entities that default. Procedures for 

transfer of swap positions and 

mutualization of losses among DCO 

members are already in place, and the 

Commission anticipates that they are 

much more likely to function in a 

manner that enables rapid transfer of 

defaulted positions than legal processes 

that would surround the enforcement of 

bilateral contracts for uncleared 

swaps.210

v. Other Public Interest Considerations 

In September 2009, the President and 

the other leaders of the ‘‘G20’’ nations 

met in Pittsburgh and committed to a 

program of action that includes, among 

other things, central clearing of all 

standardized swaps.211 Together, IRS 

and CDS represent more than 75% of 

the notional amount of outstanding 

swaps, and therefore, requiring the most 

active, standardized classes of swaps 

within those groups to be cleared 

represents a significant step toward the 

fulfillment of that commitment. 

VI. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act (RFA) 

requires that agencies consider whether 

the rules they propose will have a 

significant economic impact on a 

substantial number of small entities 

and, if so, provide a regulatory 

flexibility analysis respecting the 

impact.212 The clearing requirement 

determinations and rules proposed by 

the Commission will affect only eligible 

contract participants (ECPs) because all 

persons that are not ECPs are required 

to execute their swaps on a DCM, and 

all contracts executed on a DCM must 

be cleared by a DCO, as required by 

statute and regulation; not by operation 

of any clearing requirement.213

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47219 

Apr. 30, 1982 (DCMs and FCMs); and 66 FR 45604, 

45609, Aug. 29, 2001 (DCOs). 

214See 66 FR 20740, 20743 (Apr. 25, 2001). 

215See joint letter from EEI, NRECA, and ESPA, 

dated Nov. 4, 2011, (Electric Associations Letter), 

commenting on Swap Transaction Compliance and 

Implementation Schedule: Clearing and Trade 

Execution Requirements under Section 2(h) of the 

CEA, 76 FR 58186 (Sept. 20, 2011). 

216Small Business Administration, Table of Small 

Business Size Standards, Nov. 5, 2010. 

217See Electric Associations Letter, at 2. The 

letter also suggests that EEI, NRECA, and EPSA 

members are not financial entities. See id., at note 

5, and at 5 (the associations’ members ‘‘are not 

financial companies’’). 218 44 U.S.C. 3507(d). 

The Commission has previously 

determined that ECPs are not small 

entities for purposes of the RFA.214

However, in its proposed rulemaking to 

establish a schedule to phase in 

compliance with certain provisions of 

the Dodd-Frank Act, including the 

clearing requirement under section 

2(h)(1)(A) of the CEA, the Commission 

received a joint comment (Electric 

Associations Letter) from the Edison 

Electric Institute (EEI), the National 

Rural Electric Cooperative Association 

(NRECA) and the Electric Power Supply 

Association (EPSA) asserting that 

certain members of NRECA may both be 

ECPs under the CEA and small 

businesses under the RFA.215 These 

members of NRECA, as the Commission 

understands, have been determined to 

be small entities by the Small Business 

Administration (SBA) because they are 

‘‘primarily engaged in the generation, 

transmission, and/or distribution of 

electric energy for sale and [their] total 

electric output for the preceding fiscal 

year did not exceed 4 million megawatt 

hours.’’216 Although the Electric 

Associations Letter does not provide 

details on whether or how the NRECA 

members that have been determined to 

be small entities use the IRS and CDS 

that are the subject of this rulemaking, 

the Electric Associations Letter does 

state that the EEI, NRECA and EPSA 

members ‘‘engage in swaps to hedge 

commercial risk.’’ 217 Because the 

NRECA members that have been 

determined to be small entities would 

be using swaps to hedge commercial 

risk, the Commission expects that they 

would be able to use the end-user 

exception from the clearing requirement 

and therefore would not be affected to 

any significant extent by this 

rulemaking. 

Thus, because nearly all of the ECPs 

that may be subject to the proposed 

clearing requirement are not small 

entities, and because the few ECPs that 

have been determined by the SBA to be 

small entities are unlikely to be subject 

to the clearing requirement, the 

Chairman, on behalf of the CFTC, 

hereby certifies pursuant to 5 U.S.C. 

605(b) that the rules herein will not 

have a significant economic impact on 

a substantial number of small entities. 

The Commission invites public 

comment on this determination. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(PRA) 218 imposes certain requirements 

on federal agencies (including the 

Commission) in connection with 

conducting or sponsoring any collection 

of information as defined by the PRA. 

Proposed § 50.3(a), which would require 

each DCO to post on its Web site a list 

of all swaps that it will accept for 

clearing and clearly indicate which of 

those swaps the Commission has 

determined are required to be cleared, 

builds upon the requirements of 

§ 39.21(c)(1), which requires each DCO 

to disclose publicly information 

concerning the terms and conditions of 

each contract, agreement, and 

transaction cleared and settled by the 

DCO. Thus, this rulemaking will not 

require a new collection of information 

from any persons or entities. The 

Commission invites public comment on 

whether this rulemaking will require a 

new collection of information. 

List of Subjects in 17 CFR Part 50 

Business and industry, Clearing, 

Swaps. 

In consideration of the foregoing, and 

pursuant to the authority in the 

Commodity Exchange Act, as amended, 

and in particular section 2(h) of the Act, 

the Commission hereby adopts an 

amendment to Chapter I of Title 17 of 

the Code of Federal Regulation by 

proposing to amend part 50 as follows: 

PART 50—CLEARING REQUIREMENT 

AND RELATED RULES 

1. The authority citation for part 50 

reads as follows: 

Authority: 7 U.S.C. 2(h), 7a-1 as amended 

by Pub. L. 111–203, 124 Stat. 1376. 

2. Add new part 50 to read as follows: 

PART 50—CLEARING REQUIREMENT 

AND RELATED RULES 

Subpart A—Definitions and Clearing 

Requirement 

Sec. 

§ 50.1 Definitions. 

50.2 Treatment of swaps subject to a 

clearing requirement. 

50.3 Notice to the public. 

50.4 Classes of swaps required to be 

cleared. 

50.5 Swaps exempt from a clearing 

requirement. 

50.6 Delegation of Authority. 

50.7–9 [Reserved] 

50.10 Prevention of Evasion of the Clearing 

Requirement and Abuse of an Exception 

or Exemption to the Clearing 

Requirement. 

50.11–24 [Reserved] 

Subpart B—Compliance Schedule 

50.25 Clearing Requirement Compliance 

Schedule. 

50.26–49 [Reserved] 

Subpart C—Exceptions to Clearing 

Requirement 

§ 50.50–100 [Reserved] 

§ 50.1 Definitions. 

For the purposes of this part, 

Business day means any day other 

than a Saturday, Sunday, or [legal] 

holiday. 

Day of execution means the calendar 

day of the party to the swap that ends 

latest, provided that if a swap is (A) 

entered into after 4:00 p.m. in the 

location of a party, or (B) entered into 

on a day that is not a business day in 

the location of a party, then such swap 

shall be deemed to have been entered 

into by that party on the immediately 

succeeding business day of that party, 

and the day of execution shall be 

determined with reference to such 

business day. 

§ 50.2 Treatment of swaps subject to a 

clearing requirement. 

(a) All persons executing a swap that 

(1) is not subject to an exception under 

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

(2) is included in a class of swaps 

identified in § 50.4, shall submit such 

swap to a derivatives clearing 

organization for clearing as soon as 

technologically practicable after 

execution, but in any event by the end 

of the day of execution. 

(b) Each person subject to the 

requirements of paragraph (a) shall 

undertake reasonable efforts to verify 

whether a swap is required to be 

cleared. 

§ 50.3 Notice to the public. 

(a) In addition to its obligations under 

§ 39.21(c)(1), each derivatives clearing 

organization shall make publicly 

available on its Web site a list of all 

swaps that it will accept for clearing and 

identify which swaps on the list are 

required to be cleared under section 

2(h)(1) of the Act and this part. 

(b) The Commission shall maintain a 

current list of all swaps that are required 

to be cleared and all derivatives clearing 

organizations that are eligible to clear 

such swaps on its Web site. 

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47220 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

§ 50.4 Classes of swaps required to be 

cleared. 

(a) Interest rate swaps. Swaps that 

have the following specifications are 

required to be cleared under section 

2(h)(1) of the Act, and shall be cleared 

pursuant to the rules of any derivatives 

clearing organization eligible to clear 

such swaps under § 39.5(a) of this 

chapter. 

Fixed-to-Floating Swap Class 

Specification 

1. Currency ........................ U.S. Dollar (USD) ............. Euro (EUR) ....................... Sterling (GBP) ................... Yen (JPY). 

2. Floating Rate Indexes ... LIBOR ............................... EURIBOR .......................... LIBOR ............................... LIBOR. 

3. Stated Termination Date 

Range.

28 days to 50 years .......... 28 days to 50 years .......... 28 days to 50 years .......... 28 days to 30 years. 

4. Optionality ..................... No ...................................... No ...................................... No ...................................... No. 

5. Dual Currencies ............ No ...................................... No ...................................... No ...................................... No. 

6. Conditional Notional 

Amounts.

No ...................................... No ...................................... No ...................................... No. 

Basis Swap Class 

Specification 

1. Currency ........................ U.S. Dollar (USD) ............. Euro (EUR) ....................... Sterling (GBP) ................... Yen (JPY). 

2. Floating Rate Indexes ... LIBOR ............................... EURIBOR .......................... LIBOR ............................... LIBOR. 

3. Stated Termination Date 

Range.

28 days to 50 years .......... 28 days to 50 years .......... 28 days to 50 years .......... 28 days to 30 years. 

4. Optionality ..................... No ...................................... No ...................................... No ...................................... No. 

5. Dual Currencies ............ No ...................................... No ...................................... No ...................................... No. 

6. Conditional Notional 

Amounts.

No ...................................... No ...................................... No ...................................... No. 

Forward Rate Agreement Class 

Specification 

1. Currency ........................ U.S. Dollar (USD) ............. Euro (EUR) ....................... Sterling (GBP) ................... Yen (JPY). 

2. Floating Rate Indexes ... LIBOR ............................... EURIBOR .......................... LIBOR ............................... LIBOR. 

3. Stated Termination Date 

Range.

3 days to 3 years .............. 3 days to 3 years .............. 3 days to 3 years .............. 3 days to 3 years. 

4. Optionality ..................... No ...................................... No ...................................... No ...................................... No. 

5. Dual Currencies ............ No ...................................... No ...................................... No ...................................... No. 

6. Conditional Notional 

Amounts.

No ...................................... No ...................................... No ...................................... No. 

Overnight Index Swap Class 

Specification 

1. Currency ........................ U.S. Dollar (USD) ............. Euro (EUR) ....................... Sterling (GBP) ................... Yen (JPY). 

2. Floating Rate Indexes ... FedFunds .......................... EONIA ............................... SONIA ...............................

3. Stated Termination Date 

Range.

7 days to 2 years .............. 7 days to 2 years .............. 7 days to 2 years.

4. Optionality ..................... No ...................................... No ...................................... No ......................................

5. Dual Currencies ............ No ...................................... No ...................................... No ......................................

6. Conditional Notional 

Amounts.

No ...................................... No ...................................... No ......................................

(b) Credit default swaps. Swaps that 

have the following specifications are 

required to be cleared under section 

2(h)(1) of the Act, and shall be cleared 

pursuant to the rules of any derivatives 

clearing organization eligible to clear 

such swaps under § 39.5(a) of this 

chapter. 

North American Untranched CDS Indices Class 

Specification 

1. Reference Entities .......................................................... Corporate. 

2. Region ............................................................................ North America. 

3. Indices ............................................................................ CDX.NA.IG. 

CDX.NA.HY. 

4. Tenor .............................................................................. CDX.NA.IG: 3Y, 5Y, 7Y, 10Y. 

CDX.NA.HY: 5Y. 

5. Applicable Series ........................................................... CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current 

Series. 

CDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current 

Series. 

CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current 

Series. 

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Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 47221 

CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current 

Series. 

CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current 

Series. 

6. Tranched ........................................................................ No. 

European Untranched CDS Indices Class 

Specification 

1. Reference Entities .......................................................... Corporate. 

2. Region ............................................................................ Europe. 

3. Indices ............................................................................ iTraxx Europe. 

iTraxx Europe Crossover. 

iTraxx Europe HiVol. 

4. Tenor .............................................................................. iTraxx Europe: 5Y, 10Y 

iTraxx Europe Crossover: 5Y. 

iTraxx Europe HiVol: 5Y. 

5. Applicable Series ........................................................... iTraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current Series. 

iTraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current Series. 

iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series. 

iTraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including 

the current Series. 

6. Tranched ........................................................................ No. 

§ 50.5 Clearing Transition Rules. 

(a) Swaps entered into before July 21, 

2010 shall be exempt from the clearing 

requirement under § 50.2 if reported to 

a swap data repository pursuant to 

section 2(h)(5)(A) of the Act and § 44.02 

of this chapter. 

(b) Swaps entered into before the 

application of the clearing requirement 

for a particular class of swaps under 

§ 50.2 and § 50.4 shall be exempt from 

the clearing requirement if reported to a 

swap data repository pursuant to section 

2(h)(5)(B) of the Act and § 44.03 of this 

chapter. 

§ 50.6 Delegation of Authority. 

(a) The Commission hereby delegates 

to the Director of the Division of 

Clearing and Risk or such other 

employee or employees as the Director 

may designate from time to time, with 

the consultation of the General Counsel 

or such other employee or employees as 

the General Counsel may designate from 

time to time, the authority: 

(1) To determine whether one or more 

swaps submitted by a derivatives 

clearing organization under § 39.5 falls 

within a class of swaps as described in 

§ 50.4; and 

(2) To notify all relevant derivatives 

clearing organizations of that 

determination. 

(b) The Director of the Division of 

Clearing and Risk may submit to the 

Commission for its consideration any 

matter which has been delegated in this 

section. Nothing in this section 

prohibits the Commission, at its 

election, from exercising the authority 

delegated in this section. 

§ 50.7–9 [Reserved]. 

§ 50.10 Prevention of Evasion of the 

Clearing Requirement and Abuse of an 

Exception or Exemption to the Clearing 

Requirement. 

(a) It shall be unlawful for any person 

to knowingly or recklessly evade or 

participate in or facilitate an evasion of 

the requirements of section 2(h) of the 

Act or any Commission rule or 

regulation promulgated thereunder. 

(b) It shall be unlawful for any person 

to abuse the exception to the clearing 

requirement as provided under section 

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

chapter. 

(c) It shall be unlawful for any person 

to abuse any exemption or exception to 

the requirements of section 2(h) of the 

Act, including any exemption or 

exception as the Commission may 

provide by rule, regulation, or order. 

By the Commission. 

Issued in Washington, DC, on July 24, 

2012. 

Sauntia S. Warfield, 

Assistant Secretary of the Commission. 

Appendices to Clearing Requirement 

Determination Under Section 2(h) of the 

CEA—Commission Voting Summary 

and Statements of Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners 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 proposal to require certain 

interest rate swaps and credit default swap 

(CDS) indices to be cleared as provided by 

the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank Act). 

For over a century, through good times and 

bad, central clearing in the futures market 

has lowered risk to the broader public. DoddFrank financial reform brings this effective 

model to the swaps market. One of the 

primary benefits of swaps market reform is 

that standard swaps between financial firms 

will move into central clearing, which will 

significantly lower the risks of the highly 

interconnected financial system. 

The Dodd-Frank Act requires the 

Commission to determine whether a swap is 

required to be cleared. For purposes of this 

first set of determinations, the Commission 

has looked to swaps that are currently 

cleared based upon submissions from eight 

derivatives clearing organizations (DCOs). 

This first proposed clearing determination 

would require that swaps within identified 

classes be cleared by a DCO. This first 

determination includes interest rate swaps in 

four currencies, as well as five CDS indices. 

The proposal addresses swaps that five DCOs 

are already clearing, including standard 

interest rate swaps in U.S. dollars, euros, 

British pounds and Japanese yen, as well as 

a number of CDS indices, including North 

American and European corporate names. 

Subsequently, the Commission will consider 

other swaps, such as agricultural, energy and 

equity indices. 

I believe that the Commission’s proposed 

determination for each class satisfies the five 

factors provided for by Congress in the DoddFrank Act, including the first factor that 

addresses outstanding exposures, liquidity 

and pricing data. 

Under the proposal, a DCO would be 

required to post on its Web site a list of all 

swaps it will accept for clearing and must 

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47222 Federal Register / Vol. 77, No. 152 / Tuesday, August 7, 2012 / Proposed Rules 

1 7 U.S.C. 2(h). Congress amended section 2(h) of 

the CEA under section 723 of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act, Public 

Law 111–203, 124 Stat. 1376 (2010) (‘‘Dodd-Frank 

Act’’). 

2My letter, and comments submitted in response 

thereto, can be found on the Commission’s Web site 

at: http://www.cftc.gov/About/Commissioners/ 

ScottDOMalia/reviewofswaps. 

3Specifically, section 2(h)(2)(D)(ii) requires the 

Commission consider the following five factors 

based on a Commission initiated review of a swap 

submission: (1) The existence of significant 

outstanding notional exposures, trading liquidity, 

and adequate pricing of data; (2) the availability of 

rule framework, capacity operational expertise and 

resources, and credit support infrastructure to clear 

the contract on terms that are consistent with the 

material terms and trading conventions on which 

the contract is then traded; (3) the effect on the 

mitigation of systemic risk, taking into account the 

size of the market for such contract and the 

resources of the derivatives clearing organization 

(‘‘DCO’’) available to clear the contract; (4) the effect 

on competition, including appropriate fees and 

charges applied to clearing; and (5) the existence of 

reasonable legal certainty in the event of the 

insolvency of the relevant DCO (or one or more of 

its clearing members) with regard to the treatment 

of customer and swap counterparty positions, 

funds, and property. 

indicate which swaps the Commission had 

determined are required to be cleared. 

I look forward to receiving public input on 

this proposed rule. 

Appendix 2—Statement of 

Commissioner Scott D. O’Malia 

I respectfully concur with the Commodity 

Futures Trading Commission’s 

(‘‘Commission’’) proposal to establish a 

clearing requirement for certain classes of 

credit default swaps and interest rate swaps 

pursuant to the Commission’s authority 

under new section 2(h)(1)(A) of the 

Commodity Exchange Act (‘‘CEA’’).1

Centralized clearing is a vital part of the 

Dodd-Frank Act reforms and is expected to 

reduce counterparty credit risks, improve 

transparency and fairness around the setting 

of margin requirements, increase market 

liquidity, and reduce overall systemic risks. 

I am pleased that the Commission’s 

proposal thoughtfully incorporates comments 

received in response to my July 28, 2011 

letter 2 to the public seeking comment on the 

five substantive criteria that the Commission 

is required to consider in making mandatory 

clearing determinations.3 The comments help 

provide the necessary clarity and guidance 

that the markets have sought regarding how 

the Commission will consider and weigh 

these criteria. 

Today’s proposal also (1) includes a more 

reasoned cost-benefit analysis that is based 

on an appropriate pre-Dodd-Frank baseline, 

(2) discusses a variety of alternatives based 

on public comments, and (3) asks a series of 

questions in the absence of available data. 

Once again, I am encouraged that 

Commission staff is working with technical 

experts from the Office of Management and 

Budget (‘‘OMB’’) to improve our cost-benefit 

analyses. It is my hope that the Commission’s 

final rule similarly benefits from our 

cooperative relationship with OMB. 

Once this proposal is published in the 

Federal Register, the 90-day clock will start. 

The Commission will review all comments, 

and discuss its final determination for 

clearing the majority of swaps in due course. 

I implore commenters to provide feedback 

and to submit data as soon as possible so that 

the Commission can account for the actual 

impact that today’s rule will have on market 

liquidity, margining, and the reduction of 

risks. 

[FR Doc. 2012–18382 Filed 8–6–12; 8:45 am] 

BILLING CODE 6351–01–P 

mstockstill on DSK4VPTVN1PROD with PROPOSALS2