30596 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

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

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

LawRegulation/OTCDERIVATIVES/index.htm. 

2See Dodd-Frank Act sections 721 and 761. 

Sections 721(b)(2) and 761(b)(2) also provide that 

the CFTC and SEC may by rule further define any 

other term included in an amendment made by 

Title VII to the CEA or the Exchange Act, 

respectively. 

3 In addition, section 712(d)(1) directs the CFTC 

and SEC, in consultation with the Board, jointly to 

further define the terms ‘‘swap,’’ ‘‘security-based 

swap,’’ and ‘‘security-based swap agreement.’’ 

These further definitions are the subject of a 

separate rulemaking by the Commissions. See CFTC 

and SEC, Notice of Proposed Joint Rulemaking, 

Further Definition of ‘‘Swap,’’ ‘‘Security-Based 

Swap,’’ and ‘‘Security-Based Swap Agreement’’; 

Mixed Swaps; Security-Based Swap Agreement 

Recordkeeping, 76 FR 29818 (May 23, 2011) 

(‘‘Product Definitions Proposal’’). Section 

712(d)(2)(A), in turn, provides that the 

Commissions shall jointly adopt such other rules 

regarding the definitions set forth in section 

712(d)(1) as they ‘‘determine are necessary and 

appropriate, in the public interest, and for the 

protection of investors.’’ 

In addition, section 721(c) of the Dodd-Frank Act 

requires the CFTC to adopt a rule to further define 

the terms ‘‘swap dealer,’’ ‘‘major swap participant,’’ 

and ‘‘eligible contract participant’’ for the purpose 

of including transactions and entities that have 

been structured to evade Title VII. Also, section 

761(b) of the Dodd-Frank Act permits the SEC to 

adopt a rule to further define the terms ‘‘securitybased swap dealer,’’ ‘‘major security-based swap 

participant,’’ and ‘‘eligible contract participant,’’ 

with regard to security-based swaps, for the purpose 

of including transactions and entities that have 

been structured to evade Title VII. 

4See CFTC and SEC, Notice of Proposed Joint 

Rulemaking: Further Definition of ‘‘Swap Dealer,’’ 

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

Participant,’’ ‘‘Major Security-Based Swap 

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

Securities Exchange Act Release No. 63452, 75 FR 

80174 (Dec. 21, 2010) (‘‘Proposing Release’’). 

Prior to issuing the Proposing Release, the 

Commissions issued a joint Advance Notice of 

Proposed Rulemaking (‘‘ANPRM’’) requesting 

public comment regarding the definitions of the 

terms ‘‘swap,’’ ‘‘security-based swap,’’ ‘‘securitybased swap agreement,’’ ‘‘swap dealer,’’ ‘‘securitybased swap dealer,’’ ‘‘major swap participant,’’ 

‘‘major security-based swap participant,’’ and 

‘‘eligible contract participant.’’ See CFTC and SEC, 

Advance Notice of Proposed Joint Rulemaking: 

Definitions Contained in Title VII of Dodd-Frank 

Wall Street Reform and Consumer Protection Act, 

Securities Exchange Act Release No. 62717, 75 FR 

51429 (Aug. 20, 2010). The Proposing Release and 

these final rules both reflect comments received in 

response to the ANPRM. 

5Comment letters received in response to the 

Proposing Release may be found on the 

Commissions’ Web sites at http:// 

comments.cftc.gov/PublicComments/ 

CommentList.aspx?id=933 and at http:// 

www.sec.gov/comments/s7-39-10/s73910.shtml. 

6Summaries of these staff meetings may be found 

on the Commissions’ Web sites at http:// 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 1 

RIN 3038–AD06 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 240 

[Release No. 34–66868; File No. S7–39–10] 

RIN 3235–AK65 

Further Definition of ‘‘Swap Dealer,’’ 

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

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

Contract Participant’’ 

AGENCY: Commodity Futures Trading 

Commission; Securities and Exchange 

Commission. 

ACTION: Joint final rule; joint interim 

final rule; interpretations. 

SUMMARY: In accordance with the DoddFrank Wall Street Reform and Consumer 

Protection Act of 2010 (‘‘Dodd-Frank 

Act’’), the Commodity Futures Trading 

Commission (‘‘CFTC’’) and the 

Securities and Exchange Commission 

(‘‘SEC’’) (collectively, the 

‘‘Commissions’’), in consultation with 

the Board of Governors of the Federal 

Reserve System (‘‘Board’’), are adopting 

new rules and interpretive guidance 

under the Commodity Exchange Act 

(‘‘CEA’’), and the Securities Exchange 

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

define the terms ‘‘swap dealer,’’ 

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

swap participant,’’ ‘‘major securitybased swap participant,’’ and ‘‘eligible 

contract participant.’’ 

DATES: Effective date. The effective date 

for this joint final rule and joint interim 

final rule: July 23, 2012, except for 

CFTC regulations at 17 CFR 1.3(m)(5) 

and (6), which are effective December 

31, 2012. 

Comment date. The comment period 

for the interim final rule (CFTC 

regulation at 17 CFR 1.3(ggg)(6)(iii)) will 

close July 23, 2012. 

Compliance date. Compliance with 

the element of the CFTC regulation at 17 

CFR 1.3(m)(8)(iii) requiring that a 

commodity pool be formed by a 

registered CPO shall be required with 

respect to a commodity pool formed on 

or after December 31, 2012 for any 

person seeking to rely on such 

regulation; compliance with such 

element shall not be required with 

respect to a commodity pool formed 

prior to December 31, 2012. 

FOR FURTHER INFORMATION CONTACT: 

CFTC: Jeffrey P. Burns, Assistant 

General Counsel, at 202- 418–5101, 

jburns@cftc.gov, Mark Fajfar, Assistant 

General Counsel, at 202–418–6636, 

mfajfar@cftc.gov, Julian E. Hammar, 

Assistant General Counsel, at 202–418– 

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

Aron, Counsel, at 202–418–6621, 

daron@cftc.gov, Office of General 

Counsel; Gary Barnett, Director, at 202– 

418–5977, gbarnett@cftc.gov, or Frank 

Fisanich, Deputy Director, at 202–418– 

5949, ffisanich@cftc.gov, Division of 

Swap Dealer and Intermediary 

Oversight,Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street NW., Washington, DC 

20581; 

SEC: Joshua Kans, Senior Special 

Counsel, Richard Grant, Special 

Counsel, or Richard Gabbert, Attorney 

Advisor, at 202–551–5550, Division of 

Trading and Markets, Securities and 

Exchange Commission, 100 F Street NE., 

Washington, DC 20549–7010. 

SUPPLEMENTARY INFORMATION: 

I. Background 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act into law.1

Title VII of the Dodd-Frank Act 

established a statutory framework to 

reduce risk, increase transparency, and 

promote market integrity within the 

financial system by, among other things: 

(i) providing for the registration and 

regulation of swap dealers and major 

swap participants; (ii) imposing clearing 

and trade execution requirements on 

standardized derivative products; (iii) 

creating recordkeeping and real-time 

reporting regimes; and (iv) enhancing 

the Commissions’ rulemaking and 

enforcement authorities with respect to 

all registered entities and intermediaries 

subject to the Commissions’ oversight. 

The Dodd-Frank Act particularly 

provides that the CFTC will regulate 

‘‘swaps,’’ and that the SEC will regulate 

‘‘security-based swaps.’’ The DoddFrank Act also adds definitions of the 

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

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

‘‘major security-based swap participant’’ 

and ‘‘eligible contract participant’’ to 

the CEA and Exchange Act.2 Section 

712(d)(1) of the Dodd-Frank Act further 

directs the CFTC and the SEC, in 

consultation with the Board, jointly to 

further define those terms, among 

others.3

In December 2010, the Commissions 

proposed rules and interpretations to 

further define the meaning of the terms 

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

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

‘‘major security-based swap 

participant,’’ and ‘‘eligible contract 

participant.’’ 4 The Commissions 

received approximately 968 written 

comments in response to the Proposing 

Release.5 In addition, the Staffs of the 

Commissions participated in 

approximately 114 meetings with 

market participants and other members 

of the public about the Proposing 

Release,6 and the Commissions held a 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30597 

www.cftc.gov/LawRegulation/DoddFrankAct/ 

Rulemakings/DF_2_Definitions/index.htm and 

http://www.sec.gov/comments/s7-39-10/ 

s73910.shtml#meetings. 

7A transcript of the roundtable discussion and 

public comments received with respect to the 

roundtable may be found on the CFTC’s Web site 

at http://www.cftc.gov/PressRoom/Events/ 

opaevent_cftcsecstaff061611. 

8See section 721 of the Dodd-Frank Act (adding 

Section 1a(49) of the CEA, 7 U.S.C. 1a(49), to define 

‘‘swap dealer’’) and section 761 of the Dodd-Frank 

Act (adding Section 3(a)(71) of the Exchange Act, 

15 U.S.C. 78c(a)(71), to define ‘‘security-based swap 

dealer’’). 

9The Dodd-Frank Act excludes from the 

Exchange Act definition of ‘‘dealer’’ persons who 

engage in security-based swaps with eligible 

contract participants. See section 3(a)(5) of the 

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

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

The Dodd-Frank Act does not include comparable 

amendments for persons who act as brokers in 

swaps and security-based swaps. Because securitybased swaps, as defined in section 3(a)(68) of the 

Exchange Act, are included in the Exchange Act 

section 3(a)(10) definition of ‘‘security,’’ persons 

who act as brokers in connection with securitybased swaps must, absent an exception or 

exemption, register with the SEC as a broker 

pursuant to Exchange Act section 15(a), and comply 

with the Exchange Act’s requirements applicable to 

brokers. 

In mid-2011, the SEC issued temporary 

exemptions under the Exchange Act in connection 

with the revision of the ‘‘security’’ definition to 

encompass security-based swaps. Among other 

aspects, these temporary exemptions extended to 

certain broker activities involving security-based 

swaps. See ‘‘Order Granting Temporary Exemptions 

under the Securities Exchange Act of 1934 in 

Connection with the Pending Revision of the 

Definition of ‘‘Security’’ to Encompass SecurityBased Swaps, and Request for Comment,’’ 

Securities Exchange Act Release No. 64795 (Jul. 1, 

2011), 76 FR 39927, 39939 (Jul. 7, 2011) (addressing 

availability of exemption to registration 

requirement for securities brokers). 

10See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A); 

Exchange Act section 3(a)(71)(A), 15 U.S.C. 

78c(a)(71)(A). 

11See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); 

Exchange Act section 3(a)(71)(C), 15 U.S.C. 

78c(a)(71)(C). 

12See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); 

Exchange Act section 3(a)(71)(D), 15 U.S.C. 

78c(a)(71)(D). 

13See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A). 

14See CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B); 

Exchange Act section 3(a)(71)(B), 15 U.S.C. 

78c(a)(71)(B). 

15See proposed CFTC Regulation § 1.3(ggg)(1); 

proposed Exchange Act rule 3a71–1(a), (b). 

16See proposed CFTC Regulation § 1.3(ggg)(4); 

proposed Exchange Act rule 3a71–2. 

17See proposed CFTC Regulation § 1.3(ggg)(5). 

18See proposed CFTC Regulation § 1.3(ggg)(3); 

proposed Exchange Act rule 3a71–1(c). 

19See CFTC Regulation § 1.3(ggg); Exchange Act 

rule 3a71–1(a), (b). 

Joint Public Roundtable on the proposed 

dealer and major participant 

definitions.7 After considering the 

comments received, the Commissions 

are adopting final rules and 

interpretations to further define these 

terms. 

II. Definitions of ‘‘Swap Dealer’’ and 

‘‘Security-Based Swap Dealer’’ 

The Dodd-Frank Act definitions of the 

terms ‘‘swap dealer’’ and ‘‘securitybased swap dealer’’ focus on whether a 

person engages in particular types of 

activities involving swaps or securitybased swaps.8 Persons that meet either 

of those definitions are subject to 

statutory requirements related to, among 

other things, registration, margin, 

capital and business conduct.9

The CEA and Exchange Act 

definitions in general encompass 

persons that engage in any of the 

following types of activity: 

(i) Holding oneself out as a dealer in 

swaps or security-based swaps, 

(ii) making a market in swaps or 

security-based swaps, 

(iii) regularly entering into swaps or 

security-based swaps with 

counterparties as an ordinary course of 

business for one’s own account, or 

(iv) engaging in any activity causing 

oneself to be commonly known in the 

trade as a dealer or market maker in 

swaps or security-based swaps.10

These dealer activities are enumerated 

in the CEA and Exchange Act in the 

disjunctive, in that a person that 

engages in any one of these activities is 

a swap dealer under the CEA or 

security-based swap dealer under the 

Exchange Act, even if such person does 

not engage in one or more of the other 

identified activities. 

At the same time, the statutory dealer 

definitions provide exceptions for a 

person that enters into swaps or 

security-based swaps for the person’s 

own account, either individually or in a 

fiduciary capacity, but not as a part of 

a ‘‘regular business.’’ 11 The Dodd-Frank 

Act also instructs the Commissions to 

exempt from designation as a dealer a 

person that ‘‘engages in a de minimis 

quantity of [swap or security-based 

swap] dealing in connection with 

transactions with or on behalf of its 

customers.’’ 12 Moreover, the definition 

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

of ‘‘security-based swap dealer’’) 

provides that an insured depository 

institution is not to be considered a 

swap dealer ‘‘to the extent it offers to 

enter into a swap with a customer in 

connection with originating a loan with 

that customer.’’ 13 The statutory 

definitions further provide that a person 

may be designated as a dealer for one or 

more types, classes or categories of 

swaps or security-based swaps, or 

activities without being designated a 

dealer for other types, classes or 

categories or activities.14

In the Proposing Release, the 

Commissions proposed rules to identify 

the activity that would cause a person 

to be a dealer,15 to implement the 

exception for de minimis dealing 

activity,16 to implement the exception 

from the swap dealer definition in 

connection with the origination of loans 

by insured depository institutions,17

and to provide for the limited purpose 

designation of dealers.18 The release 

also set forth proposed interpretive 

guidance related to the definitions. 

After considering the comments 

received, the Commissions are adopting 

final rules and interpretations to further 

define the terms ‘‘swap dealer’’ and 

‘‘security-based swap dealer.’’ In this 

Adopting Release, we particularly 

address: (i) The general analysis for 

identifying dealing activity involving 

swaps and security-based swaps; (ii) the 

exclusion from the ‘‘swap dealer’’ 

definition in connection with the 

origination of loans by insured 

depository institutions; (iii) the 

application of the dealer analysis to 

inter-affiliate swaps and security-based 

swaps; (iv) the application of the de 

minimis exception from the dealer 

definitions; and (v) the limited 

designation of swap dealers and 

security-based swap dealers. 

A. General Considerations for the Dealer 

Analysis 

1. Proposed Approach 

The proposed rules to define the 

activities that would lead a person to be 

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

swap dealer’’ were based closely on the 

corresponding language of the statutory 

definitions.19 The Proposing Release 

further noted that the Dodd-Frank Act 

defined the terms ‘‘swap dealer’’ and 

‘‘security-based swap dealer’’ in a 

functional manner, and stated that those 

statutory definitions should not be 

interpreted in a constrained, overly 

technical or rigid manner, particularly 

given the diversity of the swap and 

security-based swap markets. The 

Proposing Release also identified 

potential distinguishing characteristics 

of swap dealers and security-based swap 

dealers based on the functional role that 

dealers fulfill in the swap and securitybased swap markets, such as: dealers 

tend to accommodate demand from 

other parties; dealers generally are 

available to enter into swaps or securitybased swaps to facilitate other parties’ 

interest; dealers tend not to request that 

other parties propose the terms of swaps 

or security-based swaps, but instead 

tend to enter into those instruments on 

their own standard terms or on terms 

they arrange in response to other 

parties’ interest; and dealers tend to be 

able to arrange customized terms for 

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30598 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

20Proposing Release, 75 FR at 80176. 21 Id. 22 In addition, the Proposing Release explained 

that (in general, and not specifically limited to the 

provisions relating to entering into swaps as part of 

a ‘‘regular business’’) the proposed swap dealer 

definition does not depend on whether a person’s 

activity as a swap dealer is the person’s sole or 

predominant business (other than through the de 

minimis exception discussed below). 

23See Proposing Release, 75 FR at 80177. 

24See id. at 80176–77. 

25See id. at 80177. 

26See id. 

27See id. at 80183–84. 

28After publication of the Proposing Release, the 

CFTC adopted a final rule on agricultural swaps 

under which swaps in agricultural commodities 

will be permitted to transact subject to the same 

rules as all other swaps. See Agricultural Swaps; 

Final Rule, 76 FR 49291 (Aug. 10, 2011). 

swaps or security-based swaps upon 

request, or to create new types of swaps 

or security-based swaps at the dealer’s 

own initiative.20

The proposal recognized that the 

principles for identifying dealing 

activity involving swaps can differ from 

principles for identifying dealing 

activity involving security-based swaps, 

in part due to differences in how those 

instruments are used.21

a. ‘‘Swap Dealer’’ Activity 

Consistent with the statutory 

definition, the proposed rule stated that 

the term ‘‘swap dealer’’ includes a 

person that ‘‘regularly enters into swaps 

with counterparties as an ordinary 

course of business for its own account,’’ 

but also that ‘‘the term swap dealer does 

not include a person that enters into 

swaps for such person’s own account, 

either individually or in a fiduciary 

capacity, but not as a part of a regular 

business.’’ The Proposing Release stated 

that these two provisions should be read 

in combination with each other, and 

explained that the difference between 

the two provisions is whether or not the 

person enters into swaps as a part of, or 

as an ordinary course of, a ‘‘regular 

business.’’ Thus, the Proposing Release 

equated the phrases ‘‘ordinary course of 

business’’ and ‘‘regular business.’’ The 

Proposing Release also stated that 

persons who enter into swaps as a part 

of a ‘‘regular business’’ are those 

persons whose function is to 

accommodate demand for swaps from 

other parties and enter into swaps in 

response to interest expressed by other 

parties. Such persons would be swap 

dealers.22 Conversely, the Proposing 

Release said that persons who do not 

fulfill this function in connection with 

swaps should not be deemed to enter 

into swaps as part of a ‘‘regular 

business,’’ and thus would not likely be 

swap dealers.23

In addition, the Proposing Release 

noted that the nature of swaps precludes 

importing concepts used to identify 

dealers in other areas. The Proposing 

Release explained that because swaps 

are typically not bought and sold, 

concepts such as whether a person buys 

and sells swaps, makes a two-sided 

market in swaps, or trades within a bid/ 

offer spread cannot necessarily be used 

to determine if the person is a swap 

dealer, even if such concepts are useful 

in determining whether a person is a 

dealer in other financial instruments.24

The Proposing Release further stated 

that swap dealers can be identified 

through their relationships with 

counterparties, explaining that swap 

dealers tend to enter into swaps with 

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

of swap dealers’ counterparties. In 

contrast, the Proposing Release said, 

non-dealers tend to enter into swaps 

with swap dealers more often than with 

other non-dealers. The Proposing 

Release noted that it is likely that swap 

dealers are involved in most or all 

significant parts of the swap markets.25

The Proposing Release concluded that 

this functional approach would identify 

as swap dealers those persons whose 

function is to serve as the points of 

connection in the swap markets. Thus, 

requiring registration and compliance 

with the requirements of the DoddFrank Act by such persons would 

thereby reduce risk and enhance 

operational standards and fair dealing in 

those markets.26

The Proposing Release also noted that 

the swap markets are diverse and 

encompass a wide variety of situations 

in which parties enter into swaps with 

each other, and invited comment as to 

what aspects of the parties’ activities in 

particular situations should, or should 

not, be considered swap dealing 

activities. Specifically, the Proposing 

Release invited comment regarding 

persons who enter into swaps: (i) As 

aggregators; (ii) as part of their 

participation in physical markets; or (iii) 

in connection with the generation and 

transmission of electricity.27

First, regarding aggregators, the 

Proposing Release noted that some 

persons, including certain cooperatives, 

enter into swaps with other parties in 

order to aggregate the swap positions of 

the other parties into a size that would 

be more amenable to entering into 

swaps in the larger swap market. The 

Proposing Release explained that, for 

example, certain cooperatives enter into 

swaps with smaller businesses because 

the smaller business cannot establish a 

commodity position large enough to be 

traded on a swap or futures market, or 

large enough to be of interest to larger 

financial institutions. The Proposing 

Release said that while such persons 

engage in activities that are similar in 

many respects to those of a swap dealer, 

it may be that the swap dealing 

activities of these aggregators would not 

exceed the de minimis threshold, and 

therefore they would not be swap 

dealers. The CFTC requested comment 

as to how the de minimis threshold 

would apply to such persons, and in 

general on the application of the swap 

dealer definition to this activity. The 

Proposing Release also noted that the 

CFTC was engaged in a separate 

rulemaking pursuant to section 

723(c)(3)(B) of the Dodd-Frank Act 

regarding swaps in agricultural 

commodities, and requested comment 

on the application of the swap dealer 

definition to dealers, including 

potentially agricultural cooperatives, 

that limit their dealing activity 

primarily to swaps in agricultural 

commodities.28

Second, the Proposing Release noted 

that the markets in physical 

commodities such as oil, natural gas, 

chemicals and metals have developed 

highly customized transactions, some of 

which would be encompassed by the 

statutory definition of the term ‘‘swap,’’ 

and that some participants in these 

markets engage in swap dealing 

activities that are above the proposed de 

minimis threshold. The CFTC invited 

comment as to any different or 

additional factors that should be 

considered in applying the swap dealer 

definition to participants in these 

markets. 

Third, the Proposing Release noted a 

number of complexities that arise when 

applying the swap dealer definition in 

connection with the generation and 

transmission of electricity. In particular, 

the Proposing Release noted that 

additional complexity results because 

electricity is generated, transmitted and 

used on a continuous, real-time basis, 

and because the number and variety of 

participants in the electricity market is 

very large, and some electricity services 

are provided as a public good rather 

than for profit. The CFTC invited 

comment as to any different or 

additional factors that should be 

considered in applying the swap dealer 

definition to participants in the 

generation and transmission of 

electricity. Specifically, the CFTC 

invited comment on whether there are 

special considerations, including 

without limitation special 

considerations arising from section 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30599 

29 16 U.S.C. 824(f). 

30See Exchange Act sections 3(a)(5)(A), (B), 15 

U.S.C. 78c(a)(5)(A), (B), as amended by Section 

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

31The Proposing Release referred to the fact that 

the SEC previously has noted that the dealer-trader 

distinction: ‘‘recognizes that dealers normally have 

a regular clientele, hold themselves out as buying 

or selling securities at a regular place of business, 

have a regular turnover of inventory (or participate 

in the sale or distribution of new issues, such as by 

acting as an underwriter), and generally provide 

liquidity services in transactions with investors (or, 

in the case of dealers who are market makers, for 

other professionals).’’ Proposing Release, 75 FR at 

80177 (citing Securities Exchange Act Release No. 

47364 (Feb. 13, 2003) (footnotes omitted)). The 

Proposing Release further noted that other nonexclusive factors that are relevant for distinguishing 

between dealers and non-dealers can include 

receipt of customer property and the furnishing of 

incidental advice in connection with transactions. 

See id. 

32See Proposing Release, 75 FR at 80177–78. 

33See id. at 80178. 

34See id. 

35See id. 

36See id. at 80178–79. 

37See id. at 80179. 

38See transcript of Joint CFTC–SEC Staff 

Roundtable Discussion on Proposed Dealer and 

Major Participant Definitions Under Dodd-Frank 

Act, June 16, 2011 (‘‘Roundtable Transcript’’) at 22– 

23 (remarks of Ron Filler, New York Law School), 

50–51 (remarks of Ron Oppenheimer, Working 

Group of Commercial Energy Firms), 215 (remarks 

of Bella Sanevich, NISA Investment Advisors LLC). 

201(f) of the Federal Power Act,29

related to not-for-profit power systems 

such as rural electric cooperatives and 

entities operating as political 

subdivisions of a state and on the 

applicability of the exemptive authority 

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

to address those considerations. 

b. ‘‘Security-Based Swap Dealer’’ 

Activity 

The Proposing Release noted the 

parallels between the definition of 

‘‘security-based swap dealer’’ and the 

definition of ‘‘dealer’’ under the 

Exchange Act,30 as well as the fact that 

security-based swaps may be used to 

hedge risks associated with owning 

certain types of securities or to gain 

economic exposure akin to ownership of 

certain types of securities. As a result, 

the Proposing Release took the view that 

the same factors that are relevant to 

determining whether a person is a 

‘‘dealer’’ under the Exchange Act also 

are generally relevant to the analysis of 

whether a person is a security-based 

swap dealer. The Proposing Release also 

addressed the relevance of the ‘‘dealertrader’’ distinction for identifying 

dealing activity involving security-based 

swaps,31 while recognizing that certain 

concepts associated with the dealertrader distinction—particularly 

concepts involving ‘‘turnover of 

inventory’’ and ‘‘regular place of 

business’’—appeared potentially less 

applicable to the security-based swap 

dealer definition. In addition, the 

Proposing Release noted that under the 

dealer-trader distinction, we would 

expect that entities that use securitybased swaps to hedge business risks, 

absent other activities, likely would not 

be dealers.32

c. Additional Principles Common to 

Both Definitions 

i. ‘‘Hold Themselves Out’’ and 

‘‘Commonly Known in the Trade’’ Tests 

The Proposing Release identified the 

following non-exclusive list of factors as 

potentially indicating that a person 

meets the ‘‘hold themselves out’’ and 

‘‘commonly known in the trade’’ tests of 

the statutory dealer definitions: 

• Contacting potential counterparties 

to solicit interest in swaps or securitybased swaps; 

• Developing new types of swaps or 

security-based swaps (which may 

include financial products that contain 

swaps or security-based swaps) and 

informing potential counterparties of 

the availability of such swaps or 

security-based swaps and a willingness 

to enter into such swaps or securitybased swaps with the potential 

counterparties; 

• Membership in a swap association 

in a category reserved for dealers; 

• Providing marketing materials (such 

as a Web site) that describe the types of 

swaps or security-based swaps that one 

is willing to enter into with other 

parties; or 

• Generally expressing a willingness 

to offer or provide a range of financial 

products that would include swaps or 

security-based swaps.33

The Proposing Release further stated 

that the test for being ‘‘commonly 

known in the trade’’ as a swap dealer or 

security-based swap dealer may 

appropriately reflect, among other 

factors, the perspective of persons with 

substantial experience with and 

knowledge of the swap and securitybased swap markets (regardless of 

whether a particular entity is known as 

a dealer by persons without that 

experience or knowledge). The 

Proposing Release also stated that 

holding oneself out as a security-based 

swap dealer likely would encompass a 

person who is a dealer in another type 

of security entering into a security-based 

swap with a customer, as well as a 

person expressing its availability to 

enter into security-based swaps, 

regardless of the direction of the 

transaction or across a broad spectrum 

of risks.34

ii. Market Making 

In addressing the statutory 

definitions’ ‘‘making a market’’ test, the 

Proposing Release noted that while 

continuous two-sided quotations and a 

willingness to buy and sell a security 

are important indicators of market 

making in the equities market, these 

indicia may not be appropriate in the 

swap and security-based swap markets. 

The proposal also noted that nothing in 

the statutory text or legislative history 

suggested the intent to impute a 

‘‘continuous’’ activity requirement to 

the dealer definitions.35

iii. No Predominance Test 

The Proposing Release further 

addressed whether a person should be 

a dealer only if that activity is the 

person’s sole or predominant business, 

and took the view that such an approach 

was not consistent with the statutory 

definition. The Proposing Release 

rejected this as an unworkable test of 

dealer status because many parties that 

commonly are acknowledged as dealers 

also engage in other businesses that 

outweigh their swap or security-based 

swap dealing business in terms of 

transaction volume or other measures.36

iv. Application to New Types of Wwaps 

and New Activities 

The Proposing Release noted that the 

Commissions intended to apply the 

dealer definitions flexibly when the 

development of innovative business 

models is accompanied by new types of 

dealer activity, following a facts-andcircumstances approach.37

2. Commenters’ Views 

Numerous commenters addressed the 

proposed rules and interpretations in 

connection with the ‘‘swap dealer’’ and 

‘‘security-based swap dealer’’ 

definitions. Several commenters 

addressed principles that are common 

to the two dealer definitions, while a 

number of commenters also addressed 

interpretations in the Proposing Release 

that were specific to the ‘‘swap dealer’’ 

definition. 

a. ‘‘Hold Themselves Out’’ and 

‘‘Commonly Known in the Trade’’ Tests 

Some commenters expressed the view 

that the persons that hold themselves 

out as or are commonly known as 

dealers are easy to identify.38 In 

addressing the ‘‘hold themselves out’’ 

and ‘‘commonly known’’ criteria of the 

dealer definitions, commenters placed 

particular focus on whether only dealers 

engage in the activities cited by the 

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39See letters from the Financial Services 

Roundtable (‘‘FSR’’) dated February 22, 2011 (‘‘FSR 

I’’), the International Swap Dealers Association 

(‘‘ISDA’’) dated February 22, 2011 (‘‘ISDA I’’) and 

the Midsize Bank Coalition of America (‘‘Midsize 

Banks’’). 

40See letters from the Committee on Capital 

Markets Regulation (‘‘CCMR’’) dated February 22, 

2011 (‘‘CCMR I’’), FSR I, ISDA I and Midsize Banks. 

41See letters from the BG Americas & Global LNG 

(‘‘BG LNG’’) dated February 22, 2011 (‘‘BG LNG I’’), 

CCMR I, EDF Trading North America, LLC (‘‘EDF 

Trading’’) and The Gavilon Group, LLC (‘‘Gavilon’’) 

dated February 21, 2011 (‘‘Gavilon II’’). 

42See letter from EDF Trading. 

43See meeting with American Electric Power, 

Calpine Corporation (‘‘Calpine’’), Constellation, DC 

Energy LLC (‘‘DC Energy’’), Edison International 

(‘‘Edison Int’l’’), Exelon Corp., GenOn, Southern 

Company, Edison Electric Institute (‘‘EEI’’) and 

Electric Power Supply Association (‘‘ESPA’’) 

(collectively ‘‘Electric Companies’’) on April 13, 

2011. 

44See letter from ISDA I and joint letter from 

National Corn Growers Association (‘‘NCGA’’) and 

Natural Gas Supply Association (‘‘NGSA’’) 

(‘‘NCGA/NGSA’’) dated February 22, 2011 (‘‘NCGA/ 

NGSA I’’). 

45See letter from ISDA I. 

46See letters from ISDA I and Peabody Energy 

Corporation (‘‘Peabody’’). 

47See letter from FSR I. 

48See meeting with Vitol, Inc. (‘‘Vitol’’) on 

February 16, 2011. 

49See letter from Midsize Banks. 

50See letter from EDF Trading. 

51See joint letter from American Benefits Council 

and the Committee on Investment of Employee 

Benefits Assets (‘‘ABC/CIEBA’’) and letters from 

FSR I. 

52See letters from DC Energy and FSR I. 

53See letters from Edison Int’l, NextEra Energy 

Resources, LLC (‘‘NextEra’’) dated February 22, 

2011 (‘‘NextEra I’’) and Vitol, and joint letter from 

American Electric Power, Edison Int’l, Exelon 

Corp., and Southern Company (‘‘Utility Group’’). 

54See letter from ISDA I. 

55See joint letter from EEI and EPSA (‘‘EEI/ 

EPSA’’) and letter from Vitol. 

56See letter from Americans for Financial Reform 

(‘‘AFR’’). 

57See letters from ABC/CIEBA, Managed Funds 

Association (‘‘MFA’’) dated February 22, 2011 

(‘‘MFA I’’), and Vitol. 

58See letters from NextEra Iand Vitol. 

59See letter from Newedge USA LLC 

(‘‘Newedge’’); see also Roundtable Transcript at 39 

(remarks of Eric Chern, Chicago Trading Company). 

60See letters from American Federation of State, 

County and Municipal Employees (‘‘AFSCME’’), 

and FSR I. 

61While some of these commenters specially 

addressed this issue in the context of whether a 

person is a market maker in swaps, others more 

generally addressed the issue in terms of whether 

a person is a dealer. For clarity, all of those 

comments are being addressed in the market maker 

context. 

62See letters from EEI/EPSA, International Energy 

Credit Association (‘‘IECA–Credit’’) dated February 

22, 2011 (‘‘IECA–Credit I’’), and NextEra I, joint 

letter from Shell Trading (US) Company and Shell 

Energy North America (US), L.P. (‘‘Shell Trading’’) 

dated February 22, 2011 (‘‘Shell Trading I’’), and 

joint letter from Allston Trading, LLC, Atlantic 

Trading USA LLC, Bluefin Trading LLC, Chopper 

Trading LLC, DRW Holdings, LLC, Eagle Seven, 

LLC, Endeavor Trading, LLC, Geneva Trading USA, 

LLC, GETCO, Hard Eight Futures, LLC, HTG Capital 

Partners, IMC Financial Markets, Infinium Capital 

Management LLC, Kottke Associates, LLC, Liger 

Investments Limited, Marquette Partners, LP, Nico 

Holdings LLC, Optiver US, Quantlab Financial, 

LLC, RGM Advisors, LLC, Tibra Trading America 

LLC, Traditum Group LLC, WH Trading and XR 

Trading LLC (‘‘Traders Coalition’’). 

63See letters from Shell Trading I and Traders 

Coalition. 

64See letters from EEI/EPSA, IECA–Credit I, and 

NextEra I. For further discussion of this issue, see 

parts II.A.4 and II.A.5 below. 

Proposing Release, or whether those 

activities are common both to dealers 

and to other users of swaps and 

security-based swaps. Commenters 

particularly stated that end users 

contact potential counterparties,39

develop new types of swaps or securitybased swaps,40 and propose terms or 

language for swap or security-based 

swap agreements.41 One commenter 

further stated that identifying dealing 

activity based on whether a person 

develops new types of swaps or 

proposes swap terms would discourage 

innovation and the free negotiation of 

swaps.42 Some commenters stated that 

merely responding to a request for 

proposals or quotations should not, in 

itself, constitute dealing.43 Commenters 

also criticized the Proposing Release’s 

suggestion that criteria for identifying 

dealing activity include membership in 

a dealer category of a trade 

association,44 as well as providing 

marketing materials and offering a range 

of financial products.45 Commenters 

also argued for more objective criteria 

for identifying persons ‘‘commonly 

known’’ as dealers.46

Conversely, one commenter said that 

three particular activities cited in the 

Proposing Release—membership in a 

swap association category reserved for 

dealers, providing marketing materials 

and expressing a willingness to offer a 

range of financial products—are 

indicative of holding oneself out as a 

dealer or being commonly known in the 

trade as a dealer, and should be codified 

in the final rule.47 Another commenter 

suggested other factors, such as having 

a derivatives sales team, that should be 

treated as indicators of dealer activity.48

Commenters also expressed the view 

that this aspect of the dealer definition 

should focus on whether a person 

solicits expressions of interest in swaps 

from a range of market participants,49

and that end users of swaps can actively 

seek out and negotiate swaps without 

necessarily being swap dealers.50

b. Market Making 

Several commenters generally 

requested that the Commissions provide 

more guidance as to which activities 

constitute making a market in swaps or 

security-based swaps.51 Commenters 

also described various activities as 

indicating, or not indicating, market 

making activity. For example, two 

commenters expressed the view that 

market making is characterized by 

entering into swaps on one side of the 

market and then establishing offsetting 

positions on the other side of the 

market.52 Other commenters equated 

market making to providing liquidity by 

regularly quoting bid and offer prices for 

swaps, and standing ready to enter into 

swaps.53 One commenter stated that 

market making activity is indicated by 

a person consistently presenting itself as 

willing to take either side of a trade.54

Two commenters said that market 

makers receive tangible benefits (such as 

reduced trading fees) in return for the 

obligation to transact when liquidity is 

required.55

In contrast, one commenter said the 

proposal correctly did not limit market 

making to consistently quoting a twosided market, because to do so would 

insert a loophole into the definition.56

Some commenters expressed the view 

that mere active participation in a 

market or entering into swaps on both 

sides of a market does not necessarily 

constitute market making.57 Others said 

that occasionally quoting prices on both 

sides of the market is not market making 

when done to obtain information about 

the market or to mask one’s view of the 

market.58 One commenter stated that 

futures commission merchants 

(‘‘FCMs’’) and broker-dealers that 

facilitate customers’ entering into swaps 

are not necessarily market makers.59

Other commenters urged the 

Commissions to reject the view that 

market making requires continuous 

activity.60

A number of commenters addressed 

the issue of how the dealer definitions 

should treat swaps or security-based 

swaps entered into on a trading platform 

such as a designated contract market 

(‘‘DCM’’), national securities exchange, 

swap execution facility (‘‘SEF’’), or 

security-based SEF (collectively referred 

to herein as ‘‘exchanges’’).61 Several 

stated that entering into swaps or 

security-based swaps on exchanges 

should not be considered in 

determining if a person is a dealer.62

Some of these commenters emphasized 

the fact that parties would not know the 

identity of the counterparty to the swap 

executed on an exchange (i.e., such 

swaps are ‘‘anonymous’’),63 while other 

commenters said that such swaps do not 

constitute ‘‘accommodating demand’’ 

for swaps or ‘‘facilitating interest’’ in 

swaps.64 Another commenter said that 

future means of executing swaps on 

exchanges are likely to be diverse, and 

it is premature to draw conclusions 

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65See letter from Metropolitan Life Insurance 

Company (‘‘MetLife’’). 

66See letters from Newedge and Traders 

Coalition; Roundtable Transcript at 39 (remarks of 

Eric Chern, Chicago Trading Company). 

67See letter from ISDA I. 

68See letters from FSR I, MFA I and Midsize 

Banks. 

69See Roundtable Transcript at 88 (remarks of 

Steve Walton, Bank of Oklahoma). 

70See letters from Atmos Energy Corporation 

(‘‘Atmos Energy’’), Dominion Resources, Inc. 

(‘‘Dominion Resources’’), EDF Trading, Edison Int’l, 

EEI/EPSA, Gavilon II, Hess Corporation and its 

affiliates (‘‘Hess’’), Mississippi Public Utility Staff, 

NextEra I, National Milk Producers Federation 

(‘‘NMPF’’), Shell Trading I, Utility Group and 

Working Group of Commercial Energy Firms 

(‘‘WGCEF’’) on the swap dealer definition dated 

February 22, 2011 (‘‘WGCEF I’’), and meeting with 

Bunge on February 23, 2011. 

71See letters from BT Pension Scheme 

Management Limited (‘‘BTPS’’), EDF Trading, EEI/ 

EPSA and Vitol. 

72See letters from American Petroleum Institute 

(‘‘API’’) dated February 22, 2011 (‘‘API I’’), Calpine, 

Coalition of Physical Energy Companies (‘‘COPE’’) 

dated February 22, 2011 (‘‘COPE I’’), Dominion 

Resources, EDF Trading, Edison Int’l and Peabody; 

see also Roundtable Transcript at 45 (remarks of Ed 

Prosser, Gavilon) and letter from Church Alliance. 

In addition, three commenters said that the 

interpretation of the provisions relating to a 

‘‘regular business’’ in the Proposing Release is 

correct, because it will exclude from the definition 

of swap dealer those persons using swaps to hedge 

commercial risk. See letters from Air Transport 

Association of America, Inc. (‘‘ATAA’’), IECA– 

Credit I and joint letter from Petroleum Marketers 

Association of America and New England Fuel 

Institute. 

73See letters from Church Alliance and Peabody. 

74See letters from AFR and Better Markets, Inc. 

(‘‘Better Markets’’) dated February 22, 2011 (‘‘Better 

Markets I’’). 

75See letter from IECA–Credit I. 

76See letter from NextEra I and Shell Trading I. 

Another commenter disagreed with this approach, 

however, saying that a person who enters into 

swaps as an intermediary between smaller 

customers and larger financial institutions is not 

entering into swaps for its ‘‘own account’’ and 

therefore is not a swap dealer, but rather would be 

an FCM or introducing broker. See letter from MFX 

Solutions, Inc. (‘‘MFX’’) dated February 22, 2011 

(‘‘MFX I’’). 

77See letter from Traders Coalition. 

78See letters from BG LNG I and WGCEF I. 

79See letters from NCGA/NGSA I and Vitol. One 

of these commenters asked that the final rule clarify 

that simply because a person engages in swap 

activity exceeding the thresholds for the de minimis 

exception from the swap dealer definition does not 

necessarily mean that the person is engaged in a 

‘‘regular business’’ of swap dealing. See letter from 

Vitol. 

80See letter from NextEra I; see also letter from 

Hess (proposing similar criteria). 

81See letter from Shell Trading I. 

about how they should be treated in the 

dealer definitions.65

Two commenters asserted that firms 

that provide liquidity in cleared and 

exchange-executed swaps by actively 

participating in the market provide 

heterogeneity among liquidity providers 

and thereby disperse risk, and further 

stated that to regulate such persons as 

swap dealers subject to increased capital 

requirements would discourage their 

participation in the market and increase 

risk.66

One commenter expressed the view 

that the statutory definition uses dealing 

and market making interchangeably, 

and suggested that the analysis of 

whether a person acts as a dealer should 

be subsumed within the analysis of 

whether it acts as a market maker.67

c. Exception for Activities Not Part of a 

‘‘Regular Business’’ 

Several commenters addressed the 

exception from the dealer definitions for 

swap or security-based swap activities 

that are not part of a ‘‘regular business.’’ 

Some commenters supported the 

Commissions’ proposed interpretation 

in the context of the ‘‘swap dealer’’ 

definition and stated that this 

interpretation should be codified in the 

text of the final rule.68

Many commenters said that the 

activity of entering into swaps or 

security-based swaps should not be 

deemed to be a ‘‘regular business,’’ and 

thus not indicative of dealing activity, 

when the person’s use of swaps or 

security-based swaps are ancillary to, or 

in connection with, a separate non-swap 

business that is the person’s primary 

business.69 Some commenters making 

this point said that when the person’s 

primary business relates to physical 

commodities, the person’s use of swaps 

relating to those commodities does not 

constitute a ‘‘regular business.’’ 70 Other 

commenters stated that where a person 

enters into swaps to serve its own 

business needs, as opposed to serving 

the business needs of the counterparty, 

the person’s use of swaps does not 

constitute a ‘‘regular business.’’ 71 Other 

commenters said that the use of swaps 

to hedge the commercial risks of a 

business does not constitute a ‘‘regular 

business’’ of entering into swaps.72

Some commenters also suggested that 

the ‘‘regular business’’ exclusion should 

be interpreted to mean ‘‘regular swap 

dealing business’’ or ‘‘regular securitybased swap dealing business’’ to prevent 

the dealer definitions from capturing 

hedgers.73

On the other hand, two commenters 

said that the proposed interpretation 

was correct in the view that the test of 

whether a person has a ‘‘regular 

business’’ of entering into swaps does 

not necessarily depend on whether a 

person’s swap activities are a 

predominant activity, because such an 

approach would allow a person to 

engage in a significant level of swap 

dealing activity without registering as a 

swap dealer simply because the person 

also has substantial activities in a nonswap business or businesses.74

Other commenters suggested that the 

types of swap activities that a person 

engages in are relevant to determining 

whether the person has a ‘‘regular 

business’’ of entering into swaps. One 

commenter stated that a person has a 

‘‘regular business’’ of entering into 

swaps when the person has a primary 

business of accommodating demand or 

facilitating interest in swaps,75 while 

others similarly emphasized that a 

‘‘regular business’’ of entering into 

swaps is characterized by financial 

intermediation activities.76 One 

commenter took the view that a person 

that enters into swaps primarily with 

financial intermediaries does not have a 

‘‘regular business’’ of entering into 

swaps.77

Some commenters said that the final 

rule should clarify the point at which a 

person’s episodic or occasional swap 

activities become a ‘‘regular business’’ 

of entering into swaps.78 Others stated 

that the fact that a person enters into 

swaps frequently or with a large number 

of counterparties does not necessarily 

mean that the person has a ‘‘regular 

business’’ of entering into swaps.79

Commenters proposed specific tests 

for determining if a person has a 

‘‘regular business’’ of entering into 

swaps. One commenter said the 

determination should look to whether a 

person enters into swaps to 

accommodate demand from other 

parties and to profit from a bid/ask 

spread on swaps (as opposed to swaps 

that are substitutes for physical 

transactions or positions and used by at 

least one party to hedge commercial 

risk), and consider specifically the 

volume, revenues and profits of such 

activities, the person’s value at risk 

(VaR) and exposure from such activities, 

and its resources devoted to such 

activities.80 Another commenter said 

that the determination should be based 

on the nature of the person’s business, 

the person’s business purpose for using 

swaps, and the person’s method of 

executing swap transactions (e.g., a 

person whose business primarily relates 

to physical commodities, who uses 

swaps to hedge commercial risk, and 

who executes swaps on an exchange 

would be less likely to have a ‘‘regular 

business’’ of entering into swaps).81

One commenter argued that the 

‘‘regular business’’ exception should 

apply to all four of the dealer tests—not 

only the test for persons that regularly 

enters into swaps or security-based 

swaps as an ‘‘ordinary course of 

business’’—and further argued that the 

‘‘regular business’’ exception should be 

linked to a ‘‘two-way market’’ base 

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82See letter from ISDA dated I. 

83See, e.g., letters from BG LNG I, EDF Trading, 

ISDA I, NCGA/NGSA dated February 17, 2012 

(‘‘NCGA/NGSA II’’) and WGCEF I, and joint letter 

from American Farm Bureau Federation, American 

Soybean Association, National Association of 

Wheat Growers, National Cattlemen’s Beef 

Association, National Corn Growers Association, 

National Council of Farmer Cooperatives, National 

Grain and Feed Association, National Milk 

Producers Federation and National Pork Producers 

Council (‘‘Farmers’ Associations’’). 

84See letters from COPE I, Edison Int’l, Hess, 

ISDA I, Shell Trading I, Utility Group, Vitol and 

WGCEF I; see also Roundtable Transcript at 43–45 

(remarks of Ed Prosser, Gavilon). However, other 

commenters questioned whether profiting from a 

bid/ask spread is a relevant test of dealer status, and 

emphasized that dealers are those persons who take 

risk by entering into swaps or security-based swaps 

on both sides of the market. See Roundtable 

Transcript at 21, 56 (remarks of Richard Ostrander, 

Morgan Stanley) and 43 (remarks of Russ Wasson, 

National Rural Electric Cooperative Association 

(‘‘NRECA’’)). Another commenter pointed out that 

it could be difficult to determine how a person is 

profiting from entering into swaps. See Roundtable 

Transcript at 42 (remarks of Michael Masters, Better 

Markets). 

85See letters from API I, BG LNG I and NCGA/ 

NGSA II. 

86The examples cited were: entering into swaps 

on either side of a market depending on a firm’s 

commercial purpose for entering each particular 

swap (see letters from the Industrial Energy 

Consumers of America (‘‘IECA–Consumers’’) and 

WGCEF I, and letter from the Not-For-Profit Electric 

End User Coalition (‘‘NFPEEU’’), consisting of 

NRECA, American Public Power Association 

(‘‘APPA’’) and Large Public Power Council 

(‘‘LPPC’’); see also Roundtable Transcript at 44 

(remarks of Ed Prosser, Gavilon)); entering into 

swaps on both sides of an illiquid market for 

purposes of price discovery or to elicit bids and 

offers from other market participants (see letters 

from Hess, Vitol and WGCEF I); and entering into 

swaps on both sides of the market as part of an 

investment strategy (see letter from ABC/CIEBA). 

87See letter from AFR. 

88See letters from AFR and Better Markets I. 

89See letters from BOKF, National Association 

(‘‘BOK’’) dated January 13, 2012 (‘‘BOK V’’), MFX 

I, Newedge and Northland Energy Trading LLC 

(‘‘Northland Energy’’); see also Roundtable 

Transcript at 48 (remarks of John Nicholas, 

Newedge). One commenter queried whether the 

final rule should clarify whether a customer 

relationship between the parties to a swap is 

necessary in order for the swap to be relevant in 

determining whether either of the parties is a swap 

dealer. See letter from Representative Scott 

Desjarlais (‘‘Rep. Desjarlais’’). 

90See letters from NextEra I and Peabody and 

meeting with Vitol on February 15, 2011. 91See letter from Shell Trading I. 92See letters from IECA–Credit I, National 

Association of Insurance Commissioners (‘‘NAIC’’), 

Vitol and WGCEF I. One of these commenters also 

said that entering into a bespoke swap with a 

registered swap dealer, in which the swap dealer 

lays off risk, should not be viewed as 

accommodating demand or facilitating interest. See 

letter from Vitol. 93See letter from BG LNG I, NCGA/NGSA I, 

NFPEEU, NRG Energy, Inc. (‘‘NRG Energy’’) and 

WGCEF I and meeting with Vitol on February 16, 

2011. 94See letters from AFR and MFX I. 95See letter from National Grain and Feed 

Association (‘‘NGFA’’) dated February 22, 2011 

(‘‘NGFA I’’). 96See letters from BG LNG I, EEI/EPSA, Peabody, 

Rep. Desjarlais and Utility Group. Some 

commenters said that the CFTC’s interpretive 

approach to the swap dealer definition should be 

codified in the text of the final rule. See letters from 

Alternative Investment Management Association 

Limited (‘‘AIMA’’) dated February 22, 2011 (‘‘AIMA 

I’’) and COPE I. 

requirement to avoid commercial 

hedgers being encompassed by the 

dealer definitions.82

d. Other Dealer Issues 

Commenters also addressed other 

issues in the Proposing Release, 

including: (i) Whether Congress 

intended that there be implicit 

preconditions to dealer status; (ii) 

whether the concepts of 

‘‘accommodating demand’’ for swaps or 

security-based swaps or ‘‘facilitating 

interest’’ in swaps are useful in 

identifying dealers; and (iii) whether the 

interpretation of the dealer definitions 

should depend on pre-defined, objective 

criteria. 

i. Preconditions 

Several commenters said that the 

proposal is overbroad and would 

encompass persons that Congress did 

not intend to regulate as dealers.83

Comments in this vein said that the 

statutory definition should be 

interpreted to require that persons meet 

certain criteria or engage in certain 

activity, not explicitly stated in the 

statute, to be covered by the swap dealer 

definition. For instance, some 

commenters said that a dealer is a 

person who enters into swaps or 

security-based swaps on either side of 

the market and who profits from fees for 

doing so, or from the spread between 

the terms of swaps on either side of the 

market.84 Other commenters made a 

similar point, saying that swap dealers 

are those persons that intermediate 

between swap users on either side of the 

market.85

The commenters were not all in 

agreement on this, however. Several 

commenters (including some of those 

that said swap dealers enter into swaps 

on both sides of the market) also stated 

that there are a variety of situations in 

which a person’s activity of 

contemporaneously entering into swaps 

on both sides of the market is not 

indicative of dealing activity.86 One 

commenter said that it would not be 

appropriate to require that a person 

enter into swaps or security-based 

swaps on both sides of the market as a 

litmus test for dealer status, because to 

do so would create loopholes in the 

definition.87 Two commenters also 

supported rejection of any interpretation 

that would limit the dealer definitions 

to encompass only those entities that 

solely or predominately act as dealers.88

In addition, commenters were 

particularly divided as to whether 

acting as an intermediary always is 

indicative of swap dealing, as some 

commenters said that a person is not a 

swap dealer when it simply stands 

between two parties by entering into 

offsetting swaps with each party.89

ii. ‘‘Accommodating Demand’’ and 

‘‘Facilitating Interest’’ 

A number of commenters addressed 

the Proposing Release’s view that a 

tendency to accommodate demand for 

swaps and a general availability to enter 

into swaps to facilitate other parties’ 

interest in swaps (referred to here as 

‘‘accommodating demand’’ and 

‘‘facilitating interest’’) are characteristic 

of swap dealers. Some commenters 

stated that accommodating demand and 

facilitating interest would not be 

effective factors to identify swap 

dealers, particularly in bilateral 

negotiations where it is difficult to say 

which party is accommodating demand 

for swaps.90 Other commenters said the 

activities of accommodating demand or 

facilitating interest are indicative of 

swap dealing only in certain 

circumstances, such as when they are 

not related to a person’s commodity 

business,91 or when done with the 

purpose of serving the needs of the 

other party to the swap.92 Some 

commenters argued that the statement 

in the Proposing Release that swap 

dealers are likely involved in most or all 

significant parts of the swap markets is 

incorrect in the market for energy 

swaps. There, the commenters said, 

persons can find counterparties for 

swaps without the intermediation of a 

swap dealer, and swaps entered into 

directly by two end users are more 

frequent.93

Other commenters, though, said that 

the proposal’s focus on accommodating 

demand and facilitating interest strikes 

the right balance and that the proposed 

approach is generally correct.94 Another 

commenter did not object to including 

accommodating demand and facilitating 

risk as factors in the definition, but said 

that those factors should be applied 

flexibly.95

iii. Application of Objective Criteria, 

and Additional Factors 

Some commenters, specifically 

addressing the CFTC’s proposed 

interpretive approach to the ‘‘swap 

dealer’’ definition, said that the final 

rule should set out objective criteria that 

market participants could use to 

determine whether or not they are 

covered by the definition and therefore 

required to register as swap dealers.96

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97See letters from BG LNG I, Chesapeake Energy 

Corporation (‘‘Chesapeake Energy’’), COPE I, ISDA 

I, Vitol and WGCEF I. Some commenters focused on 

particular aspects of the swap dealer definition as 

requiring further detail, such as, for example, what 

it means to be ‘‘commonly known in the trade’’ as 

a swap dealer (see letter from Peabody) and the 

definition of market making (see letters from 

Midsize Banks and Peabody). 

98See letter from Hess. 

99See letter from NextEra I. 

100See, e.g., letters from EEI/EPSA, FSR I, ISDA 

I, NextEra I and WGCEF I. 

101See letters from Better Markets I, Chris 

Barnard (‘‘Barnard’’) and Prof. Michael Greenberger, 

University of Maryland School of Law 

(‘‘Greenberger’’). 

102See letter from ISDA I (stating that sources of 

information considered by the Commissions in 

determining dealer status should be revealed to the 

entity being evaluated). 

103See, e.g., letters from Coalition for Derivatives 

End-Users (‘‘CDEU’’), CCMR I, ISDA I and MetLife. 

104See letters from AFR and AFSCME. 

105Some of these commenters said that, since 

some provisions in the statutory swap dealer 

definition are similar to the definition of a ‘‘dealer’’ 

under the Exchange Act, Congress intended that the 

two definitions would be applied in the same way. 

See letters from API I, BG LNG I, CDEU, IECA– 

Consumers and WGCEF I. Others said that the 

CFTC should apply these interpretations because 

they have been effectively applied for a long time 

in the context of securities. See letters from CCMR 

I and MFA I. 

106See letters from Gavilon II, and Next Era I, and 

meetings with Electric Companies on April 13, 2011 

and WGCEF on April 28, 2011. Another commenter 

said the interpretations mean that dealers and 

traders can be distinguished by their activities: 

dealers hold themselves out as buying and selling 

on a regular basis, derive income from providing 

services in the chain of distribution, and profit from 

price spreads, while traders do not provide services 

or extend credit but, rather, profit from changes in 

the market value of underlying items. See letter 

from API I. 

107See letters from EDF Trading and IECA– 

Consumers. 

108See letters from API I, Gavilon I and IECA– 

Consumers. 

109See letters from AFR and AFSCME; see also 

joint meeting with AFR and Better Markets on 

March 17, 2011 (dealer-trader distinction not 

helpful in identifying swap dealers because the 

transparency and operational robustness of the 

swap market is much lower than in the securities 

market). One commenter said the precedents should 

be applied only by the SEC to identify securitybased swap dealers. See letter from NAIC. 

110See letters from Dairy Farmers of America 

(‘‘DFA’’), Growmark, Land O’Lakes, Inc. (‘‘Land 

O’Lakes’’) dated February 22, 2011 (‘‘Land O’Lakes 

II’’), National Council of Farmer Cooperatives 

(‘‘NCFC’’) dated February 22, 2011 (‘‘NCFC I’’) and 

NMPF. One commenter also said that a subsidiary 

of an agricultural cooperative that enters into swaps 

with its parent cooperative, and the members of the 

parent cooperative, should be excluded from the 

swap dealer definition for the same reason. See 

meeting with Agrivisor. Another commenter said 

that an agricultural cooperative’s swaps with 

farmers and other persons for risk management 

should be disregarded in determining if the 

cooperative is a swap dealer so long as the swaps 

relate to the marketing function of the cooperative, 

even if the swaps are not with members of the 

cooperative. See letter from NMPF. 

111See letters from DFA and Growmark. 

Others focused especially on statements 

in the Proposing Release to the effect 

that swap dealers are those persons who 

‘‘tend to’’ engage in certain activities, 

and that persons who engage in certain 

activities are ‘‘likely’’ to be swap 

dealers, as being overly subjective and 

difficult to interpret.97

Certain commenters suggested 

specific objective criteria to use to 

identify swap dealers. One commenter 

said that swap dealing activity is 

characterized by more frequent use of 

swaps; having substantial staff and 

technological resources devoted to 

swaps; a larger portion of revenue and 

profit being derived from swap activity; 

and owning fewer physical assets 

related to the type of swaps entered 

into.98 Another commenter said that to 

identify swap dealers, the CFTC should 

compare a person’s revenue or profits 

generated by swap activity to its overall 

revenue or profits; compare a person’s 

total business volume to the volume, 

VaR and exposure associated with the 

swap activity; compare a person’s total 

business resources to the resources 

devoted to swap activity; and consider 

ownership or control of physical assets 

in the specific market or region to which 

the person’s swap activity is tied.99

More generally, some commenters 

supported codification of more concrete 

tests in connection with the dealer 

definitions.100 However, other 

commenters said that the use of bright 

line rules to determine whether a person 

is a dealer would be inappropriate given 

the dynamic nature of the swap and 

security-based swap markets. These 

commenters supported a facts and 

circumstances approach to the dealer 

definition as a better approach.101 One 

commenter also raised issues about the 

sources of information that may be 

considered as part of a dealer 

determination.102

e. Application of Exchange Act 

‘‘Dealer-Trader’’ distinction 

i. Security-Based Swap Dealer 

Definition 

A number of commenters supported 

the proposed use of the dealer-trader 

distinction under the Exchange Act to 

interpret the ‘‘security-based swap 

dealer’’ definition.103 Two commenters, 

however, specifically opposed use of the 

distinction in the context of securitybased swaps, arguing that use of the 

distinction would create confusion or 

would be inconsistent with the goal of 

improved transparency.104

ii. Swap Dealer Definition 

Some commenters said that the CFTC 

should apply the dealer-trader 

distinction as it has been interpreted 

with respect to the definition of 

‘‘dealer’’ under the Exchange Act to 

identify swap dealers.105 Some 

commenters said that the applicable 

interpretations under the Exchange Act 

mean that swaps a person uses for 

proprietary trading (including for 

speculative purposes) should not be 

considered in determining if the person 

is a swap dealer because dealers enter 

into transactions in order to profit from 

spreads or fees regardless of their view 

of the market for the underlying item, 

whereas traders enter into transactions 

in order to take a view on the direction 

of the market or to obtain exposure to 

movements in the price of the 

underlying item.106 Two commenters 

said that if the CFTC applied the 

distinction, traders should be subject to 

potential registration as major swap 

participants, and dealers should be 

subject to regulation as swap dealers.107

Commenters acknowledged differences 

between the market for swaps and the 

market for securities, but said that the 

Exchange Act interpretations are still 

relevant.108

On the other hand, some commenters 

agreed with the CFTC’s view not to 

apply Exchange Act interpretations to 

the definition of the term ‘‘swap 

dealer.’’ These commenters said that it 

is appropriate not to apply the 

interpretations under the Exchange Act 

to identify persons that meet the swap 

dealer definition under the CEA.109

e. Application to Particular Swap 

Markets 

i. Aggregators 

Certain commenters addressed 

persons who enter into swaps as 

aggregators, with most of those 

commenters discussing agricultural 

cooperatives. Commenters said that 

agricultural cooperatives that hedge 

their own risks or the risks of their 

members regarding agricultural 

commodities should be excluded from 

the swap dealer definition because 

Congress did not intend to treat 

agricultural cooperatives as swap 

dealers and because agricultural 

cooperatives are in effect an extension 

of their members.110 Some commenters 

said that the agricultural cooperatives’ 

use of swaps allows their members to 

hedge risks when the members’ 

transactions are too small for (or 

otherwise not qualified for) the futures 

markets.111

Some commenters said that an 

exclusion from the swap dealer 

definition also should be available to 

private companies that serve as 

aggregators for swaps in agricultural 

commodities or otherwise offer swaps 

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30604 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

112See letters from Farmers’ Associations, NGFA 

I and NMPF. 

113See id. 

114See letter from Northland Energy. This 

commenter defined an ‘‘aggregator’’ as a person 

who: (i) Enters into swaps predominantly in one 

direction with counterparties that are using swaps 

to establish bona fide hedges; and (ii) offsets risks 

associated with such swaps using regulated futures 

contracts or cleared swaps. 

115See letter from MFX dated June 3, 2011 (‘‘MFX 

II’’). This commenter said that the exclusion should 

be available to a person who operates primarily on 

a not-for-profit basis and limits its swap activities 

to offering swaps to persons in underserved markets 

and offsetting such swaps, and who meets other 

requirements to limit the scope of the exclusion. 

116See letter from Better Markets I. 

117See letters from BG LNG I, Dominion 

Resources, National Energy Marketers Association 

(‘‘NEM’’), NFPEEU, Vitol and WGCEF I joint letter 

from Senator Debbie Stabenow and Representative 

Frank Lucas (many commercial end-users of swaps 

with inherent physical commodity price risk use 

swaps to hedge such risk and otherwise for their 

own trading objectives and not for the benefit of 

others) and meetings with Bunge on May 18, 2011 

and Electric Companies on April 13, 2011. 

118See id. 

119See letters from Dominion Resources, NEM 

and NFPEEU. 

120See letters from Edison Int’l, the staff of the 

FERC (‘‘FERC Staff’’), National Association of 

Regulatory Utility Commissioners (‘‘NARUC’’), 

NEM, NextEra I, NFPEEU and National Rural 

Utilities Cooperative Finance Corporation (‘‘NRU 

CFC’’) dated February 14, 2011 (‘‘NRU CFC I’’), joint 

letter from NRECA, APPA, LPPC, EEI and EPSA 

(‘‘Electric Trade Associations’’) and meetings with 

Electric Companies on April 13, 2011 and NFPEEU 

on January 29, 2011. 

121See letters from Edison Int’l, EEI/EPSA, 

Electric Trade Associations, FERC Staff, NextEra I 

and NFPEEU and meeting with Electric Companies 

on April 13, 2011. 

122See letter from NFPEEU. This commenter said 

the exclusion from the swap dealer definition 

should extend to persons acting as an operating or 

purchasing agent for other utilities in connection 

with energy infrastructure products, or otherwise 

entering into energy commodity swaps on behalf of 

other end users. 

123See letters from EDF Trading, FERC Staff and 

NARUC. 

124See letters from DC Energy, EDF Trading and 

EEI/EPSA. 

for agricultural risk management.112

These commenters said that such an 

exclusion would reduce the costs and 

regulatory burdens imposed on such 

companies and therefore provide a 

broader choice of swap providers to 

farmers and other agricultural market 

participants, which they said would 

reduce risks.113

One commenter discussed a small 

energy firm that aggregates demand for 

swaps from small energy retailers and 

consumers. This commenter said that 

such aggregators should be excluded 

from the swap dealer definition because 

imposing the swap dealer regulations 

(which would be promulgated with 

large financial firms in mind) on such 

firms would increase costs for the 

aggregators, discourage the aggregators’ 

offering of swaps, and thereby reduce 

choice and efficiency in the market.114

Another commenter said that a firm that 

enters into swaps with microfinance 

lenders and offsetting swaps with 

commercial banks is akin to an 

introducing broker or FCM, and should 

be excluded from the swap dealer 

definition on the grounds that it does 

not enter into swaps on its own 

initiative, but rather to provide access to 

the swap markets to smaller 

counterparties.115

Another commenter said that there is 

no need for any special treatment of 

aggregators in the swap dealer 

definition. According to this 

commenter, the CFTC’s guidance 

regarding the definition and the de 

minimis exception from the definition 

address the relevant issues properly and 

completely.116

ii. Physical Commodity Swaps 

Commenters that discussed physical 

commodity swaps primarily focused on 

swaps related to energy commodities 

such as oil, natural gas and electricity. 

The commenters said that the market for 

these swaps is different from the market 

for swaps on interest rates and other 

financial commodities because, among 

other things, the swaps are used to 

mitigate price and delivery risks directly 

linked to a commercial enterprise; less 

swap activity flows through 

intermediaries; the markets for the 

underlying physical commodities are 

separately regulated; and the failure of 

a commodity market participant is not 

likely to impact financial markets as a 

whole.117 Therefore, these commenters 

believe, the application of the swap 

dealer definition to participants in these 

physical commodity swap markets 

should be different from the application 

to participants in the financial 

commodity swap markets.118 Some 

commenters said that imposing the costs 

of swap dealer regulation on 

participants in the markets for physical 

commodity swaps would discourage 

participation in the market, thereby 

reducing liquidity and increasing 

market concentration.119

iii. Electricity Swaps 

Commenters on the use of swaps in 

connection with the generation and 

transmission of electricity addressed a 

variety of issues. First, commenters said 

that markets related to electricity are 

different from markets for other physical 

commodities in that electricity must be 

generated and transmitted at the time it 

is needed (it cannot be stored for future 

use); the overall demand for electricity 

is inelastic but demand at any particular 

time is subject to external variables, 

such as weather; the generation, 

transmission and use of electricity is 

widely dispersed and geographically 

specific; the markets are overseen by 

regulators such as state Public Utility 

Commissions, regional transmission 

organizations (‘‘RTOs’’) and the Federal 

Energy Regulatory Commission 

(‘‘FERC’’); and government mandates 

require continuous supply of electricity 

and treat electricity as a ‘‘public 

good.’’ 120 Commenters said that because 

of these differences, the use of swaps 

related to electricity is different from the 

use of swaps on other physical 

commodities in that electricity swaps: 

Are more highly customized to a 

particular place and time; are more 

likely to relate to a short time period or 

be more frequently entered into; 

typically can be tied to a specific 

generation, transmission or use of 

electricity; are more likely to be entered 

into directly by end-users rather than 

through dealers; are likely to be entered 

into by electricity companies on both 

sides of the market; and in many cases 

were subject to regulatory oversight 

prior to the Dodd-Frank Act.121

Commenters made various points 

regarding how swaps related to 

electricity should be treated for 

purposes of the swap dealer definition. 

A coalition of not-for-profit power 

utilities and electric cooperatives said 

that electricity cooperatives should be 

excluded from the swap dealer 

definition because they are non-profit 

entities that enter into swaps for the 

benefit of their members, they do not 

hold themselves out as swap dealers, 

they do not make markets, and their 

swaps are not necessarily reflective of 

market rates.122 Other commenters said 

that swaps related to transactions on 

tariff schedules approved by FERC or 

the Electric Reliability Council of Texas 

should be disregarded in determining if 

a person is a swap dealer.123 And, some 

commenters said that any special 

treatment of swaps related to electricity 

should apply not only to companies that 

generate, transmit or distribute 

electricity, but also to energy marketing 

companies that use swaps to benefit 

from price changes in the underlying 

energy commodities or to hedge related 

risks.124

On the other hand, some commenters 

acknowledged that a person who makes 

a market in swaps related to electricity 

by standing ready to enter into such 

swaps in order to profit from a bid/ask 

spread would be a swap dealer, even if 

the person was in the business of 

generating, transmitting or distributing 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30605 

125See letter from EEI/EPSA and meeting with 

Electric Companies on April 13, 2011. 

126See letter from ABC/CIEBA. 

127See letter from Farm Credit Council dated 

February 22, 2011 (‘‘Farm Credit Council I’’). 

128See letters from Credit Union National 

Association (‘‘CUNA’’) and Federal Home Loan 

Banks (‘‘FHLB’’) dated February 22, 2011 (‘‘FHLB 

I’’). 

129See letter from BOK dated January 31, 2011 

(‘‘BOK I’’); but see letter from Vitol at 7 (riskless 

principal transactions are a ‘‘good model for true 

swap dealing activity’’). 

130See letter from Newedge. 

131See letter from Association of Financial 

Guaranty Insurers (‘‘AFGI’’). 

132See letter from BlackRock, Inc. (‘‘BlackRock’’) 

dated February 22, 2011 (‘‘BlackRock I’’). 

133Commenters making this point varied in their 

phrasing of potential exclusions, and particularly 

suggested exclusions for: Agricultural firms offering 

swaps as risk management tools related to physical 

commodities (see letter from NGFA I); all firms, 

other than financial entities whose primary 

business is swap dealing (see letter from NEM); any 

person that uses swaps only to reduce price 

volatility, enters into a volume of swaps relating to 

any physical commodity that is less than the 

volume of its trading in that commodity, and is not 

making a market (see letter from Chesapeake 

Energy); or any person that limit its use of swaps 

to hedging or speculating (see letters from API I). 

134See letter from ISDA I. 

135See letters from NARUC and NCGA/NGSA I. 

136See letter from MFA I. 

137See letters from FSR dated February 22, 2011 

and Midsize Banks. 

138See letters from Commodity Markets Council 

(‘‘CMC’’), EEI/EPSA, IECA-Credit I, NextEra I, Shell 

Trading I, Utility Group and Vitol. 

139See letters from NextEra I and WGCEF I. The 

commenters acknowledged that such options may 

or may not be included in the definition of ‘‘swap.’’ 

140See letter from CMC. 

141See, e.g., letters from Edison Int’l and WGCEF 

I and joint letter from Senator Stabenow and 

Representative Lucas (also saying that definition of 

‘‘hedging’’ should be consistent with respect to the 

dealer and major participant definitions and the 

end-user exception from clearing). 

142See letters from EEI/EPSA, NextEra I, Utility 

Group and WGCEF I. 

143See letters from Midsize Banks, NFPEEU and 

FSR I. 

144See letters from EEI/EPSA, Vitol and 

WGCEF I. 

145See letters from EDF Trading, FERC Staff and 

NARUC. 

146See letter from Better Markets I. 

147See letter from AFSCME. Additional 

commenters emphasized the need for transparency 

about swaps and swap activities. See letters from 

Jason Cropping and BJ D’Milli. 

148See, e.g., letters from FSR I, Institute of 

International Bankers, ISDA I, Investment 

Management Association, Japan Financial Services 

Agency, Securities Industry and Financial Markets 

Association (‘‘SIFMA’’) dated February 3, 2011 

(‘‘SIFMA I’’), and the World Bank Group, joint letter 

from the Autorite ́ de controˆle prudential and the 

Autorite ́ des marches financiers, joint letter from 

Bank of America Merrill Lynch, Barclays Capital, 

BNP Paribas S.A. (‘‘BNP Paribas’’), Citi, Cre ́dit 

Agricole Corporate and Investment Bank, Credit 

Suisse Securities (USA), Deutsche Bank AG 

(‘‘Deutsche Bank’’), HSBC, Morgan Stanley, Nomura 

Securities International, Inc. (‘‘Nomura Securities’’), 

Socie ́te ́ Ge ́ne ́rale and UBS Securities LLC (‘‘Twelve 

Firms’’), joint letter from the Bank of TokyoMitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd. 

and Sumitomo Mitsui Banking Corporation, and 

joint letter from Barclays Bank PLC, BNP Paribas, 

Credit Suisse AG, Deutsche Bank, HSBC, Nomura 

Securities, Rabobank Nederland, Royal Bank of 

Canada, the Royal Bank of Scotland Group pLc, 

Socie ́te ́ Ge ́ne ́rale, the Toronto-Dominion Bank and 

UBS AG. 

149See joint letter from Representatives Spencer 

Bachus and Frank Lucas at 2 (‘‘Casting an overlybroad net in defining [dealer and major participant] 

could force some smaller participants to leave the 

marketplace as a result of increased costs, or 

eliminate certain types of contracts used for 

hedging. If either occurs, businesses will be left 

exposed to market volatility and the consequences 

will ultimately be felt by Americans in the form of 

increased consumer costs.’’) and letters from ISDA 

Iat 7 (‘‘The substantial additional burdens and costs 

of Dealer regulation must be reserved for those 

whose business it is to ‘make the market,’ that is, 

those who consistently both buy and sell. This is 

in accord with Dodd-Frank Act’s market regulatory 

goals, as well as the legislation’s obvious intent to 

preserve healthy growth and innovation in the U.S. 

swap markets.’’ (footnote omitted)), Peabody at 2– 

3 (‘‘Legal uncertainty over the application to end 

users of the significant regulatory requirements for 

[swap dealers] could lead end users to minimize 

their use of swaps in order to avoid the risk of being 

deemed to be [a swap dealer].’’), and Church 

Alliance (stating that the risk of incurring the costs 

of dealer regulation would harm employee benefit 

plans by reducing their use of swaps and securitybased swaps for hedging and risk mitigation). 

electricity and owned physical facilities 

for that purpose.125

f. Suggested Exlusions From the Dealer 

Definitions 

Several commenters took the view 

that the swap dealer and security-based 

swap dealer definitions should 

categorically exclude, or should be 

interpreted in a way that would be 

expected to exclude, a variety of types 

of persons or transactions. Commenters 

particularly suggested that the following 

categories of persons should be 

excluded from the dealer definitions: 

Agricultural cooperatives and electric 

cooperatives (as addressed above), 

employee benefit plans as defined in the 

Employee Retirement Income Security 

Act of 1974 (‘‘ERISA’’),126 farm credit 

system institutions,127 Federal Home 

Loan Banks,128 insured depository 

institutions that limit their swap dealing 

activity to riskless principal 

transactions,129 FCMs and brokerdealers that limit their swap dealing 

activity to riskless principal 

transactions,130 financial guaranty 

insurers and their affiliates that do not 

enter into new swaps,131 asset 

managers,132 non-financial companies 

offering swaps related to their physical 

commodity business,133 any person who 

enters into swaps or security-based 

swaps only with registered dealers and 

major participants,134 persons that do 

not pose systemic risk,135 hedge 

funds 136 and entities that enter into 

swaps or security-based swaps solely in 

a fiduciary capacity.137

Commenters also suggested that the 

dealer definitions categorically exclude, 

or should be interpreted to exclude, the 

following types of swaps and securitybased swaps: Exchange-cleared swaps 

and security-based swaps,138 options to 

make or receive delivery of physical 

commodities,139 cash forward 

transactions with embedded swaps and 

book-out transactions,140 swaps or 

security-based swaps that are used for 

hedging or mitigating commercial 

risk,141 swaps entered into to profit from 

future changes in the price of the 

underlying commodity,142 swaps or 

security-based swaps entered into as a 

fiduciary or agent for another person,143

swaps or security-based swaps entered 

into for purposes of price discovery,144

and, as noted above, swaps related to 

items that are covered by a tariff 

approved by FERC or the Electric 

Reliability Council of Texas.145

In contrast, some commenters 

opposed providing any categorical 

exclusions from the dealer definitions. 

One commenter stated that the 

definitions’ focus on a person’s 

activities—as opposed to whether that 

person falls within a particular 

category—is a better means of 

determining whether the person is a 

swap dealer.146 Another commenter 

described the requested exclusions as 

attempts to achieve carve-outs that are 

not provided for in the statute.147

Lastly, several commenters addressed 

the extraterritorial application of the 

definitions of the terms ‘‘swap dealer,’’ 

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

swap participant,’’ ‘‘major securitybased swap participant,’’ and ‘‘eligible 

contract participant.’’ In general, the 

commenters addressed when and how 

the definitions should be applied to 

persons based outside the U.S. and how 

the definitions should take account of 

non-U.S. requirements that may be 

applicable to such persons.148 The 

Commissions intend to separately 

address issues related to the application 

of these definitions to non-U.S. persons 

in the context of the application of Title 

VII to non-U.S. persons. 

g. Cost-Benefit Issues and Hedging 

Deterrence 

Several commenters emphasized the 

cost of being regulated as a dealer, and 

emphasized that an overbroad scope of 

the dealer definitions would impose 

significant unwarranted costs on entities 

contrary to the goals of the Dodd-Frank 

Act, and would deter the use of swaps 

and security-based swaps for 

hedging.149 Some commenters also 

noted that impact of the provisions of 

section 716 of the Dodd-Frank Act on 

entities that are deemed to be swap 

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30606 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

150See letters from American Bankers Association 

(‘‘ABA’’) dated November 3, 2011 (‘‘ABA I’’), BOK 

I, and ISDA I. Section 716 of the Dodd-Frank Act 

prohibits any ‘‘swaps entity’’—a term that 

encompasses swap dealers and security-based swap 

dealers—from receiving Federal assistance with 

respect to any swap, security-based swap, or other 

activity of the swaps entity. 

151See letter from API I (stating that costs of 

regulatory uncertainty stem from the use of 

qualitative factors for identifying dealing, and from 

regulatory efforts to reach beyond ‘‘true’’ swap 

dealers); see also letter from Dominion Resources 

(the opportunity costs associated with regulatory 

uncertainty should be considered). 

152See letter from WGCEF I. 

153See letters from ABA I, NFPEEU and WGCEF 

dated December 20, 2011, enclosing a report 

prepared by NERA Economic Consulting (‘‘NERA’’) 

(‘‘WGCEF VIII’’); see also letter from NERA dated 

March 13, 2012. 

154See letters from NextEra I (referring to 

alternative de minimis tests) and NFPEEU. 

155See letter from Better Markets dated June 3, 

2011 (‘‘Better Markets II’’). 

156Better Markets cited estimates that the 

worldwide cost of the 2008 financial crisis in terms 

of lost output was between $60 trillion and $200 

trillion, depending primarily on the long term 

persistence of the effects. See letter from Better 

Markets II. 

157See CFTC Regulation § 1.3(ggg)(1), (2); 

Exchange Act rule 3a71–1(a), (b). 158Section 712(a)(7)(A) of the Dodd-Frank Act 

provides that in adopting rules and orders 

implementing Title VII, the Commissions shall treat 

functionally or economically similar products or 

entities in a similar manner. Section 712(a)(7)(B), 

though, provides that the Commissions need not act 

in an identical manner. 159See part V, infra. 

160See CFTC Regulation § 1.3(ggg)(1), (2). 

161See CFTC Regulation § 1.3(ggg)(6)(ii), (iii). 

162See CFTC Regulation § 1.3(ggg)(1), (2). 

163See CFTC Regulation § 1.3(ggg)(5), (6). 

164See CFTC Regulation § 1.3(ggg)(5); see also 

part II.B, infra. 

dealers or security-based swap 

dealers.150 Also, one commenter 

suggested that using a qualitative test for 

the dealer definition might increase 

costs due to regulatory uncertainty.151

One commenter specifically suggested 

that in considering the final rules, the 

Commissions should consider empirical 

data regarding the costs and benefits 

flowing from the rules and issue a 

second analysis of the costs and benefits 

of the rules for public comment,152

while other commenters said that the 

consideration of cost and benefits 

should include the cumulative cost of 

interrelated regulatory burdens arising 

from all the rules proposed under the 

Dodd-Frank Act.153 Other commenters 

said the Commissions should consider 

alternatives that would impose fewer 

costs.154

Another commenter said that the costbenefit analyses in the Proposing 

Release may have understated the 

benefits of the proposed rules, because 

focusing on individual aspects of all the 

rules proposed under the Dodd-Frank 

Act prevents consideration of the full 

range of benefits that arise from the 

rules as a whole, in terms of providing 

greater financial stability, reducing 

systemic risk and avoiding the expense 

of assistance to financial institutions in 

the future.155 This commenter said the 

consideration of benefits of the 

proposed rules should include the 

mitigated risk of a financial crisis.156

3. Final Rules and Interpretation— 

General Principles 

Consistent with the Proposing 

Release, the final rules that define the 

terms ‘‘swap dealer’’ and ‘‘securitybased swap dealer’’ closely follow the 

statutory definitions’ four tests and 

exclusion for activities that are not part 

of a ‘‘regular business.’’ 157 In addition, 

this Adopting Release sets forth 

interpretive guidance regarding various 

elements of the final rules. 

Because the definitions of the terms 

‘‘swap dealer’’ in the CEA and 

‘‘security-based swap dealer’’ in the 

Exchange Act are substantially similar, 

the rules further defining those terms 

and the accompanying interpretations in 

this Adopting Release reflect common 

underlying principles. At the same time, 

the interpretations regarding the 

application of the definitions differ in 

certain respects given the differences in 

the uses of and markets for swaps and 

security-based swaps.158 For example, 

because security-based swaps may be 

used to hedge or gain economic 

exposure to underlying individual 

securities (while recognizing 

distinctions between security-based 

swaps and other types of securities, as 

discussed below), there is a basis to 

build upon the same principles that 

presently are used to identify dealers for 

other types of securities. These same 

principles, though instructive, may be 

inapplicable to swaps in certain 

circumstances or may be applied 

differently in the context of dealing 

activities involving commodity, interest 

rate, or other types of swaps. 

For these reasons, we separately are 

addressing the interpretation of the 

‘‘swap dealer’’ and ‘‘security-based 

swap dealer’’ definitions. 

Also, as discussed below, the 

Commissions are directing their 

respective staffs to report separately 

regarding the rules being adopted in 

connection with the definition and 

related interpretations. These staff 

reports will help the Commissions 

evaluate the ‘‘swap dealer’’ and 

‘‘security-based swap dealer’’ 

definitions in all respects, including 

whether new or revised tests or 

approaches would be appropriate for 

identifying swap dealers and securitybased swap dealers.159

4. Final Rules and Interpretation— 

Definition of ‘‘Swap Dealer’’ 

The Dodd-Frank Act contains a 

comprehensive definition of the term 

‘‘swap dealer,’’ based upon types of 

activities. As noted above, we are 

adopting a final rule under the CEA 

that, like the proposed rule, defines the 

term ‘‘swap dealer’’ using terms from 

the four statutory tests and the 

exclusion for swap activities that are not 

part of ‘‘a regular business.’’ 160 The 

final rule includes modifications from 

the proposed rule that are described 

below, including provisions stating that 

swaps entered into for hedging physical 

positions as defined in the rule, swaps 

between majority-owned affiliates, 

swaps entered into by a cooperative 

with its members, and certain swaps 

entered into by registered floor traders, 

are excluded from the swap dealer 

determination.161 The Commissions, in 

consideration of comments received, are 

also making certain modifications to the 

interpretive guidance set out in the 

Proposing Release with respect to 

various elements of the statutory 

definition of the term ‘‘swap dealer,’’ as 

described below. 

The determination of whether a 

person is covered by the statutory 

definition of the term ‘‘swap dealer’’ 

requires application of various 

provisions of the rule further defining 

that term, as well as the interpretive 

guidance in this Adopting Release, 

depending on the person’s particular 

circumstances. We intend that the 

determination with respect to a 

particular person would proceed as 

follows. 

The person would begin by applying 

the statutory definition, and the 

provisions of the rule which implement 

the four statutory tests and the 

exclusion for swap activities that are not 

part of ‘‘a regular business,’’ 162 in order 

to determine if the person is engaged in 

swap dealing activity. In that analysis, 

the person would apply the interpretive 

guidance described in this part II.A.4, 

which provides for consideration of the 

relevant facts and circumstances. As 

part of this consideration, the person 

would apply elements of the dealertrader distinction, as appropriate, 

including as described in part II.A.4.a, 

below. 

The rule provides that certain swaps 

are not considered in the determination 

of whether a person is a swap dealer.163

In particular, swaps entered into by an 

insured depository institution with a 

customer in connection with originating 

a loan with that customer, 164 swaps 

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165See CFTC Regulation § 1.3(ggg)(6)(i); see also 

part II.C, infra. 

166See CFTC Regulation § 1.3(ggg)(6)(ii); see also 

part II.C, infra. 

167See CFTC Regulation § 1.3(ggg)(6)(iii); see also 

part II.B.4.e, infra. 

168See CFTC Regulation § 1.3(ggg)(6)(iv); see also 

part II.B.4.f, infra. 

169See CFTC Regulation § 1.3(ggg)(4); see also 

part II.D, infra. 

170See CFTC Regulation § 1.3(ggg)(3); see also 

part II.E, infra. 

171The Commissions note that interpretations of 

the applicability of the dealer-trader distinction to 

the ‘‘swap dealer’’ definition under the CEA do not 

affect existing, or future, interpretations of the 

dealer-trader distinction under the Exchange Act. 

172See note 31, supra. The principles embedded 

within the ‘‘dealer-trader distinction’’ are also 

applicable to distinguishing dealers from nondealers such as hedgers or investors. See note 250, 

infra. 

173The Commissions note that interpretations of 

the applicability of the dealer-trader distinction to 

the ‘‘swap dealer’’ definition under the CEA do not 

affect existing, or future, interpretations of the 

dealer-trader distinction under the Exchange Act. 

174For example, while the ‘‘dealer’’ definition 

encompasses certain persons in the business of 

‘‘buying and selling’’ securities, the ‘‘swap dealer’’ 

definition does not address either ‘‘buying’’ or 

‘‘selling.’’ We also note that the ‘‘dealer’’ definition 

requires the conjunctive ‘‘buying and selling’’— 

which connotes a degree of offsetting two-sided 

activity. In contrast, the swap dealer definition 

(particularly the ‘‘regularly enters into’’ swaps 

language of the definition’s third prong) lacks that 

conjunctive terminology. 

175 In the Proposing Release, the CFTC did not 

propose to use principles from the dealer-trader 

distinction to interpret the definition of the term 

‘‘swap dealer,’’ instead proposing an interpretive 

approach that focused on, among other things, a 

person’s functional role in the swap markets and its 

relationships with swap counterparties. See 

Proposing Release, 75 FR at 80177. There was, 

however, some overlap in practice between the 

factors identified in the Proposing Release relating 

to a swap dealer’s functional role and relationships 

and the principles of the dealer-trader distinction 

that were proposed to be applied to identify 

security-based swap dealers. Moreover, the changes 

to the interpretive approach to the swap dealer 

definition that we are adopting here and discussed 

in this part II.A.4 are in many respects similar to 

the principles of the dealer-trader distinction. We 

also acknowledge the commenters who asked for 

additional guidance regarding the application of the 

definitions. See, e.g., letters from Gavilon II, 

Peabody and the Utility Group, and meeting with 

CDEU on April 7, 2011. 

Thus, while the incorporation of the dealer-trader 

distinction in the interpretation of the term ‘‘swap 

dealer’’ constitutes a change from the Proposing 

Release, this is simply reflective of the other 

changes to the CFTC’s interpretive approach that 

we are adopting for the final rule and the overlap 

between the factors relating to a swap dealer’s 

functional role and counterparty relationships and 

the principles of the dealer-trader distinction. 

176The analysis also should account for the fact 

that a party to a swap can use other derivatives or 

cash market instruments to hedge the risks 

associated with the swap position, meaning that 

two-way trading is not necessary to maintain a flat 

risk book. 

177Even though we expect trading of swaps on 

exchanges following the implementation of Title 

VII, we expect there to remain a significant amount 

of over-the-counter activity involving swaps. 

between majority-owned affiliates, 165

swaps entered into by a cooperative 

with its members,166 swaps entered into 

for hedging physical positions as 

defined in the rule,167 and certain swaps 

entered into by registered floor 

traders 168 are excluded from the swap 

dealer determination. 

If, after completing this review (taking 

into account the applicable interpretive 

guidance and excluding any swaps as 

noted above), the person determines 

that it is engaged in swap dealing 

activity, the next step is to determine if 

the person is engaged in more than a de 

minimis quantity of swap dealing.169 If 

so, the person is a swap dealer. When 

the person registers, it may apply to 

limit its designation as a swap dealer to 

specified categories of swaps or 

specified activities of the person in 

connection with swaps.170

In this part II.A.4., we provide 

interpretive guidance on the application 

of the ‘‘swap dealer’’ definition, 

modified from the Proposing Release as 

appropriate based on comments 

received. This guidance separately 

addresses the following: application of 

the dealer-trader framework; the 

‘‘holding out’’ and ‘‘commonly known’’ 

criteria; market making; the not part of 

‘‘a regular business’’ exception; the 

exclusion of swaps entered into for 

hedging physical positions as defined in 

the rule; and the overall interpretive 

approach to the definition.171

a. Use of the Dealer-Trader Distinction 

We believe that the dealer-trader 

distinction 172—which already forms a 

basis for identifying which persons fall 

within the longstanding Exchange Act 

definition of ‘‘dealer’’—in general 

provides an appropriate framework for 

interpreting the statutory definition of 

the term ‘‘swap dealer.’’ 173 While there 

are differences in the structure of those 

two statutory definitions,174 we believe 

that their parallels—particularly their 

exclusions for activities that are ‘‘not 

part of a regular business’’—warrant 

analogous interpretive approaches for 

distinguishing dealers from nondealers.175 Thus, the dealer-trader 

distinction forms the basis for a 

framework that appropriately 

distinguishes between persons who 

should be regulated as swap dealers and 

those who should not. We also believe 

that the distinction affords an 

appropriate degree of flexibility to the 

analysis, and that it would not be 

appropriate to seek to codify the 

distinction in rule text. 

The Commissions recognize that the 

dealer-trader distinction needs to be 

adapted to apply to swap activities in 

light of the special characteristics of 

swaps and the differences between the 

‘‘dealer’’ definition, on the one hand, 

and the ‘‘swap dealer’’ definition, on the 

other. Relevant differences between the 

swap market and the markets for 

securities (other than security-based 

swaps) include: 

• Level of activity—Swap markets are 

marked by less activity than markets 

involving certain types of securities 

(while recognizing that some debt and 

equity securities are not actively 

traded). This suggests that in the swap 

context, concepts of ‘‘regularity’’ should 

account for a participant’s level of 

activity in the market relative to the 

total size of the market. 

• No separate issuer—Each 

counterparty to a swap in essence is the 

‘‘issuer’’ of that instrument; in contrast, 

dealers in cash market securities 

generally transact in securities issued by 

another party. This distinction suggests 

that the concept of maintaining an 

‘‘inventory’’ of securities is inapposite 

in the context of swaps. Moreover, this 

distinction—along with the fact that the 

‘‘swap dealer’’ definition lacks the 

conjunctive ‘‘buying and selling’’ 

language of the ‘‘dealer’’ definition— 

suggests that concepts of two-sided 

markets at times would be less relevant 

for identifying swap dealers than they 

would be for identifying dealers.176

• Predominance of over-the-counter 

and non-standardized instruments— 

Swaps an thus far are not significantly 

traded on exchanges or other trading 

systems, in contrast to some cash market 

securities (while recognizing that many 

cash market securities also are not 

significantly traded on those 

systems).177 These attributes—along 

with the lack of ‘‘buying and selling’’ 

language in the swap dealer definition, 

as noted above—suggest that concepts of 

what it means to make a market need to 

be construed flexibly in the contexts of 

the swap markets. 

• Mutuality of obligations and 

significance to ‘‘customer’’ 

relationship—In contrast to a secondary 

market transaction involving equity or 

debt securities, in which the completion 

of a purchase or sale transaction can be 

expected to terminate the mutual 

obligations of the parties to the 

transaction, the parties to a swap often 

will have an ongoing obligation to 

exchange cash flows over the life of the 

agreement. In light of this attribute, 

some market participants have 

expressed the view that they have 

‘‘counterparties’’ rather than 

‘‘customers’’ in the context of their swap 

activities. 

In applying the dealer-trader 

distinction, it also is necessary to apply 

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178E.g., capital and margin requirements (CEA 

section 4s(e)), and requirements for segregation of 

collateral (CEA sections 4d(f), 4s(l)). 

179E.g., requirements with respect to business 

conduct when transacting with special entities 

(CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5)); disclosure 

requirements (CEA section 4s(h)(3)(B)); 

requirements for fair and balanced communications 

(CEA section 4s(h)(3)(D)); other requirements 

related to the public interest and investor protection 

(CEA section 4s(h)(3)(D)); and conflict of interest 

provisions (CEA section 4s(j)(5)). 

180E.g., reporting and recordkeeping 

requirements (CEA section 4s(f)); daily trading 

records requirements (CEA section 4s(g)); regulatory 

standards related to the confirmation, processing, 

netting, documentation and valuation of securitybased swaps (CEA section 4s(i)); position limit 

monitoring requirements (CEA section 4s(j)(1)); risk 

management procedure requirements (CEA section 

4s(j)(2)); and requirements related to the disclosure 

of information to regulators (CEA section 4s(j)(3)). 

181See generally part II.A.5, infra. 

182To clarify, the activities listed in the text are 

indicative of acting as a swap dealer. Engaging in 

one or more of these activities is not a prerequisite 

to a person being covered by the swap dealer 

definition. 

183As with the interpretation of the dealer-trader 

distinction with respect to securities, a 

nomenclature distinction between ‘‘counterparties’’ 

and ‘‘customers’’ is not significant for purposes of 

applying the dealer-trader distinction to swap 

activities. Contractual provisions related to 

nomenclature, such as a provision stating that no 

‘‘customer’’ relationship is present, would not be 

significant if the reality of the situation is different. 

See note 271, infra, and accompanying text. 

184As with the dealer-trader distinction as it has 

been interpreted under the Exchange Act with 

respect to securities (and as noted below in the 

discussion of the ‘‘makes a market in swaps’’ prong 

of the swap dealer definition), the presence of an 

organized exchange or trading system is not a 

prerequisite to being a market maker for purposes 

of the swap dealer definition, nor is acting as a 

market maker a prerequisite to being a swap dealer. 

185 In interpreting the term ‘‘swap dealer,’’ we 

intend to consider, but do not formally adopt, the 

body of court decisions, SEC releases, and SEC staff 

no-action letters that have interpreted the dealertrader distinction. 

186See CFTC Regulation § 1.3(ggg)(1)(i) and (iv). 

187These factors are as follows: Contacting 

potential counterparties to solicit interest; 

developing new types of swaps or security-based 

swaps and informing potential counterparties of 

their availability and of the person’s willingness to 

enter into the swap or security-based swap; 

membership in a swap association in a category 

reserved for dealers; providing marketing materials 

describing the type of swaps or security-based 

swaps the party is willing to enter into; and 

generally expressing a willingness to offer or 

provide a range of products or services that include 

swaps or security-based swaps. See Proposing 

Release, 75 FR at 80178. 

188See By-laws of ISDA at 3, available at: 

https://www.isdadocs.org/membership. The 

Commissions note that the Primary Members of 

ISDA are not limited to only financial firms. 

the statutory provisions that will govern 

swap dealers in an effective and logical 

way. Those statutory provisions added 

by the Dodd-Frank Act advance 

financial responsibility (e.g., the ability 

to satisfy obligations, and the 

maintenance of counterparties’ funds 

and assets) associated with swap 

dealers’ activities,178 other counterparty 

protections,179 and the promotion of 

market efficiency and transparency.180

As a whole, the relevant statutory 

provisions suggest that we should 

interpret the ‘‘swap dealer’’ definition to 

identify those persons for which 

regulation is warranted either: (i) Due to 

the nature of their interactions with 

counterparties; or (ii) to promote market 

stability and transparency, in light of 

the role those persons occupy within 

the swap and security-based swap 

markets. 

There are several aspects of our 

interpretive approach to the swap dealer 

definition that are particularly similar to 

the dealer-trader distinction as it will be 

applied to determine if a person is a 

security-based swap dealer. In 

particular, the following activities, 

which are indicative of dealing activity 

in the application of the dealer-trader 

distinction,181 similarly are indicative 

that a person is acting as a swap 

dealer: 182 (i) Providing liquidity by 

accommodating demand for or 

facilitating interest in the instrument 

(swaps, in this case), holding oneself out 

as willing to enter into swaps 

(independent of whether another party 

has already expressed interest), or being 

known in the industry as being available 

to accommodate demand for swaps; (ii) 

advising a counterparty as to how to use 

swaps to meet the counterparty’s 

hedging goals, or structuring swaps on 

behalf of a counterparty; (iii) having a 

regular clientele and actively 

advertising or soliciting clients in 

connection with swaps; 183 (iv) acting in 

a market maker capacity on an 

organized exchange or trading system 

for swaps; 184 and (v) helping to set the 

prices offered in the market (such as by 

acting as a market maker) rather than 

taking those prices, although the fact 

that a person regularly takes the market 

price for its swaps does not foreclose the 

possibility that the person may be a 

swap dealer. 

The Commissions further note that 

the following elements of the 

interpretive approach to the swap dealer 

definition are also generally consistent 

with the dealer-trader distinction as it 

will be applied to determine if a person 

is a security-based swap dealer: (i) A 

willingness to enter into swaps on either 

side of the market is not a prerequisite 

to swap dealer status; (ii) the swap 

dealer analysis does not turn on 

whether a person’s swap dealing 

activity constitutes that person’s sole or 

predominant business; (iii) a customer 

relationship is not a prerequisite to 

swap dealer status; and (iv) in general, 

entering into a swap for the purpose of 

hedging, absent other activity, is 

unlikely to be indicative of dealing. 

Last, under the interpretive approach to 

the definition of both the terms ‘‘swap 

dealer’’ and ‘‘security-based swap 

dealer,’’ whether a person is acting as a 

dealer will turn upon the relevant facts 

and circumstances, as informed by the 

interpretive guidance set forth in this 

Adopting Release. 

At the same time, the Commissions 

recognize that the dealer-trader 

distinction is not static, but rather has 

evolved over time through interpretive 

materials. The Commissions expect the 

dealer-trader distinction to evolve over 

time with respect to swaps 

independently of its evolution over time 

with respect to securities or securitybased swaps. Prior interpretations and 

future developments in the law 

regarding securities or security-based 

swaps may inform the interpretation of 

the swap dealer definition, but will not 

be dispositive in identifying dealers in 

the swap markets.185

b. Indicia of Holding Oneself Out as a 

Dealer in Swaps or Being Commonly 

Known in the Trade as a Dealer in 

Swaps 

The final rule further defining the 

term ‘‘swap dealer’’ includes the 

provisions in the proposed rule which 

incorporate the statutory requirements 

that the term includes a person that is 

holding itself out as a dealer in swaps 

or is engaging in any activity causing it 

to be commonly known in the trade as 

a dealer or market maker in swaps.186

We continue to believe that the 

Proposing Release appropriately 

identifies a number of factors as indicia 

of ‘‘hold[ing] itself out as a dealer in 

swaps’’ and ‘‘engag[ing] in any activity 

causing [itself] to be commonly known 

in the trade as a dealer or market maker 

in swaps.’’ 187 In our view, those factors 

thus are relevant to determining if a 

person is a swap dealer. For example, 

regarding the proposed factor of 

‘‘membership in a swap association in a 

category reserved for dealers,’’ we note 

that the bylaws of the International 

Swaps and Derivatives Association 

(‘‘ISDA’’) provide that any business 

organization that: 

Directly or through an affiliate, as part of 

its business (whether for its own account or 

as agent), deals in derivatives shall be eligible 

for election to membership in the Association 

as a Primary Member, provided that no 

person or entity shall be eligible for 

membership as a Primary Member if such 

person or entity participates in derivatives 

transactions solely for the purpose of risk 

hedging or asset or liability management.188

We believe that in circumstances such 

as this, where a category of association 

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189However, while such membership is an 

indicator of swap dealer status, a person holding 

such membership could nonetheless be excluded by 

other provisions of the definition of the term ‘‘swap 

dealer.’’ For example, an insured depository 

institution that limits its activity to offering swaps 

in connection with the origination of loans, as 

discussed below in part II.B, would not be covered 

by the definition simply because it holds such 

membership. 

190The statutory definition of the term ‘‘swap 

dealer’’ contains four separate clauses, or ‘‘prongs,’’ 

joined by the disjunctive ‘‘or,’’ the ordinary 

meaning of which is that the prongs are stated as 

alternative types of swap dealer. Accordingly, 

where an assessment of all the activities of a swap 

participant demonstrates that the person is not 

holding itself out as a swap dealer or engaging in 

any activity that causes it to be commonly known 

as a swap dealer, that person may, nonetheless, be 

a swap dealer based on the market making or 

regular business prongs of the swap dealer 

definition, discussed below. The Commissions note, 

however, that as discussed below in part II.A.4.g, 

the CFTC’s overall interpretive guidance, including 

guidance regarding the dealer-trader framework, 

applies to identify swap dealers under all four 

prongs of the statutory ‘‘swap dealer’’ definition. 

191See CFTC Regulation § 1.3(ggg)(1)(ii). Because 

the statutory swap dealer definition contains four 

disjunctive prongs, the CFTC does not agree with 

a commenter (see letter from ISDA I) who asserted 

that status as a market maker in swaps is a 

prerequisite to a person being a swap dealer. 

192A person that occasionally, or less than 

routinely, enters into a swap at the request of a 

counterparty is not a maker of a market in swaps, 

and therefore is not a swap dealer on that basis. 

However, we reiterate, as stated in the Proposing 

Release, that since many types of swaps are not 

entered into on a continuous basis, it is not 

necessary that a person enter into swaps at the 

request or demand of counterparties on a 

continuous basis in order for the person to be a 

market maker in swaps and, therefore, a swap 

dealer. 

193 In addition, section 619 of the Dodd-Frank Act 

(the ‘‘Volcker Rule’’) generally prohibits banking 

entities from engaging in proprietary trading, but 

contains an exception for certain market makingrelated activities. The Commissions have proposed 

an approach to the Volcker Rule under which a 

person could seek to avoid the Volcker Rule in 

connection with swap activities by asserting the 

availability of that market making exception. See 

SEC, Board, Office of the Comptroller of the 

Currency (‘‘OCC’’), and Federal Deposit Insurance 

Corporation (‘‘FDIC’’), Prohibitions and Restrictions 

on Proprietary Trading and Certain Interests in, and 

Relationships With, Hedge Funds and Private 

Equity Funds; Proposed Rule, 76 FR 68846 (Nov. 7, 

2011); CFTC, Prohibitions and Restrictions on 

Proprietary Trading and Certain Interests in, and 

Relationships With, Hedge Funds and Private 

Equity Funds; Proposed Rule, 77 FR 8332 (Feb. 14, 

2012). Under this approach, such a person would 

likely also be required to register as a swap dealer 

(unless the person is excluded from the swap dealer 

definition, such as by the exclusion of certain 

swaps entered into in connection with the 

origination of a loan). The SEC has proposed to 

adopt the same approach with respect to the 

interplay of the Volcker Rule and the definition of 

the term ‘‘security-based swap dealer.’’ See note 

272, infra. 

194We recognize that routine presence in the 

swap market is not necessarily indicative of making 

a market in swaps. For example, persons may be 

routinely present in the market in order to engage 

in swaps for purposes of hedging, to advance their 

investment objectives, or to engage in proprietary 

trading. 

195See note 265, infra, and accompanying text. 

196 In this case, the spread from which a person 

profits may be between two or more swaps, or it 

may be between a swap and another position or 

financial instrument. In contrast, entering into 

swaps in order to obtain compensation attributable 

to changes in the value of the swaps is indicative 

of using swaps for a hedging, investment or trading 

purpose. 

197See letters cited in notes 52 to 58, supra. 

Although swaps are notional contracts requiring the 

performance of agreed upon terms by each party, it 

is possible to describe swap users in practical terms 

as being on either ‘‘side’’ of a market. For example, 

for many swaps the party paying a fixed amount is 

on one ‘‘side’’ of the market and the party paying 

a floating amount is on the other ‘‘side.’’ 

membership requires that a person deal 

in derivatives and not limit its 

participation in derivative transactions 

to solely risk hedging, membership in 

the category is an indicator of swap 

dealer status.189

We take note, however, of the 

comments that these activities may be 

insufficient to establish that a person is 

a swap dealer. In particular, we 

generally agree with commenters that 

many commercial end users of swaps 

do, from time to time, actively seek out 

and negotiate swaps. Yet, based on the 

applicable facts and circumstances, 

these end users do not necessarily fall 

within the definition of a swap dealer 

solely because they actively seek out 

and negotiate swaps from time to time. 

The activities described in the 

Proposing Release as indicia of holding 

oneself out as a swap dealer or engaging 

in any activity causing oneself to be 

commonly known as a swap dealer 

should not be considered in a vacuum, 

but should instead be considered in the 

context of all the activities of the swap 

participant. While the activities listed in 

the Proposing Release are indicators that 

a person is holding itself out or is 

commonly known as a swap dealer, 

these are factors to be considered in the 

analysis. They are not per se conclusive, 

and could be countered by other factors 

indicating that the person is not a swap 

dealer.190 Because of the flexibility— 

including the consideration of 

applicable facts and circumstances— 

needed for such an analysis, we do not 

believe that it is appropriate to codify 

this guidance in rule text, as suggested 

by some commenters. 

c. Market Making 

The final rule defining ‘‘swap dealer’’ 

includes the provision from the 

proposed rule which incorporates the 

statutory requirement that this term 

include a person that ‘‘makes a market 

in swaps.’’ 191

We have considered the comments 

suggesting various descriptions of 

activities that should and should not be 

deemed to be market making in swaps 

for purposes of this rule. In 

consideration of these comments, we 

clarify that making a market in swaps is 

appropriately described as routinely 

standing ready to enter into swaps at the 

request or demand of a counterparty. In 

this regard, ‘‘routinely’’ means that the 

person must do so more frequently than 

occasionally, but there is no 

requirement that the person do so 

continuously.192

It is appropriate, in response to 

comments asking for further guidance 

regarding what activities constitute 

making a market in swaps, to describe 

some of the activities indicative of 

whether a person is routinely standing 

ready to enter into swaps at the request 

or demand of a counterparty. Such 

activities include routinely: (i) Quoting 

bid or offer prices, rates or other 

financial terms for swaps on an 

exchange; (ii) responding to requests 

made directly, or indirectly through an 

interdealer broker, by potential 

counterparties for bid or offer prices, 

rates or other similar terms for 

bilaterally negotiated swaps; (iii) 

placing limit orders for swaps; or (iv) 

receiving compensation for acting in a 

market maker capacity on an organized 

exchange or trading system for 

swaps.193 These examples are not 

exhaustive, and other activities also may 

be indicative of making a market in 

swaps if the person engaging in them 

routinely stands ready to enter into 

swaps as principal at the request or 

demand of a counterparty. 

In determining whether a person’s 

routine presence in the market 

constitutes market making under these 

four factors, the dealer-trader 

interpretative framework may be 

usefully applied.194 Under the dealertrader distinction, seeking to profit by 

providing liquidity to the market is an 

indication of dealer activity.195 Thus, in 

applying these four factors, it is useful 

to consider whether the person is 

seeking, through presence in the market, 

compensation for providing liquidity, 

compensation through spreads or fees, 

or other compensation not attributable 

to changes in the value of the swaps it 

enters into.196 If not, such activity 

would not be indicative of market 

making. 

Some commenters suggested that, in 

order to be a market maker in swaps, a 

person must make a two-way market in 

swaps.197 Nonetheless, it is possible for 

a person making a one-way market in 

swaps to be a maker of a market in 

swaps and, therefore, within the swap 

dealer definition. This may be true, for 

example, where a person routinely 

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30610 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

198See, e.g., letters cited in note 62, supra. 

199As discussed above, in many cases routine 

presence in the swap market, without more, would 

not constitute market making activity. Nevertheless, 

the CFTC will, in connection with promulgation of 

final rules relating to capital requirements for swap 

dealers and major swap participants, consider 

institution of reduced capital requirements for 

entities or individuals that fall within the swap 

dealer definition and that execute swaps only on 

exchanges, using only proprietary funds. Similarly, 

the CFTC also will consider the applicability to 

such entities or individuals of the other 

requirements imposed on swap dealers (e.g., 

internal business conduct standards, external 

business conduct standards with counterparties), 

and may adjust those swap dealer requirements as 

appropriate. 

200See, e.g., letters cited in note 66, supra. Since 

the structures of the markets on which swaps will 

be executed are still in development, and market 

obligations have not been established, there is little 

support for comments asserting that market makers 

should be defined as only those persons who 

receive benefits from the market (such as reduced 

trading fees) in return for the obligation to transact 

when the market requires liquidity. 

201By contrast, it may be appropriate, over time, 

to tailor the specific requirements imposed on swap 

dealers depending on the facility on which the 

swap dealer executes swaps. For example, the 

application of certain business conduct 

requirements may vary depending on how the swap 

is executed, and it may be appropriate, as the swap 

markets evolve, to consider adjusting certain of 

those requirements for swaps that are executed on 

an exchange or through particular modes of 

execution. 

202Final CFTC Regulation § 1.3(ggg)(2) is 

modified from the proposal to include the word ‘‘a’’ 

before the words ‘‘regular business,’’ to conform the 

text of the rule to the text of the statute. See CEA 

section 1a(49)(C), 7 U.S.C. 1a(49)(C). 

As stated in the Proposing Release, we interpret 

the reference in the definition of the term ‘‘swap 

dealer’’ to a person entering into swaps ‘‘with 

counterparties * * * for its own account’’ to refer 

to a person who enters into a swap as a principal, 

and not as an agent. A person who enters into 

swaps as an agent for customers (i.e., for the 

customers’ accounts) would be required to register 

as either an FCM, introducing broker, commodity 

pool operator or commodity trading advisor, 

depending on the nature of the person’s activity. 

203We recognize, as noted by one commenter (see 

letter from ISDA I), that the ‘‘regular business’’ 

exclusion is not limited solely to the ‘‘ordinary 

course of business’’ test of the swap dealer 

definition. Our interpretations of the other three 

tests are, and should be read to be, consistent with 

the exclusion of activities that are not part of a 

regular business. 

204See, e.g., letters from BG LNG I, COPE I, IECA– 

Credit I, Shell Trading I, WGCEF I and Vitol (stating 

that the proposed approach was overly subjective 

and requesting guidance as to the specific activities 

that are covered by the statutory definition). 

205These activities are inconsistent with entering 

into a swap to hedge a physical position as defined 

in § 1.3(ggg)(6)(iii). As discussed below, such 

hedging is not dealing activity. 

206The three indicators of being engaged in ‘‘a 

regular business’’ of entering into swaps described 

stands ready to enter into swaps on a 

particular side of the market—say, 

routinely bidding for floating exposures 

on a swap trading platform—while 

entering into transactions on the other 

side of the market in other instruments 

(such as futures contracts). The relevant 

indicator of market maker status is the 

willingness of the person to routinely 

stand ready to enter into swaps at the 

request or demand of a counterparty (as 

opposed to entering into swaps to 

accommodate one’s own demand or 

desire to participate in a particular 

market), be it on one or both sides of the 

market, and then to enter into offsetting 

positions, either in the swap market or 

in other markets. 

The Commissions disagree with the 

commenters who said that swaps 

executed on an exchange should not be 

considered in determining if a person is 

a market maker in swaps and thus a 

swap dealer.198 First, the statutory 

definition of the term ‘‘swap dealer’’ 

makes no distinction between swaps 

executed on an exchange and swaps that 

are not, suggesting that the same 

protections should apply regardless of 

the method of executing the swap. 

Second, from the perspective of an end 

user seeking to execute a swap on an 

exchange, the important consideration 

under our analysis is whether a market 

maker is ready to enter into swaps, not 

whether the market maker is aware of 

the counterparty’s identity. A market 

maker in swaps routinely stands ready 

to enter into swaps at the request or 

demand of a counterparty, regardless of 

whether the counterparty and the 

market maker meet on a disclosed basis 

through bilateral negotiations or 

anonymously through an exchange.199

Similarly, the issue of whether a person 

is a registered FCM or broker-dealer is 

not necessarily relevant to whether the 

person is a maker of a market in swaps, 

if the person is routinely standing ready 

to enter into swaps at the request or 

demand of a counterparty. Third, we 

believe it would be inappropriate to 

disregard swaps executed on exchanges 

in order, as some commenters 

suggested,200 to encourage market 

participants to use, or to provide 

liquidity to, exchanges. Finally, variety 

of exchanges, markets, and other 

facilities for the execution of swaps are 

likely to evolve in response to the 

requirements of the Dodd-Frank Act, 

and there is no basis for any bright-line 

rule excluding swaps executed on an 

exchange, given the impossibility of 

obtaining information about how market 

participants will interact and execute 

swaps in the future, after the 

requirements under the Dodd-Frank Act 

are fully in effect. For all these reasons, 

we have determined that it is 

inappropriate to restrict the ‘‘making a 

market in swaps’’ prong of the swap 

dealer definition (i.e., routinely standing 

ready to enter into swaps at the request 

or demand of a counterparty) to swaps 

that are not executed on an exchange.201

d. Exception for Activities Not Part of ‘‘a 

Regular Business’’ 

The final rule includes the provisions 

in the proposed rule that incorporate the 

provisions of the statutory definition 

regarding activities that are not part of 

‘‘a regular business’’ of entering into 

swaps. One provision states that the 

term ‘‘swap dealer’’ includes a person 

that ‘‘regularly enters into swaps with 

counterparties as an ordinary course of 

business for its own account’’; the other 

provision states that the term ‘‘swap 

dealer’’ does not include a person that 

‘‘enters into swaps for such person’s 

own account, either individually or in a 

fiduciary capacity, but not as a part of 

a regular business.’’ 202

The Commissions continue to believe, 

as stated in the Proposing Release, that 

the phrases ‘‘ordinary course of 

business’’ and ‘‘a regular business’’ are, 

for purposes of the definition of ‘‘swap 

dealer’’ essentially synonymous. In this 

context, we interpret these phrases to 

focus on activities of a person that are 

usual and normal in the person’s course 

of business and identifiable as a swap 

dealing business. It is not necessarily 

relevant whether the person conducts 

its swap-related activities in a dedicated 

subsidiary, division, department or 

trading desk, or whether such activities 

are a person’s ‘‘primary’’ business or an 

‘‘ancillary’’ business, so long as the 

person’s swap dealing business is 

identifiable.203

We have taken into consideration 

comments seeking additional guidance 

regarding the types and levels of 

activities that constitute having ‘‘a 

regular business’’ of entering into 

swaps.204 In this regard, any one of the 

following activities would generally 

constitute both entering into swaps ‘‘as 

an ordinary course of business’’ and ‘‘as 

a part of a regular business’’: 205 (i) 

Entering into swaps with the purpose of 

satisfying the business or risk 

management needs of the counterparty 

(as opposed to entering into swaps to 

accommodate one’s own demand or 

desire to participate in a particular 

market); (ii) maintaining a separate 

profit and loss statement reflecting the 

results of swap activity or treating swap 

activity as a separate profit center; or 

(iii) having staff and resources allocated 

to dealer-type activities with 

counterparties, including activities 

relating to credit analysis, customer 

onboarding, document negotiation, 

confirmation generation, requests for 

novations and amendments, exposure 

monitoring and collateral calls, 

covenant monitoring, and 

reconciliation.206

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here are set forth in the alternative. Any one of 

these indicators may be sufficient, based on a facts 

and circumstances analysis, to reach a conclusion 

that an entity is engaged in ‘‘a regular business’’ of 

entering into swaps. 

207This element of the interpretation reflects our 

agreement with those commenters who said that ‘‘a 

regular business’’ of entering into swaps is 

characterized by having a business of 

accommodating demand or facilitating interest in 

swaps (see letter from IECA–Credit I), and those 

commenters who said that ‘‘a regular business’’ 

does not encompass the use of swaps to serve a 

person’s own business needs, as opposed to serving 

the business needs of the counterparty (see letters 

cited in note 71, supra). 

208See letters cited in note 80, supra. 

209See CFTC Regulation § 1.3(ggg)(6)(iii) (swaps 

entered into for hedging physical positions as 

defined in the rule are not considered in the 

determination of whether a person is a swap 

dealer). 

210Regulation of firms engaged in an underlying 

physical business is also consistent with regulatory 

practices outside the U.S. For example, nonfinancial entities register with the Financial 

Services Authority in the U.K. as ‘‘Oil Market 

Participants’’ and ‘‘Energy Market Participants.’’ 

See Financial Services Authority Handbook EMPS 

and OMPS, available at http://fsahandbook.info/ 

FSA/html/handbook. 

211For the same reasons, we do not believe it 

would be appropriate, in determining whether a 

person has a ‘‘regular business’’ of entering into 

swaps, to consider whether a person engages in 

activities normally associated with financial 

institutions, as some commenters suggested. See 

letters cited in note 76, supra. 

212See, e.g., letters cited in note 72, supra. 

213 In this regard, the statutory definition of the 

term ‘‘swap dealer’’ stands in contrast to the 

statutory definition of the term ‘‘major swap 

participant’’ which, as discussed further below, 

explicitly provides that positions in swaps held for 

hedging or mitigating commercial risk are to be 

excluded in certain parts of that definition. See CEA 

section 1a(33)(A)(i)(1), 7 U.S.C. 1a(33)(A)(i)(1). The 

absence of any explicit requirement in the ‘‘swap 

dealer’’ definition to exclude swaps held for 

hedging or mitigating commercial risk does not 

support the view that Congress intended to 

categorically exclude all swaps that may serve as 

hedges in determining whether a person is covered 

by the definition. 

Similarly, the absence of any limitation in the 

statutory definition of the term ‘‘swap dealer’’ to 

financial entities, when such limitation is included 

elsewhere in Title VII, indicates that no such 

limitation applies to the swap dealer definition. 

CEA section 2(h)(7), 7 U.S.C. 2(h)(7), specifically 

limits the application of the clearing mandate, in 

certain circumstances, to only ‘‘financial entities.’’ 

That section also provides a detailed definition of 

the term ‘‘financial entity.’’ See CEA section 

2(h)(7)(C), 7 U.S.C. 2(h)(7)(C). That such a 

limitation is included in this section, but not in the 

swap dealer definition, does not support the view 

that the statutory definition of the term ‘‘swap 

dealer’’ should encompass only financial entities. 

214For example, under the dealer-trader 

distinction, the Commissions would expect persons 

that use security-based swaps to hedge their 

business risks, absent other activity, likely would 

not be dealers. See part II.A.5.b, infra. Under the 

CFTC’s interpretive guidance, making a market in 

swaps is appropriately described as routinely 

standing ready to enter into swaps at the request or 

demand of a counterparty, and the indicia of swap 

dealing as a ‘‘regular business’’ include entering 

into swaps to satisfy the business or risk 

management needs of the counterparty. Entering 

into swaps for the purpose of hedging one’s own 

risks generally would not be indicative of this form 

of swap activity. See also, e.g., joint letter from 

Senator Stabenow and Representative Lucas (the 

Continued 

The Commissions see merit in the 

comments saying that ‘‘a regular 

business’’ of entering into swaps can be 

characterized by entering into swaps to 

satisfy the business or risk management 

needs of the other party to the swap, 

and so incorporate this element into our 

interpretation of the rule.207 Also, an 

objective indicator of a person being 

engaged in ‘‘a regular business’’ of 

entering into swaps is when the person 

accounts for the results of its swap 

activities separately, by maintaining a 

separate profit and loss statement for 

those activities or treating them as a 

separate profit center. Our interpretation 

incorporates this indicator of activity 

that is ‘‘a regular business’’ of entering 

into swaps. 

Other comments suggesting specific 

criteria to identify ‘‘a regular business’’ 

also were helpful. We agree with 

commenters 208 that ‘‘a regular 

business’’ of entering into swaps can be 

characterized by having staff and 

resources allocated to the types of 

activities in which swap dealers must 

engage with their counterparties, such 

as those noted above (e.g., credit 

analysis, confirmation generation, 

collateral calls, and covenant 

monitoring). However, we understand 

that some end users of swaps engage in 

some of these activities and, in certain 

circumstances, may have staff and 

resources available for these activities. 

Therefore, this element of the definition 

should be applied in a reasonable 

manner, taking all appropriate 

circumstances into account. This 

element does not depend on whether a 

specific amount or percentage of 

expenses or employee time are related 

to these swap activities. Instead, it is 

appropriate to objectively examine a 

person’s use of staff and resources 

related to swap activities. Using staff 

and resources to a significant extent in 

conducting credit analysis, opening and 

monitoring accounts and the other 

activities noted above, is an indication 

that the person is engaged in ‘‘a regular 

business’’ of entering into swaps. 

Regarding the commenters’ assertion 

that the activity of entering into swaps 

in connection with a person’s physical 

commodity business cannot constitute 

‘‘a regular business’’ of the person, we 

believe that while in most cases this is 

not dealing activity,209 a per se 

exclusion of this type is not appropriate 

because it is possible that in some 

circumstances a person might enter into 

swaps that are connected to a physical 

commodity business but also serve 

market functions characteristic of the 

functions served by swap dealers. Also, 

again, the statutory definition does not 

contain any such exclusion, but rather 

includes any person who ‘‘regularly 

enters into swaps with counterparties as 

an ordinary course of business for its 

own account,’’ without regard to the 

person’s particular type of business. 

Consistent with the statutory 

definition, we interpret ‘‘a regular 

business’’ of entering into swaps in a 

manner that applies equally to all 

market participants that engage in the 

activities set forth in the statutory 

definition. This will ensure that all 

participants in the swap markets are 

regulated in a fair and consistent 

manner, regardless of whether their 

underlying business is primarily 

physical or financial in nature.210

Finally, as noted above, the manner in 

which persons negotiate, execute and 

use swaps is likely to evolve in response 

to the requirements of the Dodd-Frank 

Act and the other forces that will shape 

the swap markets going forward. For 

this reason, it would be inappropriate to 

craft per se exclusions from the swap 

dealer definition at a time when the 

only available information about the use 

of swaps relates to the period prior to 

implementation of the Dodd-Frank 

Act.211

e. Interim Final Rule Excluding Swaps 

Entered Into for Hedging Physical 

Positions 

We note that some commenters said 

that swaps used to hedge or mitigate 

commercial risks should not be 

considered in determining whether a 

person is a swap dealer.212 We 

understand that swaps are used to hedge 

risks in numerous and varied ways, and 

we expect that the number of persons 

covered by the definition will be very 

small in comparison to the thousands of 

persons that use swaps for hedging. 

In terms of the statutory definition of 

the term ‘‘swap dealer,’’ the CFTC notes 

as an initial matter that there is no 

specific provision addressing hedging 

activity. Thus, the statutory definition 

leaves the treatment of hedging swaps to 

the CFTC’s discretion; it neither 

precludes consideration of a swap’s 

hedging purpose, nor does it require an 

absolute exclusion of all swaps used for 

hedging.213

In general, entering into a swap for 

the purpose of hedging is inconsistent 

with swap dealing.214 The practical 

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30612 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

final rule should distinguish using swaps for 

hedging from swap dealing). 

215See CFTC Regulation § 1.3(ggg)(6)(iii). All five 

requirements set forth in the regulation must be met 

with respect to the swap, in order for the swap to 

be excluded from the swap dealer determination by 

the regulation. 

216See CFTC Regulation § 151.5(a)(1). The 

definition of bona fide hedging in CFTC Regulation 

§ 1.3(z), which applies for excluded commodities, is 

not relevant here, because it does not contain the 

requirement that the swap represents a substitute 

for a transaction made or to be made or a position 

taken or to be taken in a physical marketing 

channel, as required by CFTC Regulation 

§ 1.3(ggg)(6)(iii)(B). We believe that this 

requirement is an important aspect of how 

principles from the bona fide hedging definition are 

useful in identifying swaps that are entered into for 

the purpose of hedging as opposed to other 

purposes. 

217See CFTC, Position Limits for Futures and 

Swaps; Final Rule, 76 FR 71626, 71649 (Nov. 18, 

2011). 

218The swaps that qualify as enumerated hedging 

transactions and positions are those listed in CFTC 

Regulation § 151.5(a)(2) and appendix B to part 151. 

These examples are illustrative of the types of 

‘‘assets,’’ ‘‘liabilities,’’ and ‘‘services’’ contemplated 

in CFTC Regulation § 1.3(ggg)(6)(iii), because the 

price risk arising from changes in their value could 

be offset or mitigated with a swap that represents 

a substitute for transactions made or to be made or 

positions taken or to be taken by the person at a 

later time in a physical marketing channel. To be 

clear, notwithstanding that a swap does not fit 

precisely within such examples, it may still satisfy 

CFTC Regulation § 1.3(ggg)(6)(iii). 

Regarding commenters’ queries about dynamic 

hedging, which one commenter described as the 

ability to modify the hedging structure related to 

physical assets or positions when relevant pricing 

relationships applicable to that asset change (see 

joint letter from WGCEF and CMC), we note that 

qualification as bona fide hedging has never been 

understood to require that hedges, once entered 

into, must remain static. We expect that entites 

would move to update their hedges periodically 

when pricing relationships or other market factors 

applicable to the hedge change. 

219See parts II.A.4.e and II.A.5.a, infra. For 

example, the conclusion that a person’s relationship 

with its counterparties can lead to associated 

obligations is consistent with the ‘‘shingle theory,’’ 

which implies a duty of fair dealing when a person 

hangs out its shingle to do business. See note 260, 

infra. 

220 In this way, the exclusion from the swap 

dealer analysis of swaps hedging physical positions 

as defined in CFTC Regulation § 1.3(ggg)(6)(iii) is 

similar to the exclusions, discussed below, of swaps 

between affiliates and swaps between a cooperative 

and its members. See CFTC Regulation 

§ 1.3(ggg)(6)(i)(ii); see also part II.C, infra. However, 

to the extent a person engages in dealing activities 

involving swaps, the presence of offsetting 

positions that hedge those dealing activities would 

not excuse the requirement that the person register 

as a swap dealer. 

221Thus, the CFTC’s interpretation of the swap 

dealer definition in this regard draws upon 

principles in the dealer-trader distinction. See part 

II.A.4.a. Additional authority for CFTC Regulation 

§ 1.3(ggg)(6)(iii) is provided by subparagraph (B) of 

the swap dealer definition. This subparagraph 

provides that a person ‘‘may be designated as a 

swap dealer for a single type or single class or 

category of swap or activities and considered not to 

be a swap dealer for other types, classes, or 

categories of swaps or activities.’’ CEA Section 

1a(49)(B), 7 U.S.C. 1a(49)(B). It thereby authorizes 

a review of a person’s various activities with respect 

to swaps, and a determination that some of the 

person’s activities are covered by a designation as 

a swap dealer, while other of the person’s activities 

are not. Thus, a person who enters into some swaps 

for hedging physical positions as defined in CFTC 

Regulation § 1.3(ggg)(6)(iii), and also enters into 

other swaps in connection with activities covered 

by the swap dealer definition, could be designated 

as a swap dealer only for the latter activities. 

222For example, ‘‘pay floating/receive fixed’’ 

swaps entered into by a swap dealer with long 

exposure to the floating side of a market would 

have the effect of hedging the dealer’s exposure. 

difficulty lies in determining when a 

person has entered into a swap for the 

purpose of hedging, as opposed to other 

purposes for entering into swaps, such 

as accommodating demand for swaps or 

as part of making a market in swaps, 

and in distinguishing a swap with a 

hedging purpose from a swap with a 

hedging consequence. In view of these 

uncertainties, the CFTC believes it is 

appropriate to adopt an interim final 

rule that draws upon the principles of 

bona fide hedging that the CFTC has 

long applied to identify when a 

financial instrument is used for hedging 

purposes, and excludes from the swap 

dealer analysis swaps entered into for 

the purpose of hedging physical 

positions that meet the requirements of 

the rule. 

Specifically, the CFTC is adopting as 

an interim final rule CFTC Regulation 

§ 1.3(ggg)(6)(iii), which provides that the 

determination of whether a person is a 

swap dealer will not consider a swap 

that the person enters into, if: 

(i) The person enters into the swap for 

the purpose of offsetting or mitigating 

the person’s price risks that arise from 

the potential change in the value of one 

or several (a) assets that the person 

owns, produces, manufactures, 

processes, or merchandises or 

anticipates owning, producing, 

manufacturing, processing, or 

merchandising; (b) liabilities that the 

person owns or anticipates incurring; or 

(c) services that the person provides, 

purchases, or anticipates providing or 

purchasing; 

(ii) the swap represents a substitute 

for transactions made or to be made or 

positions taken or to be taken by the 

person at a later time in a physical 

marketing channel; 

(iii) the swap is economically 

appropriate to the reduction of the 

person’s risks in the conduct and 

management of a commercial enterprise; 

(iv) the swap is entered into in 

accordance with sound commercial 

practices; and 

(v) the person does not enter into the 

swap in connection with activity 

structured to evade designation as a 

swap dealer.215

Thus, although the CFTC is not 

incorporating the bona fide hedging 

provisions of the CFTC’s position limits 

rule here, the exclusion from the swap 

dealer analysis draws upon language in 

the CFTC’s definition of bona fide 

hedging.216 For example, the exclusion 

expressly includes swaps hedging price 

risks arising from the potential change 

in value of existing or anticipated assets, 

liabilities, or services, if the hedger has 

an exposure to physical price risk. And, 

as in the bona fide hedging rule, the 

exclusion utilizes the word ‘‘several’’ to 

reflect that there is no requirement that 

swaps hedge risk on a one-to-one 

transactional basis in order to be 

excluded, but rather they may hedge on 

a portfolio basis.217 For these reasons, 

swaps that qualify as enumerated 

hedging transactions and positions are 

examples of the types of physical 

commodity swaps that are excluded 

from the swap dealer analysis if the 

rule’s requirements are met.218

This provision in the final rule is 

consistent with our overall interpretive 

approach to the definition of the term 

‘‘swap dealer.’’ The interpretations of 

the statutory dealer definitions by both 

Commissions focus on a person’s 

activities in relation to its counterparties 

and other market participants.219 As 

noted above, for example, one indicator 

that a person enters into swaps as part 

of ‘‘a regular business’’ is that the 

person does so to satisfy the business or 

risk management needs of the 

counterparty. This aspect of the swap 

dealer analysis turns on the 

accommodation of a counterparty’s 

needs or demands. If a person enters 

into swaps for the purpose of hedging a 

physical position as defined in CFTC 

Regulation § 1.3(ggg)(6)(iii), by contrast, 

then the swap can be identified as not 

having been entered into for the purpose 

of accommodating the counterparty’s 

needs or demands.220 Also, a person’s 

activity of seeking out swap 

counterparties in order to hedge a 

physical position as defined in the rule 

generally would not warrant regulations 

to promote market stability and 

transparency or to serve the other 

purposes of dealer regulation.221

At the same time, however, there may 

be circumstances where a person’s 

activity of entering into swaps is 

encompassed by the statutory definition 

of the term ‘‘swap dealer,’’ 

notwithstanding that the swaps have the 

effect of hedging or mitigating the 

person’s commercial risk.222 Although 

these swaps could, in theory, be 

excluded from the swap dealer analysis, 

we believe that a broader, per se 

exclusion for all swaps that hedge or 

mitigate commercial risk is 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30613 

223While we recognize that a rule delineating the 

swap activities that do not constitute swap dealing 

would simplify and make more certain, at least in 

some contexts, the application of the swap dealer 

definition, there are also reasons for caution in 

incorporating a categorical exclusion for hedging. 

224See part IV.C, infra. 

225See CEA § 1a(33)(A)(i), 7 U.S.C. 1a(33)(A)(i). 

226See CEA § 1a(33)(B), 7 U.S.C. 1a(33)(B). 

227We do not believe that the differences between 

the exclusion in the major participant definitions 

for swaps held for the purpose of hedging or 

mitigating commercial risk and the exclusion in the 

swap dealer definition for certain swaps entered 

into for the purpose of hedging risks related to 

physical positions mean that the Commissions, or 

the CFTC in particular, have implemented two 

different definitions of hedging. In fact, neither of 

these exclusions define the term ‘‘hedging.’’ Rather, 

the differences between the two exclusions reflect 

differences in the parameters that must be satisfied 

in order to ensure that hedging swaps are 

appropriately excluded from the two different 

definitions. 

228As noted in the preceding paragraph, it is not 

necessary to make this distinction for purposes of 

the major swap participant definition. 

229See, e.g., 42 FR 42751 (Aug. 8, 1977). 

Although the latest formulation of the definition of 

bona fide hedging—CFTC Regulation § 151.5(a)— 

was recently adopted, see CFTC, Position Limits for 

Futures and Swaps; Final Rule and Interim Final 

Rule, 76 FR 71626 (Nov. 18, 2011), the bona fide 

hedging test has been in use for decades. 

230To be clear, the swaps a person enters into for 

hedging physical positions as defined in CFTC 

Regulation § 1.3(ggg)(6)(iii) are not indicative of 

dealing activity under any of the prongs of the swap 

dealer definition. 

231 In this regard, CFTC Regulation 

§ 1.3(ggg)(6)(iii) is different from certain of the 

CFTC’s rules regarding bona fide hedging, where a 

person’s purpose in entering into a swap may not 

be relevant. 

232We believe that, in practice, the difficulty of 

distinguishing, in applying the swap dealer 

definition, swaps entered into for the purpose of 

hedging from other types of swaps will be 

resolvable when the facts and circumstances of a 

person’s swap activities are taken into 

consideration in light of our interpretive guidance. 

233See, e.g., letters cited in note 141, supra. 

inappropriate for the swap dealer 

definition. 

First, the hedging exclusion that we 

are adopting is in the nature of a safe 

harbor; i.e., it describes activity that will 

not be considered swap dealing activity. 

As such, the CFTC believes that it is 

appropriate that the interim final rule 

not be cast broadly.223 This does not 

mean that other types of hedging 

activity that do not meet the 

requirements of the interim final rule 

are necessarily swap dealing activity. 

Rather, such hedging activity is to be 

considered in light of all other relevant 

facts and circumstances to determine 

whether the person is engaging in 

activity (e.g., accommodating demand 

for swaps, making a market for swaps, 

etc.) that makes the person a swap 

dealer. 

Second, the usefulness of an 

exclusion of all swaps that hedge or 

mitigate commercial risk for certain 

aspects of the major swap participant 

definition 224 is not a reason to use the 

same exclusion in the swap dealer 

definition, since the swap dealer 

definition serves a different function. 

The definition of the term ‘‘major swap 

participant,’’ which applies only to 

persons who are not swap dealers,225 is 

premised on the prior identification, by 

the swap dealer definition, of persons 

who accommodate demand for swaps, 

make a market in swaps, or otherwise 

engage in swap dealing activity. The 

major swap participant definition 

performs the subsequent function of 

identifying persons that are not swap 

dealers, but hold swap positions that 

create an especially high level of risk 

that could significantly impact the U.S. 

financial system.226 Only for this 

subsequent function is it appropriate to 

apply the broader exclusion of swaps 

held for the purpose of hedging or 

mitigating commercial risk.227

The CFTC believes that since the 

over-the-counter swap markets have 

operated largely without regulatory 

oversight and encompass swaps used for 

a wide variety of commercial purposes, 

no method has yet been developed to 

reliably distinguish, through a per se 

rule, between: (i) Swaps that are entered 

into for the purpose of hedging or 

mitigating commercial risk; and (ii) 

swaps that are entered into for the 

purpose of accommodating the 

counterparty’s needs or demands or 

otherwise constitute swap dealing 

activity, but which also have a hedging 

consequence.228 In contrast, the CFTC 

notes that it has set forth and modified 

standards for bona fide hedging 

transactions and granted exemptions in 

compliance with such standards for 

decades.229 These historicallydeveloped standards form the basis of 

the interim final rule excluding from the 

swap dealer analysis certain swaps that 

hedge the risks associated with a 

physical position. 

The exclusion in CFTC Regulation 

§ 1.3(ggg)(6)(iii) depends not on the 

effect or consequences of the swap, but 

on whether the purpose for which a 

person enters into a swap is to hedge a 

physical position as defined in the rule. 

If so, then the swap is excluded from the 

dealer analysis because using swaps for 

that purpose is inconsistent with, and is 

not, dealing activity.230 On the other 

hand, if, at the time the swap is entered 

into, the person’s purpose for entering 

into the swap is not as defined in CFTC 

regulation § 1.3(ggg)(6)(iii), or if it is 

unclear whether the swap is for such 

purpose, then the fact that the swap 

hedges the person’s exposure in some 

regard does not preclude consideration 

of that swap in the dealer analysis.231 In 

this latter case, all relevant facts and 

circumstances regarding the swap and 

the person’s activity with respect to the 

swap would be relevant in the 

determination of whether the person is 

a swap dealer.232

We believe that, based on the CFTC’s 

experience in applying bona fide 

hedging principles with respect to 

swaps hedging risks related to physical 

positions, the exclusion in CFTC 

Regulation § 1.3(ggg)(6)(iii) at this time 

is the best means of providing certainty 

to market participants regarding which 

swaps may be disregarded in the dealer 

analysis. However, commenters 

presented a range of views as to the 

exclusions from the dealer analysis that 

may be appropriate in this regard.233

Accordingly, the CFTC is implementing 

this exclusion on an interim rule basis 

and is seeking comments on all aspects 

of the interim rule, including any 

adjustments that may be appropriate in 

the rule or accompanying interpretive 

guidance. 

The CFTC also seeks comments on 

whether a different approach to swaps 

entered into for the purpose of hedging 

risk is appropriate to implement the 

statutory definition of the term ‘‘swap 

dealer.’’ 

For example, the CFTC invites 

commenters to address whether any 

exclusion of hedging swaps from the 

swap dealer analysis is appropriate, and 

if so, how swaps that are entered into 

for purposes of hedging may be 

identified and distinguished from other 

swaps. Commenters are encouraged to 

address whether it is relevant to 

distinguish swaps entered into for 

purposes of hedging from swaps that 

have a consequential result of hedging, 

and if so, how such swaps may be 

distinguished. Also, commenters may 

address whether the exclusion should 

be limited to swaps hedging risks 

related to physical positions or 

extended to encompass swaps hedging 

financial risks or other types of risks. 

Commenters should address whether 

the exclusion in CFTC Regulation 

§ 1.3(ggg)(6)(iii) should be consistent 

with the exclusion in CFTC Regulation 

§ 1.3(kkk). If so, why, and if not, why 

not? If the two exclusions should be 

consistent, does consistency require that 

that exclusions be identical, or would 

there be variations in application of the 

two exclusions? Are there market 

participants whose swap positions 

would be classified as held for the 

purpose of hedging or mitigating 

commercial risk under CFTC Regulation 

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30614 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

234See letter from Trading Coalition. One 

commenter specifically discussed floor traders and 

floor brokers and the regulatory regime that should 

apply to them following implementation of the 

Dodd Frank Act. See letter from Christopher K. 

Hehmeyer. 

We note that other commenters suggested that all 

swaps cleared on an exchange should be excluded 

from the dealer definitions. See letters cited in note 

138, supra. However, the discussion here is limited 

to persons who are registered as floor traders and 

meet other conditions. Also, the final rule provision 

discussed here does not exclude floor traders from 

the definition of the term ‘‘swap dealer;’’ rather, it 

provides that if the stated conditions are met, 

certain swaps entered into by floor traders are 

excluded from the swap dealer analysis. 

235See section 721(a)(11) of the Dodd-Frank Act 

(amending the definition of the term ‘‘floor trader’’ 

in CEA section 1a(23)). The Exchange Act does not 

have an equivalent regulatory category to floor 

trader under the CEA, and thus Congress did not 

make a similar amendment to the Exchange Act. 

236The definition of the term ‘‘floor trader’’ 

includes a person entering into swaps on a 

‘‘contract market.’’ See CEA section 1a(23). This 

exclusion also encompasses swaps that a registered 

floor trader enters into on or subject to the rules of 

a SEF, in addition to on or subject to the rules of 

a DCM, so long as the swap meets the conditions 

stated in the exclusion. 

237See CFTC Regulation § 1.3(ggg)(6)(iv). 

238The Commissions note the rule applies only 

to CFTC-registered floor traders engaging in swaps 

on DCMs or SEFs and cleared through DCOs. As 

noted above, the SEC does not have a regulatory 

category under the Exchange Act equivalent to floor 

trader under the CEA and none of these provisions 

apply in the context of security-based swap dealers 

or any entity regulated under the Exchange Act. 

Any person engaging in security-based swap 

transactions, whether or not these activities are 

similar to those engaged in by floor traders, will 

need to independently consider whether they need 

to register as security-based swap dealers as a result 

of their activities. 

239See letters cited at notes 83 to 84, supra. 

§ 1.3(kkk) but would not qualify for the 

exclusion under CFTC Regulation 

§ 1.3(ggg)(6)(iii)? If so, specifically 

identify the types of market participants 

and swaps. If the CFTC were to apply 

in the swap dealer definition the 

exclusion in CFTC Regulation § 1.3(kkk) 

in lieu of the exclusion in CFTC 

Regulation § 1.3(ggg)(6)(iii), would there 

be negative market impacts? If so, what 

are they? Would there be positive 

market impacts? If so, what are they? In 

particular, what type(s) of swaps that 

‘‘hedge or mitigate commercial risk,’’ 

but that are not excluded under the 

interim rule, may constitute dealing 

activity in light of the rules and 

interpretive guidance regarding the 

swap dealer definition set forth in this 

Adopting Release? 

Comments regarding the costs and 

benefits related to the interim final rule 

and any alternative approaches, 

including in particular the 

quantification of such costs and 

benefits, are also invited. 

Commenters are encouraged, to the 

extent feasible, to be comprehensive and 

detailed in providing their approach 

and rationale. The comment period for 

the interim final rule will close July 23, 

2012. 

f. Swaps Entered Into by Persons 

Registered as Floor Traders 

Commenters discussed whether the 

swap dealer definition encompasses the 

activity of entering into swaps on or 

subject to the rules of a DCM or SEF, 

and submitted for clearing to a 

derivatives clearing organization 

(‘‘DCO’’), particularly when firms 

engage in that activity using only 

proprietary funds.234 Because Title VII 

of the Dodd-Frank Act amended the 

definition of floor trader specifically to 

encompass activities involving 

swaps,235 the CFTC believes that it 

would lead to potentially duplicative 

regulation if floor traders engaging in 

swaps in their capacity as floor traders 

were also required to register as swap 

dealers. Accordingly, the CFTC believes 

that it is appropriate not to consider 

such swaps when determining whether 

a person acting as a floor trader, as 

defined under CEA section 1a(23),236

and registered with the CFTC under 

CFTC Regulation § 3.11, is a swap dealer 

if the floor trader meets certain 

conditions. Specifically, the final rule 

provides that, in determining whether a 

person is a swap dealer, each swap that 

the person enters into in its capacity as 

a floor trader as defined by CEA section 

1a(23) or on a SEF shall not be 

considered for the purpose of 

determining whether the person is a 

swap dealer, provided that the person: 

(i) Is registered with the CFTC as a 

floor trader pursuant to CFTC 

Regulation § 3.11; 

(ii) enters into swaps solely with 

proprietary funds for that trader’s own 

account on or subject to the rules of a 

DCM or SEF, and submits each such 

swap for clearing to a DCO; 

(iii) is not an affiliated person of a 

registered swap dealer; 

(iv) does not directly, or through an 

affiliated person, negotiate the terms of 

swap agreements, other than price and 

quantity or to participate in a request for 

quote process subject to the rules of a 

DCM or SEF; 

(v) does not directly or through an 

affiliated person offer or provide swap 

clearing services to third parties; 

(vi) does not directly or through an 

affiliated person enter into swaps that 

would qualify as hedging physical 

positions pursuant to CFTC Regulation 

§ 1.3(ggg)(6)(iii) or hedging or mitigating 

commercial risk pursuant to CFTC 

Regulation § 1.3(kkk), with the 

exception of swaps that are executed 

opposite a counterparty for which the 

transaction would qualify as a bona fide 

hedging transaction; 

(vii) does not participate in any 

market making program offered by a 

DCM or SEF; and 

(viii) complies with the record 

keeping and risk management 

requirements of CFTC Regulation 

§§ 23.201, 23.202, 23.203, and 23.600 

with respect to each such swap as if it 

were a swap dealer.237

This rule permits floor traders who 

might otherwise be required to register 

as a swap dealer to be registered solely 

as floor traders with the CFTC. Given 

the limitations on the scope of the rule, 

the requirements for floor traders using 

the relief to comply with recordkeeping 

and risk management rules applicable to 

swap dealers as a condition of the relief, 

and the fact that swaps subject to the 

rule are traded on a DCM or SEF and 

cleared through a DCO, the CFTC 

believes it is not necessary to have floor 

traders subject to this rule register as 

both floor traders and swap dealers as 

a result of swaps activities covered by 

the rule.238

g. Additional Interpretive Issues 

Relating to the ‘‘Swap Dealer’’ 

Definition 

As noted above, the Commissions, in 

consideration of comments received, are 

making certain modifications to the 

interpretive guidance concerning the 

definition of the term ‘‘swap dealer’’ set 

out in the Proposing Release. However, 

the Commissions are retaining certain 

elements of their proposed 

interpretation of the term ‘‘swap 

dealer,’’ as discussed below. 

First, with respect to the comments 

asserting that the proposed interpretive 

approach is overly broad,239 we note 

that the statute provides that the term 

‘‘swap dealer’’ means ‘‘any person’’ who 

engages in the activities described in 

any of the four prongs of the definition, 

subject to the exceptions and 

qualifications set out in the statute. In 

view of this statutory text, these 

comments effectively assert that the 

statute should be interpreted to include 

preconditions to swap dealer status that 

are not set forth in the statute. For 

example, the assertion that the swap 

dealer definition must be limited to 

persons who enter into swaps on both 

sides of the market would impose a 

requirement that does not exist in the 

statute. Similarly, the comments to the 

effect that swap dealers are only those 

persons who seek to profit by 

intermediating between swap market 

participants adds a requirement not set 

forth in the statute. 

We believe, though, that the activities 

that cause a person to be covered by the 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30615 

240The language of the four statutory tests for 

swap dealer status (which refer to a person who 

holds itself out as a dealer, is commonly known as 

a dealer, makes a market in swaps or regularly 

enters into swaps with counterparties) contemplate 

that a dealer is a person who, through its swap 

activities, functions to create legal relationships that 

transfer risk between independent persons. See 

CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A). 

See also Proposing Release, 75 FR at 80177 

(describing swap dealers as those persons whose 

function is to serve as the points of connection in 

the swap markets); letter from COPE I at 4 (‘‘Simply 

stated, dealers are in the regular business of being 

a point of connection to the market for others that 

need access to the market to hedge risk.’’): 

Roundtable Transcript at 21 (remarks of Richard 

Ostrander, Morgan Stanley; ‘‘a dealer is someone 

who is out there willing to enter into trades’’). 

241See part II.B.2.d.iii, supra. 

242See parts II.A.2.f.ii and iii, supra. 

243See letters cited in note 117, supra. Comments 

expressing concern that the definition of the term 

‘‘swap dealer’’ could include physical commodities 

businesses also were presented to Congress during 

consideration of legislation leading to passage of the 

Dodd-Frank Act. See Proposed Legislation by the 

U.S. Department of the Treasury Regarding the 

Regulation of Over-The-Counter Derivatives 

Markets: Hearing Before the H. Comm. On 

Agriculture, 111th Cong. 103 (2009) (submitted 

report on behalf of the Working Group of 

Commercial Energy Firms). However, as noted 

above, there is no exclusion in the statutory 

definition for such businesses. 

244The list of ISDA Primary Members is available 

at http://www.isda.org/membership/ 

isdamemberslist.pdf. 

245See note 188, supra. 246See letters cited in note 84, supra. 247See letters cited in note 86, supra. As noted 

above in the discussion of market making, a swap 

dealer may in some circumstances enter into swaps 

on only one side of the market. 

swap dealer definition should be 

addressed in the context of the four 

prongs of the statutory definition. That 

is, the relevant question is whether a 

person engages in any of the types of 

activities enumerated in the statute, and 

not whether the person meets any 

additional, supposedly implicit 

preconditions to swap dealer status. 

Second, the Commissions continue to 

believe, as stated in the Proposing 

Release, that accommodating demand 

and facilitating interest are 

appropriately used as factors in 

identifying swap dealers. As noted by 

commenters, however, the mere fact that 

a person entering into a particular swap 

has the effect of ‘‘accommodating 

demand’’ or ‘‘facilitating interest’’ in 

swaps does not conclusively establish 

that the person is a swap dealer. Instead, 

the person’s overall activities in the 

swap market (or particular sector of the 

swap market if the person is active in a 

variety of sectors) should be compared 

against these factors. If, in the context of 

its overall swap activities, a person 

fulfills a function of accommodating 

demand or facilitating interest in swaps 

for other parties, then these factors 

would be significant in the analysis and 

the person is likely to be a swap 

dealer.240

Third, as discussed above, we have 

adopted some of the objective criteria 

suggested by commenters with respect 

to the indicia of holding oneself out as 

a dealer or being commonly known as 

a dealer, market making, and the 

‘‘regular business’’ prongs of the swap 

dealer definition.241 For instance, 

allocating staff and technological 

resources to swap activity, deriving 

revenue and profit from swap activity, 

or responding to customer-initiated 

orders for swaps can all be indicative of 

having ‘‘a regular business’’ of entering 

into swaps and, therefore, indicative of 

being a swap dealer. In addition, 

activities such as providing advice 

about swaps or offering oneself as a 

point of connection to other parties 

needing access to the swap market are 

indicative of a person holding itself out 

as a swap dealer, if the person also 

enters into swaps in conjunction with 

such activities. 

The guidance we have provided about 

these indicia is responsive to concerns 

expressed by commenters about the 

application of the swap dealer 

definition to energy markets. As 

described above, some commenters 

stated that in energy markets, unlike in 

some other markets, end-users often 

enter into swaps directly with each 

other, on both sides of the market, 

without the involvement of a separate 

category of businesses serving as 

intermediaries.242 As a result, according 

to these commenters, energy swap 

market participants often engage in 

some of the activities that are indicative 

of swap dealer status. Some of these 

commenters contended that our activitybased interpretation of the swap dealer 

definition could therefore result in the 

inappropriate inclusion of energy 

market participants in the coverage of 

the definition of the term ‘‘swap 

dealer.’’ 243

We believe that the language of the 

statutory ‘‘swap dealer’’ definition 

supports our activity-based 

interpretation and does not support 

categorical exclusions of particular 

types of persons from the ‘‘swap dealer’’ 

definition based on the general nature of 

their businesses. Further evidence that 

such a categorical exclusion is 

unwarranted is provided by the fact that 

a number of energy market 

participants—BP Plc., Cargill, 

Incorporated, Centrica Energy Limited, 

ConocoPhillips, EDF Trading Limited, 

GASELYS, Hess Energy Trading 

Company, LLC, Hydro-Quebec, Koch 

Supply & Trading, LP, RWE Supply & 

Trading GmbH, Shell Energy North 

America (US), L.P., STASCO, Totsa 

Total Oil Trading S.A., and Vattenfall 

Energy Trading Netherlands N.V.—have 

voluntarily joined ISDA as primary 

dealers.244 As previously noted, any 

business organization that ‘‘deals in 

derivatives shall be eligible for election 

to membership in the Association as a 

primary member, provided that no 

person or entity shall be eligible for 

membership as a Primary Member if 

such person or entity participates in 

derivatives transactions solely for the 

purpose of risk hedging or asset or 

liability management.’’ 245 Hence, a 

categorical exclusion from the ‘‘swap 

dealer’’ definition based on any 

particular type of business or general 

market activity also would be 

inconsistent with current industry 

structure and practice. 

At the same time, however, the fact 

that a person engages in some swap 

activities that are indicative of swap 

dealer status does not, by itself, mean 

that the person is covered by the 

definition of the term ‘‘swap dealer.’’ 

The ‘‘not as part of a regular business’’ 

exception and our guidance about its 

meaning address the issue of swap 

market participants that engage to some 

extent in the activities characteristic of 

swap dealers. The guidance we have 

provided here therefore provides the 

appropriate approach to addressing 

these issues in energy markets as 

elsewhere. 

Although several commenters 

attempted to articulate bright-line tests 

that would differentiate swap dealers 

from other swap market participants, 

the suggested bright-line tests generally 

could not be applied across the board to 

all types of swap market activity. For 

example, some commenters suggested 

that swap dealers can be identified as 

those who profit from entering into 

swaps on both sides of the market (and 

under the interpretive approach set 

forth in this Adopting Release, such 

activity may be an indicator of swap 

dealing).246 But other commenters said 

that, in certain circumstances, entering 

into swaps on both sides of the market 

is not necessarily indicative of swap 

dealing.247

The ways in which participants 

throughout the market use swaps are 

simply too diverse for swap dealer 

status to be resolved with a single, onefactor test. This is reflected in the 

statutory definition of the term ‘‘swap 

dealer’’ itself. Focused as it is on types 

of activities, with four prongs set forth 

in the alternative to cover different 

types of swap dealing activity, the 

statutory swap dealer definition is not 

susceptible to the bright-line test that 

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30616 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

248See Exchange Act rule 3a71–1(a), (b). 

249See note 31, supra. 

250The principles embedded within the ‘‘dealertrader distinction’’ are not solely useful for 

distinguishing persons who constitute dealers from 

active ‘‘traders,’’ but also are applicable to 

distinguishing dealers from non-dealers such as 

hedgers or investors. The ‘‘dealer-trader’’ 

nomenclature has been used for decades. See Loss, 

Securities Regulation 722 (1st ed. 1951) (‘‘One 

aspect of the ‘business’ concept is the matter of 

drawing the line between a ‘dealer’ and a trader— 

an ordinary investor who buys and sells for his own 

account with some frequency.’’). 

251For example, while the ‘‘dealer’’ definition 

encompasses certain persons in the business of 

‘‘buying and selling’’ securities, the ‘‘security-based 

swap dealer’’ definition does not address either 

‘‘buying’’ or ‘‘selling.’’ As we noted in the 

Proposing Release, we do not believe that the lack 

of those terms in the ‘‘security-based swap dealer’’ 

definition leads to material interpretive 

distinctions, as the Dodd-Frank Act amended the 

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

and the Exchange Act definitions of ‘‘sale’’ and 

‘‘sell,’’ to encompass the execution, termination 

(prior to its scheduled maturity date), assignment, 

exchange or similar transfer or conveyance of, or 

extinguishing of rights or obligations under, a 

security-based swap. See Proposing Release, 75 FR 

at 80178 n.26 (citing Dodd-Frank Act sections 

761(a)(3), (4), which amend Exchange Act sections 

3(a)(13), (14)). 

At the same time, we note that the ‘‘dealer’’ 

definition requires the conjunctive ‘‘buying and 

selling’’—which connotes a degree of offsetting twosided activity. In contrast, the ‘‘security-based swap 

dealer’’ definition (particularly the ‘‘regularly enters 

into security-based swaps’’ language of the 

definition’s third test) lacks that conjunctive 

terminology. 

252See note 171, supra. 

253See note 251, supra. 

254The analysis also should account for the fact 

that a party to a security-based swap can use other 

derivatives or cash market instruments to hedge the 

risks associated with the security-based swap 

position, meaning that two-way trading is not 

necessary to maintain a flat risk book. 

255Even though we expect trading of securitybased swaps on security-based swap execution 

facilities or exchanges following the 

implementation of Title VII, we expect there to 

remain a significant amount of over-the-counter 

activity involving security-based swaps. 

256For example, the definition of ‘‘market maker’’ 

in Exchange Act section 3(a)(38)—which is 

applicable for purposes of the Exchange Act ‘‘unless 

the context otherwise requires’’ (see Exchange Act 

section 3(a))—defines the term ‘‘market maker’’ to 

mean ‘‘any specialist permitted to act as a dealer, 

any dealer acting in the capacity of block 

positioner, and any dealer who, with respect to a 

security, holds himself out (by entering quotations 

in an inter-dealer communications system or 

otherwise) as being willing to buy and sell such 

security for his own account on a regular or 

continuous basis.’’ That definition is useful in the 

context of systems in which standardized securities 

are regularly or continuously bought and sold, but 

would not be apposite in the context of nonstandardized securities or securities that are not 

regularly or continuously transacted. 

some commenters seek. For these 

reasons, we continue to believe that it 

is appropriate to apply the multi-factor 

interpretive approach set forth in this 

Adopting Release. 

In closing, we emphasize that the 

purpose of in this part IV.A.4 is to 

provide guidance as to how the rules 

further defining the term ‘‘swap dealer’’ 

will be applied in particular, complex 

situations where a person’s status as a 

swap dealer may be uncertain. Even 

though bright-line tests and categorical 

exclusions are inappropriate, we 

recognize that the large majority of 

market participants use swaps for 

normal course hedging, financial, 

investment or trading purposes and are 

not swap dealers. 

5. Final Rules and Interpretation— 

Definition of ‘‘Security-Based Swap 

Dealer’’ 

a. General Reliance on the Dealer-Trader 

Distinction 

As discussed above, we are adopting 

a rule under the Exchange Act that 

defines ‘‘security-based swap dealer’’ in 

terms of the four statutory tests and the 

exclusion for security-based swap 

activities that are not as part of a 

‘‘regular business.’’ 248 Also, we believe 

that the dealer-trader distinction 249— 

which already forms a basis for 

identifying which persons fall within 

the longstanding Exchange Act 

definition of ‘‘dealer’’—in general 

provides an appropriate framework for 

interpreting the meaning of ‘‘securitybased swap dealer.’’ 250 While there are 

differences in the structure of those two 

statutory definitions,251 we believe that 

their parallels—particularly both 

definitions’ exclusions for activities that 

are ‘‘not part of a regular business’’— 

warrant analogous interpretive 

approaches for distinguishing dealers 

from non-dealers. 

As discussed above,252 the 

Commissions note that interpretations 

of the applicability of the dealer-trader 

distinction to the ‘‘swap dealer’’ 

definition under the CEA do not affect 

existing, or future, interpretations of the 

dealer-trader distinction under the 

Exchange Act—both with regard to the 

‘‘security-based swap dealer’’ definition, 

and with regard to the ‘‘dealer’’ 

definition. 

In interpreting the security-based 

swap dealer definition in terms of the 

dealer-trader distinction, the 

Commissions have been mindful that 

some commenters expressed the view 

that we instead should rely on other 

interpretive factors that were identified 

in the Proposing Release (e.g., 

accommodating demand). We believe, 

nonetheless, that the dealer-trader 

distinction forms the basis for a 

framework that appropriately 

distinguishes between persons who 

should be regulated as security-based 

swap dealers and those who should not. 

We also believe that the distinction 

affords an appropriate degree of 

flexibility to the analysis, and that it 

would not be appropriate to seek to 

codify the distinction. 

At the same time, the Commissions 

recognize that the dealer-trader 

distinction needs to be adapted to apply 

to security-based swap activities in light 

of the special characteristics of securitybased swaps and the differences 

between the ‘‘dealer’’ and ‘‘securitybased swap dealer’’ definitions. 

Relevant differences include: 

• Level of activity—Security-based 

swap markets are marked by less 

activity than markets involving certain 

other types of securities (while 

recognizing that some debt and equity 

securities are not actively traded). This 

suggests that in the security-based swap 

context concepts of ‘‘regularity’’ should 

account for the level of activity in the 

market. 

• No separate issuer—Each 

counterparty to a security-based swap in 

essence is the ‘‘issuer’’ of that 

instrument; in contrast, dealers in cash 

market securities generally transact in 

securities issued by another party. This 

distinction suggests that the concept of 

turnover of ‘‘inventory’’ of securities, 

which has been identified as a factor in 

connection with the dealer-trader 

distinction, is inapposite in the context 

of security-based swaps. Moreover, this 

distinction—along with the fact that the 

‘‘security-based swap dealer’’ definition 

lacks the conjunctive ‘‘buying and 

selling’’ language of the ‘‘dealer’’ 

definition 253—suggests that concepts of 

two-sided markets at times would be 

less relevant for identifying ‘‘securitybased swap dealers’’ than they would be 

for identifying ‘‘dealers.’’ 254

• Predominance of over-the-counter 

and non-standardized instruments— 

Security-based swaps thus far are not 

significantly traded on exchanges or 

other trading systems, in contrast to 

some cash market securities (while 

recognizing that many cash market 

securities also are not significantly 

traded on those systems).255 These 

attributes—along with the lack of 

‘‘buying and selling’’ language in the 

security-based swap dealer definition, 

as noted above—suggest that concepts of 

what it means to make a market need to 

be construed flexibly in the context of 

the security-based swap market.256

• Mutuality of obligations and 

significance to ‘‘customer’’ 

relationship—In contrast to a secondary 

market transaction involving equity or 

debt securities, in which the completion 

of a purchase or sale transaction can be 

expected to terminate the mutual 

obligations of the parties to the 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30617 

257E.g., capital and margin requirements 

(Exchange Act section 15F(e)), and requirements for 

segregation of collateral (Exchange Act section 3E). 

258E.g., requirements with respect to business 

conduct when transacting with special entities 

(Exchange Act sections 15F(h)(2), (h)(4), (h)(5)); 

disclosure requirements (Exchange Act section 

15F(h)(3)(B)); requirements for fair and balanced 

communications (Exchange Act section 

15F(h)(3)(C)); other requirements related to the 

public interest and investor protection (Exchange 

Act section 15F(h)(3)(D)); and conflict of interest 

provisions (Exchange Act section 15F(j)(5)). 

259E.g., reporting and recordkeeping 

requirements (Exchange Act section 15F(f)); daily 

trading records requirements (Exchange Act section 

15F(g)); regulatory standards related to the 

confirmation, processing, netting, documentation 

and valuation of security-based swaps (Exchange 

Act section 15F(i)); position limit monitoring 

requirements (Exchange Act section 15F(j)(1)); risk 

management procedure requirements (Exchange Act 

section 15F(j)(2)); and requirements related to the 

disclosure of information to regulators (Exchange 

Act section 15F(j)(3)). 

260The conclusion that a person’s relationship 

with its counterparties can lead to associated 

obligations is consistent with the ‘‘shingle theory,’’ 

which implies a duty of fair dealing when a person 

hangs out its shingle to do business. See Securities 

and Exchange Commission, Report of the Special 

Study of Securities Market Part I at 238 (1963) (‘‘An 

obligation of fair dealing, based upon the general 

antifraud provisions of the Federal securities laws, 

rests upon the theory that even a dealer at arm’s 

length impliedly represents when he hangs out his 

shingle that he will deal fairly with the public.’’; 

footnote omitted); Weiss, Registration and 

Regulation of Brokers and Dealers 171 (1965) (‘‘the 

solicitation and acceptance by a broker-dealer of 

orders from customers and the confirmation of 

transactions do constitute a representation by the 

broker-dealer that he will deal fairly with his 

customers and that such transactions will be 

handled promptly in the usual manner, in 

accordance with trade custom’’). 

261The importance of regulating dealers due to 

the centrality of their market role was illustrated by 

the Government Securities Act of 1986. When 

Congress provided for the regulation of government 

securities dealers, Congress specifically cited the 

lack of regulation as contributing to the failures of 

several unregulated government securities dealers. 

See S. Rep. No. 99–426 (1986), as reprinted in 1986 

U.S.C.C.A.N. 5395, 5400–04. The resulting statute 

provided for a definition of ‘‘government securities 

dealer’’ that in relevant part is parallel to the 

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

dealer,’’ particularly with regard to sharing an 

exclusion for activities that are not part of a 

‘‘regular business.’’ See Exchange Act section 

3(a)(44). 

262Similarly, depending on the relevant facts and 

circumstances, the presence of certain of the 

illustrative activities described here does not 

necessitate the conclusion that the entity is a dealer. 

263This is to be distinguished from an entity 

entering into security-based swaps for other 

business purposes, such as to gain economic 

exposure to a particular market. 

264A sales force, however, is not a prerequisite to 

a person being a security-based swap dealer. For 

example, a person that enters into security-based 

swaps in a dealing capacity can fall within the 

dealer definition even if it uses an affiliated entity 

to market and/or negotiate those security-based 

swaps (e.g., the person is a booking entity). 

Depending on the applicable facts and 

circumstances, the affiliate that performs the 

marketing and/or negotiation functions may fall 

within the Exchange Act’s definition of ‘‘broker’’ 

(which was not revised by Title VII). See Exchange 

Act section 3(a)(4)(A). 

265 Indicia of this objective may include, but 

would not be limited to, maintaining separate 

profit/loss statements in connection with this type 

of activity, and/or devoting staff and resources to 

this type of activity. 

In this regard, we believe that the issue of 

whether a person tends to take the prices offered 

in the market, rather than helping to set those prices 

(such as by providing quotes, placing limit orders, 

or otherwise accommodating demand), can be 

relevant as a factor for distinguishing security-based 

swap dealers from non-dealers. At the same time, 

we are mindful that a dealer may also accept the 

market price as part of its dealer activity (such as 

when a person enters into a security-based swap to 

offset the risk it assumes in connection with its 

security-based swap dealing activity); as a result, 

the fact that a person regularly takes the market 

price as part of its security-based swap transactions 

does not foreclose the possibility that the person 

may be a security-based swap dealer. 

266See letter from ISDA I. 

267 It is possible for a dealer to be compensated 

for providing liquidity by entering into sequential 

offsetting positions, or by hedging the securitybased swap position by using a different type of 

security-based swap, a swap or some other financial 

instrument. Accordingly, a rule of decision that 

permitted a person to avoid dealer regulation by 

providing liquidity in connection with securitybased swaps, and laying off the associated risk 

using a different type of security-based swap, a 

swap or a different instrument entirely, would be 

susceptible to abuse. Moreover, as noted above, the 

Continued 

transaction, the parties to a securitybased swap often will have an ongoing 

obligation to exchange cash flows over 

the life of the agreement. In light of this 

attribute, some market participants have 

expressed the view that they have 

‘‘counterparties’’ rather than 

‘‘customers’’ in the context of their swap 

activities. 

It also is necessary to use the dealertrader distinction to interpret the 

security-based swap dealer definition so 

that the statutory provisions that will 

govern security-based swap dealers are 

applied in an effective and logical way. 

Those statutory provisions added by the 

Dodd-Frank Act advance financial 

responsibility (e.g., the ability to satisfy 

obligations, and the maintenance of 

counterparties’ funds and assets) 

associated with security-based swap 

dealers’ activities,257 other counterparty 

protections,258 and the promotion of 

market efficiency and transparency.259

As a whole, the relevant statutory 

provisions suggest that we should apply 

the dealer-trader distinction to interpret 

the security-based swap dealer 

definition in a way that identifies those 

persons for which regulation is 

warranted either: (i) Due to the nature 

of their interactions with 

counterparties; 260 or (ii) to promote 

market stability and transparency, in 

light of the role those persons occupy 

within the security-based swap 

markets.261

b. Principles for Applying the DealerTrader Distinction to Security-Based 

Swap Activity 

In light of the statutory security-based 

swap dealer definition, statutory 

provisions applicable to security-based 

swap dealers and market characteristics 

addressed above, the Commissions 

believe that the factors set forth below 

are relevant for identifying securitybased swap dealers and for 

distinguishing those dealers from other 

market participants. This guidance 

seeks to address commenter requests 

that we further clarify the scope of the 

security-based swap dealer definition, 

and the Commissions believe that these 

factors provide appropriate guidance 

without being inflexible or allowing the 

opportunity for evasion that may 

accompany a bright-line test. At the 

same time, the determination of whether 

a person is acting as a security-based 

swap dealer ultimately depends on the 

relevant facts and circumstances. In 

light of the overall context in which a 

person’s activity occurs, the absence of 

one or more of these factors does not 

necessitate the conclusion that a person 

is not a security-based swap dealer.262

• Providing liquidity to market 

professionals or other persons in 

connection with security-based swaps. 

A market participant might manifest 

this indication of dealer activity by 

accommodating demand or facilitating 

interest expressed by other market 

participants,263 holding itself out as 

willing to enter into security-based 

swaps, being known in the industry as 

being available to accommodate demand 

for security-based swaps, or maintaining 

a sales force in connection with 

security-based swap activities.264

• Seeking to profit by providing 

liquidity in connection with securitybased swaps. A market participant may 

manifest this indication of securitybased swap dealer activity—which is 

consistent with the definition’s ‘‘regular 

business’’ requirement—by seeking 

compensation in connection with 

providing liquidity involving securitybased swaps (e.g., by seeking a spread, 

fees or other compensation not 

attributable to changes in the value of 

the security-based swap).265 The 

Commissions do not believe that this 

necessarily requires that a person be 

available to take either side of the 

market at any time, or that a person 

continuously engage in this type of 

activity, to be a security-based swap 

dealer. Although one commenter 

expressed the view that the securitybased swap dealer definition requires 

that a person be consistently available to 

take either side of the market,266 in our 

view such an approach would be 

underinclusive.267

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30618 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

definition of ‘‘security-based swap dealer’’ does not 

contain the ‘‘buying and selling’’ language found in 

the general Exchange Act definition of ‘‘dealer.’’ 

Thus, while being regularly willing to enter into 

either side of the security-based swap market would 

suggest that a person is engaged in dealing activity, 

the absence of such activity should not necessarily 

lead to an inference that a person is not acting as 

a dealer. 

We also note that some commenters have stated 

that two-way quoting by itself should not 

necessarily be enough to make a person a dealer, 

and some of those commenters specifically stated 

that a person may use two-sided quotes as part of 

the price discovery process or to elicit trading 

interest. See, e.g., letter from MFA I. Here too, it is 

important to consider whether the activity also has 

a dealing business purpose, such as seeking to 

profit by providing liquidity. Moreover, all 

participants in the security-based swap market, 

whether or not security-based swap dealers, should 

be mindful of the potential application of the 

antifraud and anti-manipulation provisions of the 

federal securities laws to such activities. Section 

10(b) of the Exchange Act and Exchange Act rule 

10b-5 particularly prescribe the use of any 

manipulative or fraudulent device in connection 

with the purchase or sale of any security, which 

includes manipulative trading. See Terrance 

Yoshikawa, Securities Exchange Act Release No. 

53731 (Apr. 26, 2006), 87 SEC Docket 2924, 2930– 

31 & n.19 (citing Ernst & Ernst v. Hochfelder, 425 

U.S. 185, 199 (1976)). The SEC has characterized 

manipulation as ‘‘the creation of deceptive value or 

market activity for a security, accomplished by an 

intentional interference with the free forces of 

supply and demand.’’ See Swartwood, Hesse, Inc., 

50 S.E.C. 1301, 1307 (1992) (citing Hochfelder, 425 

U.S. at 199; Schreiber v. Burlington Northern, Inc., 

472 U.S. 1 (1985); Feldbaum v. Avon Products, Inc., 

741 F.2d 234 (8th Cir. 1984)). 

268The SEC has proposed rules to implement 

Title VII provisions relating to external business 

conduct standards for security-based swap dealers 

(as well as major security-based swap participants). 

See Exchange Act Release No. 64766 (June 29, 

2011), 76 FR 42396 (July 18, 2011). 

269This factor would also reasonably take into 

account whether a preexisting relationship 

involving other types of securities or other financial 

instruments is present. For example, to the extent 

a person has an existing broker or dealer 

relationship with a counterparty in connection with 

other types of securities, and also enters into a 

security-based swap with that counterparty, a 

reasonable inference would be that the person 

entered into the security-based swap in a dealer 

capacity. Any other approach would invite abuse, 

as persons could seek to leverage existing 

relationships of trust while avoiding regulation as 

a security-based swap dealer. 

270See letter from FSR I. 

271For purposes of the dealer-trader analysis, as 

it applies in the context of security-based swaps or 

any other security, we would not expect contractual 

provisions stating that the counterparty is not 

relying on the person’s advice to have any 

significance. 

272Under the proposal of the SEC, the Board, the 

OCC and the FDIC to implement the provisions of 

section 619 of the Dodd-Frank Act (also known as 

the ‘‘Volcker Rule’’), a person who claims the 

benefit of the market maker exception to that 

section’s prohibitions and restrictions on 

proprietary trading in connection with securitybased swap activities would be required to register 

with the SEC as a security-based swap dealer, 

unless the person is exempt from registration or is 

engaged in a dealing business outside the U.S., and 

is subject to substantive regulation in the 

jurisdiction where the business is located. See 

Securities Exchange Act Release No. 65545, 76 FR 

68846, 68947 (Nov. 7, 2011) (proposed 

implementing rule § ___.4(b)(2)(iv)(C)). 

273See, e.g., letter from Traders Coalition. 

274 Given the current nature of the security-based 

swap market, including the present level of activity 

and the present lack of significant trading of 

security-based swaps on exchanges or organized 

trading systems, we believe that it would negate the 

legislative intent to interpret the definition’s use of 

market making concepts to require the same use of 

quotation media that are incorporated into the 

interpretation of market making concepts in the 

context of securities that are actively traded on an 

organized exchange or trading system. At the same 

time, we recognize that routine activity in the 

security-based swap market is not necessarily 

indicative of making a market in security-based 

swaps. For example, persons may routinely be 

active in the market for purposes of hedging, to 

advance their investment objectives, or to engage in 

proprietary trading. 

275The definition of ‘‘security-based swap dealer’’ 

contains four alternative tests, only two of which 

use market making terminology. Moreover, the third 

test of the security-based swap dealer definition— 

which addresses persons who regularly enter into 

security-based swaps as an ordinary course of 

business for their own account—appears 

particularly inapt as a proxy for market making 

activity. Transacting with customers is not an 

element of this alternative test. A person thus may 

be a security-based swap dealer even if it transacts 

exclusively with other market professionals. Cf. 

OCC, ‘‘Risk Management of Financial Derivatives’’ 

3–4 (1997) (stating that OCC has classified banks as 

‘‘Tier I’’ dealers if they act as market makers by 

‘‘providing quotes to other dealers and brokers, and 

other market professionals’’). Compare letter from 

ISDA I (taking the view that the dealer definition 

should be interpreted in the context of marketmaking concepts). 

276The analysis of the status of members of such 

exchanges and trading systems in part may be 

influenced by the final Exchange Act rules that 

govern such systems, as well as the internal rules 

of such systems. 

• Providing advice in connection with 

security-based swaps or structuring 

security-based swaps. Advising a 

counterparty as to how to use securitybased swaps to meet the counterparty’s 

hedging goals, or structuring securitybased swaps on behalf of a counterparty, 

also would indicate security-based swap 

dealing activity. It particularly is 

important that persons engaged in those 

activities are appropriately regulated so 

that their counterparties will receive the 

protections afforded by certain of the 

statutory business conduct rules (e.g., 

special entity requirements and 

communication requirements) 268

applicable to security-based swap 

dealers.269 The Commissions recognize 

commenter concerns that end-users may 

also develop new types of securitybased swaps,270 but also recognize that 

the activities of end-users related to the 

structuring of security-based swaps for 

purposes of hedging commercial risk are 

appreciably different than being in the 

business of structuring security-based 

swaps on behalf of a counterparty. 

• Presence of regular clientele and 

actively soliciting clients. These dealertrader factors would reasonably appear 

to be applicable in the security-based 

swap context, just as they are applicable 

in the context of other types of 

securities, as indicia of a business 

model that seeks to profit by providing 

liquidity. The Commissions are mindful 

that some industry participants have 

highlighted a distinction between 

‘‘counterparties’’ and ‘‘customers’’ in 

connection with swaps, and have 

suggested that they have no 

‘‘customers’’ in the swap context. We do 

not believe such points of nomenclature 

are significant for purposes of 

identifying security-based swap dealers, 

however.271

• Use of inter-dealer brokers. As with 

activities involving other types of 

securities, the Commissions would 

expect that a person’s use of an interdealer broker in connection with 

security-based swap activities to be an 

indication of the person’s status as a 

dealer. 

• Acting as a market maker on an 

organized security-based swap 

exchange or trading system. Acting in a 

market maker capacity on an organized 

exchange or trading system for securitybased swaps would indicate that the 

person is acting as a dealer.272 While the 

Commissions recognize that some 

commenters have expressed the view 

that persons who solely enter into 

security-based swaps on an organized 

security-based swap exchange or trading 

system should not be regulated as 

security-based swap dealers,273 in our 

view such an approach would be 

contrary to the express language of the 

definition. This is not to say, of course, 

that the presence of an organized 

exchange or trading system is a 

prerequisite to being a market maker for 

purposes of the security-based swap 

dealer definition.274 Moreover, acting as 

a market maker is not a prerequisite to 

being a security-based swap dealer.275

On the other hand, being a member of 

an organized exchange or trading system 

for purposes of trading security-based 

swaps does not necessarily by itself 

make a person a security-based swap 

dealer.276

As with the current application of the 

dealer-trader distinction to the 

Exchange Act ‘‘dealer’’ definition, the 

question of whether a person is acting 

as a security-based swap dealer 

ultimately will turn upon the relevant 

facts and circumstances, as informed by 

these criteria. 

c. Additional Interpretive Issues 

Activity by hedgers. As noted above, 

a number of commenters raised 

concerns that an overbroad ‘‘securitybased swap dealer’’ definition would 

inappropriately encompass persons 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30619 

277See, e.g., letter from Church Alliance. 

278See Proposing Release, 75 FR at 80178 n.27. 

The Proposing Release also noted that if a person’s 

other activities satisfy the definition of securitybased swap dealer, the person must comply with 

the applicable requirements with regard to all of its 

security-based swap activities, absent an order to 

the contrary. We further noted in the Proposing 

Release that we would expect end-users to use 

security-based swaps for hedging purposes less 

commonly than they use swaps for hedging 

purposes. 

279 In addition, consistent with the exclusion 

from the dealer analysis of activities involving 

majority-owned affiliates, see part II.C, infra, to the 

extent that a person engages in activities to hedge 

positions subject to the inter-affiliate exclusion, 

absent other activity, the Commission would not 

expect those hedging transactions to lead a person 

to be a security-based swap dealer. Conversely, 

security-based swap activities connected with the 

indicia of dealing discussed above (e.g., seeking to 

profit by providing liquidity in connection with 

security-based swaps) themselves would suggest 

security-based swap dealing activity. 

280For example, if a person were to use other 

instruments to hedge the risks associated with its 

security-based swap dealing activity, that hedging 

would not undermine the obligation of the person 

to register as a security-based swap dealer, 

notwithstanding the fact that it could be asserted 

that the dealing positions happen to hedge those 

other positions. 

281See letters from ISDA I and Traders Coalition. 

282Particularly in light of the view expressed by 

some market participants that they only have 

‘‘counterparties’’ in the swap markets, and not 

‘‘customers,’’ any interpretation of the ‘‘securitybased swap dealer’’ definition that is predicated on 

the existence of a customer relationship may lead 

to an overly narrow construction of the definition. 

283For example, a person’s activity involving 

entering into security-based swaps on a SEF may 

cause it to be a security-based swap dealer even in 

the absence of a customer relationship with any of 

its counterparties. 

284As noted above, these were: contacting 

potential counterparties to solicit interest; 

developing new types of swaps or security-based 

swaps and informing potential counterparties of 

their availability and of the person’s willingness to 

enter into the swap or security-based swap; 

membership in a swap association in a category 

reserved for dealers; providing marketing materials 

describing the type of swaps or security-based 

swaps the party is willing to enter into; and 

generally expressing a willingness to offer or 

provide a range of products or services that include 

swaps or security-based swaps. See Proposing 

Release, 75 FR at 80178. 

285See part II.A.2.a, supra. 

286While the Proposing Release identified 

‘‘membership in a swap association in a category 

reserved for dealers’’ as a factor in connection with 

the ‘‘holding out’’ and ‘‘commonly known’’ tests, 

we recognize that, depending on the applicable 

facts and circumstances, such membership may not 

be sufficient to cause a person to be a security-based 

swap dealer if the person does nothing else to cause 

it to be considered a dealer. 

287See part II.A.2.f, supra. 

288See CEA section 1a(49), 7 U.S.C. 1a(49); 

Exchange Act section 3(a)(71), 15 U.S.C. 78c(a)(71). 

289See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A). 

290See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); 

Exchange Act section 3(a)(71)(C), 15 U.S.C. 

78c(a)(71)(C). 

using security-based swaps for hedging 

purposes.277 As we stated in the 

Proposing Release, however, under the 

dealer-trader distinction the 

Commissions would expect persons that 

use security-based swaps to hedge their 

business risks, absent other activity, 

likely would not be dealers.278 We 

maintain that view. In other words, to 

the extent that a person engages in 

security-based swap activity to hedge 

commercial risk, or otherwise to hedge 

risks unrelated to activities that 

constitute dealing under the dealertrader distinction (particularly activities 

that have the business purpose of 

seeking to profit by providing liquidity 

in connection with security-based 

swaps), the Commissions would not 

expect those hedging transactions to 

lead a person to be a security-based 

swap dealer.279 Of course, to the extent 

a person engages in dealing activities 

involving security-based swaps, the 

presence of offsetting positions that 

hedge those dealing activities would not 

excuse the requirement that the person 

register as a security-based swap 

dealer.280

No predominance test. As discussed 

in the Proposing Release, the 

Commissions do not believe that the 

security-based swap dealer analysis 

should appropriately turn upon whether 

a person’s dealing activity constitutes 

that person’s sole or predominant 

business. The separate de minimis 

exemption, however, may have the 

effect of excusing from dealer regulation 

those persons whose security-based 

swap dealing activities are relatively 

modest. 

Presence or absence of a customer 

relationship. Although commenters 

have expressed the view that a person 

that engages in security-based swap 

activities on an organized market should 

not be deemed to be a dealer unless it 

engages in those activities with 

customers,281 we do not agree. It is true 

that having a customer relationship can 

illustrate a business model of seeking to 

profit by providing liquidity, and thus 

provide one basis for concluding that a 

person is acting as a security-based 

swap dealer. Nonetheless, the presence 

of market making terminology within 

the definition is inconsistent with the 

view that a security-based swap dealer 

must have ‘‘customers.’’ Also, Title VII 

requirements applicable to securitybased swap dealers address interests 

apart from customer protection.282

Accordingly, to the extent that a person 

regularly enters into security-based 

swaps with a view toward profiting by 

providing liquidity—rather than by 

taking directional positions—that 

person may be a security-based swap 

dealer regardless of whether it views 

itself as maintaining a ‘‘customer’’ 

relationship with its counterparties.283

Criteria associated with ‘‘holding self 

out’’ as a dealer or being ‘‘commonly 

known in the trade’’ as a security-based 

swap dealer. The Proposing Release 

articulated a number of activities that 

could satisfy the definition’s tests for a 

person ‘‘holding itself out’’ as a dealer 

or being ‘‘commonly known in the 

trade’’ as a dealer.284 Several 

commenters criticized those proposed 

criteria, largely on the grounds that 

those criteria would inappropriately 

encompass end-users who seek to use 

security-based swaps for hedging 

purposes, or otherwise would be 

overbroad or irrelevant.285 The 

Commissions recognize the significance 

of the concerns those commenters 

raised, and agree that these activities 

need to be considered within the 

context of whether a person engages in 

those activities with the purpose of 

facilitating dealing activity. While we 

do not believe that any of those 

activities by themselves would 

necessarily indicate that a person is 

acting as a security-based swap dealer, 

under certain circumstances they may 

serve as an indicia of a business purpose 

of seeking to profit by providing 

liquidity in connection with securitybased swaps.286

6. Requests for Exclusions From the 

Dealer Definitions 

Certain commenters have sought to 

exclude entire categories of persons 

from the dealer definitions, 

notwithstanding that some persons in 

those categories may engage in the 

activities set forth in the statutory 

definition (as further defined by the 

Commissions).287 The final rules 

nonetheless do not incorporate 

categorical exclusions of persons from 

the dealer definitions because the 

statutory definitions provide that ‘‘any 

person’’ who engages in the activities 

enumerated in the definitions is covered 

by the dealer definitions, unless the 

person’s activities fall within one of the 

statutory exceptions.288 In this regard, it 

is significant that the exceptions in the 

dealer definitions depend on whether a 

person engages in certain types of swap 

or security-based swap activity, not on 

other characteristics of the person. That 

is, the exceptions apply for swaps 

between an insured depository 

institution and its customers in 

connection with originating loans,289

swaps or security-based swaps entered 

into not as a part of a regular 

business,290 and swap or security-based 

swap dealing that is below a de minimis 

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291See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); 

Exchange Act section 3(a)(71)(D), 15 U.S.C. 

78c(a)(71)(D). 

292The Commissions believe that a facts and 

circumstances approach is particularly appropriate 

here, where the broad terms of the statutory dealer 

definitions indicate that the Commissions should 

apply their expertise and discretion to interpret the 

statutory text. 

293For example, a manufacturer, producer, 

processor, or merchant that enters into swaps to 

hedge its currency or interest rate risk, absent any 

facts and circumstances establishing dealing 

activity, is not a swap dealer. 

294 In response to the commenters concerns, the 

Commissions have adopted certain tailored 

exclusions of certain types of swaps and securitybased swaps in the final rule. 

295A coalition of not-for-profit power utilities and 

electric cooperatives has advised that it plans to 

submit a request for an exemption for transactions 

between entities described in section 201(f) of the 

Federal Power Act, as contemplated by section 

722(f) of the Dodd-Frank Act. See letter from 

NFPEEU. Separately, some regional transmission 

organizations and independent systems operators 

have expressed interest in submitting an exemption 

application to the CFTC as well. See generally 

section 722(e) of the Dodd-Frank Act. Such 

exemptions, if granted after notice and comment 

pursuant to CEA section 4(c), 7 U.S.C. 6(c), could 

further address commenters’ concerns in this 

regard. 

296See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A). 

297See letters from Branch Banking & Trust 

Company (‘‘BB&T’’) dated February 3, 2011 (‘‘BB&T 

I’’), B&F Capital Markets, Inc. (‘‘B&F Capital’’) dated 

February 18, 2011 (‘‘B&F Capital I’’), Capital One 

Financial Corporation (‘‘Capital One’’) and Capstar 

Bank (‘‘Capstar’’); see also joint letter from Atlantic 

Capital Bank, Cobiz Bank, Cole Taylor Bank, 

Commerce Bank, N.A., East West Bank, First 

Business Bank, First National Bank of 

Pennsylvania, Heartland Financial USA, Inc., Old 

National Bancorp, Peoples Bancorp of North 

Carolina, Inc., Susquehanna Bank, The PrivateBank 

and Trust Co, The Savannah Bank, N.A., The 

Washington Trust Company, Trustmark National 

Bank, UMB Financial Corporation, Valley National 

Bank, Webster Bank NA, WesBanco Bank 

(‘‘Regional Banks’’) (general support for limitation 

to swaps connected to financial terms of the loan). 

298See letter from Better Markets I. 

299See letters from BOK dated February 18, 2011 

(‘‘BOK II’’), FSR I, ISDA I, Midsize Banks, OCC Staff 

at 6 (noting that ‘‘[l]oan underwriting criteria for 

community and mid-size banks * * * may require, 

as a condition of the loan, that the borrower be 

hedged against the commodity price risks 

incidental to its business’’) and White & Case LLP 

(‘‘White & Case’’) and joint letter from Senator 

Stabenow and Representative Lucas. 

300See letters from BOK II, FSR I, OCC Staff and 

White & Case. 

level.291 The Dodd-Frank Act does not 

exclude any category of persons from 

the coverage of the dealer definitions; 

rather, it excludes certain activities from 

the dealer analysis. 

Given that the statutory dealer 

definitions focus on a person’s activity, 

the Commissions believe that it is 

appropriate to determine whether a 

person meets any of the tests set forth 

in those statutory definitions, and thus 

is acting as a swap dealer or securitybased swap dealer, on a case-by-case 

basis reflecting the applicable facts and 

circumstances.292 If a person’s swap or 

security-based swap activities are of a 

nature to be covered by the statutory 

definitions, and those activities are not 

otherwise excluded, then the person is 

covered by the definitions. The contrary 

is equally true—a person who is not 

engaged in activities covered by the 

statutory definitions, or whose activities 

are excluded from the definition, is not 

covered by the definitions.293 The per se 

exclusions requested by the commenters 

have no foundation in the statutory text, 

and have the potential to lead to 

arbitrary line drawing that may result in 

disparate regulatory treatment and 

inappropriate competitive 

advantages.294

The final rules particularly do not 

include any exclusions for aggregators 

of swaps or other persons that use 

swaps in connection with the physical 

commodity markets, including swaps in 

connection with the generation, 

transmission and distribution of 

electricity. It is likely, though, that a 

significant portion of the financial 

instruments used for risk management 

by such persons are forward contracts in 

nonfinancial commodities that are 

excluded from the definition of the term 

‘‘swap.’’ 295 Such forward contracts are 

not relevant in determining whether a 

person is a swap dealer. 

B. ‘‘Swap Dealer’’ Exclusion for Swaps 

in Connection With Originating a Loan 

1. Proposed Approach 

The statutory definition of the term 

‘‘swap dealer’’ excludes an insured 

depository institution (‘‘IDI’’) ‘‘to the 

extent it offers to enter into a swap with 

a customer in connection with 

originating a loan with that 

customer.’’ 296 This exclusion does not 

appear in the definition of the term 

‘‘security-based swap dealer.’’ 

Proposed CFTC Regulation 

§ 1.3(ggg)(5) would implement this 

statutory exclusion by providing that an 

IDI’s swaps with a customer in 

connection with originating a loan to 

that customer are disregarded in 

determining if the IDI is a swap dealer. 

In order to prevent evasion, the 

proposed rule further provided that the 

statutory exclusion does not apply 

where the purpose of the swap is not 

linked to the financial terms of the loan; 

the IDI enters into a ‘‘sham’’ loan; or the 

purported ‘‘loan’’ is actually a synthetic 

loan such as a loan credit default swap 

or loan total return swap. 

1. Commenters’ Views 

Nearly all the commenters on this 

issue were IDIs seeking a broad 

interpretation of the exclusion. The 

commenters addressed four primary 

issues: (i) The type of swaps that should 

be covered by the exclusion; (ii) the 

time period during which parties would 

be required to enter into the swap in 

order for the swap to be considered to 

be ‘‘in connection with originating a 

loan;’’ (iii) which transactions should be 

deemed to be ‘‘loans’’ for purposes of 

the exclusion; and (iv) which entities 

should be included within the 

definition of IDI. 

First, regarding the type of swap that 

should be covered by the exclusion, as 

proposed, § 1.3(ggg)(5) would require 

that the rate, asset, liability or other 

notional item underlying the swap be, 

or be directly related to, a financial term 

of the loan (such as the loan’s principal 

amount, duration, rate of interest or 

currency). Some commenters agreed 

with the principle of limiting the 

exclusion to swaps that are connected to 

the financial terms of the loan, stating 

that the exclusion should cover any 

swap between a borrower and the 

lending IDI, so long as the swap’s 

notional amount is no greater than the 

loan amount, the swap’s duration is no 

longer than the loan’s duration, and the 

swap’s index and payment dates match 

the index and payment dates of the 

loan.297 Another commenter, agreeing 

with the proposed approach, said that 

there is no basis to extend the loan 

origination exclusion to swaps related to 

the borrower’s business risks, as 

opposed to the financial terms of the 

loan.298

Other commenters, though, said that 

this limitation to swaps connected to 

the financial terms of the loan was 

inappropriate or inconsistent with the 

Dodd-Frank Act, and that any swap 

required by the loan agreement or 

required by the IDI as a matter of 

prudent lending should be covered by 

the exclusion.299 Some of the 

commenters arguing for the broader 

exclusion emphasized that the 

exclusion should be available for any 

swap with the lending IDI which 

reduces the borrower’s risks, such as a 

commodity swap the borrower uses for 

hedging, because reduction of 

commodity price risks faced by the 

borrower also reduces the risk that the 

loan will not be repaid to the IDI.300

Commenters said that if the exclusion 

does not apply to swaps hedging the 

borrower’s commodity price risks, then 

only IDIs that are able to create a 

separately capitalized affiliate will be 

able to offer commodity swaps (because 

section 716 of the Dodd-Frank Act 

limits the ability of IDIs to offer 

commodity swaps), thereby reducing 

the availability of commodity swaps to 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30621 

301See letters from ABA I and BOK I. Other 

commenters addressed the relationship between the 

swap dealer definition and section 619 of the DoddFrank Act (the ‘‘Volcker Rule’’). See joint letter from 

Capital One, Fifth Third Bancorp and Regions 

Financial Corporation. 

302See letters from BB&T I, B&F Capital I, BOK 

II, Capital One, Capstar, FSR I, Midsize Banks, 

Manufacturers and Traders Trust Company 

(‘‘M&T’’) dated June 3, 2011 (‘‘M&T I’’) and 

September 28, 2011 (‘‘M&T II’’), Peoples Bank Co. 

(‘‘Peoples Bank’’), Regional Banks and White & 

Case. 

303See letters from B&F Capital I, BOK II, Capital 

One, Capstar and M&T I and M&T II. 

304See letters from FSR dated October 17, 2011 

(‘‘FSR VI’’), M&T II and Wells Fargo Bank, N.A. 

(‘‘Wells Fargo’’) dated August 16, 2011 (‘‘Wells 

Fargo II’’). 

305See letters from BB&T I, Midsize Banks, 

Regional Banks and White & Case; see also letter 

from Loan Market Association (providing 

background information on loan participations). 

306See letter from Regional Banks. 

307See letter from Better Markets I. 

308See letters from BB&T I, Capital One, FSR I, 

M&T I, Midsize Banks and Regional Banks. 

309See letter from FSR I. 

310See letter from Midsize Banks. 

311See letters from Pacific Coast Bankers’ 

Bancshares (‘‘PCBB’’) and Regional Banks. 

312See letters from FSR I and Midsize Banks. 

313See letter from PCBB. 

314Consequently, the Farm Credit Council 

argued, disallowing these institutions from using 

the exclusion would give commercial banks and 

savings associations a competitive advantage in 

agricultural lending. See letters from Farm Credit 

Council I and dated February 17, 2012 (‘‘Farm 

Credit Council II’’). Another commenter argued 

that, to the contrary, making Farm Credit System 

institutions eligible for the exclusion would confer 

an inappropriate competitive advantage on those 

institutions. See letter from ABA dated February 14, 

2012 (‘‘ABA II’’). This commenter said that Farm 

Credit System institutions have certain advantages 

over other IDIs, and the commenter asserted that 

Farm Credit System institutions were left out of the 

statutory language of the exclusion in order that 

they would not receive additional competitive 

advantages. See id. 

315See letter from NAIC. 

316See letter from FHLB I. The Credit Union 

National Association said that the Federal Home 

Loan Banks should not be covered by the swap 

dealer definition because they do not enter into 

swaps for their own account as part of a regular 

business. See letter from CUNA. 

317See letters from BB&T I, B&F Capital dated 

June 1, 2011 (‘‘B&F Capital II’’), Capital One, 

Capstar, M&T I and Peoples Bank. 

318See letters from FSR VI and Midsize Banks. 

319See letter from Better Markets I. 

320See letters from B&F Capital I, FSR I, ISDA I, 

M&T I and Midsize Banks. 

borrowers that are smaller 

companies.301

Second, regarding timing, the 

proposed rule requested comment on 

whether this exclusion should apply 

only to swaps that are entered into 

contemporaneously with the IDI’s 

origination of the loan (and if so, how 

‘‘contemporaneously’’ should be 

defined for this purpose), or whether 

this exclusion also should apply to 

swaps entered into during part or all of 

the duration of the loan. In response, 

commenters said that the exclusion 

should apply to swaps entered into in 

anticipation of a loan or at any time 

during the loan term.302 Commenters 

said that application of the exclusion 

throughout the duration of the loan 

would give IDIs and borrowers 

flexibility as to when to fix interest rates 

in fixed/floating swaps relating to loans 

and would allow borrowers to make 

other hedging decisions over a longer 

time period.303 Commenters also said 

that loans such as construction loans, 

equipment loans and committed loan 

facilities may allow for draws of loan 

principal over an extended period of 

time, and that swaps entered into by the 

borrower and lending IDI through the 

course of such a loan should be covered 

by the exclusion.304

Third, as to which transactions 

should be deemed ‘‘loans’’ for purposes 

of the exclusion, the proposal said that 

the exclusion should be available in 

connection with all transactions by 

which an IDI is a source of funds to a 

borrower, including, for example, loan 

syndications, participations and 

refinancings. Commenters agreed that 

the exclusion should be available for 

IDIs that are in a loan syndicate, 

purchasers of a loan, assignees of a loan 

or participants in a loan.305 On loan 

syndications and participations in 

particular, one commenter said that the 

exclusion should be available even if 

the notional amount of the swap is more 

than the amount of the loan tranche 

assigned to the IDI, so long as the swap 

notional amount is not more than the 

entire amount of the loan.306 Another 

commenter said that the exclusion 

should not be available if the IDI’s 

participation in the loan drops below a 

minimum level (such as 20 percent) 

because such use of the exclusion by 

minimally-participating IDIs would 

invite abuse.307

Some commenters said that other 

types of transactions also should be 

treated as ‘‘loans’’ for purposes of the 

exclusion. The transactions cited by 

commenters in this regard include 

leases, letters of credit, financings 

documented as sales of financial assets, 

bank qualified tax exempt loans and 

bonds that are credit enhanced by an 

IDI.308 Other commenters said the 

exclusion should apply where entities 

related to an IDI provide financing, such 

as loans or financial asset purchases by 

bank-sponsored commercial paper 

conduits where the IDI provides 

committed liquidity,309 and transactions 

where a special purpose entity formed 

by an IDI is the source of financing and 

enters into the swap.310 Some 

commenters said the exclusion should 

encompass all transactions where an IDI 

facilitates a financing,311 or all 

extensions of credit by an IDI,312 or all 

transactions where an IDI provides risk 

mitigation to a borrower.313

Fourth, with respect to the types of 

financial institutions that are eligible for 

the loan origination exclusion, three 

commenters said that IDIs, for purposes 

of this exclusion, encompass more than 

banks or savings associations with 

federally-insured deposits. The Farm 

Credit Council said the exclusion 

should be extended to Farm Credit 

System institutions because one of these 

institutions enters into interest rate 

swaps with borrowing customers 

identical in function to those offered by 

commercial banks and savings 

associations in connection with loans, 

and the institutions are subject to 

similar regulatory requirements and 

covered by a similar insurance 

regime.314 Another commenter said that 

the exclusion should be extended to 

other regulated financial institutions, 

such as insurers, so as not to create an 

unlevel playing field.315 And the 

Federal Home Loan Banks said that the 

exclusion should be available to them 

because they are subject to similar 

regulatory oversight and capital 

standards and engage in a similar 

function of extending credit as do 

commercial banks and savings 

associations.316 In addition, some 

commenters said the exclusion should 

be broadly construed as a general 

matter, to encourage competition in the 

swap market between smaller and larger 

banks and to increase borrowers’ choice 

among potential swap providers.317

Two commenters asked for 

clarification of the following technical 

points in the proposed rule: (i) Whether 

a swap would be covered by the 

exclusion even if it does not hedge all 

the risks under the loan, (ii) whether a 

swap that is within the exclusion could 

continue to be treated as covered by the 

exclusion by an IDI if the IDI transfers 

the loan, and (iii) whether an IDI should 

count swaps covered by the exclusion in 

determining if its dealing activity is 

above the de minimis thresholds.318

Another commenter asked whether an 

IDI with swaps that are covered by the 

exclusion could be a swap dealer based 

on other dealing activity.319 And others 

asked whether the exclusion would 

cover swaps used by an IDI to hedge its 

risks arising from a loan (i.e., a swap 

which the IDI enters into with a party 

other than the loan borrower).320

3. Final Rule 

The CFTC believes that the extent of 

this exclusion should be determined by 

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30622 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

321We note that because the exclusion is 

available within the specified time period around 

the execution of the loan agreement and any draw 

of principal under the loan, any amendment, 

restructuring, extension or other modification of the 

loan will, in itself, neither preclude application of 

the exclusion nor expand application of the 

exclusion. 

322See letter from OCC Staff. 

323The final rule provides that the second 

category of swaps must hedge a price risk related 

to a commodity other than an excluded commodity 

because if the price risk relates to an excluded 

commodity (such as an interest rate) the swap must 

be connected to the financial terms of the loan in 

order to be covered by the exclusion. 

324On the other hand, there is no requirement 

that the loan agreement reference a swap in order 

for the swap to be excluded, if the swap otherwise 

qualifies for the exclusion. 

325Also, we believe that the broader range of 

swaps serving general risk management purposes 

are more likely to involve concerns regarding 

market transparency and appropriate business 

conduct practices addressed by swap dealer 

regulation than are the narrower range of swaps that 

are encompassed by the exclusion. 

326See, e.g., In Re Renshaw, 222 F.3d 82, 88 (2d 

Cir. 2000) (‘‘Because Congress did not define the 

term ‘‘loan’’ for [11 U.S.C.] § 523(a)(8), we must 

interpret it according to its settled meaning under 

common law. The classic definition of a loan [is] 

* * * as follows: To constitute a loan there must 

be (i) a contract, whereby (ii) one party transfers a 

defined quantity of money, goods, or services, to 

another, and (iii) the other party agrees to pay for 

the sum or items transferred at a later date.’’) (citing 

In re Grand Union Co., 219 F. 353, 356 (2d Cir. 

1914)). 

327The final rule adopts provisions from the 

proposed rule that, in order to prevent evasion, the 

statutory exclusion does not apply where the IDI 

originates a ‘‘sham’’ loan; or the purported ‘‘loan’’ 

is actually a synthetic loan such as a loan credit 

default swap or loan total return swap. See CFTC 

Regulation § 1.3(ggg)(5)(iii). 

328See CFTC Regulation § 1.3(ggg)(5)(ii). As is 

also stated in the Proposing Release, if an IDI were 

to transfer its participation in a loan to a non-IDI, 

then the non-IDI would not be able to claim this 

the language of the statutory definition, 

which relates to an IDI that ‘‘offers to 

enter into a swap with a customer in 

connection with originating a loan with 

that customer.’’ The expansive 

interpretation of the exclusion advanced 

by some commenters, however, would 

read the statute to exclude almost any 

swap that an IDI enters into with a loan 

customer. That is not the exclusion that 

was enacted. Instead, we interpret the 

statutory phrase ‘‘enter into a swap with 

a customer in connection with 

originating a loan with that customer’’ 

to mean that the swap is directly 

connected to the IDI’s process of 

originating the loan to the customer. 

Because of the statute’s direct 

reference to ‘‘originating’’ the loan, it 

would be inappropriate to construe the 

exclusion as applying to all swaps 

entered into between an IDI and a 

borrower at any time during the 

duration of the loan. If this were the 

intended scope of the statutory 

exclusion, there would be no reason for 

the text to focus on swaps in connection 

with ‘‘originating’’ a loan. The CFTC 

recognizes the concern expressed by 

commenters that: (i) there be flexibility 

regarding when the IDI and borrower 

enter into a swap relating to a loan, and 

(ii) the expectation when an IDI 

originates a loan with a customer is 

often that the customer will enter into 

a swap with the IDI when there is a 

subsequent advance, or a draw, of 

principal on the loan. We do not 

believe, however, that the statutory term 

‘‘origination’’ can reasonably be 

stretched to cover the entire term of 

every loan that an IDI makes to its 

customers. At some point, the temporal 

distance renders the link to loan 

origination too attenuated, and the risk 

of evasion too great, to support the 

exclusion. In order to balance these 

competing and conflicting 

considerations, the final rule applies the 

exclusion to any swap that otherwise 

meets the terms of the exclusion and is 

entered into no more than 90 days 

before or 180 days after the date of 

execution of the loan agreement, or no 

more than 90 days before or 180 days 

after the date of any transfer of principal 

to the borrower from the IDI (e.g., a 

draw of principal) pursuant to the loan, 

so long as the aggregate notional amount 

of the swaps in connection with the 

financial terms of the loan at any time 

is no more than the aggregate amount of 

the borrowings under the loan at that 

time.321

Since a loan involves the repayment 

of funds to the IDI on particular terms, 

a swap that relates to those terms of 

repayment should be covered by the 

exclusion. In addition, we recognize 

that, as stated by commenters, 

requirements in an IDI’s loan 

underwriting criteria relating to the 

borrower’s financial stability are an 

important part of ensuring that loans are 

repaid.322 Therefore, the final rule 

modifies the proposed rule to provide 

that the exclusion applies to swaps 

between an IDI and a loan borrower that 

are connected to the financial terms of 

the loan, such as, for example, the loan’s 

duration, interest rate, currency or 

principal amount, or that are required 

under the IDI’s loan underwriting 

criteria to be in place as a condition of 

the loan in order to hedge commodity 

price risks incidental to the borrower’s 

business.323 The first category of swaps 

generally serve to transform the 

financial terms of a loan for purposes of 

adjusting the borrower’s exposure to 

certain risks directly related to the loan 

itself, such as risks arising from changes 

in interest rates or currency exchange 

rates. The second category of swaps 

mitigate risks faced by both the 

borrower and the lender, by reducing 

risks that the loan will not be repaid. 

Thus, both types of swaps are directly 

related to repayment of the loan. 

Although some commenters said that 

this exclusion should also apply to 

other types of swaps, we believe it 

would be inappropriate to construe this 

exclusion as encompassing all swaps 

that are connected to a borrower’s other 

business activities, even if the loan 

agreement requires that the borrower 

enter into such swaps or otherwise 

refers to them.324 In contrast to a swap 

that transforms the financial terms of a 

loan or is required by the IDI’s loan 

underwriting criteria to reduce the 

borrower’s commodity price risks, other 

types of swaps serve a more general risk 

management purposes by reducing other 

risks related to the borrower or the loan. 

If the purpose of the exclusion were to 

cover the broad range of swaps cited by 

some commenters (such as all swaps 

reducing a borrower’s business risks), 

then the terms of the statute limiting the 

exclusion to swaps that are ‘‘in 

connection with originating a loan with 

that customer’’ would be superfluous.325

To give effect to the statutory text, the 

exclusion is limited to a swap that is 

connected to the financial terms of the 

loan or is required by the IDI’s loan 

underwriting criteria to to be in place as 

a condition of the loan in order to hedge 

commodity price risks incidental to the 

borrower’s business. 

Regarding the types of transactions 

that will be treated as a ‘‘loan’’ for 

purposes of the exclusion, courts have 

defined the term ‘‘loan’’ in other 

statutory contexts based on the settled 

meaning of the term under common 

law. This definition encompasses any 

contract by which one party transfers a 

defined quantity of money and the other 

party agrees to repay the sum 

transferred at a later date.326 Rather than 

examine at this time the many 

particularized examples of financing 

transactions cited by some commenters, 

the term ‘‘loan’’ for purposes of this 

exclusion should be interpreted in 

accordance with this settled legal 

meaning.327

As stated in the proposed rule, this 

exclusion is available to all IDIs that are 

a source of a transfer of money to a 

borrower pursuant to a loan. The final 

rule adopts provisions from the 

proposed rule that the exclusion is 

available to an IDI that is a source of 

money by being part of a loan syndicate, 

being an assignee of a loan, obtaining a 

participation in a loan, or purchasing a 

loan.328 However, the proposed rule did 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30623 

exclusion, regardless of the terms of the loan or the 

manner of the transfer. Similarly, a non-IDI that is 

part of a loan syndicate with IDIs would not be able 

to claim the exclusion. 

329See, e.g., letter from Regional Banks. 

330See letter from Better Markets I. This 

commenter suggested a minimal threshold of at 

least 20 percent of the loan. However, we believe 

that a 10 percent commitment constitutes a 

substantial participation in the loan which supports 

offering of a swap up to the loan’s full amount. 

331For example, an IDI could act as a 0.1 percent 

participant in one hundred different loans in order 

to serve as the sole swap counterparty to the 

borrowers for hedging the borrowers’ interest rate 

risk on the loans. Thus, by lending or committing 

to lend $100 million, the IDI could apply the 

exclusion to swaps with an aggregate notional 

amount of $100 billion. 

332See CFTC Regulation § 1.3(ggg)(5)(i)(D)(1) and 

(2). 

333See CFTC Regulation § 1.3(ggg)(5)(i)(D)(3). 

334See CFTC Regulation § 1.3(ggg)(5)(i)(E). 

Paragraphs (D)(3) and (E) of this regulation refer to 

all swaps ‘‘in connection with the financial terms 

of the loan’’ in order to clarify that only such swaps 

are relevant in this regard. For example, if the IDI 

were to enter into a swap with the customer that 

is not in connection with the loan’s financial terms, 

the swap would not be relevant because the 

exclusion would not apply to the swap. 

335On the other hand, if the IDI were to transfer 

the swap (but not the loan) to another IDI, and the 

IDI that is the transferee of the swap is not a source 

of money to the borrower under the loan, then the 

transferee IDI would not be able to apply the 

exclusion to the swap. 

336See CEA sections 1a(49)(A) and 1a(49)(D), 

7 U.S.C. 1a(49)(A) and 1a(49)(D). 

337An IDI that is seeking out swap counterparties 

to enter into swaps in order to hedge or lay off the 

risk of a swap that is subject to the IDI exclusion 

would generally not be accommodating demand for 

swaps or facilitating interest in swaps. 

338The final rule text in CFTC Regulation 

§ 1.3(ggg)(5)(i) has been revised to conform the text 

of the rule to the statutory provision which refers 

to ‘‘an insured depository institution [that] * * * 

enter[s] into a swap with a customer in connection 

with originating a loan with that customer.’’ See 

CEA § 1a(49)(A), 7 U.S.C. 1a(49)(A) 

not state explicitly how the notional 

amount of a swap subject to the 

exclusion must relate to the amount of 

money provided by an IDI that is in a 

loan syndicate or is an assignee of, 

participant in or purchaser of a loan. In 

this regard, some commenters said that 

a borrower and the IDIs in a lending 

syndicate need flexibility to allocate 

responsibility for the swap(s) related to 

the loan as they may agree.329 We 

believe that, to allow for this flexibility, 

the exclusion may apply to a swap 

(which is otherwise covered by the 

exclusion) even if the notional amount 

of the swap is different from the amount 

of the loan tranche assigned to the IDI. 

However, we also agree with a 

commenter that the IDI should have a 

substantial participation in the loan.330

The requirement of substantial 

participation would prevent an IDI from 

applying the exclusion where the IDI 

makes minimal lending commitments in 

multiple loan syndicates where it offers 

swaps, causing its swap activity to be far 

out of proportion to its loan activity.331

Therefore, the final rule includes a 

provision that the exclusion may apply 

regardless of whether the notional 

amount of the swap is the same as the 

amount of the loan, but only if the IDI 

is the sole source of funds under the 

loan or is committed to be, under the 

applicable loan agreements, the source 

of at least 10 percent of the maximum 

principal amount under the loan.332 If 

the IDI does not meet this 10 percent 

threshold, the final rule provides that 

the exclusion may apply only if the 

aggregate notional amount of all the 

IDI’s swaps with the customer related to 

the financial terms of the loan is no 

more than the amount lent by the IDI to 

the customer.333 We also note that, in all 

cases, application of the exclusion 

requires that the aggregate notional 

amount of all swaps entered into by the 

borrower with any person in connection 

with the financial terms of the loan at 

any time is not more than the aggregate 

principal amount outstanding under the 

loan at that time.334

We also reiterate the interpretation in 

the Proposing Release that the word 

‘‘offer’’ in this exclusion includes 

scenarios where the IDI requires the 

customer to enter into a swap, or where 

the customer asks the IDI to enter into 

a swap, specifically in connection with 

a loan made by that IDI. 

We also continue to emphasize, as 

stated in the Proposing Release, that the 

statutory language of the exclusion 

limits its availability to only IDIs as 

defined in the statute. Regarding some 

commenters’ statements about the 

competitive effect of this interpretation 

of the term ‘‘insured depository 

institution,’’ we believe that the scope of 

application of the swap dealer 

definition to various entities should be 

treated in the de minimis exception, 

which is available to all persons. 

In order to provide clarification in 

response to certain technical questions 

raised by commenters, we note that 

whether a swap hedges all of the risk, 

or only some of the risk, of a loan is not 

relevant to application of the exclusion. 

Nor is it relevant to the exclusion if the 

IDI later transfers or terminates the loan 

in connection with which the swap was 

entered into, so long as the swap 

otherwise qualifies for the exclusion 

and the loan was originated in good 

faith and was not a sham.335 Further, 

swaps that are covered by the exclusion 

should not be considered in 

determining if an IDI exceeds the de 

minimis level of swap dealing activity, 

because the statute provides that swaps 

covered by the exclusion should not be 

considered in determining if an IDI is a 

swap dealer, and the de minimis 

exception provides that it considers the 

‘‘quantity of [a person’s] swap 

dealing.’’ 336 The application of the 

exclusion to swaps entered into by an 

IDI in connection with the origination of 

loans, however, does not mean that the 

IDI could not be a swap dealer because 

of other of the IDI’s activities that 

constitute swap dealing. Regarding 

swaps used by an IDI to hedge or lay off 

its risks arising from a loan, we do not 

believe it is appropriate to treat such 

swaps as covered by the exclusion, 

because the statute explicitly limits the 

exclusion to swaps ‘‘with a customer,’’ 

which such hedging swaps are not. 

However, a swap that an IDI enters into 

for the purpose of hedging or laying off 

the risk of a swap that is covered by the 

IDI exclusion will not be considered in 

the de minimis determination, or 

otherwise in evaluating whether the 

IDI is covered by the swap dealer 

definition.337

Last, we believe it is appropriate to 

require that an IDI claiming the 

exclusion report its swaps that are 

covered by the exclusion to a swap data 

repository (‘‘SDR’’). This requirement is 

consistent with the prevailing practice 

that IDIs handle the documentation of 

loans made to borrowers, and will 

provide for consistent reporting of 

swaps that are covered by the exclusion, 

thereby allowing the CFTC and other 

regulators to monitor the use of the 

exclusion. 

In sum, the final rule balances the 

need for flexibility in response to 

existing lending practices, consistent 

with the constraints imposed by the 

statutory text as enacted, against the risk 

of establishing a gap in the regulatory 

framework enacted in Title VII.338 It 

provides that the exclusion may be 

claimed by a person that meets the 

following conditions: (i) The person is 

an IDI; (ii) the IDI enters into a swap 

with the borrower that does not extend 

beyond the termination of the loan; (iii) 

the swap is connected to the financial 

terms of the loan or is required by the 

IDI’s loan underwriting criteria to to be 

in place as a condition of the loan in 

order to hedge commodity price risks 

incidental to the borrower’s business; 

(iv) the loan is within the common law 

meaning of ‘‘loan’’ and it is not a sham 

or a synthetic loan; (v) the IDI is the 

source of money to the borrower in 

connection with the loan either directly, 

or (so long as the IDI is the source of at 

least 10 percent of the entire amount of 

the loan) through syndication, 

participation, assignment, purchase, 

refinancing or otherwise; (vi) the IDI 

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30624 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

339See Proposing Release, 75 FR at 80183. 

340 Id. The Proposing Release further noted that 

sections 721(c) and 761(b)(3) give the Commissions 

anti-evasion authority, to the extent that an entity 

were to seek to use transactions between persons 

under common control to avoid one of the dealer 

definitions. See id. (erroneously referring to section 

721(c) as section 721(b)(3). 

341See, e.g., letters from API I, COPE I, ISDA I, 

Midsize Banks, ONEOK, Inc. (‘‘ONEOK’’) and 

Peabody. 

Several commenters explained the widespread 

use of central hedging desks to allocate risk within 

affiliate groups or to gather risk from within a group 

and lay that risk off on the market. See, e.g., letters 

from EEI/EPSA, Kraft Foods Inc. (‘‘Kraft’’), MetLife 

and Prudential Financial, Inc. (‘‘Prudential’’) dated 

February 17, 2011 (‘‘Prudential I’’). 

Some commenters particularly stated that the use 

of a single entity to face the market on behalf of an 

affiliate group had several risk-reducing and 

efficiency-enhancing benefits, and that those 

benefits would be lost if the dealer definitions were 

to lead corporate groups to avoid using central 

trading desks and instead require each affiliate to 

face the market as an independent end-user. See 

letters from FSR I, Philip Morris International Inc. 

(‘‘Philip Morris’’), Shell Trading dated June 3, 2011 

(‘‘Shell Trading II’’) and Utility Group, and joint 

letter from ABA Securities Association, American 

Council of Life Insurers (‘‘ACLI’’), FSR, Futures 

Industry Association (‘‘FIA’’), Institute of 

International Bankers, ISDA and SIFMA (‘‘Financial 

Associations’’). 

Some commenters also stated that legislative 

history suggested that Congress did not intend that 

the dealer definition capture transactions involving 

the use of an affiliate to hedge commercial risk. See 

letters from CDEU and Prudential I. 

342See letters from CDEU (common control), 

Financial Associations (common control and 

consolidation), MetLife (consolidation), ONEOK 

(common control, evaluated based on whether the 

trading interests of the entities are aligned) and 

Prudential I (citing CFTC letter interpretation 

regarding common control). 

343See, e.g., letters from EDF Trading (proposing 

definition from regulations promulgated by the 

Federal Energy Regulatory Commission) and 

Peabody (proposing definition of ‘‘affiliate’’ used in 

federal securities laws) and joint letter from the 

Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho 

Corporate Bank, Ltd. and Sumitomo Mitsui Banking 

Corp. (suggesting use of control definition in Bank 

Holding Company Act). 

344See, e.g., letters from Kraft and ONEOK. 

345Within an affiliated group of companies, 

however, only those legal persons that engage in 

dealing activities will be designated as dealers; that 

designation will not be imputed to other non-dealer 

affiliates or to the group as a whole. A single 

affiliate group may, however, have multiple swap 

or security-based swap dealers. 

346Limited designation as a dealer is addressed 

in more detail below in part II.E. 

347See CFTC Regulation § 1.3(ggg)(6)(i); Exchange 

Act rule 3a71–1(d). A person’s market-facing swap 

or security-based swap activity may still cause that 

person to be a dealer, even if that market-facing 

activity is linked to the inter-affiliate activity, to the 

extent that the market-facing activity satisfies the 

dealer definition. However, a person’s marketfacing swap activity for hedging purposes as 

defined in CFTC Regulation § 1.3(ggg)(6)(iii) would 

not cause that person to be a dealer. 

348See CFTC Regulation § 1.3(ggg)(6)(i); Exchange 

Act rule 3a71–1(d)(1). For the purposes of these 

rules, the counterparties are majority-owned 

affiliates if one party directly or indirectly holds a 

majority ownership interest in the other, or if a 

third party directly or indirectly holds a majority 

interest in both, based on holding a majority of the 

equity securities of an entity, or the right to receive 

upon dissolution or the contribution of a majority 

of the capital of a partnership. See CFTC Regulation 

§ 1.3(ggg)(6)(i); Exchange Act rule 3a71–1(d)(2). 

349See Proposing Release, 75 FR at 80183 (noting 

that swaps or security-based swaps between 

affiliates ‘‘may not involve the interaction with 

unaffiliated persons that we believe is a hallmark 

of the elements of the definitions that refer to 

enters into the swap with the borrower 

within 90 days before or 180 days after 

the date the execution of the loan 

agreement, or within 90 days before or 

180 days after any transfer of principal 

to the borrower from the IDI pursuant to 

the loan; (vii) the aggregate notional 

amount of all swaps entered into by the 

borrower with all persons in connection 

with the financial terms of the loan at 

any time is not more than the aggregate 

amount of the borrowings under the 

loan at that time; and (viii) the IDI 

agrees to report the swap to an SDR. 

An IDI that enters into swaps that do 

not meet these conditions, and thus do 

not qualify for the statutory exclusion, 

is not necessarily required to register as 

a swap dealer. Rather, the IDI would 

apply the statutory definition and the 

provisions of the rule (taking into 

account the applicable interpretive 

guidance set forth in this Adopting 

Release), solely with respect to its swaps 

that are not subject to the IDI exclusion, 

in order to determine whether it is 

engaged in swap dealing activity that 

exceeds the de minimis threshold. 

C. Application of Dealer Definitions to 

Legal Persons and to Inter-Affiliate 

Swaps and Security-Based Swaps 

1. Proposed Approach and Commenters’ 

Views 

In the Proposing Release, the 

Commissions preliminarily concluded 

that designation as a dealer would apply 

on an entity-level basis (rather than to 

a trading desk or other business unit 

that is not organized as a separate legal 

person), and that an affiliated group of 

legal persons could include more than 

one dealer.339 The Proposing Release 

also stated that the dealer analysis 

should consider the economic reality of 

swaps and security-based swaps 

between affiliates, and preliminarily 

noted that swaps or security-based 

swaps ‘‘between persons under common 

control may not involve the interaction 

with unaffiliated persons that we 

believe is a hallmark of the elements of 

the definitions that refer to holding 

oneself out as a dealer or being 

commonly known as a dealer.’’ 340

Commenters supported the view that 

swaps and security-based swaps among 

affiliates should be excluded from the 

dealer analysis.341 A number of 

commenters took the view that the 

dealer definitions should not apply 

when there is common control between 

counterparties, or when common 

control is combined with the 

consolidation of financial statements.342

Some commenters suggested that this 

interpretation regarding the scope of the 

dealer definitions should incorporate 

concepts of affiliation that are found in 

other statutory and regulatory 

provisions.343 Several commenters also 

opposed the suggestion (raised as part of 

the Proposing Release’s request for 

comments) that this interpretation be 

limited to transactions among wholly 

owned subsidiaries.344

2. Final Interpretation and Rule 

a. Application to Legal Persons 

Consistent with the Proposing 

Release, the Commissions interpret 

‘‘person’’ as used in the swap dealer and 

security-based swap dealer definitions 

to refer to a particular legal person. 

Accordingly, the dealer definitions will 

apply to the particular legal person 

performing the dealing activity, even if 

that person’s dealing activity is limited 

to a trading desk or discrete business 

unit,345 unless the person is able to take 

advantage of a limited designation as a 

dealer.346

b. Application to Inter-Affiliate Swaps 

and Security-Based Swaps 

The final rules codify exclusions from 

the dealer definitions for a person’s 

swap or security-based swap activities 

with certain affiliates.347 These rules are 

consistent with the Proposing Release’s 

recognition of the need to consider the 

economic reality of any swaps or 

security-based swaps that a person 

enters into with affiliates. Market 

participants may enter into such interaffiliate swaps or security-based swaps 

for a variety of purposes, such as to 

allocate risk within a corporate group or 

to transfer risks within a corporate 

group to a central hedging or treasury 

entity. 

Under the final rules, the dealer 

analysis will not apply to swaps and 

security-based swaps between majorityowned affiliates.348 When the economic 

interests of those affiliates are aligned 

adequately—as would be found in the 

case of majority-ownership—such 

swaps and security-based swaps serve to 

allocate or transfer risks within an 

affiliated group, rather than to move 

those risks out of the group to an 

unaffiliated third party. For this reason, 

and as contemplated by the Proposing 

Release,349 we do not believe that such 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30625 

holding oneself out as a dealer or being commonly 

known as a dealer’’). 

350See FASB ASC Section 810–10–25, 

Consolidation—Overall—Recognition (stating that 

consolidation is appropriate if a reporting entity has 

a controlling financial interest in another entity and 

a specific scope exception does not apply). 

351See letter from Peabody. The commenter did 

not specify which definition of ‘‘affiliate’’ in the 

securities laws it was proposing. For example, Rule 

405 of the Securities Act of 1933 defines affiliate 

in terms of common control, see 17 CFR 230.405, 

and Section 20(a) of the Exchange Act takes a 

similar approach. The Investment Company Act of 

1940 (‘‘ICA’’) defines affiliate to include entities 

with a common ownership interest as low as 5 

percent, ICA section 2(a)(3). Two other commenters 

proposed using a common control standard, 

perhaps also in reference to the Rule 405 definition 

of ‘‘affiliate.’’ 

352The definitions of ‘‘affiliate’’ and ‘‘control’’ 

found in Rule 405 and other securities law 

provisions are appropriate in the context of the 

prophylactic and remedial provisions in which they 

are found. Rule 405, for example, uses the terms 

‘‘affiliate’’ and ‘‘control’’ to identify those persons 

that have the power to effect registration of an 

issuer’s securities, and the broad definitions ensure 

that the persons with that power actually fulfill 

their obligation to do so. By comparison, the 

exclusion of inter-affiliate swaps and security-based 

swaps from the dealer analysis should be more 

tightly focused to address situations in which 

counterparties have similar economic interests. 

Another commenter noted the definition of 

‘‘affiliate’’ found in certain Federal Energy 

Regulation Commission regulations—which define 

‘‘affiliate’’ in terms of a ten percent or five percent 

common ownership interest. See letter from EDF 

Trading. Those relatively low ownership 

thresholds, however, are intended to address 

different concerns regarding collusion and crosssubsidization, and do not appear appropriate for an 

interpretation that has the potential to reduce the 

counterparty and market protections provided by 

Title VII. See 18 CFR sections 35.36(a)(9), 35.39, 

366.2(b), 366.3. 

353 7 U.S.C. 1a(14). A cooperative association of 

producers is at least 75 percent owned or 

controlled, directly or indirectly, by producers of 

agricultural products and must comply with the 

Capper-Volstead Act (referred to in the CEA as the 

Act of February 18, 1922, 7 U.S.C. 291 and 292). 

See letters from Land O’Lakes II, NCFC I and 

NMPF. 

354See letters from Farm Credit Council I and 

FHLB I. The NRU CFC qualifies as a cooperative 

financial entity, but we understand that it does not 

enter into a significant amount of swaps with its 

members; rather, it enters into swaps with 

unaffiliated third parties. See letter from NRU CFC 

I and meeting with NRU CFC on January 13, 2011. 

355The term ‘‘cooperative association of 

producers’’ also includes any organization acting 

for a group of such associations and owned or 

controlled by such associations. See CEA section 

1a(14), 7 U.S.C. 1a(14). For a cooperative 

association of producers that is acting for and 

owned or controlled by such associations, we 

believe that this conclusion applies to any swap 

between such cooperative association of producers 

and any cooperative association of producers that 

is a member of it, and any producer that is a 

member of any such cooperative association of 

producers that is itself a member of the first 

cooperative association of producers. See CFTC 

Regulation § 1.3(ggg)(6)(ii)(C). 

However, we do not believe that this conclusion 

applies to any security-based swap that a 

cooperative association of producers may enter into, 

nor does it apply to any swap related to a nonphysical commodity (such as a rate swap). For this 

reason, the exclusion for cooperative associations of 

producers is limited to swaps that are primarily 

based on a commodity that is not an excluded 

commodity. See CFTC Regulation 

§ 1.3(ggg)(6)(ii)(A)(3). The term ‘‘excluded 

commodity’’ is defined in CEA section 1a(19), 7 

U.S.C. 1a(19). 

356See CFTC Regulation § 1.3(ggg)(6)(ii). To be 

clear, these cooperatives are not excluded from the 

dealer definitions. See part II.A.6, supra. Rather, 

swaps between a cooperative and its members (and 

swaps that a cooperative enters into to hedge or lay 

off the risk of such swaps) are excluded from the 

dealer analysis. If a cooperative were to engage in 

other swap activities that are covered by, and not 

otherwise excluded from, the statutory definition of 

the term ‘‘swap dealer,’’ then it would be required 

to register as a swap dealer. 

357See CFTC Regulation § 1.3(ggg)(6)(ii)(B). 

358See Capper-Volstead Act section 1, 7 U.S.C. 

291. 

359See Farm Credit Act of 1971, 12 U.S.C. 2001 

et seq. and Federal Home Loan Bank Act, 12 U.S.C. 

1421 et seq. 

360See letter from NFPEEU (not-for-profit power 

utilities, electric cooperatives and related persons); 

letters from Farmers’ Associations, NGFA I and 

NMPF (referring to private companies that serve as 

aggregators for swaps in agricultural commodities 

or otherwise offer swaps for agricultural risk 

management); and letter from Northland Energy 

(small energy firm that aggregates demand for 

swaps from small energy retailers and consumers). 

swaps and security-based swaps involve 

the interaction with unaffiliated persons 

to which dealer regulation is intended 

to apply. 

The standard in the final rules differs 

from the standard suggested by the 

Proposing Release, which alluded to 

affiliates as legal persons under 

‘‘common control.’’ This change is 

based on our further consideration of 

the issue, including consideration of 

comments that an inter-affiliate 

exclusion should be available when 

common control is combined with the 

consolidation of financial statements. 

Although we are not including a 

requirement that financial statements be 

consolidated—as we do not believe that 

the scope of this exclusion should be 

exposed to the risk of future changes in 

accounting standards—in our view a 

majority ownership standard is 

generally consistent with consolidation 

under GAAP.350 Absent majority 

ownership, we cannot be confident that 

there would be an alignment of 

economic interests that is sufficient to 

eliminate the concerns that underpin 

dealer regulation. 

In taking this approach, we have also 

considered alternatives suggested by 

commenters. For example, while one 

commenter suggested that we adopt a 

definition of ‘‘affiliate’’ as used in the 

securities laws,351 we believe that such 

an approach would be too broad for the 

purpose of this exclusion from dealing 

activity, given that common control by 

itself does not ensure that two entities’ 

economic interests are sufficiently 

aligned.352

c. Application to Cooperatives 

Similar considerations apply, in 

certain situations, to cooperative entities 

that enter into swaps with their 

members in order to allocate risk 

between the members and the 

cooperative. Commenters identified two 

general types of such cooperatives— 

‘‘cooperative associations of producers’’ 

as defined in section 1a(14) of the 

CEA 353 and cooperative financial 

entities such as Farm Credit System 

institutions and Federal Home Loan 

Banks.354 As is the case for affiliated 

groups of corporate entities, we believe 

that when one of these cooperatives 

enters into a swap with one of its 

members,355 the swap serves to allocate 

or transfer risks within an affiliated 

group, rather than to move those risks 

from the group to an unaffiliated third 

party, so long as the cooperative adheres 

to certain risk management practices. 

Accordingly, the final rules 

specifically provide that the dealer 

analysis excludes swaps between a 

cooperative and its members, so long as 

the swaps in question are reported to 

the relevant SDR by the cooperative and 

are subject to policies and procedures of 

the cooperative which ensure that it 

monitors and manages the risk of such 

swaps.356 The final rules define the term 

‘‘cooperative’’ to include cooperative 

associations of producers and any entity 

chartered under Federal law as a 

cooperative and predominantly engaged 

in activities that are financial in 

nature.357 The cooperatives covered by 

this relief are subject to provisions of 

Federal law providing for their 

cooperative purpose. Cooperative 

associations of producers have been 

recognized since the passage of the 

Capper-Volstead Act as being permitted 

to engage in certain cooperative 

activities without violating antitrust 

laws.358 Cooperative financial 

institutions such as the Farm Credit 

System institutions and Federal Home 

Loan Banks are chartered under Federal 

laws that limit their membership and 

require that they serve certain public 

purposes.359

We are aware that other persons 

commented that their swap activities 

should be excluded from the dealer 

analysis because they use swaps in 

connection with a cooperative or nonprofit purpose, or because they 

aggregate demand for swaps arising 

from numerous small entities.360

However, the key distinction drawn in 

granting this relief is that cooperatives 

covered by the exclusion enter into 

swaps with their members in order to 

allocate risk between the members and 

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30626 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

361See, e.g., letter from NFPEEU (not-for-profit 

power utilities and electric cooperatives generally 

enter into swaps between themselves, with large 

industrial consumers, and a wide range of other 

counterparties). Indeed, the Dodd-Frank Act 

permits the CFTC to exempt agreements, contracts 

or transactions between entities described in 

section 201(f) of the Federal Power Act, such as 

certain not-for-profit power utilities and electric 

cooperatives. See section 722(f) of the Dodd-Frank 

Act. As noted above, a coalition of not-for-profit 

power utilities and electric cooperatives has 

advised that it plans to submit a request for the 

exemption contemplated by section 722(f) of the 

Dodd-Frank Act. See note 295 supra. 

362CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); 

Exchange Act section 3(a)(71)(D), 15 U.S.C. 

78c(a)(71)(D). 

363Proposing Release, 75 FR at 80179 (footnote 

omitted). 

364See id. at 80179–80. 

365See id. at 80180. 

366Under the proposal, the factors would 

consider a person’s swap or security-based swap 

dealing activity as a whole, rather than separately 

considering different types of swaps or securitybased swaps. See Proposing Release, 75 FR at 

80181. 

367See proposed Exchange Act rule 3a71–2(a). 

The proposed standard reflected our understanding 

that in general the notional size of a small swap or 

security-based swap is $5 million or less, and that 

the proposed threshold would reflect 20 

instruments of that size. The standard also sought 

to reflect the customer protection issues implicated 

by swaps and security-based swaps. See Proposing 

Release, 75 FR at 80180. 

The proposed notional threshold would not 

consider the market risk offsets associated with 

combining long and short positions. In addition, the 

proposed notional threshold would not account for 

the amount of collateral held or posted by the 

entity, or other risk mitigating factors. See id. 

368See proposed Exchange Act rule 3a71–2(a). As 

set forth by the statutory business conduct rules 

applicable to security-based swap dealers (as set 

forth in Exchange Act section 15F(h)(2)(C)), 

‘‘special entity’’ refers to: Federal agencies; States, 

State agencies and political subdivisions (including 

cities, counties and municipalities); ‘‘employee 

benefit plans’’ as defined under the Employee 

Retirement Income Security Act of 1974 (‘‘ERISA’’); 

‘‘governmental plans’’ as defined under ERISA; and 

endowments. Title VII imposes additional business 

conduct requirements on security-based swap 

dealers in connection with special entities. See CEA 

sections 4s(h)(2), 4s(h)(4), 4s(h)(5); Exchange Act 

section 15F(h)(2), (4), (5). 

369See, e.g., letters from CDEU, MFX II, NCGA/ 

NGSA II and SIFMA—Regional Dealers Derivatives 

Committee (‘‘SIFMA—Regional Dealers’’). 

370See letter from WGCEF I (arguing that basing 

the exception on customer protection principles 

would be contrary to the statutory framework, given 

that only ECPs are eligible to participate in offexchange swap transactions). 

371See letter from Better Markets I. 

372See, e.g., letters from FHLB I, IECA–Credit I, 

NCGA/NGSA I, NRG Energy, Peabody and WGCEF 

I. One commenter said the proportionality criteria 

should also consider an entity’s activities with 

respect to the physical commodity underlying its 

swaps. See letter from NCGA/NGSA I. But see letter 

from Better Markets I (supporting rejection of a 

proportionality test). Some commenters suggested 

more than one alternative approach. 

373See letter from Better Markets I. Another 

commenter said that the ‘‘customer’’ language 

serves to emphasize that the de minimis exception 

is available to entities that provide swaps to 

customers. See letter from NGFA I. 

374See letters from ISDA I, Vitol and WGCEF I. 

Another commenter said that the use of the term 

‘‘customer’’ indicates that all transactions with 

physical commodity customers should be 

disregarded in determining if a person is a dealer. 

See letter from EDF Trading. 

the cooperative. By contrast, the other 

entities noted above enter into swaps 

with unaffiliated parties in order to 

transfer risks between unaffiliated 

parties.361 As noted above, the 

Commissions believe that the 

contemplated scope of the statutory 

definitions does not include instances 

where a person’s swap activities transfer 

risk within an affiliated group, but does 

extend to activities that create legal 

relationships that transfer risk between 

unaffiliated parties. Thus, it is 

appropriate that the dealer analysis 

exclude swaps between a cooperative 

and its members, but such analysis 

should include swaps between a 

cooperative or other aggregator and 

unaffiliated persons. 

D. De Minimis Exception 

1. Proposed Approach 

The Dodd-Frank Act’s definitions of 

‘‘swap dealer’’ and ‘‘security-based 

swap dealer’’ require that the 

Commissions exempt from dealer 

designation any entity ‘‘that engages in 

a de minimis quantity’’ of dealing ‘‘in 

connection with transactions with or on 

behalf of customers.’’ The statutory 

definitions further require the 

Commissions to ‘‘promulgate 

regulations to establish factors with 

respect to the making of any 

determination to exempt.’’ 362

In the Proposing Release, we 

preliminarily concluded that the de 

minimis exception ‘‘should be 

interpreted to address amounts of 

dealing activity that are sufficiently 

small that they do not warrant 

registration to address concerns 

implicated by the regulations governing 

swap dealers and security-based swap 

dealers. In other words, the exception 

should apply only when an entity’s 

dealing activity is so minimal that 

applying dealer regulations to the entity 

would not be warranted.’’ 363 In taking 

this view, we rejected the suggestion 

that the de minimis exception should 

compare a person’s swap or securitybased swap dealing activities to the 

person’s non-dealing activities.364

At the same time, we recognized that 

this proposed approach did not appear 

to ‘‘readily translate into objective 

criteria.’’ We further recognized that a 

range of alternative approaches may be 

reasonable, and we solicited comment 

as to what factors should be used to 

implement the exception.365

The proposed de minimis exception 

was comprised of three factors, all of 

which a person would have had to 

satisfy to avail itself of the exception.366

The first proposed factor would have 

limited the aggregate effective amount, 

measured on a gross basis, of the swaps 

or security-based swaps that a person 

entered into over the prior 12 months in 

connection with its dealing activities to 

$100 million 367 (or $25 million with 

regard to counterparties that are 

‘‘special entities’’).368

The second proposed factor would 

have limited a person’s swap or 

security-based swap dealing activity to 

no more than 15 counterparties over the 

prior 12 months (while counting 

counterparties that are members of an 

affiliated group as one counterparty for 

these purposes). The final proposed 

factor would have limited a person’s 

dealing activity to no more than 20 

swaps or security-based swaps over the 

prior 12 months (without counting 

certain amendments as new swaps or 

security-based swaps). 

2. Commenters’ Views 

a. Basis for the Exception 

Some commenters sought to link the 

de minimis exception to systemic risk 

criteria by taking the position that a 

person should have to register as a 

dealer only if its dealing activities pose 

systemic significance.369 One 

commenter specifically objected to the 

position in the Proposing Release that 

the de minimis exception should take 

into account customer protection 

principles.370 On the other hand, one 

commenter supported the rejection of a 

risk-based de minimis test.371

Some commenters argued that the de 

minimis test should account for 

proportionality criteria that would 

excuse entities whose dealing activity is 

relatively minor compared to their other 

activities.372

b. Significance of ‘‘Customer’’ Language 

One commenter took the position that 

the language within the de minimis 

exception that specifically referred to 

‘‘transactions with or on behalf of 

customers’’ meant that the exception 

should be available only for persons 

who limit their swaps or security-based 

swaps to those that are entered into with 

or on behalf of customers.373 Other 

commenters posited the opposite view 

that the ‘‘customer’’ language should be 

read to mean that a person’s dealing 

activities with counterparties other than 

customers may be disregarded for 

purposes of the exception (i.e., noncustomer transactions would not count 

against the de minimis thresholds).374

Some commenters argued that 

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375See, e.g., letter from FSR I. 

376See letter from Vitol (suggesting that the 

proposed language meant that dealing activity 

involved ‘‘customers’’ but not ‘‘counterparties’’). 

377See, e.g., letters from API I, CDEU, DFA, EDF 

Trading, Farm Credit Council I, Growmark, Land 

O’Lakes dated January 13, 2011 (‘‘Land O’Lakes I’’), 

Midsize Banks, NCFC I, NCGA/NGSA II, New York 

City Bar Association—Committee on Futures and 

Derivatives Regulation (‘‘NYCBA Committee’’), 

Northland Energy, NRG Energy, Regional Banks and 

SIFMA—Regional Dealers. Some commenters also 

said that the thresholds, particularly those for 

swaps, should vary according to the riskiness of the 

swap or type of commodity underlying the swap. 

See letters from BG LNG I, Farm Credit Council I, 

Gavilon II, ISDA I, NFPEEU, Vitol and WGCEF I. 

378See, e.g., letters from API I, BG LNG IFarm 

Credit Council I, Midsize Banks, NCFC I, NGFA I, 

Regional Banks and SIFMA—Regional Dealers and 

meetings with Electric Companies on April 13, 

2011, the Asset Management Group of SIFMA 

(‘‘SIFMA—AMG’’) on February 4, 2011 and WGCEF 

on April 28, 2011. 

379See, e.g., letters from CDEU and Vitol. Another 

commenter noted that application of a cost-benefit 

analysis of the de minimis threshold could be 

challenging. See Roundtable Transcript at 193–94 

(remarks of Camille Rudge, The PrivateBank and 

Trust Company). 

380See letter from CDEU (citing statistics 

indicating that the average respondent to an ISDA 

survey had an annual ‘‘event volume’’ of over 

297,000 OTC derivatives trade processing actions); 

see also letter from Regional Banks. 

381See meetings with Electric Companies on 

April 13, 2011, Gavilon on May 11, 2011 and 

WGCEF on April 28, 2011. 

382See letter from COPE I (suggesting 0.001% of 

the total U.S. swap market, amounting to 

approximately $3 billion); see also letters from API 

dated June 3, 2011 (‘‘API II’’), EDF Trading, Edison 

Int’l, EEI/EPSA, IECA–Credit I, NCGA/NGSA II, 

NextEra, NFPEEU, Utility Group and WGCEF I 

(suggesting 0.001% of the total U.S. swap market). 

383See, e.g., meeting with Land O’Lakes on 

January 6, 2011 (suggesting the threshold be 

increased by 2 to 5 times—i.e., to $200 million to 

$500 million); letters from Growmark, FHLB I and 

MFX II (each supporting $1 billion notional 

standard); Regional Banks (supporting $2 billion 

notional standard); letter from NCFC dated October 

31, 2011 (‘‘NCFC III’’) (supporting alternative 

notional standards of $1 billion or $3 billion 

depending on certain assumptions); letter from FSR 

VI and joint letter from Capital One, Fifth Third 

Bancorp and Regions Financial Corporation 

(suggesting notional standard of at least $2 billion); 

letter from WGCEF dated June 3, 2011 regarding the 

swap dealer definition (‘‘WGCEF V’’) (suggesting 

notional standard of $3.5 billion); and letter from 

IPR–GDF Suez Energy North America (suggesting 

notional standard of $10 billion). Some commenters 

suggested more than one possible threshold. 

384See, e.g., letters from Farm Credit Council I, 

FSR VI and Midsize Banks. Other commenters said 

the threshold should account for the effect of 

netting. See letters from API II, Chesapeake Energy, 

Land O’Lakes I and MFX II. On the other hand, one 

commenter specifically supported the use of the 

gross notional amount. See letter from Greenberger. 

385See letters from Farm Credit Council I, ISDA 

I, Land O’Lakes I, Midsize Banks, NCFC I, SIFMA— 

Regional Dealers and Vitol. 

386See letters from AFR, Better Markets I, 

Greenberger and NMPF. One of these commenters 

said that data on credit default swaps analyzed by 

the SEC’s Division of Risk, Strategy, and Financial 

Innovation indicates that the $100 million proposed 

notional thresholds are too high. See letters from 

Better Markets to CFTC and SEC dated April 6, 

2012 (‘‘Better Markets III’’). 

387See, e.g., letters from API II, Atmos Energy, 

Chesapeake Energy, COPE I, EEI/EPSA, Gavilon II, 

IECA–Credit I, Land O’Lakes I, NCGA/NGSA II, 

NEM, NextEra I, NMPF, NRG Energy, Peabody and 

Utility Group. 

388See, e.g., letters from ISDA I (suggesting 25 

transactions over 12 months); FHLB I (suggesting 25 

counterparties and 50 transactions over 12 months) 

FSR I and Midsize Banks (each suggesting 75 

counterparties and 200 transactions over 12 

months); Regional Banks (suggesting 100 

counterparties and 300 transactions over 12 

months); Growmark and MFX II (suggesting 

thresholds should be increased by a factor of 10) 

and meeting with Land O’Lakes on January 6, 2011 

(suggesting thresholds should be increased by a 

factor of between 2 and 5). 

One commenter said the number of transaction 

and number of counterparty standards should be 

disjunctive—i.e., a dealer’s activity would be de 

minimis if it were below either standard. See letter 

from Northland Energy. Other commenters raised 

questions about how counterparties or transactions 

should be counted for purposes of the standard. See 

letters from CDEU (novations should not be counted 

as new transactions) and J.P. Morgan (members of 

an affiliated group should be counted as one 

counterparty), joint letter from BB&T, East West 

Bank, Fifth Third Bank, The PrivateBank and Trust 

Company, Regions Bank, Sun Trust Bank, U.S. Bank 

National Association and Wells Fargo Bank, N.A. 

(‘‘Midmarket Banks’’) (questioning how to count 

multiple borrower counterparties to a loan and 

swap) and meeting with Land O’Lakes on January 

6, 2011 (members of a cooperative should be 

counted as one counterparty). 

Last, some commenters said that the number of 

transaction or number of counterparty standards 

should be deleted because they are not useful as 

tests of de minimis status. See letters from Gavilon 

II (eliminate both standards) and SIFMA—Regional 

Dealers (eliminate number of counterparties 

standard). 

389See letters from IECA–Credit I (suggesting that 

exception exclude persons whose positions either 

are below a notional threshold or are below a 

combined proportionality and revenue threshold), 

SIFMA—Regional Dealers (supporting annual 

threshold of 500 customer-facing or riskless 

principal swaps, consistent with the de minimis 

exception from the Exchange Act ‘‘broker’’ 

definition in connection with bank brokerage 

activity, as well as SEC rules in connection with the 

Exchange Act definition of ‘‘dealer’’), FHLB I 

(supporting non-quantitative test accounting for 

relatively small swap-related exposure compared to 

primary customer activity, collateral that also 

provides credit support for other business done 

with the customer, an existing relationship with 

customer and inability of customer to obtain swaps 

from entities that primarily are dealers), Gavilon II 

(alluding to use of non-quantitative tests), MFX II 

(suggesting establishment of a separate qualitative 

process by which a dealer may establish why 

registration is not warranted) and DC Energy 

(thresholds should be set at a level appropriate to 

support the capital levels to be required for swap 

dealers). 

390See letters from Better Markets I (arguing that 

the de minimis exception should not be available 

in connection with transactions with special 

entities), AFR (similar), Greenberger (supporting 

reduction of the notional threshold for transactions 

with special entities to $5 million) and AFSCME. 

Some commenters said the standard for swaps and 

security-based swaps with special entities should 

be a notional value equal to 0.0001% of the total 

U.S. swap market. See letters from COPE I, EDF 

Trading, EEI/EPSA, IECA–Credit I, NFPEEU and 

Utility Group. One commenter said the threshold 

for special entities should be eliminated because it 

is not useful in determining de minimis status. See 

letter from Gavilon II. 

391See letters from BG LNG I (small energy 

companies), COPE I and Northland Energy (each 

discussing commodity markets, suggesting that 

notional thresholds be based on the unit of a 

Continued 

transactions entered into in a fiduciary 

capacity should be disregarded for 

purposes of the exception.375 One 

commenter questioned the proposal’s 

use of the term ‘‘counterparty’’ in lieu 

of the statutory term ‘‘customer.’’ 376

c. Proposed Tests and Thresholds 

Commenters criticized the proposed 

de minimis thresholds in a variety of 

ways. These included arguments that 

the proposed thresholds were 

inappropriately low,377 would harm 

end-users by reducing the number of 

entities willing to enter into low-value 

swaps and security-based swaps,378

would be unjustified on a cost-benefit 

basis,379 and were disproportionately 

low compared to the activities of 

recognized dealers.380 Other 

commenters said the de minimis 

thresholds should be set at a level to 

allow entities to engage in a meaningful 

amount of customer-facing swaps or 

security-based swaps without being 

required to register as dealers.381

A number of commenters particularly 

criticized the proposed notional 

threshold, with some commenters 

suggesting that the threshold should be 

based on a percentage of the total swap 

market 382 or some other fixed value,383

or arguing in favor of an exposure-based 

threshold in lieu of a notional 

threshold.384 Other commenters said 

that the aggregate notional amount of 

swaps is not a meaningful measure of an 

entity’s dealing activity.385 A few 

commenters supported the proposed 

notional threshold.386

Some commenters argued against 

basing the de minimis exception on the 

number of a person’s swaps or securitybased swaps or the number of a person’s 

counterparties,387 or supported 

increasing those thresholds above the 

proposed standard.388 Commenters also 

suggested a variety of other alternatives 

to the proposed tests.389

d. Additional Issues 

Some commenters emphasized the 

need to provide protections in 

connection with ‘‘special entities.’’ 390

Certain commenters sought to identify 

problems related to the application of 

the proposed thresholds in connection 

with particular types of businesses or 

markets,391 or to aggregators or 

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30628 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

commodity), NCFC I (commodity prices), NGFA I 

(grain elevators) and WGCEF I (energy prices). 

392See, e.g., letters from Growmark and Land 

O’Lakes I. 

393See letters from NEM, NextEra I, and NGFA 

I. 

394See letter from CUNA. 

395See, e.g., letters from API I, EDF Trading, 

Gavilon II and SIFMA—Regional Dealers. 

396See, e.g., letter from Atmos Energy Holdings, 

Inc (‘‘Atmos Holdings’’). 

397See letters from NCGA/NGSA I (supporting 

measurement of rolling period average over 12 

months), NextEra I (supporting evaluation as of the 

last day of each calendar quarter rather than over 

the immediate preceding 12 months) and Northland 

Energy (requesting clarification that if a monetary 

notional amount is used, the evaluation periods 

should be fixed rather than rolling). 

398See letters from ISDA I (stating that the use of 

‘‘effective notional amount’’ in the test introduces 

ambiguity and uncertainty) and WGCEF I (notional 

amounts should be measured on a ‘‘deltaequivalent’’ basis). 

399See letters from Farm Credit Council I 

(supporting automatic periodic increases to reflect 

changes in market size, the size of typical contracts 

and inflation), Greenberger (supporting reevaluation 

of the de minimis criteria on an ongoing basis), and 

BG LNG I, EEI/EPSA, NCFC I and WGCEF I (each 

supporting inflation or market size adjustments). 

400See meeting with Edison Int’l (requesting 

clarification that an entity that is prohibited from 

coordinating its financial derivatives activities 

should determine whether it qualifies for the de 

minimis exception without considering financial 

derivatives entered into by its affiliated entities). 

401See letter from Covington & Burling (urging 

clarification that lookback period will not 

commence until all the relevant regulations become 

effective). 

402See letters from BGLNG I and WGCEF V. See 

also Roundtable Transcript at 50–51 (remarks of 

Ron Oppenheimer, WGCEF), 57 (remarks of Richard 

Ostrander, Morgan Stanley) and 208–09 (remarks of 

Bella Sanevich, NISA Investment Advisors). 

403See letter from FSR I. 

404See letter from WGCEF I; see also Northland 

Energy (supporting grace period for registration if 

the de minimis threshold is exceeded). 

405See letters from ISDA I and Northland Energy. 

406See letters from FSR VI and Midsize Banks. 

407Some commenters particularly took the view 

that the application of the dealer definitions to nonU.S. persons should solely address those persons’ 

U.S. dealing activities. See letters from FSR I, ISDA 

I and Socie ́te ́ Ge ́ne ́rale. Some commenters also 

specifically identified concerns of international 

comity in this context. See letters cited in note 148, 

supra. 

The Commissions intend to address the 

application of dealer regulation to non-U.S. persons 

as part of separate releases that generally will 

address the application of Title VII to non-U.S. 

persons. 

408See letter from Better Markets III. 

409See id. 

410A number of commenters expressed particular 

concerns as to the threats that an overbroad 

exception would pose to special entities. See letters 

from AFR (noting that Congress incorporated 

special protections for special entities in reaction to 

news reports about special entities losing millions 

of dollars ‘‘after signing up for derivatives deals 

they did not understand,’’ and urging the 

elimination of any de minimis exception for 

transactions with special entities); Better Markets I 

(stating that history has shown that special entities 

are vulnerable to abuse, and that they need capital, 

collateral and business conduct protections as 

much as or more than any other category of market 

participants); and AFSCME (expressing skepticism 

as to the view that dealer status would preclude 

firms from entering into transactions with special 

entities). Some of those commenters also generally 

supported the proposed $100 million de minimis 

threshold. See letters from AFR and Better Markets 

I; see also letter from Greenberger (stating that the 

dynamic nature of the derivatives sector of the 

financial markets should counsel caution, and that 

the de minimis threshold should be reevaluated on 

an ongoing basis). 

411Notwithstanding the reduction in protection, 

however, in the case of swaps and security-based 

swaps the general antifraud provisions of the CEA 

and the securities laws, respectively, including 

rules to be adopted by the SEC pertaining 

specifically to security-based swaps, will continue 

to apply to all transactions in security-based swaps. 

See, e.g., CEA section 4b(2), 7 U.S.C. 6b(2). 

cooperatives.392 Other commenters 

suggested that the exception should 

focus dealer regulation toward 

‘‘financial’’ entities.393 One commenter 

emphasized the need for the exception 

to be available when the end-user is a 

credit union, bank or thrift.394

Commenters sought clarification that 

the de minimis criteria would not apply 

to transactions for hedging or 

proprietary trading purposes,395 or to 

inter-affiliate transactions.396

Commenters also raised issues related 

to the exception’s treatment of the 

proposed use of a rolling annual period 

for calculations,397 the proposed use of 

‘‘effective notional amounts,’’ 398 the 

possibility of adjusting the thresholds 

over time,399 how the de minimis tests 

would apply in the context of affiliated 

positions,400 and how the exception 

would account for swaps or securitybased swaps entered into before the 

definition’s effective date.401

Some commenters suggested that the 

de minimis thresholds be set higher 

initially to provide for efficient use of 

regulatory resources.402 One commenter 

requested clarification that the 

exception would apply prospectively 

without regard to dealing activities 

taken prior to the effectiveness of Title 

VII.403 One commenter requested that a 

person that falls above the de minimis 

tests be able to take advantage of 

application and re-evaluation periods 

akin to those associated with the major 

participant definitions.404

Two commenters expressed support 

for the proposed self-executing 

approach of the exception.405 Some 

commenters requested clarification that 

the de minimis exception is 

independent of the loan origination 

exclusion in the CEA ‘‘swap dealer’’ 

definition.406

A number of commenters also 

addressed the application of dealer 

regulation to non-U.S. entities. While 

those comments did not specifically 

address the de minimis exception, the 

exception may be relevant to addressing 

these cross-border issues.407

One commenter separately addressed 

the credit default swap data analysis 

made available by CFTC and SEC 

staffs.408 The commenter expressed the 

view that this data supported the 

adoption of a de minimis threshold of 

$100 million or less, particularly 

focusing on the number of entities that 

may be excluded under particular 

thresholds.409

3. Final Rules—General Principles for 

Implementing the De Minimis Exception 

a. Balancing Regulatory Goals and 

Burdens 

The Commissions recognize that 

implementing the de minimis exception 

requires a careful balancing that 

considers the regulatory interests that 

could be undermined by an unduly 

broad exception as well as those 

regulatory interests that may be 

promoted by an appropriately limited 

exception. 

On the one hand, a de minimis 

exception, by its nature, will eliminate 

key counterparty protections provided 

by Title VII for particular users of swaps 

and security-based swaps.410 The 

broader the exception, the greater the 

loss of protection.411 Moreover, in 

determining the scope of the exception, 

it is important to consider not only the 

current state of the swap and securitybased swap markets, but also to account 

for how those markets may evolve in the 

future. This is particularly important 

because the full implementation of Title 

VII—including enhancements to pricing 

transparency and the increased access to 

central clearing—reasonably may be 

expected to facilitate new entrants into 

the swap and security-based swap 

markets. To the extent that such 

entrants engage in dealing activity 

below the de minimis threshold—either 

for the long term or until their activity 

surpasses the threshold—the relative 

amount of unregistered activity within 

the market may be expected to increase. 

Accordingly, a higher de minimis 

threshold may not only result in a 

certain percentage of unregistered 

activity being transacted initially, 

consistent with the current market, but 

also may result in an even greater 

proportion of unregistered activity being 

transacted in the future. 

On the other hand, the Commissions 

also recognize that Congress included a 

statutorily mandated de minimis 

exception for certain swap and securitybased swap dealing activity, and that an 

appropriately calibrated de minimis 

exception has the potential to advance 

other interests. For example, the de 

minimis exception may further the 

interest of regulatory efficiency when 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30629 

412While we are mindful that the Commissions 

have yet to adopt all the final substantive rules 

applicable to swap dealers and security-based swap 

dealers, we nonetheless believe that we have 

sufficient understanding of those potential 

requirements to reasonably balance the relevant 

factors to identify the initial level of dealing activity 

that should be considered to be de minimis. 

Moreover, finalizing the dealer definitions will help 

provide for the orderly and informed finalization of 

those other substantive rules governing swap 

dealers and security-based swap dealers. 

413 ‘‘Congress incorporated a de minimis 

exception to the Swap Dealer definition to ensure 

that smaller institutions that are responsibly 

managing their commercial risk are not 

inadvertently pulled into additional regulation.’’ 

See 156 Cong. Rec. S6192 (daily ed. July 22, 2010) 

(letter from Senators Dodd and Lincoln to 

Representatives Frank and Peterson). 

414See 478 through 487 and accompanying text, 

infra. 

415As discussed above, in part, these customer 

and counterparty protections derive from the 

financial responsibility requirements applicable to 

dealers, particularly: capital and margin 

requirements (CEA section 4s(e); Exchange Act 

section 15F(e)), and requirements for segregation of 

collateral (CEA sections 4d(f), 4s(l); Exchange Act 

section 3E). 

These customer and counterparty protections also 

derive from certain other requirements applicable to 

dealers, particularly: requirements with respect to 

business conduct when transacting with special 

entities (CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5); 

Exchange Act sections 15F(h)(2), (h)(4), (h)(5)); 

disclosure requirements (CEA section 4s(h)(3)(B); 

Exchange Act section 15F(h)(3)(B)); requirements 

for fair and balanced communications (CEA section 

4s(h)(3)(D); Exchange Act section 15F(h)(3)(C)); 

other requirements related to the public interest and 

investor protection (CEA section 4s(h)(3)(D); 

Exchange Act section 15F(h)(3)(D)); and conflict of 

interest provisions (CEA section 4s(j)(5); Exchange 

Act section 15F(j)(5)). 

416Relevant provisions are: reporting and 

recordkeeping requirements (CEA section 4s(f); 

Exchange Act section 15F(f)); daily trading records 

requirements (CEA section 4s(g); Exchange Act 

section 15F(g)); regulatory standards related to the 

confirmation, processing, netting, documentation 

and valuation of security-based swaps (CEA section 

4s(i); Exchange Act section 15F(i)); position limit 

monitoring requirements (CEA section 4s(j)(1); 

Exchange Act section 15F(j)(1)); risk management 

procedure requirements (CEA section 4s(j)(2); 

Exchange Act section 15F(j)(2)); and requirements 

related to the disclosure of information to regulators 

(CEA section 4s(j)(3); Exchange Act section 

15F(j)(3)). 

417For example, the more swaps or security-based 

swaps a dealer enters into, the more significant will 

be the efficiency benefits associated with 

confirmation, processing, netting documentation 

and valuation requirements applicable to dealers. 

418For example, the more swaps or security-based 

swaps a dealer enters into, the more significant the 

number of counterparties that will be protected by 

the disclosure and other business conduct 

obligations imposed on dealers. 

419Certain commenters also have expressed 

concerns that the prospect of regulation may deter 

certain entities from engaging in limited swap or 

security-based swap dealing activities, see, e.g., 

letters from SIFMA—Regional Dealers and Midsize 

Banks, which could reduce the availability of those 

instruments. 

420See, e.g., letters from CDEU (comparing 

proposed thresholds with statistics regarding the 

activities of recognized dealers) and EEI/EPSA 

(recommending that thresholds be set at an amount 

equal to 0.001 percent of the aggregate size of the 

U.S. swaps market, and 0.0001 percent for swaps 

in which the counterparty is a special entity). 

the amount of a person’s dealing activity 

is, in the context of the relevant market, 

limited to an amount that does not 

warrant registration to address the 

concerns implicated by government 

regulation of swap dealers and securitybased swap dealers. To advance this 

interest, it is necessary to consider the 

benefits to the marketplace associated 

with the regulation of dealers against 

the total burdens and potential impacts 

on competition, capital formation and 

efficiency associated with that 

regulation.412

In addition, the exception can provide 

an objective test for persons who engage 

in some swap or security-based swap 

activities that, in their view, potentially 

raise the risk that they would be deemed 

to be dealers.413 The exception also may 

permit persons that are not registered as 

dealers to accommodate existing clients 

that have a need for swaps or securitybased swaps in conjunction with other 

financial services or commercial 

activities, thus avoiding the need for 

such clients to establish separate 

relationships with registered dealers, 

which may have attendant costs. The 

exception further may promote 

competition in dealing activity within 

the swap or security-based swap 

markets, by helping to allow nonregistered persons to commence 

providing dealing services while 

avoiding the costs associated with fullfledged dealers. More competition 

within the market for swaps and 

security-based swaps may not only 

decrease the costs for participants in the 

market, but also may help to decrease 

systemic risk by lessening the current 

apparent concentration of dealing 

activity among a few major market 

participants.414

The statutory requirements that apply 

to swap dealers and security-based swap 

dealers include requirements aimed at 

the protection of customers and 

counterparties,415 as discussed above, as 

well as requirements aimed at helping 

to promote effective operation and 

transparency of the swap and securitybased swap markets.416 The overall 

economic benefits provided by these 

requirements in large part will depend 

on the proportion of swaps and securitybased swaps that are transacted subject 

to these requirements. In other words, 

the greater the dealing activity of a 

registered dealer, the more significant 

the resulting increase in market 

efficiency,417 and the greater the 

reduction in risks faced by the entity’s 

customers and counterparties.418 These 

benefits can be expected to accrue over 

the long term and be distributed over 

the market and its participants as a 

whole. This is not to say, however, that 

it would be insignificant for any 

particular counterparty if its swaps or 

security-based swaps were to fall 

outside of the ambit of dealer regulation. 

For example, a customer or counterparty 

that is not protected by the business 

conduct rules applicable to dealers 

might be more likely to suffer losses 

associated with entering into an 

inappropriate or misunderstood swap or 

security-based swap than if the 

instrument was transacted pursuant to 

the business conduct rules applicable to 

registered dealers. 

In contrast to the benefits associated 

with dealer regulation, many of the 

burdens of dealer regulation will accrue 

in the short term and will fall directly 

on registered dealers.419 Some of those 

burdens may be expected to be 

independent of the amount of an 

entity’s dealing activity (i.e., entities 

that engage in minimal dealing activity 

would still be expected to face certain 

burdens associated with the registration 

process and the development of 

compliance and other systems if they 

are required to register as dealers), while 

other burdens (e.g., the impact of margin 

and capital rules applicable to dealers) 

may be more directly linked to the 

amount of that entity’s dealing activity. 

As discussed below, the Commissions 

have sought to balance the various 

interests associated with a de minimis 

exception, as well as the benefits and 

burdens associated with such an 

exception, in developing the factors to 

implement the de minimis exceptions to 

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

swap dealer’’ definitions. 

However, in moving forward with 

implementing this balancing approach, 

we recognize that the information that 

currently is available regarding certain 

portions of the swap market is limited. 

Following the full implementation of 

Title VII, more information will be 

available to permit us to assess the 

effectiveness of this balancing for 

particular markets and to revise the 

exception as appropriate. 

In that context—and in light of the 

tools currently available to us—we have 

been influenced, in particular, by 

comments taking the view that the de 

minimis factors should take into 

account the size and unique attributes of 

the market for swaps and security-based 

swaps.420 We believe that factors that 

exclude entities whose dealing activity 

is sufficiently modest in light of the 

total size, concentration and other 

attributes of the applicable markets can 

be useful in avoiding the imposition of 

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421For example, it does not appear possible to 

demonstrate empirically—let alone quantify—the 

increase or decrease in the possibility that a 

financial crisis would occur at a particular future 

time and with a particular intensity in the absence 

of financial regulation or as a result of varying 

levels or types of financial regulation. It also is 

difficult to demonstrate empirically that the 

customer protections associated with dealer 

regulation would increase or decrease the 

likelihood that any particular market participant 

would suffer injury (or the degree to which the 

participant would suffer injury) associated with 

entering into an inappropriate swap or securitybased swap. At the same time, certain costs may 

also not be readily susceptible to quantification or 

measurement, for example, the costs that might be 

associated with diminished presence, if any, of new 

entrants. The inability to quantify these benefits 

and costs does not mean that the benefits and costs 

of dealer regulation are any less substantial. 

422See CFTC Regulation § 1.3(ggg)(4); Exchange 

Act rule 3a71–2(a)(1). Over the first year following 

the effective date of the final rules implementing 

the statutory definition of ‘‘swap’’ and ‘‘securitybased swap’’ as set forth in CEA section 1a(47) and 

Exchange Act section 3(a)(68), respectively, this 

notional test will be based on the person’s dealing 

activity following that effective date. See id. 

Accordingly, the analysis of whether a person may 

take advantage of the de minimis exception will not 

encompass the person’s dealing activity prior to 

that effective date, given the need for the person to 

know whether an instrument is a swap or securitybased swap for purposes of the analysis. 

423 ‘‘Changes in notional volumes are generally 

reasonable reflections of business activity, and 

therefore can provide insight into potential revenue 

and operational issues. However, the notional 

amount of derivatives contracts does not provide a 

useful measure of either market or credit risks.’’ 

OCC Quarterly Report at 8. 

424For these purposes, ‘‘special entity’’ means: (i) 

A Federal agency; (ii) a state, state agency, city, 

county, municipality, or other political subdivision 

of a state; (iii) any employee benefit plan, as defined 

in section 3 of the Employee Retirement Income 

Security Act of 1974 (‘‘ERISA’’); (iv) any 

governmental plan, as defined in section 3 of 

ERISA; or (v) any endowment, including an 

endowment that is an organization described in 

section 501(c)(3) of the Internal Revenue Code of 

1986. See CEA section 4s(h)(2)(C) and CFTC 

Regulation § 23.401(c); Exchange Act section 

15F(h)(2)(C). 

425See CEA sections 4s(h)(2), (4), (5); see also 

CFTC, Business Conduct Standards for Swap 

Dealers and Major Swap Participants with 

Counterparties; Final Rule, 77 FR 9733 (Feb. 17, 

2012); Exchange Act sections 15F(h)(2), (4), (5) 

(providing additional requirements for dealers that 

advise special entities or that enter into swaps or 

security-based swaps with special entities). 

426The importance of the statutory protections for 

special entities has been highlighted by the SEC’s 

recent action in connection with the inappropriate 

sale of notes linked to the performance of synthetic 

collateralized debt obligations to a number of 

school districts. According to a complaint filed in 

federal district court, these securities were 

unsuitable for the investment needs of the school 

districts, were sold to school districts that lacked 

the requisite sophistication and experience to 

independently evaluate the risks of the investment, 

and exposed the school districts to a heightened 

risk of catastrophic loss ultimately led to a complete 

loss of their investments. ‘‘SEC Charges Stifel, 

Nicolaus and Former Executive with Fraud in Sale 

of Investments to Wisconsin School Districts,’’ SEC 

Litigation Release No. 22064 (Aug. 10, 2011) (http:// 

www.sec.gov/litigation/litreleases/2011/ 

lr22064.htm). 

427For example, if an exchange of payments 

associated with a $1 million notional equity swap 

was based on three times the return associated with 

the underlying equity, the effective notional amount 

of the equity swap would be $3 million. 

428See, e.g., letter from COPE I. 

429See letter from Better Markets I. 

regulatory burdens on those entities for 

which dealer regulation would not be 

expected to contribute significantly to 

advancing the customer protection, 

market efficiency and transparency 

objectives of dealer regulation. The 

Commissions note, however, that they 

are not of the general view that the costs 

of extending regulation to any particular 

entity must be outweighed by the 

quantifiable or other benefits to be 

achieved with respect to that particular 

entity. The Commissions, rather, 

analyze the overall benefits and costs of 

regulation, keeping in mind, as noted 

above, that the benefits may be 

distributed, accrue over the long-term, 

and be difficult to quantify or to 

measure as easily as certain costs.421

b. Specific Factors Implementing the De 

Minimis Exception 

i. Notional Test 

Consistent with the proposal, the final 

rules implementing the de minimis 

exception take into account the notional 

amount of an entity’s swap or securitybased swap positions over the prior 12 

months arising from its dealing 

activity.422 While the Commissions 

recognize that notional amounts do not 

directly measure the exposure or risk 

associated with a swap or security-based 

swap position, such measures do reflect 

the relative amount of an entity’s 

dealing activity.423 Moreover, although 

some commenters have posited 

measures of risk or exposure as 

alternatives to notional measures, such 

risk or exposure measures could, to the 

extent they allow for netting or 

collateral offsets, potentially allow an 

unregistered entity to engage in large 

amounts of swap or security-based swap 

dealing activity while remaining within 

the de minimis exception so long as that 

entity nets or collateralizes its swap or 

security-based swap positions. Such an 

outcome could undermine the customer 

protection and market operation 

benefits associated with dealer 

regulation. As with the proposed rules, 

the notional factor in the final rules is 

based on the notional positions of an 

entity over a 12 month period, rather 

than capping the current notional 

amount of a position at any time, to 

better reflect the amount of an entity’s 

current activity. 

The final rules, like the proposed 

rules, include lower notional thresholds 

for dealing activities in which the 

counterparty is a ‘‘special entity.’’ 424

This is consistent with the fact that Title 

VII’s requirements applicable to swap 

dealers and security-based swap dealers 

provide heightened protection to those 

types of entities.425 It is important that 

the de minimis exception not 

undermine those statutory 

protections.426 Also, consistent with the 

Proposing Release, these notional 

standards will be based on ‘‘effective 

notional’’ amounts when the stated 

notional amount is leveraged or 

enhanced by the structure of the swap 

or security-based swap.427

ii. Other Tests From the Proposing 

Release 

The proposed rules limited the 

number of swaps or security-based 

swaps that an entity could enter into in 

a dealing capacity, and the number of an 

entity’s counterparties in a dealing 

capacity. The final rules do not include 

those measures. In part, this reflects 

commenter concerns that a standard 

based on the number of swaps or 

security-based swaps or counterparties 

can produce arbitrary results by giving 

disproportionate weight to a series of 

smaller transactions or 

counterparties.428

c. Significance of Statutory ‘‘Customer’’ 

Language 

Consistent with the Proposing 

Release, the final rules implementing 

the de minimis exception do not require 

the presence of any type of defined 

‘‘customer’’ relationship. 

In adopting these rules the 

Commissions have considered 

alternative approaches suggested by 

commenters, including one 

commenter’s suggestion that the de 

minimis exception should be available 

only in connection with swaps or 

security-based swaps entered into as 

part of a ‘‘customer’’ relationship.429 In 

considering that alternative view, 

however, we believe that it is significant 

that the statutory exception lacks 

terminology such as ‘‘existing’’ or 

‘‘preexisting’’ that limits the availability 

of the exception or otherwise to 

distinguishes a ‘‘customer’’ relationship 

from other types of counterparty 

relationship. Also, while that alternative 

view could still permit an unregistered 

person to provide limited dealer 

services as an accommodation to an 

existing customer or counterparty, an 

interpretation that predicates the 

exception on the presence of a 

particular type of ‘‘customer’’ 

relationship would not advance other 

potential benefits associated with a de 

minimis exception, including the 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30631 

430As discussed above, see note 413, supra, there 

is legislative history that suggests that an intended 

purpose of the exception would be to ensure that 

the dealer definition does not encompass ‘‘smaller 

institutions that are responsibly managing their 

commercial risk.’’ 

431See, e.g., letter from ISDA I. 

432See, e.g., letters from SIFMA—Regional 

Dealers and EDF Trading. 

433For purposes of the de minimis exception to 

the security-based swap dealer definition, we note 

that one indicator of dealing activity under the 

dealer-trader distinction is that a person profit by 

providing liquidity in connection with securitybased swaps. Accordingly, for purposes of the de 

minimis exception to the security-based swap 

dealer definition, a security-based swap position 

that hedges or otherwise offsets a position that was 

entered into as part of dealing activity would itself 

comprise part of the person’s dealing activity, and 

hence count against the de minimis thresholds. 

For purposes of the de minimis exception to the 

swap dealer definition, we take the view that the 

relevant question in determining whether swaps 

count as dealing activity against the de minimis 

thresholds is whether the swaps fall within the 

swap dealer definition under the statute and the 

final rules, as further interpreted by this Adopting 

Release. If hedging or proprietary trading activities 

did not fall within the definition, including because 

of the application of CFTC Regulation § 1.3(ggg)(6), 

they would not count against the de minimis 

thresholds. 

434See, e.g., letters from Atmos Holdings and FSR 

I. 

435See parts II.B and II.C, supra. 

436Swaps and security-based swaps that hedge, 

mitigate, or offset the types of swaps and securitybased swaps discussed in the foregoing paragraph, 

which do not constitute dealing activity, similarly 

should not be counted against the de minimis 

thresholds. 

437See CFTC Regulation § 1.3(ggg)(4)(i); Exchange 

Act rule 3a71–2(a)(1). For these purposes, we 

interpret control to mean the possession, direct or 

indirect, of the power to direct or cause the 

direction of the management and policies of a 

person, whether through the ownership of voting 

securities, by contract or otherwise. This is 

consistent with the definition of ‘‘control’’ and 

‘‘affiliate’’ in connection with Exchange Act rules 

regarding registration statements. See Exchange Act 

rule 12b–2. 

The final rules use a control standard in 

connection with the de minimis notional thresholds 

as a means reasonably designed to prevent evasion 

of the limitations of that exception. This contrasts 

with the majority-ownership standard used by the 

inter-affiliate exclusions from the dealer and major 

participant definitions. See parts II.C.2 and IV.G.2, 

infra. That majority-ownership standard, which in 

application will not be expected to be satisfied in 

all circumstances in which a control standard is 

satisfied, is reasonably designed to reflect the 

economic alignment that appropriately underpins 

those exclusions. 

438 In other words, for example, if a parent entity 

controls two subsidiaries which both engage in 

activities that would cause the subsidiaries to be 

covered by the dealer definitions, then each 

subsidiary must aggregate the swaps or securitybased swaps that result from both subsidiaries’ 

dealing activities in determining if either subsidiary 

qualifies for the de minimis exception. 

The SEC expects to address the application of this 

principle to the security-based swap activities of 

non-U.S. persons in a separate release. 

439See, e.g., letters from CDEU and SIFMA— 

Regional Dealers. 

440We also disagree with the suggestion that it 

would be inconsistent with the Title VII framework 

to consider customer protection issues in setting the 

de minimis factors. See letter from WGCEF I. While 

the restrictions on the availability of swaps and 

security-based swaps to non-ECPs help to mitigate 

certain customer protection concerns, Title VII 

includes specific safeguards designed to protect 

dealers’ customers and counterparties regardless of 

whether those are ECPs. It would not be consistent 

with Title VII to ignore those interests. 

benefit of providing certainty in 

connection with the swap or securitybased swap activities of end-users.430

Accordingly, we do not believe that the 

‘‘customer’’ reference standing alone 

provides a sufficient basis to conclude 

that the exception should only be 

available if there is an existing 

relationship of some type, and the final 

rules neither require that a dealer 

accommodate the demand of an existing 

customer nor require the presence of a 

preexisting relationship for the 

exception to apply. 

We also are not persuaded by the 

different commenter suggestion that the 

statutory de minimis exception’s 

‘‘customer’’ language means that an 

unregistered dealer should be permitted 

to engage in unlimited dealing activity 

so long as its counterparties are not 

customers.431 Such an unlimited 

exception would appear to be contrary 

to the express language of the statutory 

exception. In addition, such an 

approach would lead to the perverse 

result of discouraging entities from 

entering into swaps or security-based 

swaps to facilitate risk management 

activities of customers (while 

encouraging other dealing activities), 

which appears contrary to Title VII’s 

general approach of seeking to limit 

undue impacts on the swap and 

security-based swap activities of 

commercial end-users. 

d. Focus on ‘‘Dealing’’ Activity 

Some commenters suggested that we 

clarify that the limitations associated 

with the de minimis exception apply 

only in connection with a person’s 

dealing activities, and not to the 

person’s hedging or proprietary trading 

activities.432 The Commissions agree 

that the de minimis exception is 

intended to permit an unregistered 

person to engage in a limited amount of 

dealing activity without regard to the 

person’s non-dealing activity. Thus, to 

the extent that a particular swap or 

security-based swap position is not 

connected to dealing activity under the 

applicable interpretation of the statutory 

dealer definition, it will not count 

against the de minimis thresholds. 

Conversely, if a swap or security-based 

swap position is connected to the 

person’s dealing activity, the position 

will count against those thresholds.433

Commenters also requested 

clarification that the de minimis 

thresholds do not apply to a person’s 

inter-affiliate swaps and security-based 

swaps, nor apply to swaps covered by 

the exclusion for swaps entered into by 

insured depository institutions in 

connection with the origination of loans 

to customers.434 Consistent with the 

discussion above,435 such swaps or 

security-based swaps do not constitute 

dealing activity and should not be 

counted against the de minimis 

thresholds. Similarly, swaps between a 

cooperative and its members, as 

provided in CFTC Regulation 

§ 1.3(ggg)(6)(ii), and swaps entered into 

for the hedging purpose defined in 

CFTC Regulation § 1.3(ggg)(6)(iii) 

should not be counted against the de 

minimis threshold.436

In light of the increased notional 

thresholds of the final rules, and the 

resulting opportunity for a person to 

evasively engage in large amounts of 

dealing activity if it can multiply those 

thresholds, the final rules provide that 

the notional thresholds to the de 

minimis exception encompass swap and 

security-based swap dealing positions 

entered into by an affiliate controlling, 

controlled by or under common control 

with the person at issue.437 This is 

necessary to prevent persons from 

avoiding dealer regulation by dividing 

up dealing activity in excess of the 

notional thresholds among multiple 

affiliates.438

e. Alternative Approaches We Are Not 

Following 

Certain commenters have suggested 

alternative approaches to implementing 

the de minimis exception. While the 

Commissions have considered those 

suggested alternatives, we do not 

believe that they provide the optimal 

framework for implementing the 

exception. 

For example, some commenters took 

the position that the de minimis 

exception should focus dealer 

regulation on those entities whose 

dealing activities pose systemic risk, 

and excuse other dealers from having to 

register.439 Such an approach, however, 

would fail to account for regulatory 

interests apart from the control of 

systemic risk that are addressed by 

dealer regulation, including statutory 

provisions that protect customers and 

counterparties in other ways, and that 

promote effective market operations and 

transparency.440

Some commenters also have 

suggested that the de minimis exception 

should subsume a proportionality 

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441See letter from FHLB I. 

442As discussed below, if an entity is a dealer, 

the regulations applicable to dealers in general will 

govern all of the entity’s swap or security-based 

swap activities and positions. Depending on the 

applicable facts and circumstances, however, the 

entity may be able to avail itself of a limited 

purpose designation as a dealer. See part II.E, infra. 

443See letters from FHLB I, Gavilon II, and MFX 

II. 

444CFTC Regulation § 1.3(ggg)(4). As noted above, 

for the first year following the effective date of the 

rules implementing the definition of ‘‘swap’’ the 

analysis would only address activity following that 

effective date. For clarity, the final rule also has 

been revised from the proposal to provide that 

persons taking advantage of the exception ‘‘shall be 

deemed not to be’’ swap dealers (the proposed rule 

used the phrasing ‘‘shall not be deemed to be’’ swap 

dealers) The final rule also reflects certain 

structural changes consistent with the substantive 

changes from the proposed rule. In addition, as 

discussed above, see part II.D.3.d, supra, the final 

rule has been revised to provide that the notional 

thresholds to the de minimis exception encompass 

swap dealing positions entered into by an affiliate 

controlling, controlled by or under common control 

with the person at issue. 

445One commenter suggested a threshold of $3 

billion. See letter from COPE I (suggesting 0.001% 

of the total U.S. swap market, amounting to 

approximately $3 billion). Other commenters also 

supported a threshold of 0.001% of the total U.S. 

swap market. See letters cited in note 382, supra. 

446The CFTC analysis was made available to the 

public. See memorandum to the public comment 

file from the CFTC Office of the Chief Economist. 

447See id. 

448See id. 

standard, whereby an entity may be 

excluded from dealer regulation if its 

dealing activity comprises only a 

relatively small portion of its overall 

activities (or its overall swap or 

security-based swap activities), or if its 

dealing activity is ‘‘tangential’’ to its 

principal business.441 We are not 

incorporating that type of approach into 

the de minimis factors, however, 

because that approach would not appear 

to provide a logical way to balance the 

benefits and burdens of dealer 

regulation. A proportionality approach 

could permit a large entity to engage in 

a significant amount of dealing activity 

without being subject to dealer 

regulation, thus undermining the 

benefits of dealer regulation. Moreover, 

a proportionality approach could lead to 

arbitrary results by excusing a large 

entity from dealer regulation while 

requiring the registration of a smaller 

entity that engages in less total dealing 

activity (if that smaller amount of 

dealing activity comprises a greater 

portion of the smaller entity’s total 

activity).442

Some commenters also supported the 

use of non-quantitative standards in 

connection with the de minimis 

exception.443 Although we recognize 

that such an approach may help us 

weigh the facts and circumstances 

associated with a particular person’s 

dealing activity, we believe that it is 

more appropriate to base the exception 

on an objective quantitative standard, to 

allow the exception to be self-executing, 

and to promote predictability among 

market participants and the efficient use 

of regulatory resources. Unlike the 

overall definitions of ‘‘swap dealer’’ and 

‘‘security-based swap dealers,’’ which 

consider the entirety of a person’s 

activities with respect to swaps, the de 

minimis exception is only relevant to 

persons who have determined that they 

are engaged in swap or security-based 

swap dealing, and are looking to 

determine whether the quantity of their 

dealing activity is de minimis. For this 

more particular and focused 

determination, an objective quantitative 

standard is more appropriate. 

Commenters also made various 

suggestions as to the types of factors and 

accompanying thresholds that should be 

used in connection with the de minimis 

exception. Those suggestions are 

addressed more specifically below in 

the specific context of the swap dealer 

and security-based swap dealer de 

minimis exceptions. 

4. Final Rules—De Minimis Exception to 

Swap Dealer Definition 

a. Overview of the Final Rule 

After considering commenters’ views, 

the final rule implementing the de 

minimis exception caps an entity’s 

dealing activity involving swaps at $3 

billion over the prior 12 months.444 This 

amount is based on input from 

commenters and is supported by several 

rationales, including the estimated size 

of the domestic swap market, among 

others. 

As noted above, commenters who 

suggested a fixed notional standard 

proposed that the standard be set at a 

level between $200 million and $3.5 

billion in notional amount of swaps 

entered into over a period of twelve 

months.445 In considering these 

comments, we are mindful of the variety 

of uses of swaps in various markets and 

therefore it is understandable that 

various commenters would reach 

different conclusions regarding the 

appropriate standard. At the same time, 

we see value in setting a single standard 

for all swaps so that there is a ‘‘level 

playing field’’ for all market participants 

and so that the standard can be 

implemented easily without the need to 

categorize swaps. Considering the 

written input of the commenters as well 

as the discussions of the de minimis 

standard at the Commissions’ joint 

roundtable and numerous meetings with 

market participants, and the benefits of 

the regulation of swap dealers (i.e., 

protection of customers and 

counterparties, and promotion of the 

effective operation and transparency of 

the swap markets), we believe a notional 

standard at a level of $3 billion 

appropriately balances the relevant 

regulatory goals. 

As noted above, several commenters 

suggested that the standard be set at an 

amount equal to 0.001 percent of the 

overall domestic market for swaps. The 

Commissions note, however, that 

comprehensive information regarding 

the total size of the domestic swap 

market is incomplete, with more 

information available with respect to 

certain asset classes than others. The 

CFTC evaluated data regarding one 

particular type of swap—credit default 

swaps (‘‘CDS’’) based on indices of debt 

securities known as ‘‘index CDS’’—that 

was provided by the SEC.446 As noted 

in the CFTC analysis of this data, 

however, the information is not filtered 

to reflect activity that would constitute 

swap dealing under the Dodd-Frank 

Act, so it is not possible to use the data 

to draw conclusions regarding any 

specific entity’s status as a swap 

dealer.447 The data reflects only activity 

relating to index CDS, which constitute 

a very narrow part of the overall swap 

market, and, as noted in the CFTC 

analysis, similar data regarding other 

types of swaps is not available.448

Subject to these limitations, the data 

may help evaluate the impact of 

alternative approaches to implementing 

the de minimis exception. 

One often-cited measure of the 

market, the Quarterly Report on Bank 

Trading and Derivatives Activities 

issued by the OCC (‘‘OCC Quarterly 

Report’’) is both limited, in that it 

includes only data related to the 

activities of U.S. bank holding 

companies, commercial banks and trust 

companies, and over-inclusive, in that it 

includes activities related to 

instruments that are not or may not be 

included in the final definition of 

‘‘swap’’ (including futures, forwards, 

certain foreign exchange instruments, 

and certain options) and it includes 

both swaps and security-based swaps. 

Nonetheless, the Commissions believe 

that the available (imperfect) data 

suggests that a $3 billion notional 

standard is generally consistent with the 

commenters’ suggestion of basing the 

standard on a percentage of the overall 

domestic market for swaps. 

The total notional value of $333.1 

trillion in ‘‘derivatives’’ stated in the 

most recent OCC Quarterly Report 

includes approximately $221.1 trillion 

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449See Office of the Comptroller of the Currency, 

‘‘Quarterly Report on Bank Trading and Derivatives 

Activities, Second Quarter 2011’’ at tables 1 and 2 

(http://www.occ.gov/topics/capital-markets/ 

financial-markets/trading/derivatives/dq211.pdf). 

These totals reflect the sum of the amounts reported 

for the top 25 bank holding companies reported in 

table 1 and for all but the top 25 commercial banks 

and trust companies reported in table 2. 

However, this adjustment is only approximate, 

because the definitions of ‘‘swap’’ and ‘‘credit 

derivative’’ used in the OCC Quarterly Report are 

likely to be significantly different from the final 

definition of ‘‘swap’’ and ‘‘security-based swap’’ for 

purposes of the Dodd-Frank Act. For the same 

reason, it is uncertain how many of the notional 

value of $54.5 trillion in options reported in the 

OCC Quarterly Report are swaps or security-based 

swaps. 

Also, data from the CDS trade information 

warehouse maintained by the Depository Trust & 

Clearing Corporation (‘‘DTCC’’) indicates that total 

global notional CDS positions on indices amount to 

approximately $10.47 trillion. See http://dtcc.com/ 

products/derivserv/data_table_i.php?tbid=3 (data 

for the week ending October 7, 2011, obtained on 

October 17, 2011). 

450See part II.D.5, infra, for a discussion of the 

size of the security-based swap market. 

451See OCC Quarterly Report at Graph 1. 

452See OCC Quarterly Report at Graph 3. 

453CFTC Regulation § 1.3(ggg)(4)(i). 

454See letters from AFR and Better Markets I. 

455See letters cited in footnote 402, supra. 

456See, e.g., Roundtable Transcript at 35 (remarks 

of Ron Filler, New York Law School) and letters 

from FSR dated May 12, 2011 (‘‘FSR III’’) and 

WGCEF V. 

in ‘‘swaps’’ and ‘‘credit derivatives.’’ 449

Since some instruments that are 

security-based swaps are included in 

this total,450 the total notional value of 

swap positions at U.S. bank holding 

companies, commercial banks and trust 

companies at the end of the second 

quarter of 2011 of may be estimated to 

be somewhat less than $221.1 trillion. 

This total notional value is by nature 

under-inclusive, because it reflects only 

swap positions at U.S. bank holding 

companies, commercial banks and trust 

companies and not the swap positions 

of other market participants. However, 

there are also reasons that the 

information from the OCC Quarterly 

Report may overstate the notional value 

of swaps that would be relevant to 

estimating the size of the domestic swap 

market for purposes of the de minimis 

standard. While we believe the data is 

not sufficiently precise at this time to 

serve as the sole basis for the notional 

standard, a standard of $3 billion seems 

that it is likely generally consistent with 

0.001 percent of the domestic swap 

market that would be relevant to a 

potential dealer’s de minimis swap 

activity figure. First, the large majority 

of derivatives in the OCC Quarterly 

Report (approximately $229 trillion in 

notional value for commercial banks 

and trust companies) are derivatives 

between ‘‘dealers’’ (as defined for the 

purposes of the report.) 451 Thus, it is 

likely that a large part of the derivatives 

in the OCC Quarterly Report reflect 

transactions between financial 

institutions that will be swap dealers. It 

is also notable that approximately 

$204.6 trillion in notional value of the 

derivatives (i.e., not only swaps) 

reported by U.S. commercial banks were 

interest rate contracts, many of which 

are swaps entered into by IDIs with 

customers in connection with the 

origination of loans which will be 

excluded from the determination of 

whether the IDIs are swap dealers.452

Finally, the OCC Quarterly Report 

measures swap positions held at a 

certain point in time, rather than the 

level of swap activity over a certain time 

period, again indicating that the figures 

are broader than those that would be 

subject to the de minimis figure. 

Accordingly, it appears that notional 

amount of the overall domestic market 

for swaps that actually would be 

relevant to determining the notional 

standard, and thus the appropriate basis 

for the 0.001 percent calculation, may 

be significantly lower than $331 trillion. 

Because there is merit in the 0.001 

percent ratio suggested by several 

commenters, we believe an appropriate 

balance of the goal of promoting the 

benefits of regulation (while recognizing 

the unquantifiable nature of those 

benefits) against the competing goal of 

avoiding the imposition of burdens on 

those entities for which regulation as a 

dealer would not be associated with 

achieving those benefits in a significant 

way, would be reached by setting the 

notional standard for swaps at a level 

that is near (taking into account the 

uncertainties noted above) 0.001 percent 

of a reasonable estimate of the overall 

domestic market for all swaps between 

all counterparties. We believe a $3 

billion notional value standard is 

appropriate taking all these 

considerations into account. 

b. Dealing Activity Involving Special 

Entities 

For swaps in which the counterparty 

is a special entity, the final rules set a 

notional standard consistent with the 

proposal of $25 million over the prior 

12 months.453 The Commissions believe 

that this notional standard is 

appropriate in light of the special 

protections that Title VII affords to 

special entities. In adopting this 

threshold, we recognize the serious 

concerns raised by commenters stating 

that the de minimis exception should 

not permit any dealing activities (by 

persons who are not registered as swap 

dealers) involving special entities, in 

light of losses that special entities have 

incurred in the financial markets.454

However, the final rule does not fully 

exclude such dealing activity from the 

exception, in light of the potential 

benefits that may arise from a de 

minimis exception. In this way, the 

threshold would not completely 

foreclose the availability of swaps to 

special entities from unregistered 

dealers, but the threshold would limit 

the financial and other risks associated 

with those positions for a special entity, 

which would in turn limit the 

possibility of inappropriately 

undermining the special protections 

that Title VII provides to special 

entities. 

c. Phase-in Procedure 

The Commissions believe that a 

phase-in period for the de minimis 

threshold would facilitate the orderly 

implementation of Title VII by 

permitting market participants and the 

Commissions to familiarize themselves 

with the application of the swap dealer 

definition and swap dealer requirements 

and to consider the information that 

will be available about the swap market, 

including real-time public reporting of 

swap data and information reported to 

swap data repositories. In addition, a 

phase-in period would afford the 

Commissions additional time to study 

the swap markets as they evolve in the 

new regulatory framework and allow 

potential swap dealers that engage in 

smaller amounts of activity (relative to 

the current size of the market) 

additional time to adjust their business 

practices, while at the same time 

preserving a focus on the regulation of 

the largest and most significant swap 

dealers. The Commissions also 

recognize that the data informing their 

current view of the de minimis 

threshold is based on the markets as 

they exist today, and that the markets 

will evolve over the coming years in 

light of the new regulatory framework 

and other developments. 

We have also considered that there 

may be some uncertainty regarding the 

exact level of swap dealing activity, 

measured in terms of a gross notional 

amount of swaps, that should be 

regarded as de minimis. While some 

quantitative data regarding the usage of 

swaps is available, there are many 

aspects of the swap markets for which 

definitive data is not available. We have 

also considered comments suggesting 

that the de minimis thresholds should 

be set higher initially to provide for 

efficient use of regulatory resources,455

or that implementation of the dealer 

requirements should be phased.456 For 

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457See CFTC Regulation § 1.3(ggg)(4)(i). 

458This limitation regarding swaps with special 

entities during the phase-in period is consistent 

with the Dodd-Frank Act’s goal of helping special 

entities be in a position to benefit from the 

counterparty protections associated with the 

regulation of registered swap dealers under Title 

VII. 

459See, e.g., part II.D.4.a, supra. 

460See CFTC Regulation § 1.3(ggg)(4)(ii)(C). 

461See CFTC Regulation § 1.3(ggg)(4)(ii)(C). 

462See CFTC Regulation § 1.3(ggg)(4)(ii)(D). 

463See CFTC Regulation § 1.3(ggg)(4)(vi). 

464CFTC Regulation § 1.3(ggg)(4)(v). CEA section 

1a(49)(D) (like Exchange Act section 3(a)(71)(D)) 

particularly states that the ‘‘Commission’’— 

meaning the CFTC—may exempt de minimis 

dealers and promulgate related regulations. We do 

not interpret the joint rulemaking provisions of 

section 712(d) of the Dodd-Frank Act to require 

joint rulemaking here, because such an 

interpretation would read the term ‘‘Commission’’ 

out of CEA section 1a(49)(D) (and Exchange Act 

section 3(a)(71)(D)), which themselves were added 

by the Dodd-Frank Act. 

465See letter from Greenberger (stating that the 

dynamic nature of the derivatives sector of the 

financial markets should counsel caution, and that 

the de minimis threshold should be reevaluated on 

an ongoing basis). 

all these reasons, the Commissions 

believe it is appropriate that the final 

rules provide for a phase-in period 

following the effective date during 

which higher de minimis thresholds 

would apply. 

In particular, during this phase-in 

period, a person’s swap dealing activity 

over the prior 12 months is capped at a 

gross notional value of $8 billion.457

With respect to swaps with special 

entities, the Commissions believe it is 

appropriate that the $25 million gross 

notional value threshold apply during 

the phase-in period.458 In light of the 

available data—and the limitations of 

that data in predicting how the full 

implementation of Title VII will affect 

dealing activity in the swap markets— 

the Commissions believe that the 

appropriate threshold for the phase-in 

period is an annual gross notional level 

of swap dealing activity of $8 billion or 

less. In particular, the $8 billion level 

should still lead to the regulation of 

persons responsible for the vast majority 

of dealing activity within the swap 

markets. 

Accordingly, the Commissions believe 

that while a $3 billion notional 

threshold reflects an appropriate longterm standard based on the available 

data,459 it also is appropriate to allow a 

degree of latitude in applying the 

threshold over time in the event that 

subsequent developments in the 

markets or the evaluation of new data 

from swap data reporting facilities 

suggest that the thresholds should be 

adjusted. In particular, the 

implementation of swap data reporting 

under the Dodd-Frank Act may result in 

new data that would be useful in 

confirming the Commissions’ 

determination to establish the $3 billion 

threshold which applies after the phasein period. 

For these reasons, review of the de 

minimis exception will comprise an 

important part of the reports that the 

CFTC is directing its staff to conduct 

with regard to the swap dealer 

definition during the phase-in period. 

Among other topics, the report should 

consider market data addressing swap 

dealing activity over a period of 

approximately two years, and any 

resulting changes in swap dealing 

activity, by dealers above and below the 

$8 billion phase-in threshold, and above 

and below the $3 billion level 

applicable after the phase-in period. The 

report is required to be completed by 

the CFTC staff no later than 30 months 

following the date that a swap data 

repository first receives swap data under 

the CFTC’s regulations, and the report 

will be published for public 

comment.460 The CFTC will take this 

report, in conjunction with any public 

comment on it, into account in weighing 

further action on the de minimis 

exception at the end of the phase-in 

period. 

The final rules provide that nine 

months after publication of its staff 

report, the CFTC may, in its discretion, 

either promulgate an order that the 

phase-in period will end as of the date 

set forth by the CFTC in that order, or 

issue for public comment a notice of 

proposed rulemaking to modify the de 

minimis threshold, in which case the 

CFTC would also issue an order 

establishing the date that the phase-in 

period will end.461 The period of nine 

months provided in the rule is intended 

to provide the CFTC an opportunity to 

consider its staff report, public 

comments on the staff report and any 

other relevant information. 

The CFTC recognizes that the 

determination of the appropriate de 

minimis threshold is a significant issue 

requiring thorough consideration of a 

variety of regulatory and market factors. 

At the same time, the CFTC recognizes 

the need for predictability in how the de 

minimis exception will apply. 

Therefore, the final rules include a 

finality provision, stating that the phasein period will end no later than five 

years after the date that a swap data 

repository first receives swap data under 

the CFTC’s regulations.462

Persons who are able to avail 

themselves of the higher de minimis 

threshold that applies during the phasein period will not be required to do so. 

In particular, a person that is engaged in 

dealing activity involving swaps in 

excess of the $3 billion threshold may 

choose to commence the process for 

registering as a swap dealer during the 

phase-in period.463

d. CFTC Staff Report 

As noted above, the CFTC is directing 

its staff to report to the CFTC as to 

whether changes are warranted to the 

rules implementing the swap dealer 

definition, including the rule 

implementing the de minimis exception. 

We are mindful that following the full 

implementation of Title VII—which 

itself is contingent on the 

implementation of the dealer 

definition—more data will be available 

to the CFTC via swap data repositories. 

We expect that this additional data will 

assist the CFTC in testing the 

assumptions and addressing the effects 

of the final rule we are adopting to 

implement the de minimis exception. 

For example, this data should help the 

CFTC assess, among other things, the 

nature and amount of unregulated 

dealing activity that occurs under the $3 

billion threshold. The CFTC will make 

this report available for public comment 

so that it may benefit from additional 

input and analysis regarding the swap 

dealer definition. 

By making use of postimplementation data, the staff report 

(together with public comment on the 

report) will help the CFTC better 

evaluate the exception in light of 

potential market changes resulting from 

the full implementation of Title VII— 

including market changes resulting from 

the de minimis exception itself—as part 

of determining whether revised de 

minimis thresholds would be 

appropriate. The report and public 

comment thereon will also be taken into 

consideration by the CFTC in 

determining what action, if any, to take 

with respect to the phase-in period 

associated with the de minimis 

exception. 

The final rules provide, moreover, 

that the CFTC may change the 

requirements of the de minimis 

exception by rule or regulation.464

Through this mechanism, the CFTC may 

revisit the rule implementing the 

exception and potentially change that 

rule, for example, if data regarding the 

post-implementation swap market 

suggests that different de minimis 

thresholds would be appropriate.465 In 

determining whether to revisit the 

thresholds, the CFTC intends to pay 

particular attention to whether the de 

minimis exception results in a swap 

dealer definition that encompasses too 

many entities whose activities are not 

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466See part II.D.3.b, supra. 

467For clarity, the final rule also has been revised 

from the proposal to provide that persons taking 

advantage of the exception ‘‘shall be deemed not to 

be’’ dealers (the proposed rule used the phrasing 

‘‘shall not be deemed to be’’ dealers), and to provide 

that such persons ‘‘shall not be subject to Section 

15F of the Exchange Act and the rules, regulations 

and interpretations issued thereunder.’’ See 

Exchange Act rule 3a71–2(a). The final rule also 

reflects certain structural changes consistent with 

the substantive changes from the proposed rule. 

In addition, as discussed above, see part II.D.3.d, 

supra, the final rule has been revised to provide 

that the notional thresholds to the de minimis 

exception encompass swap and security-based 

swap dealing positions entered into by an affiliate 

controlling, controlled by or under common control 

with the person at issue. 

468Exchange Act rule 3a71–2(a)(1)(i). The final 

rule, like the proposal, requires the analysis of de 

minimis levels to be based on effective notional 

amounts to the extent that the stated notional 

amount is leveraged or enhanced by the structure 

of the security-based swap (such as, for example, if 

the exchange of payments associated with an equity 

swap was based on a multiple of the return 

associated with the underlying equity). See 

Exchange Act rule 3a71–2(a)(3). 

It is important to recognize that while these types 

of de minimis principles are relevant to the 

‘‘security-based swap dealer’’ definition, they are 

not applicable to the general definitions of ‘‘broker’’ 

and ‘‘dealer’’ under the Exchange Act, or the brokerdealer registration requirements of Exchange Act 

section 15(a). Unlike the ‘‘security-based swap 

dealer’’ definition, those other definitions, with the 

exception of the bank-broker definition in section 

3(a)(4)(B)(xi) of the Exchange Act, lack de minimis 

exceptions. 

469Exchange Act rule 3a71–2(a)(1)(ii). 

470Exchange Act rule 3a71–2(a)(1)(iii). 

471Exchange Act rule 3a71–2(d); see part II.D.5.f, 

infra. 

472Certain data has been addressed by an analysis 

regarding the market for single-name credit default 

swaps performed by the SEC’s Division of Risk, 

Strategy, and Financial Innovation. See 

‘‘Information regarding activities and positions of 

participants in the single-name credit default swap 

market’’ (Mar. 15, 2012) (available at http:// 

www.sec.gov/comments/s7-39-10/s73910-154.pdf) 

(‘‘CDS Data Analysis’’). We believe that the data 

underlying this analysis provides reasonably 

comprehensive information regarding the credit 

default swap activities and positions of U.S. market 

participants, but note that the data does not 

encompass those credit default swaps that both: (i) 

do not involve U.S. counterparties; and (ii) are 

based on non-U.S. reference entities. Our reliance 

on this data, which we believe to be the best 

available, should not be interpreted to indicate our 

views as to the nature or extent of the application 

of Title VII to non-U.S. persons; instead, the SEC 

anticipates that issues regarding the extraterritorial 

application of Title VII will be addressed in a 

separate release. 

As discussed below, see notes 476 and 485, infra, 

we also have considered more limited publicly 

available data regarding equity swaps. 

The CDS Data Analysis also included an 

appendix of data regarding index credit default 

swaps. We do not consider that data for purposes 

of the analysis described in this section because the 

statutory definition of ‘‘security-based swap’’ in 

relevant part encompasses swaps based on single 

securities or on narrow-based security indices. See 

Exchange Act sec. 3(a)(68)(A); see also Exchange 

Act Release No. 64372, 76 FR 29818 (May 23, 2011) 

(proposed rules further defining ‘‘security-based 

swap’’ and certain other terms). 

473We believe that the application of the dealertrader distinction and the guidance we have 

provided that distinguishes hedging activities from 

dealing activities in the security-based swap market 

will also help dealers meet their obligations. 

474See part II.D.3.a, supra. 

475See note 472, supra. 

significant enough to warrant full 

regulation under Title VII, or, 

alternatively, whether the de minimis 

exception leads an undue amount of 

dealing activity to fall outside of the 

ambit of the Title VII regulatory 

framework, or leads to inappropriate 

reductions in counterparty protections 

(including protections for special 

entities). The CFTC also intends to pay 

particular attention to whether 

alternative approaches would more 

effectively promote the regulatory goals 

that may be associated with a de 

minimis exception. 

5. Final Rules—De Minimis Exception to 

‘‘Security-Based Swap Dealer’’ 

Definition 

a. Overview of the Final Rule 

The final rule implementing the de 

minimis exception to the ‘‘securitybased swap dealer’’ definition has been 

revised from the proposal in a number 

of ways. As discussed above, the final 

rule does not incorporate proposed 

limits on the number of security-based 

swaps that a person may enter into in 

a dealing capacity, or on the number of 

security-based swap counterparties a 

person may have when acting in a 

dealing capacity.466 Moreover, the 

provisions of the exception that cap an 

unregistered person’s annual notional 

dealing activity with counterparties 

other than ‘‘special entities’’ have been 

increased from the proposed $100 

million threshold.467 Instead, the final 

rule caps such dealing activity involving 

security-based swaps that are credit 

default swaps—which largely would 

consist of single-name credit default 

swaps—at $3 billion in notional amount 

over the prior 12 months.468 For other 

types of security-based swaps (e.g., 

single-name or narrow-based equity 

swaps or total return swaps), the 

exception caps an unregistered person’s 

dealing activity at $150 million in 

notional amount over the prior 12 

months.469 Also, as addressed below, 

the final rule provides for phase-in 

levels in excess of those $3 billion and 

$150 million thresholds for a certain 

period of time. 

In addition, consistent with the 

proposal, the final rule caps an 

unregistered person’s security-based 

swap dealing activity involving 

counterparties that are ‘‘special entities’’ 

at $25 million in notional amount over 

the prior 12 months.470 The final rule 

further provides that the SEC may 

establish alternative methods of 

determining the scope of the de minimis 

exception by rule or regulation.471

b. Interests Associated With a De 

Minimis Exception 

In developing this final rule, we have 

sought to balance the interests advanced 

by the de minimis exception against the 

protections that would be weakened 

were the exception applied in an 

overbroad manner. In making this 

evaluation, we have taken into account 

data regarding the security-based swap 

market and especially data regarding the 

activity—including activity that may be 

suggestive of dealing behavior—of 

participants in the single-name credit 

default swap market.472

As discussed above, a de minimis 

exception eliminates key Title VII 

protections for some market participants 

by regulating less dealer activity. 

Conversely, an appropriately applied de 

minimis exception may provide an 

objective test when there is doubt as to 

whether particular activities may cause 

a person to be deemed to be a dealer; 473

allow non-dealers to accommodate the 

incidental security-based swap needs of 

existing clients; and help to facilitate 

competition by allowing the entry of 

new dealers into the market. In 

addition, as discussed above, a de 

minimis exception may promote 

regulatory efficiency by providing a 

framework to help focus dealer 

regulation upon those entities for which 

such regulation is warranted, rather 

than upon entities that engage in 

relatively limited amounts of dealing 

activity.474

i. Providing for Regulatory Coverage of 

the Vast Majority of Dealing Activity 

In seeking to develop a de minimis 

exception that preserves key 

counterparty and market protections 

while promoting regulatory efficiency, 

we have considered the comparative 

amount of security-based swap dealing 

activity that could fall outside the ambit 

of dealer regulation as a result of the 

exception. In doing so we have 

considered not only the security-based 

swap market as it currently exists, but 

also how the market reasonably may be 

expected to change after the full 

implementation of Title VII. 

In performing this comparative 

exercise we are, in part, drawing 

inferences from the CDS Data Analysis, 

a dataset released by the SEC staff that 

characterizes nearly all transactions in 

single-name credit default swaps during 

the 2011 calendar year.475 Though the 

final rules apply to all security-based 

swaps, not just single-name credit 

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476While recognizing that the Commissions have 

yet to adopt final rules defining a ‘‘security-based 

swap,’’ we believe that single-name credit default 

swaps will constitute roughly 95 percent of the 

market, as measured on a notional basis, for 

instruments that will fall within that definition, 

with certain equity swaps (in other words, total 

return swaps based on single equities or narrowbased indices of equities) constituting the primary 

example of security-based swaps that are not credit 

default swaps. 

In particular, according to data published by BIS, 

the global notional amount outstanding in equity 

forwards and swaps as of June 2011 was $2.03 

trillion, and the notional amount outstanding in 

credit default swaps was approximately $32.4 

trillion. See Statistical Annex, BIS Quarterly 

Review (December 2011), at A10 (available at http:// 

www.bis.org/publ/qtrpdf/r_qs1112.pdf). Although 

the BIS data reflects the global OTC derivatives 

market, and not just U.S. market, we have no reason 

to believe that these ratios differ significantly in the 

U.S. market. In fact, OCC data regarding U.S. 

entities generally confirms these ratios, in that as of 

June 30, 2011, U.S. commercial banks and trust 

companies held $15.23 trillion in notional 

outstanding credit derivative positions and $677 

billion in equity derivative positions, meaning that 

credit derivatives accounted for approximately 95 

percent of the total credit and equity derivative 

positions held by these entities. See OCC Quarterly 

Report at tables 1 and 10. Cf. letter from 

Greenberger (referencing OCC data as relevant to 

determining size of swap market). 

477A person that is engaged in security-based 

swap dealing activity, for example, may also engage 

in proprietary trading involving security-based 

swaps that would be reflected in the transaction 

data. Even accounting for such possibilities, 

however, the SEC believes that the data nonetheless 

support the broad conclusion described below that 

dealing activity within the security-based swap 

market is highly concentrated. 

478See CDS Data Analysis at table 3c. The SEC 

recognizes that the analysis of this transaction data 

is imperfect as a tool for identifying dealing 

activity, given that the presence or absence of 

dealing activity ultimately turns upon the relevant 

facts and circumstances of an entity’s securitybased swap transactions, as informed by the dealertrader distinction. Criteria based on the number of 

an entity’s counterparties that are not recognized as 

dealers nonetheless appear to be useful for 

identifying apparent dealing activity in the absence 

of full analysis of the relevant facts and 

circumstances, given that engaging in securitybased swap transactions with non-dealers would be 

consistent with the conduct of seeking to profit by 

providing liquidity to others, as anticipated by the 

dealer-trader distinction. In emphasizing this 

criterion for identifying dealing activity, we are not 

seeking to predict with precision how many entities 

ultimately may register as security-based swap 

dealers. The ultimate number of dealers that may 

register can also be expected to reflect growth in the 

market, new dealing entrants, and in some cases the 

registration of multiple dealing entities within an 

affiliated group. 

479See CDS Data Analysis at table 3c. In 

particular, those 15 entities engaged in a total of 

$11.01 trillion in notional single-name credit 

default swap transactions over 2011, which reflects 

98.5 percent of the total $11.18 trillion in notional 

transactions over 2011 for the 28 total identified 

possible dealers. 

480See id. The 21 possible dealers with a 2011 

notional in excess of $10 billion account for a total 

of $11.15 trillion in notional single-name credit 

default swap transactions in 2011, or over 99.7 

percent of the total. The 25 possible dealers in 

excess of $3 billion account for almost $11.18 in 

notional transactions in 2011, or over 99.9 percent 

of the total. 

481For example, two other criteria consider the 

number of an entity’s non-dealer counterparties (in 

those cases identifying as dealers those persons that 

have seven or more, or five or more, counterparties 

not recognized as dealers by ISDA) also indicate 

that potential dealers with notional amounts in 

excess of $100 billion in 2011 account for over 

98 percent of the notional transactions of all entities 

meeting the applicable criteria in 2011. Potential 

dealers with notional transactions above $10 billion 

in 2011 (let alone those with notional transactions 

above $3 billion) reflect all or virtually the entire 

notional amount of all dealers identified by those 

criteria. See id. at tables 3a and 3b. 

482The CDS Data Analysis also sought to identify 

dealing activity based on the total number of an 

entity’s counterparties. See id. at tables 2a through 

2c. Those criteria similarly suggest a high degree of 

concentration of dealing activity within the singlename credit default swap market: 

i. A criterion that identifies potential dealing 

activity based on an entity having twenty or more 

counterparties in single-name security-based swaps 

identified 16 possible dealers. Fourteen of those 

entities had notional transactions in excess of $100 

billion in 2011, reflecting over 99 percent of the 

total associated with all 16. The remaining two 

identified entities had notional transactions in 

excess of $10 billion in 2011. See id. at table 2a. 

ii. A criterion that identifies potential dealing 

activity based on an entity having 15 or more 

counterparties in single-name security-based swaps 

identified 33 possible dealers. Fifteen of those 

entities had notional transactions in excess of $100 

billion in 2011, reflecting over 97 percent of the 

total associated with all 33. A total of 27 of those 

entities had notional transactions in excess of $10 

billion in 2011, and a total of 32 of those entities 

had notional transactions in excess of $3 billion in 

2011, both reflecting over 99 percent of the total. 

See id. at table 2b. 

iii. A criterion that identifies potential dealing 

activity based on an entity having 10 or more 

counterparties in single-name security-based swaps 

identified 154 possible dealers. Fifteen of those 

exceeded $100 billion in notional transactions in 

2011, reflecting over 90 percent of the total; 49 of 

those exceeded $10 billion in notional transactions 

in 2011, reflecting over 97 percent of the total; and 

93 exceeded $3 billion in notional transactions in 

2011, reflecting over 99 percent of the total. See id. 

at table 2c. 

In considering the data we are weighing these 

criteria less heavily than we are weighing the 

criteria based on the number of counterparties who 

are not identified by ISDA as dealers. This is 

because it is reasonable to foresee a non-dealer 

making use of multiple dealers to get the best 

possible price or to make use of special expertise 

possessed by certain dealers, meaning that the 

criteria discussed in this footnote are more likely 

to identify entities not engaged in dealing activity. 483Other criteria in the CDS Data Analysis sought 

to identify dealing activity based on whether an 

entity maintains a relatively flat book. Those 

criteria also indicated that entities with notional 

transactions in excess of $100 billion in 2011 

represented over 97 percent of the total for all 

entities identified by those criteria, while entities 

with notional transactions in excess of $10 billion 

in 2011 represented over 99 of the total for all 

entities identified by those criteria. See id. at tables 

4 and 5. We are weighing those criteria less heavily 

than we are weighing the counterparty-based 

criteria discussed above because an entity that 

engages in directional trades could also appear to 

have a flat book if its portfolio contained 

transactions representing various directional bets, 

but of similar aggregate notional sizes on both sides 

of the market. See id. at 3. 

The analysis also included one criterion that 

considers potential dealing activity based on a low 

propensity to post margin. See id. at table 6. While 

we do not believe that this analysis deserves the 

same degree of weight as the others, given concerns 

about the completeness of the data (see id. at 4), we 

note that this criterion nonetheless also indicates a 

high concentration of dealing activity in the market. 

See id. at table 6 (indicating that of the 473 entities 

identified by this criterion, the 14 entities with 

notional transactions in excess of $100 billion in 

2011 account for roughly 94 percent of the total 

notional transaction activity associated with all 473 

entities over 2011). 

484Finally, the CDS Data Analysis also included 

criteria that identified potential dealing activity 

default swaps, the SEC believes that 

these data are sufficiently representative 

of the market to help inform the analysis 

because an estimated 95 percent of all 

security-based swap transactions appear 

likely to be single-name credit default 

swaps.476 The SEC also recognizes that 

although the de minimis exception is 

applicable to persons only with respect 

to their dealing activity, the CDS Data 

Analysis contains transactions reflecting 

both dealing activity and non-dealing 

activity, including transactions by 

persons who may engage in no dealing 

activity whatsoever.477

As described more fully in the CDS 

Data Analysis, to ascertain which 

entities might be transacting as dealers, 

and which may not be, various criteria 

were employed as indicia of possible 

dealing activity. In each case, the results 

suggest the great extent to which there 

is currently a high degree of 

concentration of potential dealing 

activity in the single-name credit default 

swap market. For example, using the 

criterion that dealers are likely to 

transact with many counterparties who 

themselves are not dealers, analysis of 

2011 transaction data show that only 28 

out of 1,084 market participants have 

three or more counterparties that 

themselves are not recognized as dealers 

by ISDA.478 As the data show, 15 of 

these 28 potential dealers exceeded a 

threshold of $100 billion notional 

transacted in single-name credit swaps 

during 2011, which accounts for over 98 

percent of the 28 entities’ total 

activity.479 At a lower threshold of $10 

billion notional, 21 of the 28 potential 

dealers are included (representing 99.7 

percent of the activity of potential 

dealers), and at an even lower threshold 

of $3 billion notional, 25 potential 

dealers are included (representing 99.9 

percent).480

Other criteria for identifying possible 

dealing activity based on the number of 

an entity’s non-dealer counterparties 

similarly suggest a high degree of 

concentration of dealing activity within 

the current security-based swap 

market.481 Criteria that consider the 

number of an entity’s total single-name 

security-based swap counterparties,482

criteria that consider alternative factors 

for identifying dealing activity,483 and 

certain combined criteria 484 further 

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based on an entity meeting two or three of the other 

criteria considered. See id. at tables 7 and 8. These 

criteria again indicate a high degree of 

concentration of dealing activity in the market. The 

analysis that addressed whether an entity met two 

of the other criteria identified 92 possible dealers, 

with the 15 entities having notional transactions in 

excess of $100 billion in 2011 representing over 96 

percent of the total activity of those 92 entities in 

2011. See id. at table 7. The analysis that addressed 

whether an entity met three of the other criteria 

identified 41 possible dealers, with the 15 entities 

having notional transactions in excess of $100 

billion in 2011, representing over 98 percent of the 

total activity of those 41 entities in 2011. See id. 

at table 8. 

485For example, OCC data shows that, of the five 

largest bank or trust companies, four have notional 

equity derivative positions of above $1 billion, and 

that those four entities account for $630 billion in 

notional positions out of $677 billion for all U.S. 

commercial banks or trust companies, which 

constitutes approximately 93 percent of the total. 

See OCC Quarterly Report at table 10. Similarly, a 

review of the equity swaps positions of the 50 

largest U.S. bank holding companies shows that 

nine bank holding companies have notional equity 

swap positions exceeding $1 billion, and account 

for 99.5 percent of the total positions held by such 

companies, and 29 have no positions in equity 

swaps. (Data was compiled from each bank holding 

company’s FR 9–YC, available at http:// 

www.ffiec.gov/nicpubweb/nicweb/ 

Top50Form.aspx). Cf. letter from WGCEF V 

(referencing swap position data from bank holding 

companies’ Forms FR Y–9C as relevant to 

determining size of the swap market). 

486Cf. Bessembinder and Maxwell, 

‘‘Transparency and the Corporate Bond Market,’’ 

Journal of Economic Perspectives, Spring 2008, at 

217, 226 (noting that after reporting of U.S. OTC 

bond transactions through the Trade Reporting and 

Compliance Engine (‘‘TRACE’’) became mandatory, 

the portion of trades completed by the 12 largest 

dealers fell from 56 percent to 44 percent). 

487We understand that large dealers have 

competitive advantages under the current market, 

in light of the desire of counterparties to engage in 

security-based swap transactions with large, well 

capitalized and highly rated dealers. See, e.g., Craig 

Pirrong, Rocket Science, Default Risk and The 

Organization of Derivatives Markets, Working 

Paper, University of Houston (2006) (available at 

http://www.cba.uh.edu/spirrong/Derivorg1.pdf). 

The lower business costs associated with being 

unregulated may prove to partially offset that 

advantage. At the same time, we reasonably may 

expect that informed counterparties will take into 

account the lower protections—and higher risks— 

associated with transactions with unregulated 

dealers in determining whether to use regulated or 

unregulated dealers as counterparties. 

488We note that there also are benefits to 

increased competition and a decrease in 

concentration of dealer activity, as contemplated by 

Title VII, including potentially lower costs for 

market participants and a decrease in systemic risk. 

489See CDS Data Analysis at table 3c; see also 

note 479, supra. As noted above, these amounts 

may not only reflect dealing activity by an entity. 

Thus, even putting aside the possibility of new 

unregulated entrants into the market, the portion of 

dealing activity in the market that is represented by 

entities whose trailing notional dealing activity 

exceeds $100 billion may in fact be less than 98 

percent. 

490The illustrative use of new entrants for 

purposes of this discussion is intended to reflect the 

potential that new entrants to the market could take 

advantage of a de minimis threshold in a way that 

leads to a higher level of unregulated dealing 

activity within the market. In using this illustration 

we are not seeking to explicitly predict how many 

new entrants may come into the market in response 

to any particular de minimis threshold, nor are we 

seeking to predict how many new entrants may seek 

to stay under the de minimis thresholds and how 

many instead would seek to use the exception as 

a step on the way to eventually registering as a 

security-based swap dealer. Rather, we simply are 

illustrating why it is important to account for 

market changes in connection with setting the de 

minimis threshold. 

The OTC Derivatives Supervisors Group—a group 

chaired by the Federal Reserve Bank of New York 

and consisting of the CFTC and SEC as well as other 

international supervisors and major over-thecounter derivatives market participants—currently 

recognizes 15 major OTC derivatives dealers. 

Accordingly, as an illustrative example, we have 

assumed that this number of significant securitybased swap dealers would approximately double— 

i.e., include 15 new dealers—in the wake of the 

various regulatory changes contemplated by the 

Dodd-Frank Act, many of which may result in 

increased access and competition in the securitybased swap market (e.g., enhanced priced 

transparency and increased access to central 

clearing). However, we emphasize that this number 

has been selected as an illustrative example, and 

have accordingly provided similar examples 

assuming ten and five new entrants. 

491Fifteen new entities that each engage in $100 

billion in dealing activity would reflect $1.5 trillion 

in additional dealing activity outside the ambit of 

Continued 

suggest a high concentration of dealing 

activity within the security-based swap 

market. 

While less data are available in 

connection with other types of 

instruments constituting security-based 

swaps, such as equity swaps, the 

available data similarly suggest a high 

concentration of positions in those 

instruments among potential dealers.485

Though inspection of the data does 

not seem to suggest a single precise de 

minimis threshold, the above analysis of 

potential dealing activity is useful in 

that it reveals a range of possible 

thresholds from $100 billion to $3 

billion that would cover anywhere from 

98 percent through 99.9 percent of the 

total activity of all potential dealers in 

2011. However, these thresholds—and 

their implied market coverage ratios— 

only reflect levels of activity that exist 

in today’s highly concentrated market. 

In order to further narrow the range of 

possible thresholds, and to select an 

appropriate level for the de minimis 

exception, the analysis must consider 

the potential state of the market as it 

might reasonably exist after the 

implementation of Title VII. 

ii. Avoiding Gaps Resulting From the 

Regulatory Changes in Conjunction 

With the Exception 

Although the overall portion of 

security-based swap activity that would 

appear to be subject to dealer regulation 

based on current measures of dealing 

concentration in the market constitutes 

an important factor to consider in 

balancing the regulatory burdens and 

benefits associated with a de minimis 

exception, analysis of the current 

market should not serve as the sole 

mechanism for setting the exception. 

In particular, sole reliance on an 

approach that focuses on current 

measures of market concentration 

would not adequately account for likely 

changes to the market associated with 

the implementation of regulation. In 

part, these changes may be a direct 

result of the full implementation of Title 

VII—including enhancements to 

transparency and increases in central 

clearing—as those changes reasonably 

may be expected to reduce the 

concentration of dealing activity within 

the market over time.486 Also, to the 

extent implementation of Title VII 

permits new dealers to enter the market, 

the availability of a de minimis 

exception would mean those new 

dealing entrants would fall outside the 

ambit of dealer regulation, either for the 

long term or until their dealing activity 

surpasses the applicable notional 

threshold.487 Accordingly, de minimis 

thresholds that are based solely on the 

current state of the market, including 

the current concentration of dealing 

activity within the market, may 

reasonably be expected to fail to account 

for the amount of dealing activity that 

in the future could fall outside of the 

ambit of dealer regulation due to the 

exception.488

For example, as discussed above, 

when possible dealers in single-name 

credit default swaps are identified by an 

entity having three or more 

counterparties that are not recognized 

by ISDA as being dealers, entities with 

notional transactions in excess of $100 

billion over a 12 month period represent 

over 98 percent of the total activity of 

all such possible dealers over that 

period, leaving two percent of possible 

dealing activity below that level.489

However, a de minimis threshold of 

$100 billion would allow new entrants 

to commence engaging in unregulated 

dealing in competition with persons 

who are regulated as dealers pursuant to 

Title VII, which, depending on the 

number and size of such entrants, could 

significantly decrease the portion of 

dealing activity in the market done by 

registered dealers (at least until the 

point that new entrants cross the de 

minimis threshold, if they do at all). For 

example, if 15 new entrants 490 were to 

engage in security-based swap dealing 

activity up to a $100 billion threshold, 

the result could be that nearly 15 

percent of dealing activity within the 

single-name credit default swap market 

would be left outside of the ambit of 

dealer regulation.491

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30638 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

dealer regulation, which could lead to roughly 14.9 

percent of total dealing activity being outside the 

ambit of dealing regulation (with that $1.5 trillion 

being added to the existing $168 billion reflected 

by entities that fall below the $100 billion 

threshold, and that sum divided by $11.18 trillion, 

under the assumption that the new entrants 

displace business from the fifteen entities above the 

de minimis threshold). To further illustrate, under 

the same assumptions and analysis, the implied 

unregulated market share would be roughly 10.4 

percent for ten new entities and 6.0 percent for five 

new entities. 

In certain regards these illustrations, on the one 

hand, may overestimate the effect of new entrants 

because of the assumption that such entrants engage 

in dealing activities up to, but not surpassing, the 

de minimis threshold. While it is not impossible 

that some entities may seek to use the de minimis 

exception to conduct business as an unregulated 

niche dealer, it also is plausible that entities 

generally may seek to use the exception to 

commence engaging in dealing activity, with the 

goal of ultimately becoming registered dealers that 

are not constrained by the de minimis threshold. 

On the other hand, these illustrations in certain 

respects may underestimate the amount of dealing 

activity that can fall outside of the regulatory ambit. 

For example, the amounts of security-based swap 

activity of persons identified in the analysis as 

dealers may not exclusively constitute dealing 

activity, meaning that persons whose notional 

transactions over a 12-month period exceed a 

particular threshold in fact may not be engaged in 

that amount of dealing activity, and hence may still 

be able to take advantage of the de minimis 

exception. Also, these illustrations do not seek to 

reflect increased activity by existing dealers that 

already fall below the assumed threshold. 

492Fifteen new entities each engaged in $25 

billion in dealing activity would reflect $375 billion 

in additional dealing activity outside the ambit of 

dealer regulation, which could lead to 4.1 percent 

of total dealing activity being outside the ambit of 

dealing regulation (with that $375 billion being 

added to the existing $80.2 billion reflected by 

entities that fall below the $25 billion threshold, 

and that sum divided by $11.18 trillion, under the 

assumption that the new entrants displace business 

from the seventeen entities above the de minimis 

threshold). To further illustrate, under the same 

assumptions and analysis, the implied unregulated 

market share would be 3.0 percent for 10 new 

entities and 1.8 percent for 5 new entities. 

Obviously, these illustrations are subject to the 

same limitations as are discussed above in the 

context of the $100 million threshold illustration. 

493For example, similar results are obtained 

when possible dealing activity is identified based 

on whether an entity passes at least three of the 

other metrics discussed above. See CDS Data 

Analysis at table 8. Using the same types of 

assumptions as are discussed above, with fifteen 

new entities, a de minimis threshold of $100 billion 

could lead to 15.0 percent of dealing activity falling 

outside the ambit of dealer regulation, while a de 

minimis threshold of $25 billion could lead to 4.2 

percent of dealing activity falling outside of 

regulation. 

494As noted above, encouraging new entrants also 

has benefits flowing from increased competition 

and a decrease in concentration of dealer activity. 

See note 488, supra. 495For example, 15 new dealer entrants engaged 

in up to $3 billion in dealing activity would 

account for up to $45 billion in dealing activity. 

This result would mean approximately 0.4 percent 

of total potential future dealing activity could be 

transacted by unregistered dealers, as opposed to 

the potential for approximately 15 percent of 

potential future dealing activity to be transacted by 

unregistered dealers if the de minimis were set to 

$100 billion. See CDS Data Analysis at table 3c. As 

with the illustrative examples above, these 

calculations assume that the new entrants displace 

business from the entities above the de minimis 

threshold. 

496See part II.D.3.a, supra; see also Proposing 

Release at 80180 (highlighting ‘‘customer protection 

issues raised by swaps and security-based swaps— 

including risks that counterparties may not fully 

appreciate when entering into swaps and securitybased swaps’’). 

497See Federal Reserve Bank of New York staff 

report, ‘‘An Analysis of CDS Transactions: 

Implications for Public Reporting’’ (2011) at 8 

(stating that for dollar-denominated single name 

CDS on corporate or sovereign reference entities, $5 

million represented the most common notional 

size) (available at http://www.newyorkfed.org/ 

research/staff_reports/sr517.pdf); see also 

Proposing Release at 80180 (noting ‘‘that in general 

the notional seize of a small swap or security-based 

swap is $5 million or less’’). 

We note, by comparison, that Congress has 

determined that a de minimis amount of securities 

broker activity by banks entails 500 trades annually. 

See Exchange Act section 3(a)(4)(B)(xi) (excluding 

from the ‘‘broker’’ definition a bank that annually 

effects no more than 500 securities transactions, 

other than transactions subject to certain other 

exceptions, so long as the transaction is not effected 

by a bank employee that also is a broker-dealer 

employee). 

We further note that, while the number of 

counterparties or transactions potentially 

implicated by unregistered dealing activity is an 

important consideration in establishing an initial de 

minimis level, it does not alter our view, described 

above, that a single de minimis standard based on 

notional value—rather than the proposal’s 

framework of three distinct standards based on 

notional value, number of counterparties, and 

number of transactions—is an appropriate choice in 

light of concerns expressed by commenters that a 

standard based on the number of transactions or 

counterparties can produce arbitrary results. See 

part II.D.3.b.ii, supra. 

498Exchange Act section 3E, which was added by 

section 763(d) of the Dodd-Frank Act, provides a 

series of requirements in connection with the 

segregation of assets held as collateral in securitybased swap transactions. These include 

requirements that security-based swap dealers and 

major security-based swap participants provide 

their counterparties with notice that they have the 

right to require segregation, and that such 

segregation must be at an independent third-party 

custodian. 

Similarly, a de minimis threshold of 

$25 billion may also lead to a material 

reduction in the portion of the market 

covered by registered dealers. For 

example, using the same assumptions as 

above, 15 new entrants up to a $25 

billion threshold could leave over four 

percent of dealing activity in the market 

outside of the ambit of dealing 

regulation.492 When other metrics are 

used to identify possible dealing 

activity, the possibility of a significant 

regulatory gap remains.493

Overall, it is reasonable to conclude 

that the higher the de minimis 

threshold, the greater the likelihood that 

the exception, combined with other 

changes resulting from the 

implementation of Title VII that may 

encourage new entrants, will lead to a 

proportionately larger amount of 

unregulated (except with respect to 

antifraud and anti-manipulation 

prohibitions) dealing activity.494 We 

believe that it is reasonable to interpret 

the statutory language of the de minimis 

exception in a way that prevents a 

proportionately large amount of dealing 

activity within the security-based swap 

market from falling outside the ambit of 

dealer regulation. Accordingly, choosing 

to set a lower de minimis threshold from 

among the range of potential thresholds 

would limit the amount of potential 

future dealing activity that could be 

transacted without being subject to 

dealer rules and regulations.495

iii. Promoting Statutory Counterparty 

Protections 

Sole reliance on an approach based on 

overall market coverage in balancing 

regulatory burdens and benefits would 

also threaten to unduly discount 

important counterparty protection 

interests, as discussed above and 

highlighted in the proposal.496 For 

example, in light of data indicating that 

$5 million constitutes a common 

notional size for a single-name credit 

default swap position,497 a de minimis 

notional threshold of $25 billion 

annually would permit an unregistered 

dealer to engage in as many as 5000 

trades of that size. The counterparties to 

these unregistered dealers would not 

receive the benefit of the protections 

that Title VII affords to the 

counterparties of registered dealers. 

These include, among others, the 

segregation protections afforded to 

persons who post margin to dealers in 

connection with over-the-counter 

security-based swap transactions.498

Accordingly, this consideration also 

suggests that choosing a de minimis 

threshold closer to the lower end of the 

range of potential thresholds would 

better preserve the counterparty 

protections contemplated by Title VII. 

c. Balancing Reflected in the Final 

Rules—Credit Default Swaps That 

Constitute Security-Based Swaps 

The final thresholds that implement 

the de minimis exception (and 

corresponding phase-in levels) address 

security-based swaps that are credit 

default swaps separately from other 

types of security-based swaps, in light of 

differences in the respective markets. 

i. General Threshold for Credit Default 

Swaps That Constitute Security-Based 

Swaps 

We conclude that $3 billion over the 

prior 12 months constitutes an 

appropriate notional threshold for 

applying the de minimis exception in 

connection with dealing activity 

involving credit default swaps that 

constitute security-based swaps. 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30639 

499See letters from Better Markets I and AFR. 

500See letter from Greenberger. 

501See, e.g., letter from COPE I. 

502Of the 28 market participants that have three 

or more security-based swap counterparties that 

themselves are not recognized by dealers by ISDA, 

25 had notional single-name credit default swap 

positions in excess of $3 billion in 2011. The 

remaining three entities in total accounted for only 

$3.59 billion in notional transactions in 2011, 

reflecting less than 0.1 percent of the $11.18 trillion 

total for those 28 market participants. See CDS Data 

Analysis at table 3c. 

The other criteria set forth in the analysis for 

identifying possible dealing activity in general 

similarly indicate that entities with notional 

transactions in excess of $3 billion in 2011 account 

for more than 99 percent of the total notional 

transactions of all identified entities in 2011. See 

id. at tables 2a–c, 3a–b, 4, 5, 7 and 8. While the 

criterion based on the posting of initial margin only 

indicates 98 percent coverage for all of the 473 

identified entities, see id. at table 6, as discussed 

above we believe it is appropriate to provide less 

weight to that criterion, which is based on 

voluntary reporting. 

As noted above, see note 478, supra, we recognize 

that the underlying market data encompasses all of 

the security-based swap activity of persons 

identified as dealers, not only their dealing activity. 

Because the thresholds that implement the de 

minimis exception address only a person’s dealing 

activity, this raises the possibility that the analysis 

overstates the extent to which a $3 billion threshold 

would encompass persons responsible for dealing 

activity within the single-name security-based swap 

market. Even with that possibility, however, we 

believe that the data indicates such a high 

concentration of dealing activity within the market 

that it is reasonable to conclude that a $3 billion 

threshold likely would encompass persons 

responsible for the vast majority of dealing activity 

within the market. 

503See Exchange Act section 3(a)(4)(B)(xi); see 

also letter from SIFMA—Regional Dealers 

(supporting a threshold of 500 trades consistent 

with the statutory de minimis exception in 

connection with bank brokerage activity). 

504For example, $3 billion is equal to the 

threshold suggested by many commenters in the 

context of the swap market, which is much larger 

than the security-based swap market. See letter 

from COPE (supporting a 0.001 percent notional 

threshold based on the overall swaps market, which 

would amount to $3 billion). Indeed, this $3 billion 

threshold appears to reflect roughly 0.024 percent 

of the overall market for single-name credit default 

swaps, a percentage that is much greater than the 

0.001 percent multiplier that a number of 

commenters (see, e.g., letters cited in note 382, 

supra) suggested in the swap market context. See 

CDS Data Analysis at table 1 (indicating that 

participants in the single-name credit default swap 

market engage in a total of $12.6 trillion in singlename credit default swap transactions in 2011). 

505See letter from Better Markets III. 

506The letter also raised issues regarding the 

‘‘customer’’ language of the exception and argued 

that the de minimis exception should not represent 

a risk-based test. We address those issues 

elsewhere. See parts II.D.3.c (regarding ‘‘customer’’ 

language) and II.D.3.e (regarding rejection of riskbased and proportionality tests), infra. 

In addition, the letter expressed the view that a 

percentage-based formula would be difficult to 

implement, by requiring market participants to 

repeatedly calculate the ratio of their activity to 

total market activity. We concur. The $3 billion 

threshold we are adopting reflects a fixed dollar 

amount, and does not share the complications that 

would arise from an approach based on a particular 

percentage of the market. 

507See Exchange Act section 3(a)(71)(D). 

508The commenter correctly pointed out that the 

regulatory requirements applicable to registered 

dealers encompass counterparty protection 

requirements, and that the de minimis exception 

should not defeat those requirements. We recognize 

that the implementation of the exception should 

take those counterparty protections into account, 

and we have sought to do so. We do not believe, 

however, that those important counterparty 

protection goals require a de minimis approach that 

focuses on the number of entities that would be 

excluded, in lieu of the statutory focus on whether 

a particular entity engages in a de minimis quantity 

of dealing activity. 

In reaching this conclusion, we 

recognize the significance of comments 

that supported the proposed $100 

million threshold,499 and that urged 

caution in raising that proposed 

threshold,500 as well as commenters 

who supported increases to the 

threshold.501 We further recognize the 

importance of applying the de minimis 

exception in a way that promotes 

regulatory efficiency. We also recognize 

the range of potential thresholds 

suggested by the data currently 

available. Based on the competing 

factors described above, we believe that 

$3 billion reflects a reasonable notional 

threshold—though not necessarily the 

only such threshold. 

In our view, the currently available 

data regarding the single-name credit 

default swap market indicates that a 

notional threshold of $3 billion would 

be expected to result in the regulation, 

as dealers, of persons responsible for the 

vast majority of dealing activity within 

that market, both as of today and, as 

described above, in the future as the 

benefits of the other Title VII rules are 

implemented and new dealer entrants 

come to market.502

In providing for a $3 billion notional 

threshold, we also recognize the 

threshold would permit an unregistered 

dealer annually to engage in up to 600 

security-based swaps (as opposed to 20 

transactions under the proposed 

threshold, assuming a $5 million 

average notional size). In this regard, we 

note that Congress, in another statutory 

de minimis exception within the 

Exchange Act, determined that 500 

securities transactions annually 

constituted a de minimis amount of 

transactions for banks under the 

‘‘broker’’ definition.503 We further 

believe that a $3 billion threshold 

appropriately addresses commenter 

concerns regarding the de minimis 

exception being unduly narrow.504

In adopting this $3 billion threshold, 

we have carefully considered one 

commenter’s view that the CDS Data 

Analysis suggests that the proposed 

$100 million threshold in fact is too 

high, and that any increase in that 

proposed $100 million threshold would 

be arbitrary and capricious.505 In 

reaching these conclusions, the 

commenter focused on the number of 

entities that potentially are engaged in 

dealing activity but that could be 

excluded based on particular de 

minimis thresholds. For example, the 

commenter indicated that pursuant to 

one of the CDS Data Analysis’s 

combined metrics for identifying 

dealing activity, a de minimis threshold 

of $3 billion could lead to the exclusion 

of up to 58 percent of all persons 

engaged in possible dealing activity. 

The commenter further suggested that 

some entities engaged in dealing activity 

may reduce their activities to take 

advantage of the de minimis exception 

and hence reduce liquidity, and argued 

that there would be no basis for the 

exception to be based on a market 

participant’s percentage of total 

security-based swap activity.506

It is important to recognize that while 

the commenter focused on the number 

of entities that might be excluded 

pursuant to the exception, and 

suggested that higher notional dollar 

amount thresholds could lead to the 

exclusion of a larger number of entities, 

the statutory provision for the de 

minimis exception does not require the 

exemption of a ‘‘de minimis number’’ of 

dealers. The statute instead requires the 

exemption of persons engaged in a ‘‘de 

minimis quantity’’ of dealing activity.507

The statutory language therefore 

indicates that the focus of the rule 

implementing the exception should be 

the amount of an entity’s dealing 

activity, not how many entities 

ultimately may be able to take advantage 

of the exception. 

Also, although the commenter 

implied that there would be no basis for 

the rule implementing the exception to 

take into account a market participant’s 

security-based swap dealing activity 

compared to total dealing activity in the 

market, for the reasons discussed in this 

section we believe that such an 

approach can appropriately provide for 

the regulatory coverage of the vast 

majority of dealing activity in a way that 

promotes regulatory efficiency, without 

leading to unwarranted regulatory gaps. 

In contrast, in our view the commenter 

did not persuasively articulate a strong 

rationale for adopting the alternative 

approach proposed in the letter, which 

would appear to lead to the registration 

of a number of dealers that 

proportionately engage in a very small 

amount of dealing activity.508

In support of its approach, the 

commenter emphasized data regarding 

persons who meet certain combined 

criteria outlined in the CDS Data 

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30640 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

509See notes 478, 482, and 483, supra. 

510For example, the CDS Data Analysis identifies: 

• Three possible dealers with notional 

transactions below $3 billion in 2011—out of a total 

of 28 possible dealers—when possible dealing 

activity is based on having three or more 

counterparties that themselves are not identified as 

dealers; 

• One possible dealer with notional transactions 

below $3 billion in 2011– out of a total of 20 

possible dealers—when possible dealing activity is 

based on having five or more counterparties that 

themselves are not identified as dealers; and 

• Zero possible dealers with notional 

transactions below $3 billion in 2011—out of a total 

of 16 possible dealers—when possible dealing 

activity is based on having seven or more 

counterparties that themselves are not identified as 

dealers. 

See CDS Data analysis at tables 3c, 3b and 3a. 

In addition, as described above, an approach 

focused on the quantity of activity is supported by 

relatively consistent results depending on which 

criterion from the CDS Data Analysis is applied— 

i.e., each criterion shows a high amount of 

concentration and a commensurately low quantity 

of activity below the $3 billion threshold. By 

contrast, applying different criteria results in very 

different numbers of entities excluded under any 

specified threshold, suggesting that an approach 

focused on the number of entities may be highly 

dependent on how the possible dealing activity of 

those entities is defined. 

511 In particular, in arguing that this incentive 

would reduce liquidity by five percent, the 

commenter excluded all business done by entities 

within the top two brackets (i.e., above $100 billion 

notional), on the grounds that those entities ‘‘are 

assumed to transact mostly with larger entities.’’ 

Based on the criteria on which the commenter 

relied, those 15 entities are responsible for over 96 

percent of the activity of all possible dealers. See 

CDS Data Analysis at tables 7 and 8. Absent that 

exclusion, the estimated reduction of liquidity 

would amount to a small fraction of a percent. 

512Exchange Act rule 3a71–2(a)(2). 

513Even with the general 60 day compliance 

period, however, market participants will not 

necessarily be security-based swap dealers at the 

end of 60 days. In particular, for the first year 

following the effective date of the final rules 

implementing the definition of ‘‘security-based 

swap’’ pursuant to the Exchange Act section 

3(a)(68), the de minimis analysis would only 

address security-based swap dealing activity 

following that effective date. See Exchange Act rule 

3a71–2(a)(1). Among other things, this means that 

until the rules defining ‘‘security-based swap’’ are 

effective, no market participants would be deemed 

to be security-based swap dealers. 

514See note 502, supra. 

515See Exchange Act rule 3a71–2A(a)(1); see also 

part V, infra. 

516See Exchange Act rule 3a71–2A(b). 

517The SEC will announce the data collection 

initiation date on its Web site and publish it in the 

Federal Register. See Exchange Act rule 3a71– 

1(a)(2)(iii). 

Analysis. As discussed above, we 

believe that criteria based on the 

number of an entity’s counterparties 

that are not recognized as dealers 

deserve special weight due to the 

potential consistency of those criteria 

with the dealer-trader distinction.509

Identifying dealer activity using those 

criteria does not support the view that 

a $3 billion threshold would lead to the 

exclusion of a large number of entities 

engaged in dealing activity.510

Finally, we also are not persuaded by 

the commenter’s suggestion that a 

number of entities engaged in dealing 

activity would reduce those activities to 

take advantage of a $3 billion de 

minimis threshold, and hence reduce 

liquidity in the market by five percent. 

To reach that figure, the commenter 

needed to exclude the vast majority of 

dealing activity in the market.511 While 

we recognize that it is possible that 

current market participants may adjust 

their dealing activity in light of the de 

minimis threshold, and that this 

potentially could reduce the liquidity 

provided by certain entities, we also 

recognize that the de minimis exception 

has the potential to promote liquidity by 

facilitating new entrants into the 

market. 

ii. Phase-in Period in Connection With 

Dealing Activity Involving Credit 

Default Swaps That Constitute SecurityBased Swaps 

The final rules further provide that 

persons with notional dealing activity of 

$8 billion or less over the prior 12 

months involving credit default swaps 

that constitute security-based swaps 

would be able to avail themselves of a 

phase-in period.512 Those persons 

would not be subject to the generally 

applicable compliance date that occurs 

no later than 60 days following 

publication of these final rules in the 

Federal Register.513

The use of a phase-in period—in 

connection with a person’s status as a 

security-based swap dealer and in 

connection with the other regulatory 

requirements that are appurtenant to 

dealer status—is intended to facilitate 

the orderly implementation of Title VII. 

In addition, the phase-in period will 

afford the SEC additional time to study 

the security-based swap market as it 

evolves in the new regulatory 

framework and will allow potential 

dealers that engage in smaller amounts 

of activity (relative to the current size of 

the market) additional time to adjust 

their business practices, while at the 

same time preserving the focus of the 

regulation on the largest and most 

significant dealers. The SEC also 

recognizes that the data informing its 

current view of the de minimis 

threshold is based on the market as it 

exists today, and that the market will 

evolve over the coming years in light of 

the new regulatory framework and other 

developments. 

Accordingly, while the SEC believes 

that a $3 billion notional threshold 

reflects an appropriate long-term 

standard based on the currently 

available data,514 it also is appropriate 

to provide for a phase-in period for 

those entities with $8 billion or less in 

dealing activity, because subsequent 

developments in the market or the 

evaluation of new data from the 

security-based swap reporting facilities 

contemplated by the Dodd-Frank Act 

may suggest that the threshold should 

be increased or decreased. In particular, 

the implementation of security-based 

swap data reporting under the DoddFrank Act will result in significant new 

data and afford an opportunity to review 

the Commission’s determination to 

establish a $3 billion threshold. 

For these reasons, an important part 

of the report that the SEC is directing its 

staff conduct with regard to the 

definitions of ‘‘security-based swap 

dealer’’ and ‘‘major security-based swap 

participant’’ (described in detail below) 

will be a consideration of the operation 

of the de minimis exception following 

the full implementation of Section 15F 

under Title VII.515 The SEC will take 

into account this report, along with 

public comment on the report, in 

determining whether to propose any 

changes to the rule implementing the de 

minimis exception, including any 

increases or decreases to the $3 billion 

threshold. The report will be linked to 

the availability of data regarding the 

activity of regulated security-based 

swap market participants in that it must 

be completed no later than three 

years 516 following a ‘‘data collection 

initiation date’’ that is the later of: the 

last compliance date for the registration 

and regulatory requirements for 

security-based swap dealers and major 

security-based swap participants under 

Section 15F of the Exchange Act; or the 

first date on which compliance with the 

trade-by-trade reporting rules for creditrelated and equity-related securitybased swaps to a registered securitybased swap data repository is 

required.517

In light of the available data—and the 

limitations of that data in predicting 

how the full implementation of Title VII 

will affect dealing activity in the 

security-based swap market—the SEC 

believes that $8 billion constitutes an 

appropriate level for the availability of 

the phase-in period. The available data 

indicate that such a level generally 

comports with the balance of interests 

that informed the determination of the 

appropriate long-term threshold of $3 

billion described above. In particular, 

the $8 billion level should still lead to 

the regulation of persons responsible for 

the vast majority of dealing activity 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30641 

518Of the 28 market participants that have three 

or more security-based swap counterparties that 

themselves are not recognized by dealers by ISDA, 

23 had notional single-name credit default swap 

transactions in excess of $8 billion in 2011. The 

remaining five entities in total accounted for only 

$12.3 billion in notional transactions in 2011, 

reflecting roughly 0.1 percent of the $11.18 total for 

the 28 market participants. See CDS Data Analysis 

at table 3c. Only two of the 28 entities identified 

as possible dealers by that criterion had annual 

notional transactions between $3 billion and $8 

billion in 2011. 

Most of the other criteria set forth in the analysis 

for identifying possible dealing activity in general 

similarly indicate that entities with notional 

transactions in excess of $8 billion in 2011 account 

for more than 99 percent of the total notional 

transactions of all identified entities that year. See 

id. at tables 2a–b, 3a–b, 4 and 5. While the criterion 

based on an entity having 10 or more counterparties 

only indicates 98 percent coverage for all of the 154 

identified entities at an $8 billion transaction level, 

see id. at table 2c, as noted above this criterion may 

identify persons who in reality are not engaged in 

dealing activity. See note 482, supra. Also, while 

the criterion based on the posting of initial margin 

only indicates 97 percent coverage for all of the 473 

identified entities at an $8 billion transaction level, 

see id. at table 6, as discussed above that criterion 

is based on voluntary reporting. 

519For example, 15 new dealer entrants up to $8 

billion in annual notional dealing activity would 

account for $120 billion in dealing activity. This 

would amount to roughly 1.2 percent of the total 

notional single-name security-based swap activity 

over 12 months of entities identified as possible 

dealers by virtue of having three or more 

counterparties that are not recognized by dealers by 

ISDA. See CDS Data Analysis at table 2c. 

520Exchange Act rule 3a71–2(a)(2)(i). 

521Exchange Act rule 3a71–2(a)(2)(iii)(A). 

522Exchange Act rule 3a71–2(a)(2)(iii)(B). 

523This approach balances the fact that the SEC 

believes that its $3 billion and $150 million de 

minimis thresholds are appropriate in light of the 

currently available data and the market’s need for 

a degree of certainty as to the length of this phasein period, on the one hand, against the possibility 

that the staff report and the accompanying public 

comment may demonstrate that revision to these 

thresholds is necessary, on the other hand. 

524See Exchange Act rule 3a71–2(a)(2)(i). In other 

words, the phase-in period will still be available in 

connection with dealing activities with natural 

persons who are ECPs because they have entered 

into a security-based swap for hedging purposes. 

While we recognize the importance of Title VII 

protections to natural persons who engage in 

security-based swap activity, we also recognize the 

benefit of facilitating such persons’ use of securitybased swaps as hedges. Accordingly, persons who 

engage in dealing activity with natural persons who 

are ECPs under other provisions of the ECP 

definition will be subject to the applicable de 

minimis threshold for all of their dealing activity, 

without the availability of the phase-in period. 

Persons who engage in dealing activity with 

natural persons who are not ECPs will fall within 

the Exchange Act definition of ‘‘dealer,’’ which has 

no de minimis exception. See Exchange Act section 

3(a)(5)(A) (generally excluding dealers in securitybased swaps from the Exchange Act definition of 

‘‘dealer,’’ unless the counterparty is not an ECP). 

525See Exchange Act rule 3a71–2(e). 

526Exchange Act rule 3a71–2(a)(1)(ii). The 

proposal requested comment on whether different 

segments of the security-based swap market should 

be treated differently. See Proposing Release at 

80101 (‘‘Commenters further are requested to 

address * * * whether the [de minimis] 

exemption’s factors should vary depending on the 

type of swap or security-based swap at issue.’’). 

527See note 476, supra. 

within the market.518 In addition, we do 

not believe that providing a phase-in 

period for persons with notional dealing 

activity over the prior 12 months of less 

than $8 billion would lead to a risk of 

an undue portion of the market falling 

outside of the ambit of dealer regulation, 

even after considering the potential 

entry of unregulated new dealers into 

the market.519

The final rule provides that the phasein period will continue until the 

‘‘phase-in termination date’’ that the 

SEC will publish on its Web site and in 

the Federal Register.520 In particular, 

the rule provides that nine months 

following publication of that report, and 

after giving due consideration of the 

report and associated public comment, 

the SEC may either: (1) Terminate the 

phase-in period and by order establish 

and publish the phase-in termination 

date; or (2) determine that it is necessary 

or appropriate in the public interest to 

propose an alternative de minimis 

threshold, in which case the SEC, by 

order published in the Federal Register, 

will provide notice of that 

determination and establish the phasein termination date.521 If the SEC does 

not establish the phase-in termination 

date in either of those ways, the phasein termination date shall automatically 

occur in any event on what would be a 

date certain, which will be five years 

following the data collection initiation 

date.522

These provisions should allow 

sufficient time for the staff to complete 

its report, for the SEC to receive and 

review public comment on the report, 

and for the SEC to draw conclusions 

regarding establishing the phase-in 

termination date or proposing potential 

changes to the rule implementing the de 

minimis exception, in a way that also 

promotes the orderly and predictable 

termination of the phase-in period.523

This phase-in period will not be 

available in connection with the $25 

million threshold for dealing activity 

involving special entities, discussed 

below. In addition, the final rule 

provides that this phase-in period will 

not be available in connection with 

security-based swap dealing activities 

involving natural persons, other than 

natural persons who qualify as ECPs by 

virtue of CEA section 1a(18)(A)(xi)(II), 

which addresses natural persons who 

have $5 million or more invested on a 

discretionary basis and who enter into 

a security-based swap to manage the 

risk associated with their assets and 

liabilities.524 These limitations to the 

availability of the phase-in period are 

consistent with the Dodd-Frank Act’s 

goal of helping special entities be in a 

position to benefit from the 

counterparty protections associated 

with the regulation of registered 

security-based swap dealers under Title 

VII, as well as the SEC’s mandate to 

protect participants in the securities 

markets. 

Persons who are able to avail 

themselves of the phase-in period, of 

course, will not be required to do so. 

Any person that chooses to register with 

the SEC as a security-based swap dealer 

shall be deemed to be a security-based 

swap dealer subject to all applicable 

regulatory requirements for such 

registrants, regardless of whether the 

person engages in security-based swap 

dealing activity in an amount that is 

below the applicable de minimis 

threshold or phase-in level.525

d. Balancing Reflected in the Final 

Rules—Other Types of Security-Based 

Swaps 

The final rule provides that the de 

minimis exception for dealing activity 

involving security-based swaps other 

than credit default swaps will be based 

on a threshold of $150 million notional 

over the prior 12 months.526 In addition, 

a phase-in period will be available in 

connection with persons whose dealing 

activity involving those instruments is 

$400 million or less in notional amount 

over the prior 12 months. 

These amounts reflect roughly onetwentieth of the corresponding amounts 

associated with the exception for credit 

default swaps that constitute securitybased swaps. As discussed above, while 

less data is available regarding other 

types of security-based swaps than is 

available regarding single-name credit 

default swaps, the available data is 

consistent in indicating that those other 

types of security-based swaps on a 

notional basis currently comprise 

roughly one-twentieth of the total 

amount of instruments that will be 

expected to constitute security-based 

swaps.527 In light of this significantly 

smaller market, we believe that a $3 

billion notional threshold would 

threaten to cause an overly large portion 

of dealing activity within the market to 

fall outside the ambit of dealer 

regulation. 

In this regard, we note that it is likely 

that there are fewer barriers to entry in 

connection with acting as a dealer in 

security-based swaps such as equity 

swaps and total return swaps on debt 

than there are in connection with acting 

as a dealer in single-name credit default 

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528For example, persons registered with the SEC 

as broker-dealers in connection with other types of 

securities would appear to be well positioned to act 

as dealers in connection with equity swaps, as such 

broker-dealers already would be expected to have 

systems in place to enter into equity positions to 

hedge their equity swap dealing positions. 

529As noted above, four commercial banks and 

trust companies accounted for 93 percent of all 

equity positions held by such companies as of June 

30, 2011, and nine bank holding companies 

accounted for over 99 percent of all equity positions 

held by the fifty largest such companies as of 

December 2011. See note 485, supra. 

530See Exchange Act rule 3a71–2(a)(2); see also 

notes 520 through 522, supra, and accompanying 

text. 

531The SEC expects that the staff report should 

be especially helpful for providing data regarding 

dealing activity in connection with those other 

types of security-based swaps to consider the 

impact of the termination of the phase-in period, as 

well as potential changes to the de minimis 

exception in connection with these instruments. 

532Exchange Act rule 3a71–2(a)(1)(iii). 

533See letters from AFR and Better Markets I. 

534 In this regard we note that Title VII authorizes 

the SEC to impose special business conduct 

requirements when a security-based swap dealer is 

counterparty to a special entity. See Exchange Act 

section 15F(h)(5). In proposing rules to implement 

these requirements, the SEC requested comment 

regarding the scope of the ‘‘special entity’’ 

definition, including, for example, regarding 

whether the SEC should interpret ‘‘special entity’’ 

to exclude a collective investment vehicle in which 

one or more special entities have invested. See 

Exchange Act Release No. 64766 (June 29, 2011), 76 

FR 42396, 42422 (July 18, 2011). For purposes of 

interpreting this special entity threshold to the de 

minimis exception—particularly with regard to 

when a special entity would be a counterparty to 

a person that is engaged in dealing activity—the 

SEC believes that it will be appropriate to be guided 

by final interpretations regarding when a dealer will 

be a counterparty to a special entity for purposes 

of those business conduct requirements. 

535See CDS Data Analysis at table 9. 

536See id. at n.8 (noting that the average notional 

activity of those 16 counterparties was $680 billion, 

with the lowest being approximately $9 billion). 

537See Exchange Act rule 3a71–2A(a)(1). 

538See notes 520 through 522, supra, and 

accompanying text. 

539Exchange Act rule 3a71–2(d). Exchange Act 

section 3(a)(71)(D) particularly states that the 

‘‘Commission’’—meaning the SEC—may exempt de 

minimis dealers and promulgate related regulations. 

We do not interpret the joint rulemaking provisions 

of section 712(d) of the Dodd-Frank Act to require 

swaps.528 We also note that because 

equity swaps and total return swaps on 

debt can serve as close economic 

proxies for equity and debt securities, 

an overly broad de minimis threshold in 

connection with such instruments could 

threaten to undermine the Exchange Act 

framework for regulating persons who 

act as dealers in equity and debt. 

At the same time—notwithstanding 

the smaller scope of this market and the 

lesser availability of data regarding 

dealing activity within the market—we 

do not believe that it is necessary to 

make the de minimis exception 

unavailable in connection with dealing 

activity involving security-based swaps 

that are not credit default swaps. In this 

regard we particularly note that the 

limited available data regarding equity 

swaps suggests a high degree of 

concentration in dealing activity 

involving those instruments,529 which 

indicates that an appropriately sized de 

minimis threshold can be expected to 

promote regulatory efficiency. 

Balancing those factors, we conclude 

that a $150 million annual notional 

threshold is appropriate to implement 

the de minimis exception in connection 

with security-based swaps that are not 

credit default swaps, consistent with 

our understanding of the comparative 

size of that market as applied to the 

threshold applicable to credit default 

swap dealing activity. For reasons 

similar to those described above, we 

conclude that there should be a phasein period available to persons whose 

annual notional dealing activity in 

connection with security-based swaps 

that are not credit default swaps is no 

more than $400 million in annual 12- 

month notional amount. This phase-in 

period is subject to the same limitations 

regarding transactions involving special 

entities and natural persons as apply to 

the phase-in period for credit default 

swaps. It also will be subject to the same 

provisions regarding the termination of 

the phase-in period as apply in 

connection with credit default swaps.530

The comparative lack of data involving 

these markets—in contrast to the market 

for single-name credit default swaps— 

particularly highlights how the use of a 

phase-in period that is linked to the 

availability of post-implementation data 

is appropriate.531

As above, a person who is eligible to 

take advantage of the phase-in period in 

connection with these types of securitybased swaps may nonetheless register as 

a security-based swap dealer. 

e. Dealing Activity Involving Special 

Entities 

Consistent with the proposal, the final 

rules in general will cap an entity’s 

dealing activity involving security-based 

swaps at no more than $25 million 

notional amount over the prior 12 

months when the counterparty to the 

security-based swap is a special 

entity.532 There will be no phase-in 

period in connection with transactions 

involving special entities. In adopting 

this threshold, we recognize the serious 

concerns raised by commenters that 

stated that the de minimis exception 

should not permit any dealing activities 

involving special entities in light of 

losses that special entities have incurred 

in the financial markets,533 as well as 

the special protection that Title VII 

affords special entities.534

At this time, the final rule does not 

fully exclude such dealing activity from 

the exception, in light of the potential 

benefits that may arise from a de 

minimis exception. In this way, the 

threshold would not completely 

foreclose the availability of securitybased swaps to special entities from 

unregistered dealers—as $25 million 

would annually accommodate up to five 

single-name credit default swaps of a $5 

million notional size—but the threshold 

would limit the financial and other risks 

associated with those positions for a 

special entity, which would in turn 

limit the possibility of inappropriately 

undermining the special protections 

that Title VII provides to special 

entities. 

In reaching this conclusion we 

recognize that special entities do 

participate in the single-name credit 

default swap market, given that an 

analysis of market data indicates that in 

2011 special entities were parties to 

over $40 billion in single-name credit 

default swap transactions.535 At the 

same time, the impact of this $25 

million threshold—particularly 

concerns that the threshold may 

foreclose the ability of special entities to 

access dealers in the market—appears to 

be mitigated by the fact that the 

counterparties to those special entities 

tend to engage in notional transactions 

in single-name credit default swap well 

in excess of the general de minimis 

standards.536 In light of the underlying 

counterparty protection issues, we see 

no basis to distinguish between types of 

security-based swaps in setting this 

special entity threshold. 

For similar reasons, in the future as 

we consider whether to amend the de 

minimis exception we expect to pay 

particular attention to whether the 

threshold for transactions involving 

special entities should further be 

lowered. 

f. Future Revisions to the Rule 

As noted above and described in 

detail below in part V, the SEC is 

directing its staff to report on whether 

changes are warranted to the rules and 

interpretations implementing the 

security-based swap dealer definition, 

including the rule implementing the de 

minimis exception.537 The SEC will take 

the report and associated public 

comment into account in determining 

whether to propose any changes to the 

rule implementing the exception.538

Consistent with that possibility, the 

final rule provides that the SEC may 

change the requirements of the de 

minimis exception by rule or 

regulation.539 Through this mechanism, 

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joint rulemaking here, because such an 

interpretation would read the term ‘‘Commission’’ 

out of Exchange Act section 3(a)(71)(D), which itself 

was added by the Dodd-Frank Act. 

540See letter from Greenberger (stating that the 

dynamic nature of the derivatives sector of the 

financial markets should counsel caution, and that 

the de minimis threshold should be reevaluated on 

an ongoing basis). 

541See letters from Northland Energy and 

WGCEF I. 

542Compare CFTC Regulation § 1.3(hhh)(3); 

Exchange Act rule 3a67–8(a) (providing that 

persons who meet the criteria to be major 

participants will have two months to submit a 

completed registration application). 

543See CFTC Regulation § 1.3(ggg)(4)(ii); 

Exchange Act rule 3a71–2(b). As discussed below 

with regard to the implementation period for the 

major participant definitions, persons will have 

additional time to comply with the applicable 

requirements following the submission of a 

completed application. See part IV.L.3, infra. 

544Compare CFTC Regulation § 1.3(hhh)(5); 

Exchange Act rule 3a67–8(c) (providing that a major 

participant may be deemed to no longer be a major 

participant if its swap or security-based swap 

positions are below the relevant thresholds for four 

quarters). 

545See CFTC Regulation § 1.3(ggg)(4)(ii); 

Exchange Act rule 3a71–2(c). Consistent with this 

approach, moreover, the final rule has been revised 

from the proposal to clarify that the de minimis 

exception in general is not available to a registered 

swap dealer or security-based swap dealer. See 

CFTC Regulation § 1.3(hhh)(1)(i); Exchange Act rule 

3a71–2(a)(1) (revised language clarifying 

availability of exception to a person that is not a 

swap dealer or security-based swap dealer). 

546Compare CFTC Regulation § 1.3(hhh)(4); 

Exchange Act rule 3a67–8(b) (providing for a 

reevaluation period in connection with the major 

participant definitions when a person does not 

exceed any applicable threshold by more than 20 

percent in a calendar quarter). 

547CEA section 1a(49)(B); Exchange Act section 

3(a)(71)(B). 

548See Proposing Release, 75 FR at 80182. 

549See id.; see also proposed CFTC Regulation 

§ 1.3(ggg)(3); proposed Exchange Act rule 3a71–1(c). 

550See Proposing Release, 75 FR at 80182. 

551See id. 

the SEC may revisit the rule 

implementing the exception and 

potentially change that rule, for 

example, if data regarding the securitybased swap market following the 

implementation of Section 15F under 

Title VII suggests that different de 

minimis thresholds would be 

appropriate.540 In determining whether 

to revisit the thresholds, the SEC 

intends to pay particular attention to 

whether the de minimis exception 

results in a dealer definition that 

encompasses too many entities whose 

activities are not significant enough to 

warrant full regulation under Title VII, 

or, alternatively, whether the de 

minimis exception leads an undue 

amount of dealing activity to fall outside 

of the ambit of the Title VII regulatory 

framework, or leads to inappropriate 

reductions in counterparty protections 

(including protections for special 

entities). The SEC also intends to pay 

particular attention to whether 

alternative approaches would more 

effectively promote the regulatory goals 

that may be associated with a de 

minimis exception. 

6. Registration Period for Entities That 

Exceed the De Minimis Factors 

The de minimis exception raises 

implementation issues akin to those 

associated with the major participant 

definition, in that both provisions use 

tests that have retrospective elements to 

determine whether an entity must 

register and be subject to future 

regulation. As a result, some 

commenters have suggested that entities 

that surpass the de minimis thresholds 

should be able to take advantage of a 

grace period to undertake the process of 

registering as swap dealers or securitybased swap dealers.541 Otherwise, 

absent such a ‘‘roll-in’’ period, entities 

whose dealing activities surpass the 

relevant de minimis factors would 

immediately be in violation of dealer 

registration requirements. In light of 

these concerns, and the interest of 

avoiding undue market disruptions, the 

Commissions believe that it is 

appropriate to provide entities that 

exceed applicable the de minimis 

factors a period of time to register as 

dealers. 

Accordingly, the final rules have been 

revised from the proposal to provide for 

a timing standard that is similar to what 

we are using in connection with the 

major participant definition.542 That is, 

if an entity that has relied on the de 

minimis exception no longer is able to 

rely on the exception because its dealing 

activity exceeds a relevant threshold, 

the entity would have two months, 

following the end of the month in which 

it no longer is able to take advantage of 

the exception, to submit a completed 

application to register as a swap dealer 

or security-based swap dealer.543

Also, akin to the major participant 

definitions,544 a person registered as a 

swap dealer or security-based swap 

dealer may apply to withdraw that 

registration, while continuing to engage 

in a limited amount of dealing activity 

in reliance on the de minimis exception, 

if that person has been registered as a 

dealer for at least 12 months.545 This 

should help ensure that persons do not 

rapidly move in and out of dealer status 

based on short-term fluctuations in their 

swap or security-based swap activities. 

The final rules implementing the de 

minimis exception do not provide any 

reevaluation period for entities that 

engage in a level of dealing activity 

above the de minimis thresholds, in 

contrast to the major participant 

definitions.546 We do not believe that 

there is an appropriate basis for such a 

provision, particularly given that dealer 

regulation addresses customer 

protection and market operation and 

transparency concerns apart from risk 

concerns. 

E. Limited Purpose Designation as a 

Dealer 

1. Proposed Approach 

The definitions of the terms ‘‘swap 

dealer’’ and ‘‘security-based swap 

dealer’’ provide that the Commissions 

may designate a person as a dealer for 

one type, class or category of swap or 

security-based swap, or specified swap 

or security-based swap activities, 

without the person being considered a 

dealer for other types, classes, categories 

or activities.547

In the Proposing Release, we noted 

that these provisions represent 

permissive grants of authority that do 

not require the Commissions to provide 

limited designations.548 We further 

stated that a person that is covered by 

the definitions of the terms ‘‘swap 

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

would be considered a dealer for all 

types, classes or categories of the 

person’s swaps or security-based swaps, 

or activities involving swaps or securitybased swaps, in light of the difficulty of 

seeking to separate a person’s dealing 

activities from their non-dealing 

activities involving swaps or securitybased swaps, unless such person sought 

and received designation as a dealer for 

only specified categories of swaps or 

security-based swaps, or specified 

activities.549 We explained that this 

would provide persons the opportunity 

to seek a limited designation based on 

applicable facts and circumstances, and 

that we anticipated that a dealer could 

seek a limited designation at the time of 

its initial registration or later.550

In the Proposing Release, the CFTC 

further noted that non-financial entities 

such as physical commodity firms 

potentially may conduct dealing activity 

through a division rather than through 

a separately incorporated subsidiary, 

and that such an entity’s swap dealing 

activity would not be a core component 

of its overall business. The CFTC added 

that if this type of entity registered as a 

dealer, certain swap dealer requirements 

would apply to the dealing activities of 

the division, but not necessarily to the 

swap activities of other parts of the 

entity.551

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552See letters from Cargill Incorporated 

(‘‘Cargill’’), CDEU and Investment Company 

Institute (‘‘ICI’’) dated February 22, 2011 (‘‘ICI I’’). 

553See letters from MetLife and WGCEF I. 

554See letter from Cargill (stating that limited 

designation promotes the policy of encouraging 

non-financial firms that primarily are engaged in 

non-dealing businesses to continue to conduct 

limited dealing activities, adding that such firms 

‘‘do not present the potential systemic risks of 

financial firms,’’ and that their full designation as 

dealers would discourage them from providing risk 

management products). 

555See letter from EDF Trading. 

556See letter from Capital One. 

557See letters from NCGA/NGSA II (particularly 

referring to groupings based on individual physical 

commodities) and WGCEF dated June 9, 2011 

(‘‘WGCEF VII’’) (limited designation should permit 

firms to structure organization of limited purpose 

registrans as appropriate in particular 

circumstances). 

558See letters cited in note 148, supra. 

559See letters from MFA I (specifically requesting 

that the rules provide that an entity can receive a 

limited purpose designation at the time of their 

initial registration) and FSR I. 

560See letter from National Futures Association 

(‘‘NFA’’). 

561See letters from Capital One, Farm Credit 

Council I and FHLB I. 

562See letters from BG LNG I and ISDA I. 

563See letter from Cargill (arguing that a firm 

should be presumptively entitled to limited swap 

dealer status if: it is a non-financial company; its 

non-dealing activities include (but need not be 

limited to) production, merchandising or processing 

of physical commodities; the firm’s dealing 

activities take place in a separately identifiable 

division or business unit with separate 

management; and dealing revenues are less than 30 

percent of the firm’s total revenues in the firm’s 

most recent fiscal year). 

564See letter from WGCEF VII (stating that so long 

as a registered swap dealer bears the onus of 

demonstrating compliance with regulatory 

requirements, regulators ‘‘should not dictate’’ 

whether the firm registers a legal entity or a 

division as a dealer; also requesting guidance as to 

how applicable regulatory requirements may apply 

to a subdivision of a legal entity that registers as a 

dealer, and requesting a safe harbor from 

enforcement action when a decision to register only 

a particular desk or division as a dealer is made in 

good faith). 

565See letter from Capital One. 

566Compare letter from Capital One (stating that 

all market participants, including financial 

institutions, should be allowed to apply for limited 

swap dealer designations) with letter from Cargill 

(suggesting that an entity’s status as a financial 

company should be relevant to limited dealer 

determinations). 

567See letter from Cargill. 

568See letter from FSR I (recommending that to 

the extent that capital requirements are tied to swap 

activity or exposures, that only activities or 

exposures in the designated category be reflected in 

the calculation). 

569See id. (recommending that the corporate 

treasurer of an entity with a limited designation as 

a swap dealer for ‘‘other commodity swaps’’ as a 

result of its energy derivatives activity be able to 

hedge the entity’s interest rate and currency risk 

without being subject to the business conduct, 

reporting, recordkeeping or other rules applicable to 

dealers and major participants). 

570See id. 

571See letter from NFA. As discussed below, see 

752, infra, a person who is designated as a dealer 

in connection with particular types of swaps or 

security-based swaps may be major participants 

with regard to other types. 

2. Commenters’ Views 

A number of commenters addressed 

the limited designation of dealers in 

conjunction with the limited 

designation of major participants. Many 

of the issues those commenters raised 

thus are relevant to both sets of 

definitions. 

a. Presumption of Full Designation 

A number of commenters objected to 

the proposed presumption that an entity 

would be designated as a dealer (or 

major participant) for all categories of 

swaps or security-based swaps and all of 

the person’s activities connected to 

swaps or security-based swaps. Several 

commenters argued that this approach 

would be contrary to Congressional 

intent,552 conflict with the statutory 

language,553 or conflict with underlying 

policy concerns.554 One commenter 

suggested that the Commissions lack the 

statutory authority to apply swap dealer 

requirements to an entity’s non-swap 

dealing activities.555

b. Potential Types of Limited 

Designations 

A number of commenters addressed 

potential types of limited designations. 

One expressed support for limited swap 

dealer designations for particularized 

business units and for particular swap 

categories,556 while another requested 

that limited swap dealer designations be 

available based on any reasonable 

commercial groupings.557 Some 

commenters urged that limited dealer 

designations should be available for the 

branches or business units of foreign 

swap dealers and security-based swap 

dealers with U.S.-based customers or 

U.S. business lines.558

c. Applications for Limited Designations 

A number of commenters addressed 

issues relating to the application process 

for limited designations. Some 

commenters supported the ability of a 

person to apply for limited designations 

at the time of initial registration,559

while one commenter sought 

clarification on how and when a person 

could apply for limited swap dealer 

status.560 Some commenters suggested 

that entities should be considered to 

have a provisional limited designation 

upon the filing of a completed 

application for limited dealer 

designation.561

Some commenters requested further 

clarification as to what factors or criteria 

would be considered relevant to limited 

designation determinations.562 One 

commenter stated that non-financial 

companies should have a presumption 

of limited swap dealer designation 

under certain circumstances.563 Another 

commenter took the view that 

commercial firms should be able to 

determine whether to register a legal 

entity or a division as a dealer.564 One 

commenter suggested the analysis 

consider the complexity of an entity’s 

dealing and non-dealing activities, and 

further suggested that limited 

designations should automatically be 

available if an entity’s dealing activities 

do not exceed 50 percent of its total 

swap activities.565 Commenters also 

raised issues related to how a person’s 

status as a financial or a non-financial 

entity affects a person’s eligibility for 

limited designations.566

d. Application of Regulatory 

Requirements to Limited Dealers 

Commenters also addressed issues 

related to the application of regulatory 

requirements to limited dealers. One 

commenter recommended that dealer 

regulatory requirements generally 

should apply only to a division 

undertaking limited dealing activities; 

that commenter further stated that 

capital requirements should be 

calculated based only on the activities 

of that division, while recognizing that 

capital must be held by the entity as a 

whole.567 Other commenters argued that 

capital and margin requirements should 

only be applied to an entity on a limited 

basis.568

e. Miscellaneous Issues 

One commenter recommended that 

non-financial entities that are deemed to 

be limited dealers (or major 

participants) be permitted to be treated 

as end-users for the aspects of their 

businesses that are not subject to the 

limited designation.569 The commenter 

further suggested that the swaps ‘‘pushout’’ rule requirements of section 716 of 

the Dodd-Frank Act be interpreted so 

that an insured depository institution 

that is a limited purpose dealer would 

only have to push out the dealing 

portion of its swap business, and be 

allowed to retain the other aspects of its 

swaps business.570 One commenter 

requested clarification as to whether a 

person that is a limited purpose dealer 

in connection with one category of swap 

could be a major participant in 

connection with another category (in 

light of the statutory language excluding 

dealers from the major participant 

definitions).571

3. Final Rules and General Principles 

Consistent with the proposal, the final 

rules retain the presumption that a 

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572CFTC Regulation§ 1.3(ggg)(3); Exchange Act 

rule 3a71–1(c). 

573The SEC expects to address the process for 

submitting an application for limited designation as 

a security-based swap dealer, along with principles 

to be used by the SEC in analyzing such 

applications, as part of separate rulemakings. 

574The rules particularly have been revised from 

the proposal to add ‘‘type’’ and ‘‘class’’ language to 

supplement the use of the term ‘‘category.’’ This 

change is consistent with the statutory language. In 

addition, the final rules related to limited 

designations for ‘‘security-based swap dealers’’ 

corrects an erroneous reference to major participant 

designation. 

575This approach also is consistent with the 

treatment of dealers of other types of securities 

under the Exchange Act. When a person’s securities 

activities cause them to be a ‘‘dealer’’ for purposes 

of the Exchange Act, the statutory requirements and 

regulations applicable to dealers will apply to all 

of that person’s securities activities, regardless of 

whether particular activities would not have caused 

the entity to fall within the ‘‘dealer’’ definition. For 

example, Exchange Act section 15(c)(3)(A) prohibits 

brokers and dealers from engaging in certain 

securities-related activity in contravention of SECprescribed rules with respect to financial 

responsibility or related practices. This provision 

does not distinguish between those activities that 

cause a person to fall within the ‘‘broker’’ or 

‘‘dealer’’ definitions, and other activities that 

themselves do not cause that person to be a broker 

or dealer. The SEC’s authority extends to all 

securities activities by those brokers or dealers. 

576See letter from EDF Trading. 

577See, e.g., CEA section 4s(e); Exchange Act 

section 15F(e). 

578The substantive regulations applicable to 

dealers, of course, can account for the nature of a 

dealer’s particular swap or security-based swap 

activities. 

The SEC also intends to address limited 

designation issues in the context of a separate 

release addressing the application of Title VII to 

non-U.S. entities. 

579Consistent with this approach, applications to 

limit a person’s dealer designation to ‘‘specified 

categories’’ of swaps or security-based swaps (see 

CFTC Regulation § 1.3(ggg)(3); Exchange Act rule 

3a71–1(c)), would not be required to interpret the 

term ‘‘category’’ consistently with the use of that 

term in connection with the major participant 

definitions. CFTC Regulation § 1.3(iii) and 

Exchange Act rule 3a67–2, defining the terms 

‘‘major swap category’’ and ‘‘major security-based 

swap category,’’ respectively, do not apply for this 

purpose. 

580See, e.g., CEA section 4s(h)(3), Exchange Act 

section 15F(h)(3) (business conduct standards, 

including disclosure requirements, for dealers); 

CEA section 4s(g), Exchange Act section 15F(g) 

(daily trading record requirements for dealers); CEA 

section 4s(i); Exchange Act section 15F(i) 

(documentation requirements for dealers). 581See, e.g., CEA section 4s(a)(1), Exchange Act 

section 15F(a)(1) (registration requirements for 

dealers); CEA section 4s(e), Exchange Act section 

15F(e) (capital and margin requirements for 

dealers). The Dodd-Frank Act provides that in 

setting the capital requirements for swap dealers 

and security-based swap dealers (as well as major 

participants) that are subject to a limited 

designation, the Commissions and the prudential 

regulators must take into account the risks 

associated with other types, classes, or categories of 

swaps or security-based swaps engaged in, and the 

other swap or security-based swap activities 

conducted by, that person ‘‘that are not otherwise 

subject to regulation applicable to that person by 

virtue of the status of the person’’ as a dealer or 

major participant. See CEA section 4s(e)(2)(C); 

Exchange Act section 15F(e)(2)(C). In the case of a 

commercial agricultural or energy company that 

obtains a limited purpose designation for a 

particular business unit, the CFTC does not expect 

that this provision will generally require the limited 

purpose designee to calculate its required capital on 

the basis of swaps engaged in, or activities 

conducted by, other business units within the 

company, to the extent those swaps or activities do 

not generate risk beyond the agricultural or energy 

company’s ordinary commercial line of business. 

person who meets one of the dealer 

definitions will be deemed to be a 

dealer with regard to all of its swaps or 

security-based swaps activities, unless 

the CFTC or SEC exercises its authority 

to limit the person’s designation as a 

dealer to specified categories of swaps 

or security-based swaps, or specified 

activities.572 As discussed in the 

Proposing Release, moreover, a person 

may apply for a limited designation 

when it submits a registration 

application, or at a later time.573 The 

final rules also contain a technical 

change from the proposed rules to 

clarify that limited designations may be 

based on a particular type, class or 

category of swap or security-basedswap.574

a. Default Presumption of Full 

Designation 

Consistent with the proposal, the final 

rules retain the standard that a person 

that satisfies the ‘‘swap dealer’’ or 

‘‘security-based swap dealer’’ definition 

in general would be considered a dealer 

for all types, classes or categories of the 

person’s swaps or security-based swaps, 

or all activities involving swaps or 

security-based swaps. 

The Commissions are not persuaded 

by the suggestion that this presumption 

is inconsistent with the statute, 

legislative intent or underlying policy. 

Not only is the relevant statutory 

language written as a grant of authority 

rather than a specific mandate to 

designate certain entities as limited 

purpose dealers, but the presumption 

also reasonably reflects the difficulty of 

separating a dealer’s dealing activities 

from its non-dealing activities, and the 

challenges of applying dealer regulatory 

requirements to only a portion of a 

dealer’s swap or security-based swap 

activities.575

We similarly are not persuaded by the 

view that the Commissions lack the 

authority to apply dealer regulation to 

non-dealing activities of a registered 

swap dealer or security-based swap 

dealer.576 Certain of the statutory 

requirements applicable to swap dealers 

and security-based swap dealers—such 

as capital requirements—simply do not 

distinguish between a person’s dealing 

activities and their non-dealing 

activities.577 In other words, absent a 

limited designation, the statutory 

requirements applicable to dealers 

address the regulation of all of a dealer’s 

swap or security-based swap 

activities.578

b. Demonstration of Compliance With 

Dealer Requirements 

The Commissions will consider 

limited purpose applications on an 

individual basis through analysis of the 

unique circumstances of each applicant, 

given that the types of entities that 

engage in swap or security-based swap 

dealing are diverse and their 

organization and activities are varied.579

Regardless of the type of limited 

designation being requested, the 

Commissions will not designate a 

person as a limited purpose dealer 

unless it can demonstrate that it can 

fully comply with the requirements 

applicable to dealers. 

Certain of the statutory requirements 

applicable to dealers particularly focus 

on the entity’s swap or security-based 

swap activities and positions. These 

include, among other aspects, 

requirements related to trading records, 

documentation and confirmations.580

An applicant for a limited purpose 

designation would have to demonstrate 

how it would satisfy those transactionspecific requirements in the context of 

a limited designation. 

Other statutory requirements 

applicable to dealers particularly focus 

on the entity itself. These include 

requirements related to registration, 

capital, risk management, supervision, 

and chief compliance officers.581 Here 

too, an applicant for a limited purpose 

designation would have to demonstrate 

how it would satisfy those requirements 

in the context of limited designations. 

A limited purpose designation might 

be appropriate, for example, where a 

commercial agricultural company is a 

dealer in swaps related to a thinlytraded commodity, such as a particular 

fertilizer, but is not a dealer in, and does 

not wish to be subject to the swap dealer 

requirements with respect to its swaps 

that relate to broadly-traded 

commodities like corn or wheat (or 

where, say, a commercial energy 

company is a dealer in swaps involving 

a commodity to be delivered at a 

particular location and does not wish to 

be subject to the swap dealer 

requirements for its swaps involving 

that commodity to be delivered at other 

locations, for which it is not a swap 

dealer). A limited designation might 

also be appropriate so that the swap 

dealer requirements do not apply to 

interest rate or currency swaps that the 

agricultural or energy company enters 

into in managing its financial risk. 

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30646 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

582 In particular, section 723(a)(2) of the DoddFrank Act adds new subsection (e) to CEA section 

2 (7 U.S.C. 2(e)), providing that ‘‘[i]t shall be 

unlawful for any person, other than an eligible 

contract participant, to enter into a swap unless the 

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

a board of trade designated as a contract market 

under section 5.’’ 

583 In particular, section 763(e) of the Dodd-Frank 

Act adds paragraph (l) to Exchange Act section 6 

(15 U.S.C. 78f(l)), providing that ‘‘[i]t shall be 

unlawful for any person to effect a transaction in 

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

not an eligible contract participant, unless such 

transaction is effected on a national securities 

exchange registered pursuant to subsection (b).’’ 

584 15 U.S.C. 77a et seq. 

585 In particular, section 768(b) of the Dodd-Frank 

Act adds paragraph (d) to Securities Act section 5 

(15 U.S.C. 77e(d)), providing that 

‘‘[n]otwithstanding the provisions of section 3 or 4, 

unless a registration statement meeting the 

requirements of section 10(a) is in effect as to a 

security-based swap, it shall be unlawful for any 

person, directly or indirectly, to make use of any 

means or instruments of transportation or 

communication in interstate commerce or of the 

mails to offer to sell, offer to buy or purchase or sell 

a security-based swap to any person who is not an 

eligible contract participant as defined in section 

1a(18) of the Commodity Exchange Act (7 U.S.C. 

1a(18)).’’ The Commissions note that market 

participants must make the determination of ECP 

status with respect to the parties to transactions in 

security-based swaps and mixed swaps prior to the 

offer to sell or the offer to buy or purchase the 

security-based swap or mixed swap. 

586See Sections 741(b)(10) and 721(a)(9) of the 

Dodd-Frank Act; see also Financial Regulatory 

Reform, A New Foundation: Rebuilding Financial 

Supervision and Regulation, available at http:// 

www.treasury.gov/initiatives/Documents/ 

FinalReport_web.pdf, at 48–49 (June 17, 2009). 

587See CEA section 1a(18)(A)(vii), 7 U.S.C. 

1a(18)(A)(vii). 

588See CEA section 1a(18)(A)(xi), 7 U.S.C. 

1a(18)(A)(xi). The Dodd-Frank Act did not amend 

the monetary thresholds for individuals to qualify 

as ECPs. As such, an individual can qualify as an 

ECP if such individual has amounts invested on a 

discretionary basis, the aggregate of which is in 

excess of (i) $10,000,000, or (ii) $5,000,000 if such 

individual also enters into the agreement, contract, 

or transaction in order to manage the risk associated 

with an asset owned or liability incurred, or 

reasonably likely to be owned or incurred, by such 

individual. 

589See CEA sections 2(c)(2)(B)(vi) and 

2(c)(2)(C)(vii), 7 U.S.C. 2(c)(2)(B)(vi) and 7 U.S.C. 

2(c)(2)(C)(vii). In this context, the term ‘‘offexchange’’ means other than on or subject to the 

rules of an organized exchange, as defined in CEA 

section 1a(37), 7 U.S.C. 1a(37). 

590See CEA section 1a(18)(A)(iv), 7 U.S.C. 

1a(18)(A)(iv); see also CFTC Regulation § 1.3(m)(5) 

(exporting the look-through language of CEA 

section 1a(18)(A)(iv) to CEA section 1a(18)(A)(v)). 

The Dodd-Frank Act amended the ECP definition to 

include a provision that specifically applies to 

Forex Pools engaging in these types of foreign 

currency transactions. See Section 741(b)(10) of the 

Dodd-Frank Act (adding a provision to CEA section 

1a(18)(A)(iv), 7 U.S.C. 1a(18)(A)(iv), stating 

‘‘provided, however, that for purposes of section 

2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term 

‘eligible contract participant’ shall not include a 

commodity pool in which any participant is not 

otherwise an eligible contract participant.’’). See 

part III.B below for a discussion of this provision. 

This provision applies only with respect to retail 

forex transactions. This means that a Retail Forex 

Pool, as defined above, that is not an ECP for retail 

forex transaction purposes could be an ECP for 

other transactions it enters into that are not retail 

forex transactions. 

591 In many commodity pool structures, this is the 

master fund alone. 

592But see note 652, infra, with respect to single 

level Forex Pools using retail forex transactions 

solely to hedge. 

A limited purpose designee could be 

a particular business unit within a 

company. Additionally, a limited 

designation might be considered to 

‘‘split the desk’’ by applying the swap 

dealer requirements solely to the 

designee’s limited activities involving 

swaps not entered into for the purpose 

of hedging a physical position as 

defined in CFTC Regulation 

§ 1.3(ggg)(6)(iii). Any particular limited 

purpose application will be analyzed in 

light of the unique circumstances 

presented by the applicant. 

A key challenge that any applicant to 

a limited dealer designation will face is 

the need to demonstrate full compliance 

with the requirements that apply to the 

type, class or category of swap or 

security-based swap, or the activities 

involving swaps or security-based 

swaps, that fall within the swap dealer 

designation. 

III. Amendments to the Definition of 

Eligible Contract Participant 

A. Background 

The Dodd-Frank Act makes it 

unlawful for a person that is not an 

eligible contract participant (‘‘ECP’’) to 

enter into a swap other than on, or 

subject to the rules of, a DCM.582 In 

addition, section 763(e) of the DoddFrank Act makes it unlawful for a 

person to effect a transaction in a 

security-based swap with or for a person 

that is not an ECP unless the transaction 

is effected on a national securities 

exchange registered with the SEC.583

Moreover, section 768(b) of the DoddFrank Act makes it unlawful for a 

person to offer to sell, offer to buy or 

purchase, or sell a security-based swap 

to a person that is not an ECP unless a 

registration statement under the 

Securities Act of 1933 (‘‘Securities 

Act’’) 584 is in effect with respect to that 

security-based swap.585 These 

provisions mean that persons can 

engage in neither swaps nor securitybased swaps transactions with persons 

that are not ECPs on SEFs, on securitybased SEFs, or on a bilateral, offexchange basis. 

The Dodd-Frank Act also amended 

the ECP definition by: 586 (i) Providing 

that, for purposes of CEA sections 

2(c)(2)(B)(vi) and 2(c)(2)(C)(vii), the term 

ECP does not include a commodity pool 

in which any participant is not itself an 

ECP; (ii) raising the monetary threshold 

that governmental entities may use to 

qualify as ECPs, in certain situations, 

from $25 million in investments owned 

and invested on a discretionary basis to 

$50 million in investments owned and 

invested on a discretionary basis; 587

and (iii) replacing the ‘‘total asset’’ 

standard for individuals to qualify as 

ECPs with an ‘‘amounts invested on a 

discretionary basis’’ standard.588

Commodity pools may, among other 

things, enter into transactions involving 

foreign currency. ECP status is 

important for commodity pools that 

enter into the following types of foreign 

currency transactions (such commodity 

pools, ‘‘Forex Pools’’): (i) Off-exchange 

foreign currency futures; (ii) offexchange options on foreign currency 

futures; (iii) off-exchange options on 

foreign currency; (iv) leveraged or 

margined foreign currency transactions; 

and (v) foreign currency transactions 

that are financed by the offeror, the 

counterparty or a person acting in 

concert with the offeror or counterparty 

on a similar basis.589 In some cases, 

discussed below in detail, if a Forex 

Pool does not satisfy the ECP definition 

applicable to commodity pools engaging 

in the types of foreign currency 

transactions noted above 590 and it 

engages in these types of foreign 

currency transactions (such 

transactions, ‘‘retail forex transactions’’ 

and such commodity pools, ‘‘Retail 

Forex Pools’’), the transactions will be 

subject to a regulatory regime that 

imposes certain requirements and 

restrictions on the counterparties to the 

Retail Forex Pool, and, if the Retail 

Forex Pool engages in retail forex 

transactions other than with certain 

counterparties, on the commodity pool 

operator (‘‘CPO’’) who operates the 

Retail Forex Pool. These requirements 

and restrictions do not apply if the 

Forex Pool satisfies the ECP definition 

applicable to commodity pools engaging 

in the types of foreign currency 

transactions noted above. 

The Commissions are adopting further 

definitions of the term ‘‘eligible contract 

participant’’ in the following six 

respects: (i) Generally prohibiting a 

Forex Pool from qualifying as an ECP if 

such Forex Pool directly enters into 

retail forex transactions 591 and has one 

or more direct participants that are not 

ECPs; 592 (ii) clarifying that, in 

determining whether a direct 

participant in a Forex Pool is an ECP, 

the indirect participants in the Forex 

Pool will not be considered unless such 

Forex Pool, a commodity pool holding 

a direct or indirect (through one or more 

intermediate tiers of pools) interest in 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30647 

593Section 721(c) of the Dodd-Frank Act requires 

the CFTC to adopt a rule to further define the terms 

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

and ‘‘eligible contract participant,’’ in order ‘‘[t]o 

include transactions and entities that have been 

structured to evade’’ subtitle A of Title VII (or an 

amendment to the CEA made by subtitle A). 

594 7 U.S.C. 1a(18)(A)(iv)(II). 

595 7 U.S.C. 1a(18)(A)(vii). 

596These issues include: (i) The ECP status of 

jointly and severally liable borrowers and 

counterparties, non-ECPs guaranteed by ECPs, and 

non-ECP swap collateral providers; (ii) whether 

bond proceeds count toward the ‘‘owns and invests 

on a discretionary basis $50,000,000 or more in 

investments’’ element of the governmental ECP 

prong (CEA section 1a(18)(A)(vii), 7 U.S.C. 

1a(18)(A)(vii)); (iii) the relationship between the 

ECP and eligible commercial entity definitions for 

purposes of CEA section 1a(18)(A)(vii), 7 U.S.C. 

1a(18)(A)(vii); (iv) the scope of the ‘‘proprietorship’’ 

element of the entity prong of the ECP definition 

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

(which the Commissions are addressing to a limited 

extent in the discussion of the new line of business 

ECP category in part III.F, infra, and in Regulation 

§ 1.3(m)(7)(ii)(C) under the CEA); (v) the meaning of 

the new ‘‘amounts invested on a discretionary 

basis’’ element of the individual prong of the ECP 

definition (CEA section 1a(18)(A)(xi), 7 U.S.C. 

1a(18)(A)(xi)); (vi) whether persons can be ECPs in 

anticipation of receiving, but before they have, the 

necessary assets; and (vii) that swap dealers are not 

among the entities listed in CEA section 

2(c)(2)(B)(i)(II), 7 U.S.C. 2(c)(2)(B)(i)(II), as 

acceptable counterparties to non-ECPs engaging in 

retail forex transactions. 

597Clause (A)(iv) of the pre-Dodd-Frank Act ECP 

definition also included a commodity pool operated 

by a foreign person performing a similar role or 

function as a person regulated under the CEA and 

subject as such to foreign regulation (regardless of 

whether the foreign person was itself an ECP). 

598The proviso states ‘‘provided, however, that 

for purposes of section 2(c)(2)(B)(vi) and section 

2(c)(2)(C)(vii), the term ‘eligible contract 

participant’ shall not include a commodity pool in 

which any participant is not otherwise an eligible 

contract participant.’’ CEA section 1a(18)(A)(iv); 7 

U.S.C. 1a(18)(A)(iv). 

599See CEA section 1a(18)(A)(iv), 7 U.S.C. 

1a(18)(A)(iv). In other words, the proviso in section 

1a(18)(A)(iv) does not reference or implicate ECP 

status for purposes of (i) CEA section 2(e), 7 U.S.C. 

2(e) (which, as discussed above, permits non-ECPs 

to trade swaps only on or subject to the rules of a 

DCM); (ii) Securities Act section 5(d) (which, as 

discussed above, makes it unlawful for a person to 

offer to sell, offer to buy or purchase, or sell a 

security-based swap to a person that is not an ECP 

unless a registration statement under the Securities 

Act is in effect with respect to that security-based 

swap); or (iii) Exchange Act section 6(l) (which as 

discussed above, makes it unlawful for a person to 

effect a transaction in a security-based swap with 

or for a person that is not an ECP unless the 

transaction is effected on a national securities 

exchange registered with the SEC). The lookthrough proviso does not expressly state that 

indirect participants, as well as direct participants, 

in the Forex Pool must be ECPs for the Forex Pool 

to be an ECP. But see notes 636 and 638, infra 

(discussing the authority for such an approach). 

600 7 U.S.C. 2(c)(2)(B)(i)(II)(aa). The term 

‘‘financial institution’’ is defined in CEA Section 

1a(21), 7 U.S.C. 1a(21). 601 7 U.S.C. 2(c)(2)(B)(i)(II)(bb). This category is 

comprised of each: 

(AA) [] broker or dealer registered under section 

15(b) (except paragraph (11) thereof) or 15C of the 

Securities Exchange Act of 1934 (15 U.S.C. 78o(b), 

78o–5); [and] (BB) [ ] associated person of a broker 

or dealer registered under section 15(b) (except 

paragraph (11) thereof) or 15C of the Securities 

Exchange Act of 1934 (15 U.S.C. 78o(b), 78o–5) 

concerning the financial or securities activities of 

which the broker or dealer makes and keeps records 

under section 15C(b) or 17(h) of the Securities 

Exchange Act of 1934 (15 U.S.C. 78o–5(b), 78q(h)). 

602 7 U.S.C. 2(c)(2)(B)(i)(II)(cc). This category is 

comprised of each: 

(cc)(AA) []futures commission merchant that is 

primarily or substantially engaged in the business 

activities described in section 1a of this Act, is 

registered under this Act, is not a person described 

in item (bb) of this subclause, and maintains 

adjusted net capital equal to or in excess of the 

dollar amount that applies for purposes of clause 

(ii) of this subparagraph; [and] (BB) [ ] affiliated 

person of a futures commission merchant that is 

primarily or substantially engaged in the business 

activities described in section 1a of this Act, is 

registered under this Act, and is not a person 

described in item (bb) of this subclause, if the 

affiliated person maintains adjusted net capital 

equal to or in excess of the dollar amount that 

applies for purposes of clause (ii) of this 

subparagraph and is not a person described in such 

item (bb), and the futures commission merchant 

makes and keeps records under section 4f(c)(2)(B) 

of this Act concerning the futures and other 

financial activities of the affiliated person. 

603 7 U.S.C. 2(c)(2)(B)(i)(II)(dd). The enumerated 

counterparty in this category is ‘‘a financial holding 

company (as defined in section 2 of the Bank 

Holding Company Act of 1956).’’ 

604 7 U.S.C. 2(c)(2)(B)(i)(II)(ff). This category is 

comprised of each: 

retail foreign exchange dealer that maintains 

adjusted net capital equal to or in excess of the 

dollar amount that applies for purposes of clause 

(ii) of this subparagraph and is registered in such 

capacity with the [CFTC], subject to such terms and 

conditions as the [CFTC] shall prescribe, and is a 

member of a futures association registered under 

section 17 [of the CEA]. 

605 7 U.S.C. 2(c)(2)(C)(i)(I)(bb). 

such Forex Pool, or any commodity pool 

in which such Forex Pool holds a direct 

or indirect interest has been structured 

to evade Subtitle A of Title VII of the 

Dodd-Frank Act; 593 (iii) prohibiting a 

commodity pool from qualifying as an 

ECP unless it has total assets exceeding 

$5 million and is operated by a person 

described in CEA section 

1a(18)(A)(iv)(II);594 (iv) explicitly 

including swap dealers, security-based 

swap dealers, major swap participants, 

and major security-based swap 

participants in the definition of ECP; (v) 

permitting a non-ECP to qualify as an 

ECP, with respect to certain swaps, 

based on the collective net worth of its 

owners, subject to several conditions, 

including that the owners are ECPs; and 

(vi) permitting a Forex Pool to qualify as 

an ECP notwithstanding that it has one 

or more direct participants that are not 

ECPs if the Forex Pool (a) is not formed 

for the purpose of evading regulation 

under CEA sections 2(c)(2)(B) or (C) or 

related rules, regulations or orders, (b) 

has total assets exceeding $10 million 

and (c) is formed and operated by a 

registered CPO or by a CPO who is 

exempt from registration as such 

pursuant to § 4.13(a)(3). In addition, the 

Commissions are issuing interpretive 

guidance regarding the definition of ECP 

to correct an inaccurate statutory crossreference with respect to the ability of 

government entities to qualify as ECPs 

under CEA section 1a(18)(A)(vii).595 The 

Commissions also are issuing 

interpretive guidance with respect to the 

ECP status of Forex Pools whose 

participants are limited solely to nonU.S. persons and which are operated by 

CPOs located outside the United States, 

its territories or possessions. 

The Commissions note that 

commenters raised interpretive and 

other issues related to the ECP 

definition that the Commissions may 

consider in the future.596

B. Commodity Pool Look-Through for 

Retail Forex Transactions 

1. Statutory Provisions 

Prior to the Dodd-Frank Act, clause 

(A)(iv) of the ECP definition provided 

that a commodity pool was an ECP if it 

had $5 million in total assets and was 

operated by a person regulated under 

the CEA, regardless of whether each 

participant in the commodity pool was 

itself an ECP.597 Section 741(b)(10) of 

the Dodd-Frank Act added a proviso to 

clause (A)(iv) 598 stating that a Forex 

Pool will not qualify as an ECP, solely 

for purposes of CEA sections 

2(c)(2)(B)(vi) or 2(c)(2)(C)(vii) (i.e., retail 

forex transactions) if any participant in 

the Forex Pool is itself not an ECP.599

Thus, for purposes of retail forex 

transactions, the Dodd-Frank Act 

imposed a requirement to ‘‘look 

through’’ a Forex Pool—meaning that 

ECP status would be limited to Forex 

Pools in which each participant is itself 

an ECP. This is important for two 

reasons. First, a Forex Pool that does not 

qualify as an ECP can enter into a retail 

forex transaction described in CEA 

section 2(c)(2)(B)(i)(I) only with one of 

the federally-regulated counterparties 

enumerated in CEA sections 

2(c)(2)(B)(i)(II)(aa) (U.S. financial 

institutions),600 (bb) (certain brokers, 

dealers and their associated persons),601

(cc) (certain futures commission 

merchants (‘‘FCMs’’) and their affiliated 

persons),602 (dd) (certain financial 

holding companies) 603 or (ff) (certain 

retail foreign exchange dealers 

(‘‘RFEDs’’)) 604 (each an ‘‘Enumerated 

Counterparty’’ and collectively 

‘‘Enumerated Counterparties’’); the 

counterparty restriction does not apply 

to retail forex transactions described in 

CEA section 2(c)(2)(C)(i)(I)(bb) 605

entered into by a Forex Pool that does 

not qualify as an ECP, though such 

transactions are subject to antifraud 

protections and related enforcement 

provisions if entered into with a 

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30648 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

606The counterparty limitation with respect to 

CEA section 2(c)(2)(B)(i)(I) retail forex transactions 

is a function of the fact that the CEA’s exchangetrading requirement generally applies with respect 

to foreign currency futures, foreign currency 

options on futures, and foreign currency options. 

See CEA section 4(a), 7 U.S.C. 6(a) (generally 

requiring futures contracts to be traded on or 

subject to the rules of a DCM); CEA section 4c(b), 

7 U.S.C. 6c(b) (prohibiting trading options subject 

to the CEA contrary to CFTC rules, regulations or 

orders permitting such trading); Part 32 of the 

CFTC’s rules, 17 CFR part 32 (generally prohibiting 

entering into options subject to the CEA) and CFTC 

Regulation § 33.3(a), 17 CFR 33.3(a) (prohibiting 

entering into options on futures other than on or 

subject to the rules of a DCM). Because CEA section 

4(a) would render an off-exchange futures contract 

illegal but for CEA section 2(c)(2)(B) permitting 

such transactions with an Enumerated 

Counterparty, it would be illegal for a nonEnumerated Counterparty to enter into a futures 

contract described in 2(c)(2)(B)(i)(I) with a non-ECP. 

Similarly, because options can be conducted only 

pursuant to CFTC authority and the CFTC has 

proposed to treat commodity options within its 

jurisdiction as swaps, CEA section 2(e) would 

prohibit such options, if on foreign exchange and 

entered into with a non-ECP, but for the fact that 

2(c)(2)(B) permits them if traded with an 

Enumerated Counterparty. 

The lack of a counterparty limitation with respect 

to CEA section 2(c)(2)(C)(i)(I)(bb) retail forex 

transactions is a function of the different structures 

of CEA sections 2(c)(2)(B) and (C). Whereas CEA 

section 2(c)(2)(B)(i) covers transactions that would 

be illegal but for compliance with CEA section 

2(c)(2)(B) (due to such section’s incorporation of the 

entire CEA, including, for example, the exchangetrading requirement discussed above), falling 

within CEA section 2(c)(2)(C)(i)(I), by that section’s 

own terms, merely brings a covered transaction 

within the scope of CEA section 2(c)(2)(C), which 

does not include the exchange-trading requirement 

of CEA section 4(a). Because CEA section 

2(c)(2)(C)(i)(I) covers transactions that may or may 

not also be transactions described in section 

2(c)(2)(B)(i)(I) and the far fewer requirements 

imposed by CEA section 2(c)(2)(C) invite 

characterization of such difficult-to-categorize 

transactions as falling solely within CEA section 

2(c)(2)(C), the CFTC will interpret such dually 

characterizable transactions as governed by CEA 

section 2(c)(2)(B). If such transactions fall only 

within CEA section 2(c)(2)(C), however, because 

they would be subject to neither the exchangetrading requirement of CEA section 4(a) nor the 

CFTC’s plenary options authority under CEA 

section 4c(b) (while CEA section 2(c)(2)(C)(ii)(I), 7 

U.S.C. 2(c)(2)(C)(ii)(I), reserves the CFTC’s section 

4c(b) authority, in this scenario, the contract in 

question is not an option), a person other than an 

Enumerated Counterparty may act as counterparty 

to a non-ECP. Such contracts would, however, be 

subject to two of the CEA’s antifraud provisions, 

sections 4(b) and 4b, 7 U.S.C 6(b) and 7 U.S.C 6b, 

respectively, as if they were futures contracts. See 

CEA section 2(c)(2)(C)(iv), 7 U.S.C. 2(c)(2)(C)(iv). 

Such contracts also would be subject to related 

enforcement provisions. See CEA section 

2(c)(2)(C)(ii)(I), 7 U.S.C. 2(c)(2)(C)(ii)(I). 

607See CEA sections 2(c)(2)(B)(iv)(I) and (C)(iii)(I) 

(requiring registration for CPOs of Retail Forex 

Pools entering into retail forex transactions with 

FCMs, specified affiliated persons thereof or 

RFEDs). By contrast, those sections exclude from 

the CPO registration requirement CPOs of Retail 

Forex Pools engaging in retail forex transactions 

with Enumerated Counterparties described in CEA 

section 2(c)(2)(B)(i)(II)(aa), (bb), (ee) and (ff). While 

the cited CEA sections refer to counterparties not 

described in ‘‘any of item (aa), (bb), (ee), or (ff)’’ of 

subparagraph (B)(i)(II), the CFTC Reauthorization 

Act of 2008 (‘‘CRA’’), included as Title XIII of the 

Food, Conservation and Energy Act of 2008, Pub.L. 

110–246, 122 Stat. 1651 changed item (ee) to item 

(dd) (a financial holding company as defined in 

section 2 of the Bank Holding Company Act of 

1956) and removed item (ff) (formerly an 

investment bank holding company (as defined in 

section 17(i) of the Exchange Act (15 U.S.C. 78q(i))). 

Therefore, the Commissions interpret the reference 

in CEA sections 2(c)(2)(B)(iv)(I)(cc) and 

2(c)(2)(C)(iii)(I)(cc) to items (aa), (bb), (ee), or (ff) to 

be references to items (aa), (bb) and (dd). Cf. Retail 

Foreign Exchange Transactions; Conforming 

Changes to Existing Regulations in Response to the 

Dodd-Frank Wall Street Reform and Consumer 

Protection Act, 76 FR 56103 (Sept. 12, 2011) 

(providing background on related incorrect internal 

references in CEA sections 2(c)(2)(B) and (C)). See 

also CFTC Regulation § 5.3(a)(2)(i), 17 CFR 

5.3(a)(2)(i), which requires a CPO, as defined in 

CFTC Regulation § 5.1(d)(1), 17 CFR 5.1(d)(1), to 

register as such. CFTC Regulation § 5.1(d)(1), in 

turn, defines a CPO, for purposes of Part 5 of the 

CFTC’s Regulations, 17 CFR part 5, as ‘‘any person 

who operates or solicits funds, securities or 

property for a pooled investment vehicle that is not 

an [ECP] as defined in section 1a(18) of the Act, and 

that engages in retail forex transactions.’’ The CFTC 

interprets the references in Regulation § 5.1(d)(1) to 

ECPs as defined in CEA section 1a(18) to include 

the ECP definition as further defined or interpreted 

by the Commissions under authority conferred by 

the Dodd-Frank Act or otherwise amended or 

interpreted by the Commissions or a court. While 

the statutory CPO definition in CEA section 

1a(11)(A), 7 U.S.C. 1a(11)(A), does not include 

transactions described in CEA section 2(c)(2)(B)(i), 

the Commissions believe this was an oversight. In 

any case, CEA section 1a(11)(B), 7 U.S.C. 1a(11)(B), 

grants the CFTC the authority to further define the 

term CPO, which the CFTC has done in CFTC 

Regulation § 5.1(d)(1). Therefore, a person operating 

a commodity pool engaging in transactions 

described in CEA section 2(c)(2)(B)(i) is a CPO. 

608See CEA sections 2(c)(2)(B)(iv)(II) and 

2(c)(2)(C)(iii)(II). While CEA sections 

2(c)(2)(B)(iv)(II) and 2(c)(2)(C)(iii)(II) refer to 

counterparties described in item (aa), (bb), (ee), or 

(ff) of subparagraph (B)(i)(II), the CFTC 

Reauthorization Act of 2008 changed item (ee) to 

item (dd) and removed item (ff). Therefore, the 

Commissions interpret the reference in CEA 

sections 2(c)(2)(B)(iv)(II) and 2(c)(2)(C)(iii)(II) to 

items (aa), (bb), (ee), or (ff) to be references to items 

(aa), (bb) and (dd). Cf. Retail Foreign Exchange 

Transactions; Conforming Changes to Existing 

Regulations in Response to the Dodd-Frank Wall 

Street Reform and Consumer Protection Act, 76 FR 

56103 (Sept. 12, 2011) (providing background on 

related incorrect internal references in 2(c)(2)(B) 

and (C)). 

609See, e.g., CFTC Regulation § 4.13(a)(3) 

(exempting from CPO registration operators of 

commodity pools engaged in a de minimis amount 

of trading in CFTC-jurisdictional contracts). 

610 7 U.S.C. 2(c)(2)(E)(ii)(I). 

611 7 U.S.C. 2(c)(2)(E)(iii)(II). 

612 Individuals also are covered by a different 

prong of the ECP definition. An individual can 

qualify as an ECP under clause (A)(xi) of the ECP 

definition. See CEA section 1a(18)(A)(xi), 7 U.S.C. 

1a(18)(A)(xi). 

613There are two other ways a person can qualify 

as an ECP under clause (A)(v): (i) being an entity 

with total assets exceeding $10 million; or (ii) being 

an entity the obligations of which under an 

agreement, contract, or transaction are guaranteed 

or otherwise supported by a letter of credit or 

keepwell, support, or other agreement by an entity 

with total assets exceeding $10 million or an entity 

described in clause (A)(i), (ii), (iii), (iv) or (vii), or 

paragraph (C), of the ECP definition. See CEA 

section 1a(18)(A)(v)(I) and (II), 7 U.S.C. 

1a(18)(A)(v)(I) and (II), respectively. 

614Proposing Release, 75 FR at 80185. 

counterparty other than an Enumerated 

Counterparty described in CEA section 

2(c)(2)(B)(i)(II)(aa), (bb) or (dd).606

Second, the operator of a Retail Forex 

Pool engaging in retail forex 

transactions with an Enumerated 

Counterparty that is an FCM, specified 

affiliated person of an FCM or RFED 

must register with the CFTC as a 

CPO,607 unless the CPO also is an 

Enumerated Counterparty under 

2(c)(2)(B)(i)(II)(aa), (bb) or (dd) 608 or an 

exemption from CPO registration 

applies.609 Moreover, CEA section 

2(c)(2)(E)(ii)(I),610 which was added by 

section 742(c)(2) of the Dodd-Frank Act, 

prohibits an Enumerated Counterparty 

from entering into retail forex 

transactions described in CEA section 

2(c)(2)(B)(i)(I) with a person that is not 

an ECP ‘‘except pursuant to a rule or 

regulation of [the appropriate Federal 

regulator of such Enumerated 

Counterparty allowing such 

transactions] under such terms and 

conditions as [such regulator] shall 

prescribe.’’ CEA section 

2(c)(2)(E)(iii)(II) 611 requires that such 

rules or regulations treat similarly all 

agreements, contracts, and transactions 

in foreign currency that are functionally 

or economically similar to CEA section 

2(c)(2)(B)(i)(I) agreements, contracts, 

and transactions. 

Separately, subclause (A)(v)(III) of the 

ECP definition, both before and after 

enactment of the Dodd-Frank Act, 

provides that a corporation, partnership, 

proprietorship,612 organization, trust or 

other business entity may qualify as an 

ECP if it has a net worth exceeding $1 

million and ‘‘enters into an agreement, 

contract, or transaction in connection 

with the conduct of the entity’s business 

or to manage the risk associated with an 

asset or liability owned or incurred or 

reasonably likely to be owned or 

incurred by the entity in the conduct of 

the entity’s business.’’ 613

2. Proposed Approach 

The Commissions stated in the 

Proposing Release that ‘‘in some cases 

commodity pools unable to satisfy the 

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

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

qualify as ECPs instead for purposes of 

retail forex’’ and that permitting such 

reliance would frustrate the intent of 

Congress in imposing the look-through 

requirement on Forex Pools in clause 

(A)(iv) of the ECP definition.614

The Commissions proposed to further 

define the term ‘‘eligible contract 

participant’’ to preclude a Forex Pool 

from qualifying as an ECP for purposes 

of retail forex transactions in reliance on 

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

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615See letter from the NFA. The NFA indicated 

that it recently took separate emergency actions 

against two firms that did not qualify under the 

NFA’s requirements for retail forex transactions. In 

one case, the commodity pool fell short of the $5 

million total asset requirement in clause (A)(iv) of 

the ECP definition; in the other case, the firm never 

properly formed a commodity pool. The NFA 

cautioned in its letter, ‘‘these cases illustrate that 

firms will attempt to obtain ECP status to shield 

themselves from the jurisdiction of regulators to the 

detriment of pool participants.’’ 

616 Id. 

617 Id. 

618See, e.g., letters from SIFMA—AMG dated 

September 15, 2011 (‘‘SIFMA AMG IV’’) 

(acknowledging some form of ECP look-through is 

appropriate to prevent evasion where 

circumvention otherwise could occur and stating 

that it is sympathetic to the Commissions’ implicit 

objective of ensuring that a person that would not 

qualify as an ECP not be permitted to accomplish 

indirectly what it is not permitted to do directly), 

Sidley Austin LLP (‘‘Sidley’’) (stating that the 

commenter fully appreciates that Congress added 

the look-through language to the ECP definition to 

prevent unscrupulous forex market participants 

from avoiding the retail forex provisions of the CEA 

and the CFTC’s rules by ‘‘engineering’’ an ECP by 

pooling the capital of a large group of retail 

customers, thus depriving those investors of the 

protections otherwise afforded to them), AIMA I 

(stating that ‘‘we understand Congress has made a 

decision to try to protect retail investors by 

amending the definition of ECP under Section 

1a(1[8]) of the [CEA] to include that, for a 

commodity pool to qualify as an ECP under subsection (A)(iv), the pool’s underlying participants 

must also qualify as ECPs under section 1a(1[8])).’’ 

619See letter from Sidley. Sidley noted that FOF 

managers’ retail forex transactions are largely 

undertaken for hedging purposes and that most FOF 

managers offer investments to non-U.S. persons, a 

significant number of which pay for their 

investments in FOF interests using their own 

currency. Sidley further noted that, because most 

FOFs accept investments only in U.S. dollars, FOF 

managers must convert to U.S. dollars the foreign 

currency received from such investors and invest 

those dollars in underlying funds, and that they 

enter into a hedging transaction to reduce the risk 

of exchange rate changes between an investor’s 

currency and the U.S. dollar. 

620See letters from Willkie Farr & Gallagher LLP 

(‘‘Willkie Farr’’) and the NYCBA Committee. 

621 Id. 

622See letter from Willkie Farr. 

623See letter from Akin Gump Strauss Hauer & 

Feld LLP (‘‘Akin Gump’’). 

624 Id. 

625See letters from AIMA I and Ropes & Gray LLP 

(‘‘Ropes & Gray’’). 

626See letters from Akin Gump, Sidley and 

Skadden, Arps, Slate, Meagher & Flom LLP 

(‘‘Skadden’’). Sidley also indicated that there seems 

to be no compelling reason to treat commodity 

pools worse than other sophisticated market 

participants with respect to retail forex transactions 

with non-Enumerated Counterparties, and no 

reason to treat them worse than a corporation or 

other entity with only $10 million in total assets 

that therefore qualifies as an ECP under clause 

(A)(v) of the ECP definition to trade retail forex 

transactions although it may have no particular 

expertise in such markets. 

627See letter from AIMA I. 

628 Id. 

629The term ‘‘qualified eligible person’’ is defined 

in CFTC Regulation §§ 4.7(a)(2) and (3). 

630See letter from Sidley. 

631 Id. 

such Forex Pool has any participant that 

is not an ECP and, therefore, is not an 

ECP due to the look-through provision 

added to clause (A)(iv). Further, because 

commodity pools can be structured in 

various ways and can have one or more 

feeder funds and/or pools, the 

Commissions proposed to preclude a 

Forex Pool from being an ECP for 

purposes of retail forex transactions if 

there was any non-ECP participant at 

any level of the pool structure (e.g., the 

pool itself, a direct participant that 

invests in the pool, or any indirect 

participant that invests in that pool 

through other pools or vehicles). 

3. Commenters’ Views 

One commenter supported the 

Commissions’ efforts to close the 

potential loophole of Forex Pools that 

are unable to qualify as ECPs due to the 

new look-through provision in clause 

(A)(iv) of the ECP definition instead 

qualifying as ECPs under clause (A)(v) 

of the ECP definition.615 This 

commenter indicated that it shares the 

Commissions’ concern that Forex Pools 

that do not satisfy the amended ECP 

definition due to the look-through 

provision for commodity pools in clause 

(A)(iv) may alternatively rely upon 

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

qualify as an ECP for purposes of retail 

forex transactions.616 This commenter 

further stated that Congressional intent 

in requiring a look-through for Forex 

Pools would be frustrated if fraudulent 

pool operators could avail themselves of 

this alternative.617

However, several commenters 

recognized the importance of the 

concern about a potential loophole 618

but stated that the Commissions should 

revise the proposal to mitigate the 

potential adverse consequences to 

market participants. One commenter, for 

example, commented on the expected 

effects of the proposed rule on funds of 

funds (‘‘FOFs’’).619 According to this 

commenter, FOFs (i) normally face as 

counterparties foreign subsidiaries of 

U.S. banks and foreign banks, and (ii) 

would incur substantial counterparty, 

documentation and operational costs in 

moving their retail forex transactions 

onto DCMs or toward the Enumerated 

Counterparties. 

In a similar vein, two commenters 

advised that a substantial number of 

hedge funds, as well as publicly offered 

commodity pools, would, under the 

Commissions’ proposal, fail to qualify as 

ECPs for purposes of retail forex 

transactions, as most such funds have at 

least one direct or indirect non-ECP 

participant.620 These commenters 

indicated that this would disrupt the 

trading strategies employed by many 

commodity trading advisors (‘‘CTAs’’) 

on behalf of commodity pools.621 One of 

these commenters suggested an antievasion approach combining a lower 

level of pool assets with a requirement 

that the commodity pool not be formed 

for the purpose of evading the 

regulatory requirements applicable to 

retail forex transactions.622

Another commenter argued that 

Congress did not include the lookthrough provision in clause (A)(v) of the 

ECP definition because of its effect on 

bona fide hedgers.623 This commenter 

also advised that the primary entities 

affected are hedge fund and private 

equity fund managers investing in 

securities who use retail forex 

transactions solely to hedge investment 

portfolio currency risks, and/or because 

they accept subscriptions in currencies 

other than U.S. dollars.624

Several commenters disagreed with 

the Commissions’ statement in the 

proposal that extending the lookthrough provision in clause (A)(iv) of 

the ECP definition to clause (A)(v) 

would effectuate Congressional intent. 

Two commenters noted that there is no 

specific Dodd-Frank Act provision 

requiring such a change.625 Two other 

commenters argued that clause (v) of the 

ECP definition provides an independent 

basis for qualification as an ECP, which 

should not be affected by the changes in 

clause (A)(iv) of the ECP definition.626

One commenter indicated that the 

extraterritorial application of the 

proposed rules regarding the ECP 

definition is unclear.627 Among other 

things, this commenter indicated it is 

unnecessary to extend the scope of the 

look-through to protect possible retail 

investors outside of the U.S., especially 

where a CPO has not marketed a pool 

in the U.S. and does not otherwise have 

any U.S. investors.628

Commenters proposed several 

alternative approaches that they 

believed would address the 

Commissions’ concerns. One 

commenter suggested that the 

Commissions create a new category of 

ECPs for Forex Pools comprised entirely 

of qualified eligible persons 

(‘‘QEPs’’) 629 and operated by persons 

subject to regulation under the CEA.630

This commenter also suggested that the 

Commissions create a new category of 

ECPs for Forex Pools that satisfy a 

monetary threshold for total assets or for 

the minimum initial investment of a 

Forex Pool to be sufficiently large that, 

in general, only legitimate pools would 

exceed such thresholds.631 Finally, this 

commenter suggested that the 

Commissions create a category of ECPs 

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632 Id. Sidley cited to the approach in Regulation 

S under the Securities Act (17 CFR 230.901 et seq.), 

Sections 3(c)(1) and (7) of the Investment Company 

Act of 1940 (15 U.S.C. 80a–3(c)(1) and (7)), and 

CFTC Regulation § 4.7(a)(2)(xi). 

633See letter from Willkie Farr. 

634See letter from Sidley. 

635Commodity pool structures can take various 

forms. One common commodity pool structure is a 

‘‘master-feeder’’ fund structure. In such a structure, 

investors purchase interests in ‘‘feeder funds,’’ 

which in turn purchase interests in a ‘‘master 

fund.’’ Typically, the only fund in a commodity 

pool structure that enters into retail forex 

transactions (and other transactions) directly is the 

master fund; the feeder funds (and their investors) 

typically would participate indirectly by receiving 

the profit or loss from such retail forex transactions 

(and other transactions) as distributions based on 

the feeder funds’ interests in the master fund. 

Notwithstanding that the master-feeder structure is 

common, other structures exist. Thus, each fund in 

a commodity pool structure that directly enters into 

retail forex transactions is a transaction-level 

commodity pool. 

636A fund that does not itself engage in retail 

forex transactions but that holds an interest in a 

transaction-level Forex Pool that engages in retail 

forex transactions is itself a commodity pool. Cf. 

U.S. Regulation of the International Securities and 

Derivatives Markets—Greene, Beller, Rosen, 

Silverman, Braverman and Sperber, § 12.13[1], 

n.351 and related text. 

637The Commissions caution, however, that they 

will closely monitor developments in this part of 

the market and will not hesitate to revisit their 

decision to limit the look-through provision 

pursuant to 1.3(m)(5)(ii) should they observe a 

pattern of evasion or misconduct. 

638The proposed rule was based on the CFTC’s 

longstanding, broad view of what constitutes a 

‘‘pool,’’ a view recently codified in the ‘‘commodity 

pool’’ definition by section 721(a)(5) of the DoddFrank Act in CEA section 1a(10), 7 U.S.C. 1a(10), 

and recognized by courts, and thus applied the 

look-through provision at each level of a Forex 

Pool’s investment structure. See CFTC, Commodity 

Pool Operators and Commodity Trading Advisors: 

Amendments to Compliance Obligations, 77 FR 

11252 (Feb. 24, 2012) (‘‘CPO/CTA Compliance 

Release’’) (advising that ‘‘it is the position of the 

[CFTC] that a fund investing in an unaffiliated 

commodity pool it itself a commodity pool’’ and 

‘‘[t]his interpretation is consistent with the statutory 

definition of commodity pool, which draws no 

distinction between direct and indirect investments 

in commodity interests’’); CFTC v. Equity Financial 

Group, 572 F.3d 150, 157–158 (July 13, 2009) 

(concluding, in the context of a commodity pool 

that invested all of its assets with a commodity pool 

operated by a different CPO, that the CFTC’s 

commodity pool regulations ‘‘cover pools that 

invest in other pools’’ and that ‘‘the remedial 

purposes of the statute would be thwarted if the 

operator of a fund could avoid the regulatory 

scheme simply by investing in another pool rather 

than trading’’). The same logic applies to a masterfeeder structure operated by the same CPO: the 

remedial purpose of the look-through proviso in 

clause (A)(iv) of the statutory ECP definition would 

be thwarted if the look-through could be defeated 

simply by funneling pool participants into a master 

fund through a feeder fund. 

The proposed rule also was borne of the CFTC’s 

long history of combating fraudulent practices by 

typically unregistered individuals or entities that 

prey upon often unsophisticated retail customers 

through complex and highly leveraged off-exchange 

transactions in foreign currency. However, the 

operators and managers of commodity pool FOFs, 

master-feeder structures and hedge funds for 

sophisticated investors have not generally been the 

subject of CFTC enforcement actions with respect 

to retail forex transactions. For an in depth 

discussion of the history of the CFTC’s authority 

over retail forex transactions, the abuses giving rise 

to that authority, and related enforcement actions, 

see CFTC, Regulation of Off-Exchange Retail 

Foreign Exchange Transactions and Intermediaries, 

75 FR 3282 (Jan. 20, 2010). Congress acted three 

times in a decade to clarify the CFTC’s authority to 

prosecute the rampant fraud seen in this area—first 

in the Commodity Futures Modernization Act of 

2000, Public Law 106–554, 114 Stat. 2763 (Dec. 21, 

2000) in 2000, then again in the CRA, and finally 

in the Dodd-Frank Act in 2010. 

for non-U.S. persons.632 A second 

commenter suggested that the 

Commissions create a category of ECPs 

for commodity pools that are operated 

by a CPO or advised by a CTA subject 

to regulation by a foreign regulator 

comparable to the CFTC.633

One commenter suggested (i) allowing 

commodity pools and their 

counterparties to rely, for the duration 

of an investment and each time 

commodity pool participants make an 

investment decision, on participant ECP 

representations provided in connection 

with an initial investment, provided 

that each participant covenants to 

update such representations if they 

become inaccurate, and (ii) providing 

specific relief for FOFs because they 

generally invest all or substantially all 

of their assets in underlying portfolio 

funds and use retail forex transactions 

to reduce foreign exchange exposure.634

4. Final Rule 

After considering commenters’ 

concerns, the Commissions are adopting 

final rules that have been revised from 

the proposal. In particular, consistent 

with the statutory text of the DoddFrank Act, CFTC Regulation 

§ 1.3(m)(5)(i) further defines the term 

‘‘eligible contract participant’’ to 

prohibit a Forex Pool that directly enters 

into a retail forex transaction (i.e., a 

transaction-level commodity pool) 635

from qualifying as an ECP under clause 

(A)(iv) or clause (A)(v) of the ECP 

definition, solely for purposes of 

entering into retail forex transactions, if 

the pool has one or more direct 

participants that are not ECPs. In 

response to commenters’ concerns 

described above, CFTC Regulation 

§ 1.3(m)(5)(ii) is revised to provide that, 

in determining whether a commodity 

pool that is a direct participant in a 

transaction-level Forex Pool is an ECP, 

the indirect participants in the 

transaction-level Forex Pool 636 will not 

be considered unless such Forex Pool, a 

commodity pool holding a direct or 

indirect (through one or more 

intermediate tiers of pools) interest in 

such Forex Pool, or any commodity pool 

in which such Forex Pool holds a direct 

or indirect interest has been structured 

to evade Subtitle A of Title VII of the 

Dodd-Frank Act by permitting persons 

that are not ECPs to participate in 

agreements, contracts, or transactions 

described in section 2(c)(2)(B)(i) or 

section 2(c)(2)(C)(i) of the Commodity 

Exchange Act. That is, absent evasion, 

the Commissions are changing the 

proposed ‘‘indefinite look-through’’ to 

an ‘‘evasion-based look-through’’ in the 

final rule.637

In adding the look-through provision 

to the commodity pool prong of the ECP 

definition, Congress made a decision to 

protect retail foreign exchange investors 

by requiring that the participants in a 

Forex Pool qualify as ECPs for the Forex 

Pool itself to qualify as an ECP. The 

Commissions believe that the intent of 

the look-through provision—protecting 

Forex Pool participants from fraudulent 

and abusive conduct—must be given 

effect to comply with this Congressional 

mandate. Nevertheless, the 

Commissions acknowledge commenters’ 

concerns about potential unintended 

consequences of applying an indefinite 

look-through to every direct and 

indirect participant of a Forex Pool, as 

proposed. Accordingly, to avoid 

unintended consequences and related 

costs for Forex Pools whose operators 

and managers have not historically 

presented the risks that the look-through 

provision was intended to address,638

the Commissions are replacing the 

proposed indefinite look-through of 

every participant in a Forex Pool with 

a limited, evasion-based look-through 

pursuant to which a transaction-level 

Forex Pool will qualify as an ECP, for 

purposes of retail forex transactions, if 

all of such Forex Pool’s direct 

participants are ECPs, and will look 

through a commodity pool participant 

in such Forex Pool only if it, at any 

level, has been structured to evade the 

look-through provision in clause (A)(iv) 

of the ECP definition. 

The Commissions believe the final 

rule strikes the right balance between 

implementing strong protections for 

non-ECP commodity pool participants 

and not imposing undue burdens or 

costs on CPOs, CTAs and commodity 

pool participants related to retail forex 

transactions. In addition, the 

Commissions believe that replacing the 

indefinite look-through with the 

limited, evasion-based look-through 

alleviates many of the commenters’ 

concerns. Accordingly, the 

Commissions believe it is appropriate to 

limit the look-through provision to the 

level of a commodity pool structure that 

enters into retail forex transactions and 

to look through commodity pools to 

their ultimate participants only in those 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30651 

639 In section 712(d)(2)(A) of the Dodd-Frank Act, 

Congress granted the Commissions the authority to 

adopt such rules regarding the ECP definition as the 

Commissions determine are necessary and 

appropriate, in the public interest, and for the 

protection of investors. 

640The Commissions note that several 

commenters requested clarification regarding the 

relationship between the look-through provision set 

forth in CFTC Regulation § 1.3(m)(5) and the 

prohibition on a commodity pool qualifying as an 

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

does not qualify as an ECP under clause (A)(iv) of 

the ECP definition set forth in CFTC Regulation 

§ 1.3(m)(6). See, e.g., meeting with SIFMA—AMG 

on August 2, 2011. The look-through provision is 

limited to determining ECP status under clause 

(A)(iv) or clause (A)(v) of the ECP definition for 

purposes of retail forex transactions entered into by 

Forex Pools. The look-through provision does not 

reference or implicate ECP status for purposes of 

CEA section 2(e) (which prohibits non-ECPs from 

entering into swaps other than on or subject to the 

rules of a DCM), Securities Act section 5(d) (which 

prohibits a person from offering to sell, offering to 

buy or purchase, or selling a security-based swap 

to a person that is a non-ECP unless a registration 

statement under the Securities Act is in effect with 

respect to that security-based swap), or Exchange 

Act section 6(l) (which prohibits a person from 

effecting a transaction in a security-based swap 

with or for a person that is a non-ECP unless the 

transaction is effected on a national securities 

exchange registered with the SEC). The prohibition 

in CFTC Regulation § 1.3(m)(6) on a commodity 

pool qualifying as an ECP under clause (A)(v) of the 

ECP definition if it does not qualify as an ECP 

under clause (A)(iv) of the ECP definition does not 

involve any look-through. Rather, in contrast with 

CFTC Regulation § 1.3(m)(5), CFTC Regulation 

§ 1.3(m)(6) applies for purposes of all agreements, 

contracts and transactions for which ECP status is 

relevant. See part III.C, infra, for a discussion of the 

prohibition on a commodity pool qualifying as an 

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

does not qualify as an ECP under clause (A)(iv) of 

the ECP definition. 

641See also part III.G, infra, discussing CFTC 

Regulation § 1.3(m)(8), one effect of which is to 

eliminate the retail forex transaction counterparty 

restriction for Forex Pools qualifying as ECPs. 

642See generally Part 5 of the CFTC’s regulations, 

17 CFR 5, and CFTC, Regulation of Off-Exchange 

Retail Foreign Exchange Transactions and 

Intermediaries, 75 FR 55410 (Sept. 10, 2010). See 

also CFTC, Retail Foreign Exchange Transactions; 

Conforming Changes to Existing Regulations in 

Response to the Dodd-Frank Wall Street Reform and 

Consumer Protection Act 76 FR 56103 (Sept. 12, 

2011). 

643See FDIC, Retail Foreign Exchange 

Transactions, 76 FR 40779 (July 12, 2011) (final 

FDIC retail forex rules); OCC, Retail Foreign 

Exchange Transactions, 76 FR 41375 (July 14, 2011) 

(final OCC retail forex rules); see also OCC, Retail 

Foreign Exchange Transactions, 76 FR 56094 (Sept. 

12, 2011) (interim final OCC retail forex rules for 

federal savings associations and their operating 

subsidiaries). 

644See SEC, Retail Foreign Exchange 

Transactions, 76 FR 41676 (July 15, 2011). In the 

release accompanying the rules, the SEC requested 

comment on broker-dealers’ involvement in retail 

forex transactions to inform the SEC in developing 

permanent rules to regulate these activities. See id. 

at 46181–83. 

645See Board, Retail Foreign Exchange 

Transactions (Regulation NN), 76 FR 46652 (Aug. 3, 

2011) (proposed Board rules for retail forex 

transactions). 

646See part III.B.1, supra, discussing the 

applicability of the counterparty limitation. 

647Of course, upon the Board’s finalization of its 

retail forex rules, U.S. financial institutions 

regulated by the Board also will be acceptable 

counterparties. 

648Feeder funds are usually added to commodity 

pool structures for purposes such as tax efficiency. 

A master-feeder structure ‘‘[permits] U.S. taxable 

investors to take advantage of investing in a U.S. 

limited partnership feeder fund, which[,] through 

certain elections made at the time the structure is 

established, is tax effective for such U.S. taxable 

investors’’ and ‘‘[permits] [n]on-U.S. and U.S. taxexempt investors [to] subscribe via a separate 

offshore feeder company so as to avoid coming 

directly within the U.S. tax regulatory net 

applicable to U.S. taxable investors.’’ Effie 

Vasilopoulos & Katherine Abrat, The Benefits of 

Master-Feeder Fund Structures for Asian-based 

Hedge Fund Managers, Hedge Fund Monthly (April 

2004), available at http://www.eurekahedge.com/ 

news/04apr_archive_Sidley_master_feeder.asp. 

Other benefits can include efficiencies gained by 

the use of only a single trading entity, avoiding the 

need to split trade tickets, eliminating the need to 

duplicate agreements with counterparties and 

greater economies of scale in administering the 

fund. Id. 

649Sidley notes that the typical FOF operates in 

this manner. See generally letter from Sidley for a 

more detailed discussion of these transactions. 

650 In this context, bona fide hedging purposes 

means bona fide hedging purposes within the 

meaning and intent of CFTC Regulation § 1.3(z)(1), 

except that the requirement therein that the 

transaction or position be on a DCM or SEF that is 

a trading facility will not be a factor in the bona 

fide hedging purpose analysis. Compare CFTC 

Regulation § 4.5(c)(2)(iii)(A) (relying in part on the 

bona fide hedging concepts in CFTC Regulations 

§§ 1.3(z)(1) and 151.5 to provide relief from the CPO 

definition). See also CPO/CTA Compliance Release 

Continued 

cases in which it is required to prevent 

evasion of the protections for those 

persons whom Congress intended to be 

subject to retail forex transactions 

restrictions. 

At the same time, the Commissions do 

not believe that Forex Pools failing to 

qualify as ECPs due to the look-through 

provision in clause (A)(iv) of the ECP 

definition should, nonetheless, be 

permitted unfettered access to ECP 

status under clause (A)(v).639 The lookthrough provision for Forex Pools 

provides heightened investor protection 

from forex fraud for Forex Pool 

participants that are not themselves 

ECPs. Thus, the Commissions believe 

that permitting Forex Pools with one or 

more non-ECP participants to achieve 

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

the ECP definition, which applies to 

business entities generally, would serve 

to undermine the look-through 

provision that Congress specifically 

imposed on Forex Pools under clause 

(A)(iv).640

Moreover, developments subsequent 

to the issuance of the Proposing Release 

should ameliorate commenters’ 

concerns that CEA section 

2(c)(2)(E)(ii)(I) significantly limits the 

universe of possible retail forex 

transaction counterparties.641 At the 

time the Commissions issued the 

Proposing Release and throughout the 

comment period, the CFTC was the only 

Federal regulatory agency that had 

issued final rules governing retail forex 

transactions by its regulated persons 

and entities.642 Since then, though, both 

the OCC and the FDIC finalized 

(effective July 15, 2011) rules governing 

retail forex transactions by Enumerated 

Counterparties regulated by those 

agencies.643 In addition, the SEC has 

issued interim temporary final rules 

(also effective July 15, 2011) governing 

retail forex transactions by registered 

broker-dealers.644 Also, the Federal 

Reserve Board proposed rules to govern 

retail forex transactions by its regulated 

banks on August 3, 2011.645 As a result 

of these regulatory actions, Forex Pools 

that are not ECPs due to the lookthrough provision and who are subject 

to a counterparty limitation 646 may 

enter into retail forex transactions with 

any Enumerated Counterparty but for 

those regulated by the Federal Reserve 

Board.647

The Commissions believe that the 

final rules reasonably address 

commenters’ concerns. In this regard, 

the Commissions note that in applying 

the look-through provision, the 

Commissions will consider the indirect 

participants in a transaction-level Forex 

Pool if such Forex Pool, a commodity 

pool holding a direct or indirect 

(through one or more intermediate tiers 

of pools) interest in such Forex Pool, or 

any commodity pool in which such 

Forex Pool holds a direct or indirect 

interest has been structured to evade 

Subtitle A of Title VII of the Dodd-Frank 

Act by permitting persons that are not 

ECPs to participate in agreements, 

contracts, or transactions described in 

section 2(c)(2)(B)(i) or section 

2(c)(2)(C)(i) of the Commodity Exchange 

Act. One example of a scheme to evade 

would be if a commodity pool tier has 

been included in the structure of the 

Forex Pool primarily to provide nonECP participants exposure to retail forex 

transactions rather than to achieve any 

other legitimate business purpose.648

One example of a ‘‘legitimate business 

purpose’’ that would not trigger the 

look-through provision is a FOF 

operated primarily for the purpose of 

investing in underlying funds and using 

retail forex transactions solely to hedge 

the currency risk posed by an 

unfavorable change in the exchange rate 

between the currency in which 

underlying funds accept investments 

and the currency in which FOF 

investors pay for their investments in 

the FOF.649 Similarly, the Commissions 

would not consider a commodity pool 

using retail forex transactions solely for 

bona fide hedging purposes 650 with 

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30652 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

at 11256–11257 (discussing and declining to adopt 

commenters’ request to expand the definition of 

bona fide hedging to include risk management). 

Where a Forex Pool’s counterparty, but not the 

Forex Pool, is hedging its risks, it is not the case 

that the Forex Pool is entering the retail forex 

transaction solely to hedge its own risk. 

651The examples mentioned in text should not be 

construed to mean that any other fact pattern does 

or does not constitute evasion, which must be 

determined on a case-by-case basis. 

652Based on the same reasoning, the 

Commissions do not believe it was the intent of the 

look-through proviso in CEA section 1a(18)(A)(iv) 

to subject to a retail forex regime a single level 

commodity pool engaging in retail forex 

transactions solely for bona fide hedging purposes 

with respect to foreign exchange exposure arising 

in the course of a commodity pool’s operations. 

Consequently, the Commissions will interpret such 

a commodity pool as an ECP if it otherwise satisfies 

the terms of CEA section 1a(18)(A)(iv) even if such 

a pool has one or more non-ECP participants. 

653See letter from Sidley. 

654See CFTC, Business Conduct Standards for 

Swap Dealers and Major Swap Participants With 

Counterparties; Final Rule, 77 FR 9733 (Feb. 17, 

2012). 655Cf. CFTC Regulation §§ 23.430(d), 23.402(d). 

respect to currency risk as being 

structured to avoid the look-through 

provision.651 The ‘‘participate in 

agreements, contracts, or transactions 

described in section 2(c)(2)(B)(i) or 

section 2(c)(2)(C)(i) of the Act’’ language 

of CFTC Regulation § 1.3(m)(5)(ii) is 

aimed at exposure to retail forex 

transactions as an asset class, 

investment strategy, or an end in itself, 

not at exposure to retail forex 

transactions solely designed for bona 

fide hedging purposes with respect to 

foreign exchange exposure arising in the 

course of a commodity pool’s 

business.652

In applying the limited look-through 

provision in the final rule, the 

Commissions would consider a Forex 

Pool’s direct participants to include not 

only persons that initially hold interests 

in the level of the commodity pool 

structure that enters into retail forex 

transactions, but also persons that can 

acquire those interests or that 

subsequently hold those interests. As 

applied to exchange-traded products 

(‘‘ETPs’’) that are Forex Pools, any 

person that acquires an interest in the 

ETP Forex Pool in secondary market 

transactions would be a direct 

participant. ETPs typically issue shares 

only in the large aggregations or blocks 

(such as 50,000 ETP shares) called 

‘‘Creation Units.’’ An authorized 

purchaser, usually an investment bank, 

broker dealer or large institutional 

investor, may purchase a Creation Unit. 

After purchasing a Creation Unit, the 

authorized purchaser may hold the 

Creation Unit, or sell some or all of the 

ETP shares in the Creation Unit to 

investors in secondary market 

transactions by splitting up the Creation 

Unit and selling the individual ETP 

shares on a national securities exchange 

or in off-exchange transactions. The 

ability to break up the Creation Unit 

into ETP shares permits other investors, 

such as non-ECPs, to purchase the 

individual ETP shares in secondary 

market transactions. 

All participants in an ETP Forex Pool 

must be ECPs when they purchase or 

otherwise acquire an interest in the ETP 

Forex Pool. In addition, an ETP Forex 

Pool will not be able to verify whether 

the persons that acquire interests in the 

ETP Forex Pool in exchange 

transactions are ECPs. The ability of 

non-ECPs to acquire interests in an ETP 

Forex Pool and the inability of the ETP 

Forex Pool to verify ECP status with 

respect to exchange transactions create 

a presumption that ETP Forex Pools are 

not ECPs and, therefore, are Retail Forex 

Pools. This presumption would not 

apply in the case of a Forex Pool that 

is structured in a manner that does not 

involve exchange trading and in which 

the Forex Pool would be able to verify 

the ECP status of its participants. 

One commenter suggested that the 

Commissions allow commodity pools 

and their counterparties to rely on 

participant ECP representations 

provided in connection with an initial 

investment.653 The Commissions note 

that the obligation to determine that the 

parties to retail forex transactions are 

ECPs is imposed on the CPOs of Forex 

Pools and the counterparties looking to 

enter into retail forex transactions with 

Forex Pools. In making that 

determination, the Commissions expect 

CPOs and retail forex transaction 

counterparties to Forex Pools to be 

guided by the principles for verifying 

the ECP status of a swap dealer’s or 

major swap participant’s counterparty 

discussed in the CFTC’s recently 

adopted external business conduct 

standards, including the safe harbor.654

Thus, solely for purposes of CEA section 

1a(18)(A)(iv) and CFTC Regulation 

§ 1.3(m)(5), the Commissions will 

permit CPOs and retail forex transaction 

counterparties to rely on written 

representations from, as applicable, pool 

participants or potential pool 

participants that the person making the 

representation is an ECP (or is a nonU.S. person; as discussed below in this 

section III.B.4., solely for purposes of 

CEA section 1a(18)(A)(iv) and CFTC 

Regulation § 1.3(m)(5), the Commissions 

will consider Forex Pools whose 

participants are limited solely to nonU.S. persons (and which are operated by 

CPOs located outside of the U.S., its 

territories or possessions) to be ECPs), or 

from Forex Pools that the Forex Pool is 

an ECP, provided that the CPO or retail 

forex transaction counterparty has a 

reasonable basis to so rely, just as swap 

dealers and major swap participants are 

permitted to do pursuant to the safe 

harbor in new CFTC Regulation 

§ 23.430(d), 17 CFR 23.430(d). Solely for 

purposes of CEA section 1a(18)(A)(iv) 

and CFTC Regulation § 1.3(m)(5), a CPO 

or retail forex transaction counterparty 

will have a reasonable basis to rely on 

such written representations if the 

person making the representation 

specifies therein the provision(s) of, as 

applicable, section 1a(18) of the CEA or 

CFTC Regulation § 4.7(a)(1)(iv) pursuant 

to which the person qualifies as an ECP 

or a non-U.S. person, respectively, 

unless it has information that would 

cause a reasonable person to question 

the accuracy of the representation.655

Solely for purposes of CEA section 

1a(18)(A)(iv) and CFTC Regulation 

§ 1.3(m)(5), persons representing that 

they qualify as non-U.S. persons based 

on CFTC Regulation § 4.7(a)(1)(iv)(D) 

must represent that they are relying on 

such provision as modified as discussed 

below (i.e., without the 10% carve-out 

for U.S. persons). 

Furthermore, the CFTC recognizes 

that, despite a counterparty’s reasonable 

good faith efforts to ensure that Forex 

Pools do not in fact have any U.S. 

participants, a situation may arise where 

a Forex Pool does turn out to have U.S. 

participants. If a counterparty has 

reasonable policies and procedures in 

place to verify the ECP status of Forex 

Pool counterparties and, 

notwithstanding such reasonable good 

faith efforts and following such policies 

and procedures, enters into retail forex 

transactions with such a Forex Pool in 

good faith and it was subsequently 

determined that U.S. participants 

represented no more than a de minimis 

number of participants or amount of 

ownership of the Forex Pool, absent 

other material factors, the CFTC would 

not expect to bring an enforcement 

action against the counterparty for 

entering into a retail forex transaction in 

contravention of the requirements of the 

retail forex regime. For purposes of this 

analysis only, and without this being 

viewed as a de minimis threshold for 

purposes of this rule or otherwise, the 

CFTC would consider as de minimis, 

ownership of units of participation of a 

Forex Pool held by U.S. participants of 

less than 10% of the beneficial interest 

in the Forex Pool. The fact that, absent 

other material factors, the CFTC would 

not expect to bring an enforcement 

action against a forex transaction 

counterparty in such case does not 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30653 

656See letter from Sidley. The Commissions note 

that the obligation to determine that the parties to 

retail forex transactions are ECPs is imposed on the 

CPOs of Forex Pools and the persons looking to 

engage in retail forex transactions with Forex Pools. 657See, e.g., letter from SIFMA AMG IV. 658The adoption of CFTC Regulation § 1.3(m)(8), 

discussed in part III.G, infra, also should reduce the 

number of pools subject to regulation of their retail 

forex transactions, and the associated costs, 

accordingly. 

659See, e.g., letter from Sandalwood Securities, 

Inc. (expressing concern that ‘‘the Proposed Rule 

extends Dodd-Frank’s limited look-through 

provision to all sub-sections of section la(12)’’). 

660Thus, for example, investment companies 

qualifying under clause (A)(iii) of the ECP 

definition and employee benefit plans qualifying 

under clause (A)(vi) of the ECP definition (and, as 

stated in each clause, ‘‘a foreign person performing 

a similar role or function subject as such to foreign 

regulation’’) would not be covered by the lookthrough provision. To the extent that other entities 

would otherwise be captured by the look-through 

as proposed (such as collective investment trusts 

whose investors are ERISA plans not excluded from 

the commodity pool definition by CFTC Regulation 

§ 4.5(a)(4) and which qualify as ECPs under clause 

(A)(v) of the ECP definition), the Commissions 

believe that focusing on the level of the Forex Pool 

entering into the retail forex transactions, and such 

Forex Pool’s direct participants (absent evasion), 

should alleviate such concerns. 

661Cf. letters from Sidley and Millburn Ridgefield 

Corporation (‘‘Millburn’’). 

662See section 742(c) of the Dodd-Frank Act, 

amending CEA section 2(c)(2)(B)(i)(II)(aa), 7 U.S.C. 

2(c)(2)(B)(i)(II)(aa). 

663See letter from Sidley. This commenter also 

suggested deeming non-U.S. persons to be ECPs by 

definition. The Commissions have addressed this 

comment below in this section in response to the 

comment regarding the extraterritorial impact of the 

proposed ECP rules. 

664See letter from AIMA I. 

665 7 U.S.C. 1a(18)(A)(iv). 

666See F. Hoffman-LaRoche, Ltd. v. Empagran 

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

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

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

construed to violate the law of nations if any other 

possible construction remains’’); Hartford Fire 

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

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

Foreign Relations Law § 403 (scope of a statutory 

grant of authority must be construed in the context 

of international law and comity including, as 

appropriate, the extent to which regulation is 

consistent with the traditions of the international 

system). 

667See also CFTC, Exemption From Registration 

for Certain Foreign Persons, 72 FR 63976 (Nov. 14, 

2007) (where the CFTC stated that: 

Given this agency’s limited resources, it is 

appropriate at this time to focus [the Commission’s] 

customer protection activities upon domestic firms 

and upon firms soliciting or accepting orders from 

domestic users of the futures markets and that the 

protection of foreign customers of firms confining 

their activities to areas outside this country, its 

territories, and possessions may best be for local 

authorities in such areas) 

Continued 

relieve any obligation on the part of the 

CPO of the Forex Pool either to register 

as a CPO, claim the 4.13(a)(3) exemption 

therefrom or redeem the U.S. 

participants as described above. 

One commenter suggested that the 

Commissions allow commodity pools 

and their counterparties to rely on 

participant ECP representations 

provided in connection with an initial 

investment.656 The Commissions 

believe that if participants make ECP 

representations in connection with an 

initial investment in a Forex Pool, 

absent an additional investment (which 

would require a new ECP verification, 

other than in the case of automatically 

reinvested distributions), the 

subsequent loss of a participant’s ECP 

status would not cause the Forex Pool 

to lose its own ECP status for purposes 

of retail forex transactions so long as the 

operating agreement of the Forex Pool or 

the subscription or other agreement 

pursuant to which the participant 

invested in the Forex Pool requires the 

participant to advise the CPO of the 

Forex Pool promptly of a loss of the 

participant’s ECP status. In the event of 

the loss of ECP status of a participant, 

the CPO would be required to redeem 

the non-ECP from the Forex Pool at the 

first opportunity following notification 

to avoid the Forex Pool losing its ECP 

status for subsequent retail forex 

transactions. 

The Commissions are mindful that 

several commenters indicated that CPOs 

do not customarily include a question or 

representation as to ECP status in 

subscription agreements for pool 

participants, and stated that requiring 

CPOs to qualify or redeem existing 

participants due to the new lookthrough provision would be expensive, 

burdensome and disruptive.657 In this 

regard, the Commissions note that the 

look-through requirement for 

commodity pools was imposed by 

statute. As a result of the Commissions 

adopting the limited look-through in the 

final rule (as compared to the proposed 

indefinite look-through), however, the 

number of commodity pools subject to 

the look-through provision should be 

dramatically reduced, reducing the 

number of pools subject to regulation of 

their retail forex transactions, and the 

associated costs, accordingly.658

Also, in response to commenter 

concerns that the look-through 

provision would be applied to entities 

other than commodity pools (e.g., 

operating companies),659 the 

Commissions revised the text of CFTC 

Regulation § 1.3(m)(5)(i) to reflect their 

intent to apply the look-through 

provision solely to commodity pools 

qualifying as ECPs, if at all, under 

clause (A)(iv) and clause (A)(v) of the 

ECP definition.660 This is consistent 

with the statutory text, which is limited 

to looking through commodity pools 

under clause (A)(iv) of the ECP 

definition, and the intent behind the 

look-through provision, as it relates to 

clause (A)(v) thereof. 

Commenters also stated that Retail 

Forex Pools will no longer be able to 

enter into retail forex transactions with 

foreign financial institutions.661 As 

discussed in section III.B.1. above, 

however, this is not the case with 

respect to retail forex transactions 

described in CEA section 

2(c)(2)(C)(i)(I)(bb). With respect to retail 

forex transactions described in CEA 

section 2(c)(2)(B)i)(I), this is a 

consequence of the express statutory 

text of the Dodd-Frank Act, which 

removed non-U.S. financial institutions 

from the list of Enumerated 

Counterparties eligible to enter into 

retail forex transactions with nonECPs.662

Commenters further suggested 

generally that the Commissions create 

additional categories of ECPs to address 

the Commissions’ concerns regarding 

the potential loophole of Retail Forex 

Pools that are unable to qualify as ECPs 

due to the new look-through provision 

in clause (A)(iv) of the ECP definition 

qualifying as an ECP under clause (A)(v) 

of the ECP definition. While one 

commenter proposed adopting a new 

rule clarifying that Forex Pools 

comprised entirely of QEPs and 

operated by persons subject to 

regulation under the CEA are ECPs,663

Congress chose to look to ECP status of 

Forex Pool participants, not QEP status, 

as the basis for determining whether 

such Forex Pools are ECPs. Therefore, it 

is more appropriate to rely on Retail 

Forex Pool participants’ ECP status than 

to rely on QEP status to establish ECP 

status. 

One commenter stated a concern 

regarding what it characterized as the 

lack of clarity surrounding the 

extraterritoriality impact of the 

proposed ECP rules.664 The 

Commissions recognize the potential 

consequences of the broad look-through 

language in CEA section 

1a(18)(A)(iv) 665 and are providing 

guidance as to the application of the 

look-through to Forex Pools whose 

participants are limited solely to nonU.S. persons and which are operated by 

CPOs located outside the United States, 

its territories or possessions. 

As discussed below, while foreign 

entities are not necessarily immune 

from U.S. jurisdiction for commercial 

activities undertaken with U.S. 

counterparties or in U.S. markets, 

canons of statutory construction 

‘‘assume that legislators take account of 

the legitimate sovereign interests of 

other nations when they write American 

laws,’’ 666 particularly when limited 

U.S. interests are at stake.667

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30654 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

(citing CFTC, Introducing Brokers and Associated 

Persons of Introducing Brokers, Commodity Trading 

Advisors and Commodity Pool Operators; 

registration and Other Regulatory Requirements, 48 

FR 35248, 35261 (Aug. 3, 1983)). 

668CFTC Regulation § 4.7(a)(i)(iv)(D) lists the 

following as one category of non-United States 

person: 

An entity organized principally for passive 

investment such as a pool, investment company or 

other similar entity; Provided, That units of 

participation in the entity held by persons who do 

not qualify as Non-United States persons or 

otherwise as qualified eligible persons represent in 

the aggregate less than 10% of the beneficial 

interest in the entity, and that such entity was not 

formed principally for the purpose of facilitating 

investment by persons who do not qualify as NonUnited States persons in a pool with respect to 

which the operator is exempt from certain 

requirements of part 4 of the Commission’s 

regulations by virtue of its participants being NonUnited States persons. 

It would be inappropriate to disregard the 

presence of U.S. persons constituting as much as 

10% of such entities’ participants in the context of 

this interpretive guidance. As discussed elsewhere 

herein, however, entities described in CEA section 

1a(18)(A)(iii) or (vi), 7 U.S.C. 1a(18)(A)(iii) or (vi), 

are not subject to the look-through and are ECPs 

irrespective of the ECP status of their participants. 

669Cf. CPO/CTA Compliance Release at 11264 

(stating that ‘‘it is prudent to withhold 

consideration of a foreign advisor exemption until 

the [CFTC] has received data regarding such firms 

on Forms CPO–PQR and/or CTA–PR * * * to 

enable the [CFTC] to better assess [which] firms 

* * * may be appropriate to include within the 

exemption, should the [CFTC] decide to adopt 

one’’). 

670Proposing Release, 75 FR at 80185. 

671 Id. 

672See letters from Sidley and Skadden. 

673See letter from Akin Gump. Akin Gump noted 

that ‘‘[a]s opposed to [clause] (A)(iv), [clause] (A)(v) 

includes as one means of satisfying its criteria that 

the entity be entering into a contract for hedging 

purposes.’’ While correct, clause (A)(v) also 

includes as another means of satisfying its criteria 

that an entity enter into agreements, contracts or 

transactions in connection with the conduct of the 

entity’s business, which would be a much lower 

standard. 

674 7 U.S.C. 1a(18)(A)(iv)(II). 

675See letter from SIFMA AMG IV. CEA Section 

1a(18)(A)(iv)(II) refers to a commodity pool that ‘‘is 

formed and operated by a person subject to 

regulation under this Act or a foreign person 

performing a similar role or function subject as such 

to foreign regulation (regardless of whether each 

investor in the commodity pool or the foreign 

person is itself an eligible contract participant) 

provided, however, that for purposes of section 

2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term 

‘eligible contract participant’ shall not include a 

commodity pool in which any participant is not 

otherwise an eligible contract participant.’’ 676The Commissions have made certain technical 

corrections to proposed CFTC Regulation 

§ 1.3(m)(6)(i) as concerns its citations to the CEA. 

677 Interpreting statutory language as surplusage 

is disfavored. Effect should be given to every clause 

and word of a statute. See Negonsott v. Samuels, 

507 U.S. 99 (1993). 

The Commissions do not believe that 

Congress intended for Forex Pools with 

no U.S. participants and operated by 

CPOs located outside the United States, 

its territories or possessions to be 

subject to a U.S. retail forex regime and, 

therefore, will consider Forex Pools 

whose participants are limited solely to 

non-U.S. persons and which are 

operated by CPOs located outside the 

United States, its territories or 

possessions to be ECPs for purposes of 

CFTC Regulation § 1.3(m)(5). For this 

purpose, a Forex Pool participant is a 

non-U.S. person if it satisfies the 

definition of ‘‘Non-United States 

person’’ in CFTC Regulation 

4.7(a)(1)(iv); provided, however, that, if 

a participant is an entity organized 

principally for passive investment, such 

as a pool, investment company or other 

similar entity, such entity will be 

considered to be a Non-United States 

person under paragraph (D) of CFTC 

Regulation 4.7(a)(1)(iv) for purposes of 

CFTC Regulation § 1.3(m)(5) solely if all 

units of participation in such passive 

investment vehicle participant are held 

by Non-United States persons.668 A 

broader interpretation or relief is not 

appropriate at this time.669

C. ECP Status for Commodity Pools 

Under Clause (A)(v) vs. Under Clause 

(A)(iv) of the ECP Definition 

1. Proposed Approach 

The Commissions stated in the 

Proposing Release that they believe 

‘‘some commodity pools unable to 

satisfy the total asset or regulated status 

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

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

qualify as ECPs instead.’’ 670 The 

Commissions further stated in the 

Proposing Release that ‘‘a commodity 

pool that cannot satisfy the monetary 

and regulatory status conditions 

prescribed in clause (A)(iv) should not 

qualify as an ECP in reliance on clause 

(A)(v) of the ECP definition.’’ 671 Based 

on those views, the Commissions 

proposed to further define the term 

‘‘eligible contract participant’’ to 

prevent such a commodity pool from 

qualifying as an ECP pursuant to clause 

(A)(v) of the ECP definition. This 

proposal applied to all commodity 

pools, not just Forex Pools engaged in 

retail forex transactions. 

2. Commenters’ Views 

Two commenters argued that, had 

Congress wished to prevent commodity 

pools from relying on the general ECP 

provision for business entities in clause 

(A)(v), it could have expressly excluded 

commodity pools from clause (A)(v).672

Another commenter attempted to 

illustrate that clause (A)(v) of the ECP 

definition is an independent basis for 

qualifying as an ECP by distinguishing 

clause (A)(v) from clause (A)(iv).673

One commenter expressed the view 

that it is unclear whether ‘‘subject to 

regulation under this Act’’ in CEA 

section 1a(18)(A)(iv)(II) 674 means a 

registered CPO or something else (e.g., 

a person excluded from the definition of 

a CPO, a CPO exempt from registration 

conditioned in part upon making a 

filing to claim such relief).675

3. Final Rule 

The Commissions are adopting CFTC 

Regulation § 1.3(m)(6) as proposed, 

which states that ‘‘[a] commodity pool 

that does not have total assets exceeding 

$5,000,000 or that is not operated by a 

person described in subclause (A)(iv)(II) 

of section 1a(18) of the Act is not an 

eligible contract participant pursuant to 

clause (A)(v) of such Section.’’ 676 As 

noted, the Commissions are concerned 

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

may undermine the protections that 

specifically apply to commodity pool 

participants pursuant to the limitations 

on ECP status for commodity pools set 

forth in clause (A)(iv) of the ECP 

definition. Allowing a commodity pool 

that cannot satisfy the monetary and 

regulatory status conditions prescribed 

for commodity pools in clause (A)(iv) to 

qualify as an ECP under clause (A)(v) 

would undermine these protections. 

The Commissions acknowledge the 

comments stating that clause (A)(v) of 

the ECP definition is an independent 

basis for qualifying as an ECP and that 

Congress did not explicitly provide that 

a commodity pool that fails to qualify as 

an ECP under clause (A)(iv) cannot do 

so under clause (A)(v). However, when 

specifically legislating for commodity 

pools, Congress determined that total 

assets of $5 million and operation by a 

person subject to regulation under the 

CEA (or a foreign equivalent) are 

necessary to assure appropriate 

protection for non-ECP participants in a 

commodity pool. Furthermore, the 

commenters’ view that Congress’s use of 

the disjunctive term ‘‘or’’ between 

clauses (A)(x) and (A)(xi) of the ECP 

definition means that an entity can rely 

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

notwithstanding that such entity cannot 

satisfy a prong more specific to it, 

would largely render superfluous each 

clause under subparagraph (A) of the 

ECP definition other than clause (v) and 

clause (xi) (for individuals).677 As such, 

the Commissions believe that the final 

rule adopted in this release is consistent 

with Congressional intent. 

The Commissions also are mindful 

that one commenter expressed a 

concern that the Commissions’ reliance 

on clause (A)(iv) of the ECP definition 

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678See letter from SIFMA AMG IV. 

679For these purposes, the Commissions would 

take the same approach to insignificant deviations 

from exemptive filings as the CFTC does in CFTC 

Regulation § 4.7(e). 

680 If the Commissions interpreted the ‘‘subject to 

regulation under this Act’’ language in CEA section 

1a(18)(A)(iv)(II) to mean that the commodity pool 

operator must be registered as a CPO and limited 

CPOs to claiming ECP status solely under clause 

(iv) of the ECP definition, then the operators of all 

commodity pools trading swaps would have to 

register as CPOs to be ECPs. While more CPOs will 

be registering with the CFTC because the CFTC has 

withdrawn CFTC Regulation § 4.13(a)(4), see 

CPO/CTA Compliance Release, and the Dodd-Frank 

Act has expanded the scope of the transactions 

within the CFTC’s jurisdiction, thus reducing the 

number of CPOs who can rely on the 5 percent 

threshold in CFTC Regulation § 4.13(a)(3) and thus 

claim the CPO registration exemption, the CFTC did 

not withdraw 4.13(a)(3), so some CPOs will be able 

to continue to rely on it. Also, not all persons 

operating commodity pools will be CPOs. See CFTC 

Regulation § 4.5 (exclusion from the definition of 

the term ‘‘commodity pool operator’’). The 

Commissions do not believe Congress intended 

commodity pool ECP status to require CPO 

registration by the commodity pools’ operators in 

all cases. 

681 If the mere act of forming or operating a 

commodity pool means that a person is ‘‘subject to 

regulation’’ under the CEA, then the ‘‘subject to 

regulation’’ language would not be needed. 

682Proposing Release, 75 FR at 80184. 

683One representative commenter stated that ‘‘the 

proposed definition in CFTC Proposed CFTC 

Regulation § 1.3(m)(1)–(4) fills important gaps left 

by Congress by ensuring that major swap 

participants, major security-based swap 

participants, swap dealers and security-based swap 

dealers are treated as ECPs.’’ See letter from Sidley. 

684These new ECP categories are set forth in new 

CFTC Regulation § 1.3(m)(1)–(4). 

685CEA section 1a(18)(A)(vii)(cc), 7 U.S.C. 

1a(18)(A)(vii)(cc). 

686 7 U.S.C. 2(c)(2)(B)(ii)(I)–(III). 

687A government entity, though, can still qualify 

as an ECP under the other provisions of clause 

(A)(vii) if it is a certain type of ‘‘eligible commercial 

entity’’ as defined in CEA section 1a(17), 7 U.S.C. 

1a(17), or owns and invests on a discretionary basis 

$50 million or more in investments. 

688See letter from Wells Fargo dated June 3, 2011 

(‘‘Wells Fargo I’’). 

689 7 U.S.C. 2(c)(2)(B)(i)(II). 

690See section 13101 of the CRA. 

might cause commodity pools to lose 

their ability to claim ECP status under 

clauses of the ECP definition, other than 

clause (v), and asked the Commissions 

to clarify the meaning of the phrase 

‘‘formed and operated by a person 

subject to regulation under the [CEA]’’ 

in clause (A)(iv).678 In response, the 

Commissions note that a commodity 

pool that does not qualify for ECP status 

under clause (A)(iv) of the ECP 

definition may still qualify as an ECP 

under either of the two clauses of the 

ECP definition other than clause (A)(v) 

applicable to subcategories of 

commodity pools. Thus, registered 

investment companies and foreign 

equivalents may qualify as ECPs under 

clause (A)(iii) of the ECP definition, and 

ERISA plans and the other entities 

described in clause (A)(vi) of the ECP 

definition may qualify as ECPs 

thereunder. The Commissions’ actions 

in this release do not change that result. 

Also, with regard to that commenter’s 

request for clarification, for purposes of 

CFTC Regulation § 1.3(m)(6), the 

Commissions interpret the language 

‘‘subject to regulation under the [CEA]’’ 

in clause (A)(iv) of the ECP definition as 

requiring lawful operation of the 

commodity pool by a person excluded 

from the CPO definition, a registered 

CPO, or a person properly exempt from 

CPO registration.679 Congress did not 

limit ECP status under clause (A)(iv) to 

commodity pools operated by persons 

registered as CPOs; it used the more 

encompassing phrase ‘‘subject to 

regulation’’ under the CEA.680 On the 

other hand, to construe that phrase to 

include any person operating a 

commodity pool would render the 

phrase superfluous.681 The commenters’ 

view would enable a CPO that fails to 

register as required to claim that the 

commodity pool it operates is an ECP 

under clause (A)(v) and thus is not 

subject to regulation of its retail forex 

transactions. The Commissions believe 

that construing the phrase ‘‘formed and 

operated by a person subject to 

regulation under the [CEA]’’ to refer to 

a person excluded from the CPO 

definition, registered as a CPO or 

properly exempt from CPO registration 

appropriately reflects Congressional 

intent. 

D. Dealers and Major Participants as 

ECPs 

1. Proposed Approach 

The Commissions proposed to add 

swap dealers, security-based swap 

dealers, major swap participants and 

major security-based swap participants 

to the ECP definition on the basis that 

such persons ‘‘are likely to be among the 

most active and largest users of swaps 

and security-based swaps.’’ 682

2. Commenters’ Views 

Several commenters supported the 

proposed addition of swap dealers, 

security-based swap dealers, major swap 

participants, and major security-based 

swap participants to the ECP 

definition.683 No commenter opposed 

this aspect of the proposal. 

3. Final Rule 

The Commissions are adopting the 

new ECP categories as proposed. The 

rules as adopted clarify that the terms 

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

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

‘‘major security-based swap participant’’ 

have their respective meanings as 

defined in the CEA and the Exchange 

Act and as otherwise further defined by 

the Commissions.684

E. Government Entities: Incorrect CrossReference 

1. Description of the Issue 

Clause (A)(vii) of the ECP definition 

conditions the ECP status of 

governmental entities, and their 

political subdivisions, agencies, 

instrumentalities and departments 

(collectively, ‘‘government entities’’), in 

part, on the identity of their 

counterparties. Specifically, a 

government entity may qualify as an 

ECP under the provision in clause 

(A)(vii) that requires the entity’s 

counterparty to be ‘‘listed in any of 

subclauses (I) through (VI) of section 

2(c)(2)(B)(ii)’’ of the CEA.685 However, 

subclauses (I) through (III) of CEA 

section 2(c)(2)(B)(ii) 686 are unrelated to 

counterparty types (rather, they describe 

the dollar amounts that apply for 

purposes of retail forex transactions 

under CEA section 2(c)(2)(B)), and 

subclauses (IV) through (VI) of CEA 

section 2(c)(2)(B)(ii) no longer exist in 

the statute. Read literally, then, this 

provision of the ECP definition is 

inherently a nullity and, thus, cannot 

enable government entities to qualify as 

ECPs.687

2. Commenters’ Views 

One commenter traced the history of 

the relevant provisions and concluded 

that the reference to subclauses 

(I) through (VII) of CEA section 

2(c)(2)(B)(ii) in clause (A)(vii) of the ECP 

definition is erroneous.688 This 

commenter pointed instead to CEA 

section 2(c)(2)(B)(i)(II) 689 as the 

reference that should be included in 

clause (A)(vii) of the ECP definition 

because it lists the entities that are 

eligible to serve as counterparties in 

retail forex transactions. 

This commenter noted that the crossreference in clause (A)(vii) of the ECP 

definition was correct when it was 

added to the CEA as part of the CFMA, 

but that it became incorrect in 2008 

when an unrelated amendment to the 

CEA was enacted 690 that changed the 

numbering of the CEA’s provisions 

governing retail forex transactions but 

that failed to make a conforming 

amendment to clause (A)(vii) of the ECP 

definition. As a result of this 2008 

amendment to the CEA, the list of 

entities that formerly appeared in 

subclauses (I) through (VI) of CEA 

sections 2(c)(2)(B)(ii) now appear in 

items (aa) through (ff) of CEA section 

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691 7 U.S.C. 2(c)(2)(B)(i)(II)(aa)–(ff). 

692See letter from Wells Fargo I. 

693See Proposing Release, 75 FR at 80185. The 

reference to the ‘‘Swap Policy Statement’’ is to the 

CFTC’s Policy Statement Concerning Swap 

Transactions, 54 FR 30694 (July 21, 1989). The 

Swap Policy Statement ‘‘identifie[d] those swap 

transactions which [were] not * * * regulated as 

futures or commodity option transactions under the 

[CEA] or the related regulations.’’ 54 FR at 30694. 

One element of the Swap Policy Statement required 

that the swap be entered into in connection with 

each swap counterparty’s line of business. Id. at 

30697. The Swap Policy Statement was applicable 

to cash-settled swaps only, with foreign exchange 

considered to be cash for this purpose. Id. at 30696. 

The Swap Policy Statement required that the terms 

of the relevant swap be individually tailored, 

meaning that the material terms of the swap had to 

be negotiated, the parties had to make 

individualized credit determinations, and the swap 

documentation could not be fully standardized. Id. 

at 30696–97. The Swap Policy Statement did not 

apply to swaps subject to exchange-style offset, 

swaps that were cleared or subject to a margin 

system, or swaps marketed to the public. Id. As 

noted in the Product Definitions Proposal, the 

Dodd-Frank Act supersedes the Swap Policy 

Statement. 76 FR at 29829, n. 74. 

694The discussion in this section relates only to 

swaps and has no effect on the laws or regulations 

applicable to security-based swaps, security-based 

swap agreements or mixed swaps. 

As noted above, the Dodd-Frank Act also 

amended the Exchange Act and the Securities Act 

to make it unlawful for a person to effect a 

transaction in a security-based swap with or for a 

person that is not an ECP unless the transaction is 

effected on a national securities exchange registered 

with the SEC, and to make it unlawful for a person 

to offer to sell, offer to buy or purchase, or sell a 

security-based swap to a person that is not an ECP 

unless a registration statement under the Securities 

Act is in effect with respect to that security-based 

swap. 

695See letter from CDEU. One commenter 

estimated that swap transactions completed by 

regional and community banks in reliance on the 

Swap Policy Statement constituted 30–40% of all 

of such banks’ swaps, representing approximately 

7,000 to 10,000 swaps per year and $15 to $20 

billion in related loan principal. See letter from B&F 

I. Another commenter advised that it has entered 

11 swaps, with a total notional of $26 million, since 

its formation in 2007, almost all of the 

counterparties to which ‘‘qualified for the swap 

under the [Swap Policy Statement] business 

purpose exemption.’’ See letter from Capstar. The 

CFTC stated when issuing the Swap Policy 

Statement that it ‘‘reflects the [CFTC]’s view that at 

this time most swap transactions, although 

possessing elements of futures or options contracts, 

are not appropriately regulated as such under the 

[CEA] and [CFTC] regulations.’’ Swap Policy 

Statement at 30694. 

696See, e.g., letter from Rabobank, N.A., Rabo 

AgriFinance, Inc. and Coo ̈peratieve Centrale 

Raiffeisen-Boerenleenbank B.A. (‘‘Rabobank, New 

York Branch’’) (relating that ‘‘[f]or a variety of estate 

planning and regulatory purposes, farmers 

commonly hold their ownership interests in land, 

buildings and farm equipment indirectly, through a 

network of legal entities’’). 

697See, e.g., letter from Fifth Third Bank and 

Union Bank, N.A. (advising that ‘‘[i]t is common for 

an operating business to organize a separate limited 

liability company (for tax and legal reasons) to 

acquire * * * assets * * * and to lease these assets 

to the operating company[, which] becomes the 

borrow[er] * * * for the loan used to acquire those 

assets’’ and that ‘‘[t]he limited liability company 

often does not maintain sufficient capital to qualify 

as an ECP’’). 698See, e.g., letters from Capstar, Frost National 

Bank, FTN Financial Capital Markets, Midsize 

Banks and NAREIT. 

699See letters from BB&T I and B&F I. 

Commenters said that these businesses may 

intentionally maintain less than $1 million in 

equity primarily for tax and legal reasons. See 

letters from Capital One and Columbia State Bank 

(stating that over 65% of its borrowers are 

structured as limited liability companies or 

S corporations and intentionally maintain less than 

$1 million in equity at the entity entering into the 

swap). 

700See letter from Columbia State Bank. See also 

letter from BB&T I. 

701See letters from BB&T I, Capital One, Capstar, 

Columbia State Bank, Midsize Banks, NAREIT and 

Wells Fargo II. 

702See letter from FSR I. 

703See letters from BB&T I, Midsize Banks and 

Wells Fargo II. 

704See letters from CDEU and Regional Banks. 

2(c)(2)(B)(i)(II) instead.691 This 

commenter requested that ‘‘the 

Commissions correct this clearly 

erroneous reference in the definition of 

ECP through interpretive guidance, 

rulemaking or Commission order.’’ 692

3. Interpretive Guidance 

Clause (A)(vii) of the ECP definition 

contains an erroneous cross-reference to 

subclauses (I) through (VI) of CEA 

section 2(c)(2)(B)(ii). Accordingly, the 

Commissions are issuing interpretive 

guidance by identifying the 

counterparties with which a 

governmental entity can enter into 

swaps to attain ECP status under the 

provision in clause (A)(vii) that requires 

the entity’s counterparty to be ‘‘listed in 

any of subclauses (I) through (VI) of 

section 2(c)(2)(B)(ii)’’ of the CEA. The 

Commissions consider a government 

entity covered by the counterparty 

limitation in clause (A)(vii) to be an ECP 

with respect to an agreement, contract, 

or transaction that is offered by, and 

entered into with, a person that is listed 

in items (aa) through (ff) of section 

2(c)(2)(B)(i)(II) of the CEA. The 

limitation of ECP status ‘‘with respect 

to’’ a particular transaction is consistent 

with Congress’ determination that, for 

purposes of this provision of clause 

(A)(vii), governmental entities may 

derive their ECP status from the status 

of their counterparty. 

F. Qualification as an ECP With Respect 

to Swaps Used To Hedge or Mitigate 

Commercial Risk in Connection With 

the Conduct of an Entity’s Business 

1. Proposing Release 

In the Proposing Release, the 

Commissions requested comment on 

whether any additional categories 

should be added to the definition of 

ECP, ‘‘such as the following categories 

suggested by commenters [on the 

ANPRM]: Commercial real estate 

developers; energy or agricultural 

cooperatives or their members; or firms 

using swaps as hedges pursuant to the 

terms of the CFTC’s Swap Policy 

Statement.’’ 693 As noted above, the ECP 

definition is important because the 

Dodd-Frank Act amended the CEA to 

prohibit a person that is not an ECP 

from entering into swaps other than on 

or subject to the rules of a DCM.694

2. Commenters’ Views 

Several commenters supported the 

addition of categories to the definition 

of ECP because, these commenters said, 

not all current swap market participants 

are ECPs. Many of these commenters 

said that non-ECPs have entered into 

swaps in reliance on the Swap Policy 

Statement.695 Commenters highlighted, 

among other things, the importance of 

the Swap Policy Statement to passthrough entities used by farmers,696

operating companies 697 and commercial 

property developers,698 noting that such 

entities may not meet the ECP criteria. 

According to these commenters, these 

pass-through entities often are small and 

medium-sized businesses that enter into 

interest rate swaps with lending 

financial institutions in reliance on the 

Swap Policy Statement.699 The 

commenters explained that the loans 

usually are guaranteed by the principals 

of the entity entering into the swap, and 

that the borrower would qualify as an 

ECP if structured as a single-level 

corporate entity or sole 

proprietorship.700 Commenters said that 

if these non-ECP entities were limited to 

swaps that are available on or subject to 

the rules of a DCM, many regional bank 

borrowers would lose the ability to use 

swaps, real estate companies would 

have less flexibility in risk management, 

and smaller lenders would be at a 

competitive disadvantage.701 Another 

commenter said that Dodd-Frank Act 

provisions such as the end-user clearing 

exception indicate that Congress 

intended to preserve the availability of 

swaps used for business reasons rather 

than for investment or speculation.702

To mitigate the impact of restricting 

non-ECPs to swaps that are available on 

or subject to the rules of DCMs, some 

commenters said that an entity should 

be able to qualify as an ECP based on 

the financial qualifications of related 

entities, so long as various conditions 

proposed by the commenters are 

satisfied. Some commenters said that an 

entity should be eligible to be an ECP 

if its swap obligations are guaranteed by 

an ECP,703 or if its controlling entity 

qualifies as an ECP under clause (A)(v) 

of the statutory definition.704 Another 

commenter suggested revisions to the 

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705See letter from NAREIT. 

706See letters from the American Public Gas 

Association (‘‘APGA’’), Capital One and Gavilon 

dated December 23, 2010 (‘‘Gavilon I’’). 

707See meeting with Ron Eliason on December 

16, 2010 (in which Mr. Eliason contended that 

farmers should be able to enter into swaps, even if 

they do not meet the income or asset tests in the 

current ECP definition and, therefore, would not be 

permitted to enter into swaps other than on or 

subject to the rules of a DCM). 

708See letter from APGA (requesting that ‘‘the 

[CFTC] exercise its authority under section la(18)(C) 

of the Act and determine that public natural gas 

distribution companies, including member-owned 

co-operatives, that enter into swaps in connection 

with their business of supplying customers with 

natural gas are ECPs within the meaning of section 

la(18) of the Act’’). 

709CEA section 1a(18)(A)(v)(III) provides that the 

term ‘‘eligible contract participant’’ includes ‘‘a 

corporation, partnership, proprietorship, 

organization, trust, or other entity * * * that (aa) 

has a net worth exceeding $1,000,000; and (bb) 

enters into an agreement, contract, or transaction in 

connection with the conduct of the entity’s business 

or to manage the risk associated with an asset or 

liability owned or incurred or reasonably likely to 

be owned or incurred by the entity in the conduct 

of the entity’s business.’’ 7 U.S.C. 1a(18)(A)(v)(III). 

710For example, if a commodity pool were 

precluded by CFTC Regulation § 1.3(m)(6) from 

relying on clause (A)(v) of the statutory definition 

to qualify as an ECP, such pool would not be able 

to rely on CFTC Regulation § 1.3(m)(7) to qualify as 

an ECP. 

711See, e.g., letters from B&F I (stating that ‘‘[i]f 

the customer does not * * * [itself] meet the ECP 

definition, then the transaction would have to be 

guaranteed by any entity or individual who is an 

owner * * * [who] meets the $10,000,000 total 

asset test of section 1(a)(18)(A)(v)(I) of the Act or the 

$1,000,000 net worth test of section 

1(a)(18)(A)(v)(III) of the Act.’’), NAREIT (urging that 

the Commissions impute ECP status to non-ECP 

entities involved in specified real estate businesses 

to such entities whose ‘‘majority owner or 

controlling entity’’ is an ECP) and Midsize Banks 

(recommending that the ECP determination be 

made with respect to a non-ECP entity’s owners 

based on criteria including qualifying natural 

persons as ECPs based on a $1,000,000 net worth). 

712 7 U.S.C. 2(e). 

713 7 U.S.C. 6(c)(6)(C). 

714 16 U.S.C. 824(f). 

715 76 FR 6095 (Feb. 3, 2011). 

716See, e.g., letters from NCFC dated April 4, 

2011 (‘‘NCFC II’’) (stating ‘‘[o]n behalf of the more 

than two million farmers and ranchers who belong 

to one or more farmer cooperative(s), the [NCFC] 

* * * [believes] the limitation on participation [in 

agricultural swaps] to [ECPs] outside of a DCM 

* * * should limit [agricultural swap] participation 

to appropriate persons’’ and that ‘‘[t]he ECP 

requirement with a threshold of $1 million in net 

worth to be allowed to use swaps and options, other 

than on a DCM, is appropriate for the products 

cooperatives offer their members’’), ; letter from 

NGFA dated April 4, 2011 (‘‘NGFA II’’) (stating that 

‘‘[t]he use of agricultural swaps has been 

constrained relative to other swaps by virtue of 

being subject to CFTC regulatory requirements, 

while other swaps have been exempted from CFTC 

oversight,’’ ‘‘the Dodd-Frank Act * * * institutes a 

number of safeguards, including the limitation that 

Continued 

ECP definition that included looking to 

the ECP status or sophistication of the 

majority owner of an entity in 

determining if the entity itself is an 

ECP.705 Other commenters suggested 

other provisions to allow non-ECPs to 

enter into swaps other than on or 

subject to the rules of a DCM, so long 

as the non-ECP meets various 

conditions indicating that the swap is 

used in connection with its line of 

business.706

Other commenters argued for per se 

ECP qualification based on their status 

as certain types of persons, such as 

farmers707 or for ECP status based solely 

on a combination of a person’s status 

and the swap being related to a person’s 

line of business with no additional 

conditions.708

3. Final Rules and Interpretation 

In response to the commenters’ 

concerns, the CFTC is adopting CFTC 

Regulation § 1.3(m)(7) to permit an 

entity, in determining its net worth for 

purposes of subclause (A)(v)(III) of the 

ECP definition,709 to include the net 

worth of its owners, solely for purposes 

of determining its ECP status for swaps 

used to hedge or mitigate commercial 

risk, provided that all of its owners are 

themselves ECPs (disregarding shell 

companies). Under CFTC Regulation 

§ 1.3(m)(7) as adopted, an entity seeking 

to qualify under subclause (A)(v)(III) of 

the ECP definition in order to enter into 

a swap used to hedge or mitigate 

commercial risk is permitted to count 

the net worth of its owners in 

determining its own net worth, so long 

as all its owners are ECPs. This 

regulation applies only to entities that 

are otherwise eligible to rely on 

subclause (A)(v)(III) to determine ECP 

status; it does not expand or change the 

scope of application of that 

paragraph.710

CFTC Regulation § 1.3(m)(7) as 

adopted applies only when determining 

ECP status for swaps used to hedge or 

mitigate commercial risk. This new 

regulation does not apply when 

determining ECP status for other swaps 

or for security-based swaps, securitybased swap agreements, mixed swaps, 

or agreements, contracts or transactions 

that are not swaps (regardless of the 

purpose for which they are used). 

The Commissions have considered 

the comments indicating that, as 

currently structured, many businesses 

are owned by multiple legal entities 

and/or individuals, and the net worth of 

all the owners in the aggregate in some 

cases would satisfy the $1 million net 

worth requirement in subclause 

(A)(v)(III), even though the particular 

legal entity that enters into a swap does 

not have a net worth exceeding 

$1 million.711 While the Commissions 

recognize that the requirement, in 

subclause (A)(v)(III)(aa) of the ECP 

definition, that the entity relying on that 

paragraph have a net worth exceeding 

$1 million evidences Congress’ intent 

that only entities with this level of 

financial resources should be eligible for 

ECP status under this paragraph of the 

definition, the Commissions agree with 

commenters that application of this 

requirement in these circumstances 

would inappropriately limit the ability 

of business entities to use swaps to 

hedge or mitigate commercial risk. As a 

result, the Commissions are persuaded 

that in this limited situation, the entity 

should qualify as an ECP and be eligible 

to enter into swaps other than on or 

subject to the rules of a DCM, so long 

as the entity is using the swap to hedge 

or mitigate commercial risk and all of 

the owners of the entity are ECPs (other 

than shell companies). 

In response to those commenters 

requesting per se ECP status or the 

ability to qualify as an ECP based on a 

combination of status and engaging in 

swaps related to a line of business, 

without further restriction, the 

Commissions do not believe it is 

necessary or appropriate to further 

define the term ECP to such an extent 

in order to address most commenters’ 

concerns. The Commissions note that 

such approaches would undermine the 

prohibition in CEA section 2(e) 712 on 

non-ECPs executing swaps other than 

on or subject to the rules of a DCM. The 

Commissions also note that focusing 

solely on a link between a swap and a 

line of business would undermine the 

application of the ECP definition to 

swaps in that the various prongs of the 

ECP generally are linked to dollar 

thresholds, regulated status, or a 

combination of the two. 

The Commissions also note that it 

currently is considering a draft petition 

for relief pursuant to CEA section 

4(c)(6)(C) 713 for certain entities 

described in Federal Power Act section 

201(f),714 which may address the 

concerns of some commenters. 

Additionally, the Commissions are 

developing joint rules to further define 

the term ‘‘swap,’’ including the forward 

exclusion from the swap definition 

which, in turn, may result in certain 

transactions not being considered 

swaps. Further, the CFTC also is 

considering today a form of trade option 

exemption, which may further address 

commenters’ concerns. 

With respect to farmers, in response 

to the CFTC’s Commodity Options and 

Agricultural Swaps rulemaking 

proposal,715 commenters generally were 

of the view that the ECP definition is 

appropriate in its current form.716 While 

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30658 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

only [ECPs] may engage in swaps unless entered 

into on a designated contract market,’’ and ‘‘[t]he 

NGFA believes that these safeguards provide morethan-ample protection in the swaps marketplace for 

both agricultural and non-agricultural swaps and 

that there is no compelling reason to place 

additional burdens on agricultural swaps.’’). 

717The Commissions note that this regulation 

provides an alternative means for certain business 

entities to qualify as ECPs. It neither diminishes nor 

qualifies in any way the requirement in CEA section 

2(e) that persons that are not ECPs enter into swaps 

only on or subject to the rules of a DCM. 

718CEA section 1a(18)(A)(v)(III)(bb), 7 U.S.C. 

1a(18)(A)(v)(III)(bb). The Commissions note that an 

entity that would qualify as an ECP under subclause 

(A)(v)(III) without application of CFTC Regulation 

§ 1.3(m)(7) is not required to meet the conditions 

stated in, this regulation. 

719See part IV.C. The use of the phrase ‘‘hedge 

or mitigate commercial risk’’ in CFTC Regulations 

§§ 1.3(m)(7) and 1.3(kkk) is similar to the use of the 

same phrase in the exception to the mandatory 

clearing requirement in CEA section 2(h)(7), 7 

U.S.C. 2(h)(7). 

720See, e.g., letter from NAREIT. 

721See CEA section 2(e), 7 U.S.C. 2(e). 

722See CFTC Regulation § 1.3(m)(7)(ii). 

The term ‘‘shell company’’ means any entity that 

limits its holdings to direct or indirect interests in 

entities that are ECPs through reliance on CFTC 

Regulation § 1.3(m)(7). Any entity that holds at least 

one direct or indirect interest in an entity not 

relying on CFTC Regulation § 1.3(m)(7) would not 

be a shell company. The ECP status of owners of 

entities that are not shell companies is not relevant 

for purposes of CFTC Regulation § 1.3(m)(7), which 

should permit wider financing of small businesses 

using swaps to hedge or mitigate commercial risk. 

To be clear, an individual will never be 

considered to be a shell company for purposes of 

CFTC Regulation § 1.3(m)(7). 

723This provision may apply repeatedly in a 

‘‘chain.’’ For example, if in determining whether an 

entity may rely on CFTC Regulation § 1.3(m)(7), an 

owner of that entity that is a shell company is 

disregarded, then if the owner of that shell 

company is also a shell company, that second shell 

company also is disregarded, and so on. 

724A proprietorship generally is a business that 

a person operates in a personal capacity and with 

respect to which that person directly owns all the 

assets and directly is responsible for all of the 

liabilities, rather than through a corporation, 

partnership or other structure conveying limited 

liability. See letters from Midmarket Banks and 

Wells Fargo II (stating that ‘‘proprietors . . . 

typically are not separate legal entities’’); see also 

State of California Franchise Tax Board Web site 

(advising that ‘‘[t]he business and the owner are 

one. There is no separate legal entity and thus no 

separate legal person’’), at https://www.ftb.ca.gov/ 

businesses/bus_structures/soleprop.shtml. A 

proprietorship is not a separate taxable entity but 

reports the income or loss of the business, which 

is taxed along with a sole proprietor’s other income, 

on a separate schedule attached to his or her 

individual federal income tax return. See letter from 

Midmarket Banks. See also 2011 Form1040 

Schedule C: Profit or Loss from Business (Sole 

Proprietorship), available at http://www.irs.gov/ 

pub/irs-pdf/f1040sc.pdf; 2011 Instructions for 

Schedule C, available at http://www.irs.gov/pub/irspdf/i1040sc.pdf. 

725CFTC Regulation § 1.3(m)(7)(ii)(C)(I) is 

designed to ensure that the individual qualifies as 

a proprietorship, if at all, other than due to its 

interest in either an entity seeking to qualify as an 

ECP under CFTC Regulation § 1.3(m)(7)(i) or in any 

other entity. 

726See CFTC Regulation § 1.3(m)(7)(ii)(C)(IV). 

This language is modeled on the language in 7 

U.S.C. 1a(18)(A)(v)(III)(bb). 

727The Commissions note that this guidance 

regarding proprietorships applies only when an 

entity is relying on CFTC Regulation § 1.3(m)(7). 

The Commissions do not intend that this guidance 

would expand or limit the circumstances when a 

proprietorship may otherwise rely on clause (A)(v) 

of the statutory definition in establishing its ECP 

status. 

the Commissions may consider 

providing further relief should 

experience show, after the ECP 

definition becomes effective, that 

further relief is warranted, neither the 

ECP definition nor the various actions 

cited in the foregoing paragraph are 

final, so providing further relief is 

premature. The Commissions’ measured 

approach, which builds on the existing 

net worth requirement in the general 

entity ECP category, provides broad 

relief to many of the commenters (e.g., 

borrowers generally) while otherwise 

adhering to the existing ECP categories. 

The Commissions note that 

commenters said that, because of the 

way some businesses are structured for 

tax, estate planning or other purposes, 

they enter into swaps through a legal 

entity that does not, by itself, qualify as 

an ECP even though the net worth of the 

business and its owners, taken in the 

aggregate, would qualify as an ECP 

pursuant to subclause (A)(v)(III) of the 

ECP definition. The Commissions 

believe that the best way to address this 

concern is to allow such a business to 

consider the net worth of all its owners 

in determining whether the net worth 

requirement in subclause (A)(v)(III) is 

satisfied.717

CFTC Regulation § 1.3(m)(7) is 

available only to an entity that seeks to 

qualify as an ECP under subclause 

(A)(v)(III) of the statutory definition in 

order to enter into a swap that will be 

used to hedge or mitigate commercial 

risk. The Commissions limited CFTC 

Regulation § 1.3(m)(7) to subclause 

(A)(v)(III) because this provision of the 

ECP definition is available to a business 

entity that uses swaps in connection 

with the conduct of its business or to 

manage risks associated with assets or 

liabilities related to the conduct of its 

business.718

The purpose of CFTC Regulation 

§ 1.3(m)(7) is to maintain the ability of 

business entities to enter into swaps 

other than on or subject to the rules of 

a DCM for limited purposes. This 

regulation therefore is available only 

with respect to a swap that is used to 

hedge or mitigate commercial risk 

within the meaning of CFTC Regulation 

§ 1.3(kkk).719 CFTC Regulation 

§ 1.3(m)(7) applies only if all of an 

entity’s owners qualify as ECPs under 

the provision of the ECP definition 

applicable to such owner. Although 

some commenters suggested that an 

entity should be able to qualify as an 

ECP based on the status of its majority 

or controlling owners,720 the 

Commissions believe that CFTC 

Regulation § 1.3(m)(7) should be 

available only when all of an entity’s 

owners qualify as ECPs. The 

Commissions do not believe it would be 

appropriate to impair the protection of 

non-ECPs that flows from the 

requirement that non-ECPs enter into 

swaps only on or subject to the rules of 

a DCM.721 In order to maintain these 

protections and prevent evasion, CFTC 

Regulation § 1.3(m)(7) provides that any 

shell company will be disregarded, and 

in order to determine if the underlying 

entity may use CFTC Regulation 

§ 1.3(m)(7), each owner of such shell 

company must be an ECP.722

Correspondingly, in aggregating net 

worth for purposes of determining the 

ECP status of an entity pursuant to 

CFTC Regulation § 1.3(m)(7), if the 

entity is owned by a shell company, 

then it is the net worth of the owners 

of that shell company that is relevant, 

not the net worth of the shell 

company.723

Last, also in order to prevent evasion, 

CFTC Regulation § 1.3(m)(7)(ii)(C) 

specifies that an individual may rely on 

the proprietorship provision of clause 

(A)(v) of the statutory definition for 

purposes of determining its status as an 

ECP owner of an entity only if the 

proprietorship 724 status arises 

independent of the business conducted 

by such entity 725 and the individual 

proprietor acquires his/her interest in 

such entity (i) in connection with the 

conduct of the individual’s 

proprietorship or (ii) to manage the risk 

associated with an asset or liability 

owned or incurred or reasonably likely 

to be owned or incurred by the 

proprietorship.726 The Commissions are 

adopting CFTC Regulation 

§ 1.3(m)(7)(ii)(C) because they believe 

that the only circumstance in which a 

proprietorship should be considered an 

ECP for purposes of CFTC Regulation 

§ 1.3(m)(7)(i) is if it is making an 

investment related to the 

proprietorship.727 The ECP status of an 

individual acting other than with 

respect to its proprietorship is 

determined based on the ECP clause 

applicable to individuals. The 

Commissions note that they have 

authority to take action to prevent 

evasion of the provisions regarding shell 

companies and proprietorships by 

entities relying on CFTC Regulation 

§ 1.3(m)(7) to establish ECP status. 

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728See, e.g., letters from Millburn (characterizing 

the proposed rules as ‘‘greatly limit[ing] the ability 

of entities managed by sophisticated money 

managers that are subject to registration and 

examination by regulators to qualify as ECPs’’) and 

Sidley (describing ‘‘[a] commodity pool, like a 

registered investment company or an employee 

benefit plan, [a]s a pool of assets from investors of 

varying (and, in some cases, undetermined) levels 

of sophistication that are advised by a sophisticated 

adviser’’). 

729See joint letter from the Global Foreign 

Exchange Division (‘‘GXFD’’) and MFA dated 

January 19, 2011 (‘‘GFXD II’’) (describing 35 CFTC 

Forex Pool enforcement cases from 2010 and 2011 

and noting that in 80% of these cases, the amount 

at issue in the misconduct was less than $10 

million, and that only one case involved a 

registered CPO where the amount at issue in the 

misconduct was more than $10 million; two 

additional cases involved misconduct involving 

CPOs exempt from registration as such under CFTC 

Regulation § 4.13(a). While the commenter did not 

characterize these amounts as ‘‘total assets’’ 

(instead, the commenter used terms such as 

‘‘fraudulently obtained’’ or ‘‘sustained losses of’’ to 

modify the cited dollar amounts) in most cases, it 

is clear that these amounts are equivalent to, or 

subsets of, total assets. For instance, for a CPO to 

have fraudulently obtained $10 million from 

commodity pool participants, the CPO must have 

taken in $10 million from them, resulting in the 

commodity pool at one time having $10 million in 

total assets. See also letter from Sidley (providing 

26 examples of CFTC Forex Pool-related 

enforcement cases, all but one of which involved 

Forex Pools with less than $50 million in total 

assets). A number of the cases cited by GXFD and 

Sidley overlap; in the aggregate, these commenters 

appear to have presented data on 45 different cases 

rather than 61. 

730See letter from GFXD II. 

731See letters from GXFD II and Skadden. 

732See meeting with SIFMA on January 20, 2012 

(in which representatives of SIFMA proposed a new 

non-exclusive set of criteria for a Forex Pool to 

qualify as an ECP, which included, as one of several 

alternatives in one element of the proposed criteria, 

that a Forex Pool be operated by a registered CPO). 

See also letter from Willkie Farr (observing that ‘‘[i]t 

may be time to regulate certain previously 

unregulated transactions and traders, so that more 

CPOs are registered’’ and that ‘‘many commodity 

pools are operated and advised by registered 

professionals’’). 

733See letter from Sidley. 

734See id. 

735See joint letter from the GFXD and MFA dated 

January 10, 2012 (‘‘GFXD I’’). These commenters 

indicated that, while 

[s]ome swap dealers may be dually licensed as a 

bank or a broker-dealer [and therefore] eligible to 

transact in OTC foreign exchange with retail 

investors as well as swaps with institutional 

investors * * * as an operational matter, it is not 

clear that firms will be able to and find it efficient 

to structure their business so that the retail foreign 

exchange platform is conducted from the same 

entity as the institutional swaps business. 

736 Given that (i) many CPOs will be registering 

as such for the first time due to the CFTC’s recent 

rescission of the exemption from CPO registration 

set forth in CFTC Regulation § 4.13(a)(4) or its 

modification of the criteria for claiming the 

exclusion from the CPO definition in CFTC 

Regulation § 4.5 and (ii) such pools were formed 

prior to their CPOs’ registration as such, commodity 

pools formed prior to December 31, 2012 need not 

have been ‘‘formed’’ by a registered CPO or by a 

CPO exempt from registration as such pursuant to 

CFTC Regulation § 4.13(a)(3) in order to be qualified 

as ECPs under the new prong, so long as they are 

operated by a registered CPO on or before such date. 

G. ECP Status for Forex Pools Operated 

by Registered CPOs or CPOs Exempt 

From Registration Under Certain 

Conditions 

1. Description of the Issue and 

Commenters’ Views 

Notwithstanding the modifications to 

the look-through provisions for Forex 

Pools discussed above in section III.B., 

the Commissions acknowledge 

commenters’ concerns about the 

potential for unintended consequences 

arising from the look-through provisions 

of the Dodd-Frank Act. Several 

commenters asserted that many Forex 

Pools are operated by sophisticated, 

professional managers that do not need 

the protections of a retail forex regime 

designed to protect non-ECPs that are 

engaging in retail forex transactions.728

More specifically, some commenters, 

based on CFTC enforcement actions 

involving Forex Pools, suggested that 

commodity pools of a sufficient size, 

and/or operated by a registered or 

exempt CPO, do not pose the risks of 

fraud and abuse of non-ECP customers 

that the statutory look-through 

provision is intended to address.729

As a result, commenters suggested 

that the look-through provision should 

not apply in determining ECP status of 

commodity pools that meet certain 

conditions. For example, commenters 

suggested that the look-through not be 

applied to a commodity pool with $10 

million in total assets paired with 

another or other factors, such as not 

being structured to evade,730 being 

subject to regulation under the CEA731

or the CPO being registered as such.732

Another commenter suggested requiring 

the total assets or minimum initial 

investment of a Forex Pool to be 

sufficiently large that, in general, only 

legitimate pools would exceed such 

thresholds.733 This commenter 

suggested a total asset threshold of $50 

million.734

Separately, one commenter also 

claimed that the statutory look-through, 

if strictly implemented, might 

inappropriately preclude Forex Pools 

and their CPOs, many of whom are 

registered, from engaging in retail forex 

transactions with swap dealers because 

swap dealers are not Enumerated 

Counterparties (and some swap dealers 

also may not be Enumerated 

Counterparties in a different capacity, 

such as being a U.S. financial 

institution).735 This commenter stated 

that such a result could reduce close out 

netting opportunities in the event of the 

insolvency of a counterparty. 

2. Final Rule 

In response to commenters, the CFTC 

is adopting CFTC Regulation § 1.3(m)(8), 

pursuant to which certain Forex Pools 

may qualify as ECPs notwithstanding 

the look-through requirement. As 

adopted, CFTC Regulation § 1.3(m)(8) 

enables a Forex Pool that enters into a 

retail forex transaction to qualify as an 

ECP with respect thereto, irrespective of 

whether each participant in the Forex 

Pool is an ECP, if the Forex Pool 

satisfies the following conditions: 

• It is not formed for the purpose of 

evading CFTC regulation under Section 

2(c)(2)(B) or Section 2(c)(2)(C) of the 

CEA or related CFTC rules, regulations 

or orders governing Retail Forex Pools 

and retail forex transactions); 

• It has total assets exceeding $10 

million; and 

• It is formed and operated by a 

registered CPO or by a CPO who is 

exempt from registration as such 

pursuant to CFTC Regulation 

§ 4.13(a)(3). 

CFTC Regulation § 1.3(m)(8) as 

adopted requires that the Forex Pool not 

be formed for the purpose of evading 

CFTC regulation of Retail Forex Pools 

and retail forex transactions under CEA 

Section 2(c)(2)(B) or (C). A Forex Pool 

that is formed for that purpose would 

not be an ECP under new CFTC 

Regulation § 1.3(m)(8). 

CFTC Regulation § 1.3(m)(8) as 

adopted also requires that the Forex 

Pool have total assets exceeding $10 

million to qualify as an ECP. The $10 

million threshold is twice the current 

total asset threshold for a commodity 

pool to qualify as an ECP under CEA 

section 1a(18)(A)(iv). The Commissions 

believe the $10,000,000 threshold is 

appropriate in light of the potential 

regulatory burdens a higher threshold 

might impose on smaller commodity 

pools. The Commissions believe that 

such a threshold, coupled with the other 

conditions of the rule, is sufficiently 

high to assure that the protections 

provided to retail forex transactions are 

not needed for these types of 

commodity pools. The Commissions 

will vigilantly monitor developments 

with respect to Forex Pools, including 

enforcement activity, and revisit this 

total asset threshold if warranted by 

subsequent events. 

Finally, CFTC Regulation § 1.3(m)(8) 

as adopted requires that Forex Pool be 

formed 736 and operated by a CPO 

registered as such with the CFTC or by 

a CPO who is exempt from registration 

as such pursuant to CFTC Regulation 

§ 4.13(a)(3). The Commissions believe 

that the registered CPO aspect of this 

condition is appropriate for several 

reasons, including that it will ensure 

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30660 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

737See CPO/CTA Compliance Release at 11254 

(noting that ‘‘registration allows the Commission to 

ensure that all entities operating collective 

investment vehicles participating in the derivatives 

markets meet minimum standards of fitness and 

competency’’). See http://www.nfa.futures.org/NFAregistration/cpo/index.html for an overview of 

registration and related requirements for CPOs, 

their principals and their associated persons and 

http://www.nfa.futures.org/NFA-compliance/NFAcommodity-pool-operators/index.html for an 

overview of the compliance regime for registered 

CPOs overseen by the NFA. The CFTC anticipates 

that more CPOs will register in the coming months 

now that it has withdrawn the CFTC Regulation 

§ 4.13(a)(4) exemption from CPO registration, 

increasing the number of registered CPOs, in turn 

increasing the number of CPOs who can satisfy the 

registered CPO alternative under CFTC Regulation 

§ 1.3(m)(8)(iii). 

738See CPO/CTA Compliance Release at 11254 

(stating that ‘‘the [CFTC] has clear authority to take 

punitive and/or remedial action against registered 

entities for violations of the CEA or of the [CFTC’’s 

regulations * * * [and] to deny or revoke 

registration, thereby expelling an individual or 

entity from serving as an intermediary in the 

industry’’ and that the CFTC’s reparations program 

and the NFA’s arbitration program also are available 

avenues ‘‘to seek redress for wrongful conduct by 

a [CFTC] registrant’’). 

739As discussed above in note 729, only one of 

the 45 unique cases presented by commenters 

involved a pool with more than $10 million in total 

assets and a registered CPO. Only two of those cases 

involved a pool operated by CPOs exempt from 

registration: in both of those cases, however, the 

CPO raised less than $10 million. In addition, one 

of those CPOs relied on the CFTC Regulation 

§ 4.13(a)(4) CPO registration exemption. As 

discussed above, the CFTC has withdrawn that 

exemption. 

740The term ‘‘commodity interest’’ is defined in 

CFTC Regulation § 1.3(yy), and includes ‘‘[a]ny 

contract, agreement or transaction subject to [CFTC] 

jurisdiction under section 2(c)(2) of the [CEA].’’ 

CFTC Regulation § 1.3(yy)(3). 

741See CFTC, Regulation of Off-Exchange Retail 

Foreign Exchange Transactions and Intermediaries; 

Final Rules, 75 FR 55410 (Sept. 10, 2010). 

742CFTC, Regulation of Off-Exchange Retail 

Foreign Exchange Transactions and Intermediaries; 

Proposed Rules, 75 FR 3282 (Jan. 10, 2010). 

743Section 12 of the NFA’s Financial 

Requirements impose the following minimum 

security deposit requirements for retail forex 

transactions: (i) 2% of the notional value of 

transactions in the British pound, the Swiss franc, 

the Canadian dollar, the Japanese yen, the Euro, the 

Australian dollar, the New Zealand dollar, the 

Swedish krona, the Norwegian krone, and the 

Danish krone; (ii) 5% of the notional value of other 

transactions; (iii) for short options, the above 

amount plus the premium received; and (iv) for 

long options, the entire premium. See NFA Manual, 

available at http://www.nfa.futures.org/nfamanual/ 

NFAManual.aspx?

RuleID=SECTION%2012&Section=7. 

744CFTC, Regulation of Off-Exchange Retail 

Foreign Exchange Transactions and Intermediaries; 

Proposed Rules, 75 FR 3282, 3287 (Jan. 10, 2010). 

745 Id. at 3282. 

746CPO/CTA Compliance Release at 11261. The 

CFTC also stated that: 

[t]he Commission believes that trading exceeding 

five percent of the liquidation value of a portfolio, 

or a net notional value of commodity interest 

positions exceeding 100 percent of the liquidation 

value of a portfolio, evidences a significant 

exposure to the derivatives markets, and that such 

exposure should subject an entity to the 

Commission’s oversight. 

Id. at 11263. 

747The nature of a swap dealer’s business 

activities and assets may detract from what is 

considered regulatory capital for an FCM or RFED 

engaging in retail forex transactions, thereby 

making it difficult for some swap dealers to dually 

register both as such and as an FCM or RFED in 

order to do retail forex business. As an ECP, a Forex 

Pool’s choice of retail forex transaction 

counterparties will not be limited to Enumerated 

Counterparties, and thus may include swap dealers. 

that the NFA oversees compliance by 

those registered CPOs relying on this 

new regulation.737 CPO registration also 

provides a clear means of addressing 

wrongful conduct.738 Although some 

commenters suggested that a CPO need 

only be ‘‘subject to regulation under the 

CEA’’ in order for a Forex Pool operated 

by that CPO to qualify as an ECP 

notwithstanding the look-through 

requirements, CFTC Regulation 

§ 1.3(m)(8) instead requires that the CPO 

of a Forex Pool be registered as a CPO 

or be a CPO who is exempt from 

registration as such pursuant to CFTC 

Regulation § 4.13(a)(3), alternative 

conditions supported by other 

commenters. The Commissions are 

requiring operation by a registered CPO, 

or by a CPO who is exempt from 

registration as such pursuant to CFTC 

Regulation § 4.13(a)(3), as a condition 

for a Forex Pool to qualify for ECP status 

under CFTC Regulation § 1.3(m)(8) 

because, based on the data presented by 

commenters, CFTC enforcement actions 

involving Forex Pools rarely involve 

registered CPOs or CPOs exempt from 

registration as such.739

While NFA oversight of CPOs 

operating Retail Forex Pools is a useful 

criterion to determine whether an 

exclusion from the look-through 

provisions of CEA section 1a(8)(A)(iv) 

and CFTC Regulation § 1.3(m)(5) is 

warranted, the Commissions believe 

that Retail Forex Pools operated by 

CPOs exempt from registration as such 

pursuant to CFTC Regulation 

§ 4.13(a)(3) also merit relief from those 

look-through provisions. On September 

10, 2010, the CFTC published in the 

Federal Register a final rule revising the 

CPO registration exemption in CFTC 

Regulation § 4.13(a)(3) to incorporate 

retail forex transactions into the 

transactions subject to the alternative 

caps on the use of commodity 

interests 740 by CPOs claiming the 

exemption.741 The CFTC explained in 

the related Federal Register proposing 

release that the proposed change to 

CFTC Regulation § 4.13(a)(3) was part of 

a proposal to adopt a comprehensive 

regulatory scheme to implement the 

CRA with respect to retail forex 

transactions (‘‘CRA-Related Forex 

Proposal’’).742 The CFTC also explained 

that ‘‘the NFA-specified minimum 

security deposit for off-exchange retail 

forex transactions would be included 

among the amounts that cannot exceed 

5 percent of the liquidation value of the 

pool’s portfolio in order for the operator 

to claim the exemption from registration 

under Regulation 4.13(a)(3)’’743 and that 

‘‘such amounts are roughly equivalent 

to initial margin and option 

premiums).’’ 744 The CFTC also 

described the CRA-Related Forex 

Proposal as ‘‘amend[ing] existing 

regulations as needed to clarify their 

application to, and inclusion in, the 

new regulatory scheme for retail 

forex.’’ 745 More recently, 

notwithstanding the Dodd-Frank Act’s 

addition of the look-through provision 

in CEA section 1a(8)(A)(iv), the CFTC 

determined to retain the exemption 

from CPO registration under Regulation 

4.13(a)(3), reasoning that ‘‘overseeing 

entities with less than five percent 

exposure to commodity interests is not 

the best use of the Commission’s 

resources.’’ 746

Given that, shortly before the 

adoption of the Dodd-Frank Act, the 

CFTC proposed to add retail forex 

transactions to those that can be entered 

into by CPOs claiming relief from 

registration as such under CFTC 

Regulation § 4.13(a)(3), that it finalized 

that action shortly after the Dodd-Frank 

Act was adopted and that it recently left 

CFTC Regulation § 4.13(a)(3) in place 

despite having proposed to withdraw 

that CPO registration exemption, and for 

the reasons described above, the 

Commissions believe CPOs exempt from 

registration as such pursuant to CFTC 

Regulation 4.13(a)(3) and operating 

Retail Forex Pools should be able to 

continue to do so outside the retail forex 

regime. 

Section 712(d)(2)(A) of the DoddFrank Act grants the Commissions the 

authority to adopt such rules related to 

the ECP definition as the Commissions 

determine are necessary and 

appropriate, in the public interest, and 

for the protection of investors. Based on 

commenters’ views, the Commissions 

have determined that CFTC Regulation 

§ 1.3(m)(8) as adopted is necessary and 

appropriate because the statutory lookthrough provision, if strictly 

implemented, would subject Forex 

Pools operated by CPOs that are 

sophisticated, professional asset 

managers to an array of additional 

compliance costs and deprive them of 

access to swap dealers as counterparties 

when engaging in retail forex 

transactions.747 The Commissions also 

have determined that it is appropriate to 

limit the availability of ECP status under 

CFTC Regulation § 1.3(m)(8) to Forex 

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748The Commissions note that the statistics 

presented by commenters indicate that Forex Pool 

misconduct by registered CPOs and those exempt 

from CPO registration is significantly rarer than 

Forex Pool misconduct by otherwise unregistered 

CPOs. See letter from the GFXD II. 

749See letter from Sidley (showing that 6 of the 

27 cases presented involved more than $10 

million). 

750CEA section 1a(33). 

751Exchange Act section 3(a)(67). 

752As discussed above, a person may be 

designated as a dealer for particular activities 

involving swaps or security-based swaps, or 

particular swap or security-based swap activities, 

without being deemed to be a dealer with regard to 

other categories or activities. See part II.E, supra. To 

the extent that a person is subject to that type of 

limited designation as a swap dealer or securitybased swap dealer, the person may be subject to 

being a major swap participant or a major securitybased swap participant in connection with 

positions that fall outside of that limited dealer 

designation. 

753See CEA section 1a(33)(A)(ii); Exchange Act 

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

754See CEA section 1a(33)(A)(iii); Exchange Act 

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

755See CEA section 1a(33)(A)(i); Exchange Act 

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

756See CEA section 1a(33)(B) and Exchange Act 

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

757See CEA section 1a(33)(C); Exchange Act 

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

758See CEA section 1a(33)(D). 

759See Proposing Release, 75 FR at 80185. 

760 In particular, under CEA section 4s and 

Exchange Act section 15F, dealers and major 

participants in swaps or security-based swaps 

generally are subject to the same types of margin, 

capital, business conduct and certain other 

requirements, unless an exclusion applies. See CEA 

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

(5). See also CFTC, Business Conduct Standards for 

Swap Dealers and Major Swap Participants with 

Counterparties; Final Rule, 77 FR 9733 (Feb. 17, 

2012); Notice of Proposed Rulemaking: Capital 

requirements of swap dealers and major swap 

participants, 76 FR 27802 (May 12, 2011); and SEC, 

Notice of Proposed Rulemaking: Business Conduct 

Standards for Security-Based Swap Dealers and 

Major Security-Based Swap Participants, Securities 

Exchange Act Release No. 64766, 76 FR 42396 (July 

18, 2011). 

761As discussed below, the tests of the major 

participant definitions use terms—particularly 

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

financial system’’ or ‘‘create substantial 

counterparty exposure’’—that denote a focus on 

entities that pose a high degree of risk through their 

swap and security-based swap activities. In 

addition, the link between the major participant 

definitions and risk was highlighted during the 

Congressional debate on the statute. See 156 Cong. 

Rec. S5907 (daily ed. July 15, 2010) (colloquy 

between Senators Hagen and Lincoln, discussing 

how the goal of the major participant definitions 

was to ‘‘focus on risk factors that contributed to the 

recent financial crisis, such as excessive leverage, 

under-collateralization of swap positions, and a 

lack of information about the aggregate size of 

positions’’). 

Pools operated by registered CPOs or by 

CPOs exempt from registration as such 

pursuant to CFTC Regulation 

§ 4.13(a)(3).748 The conditions in CFTC 

Regulation § 1.3(m)(8) also are 

appropriate in that they require Forex 

Pools seeking ECP status thereunder to 

have total assets exceeding $10 million. 

Historically, CFTC enforcement actions 

have involved fewer instances of 

misconduct by CPOs of Forex Pools 

with total assets above this threshold.749

The Commissions have determined 

that CFTC Regulation § 1.3(m)(8) is in 

the public interest in that it will make 

available a category of counterparty (i.e., 

swap dealers) that likely would not 

otherwise be available, and help to 

assure that sophisticated, professional 

managers operating qualifying Forex 

Pools can continue to engage in retail 

forex transactions. The Commissions 

have determined that the conditions of 

CFTC Regulation § 1.3(m)(8) are 

sufficient for the protection of investors 

for the reasons discussed above, such as 

a significant reduction in the incidence 

of Forex Pool misconduct among CPOs, 

whether registered as such or exempt 

therefrom, operating Forex Pools with 

more than $10 million in total assets. 

The Commissions intend to monitor 

developments in the Forex Pool area 

and will revisit the conditions of this 

regulation as warranted by subsequent 

events. 

IV. Definitions of ‘‘Major Swap 

Participant’’ and ‘‘Major SecurityBased Swap Participant’’ 

The statutory definitions of ‘‘major 

swap participant’’750 and ‘‘major 

security-based swap participant’’751

(collectively, ‘‘major participant’’) 

encompass any person that is not a 

swap dealer or security-based swap 

dealer 752 and that satisfy any one of 

three alternative statutory tests that 

encompass a person: (i) That maintains 

a ‘‘substantial position’’ in swaps or 

security-based swaps for any of the 

major swap categories as determined by 

the Commissions; (ii) whose 

outstanding swaps or security-based 

swaps create substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the U.S. banking system or financial 

markets;753 or (iii) that is a ‘‘financial 

entity’’ that is ‘‘highly leveraged’’ 

relative to the amount of capital it holds 

(and that is not subject to capital 

requirements established by an 

appropriate Federal banking agency) 

and maintains a ‘‘substantial position’’ 

in outstanding swaps or security-based 

swaps in any major category as 

determined by the Commissions.754 The 

first—and only the first—of those three 

statutory tests explicitly excludes: (i) 

Positions held for ‘‘hedging or 

mitigating commercial risk,’’ and (ii) 

positions maintained by any employee 

benefit plan as defined in sections 3(3) 

and (32) of ERISA for the ‘‘primary 

purpose of hedging or mitigating any 

risk directly associated with the 

operation of the plan.’’755

The statutory definitions require the 

Commissions to define the term 

‘‘substantial position’’ at the threshold 

determined to be prudent for the 

effective monitoring, management, and 

oversight of entities that are 

systematically important or can 

significantly impact the financial system 

of the U.S. In setting these thresholds, 

the Commissions are required to 

consider the person’s relative position 

in uncleared as opposed to cleared 

swaps and may take into consideration 

the value and quality of collateral held 

against counterparty exposures.756

The statutory definitions further 

permit the Commissions to limit the 

scope of the major participant 

designations so that a person may be 

designated as a major participant in 

certain categories of swaps or securitybased swaps, but not all categories.757

In addition, the ‘‘major swap 

participant’’ definition excludes certain 

entities whose primary business is 

providing financing and that use 

derivatives for the purpose of hedging 

underlying commercial risks related to 

interest rate and foreign currency 

exposures, 90 percent or more of which 

arise from financing that facilitates the 

purchase or lease of products, 90 

percent or more of which are 

manufactured by the parent company or 

another subsidiary of the parent 

company.758 The ‘‘major security-based 

swap participant’’ definition does not 

contain this type of exclusion. 

As detailed in the Proposing Release, 

the major participant definitions focus 

on the market impacts and risks 

associated with a person’s swap and 

security-based swap positions.759 This 

is in contrast to the definitions of ‘‘swap 

dealer’’ and ‘‘security-based swap 

dealer,’’ which focus on a person’s 

activities and account for the amount or 

significance of those activities only in 

the context of the de minimis exception. 

However, persons that meet the major 

participant definitions in large part 

must follow the same statutory 

requirements that will apply to swap 

dealers and security-based swap 

dealers.760 In this way, the statute 

applies comprehensive regulation to 

entities whose swap or security-based 

swap activities do not cause them to be 

dealers, but nonetheless could pose a 

high degree of risk to the U.S. financial 

system generally.761

Although the two major participant 

definitions are similar, they address 

instruments that reflect different types 

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

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762See part V, infra. 

763See CEA section 1a(33)(A)(i), (iii); Exchange 

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

764See Proposing Release, 75 FR at 80186–87. 

765See proposed CFTC Regulation § 1.3(iii). 

766The statutory definition of ‘‘swap’’ lists 22 

different types of swaps. 

767See proposed Exchange Act rule 3a67–2. 

768The second category also encompasses all 

security-based swaps on narrow based indices that 

are comprised of both debt and equity components. 

769See Proposing Release, 75 FR at 80187. 

770See letter from ISDA I. 

771See letter from Freddie Mac. 

772See meeting with Professor Darrell Duffie, 

Stanford University Graduate School of Business 

(‘‘Duffie’’) on February 2, 2011. 

773See letter from Better Markets I. 

774See letter from ACLI. 

775See letters from Barnard, ISDA I and MetLife; 

see also letter from American Insurance Association 

(‘‘AIA’’) (agreeing that the defined major categories 

would cover substantially all significant swaps and 

security-based swaps). 

different purposes. Interpretation of the 

definitions must account for those 

differences as appropriate. 

The Commissions in the Proposing 

Release proposed to further define the 

‘‘major swap participant’’ and ‘‘major 

security-based swap participant’’ 

definitions, by specifically addressing: 

(i) The ‘‘major’’ categories of swaps or 

security-based swaps; (ii) the meaning 

of ‘‘substantial position’’; (iii) the 

meaning of ‘‘hedging or mitigating 

commercial risk’’; (iv) the meaning of 

‘‘substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets’’; and (v) the meanings of 

‘‘financial entity’’ and ‘‘highly 

leveraged.’’ The proposal also addressed 

the period of time that a major 

participant would have to register (as 

well as the minimum length of time for 

being a major participant), the limited 

purpose designations of major 

participants, the exclusion for ERISA 

plan hedging positions, and certain 

additional interpretive issues. 

After considering commenters’ views, 

the Commissions are adopting final 

rules further defining the meaning of 

major participant. 

As discussed below, the Commissions 

also are directing their respective staffs 

to report separately as to whether 

changes are warranted to any of the 

rules implementing the major 

participant definitions. These staff 

reports will help the Commissions 

evaluate the ‘‘major swap participant 

and ‘‘major security-based swap 

participant’’ definitions, including 

whether new or revised tests or 

approaches would be appropriate for 

identifying major participants.762

A. ‘‘Major’’ Categories of Swaps and 

Security-Based Swaps 

1. Proposed Approach 

The first and third tests of the 

statutory major participant definitions 

encompass entities that maintain a 

substantial position in a ‘‘major’’ 

category of swaps or security-based 

swaps.763

In the Proposing Release, the 

Commissions proposed to designate four 

‘‘major’’ categories of swaps and two 

‘‘major’’ categories of security-based 

swaps. These categories sought to reflect 

the risk profiles of the various types of 

swaps and security-based swaps, and 

the different purposes for which endusers use those instruments. The 

Proposing Release also noted the 

importance of not parsing the ‘‘major’’ 

categories so finely as to base the 

‘‘substantial position’’ thresholds on 

unduly narrow risks and reduce those 

thresholds’ effectiveness as risk 

measures.764

The proposed four ‘‘major’’ categories 

of swaps were rate swaps, credit swaps, 

equity swaps and other commodity 

swaps.765 Rate swaps would encompass 

any swap which is primarily based on 

one or more reference rates, such as 

swaps of payments determined by fixed 

and floating interest rates, currency 

exchange rates, or other monetary rates. 

Credit swaps would encompass any 

swap that is primarily based on default, 

bankruptcy and other credit-related 

risks related to, or the total returns on, 

instruments of indebtedness (including 

loans), including but not limited to any 

swap primarily based on one or more 

broad-based indices related to debt 

instruments, and any swap that is a 

broad-based index credit default swap 

or total return swap. Equity swaps 

would encompass any swap that is 

primarily based on equity securities, 

such as any swap primarily based on 

one or more broad-based indices of 

equity securities, including any total 

return swap on one or more broad-based 

equity indices. Other commodity swaps 

would encompass any swap not 

included in any of the first three 

categories, and would generally include, 

for example and not by way of 

limitation, any swap for which the 

primary underlying item is a physical 

commodity or the price or any other 

aspect of a physical commodity. The 

four categories were intended to cover 

all swaps, and each swap would be in 

the category that most closely describes 

the primary item underlying the 

swap.766

The Commissions proposed to 

designate two ‘‘major’’ categories of 

security-based swaps.767 The first 

category would encompass any securitybased swap that is based, in whole or in 

part, on one or more instruments of 

indebtedness (including loans), or a 

credit event relating to one or more 

issuers or securities, including but not 

limited to any security-based swap that 

is a credit default swap, total return 

swap on one or more debt instruments, 

debt swaps, or debt index swaps. The 

second category would encompass any 

other security-based swaps not included 

in the first category, including for 

example, swaps on equity securities or 

narrow-based security indices 

comprised of equity securities.768 These 

proposed categories were based on the 

different uses of these types of securitybased swaps, and were consistent with 

market statistics and infrastructures that 

distinguish between those types of 

security-based swaps.769

2. Commenters’ Views 

Certain commenters requested 

clarification regarding how the major 

categories would be applied. One 

commenter particularly requested 

additional clarity as to how the 

proposed categories will apply to mixed 

swaps and to swaps that are based on 

debt that is convertible to equity,770

while another commenter requested 

additional clarity as to the status of 

certain mortgage-related transactions.771

One commenter suggested that the 

final rules should include a catch-all 

provision to allow the Commissions to 

review large positions that appear to be 

structured to evade proper 

categorization, and that market 

participants should suggest the 

protocols for categorization of swaps or 

security-based swaps.772

One commenter suggested that the 

rate swap category should be divided 

between interest rates and currencies, 

and that energy, agriculture and metals 

swaps should be separate categories.773

Another commenter expressed the view 

that creation of a separate category for 

cross currency swaps could lead to 

confusion among market participants 

who may feel obligated to bifurcate 

cross currency swaps between two 

categories.774 Some commenters 

expressed general support for the major 

categories as proposed.775

3. Final Rules 

After considering the issue in light of 

comments received, the Commissions 

are adopting final rules designating 

‘‘major’’ categories of swaps and 

security-based swaps consistent with 

the proposal. Accordingly, the final 

rules provide that the four ‘‘major’’ 

categories of swaps are rate swaps, 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30663 

776See CFTC Regulation § 1.3(iii). The four major 

categories of swaps are the same as the asset classes 

used in the CFTC Regulations relating to SDRs and 

reporting, except that the asset classes for interest 

rate swaps and foreign exchange transactions are 

combined into the single rate swap major category 

of swaps. See CFTC, Swap Data Repositories: 

Registration Standards, Duties and Core Principles; 

Final Rule, 76 FR 54538 (Sept. 1, 2011) and Swap 

Data Recordkeeping and Reporting Requirements; 

Final Rule, 77 FR 2136 (Jan. 13, 2012). 

777The name of the first major category of 

security-based swaps has been changed to ‘‘debt 

security-based swaps’’ in this Adopting Release 

from ‘‘security-based credit derivatives’’ in the 

Proposing Release. This change more accurately 

reflects the products encompassed by this category, 

particularly total return swaps on debt instruments. 

See Exchange Act rule 3a67–2(a). 

In addition, the final rules defining the major 

categories for purposes of the major participant 

definitions remove a cross-reference to the 

corresponding dealer definitions under the CEA or 

the Exchange Act to clarify that the rules apply only 

in the context of the major participant definitions, 

and not the dealer definitions. See CFTC Regulation 

§ 1.3(iii); Exchange Act rule 3a67–2. 

778See Exchange Act rule 3a67–2(b). 

779The Commissions have proposed rules 

regarding the regulation of mixed swaps. See 

Product Definitions Proposal, note 3, supra. 

780 In the case of instruments on debt securities 

that are convertible into equity, in general we 

would expect the instrument to be categorized 

based on its status (as debt or equity) at the time 

of evaluation. 

781See CEA section 1a(33)(B); Exchange Act 

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

782See proposed CFTC Regulation § 1.3(jjj)(1); 

proposed Exchange Act rule 3a67–3(a)(1), (d). 

783See proposed CFTC Regulation § 1.3(jjj)(1); 

proposed Exchange Act rule 3a67–3(a)(2), (d). 

784See proposed CFTC Regulation § 1.3(jjj)(2)(ii); 

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

785See proposed CFTC Regulation § 1.3(jjj)(2)(iii); 

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

786See Proposing Release, 75 FR at 80190. 

787See id. at 80191–92. 

788See proposed CFTC Regulation § 1.3(jjj)(3)(iii); 

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

789See proposed CFTC Regulation 

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

3(c)(2)(ii). 

790See proposed CFTC Regulation § 1.3 

(jjj)(3)(iii)(A); proposed Exchange Act rule 3a67– 

3(c)(3)(i). This discount for daily margining would 

be available even in the presence of a threshold or 

a minimum transfer amount, so long as the 

threshold and the minimum transfer amount (if the 

latter exceeds $1 million) are separately added to 

the entity’s current exposure for purposes of the 

current exposure plus potential future exposure 

test. See proposed CFTC Regulation 

§ 1.3(jjj)(3)(iii)(B); proposed Exchange Act rule 

3a67–3(c)(3)(ii). 

791E.g., letters from BlackRock I and MFA I. 

792See letter from Better Markets I. 

793See letter from BlackRock I. 

credit swaps, equity swaps and other 

commodity swaps.776 The two ‘‘major’’ 

categories of security-based swaps are 

debt security-based swaps 777 and other 

security-based swaps.778

The Commissions believe that it is not 

necessary to further divide the proposed 

categories or add new categories for 

swaps and security-based swaps for 

purposes of the major participant 

definitions. We believe that maintaining 

a large number of narrow categories of 

swaps and security-based swaps would 

increase the possibility of confusion by 

market participants with regard to 

categorizing the swaps and securitybased swaps in which they transact. The 

Commissions also continue to believe 

that it is important not to parse the 

‘‘major’’ categories so finely as to base 

the ‘‘substantial position’’ thresholds on 

unduly narrow groupings that would 

reduce those thresholds’ effectiveness as 

risk measures. Categories that are broad 

and clearly delineated further should 

help prevent action to evade designation 

as a major participant in a particular 

‘‘major’’ category. 

While we believe that these rules in 

general are sufficiently clear to allow 

each swap and security-based swap to 

be placed in the appropriate category, 

we are mindful of the commenters’ 

request for guidance with regard to 

certain circumstances. In the case of 

mixed swaps, we would expect that the 

instrument would be placed in the 

‘‘swap’’ and ‘‘security-based swap’’ 

categories that are consistent with the 

underlying attributes that cause such 

instrument to be a mixed swap.779 Also, 

swaps or security-based swaps that are 

based on more than one item, 

instrument or risk, should be placed in 

the category that most closely describes 

the primary item, instrument or risk 

underlying the swap or security-based 

swap.780

B. ‘‘Substantial Position’’ 

1. Proposed Approach 

The major participant definitions 

require that the Commissions define a 

‘‘substantial position’’ in swaps or 

security-based swaps at a threshold that 

we determine to be ‘‘prudent for the 

effective monitoring, management, and 

oversight’’ of entities that are 

systemically important or can 

significantly impact the U.S. financial 

system. The definitions further require 

that we consider a person’s relative 

position in uncleared and cleared swaps 

or security-based swaps, and permit us 

to consider the value and quality of 

collateral held against counterparty 

exposure.781

The proposed rules provided that a 

person would have a ‘‘substantial 

position’’ in swaps or security-based 

swaps if the daily average current 

uncollateralized exposure associated 

with its swap or security-based swap 

positions in a major category in a 

calendar quarter amounted to $1 billion 

or more (or $3 billion in the case of rate 

swaps).782 A person also would have a 

‘‘substantial position’’ if the daily 

average of the sum of the current 

uncollateralized exposure plus the 

potential future exposure associated 

with its positions in a major category in 

a calendar quarter amounted to 

$2 billion or more (or $6 billion for the 

rate swap category).783

The proposed rules did not prescribe 

any particular methodology for 

measuring current exposure or valuing 

collateral posted, and instead provided 

that the method used should be 

consistent with counterparty practices 

and industry practices generally.784 The 

proposed rules also provided that an 

entity could calculate its current 

uncollateralized exposure by accounting 

for netting agreements on a 

counterparty-by-counterparty basis,785

and the Proposing Release set forth a 

method for allocating any residual 

uncollateralized exposure to a 

counterparty that remains following 

netting.786

The proposed potential future 

exposure test was based on the riskadjusted notional amount of the entity’s 

swap and security-based swap 

positions, consistent with a test used by 

bank regulators for purposes of setting 

capital standards.787 The test also 

excluded or lowered the potential 

exposure associated with certain lowerrisk positions.788 In addition, the 

measures of potential future exposure 

would be discounted by up to 60 

percent to reflect the risk mitigation 

provided by netting agreements,789 and 

would further be decreased by 80 

percent for positions subject to central 

clearing or daily mark-to-market 

margining.790

2. Commenters’ Views 

a. Basis for Regulating Major 

Participants and Alternative 

Approaches for Identifying ‘‘Substantial 

Positions’’ 

Several commenters expressed the 

view that the major participant 

definition is intended to address entities 

whose swap or security-based swap 

positions pose systemic risk,791 while 

one commenter took the contrary view 

that the definition also is intended to 

address the significance of an entity’s 

swap or security-based swap positions 

(as well as the risk those positions 

pose).792

One commenter stated that the 

proposal inappropriately sought to 

account for the risk posed by the 

potential default of multiple entities, 

rather than a single entity.793 Some 

commenters suggested that the analysis 

should account for the concentration of 

the risk posed by an entity’s 

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30664 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

794See letters from Black Rock I (suggesting a 

two-step process that accounts for the reduced risk 

associated with entities whose positions are 

distributed among several counterparties); CCMR I 

and APG Algemene Pensioen Groep NV (‘‘APG’’). 

795See letter from NYCBA Committee. 

796See letters from ABC/CIEBA (indirectly 

referring to AIG Financial Products, and noting that 

it had $400 billion in notional positions and 

defaulted when it was required to post 

approximately $100 billion in collateral); BG LNG 

I (alluding to lack of systemic impact associated 

with Enron’s failure, and suggesting that the 

Commissions convene an advisory committee to 

develop thresholds); NCGA/NGSA I (alluding to 

corporate financial losses involving derivatives that 

have exceeded the proposed thresholds without 

significantly impacting the U.S. financial system); 

ACLI (supporting increase in proposed thresholds 

under the CEA to $4 billion current uncollateralized 

exposure and $8 billion current uncollateralized 

exposure plus potential future exposure); and 

Chesapeake Energy. 

797See letters from MFA dated February 25, 2011 

(‘‘MFA II’’) (stating that thresholds initially should 

be set higher, while later survey-based thresholds 

should be based on potential systemic risk impact 

and the cost of performing the calculations); CCMR 

I (stating that the Commissions presently have 

insufficient data to determine appropriate 

thresholds, and that thresholds initially should be 

high); BlackRock I (stating that the Commissions 

should refrain from establishing thresholds if 

sufficient information is not available); and Freddie 

Mac. Two commenters particularly addressed the 

proposed thresholds applicable to rate swaps. See 

letters from ACLI and MetLife. 

798See, e.g., letters from ACLI, Fidelity, SIFMA 

AMG dated Feb. 22, 2011 (‘‘SIFMA AMG II’’) and 

Vanguard (supporting proposed limits for credit 

swaps, equity swaps and other commodity swaps, 

but not rate swaps). 

799See letters from AFR (supporting use of a 

$500 million uncollateralized exposure threshold, 

or a $1 billion current exposure plus potential 

future exposure threshold, with higher thresholds 

for rate swaps) and Greenberger. 

800See, e.g., letters from MFA I (referring to 

inflation and measures such as the amount of equity 

in the U.S. banking system) and ISDA I (referring 

to evolution of the size and fundamental 

characteristics of the markets, and changes to 

valuation methodologies and economic conditions). 

801See letters from Fidelity, ICI I, ISDA I and 

MFA I. 

802See letter from BlackRock I. Consistent with 

the proposal, the final rules contemplate the use of 

industry standard practices in the calculation of 

current exposure and potential future exposure. As 

with other rules adopted by the Commissions, a 

market participant may raise questions with the 

Commissions about the participant’s approach to 

addressing the final rules—including its use of 

particular methodologies—for further guidance as 

may be necessary or appropriate. 

803See letter from FSR I (particularly noting 

difficulty of valuing illiquid or bespoke positions). 

804See letter from Better Markets I. 

805See, e.g., letters from ACLI, CDEU and 

MetLife. 

806See letters from SIFMA AMG II and Vanguard. 

807See letters from ISDA I (specifically 

addressing securities contracts and forward 

contracts); NRG Energy (specifically addressing 

forwards); and APG (specifically addressing 

securities options and forwards). 

808See letter from FSR I. 

809See letter from Fidelity (seeking confirmation 

that ‘‘master netting agreement’’ can include an 

ISDA Master Agreement). 

810See letter from ACLI. 

811See letters from SIFMA AMG II and Vanguard. 

812See letters from FSR I and ISDA I; see also 

letter from MetLife (suggesting pro rata allocation 

of uncollateralized current exposure among each 

major category with current exposure). 

813See letters from SIFMA AMG II and Vanguard. 

814See letters from Riverside Risk Advisors LLC 

(‘‘Riverside Risk Advisors’’) (criticizing, among 

other aspects, discontinuities in table, a failure to 

account for how far a swap is in or out of the 

money, the use of a single discount factor for credit 

default swaps, the fact that the risk factor for shortterm equity swaps is lower than the risk factor for 

credit swaps, and the fact that equity swaps do not 

distinguish between high-volatility and lowvolatility stocks, as well as the failure to address 

portfolio effects of diversification and correlation, 

and ‘‘wrong-way’’ risk in the form of ‘‘an adverse 

correlation between counterparty default risk and 

the value of its derivatives contracts’’); and ISDA I 

(noting that the conversion factors were calibrated 

more than 15 years ago and were not designed for 

later instruments such as credit products). 

815See letters from Riverside Risk Advisors 

(supporting giving end-users the option to use a 

model-based approach); and Better Markets I 

(supporting use of a value-at-risk calculation). 

816See letter from ISDA I. 

817See letters from AIMA I and MFA I. 

818See letter from MetLife. 

819See letters from SIFMA AMG II and Vanguard. 

positions,794 and one commenter 

suggested that the analysis should not 

account for individual categories of 

swaps or security-based swaps.795

b. Levels of Proposed ‘‘Substantial 

Position’’ Thresholds 

A number of commenters expressed 

the view that the proposed thresholds 

are inappropriately low.796 Some 

commenters stated the thresholds 

initially should be high, with later 

revisions based on market data.797

Some commenters did not oppose the 

proposed thresholds or expressed 

support for the thresholds (though many 

of those commenters separately raised 

issues about the underlying tests),798

while two commenters supported 

lowering the proposed thresholds.799

Some commenters took the position that 

the thresholds should be adjusted over 

time to reflect factors such as inflation 

or market characteristics.800

c. Current Uncollateralized Exposure 

Test 

Measures of exposure and valuation 

of collateral—A number of commenters 

supported the Proposing Release’s 

position that the current exposure 

analysis not prescribe any methodology 

for measuring exposure or valuing 

collateral.801 On the other hand, some 

commenters requested explicit approval 

of particular methodologies,802 a good 

faith safe harbor,803 or regulatorprescribed measurement standards.804

Some commenters emphasized the need 

to be able to post non-cash collateral in 

connection with positions.805 Two 

commenters requested codification of 

the proposal’s position that operational 

delays associated with the daily 

exchange of collateral would not lead to 

current uncollateralized exposure for 

purposes of the analysis.806

Netting issues—Some commenters 

stated that the proposed netting 

provisions should be expanded to 

encompass additional products that may 

be netted for bankruptcy purposes.807

One commenter took the view that these 

provisions should be expanded across 

multiple netting agreements to the 

extent that offsets are permitted.808 One 

commenter asked for clarification as to 

the scope of the netting provisions,809

and one commenter expressed general 

support for the proposed netting 

provisions.810

Allocation of uncollateralized 

exposure—Some commenters requested 

that the final rules incorporate the 

principles, articulated in the Proposing 

Release, for allocating any 

uncollateralized exposure that remains 

following netting.811 Other commenters 

raised concerns that those principles 

were based on an unwarranted 

assumption that collateral is specifically 

earmarked to particular transactions.812

d. Potential Future Exposure Test 

General concerns and suggested 

alternative approaches—Some 

commenters disagreed with the 

Proposing Release’s statement that the 

potential future exposure analysis 

would evaluate potential changes in the 

value of a swap or security-based swap 

over the remaining life of the contract; 

those commenters stated that the test 

instead should focus on potential 

volatility during the time it would take 

for a non-defaulting party to close out a 

defaulting party’s positions.813

Some commenters criticized the 

tables setting forth the risk adjustments 

used to calculate potential future 

exposure.814 Commenters further 

suggested using, as alternatives, valueat-risk measures or other models,815 or 

the ‘‘standardized method’’ under Basel 

II.816 Commenters also argued that risk 

adjustments should provide a greater 

discount to credit swaps on ‘‘investment 

grade’’ instruments than to other credit 

swaps, that index CDS should be subject 

to a greater discount than single name 

CDS, and that there should be a lower 

discount factor for CDS of shorter 

maturity.817 One commenter generally 

supported the proposed conversion 

factors and adjustments.818

Some commenters expressed the view 

that measures of potential future 

exposure should be superseded by 

negotiated independent amounts or 

regulator-required initial margin.819

Some commenters also argued that 

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820See, e.g., letters from AIMA I, Fidelity, MFA 

I, SIFMA AMG II and Vanguard. 

821See letters from MFA I (citing fixed portions 

of interest rate swaps), MetLife (citing purchased 

options as well as CDS), ACLI and Ropes & Gray. 

822See letters from MFA I (arguing that the 

tightening of credit spreads would imply a healthy 

credit environment) and AIMA; see also meeting 

with MFA on February 14, 2011. 

823See letter from Vanguard. 

824See letter from MFA I (suggesting the possible 

use of the LIBOR/Swap rate) and AIMA I. 

825See letter from ISDA I. 

826See letter from SIFMA AMG II. 

827See letters from ACLI. 

828See, e.g., letters from MFA I, SIFMA AMG II 

and Vanguard. 

829See letters from BG LNG I, Fidelity and ICI I. 

830See letter from ISDA I. 

831See letter from FHLB I (suggesting 90 percent 

discount for cleared swaps and for uncleared swaps 

for which initial margin has been posted; 

alternatively suggesting that posted initial margin 

be subtracted from the calculated amount). 

832See letters from Fidelity and Canadian Master 

Asset Vehicle I and Master Asset Vehicle II 

(‘‘Canadian MAVs’’). 

833See letter from FHLB I (giving as an example 

swaps collateralized by security interests in real 

estate, oil or gas interests, or by first liens on 

financial assets). 

834See letter from Better Markets I; see also letter 

from AFR (generally opposing use of risk 

adjustments, but suggesting that any such discounts 

should be larger for cleared positions). 

835See letter from SIFMA AMG II. 

836See letter from CDEU (stating that the proposal 

could overstate an entity’s future exposure, and 

favoring use of the lower of the calculated potential 

future exposure or the CSA threshold); see also 

letters from SIFMA AMG II and Vanguard. 

837See letters from ACLI and MetLife. 

838See letter from Vanguard. 

839See letter from Better Markets I. 

840See letters from SIFMA AMG II and Vanguard. 

841See letters from FSR I, SIFMA AMG II and 

Vanguard. 

842See letters from MFA I and Ropes & Gray. 

843See letter from MFA I. 

844See id. 

845See joint letter from Representatives Bachus 

and Lucas. 

846See, e.g., letters from SIFMA AMG II (stating 

that the commenter’s suggested changes in 

connection with the substantial position analysis 

would reduce burdens and costs to market 

participants, and more closely align the tests with 

the objectives they are meant to achieve) and ABC/ 

CIEBA; see also letter from NFPEEU (reserving the 

right to dispute the cost-benefit analysis associated 

with the proposed dealer and major participant 

rules until all relevant Dodd-Frank Act releases 

could be analyzed as a whole). 

847See letter from CDEU. 

848See letters from ICI I, SIFMA AMG II and 

Vanguard. 

849See letter from ICI I. 

850See letter from ICI I (noting size of government 

security market and Federal Reserve control over 

supply and demand, and stating that the proposed 

thresholds are ill-suited to address the ‘‘vast’’ 

government securities market). 

851See letter from ISDA I. 

excess posted collateral or net in-themoney positions should be offset against 

potential future exposure.820

Potential future exposure measures 

for lower-risk positions—Some 

commenters stated that the proposal to 

cap potential future exposure when a 

person buys credit protection using a 

credit default swap should be expanded 

to apply to any position with a fixed 

downside risk.821 Commenters also 

suggested that the potential future 

exposure associated with purchases of 

credit protection be further 

discounted,822 while one commenter 

took the position that purchases of 

credit default swaps should be excluded 

from the potential future exposure 

test.823 Commenters also addressed the 

appropriate discount rate for calculating 

the net present value of unpaid 

premiums.824

Netting issues—One commenter 

stated that the proposal’s netting 

provisions did not adequately account 

for the risk mitigation associated with 

hedged positions,825 while another 

commenter asked that the proposed 

netting provisions be clarified and 

simplified.826 One commenter 

supported the proposed netting 

approach.827

Discount for cleared or margined 

positions—Several commenters took the 

view that cleared positions should be 

excluded entirely from the potential 

future exposure analysis, rather than 

only being subject to an 80 percent 

discount,828 and some commenters also 

supported a complete exclusion for 

positions subject to daily mark-tomarket margining.829 One commenter 

suggested a minimum 98 percent 

reduction for positions subject to central 

clearing or mark-to-market 

margining,830 while one commenter 

suggested that there be a higher 

discount for positions subject to the 

posting of initial margin.831

Some commenters also stated that 

there should be a partial discount 

provided in connection with positions 

for which mark-to-market margining is 

done less than daily,832 and that there 

should be a discount for positions that 

are margined using security interests or 

liens.833 On the other hand, one 

commenter stated that there is no basis 

for providing any discount for markedto-market positions.834

One commenter requested that the 

rule language codify language in the 

Proposing Release as to when a position 

is subject to daily mark-to-market 

margining.835 A number of commenters 

addressed proposed rule language that 

was intended to clarify that the discount 

for daily mark-to-market margining 

would be available even in the presence 

of thresholds and minimum transfer 

amounts.836

Two commenters supported the 

proposed approach in general.837 One 

commenter specifically supported the 

proposed 80 percent reduction for 

positions subject to daily mark-tomarket margining,838 and one 

commenter specifically supported a 

reduction for cleared positions.839

Additional issues regarding the 

potential future exposure test—Some 

commenters argued that the 

Commissions should clarify how the 

categories in the proposed potential 

future exposure tables would be 

applied, given how those differ from the 

proposed ‘‘major’’ categories of swaps 

and security-based swaps.840

Some commenters raised concerns 

that the proposed use of an instrument’s 

‘‘effective notional’’ amount is 

ambiguous.841 Commenters also took 

the position that for purposes of the 

potential future exposure calculation, 

notional amounts should be adjusted to 

reflect delta weighting,842 that the 

measure of duration for options on 

swaps should consider whether the 

underlying swap is cash-settled,843 and 

that the adopting release should set 

forth examples of potential future 

exposure calculations.844

e. Cost Concerns 

Some commenters emphasized the 

need to avoid an overbroad major 

participant definition, 845 and 

highlighted concerns about being 

subject to unnecessary regulation.846

f. Additional Issues 

One commenter suggested there be an 

explicit presumption against imposing 

major participant (or dealer) regulation 

on end-users.847 Some commenters 

requested that the current 

uncollateralized exposure test explicitly 

exclude cleared positions, net in-themoney positions, and fully 

collateralized out-of-the-money 

positions,848 and one commenter also 

supported excluding those positions 

from the potential future exposure 

analysis.849 That commenter also 

supported excluding swaps on 

government securities from the 

substantial position analysis.850

One commenter requested 

confirmation that dealers and major 

participants would not be required to 

compute, assist with, or verify 

computations for counterparties that 

may be major participants, and also that 

market participants can enlist thirdparty services to assist in performing the 

calculations.851 One commenter 

requested clarification that the proposed 

focus on uncollateralized exposure does 

not mean that end-users themselves 

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30666 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

852See letter from FHLB I. 

853At the same time, as discussed above in the 

context of the de minimis exception to the dealer 

definitions, we are mindful that the benefits of 

financial regulation cannot be quantified. For 

example, while the regulation of major participants 

will comprise one component of Title VII’s 

comprehensive regulatory framework that should be 

expected to help lessen the amount and frequency 

of financial crises, we cannot place a dollar figure 

on the contribution of major participant regulation 

to those benefits. In light of those factors, we 

believe that it would be ‘‘prudent’’ to regulate, as 

major participants, those persons whose swap or 

security-based swap positions are large enough to 

pose a material potential of causing significant 

counterparty impacts, consistent with the levels set 

forth in the final rules. The Commissions will 

further address the comparative costs and benefits 

associated with regulating major participants in the 

context of the substantive rules applicable to major 

participants. 

854As with the proposal, the final rules apply 

these tests to swap and security-based swap 

positions in a ‘‘major’’ category. See CFTC 

Regulation § 1.3(jjj)(1); Exchange Act rule 3a67–3(a). 

The final rules have been modified from the 

proposal, however, by removing a reference to 

‘‘positions excluded from consideration.’’ We have 

concluded that this reference is unnecessary 

because the first statutory major participant test 

explicitly provides that positions that are subject to 

the commercial risk hedging and the ERISA hedging 

exclusions of the first major participant test need 

not be considered for purposes of that test. 

855See, e.g., letter from Better Markets I. 

856We also believe that the statutory definition 

should focus on all default-related credit risks 

associated with swap or security-based swap 

positions. We do not see a basis for excluding any 

class of risks (e.g., risks associated with swaps 

based on government securities) from the analysis. 

857See letter from BlackRock I. 

858Moreover, a test that focuses on the 

concentration of an entity’s swap or security-based 

swap exposure toward one or a few individual 

parties potentially poses a tension with the view 

that interconnections of exposure among multiple 

parties are important to establishing systemic risk. 

859See letter from BlackRock I. 

860The major participant definitions specifically 

require that the term ‘‘substantial position’’ be 

defined ‘‘by rule or regulation’’ via a ‘‘threshold.’’ 

That language would not appear to anticipate the 

use of a multi-tier approach that accounts for 

subjective criteria. 

In this respect, the major participant definitions 

may be compared with section 113 of the DoddFrank Act, which authorizes the Financial Stability 

Oversight Council (‘‘FSOC’’) to provide for a nonbank financial company to be supervised by the 

Board if the FSOC ‘‘determines that material 

financial distress at the U.S. nonbank financial 

company, or the nature, scope, size, scale, 

concentration, interconnectedness, or mix of the 

activities of the U.S. nonbank financial company, 

could pose a threat to the financial stability of the 

United States.’’ Section 113 further provides that 

these designations will result from a vote of the 

FSOC based on a variety of factors. The ‘‘major 

participant’’ definition does not provide for this 

type of entity-specific determination, and we 

believe that the ‘‘major participant’’ definition more 

appropriately is implemented by objective factors 

that allow market participants to determine whether 

they will fall within the definition. 

861 In addition, the final rules provide that the 

‘‘substantial position’’ analysis that implements the 

first (and third) major participant test will be based 

on the ‘‘major’’ categories of swaps and securitybased swaps. Notwithstanding commenter concerns 

that this approach will require market participants 

to analyze their swaps and security-based swaps in 

new ways and will result in additional costs, this 

focus on ‘‘major’’ categories is dictated by the plain 

language of the statute. 

should not demand collateral from 

dealers.852

3. Final Rules 

a. Guiding Principles 

The final rules defining ‘‘substantial 

position’’ focus on identifying persons 

whose large swap and security-based 

swap positions pose market risks that 

are significant enough that it would be 

‘‘prudent’’ to regulate those persons. In 

developing these rules we have been 

mindful of the costs associated with 

regulating major participants, and have 

considered cost and benefit principles 

as part of the analysis of what level of 

swap and security-based swap positions 

reasonably form the lower bounds for 

identifying when it would be ‘‘prudent’’ 

that particular entities be subject to 

monitoring, management and oversight 

of entities that may be systemically 

important or may significantly impact 

the U.S. financial system.853

The final rules implementing the 

‘‘substantial position’’ definition follow 

the basic approach that the 

Commissions proposed, including the 

combined use of current exposure and 

potential future exposure tests.854 While 

we have carefully considered the views 

of commenters who suggested 

alternative approaches, we have 

concluded that it is appropriate to adopt 

the basic approach that was proposed, 

as described below. 

• Focus on default-related credit 

risks. The final rules implement tests 

that seek to reflect the credit risk that a 

person’s swap or security-based swap 

positions would pose in the event of 

default. In arguing that the analysis 

should consider factors in addition to 

default-related risks, commenters have 

noted that certain regulations applicable 

to major participants address business 

conduct issues that are distinct from 

systemic risk issues.855 We nonetheless 

believe that the statutory definition of 

‘‘substantial position’’ indicates that the 

analysis should focus on default-related 

credit risks, because a default-related 

approach is more closely linked to the 

statutory criteria that the definition 

focus on entities that are ‘‘systemically 

important’’ or can ‘‘significantly 

impact’’ the U.S. financial system than 

would be an approach that focuses on 

the potential for disruptive market 

movements.856

• Failure of multiple entities close in 

time. The final rules that implement the 

‘‘substantial position’’ definition seek to 

reflect the risks that would be posed by 

the default of multiple entities close in 

time. Although one commenter took the 

view that the purpose of major 

participant regulation is to prevent the 

credit exposure of a single person from 

having a systemic impact,857 we do not 

believe that the major participant 

definitions should be construed so 

narrowly. The events of recent years 

demonstrate that market stress may lead 

to the failure and near-failure of 

multiple entities with large financial 

positions over a relatively short time 

period. We do not believe that it would 

be prudent or well-reasoned to presume 

that recent history cannot repeat itself, 

and to assume that future failures of 

entities with large financial positions 

will be isolated events. 

• Aggregate risk. The final rules 

address the aggregate risk posed by an 

entity’s swap or security-based swap 

positions, rather than seeking to focus 

on principles of concentration (such as 

by using a threshold that addresses an 

entity’s largest exposure to an 

individual counterparty) or on converse 

principles of interconnection. The 

statutory ‘‘substantial position’’ 

definition is specifically written in 

terms of market risk concerns (i.e., 

‘‘systemically important’’ and ‘‘can 

significantly impact the financial system 

of the United States’’), and measures of 

aggregate risk appear to be best geared 

to reflect this standard.858

• Use of objective, quantitative 

criteria. The final rules provide for a 

‘‘substantial position’’ analysis that is 

based on objective, quantitative criteria 

that would permit a market participant 

to determine which level of swap or 

security-based swap positions would 

cause it to be a major participant. 

Although one commenter has suggested 

the use of a two-step approach that uses 

thresholds as a safe harbor and that 

would be accompanied by a secondlevel determination,859 we do not 

believe that such an approach would be 

consistent with the statutory language or 

with principles of regulatory 

efficiency.860 Accordingly, a person 

whose swap or security-based swap 

positions satisfy the applicable 

thresholds will be a major participant, 

with no further layer of review 

provided.861

b. Current Uncollateralized Exposure 

Test 

Consistent with the proposal, the final 

rules implementing the ‘‘substantial 

position’’ definition include a test that 

accounts for the current uncollateralized 

exposure posed by an entity’s swap or 

security-based swap positions in a major 

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862CFTC Regulation § 1.3(jjj)(1); Exchange Act 

rule 3a67–3(b)(2). The final rules contain technical 

changes from the proposal to clarify the steps 

entailed by this calculation. 

863See Proposing Release, 75 FR at 80188. 

864As we noted in the Proposing Release, we 

recognize that there may be operational delays 

between changes in exposure and the resulting 

exchanges of collateral, and in general we would 

not expect that operational delays associated with 

the daily exchange of collateral would be 

considered to lead to uncollateralized exposure for 

these purposes. See Proposing Release, 75 FR at 

80189 n.92. Although we are not codifying this 

principle within the final rules, we will be mindful 

of the principle when enforcing those rules. 

865CFTC Regulation § 1.3(jjj)(2); Exchange Act 

rule 3a67–3(b)(2). 

866CFTC Regulation § 1.3(jjj)(2); Exchange Act 

rule 3a67–3(b)(1). As we noted in the Proposing 

Release, collateral may be posted to a third-party 

custodian, directly to the counterparty, or in 

accordance with the rules of a derivatives clearing 

organization or clearing agency. See Proposing 

Release, 75 FR at 80189 n.94. 

867See letters from BlackRock I, Better Markets I 

and FSR I. 

868These principles should apply even in the 

case of valuing illiquid or bespoke positions. 

Market participants have the flexibility to use 

commercially reasonable approaches that are 

consistent with their financial statements, tax 

calculations and compliance with other regulations. 

869For non-cash collateral to be considered for 

purposes of these calculations, the collateral must 

be available for the counterparty’s use if the entity 

posting the collateral were to default. At a 

minimum, this would require that the counterparty 

possess a perfected security interest in that 

collateral. As we noted in the Proposing Release, 

while we expect that other regulatory requirements 

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

relevant to certain calculations relating to major 

participant status, these rules would not necessarily 

be relevant for other purposes, such as in the 

context of capital and margin requirements. See 

Proposing Release, 75 FR at 80189 n.95. 

870CFTC Regulation § 1.3(jjj)(2)(iii); Exchange Act 

rule 3a67–3(b)(3)(i). This provision provides for 

netting under the master netting agreement of any 

instruments, contracts or agreements (including 

contracts on physical commodities), that would 

qualify for netting under applicable bankruptcy 

law. As we noted in the Proposing Release, the 

proposed rules regarding possible offsets of various 

positions are for purposes of determining major 

participant status only. Other rules proposed by the 

Commissions may address the extent to which, if 

any, persons such as dealers and major participants 

may offset positions for other purposes. See 

Proposing Release, 75 FR at 80189 n.98. As 

proposed, Exchange Act rule 3a67–3(b)(3)(i) 

referred to ‘‘security-based swaps (in any swap 

category)’’; this reference has been revised in the 

final rule to ‘‘security-based swaps (in any securitybased category).’’ 

871CFTC Regulation § 1.3(jjj)(2)(iii); Exchange Act 

rule 3a67–3(b)(3)(ii). 

872The fact that positions with third parties do 

not offset exposure to a particular counterparty was 

recently highlighted by a decision finding that the 

Bankruptcy Code does not permit excess collateral 

held by one creditor to offset amounts that the 

debtor owed to the creditor’s affiliates. See In re 

Lehman Brothers Inc., Case No. 08–01420 (JMP) 

(SIPA), slip op. (Bankr. S.D.N.Y Oct. 4, 2011). 

category.862 This provides a measure of 

the amount of potential risk that an 

entity would pose to its counterparties 

if the entity currently were to default.863

As with the proposal, a person would 

apply this test by examining the 

positions it maintains with each of its 

counterparties in a particular major 

category of swaps or security-based 

swaps. For each counterparty, the 

person would determine the dollar 

value of the aggregate current exposure 

arising from each of its swap or securitybased swap positions with negative 

value in that major category by markingto-market using industry standard 

practices, and deduct from that amount 

the aggregate value of the collateral the 

entity has posted with respect to the 

swap or security-based swap 

positions.864 The ‘‘aggregate 

uncollateralized outward exposure’’ 

would be the sum of those 

uncollateralized amounts over all 

counterparties with which the person 

has entered into swaps or security-based 

swaps in that major category.865

The final rules implementing this test 

largely are the same as the rules the 

Commissions proposed, but with certain 

modifications to address issues raised 

by commenters. 

i. Measure of Exposure and Valuation of 

Collateral 

Consistent with the proposal, the final 

rules do not prescribe any particular 

methodology for measuring current 

exposure or for valuing collateral 

posted, but instead require the use of 

industry standard practices.866 In this 

regard we do not concur with 

commenter requests that we approve or 

prescribe particular methodologies, or 

provide a safe harbor for measures or 

valuations made in good faith.867

Instead, it is appropriate that the final 

rules provide market participants with 

the flexibility to use the same 

methodologies that they use in 

connection with their business 

activities. Accordingly, we would 

expect entities to value current 

uncollateralized exposure based on the 

amounts that would be payable if the 

transaction were terminated. 

To the extent the measure of exposure 

or the valuation of collateral is subject 

to other rules or regulations, we also 

would expect those measures and 

valuations for purposes of the major 

participant calculations to be consistent 

with those other applicable rules.868 In 

addition, the ‘‘substantial position’’ 

analysis may take into account the 

posting of non-cash collateral to the 

extent that the posting of such 

collateral, and the valuation of that 

collateral, is consistent with industry 

standard practices or applicable 

regulation.869

ii. Netting 

The final rules build upon the 

proposal with regard to the measure of 

uncollateralized current exposure in the 

presence of netting arrangements. In 

particular, to address commenter 

concerns these provisions have been 

modified from the proposal to account 

for the fact that two counterparties may 

have multiple netting agreements for 

which offsets are permitted, and to 

extend the netting principles to any 

financial instruments that may be netted 

for purposes of applicable bankruptcy 

law (rather than limiting those 

instruments to swaps, security-based 

swaps and securities financing 

transactions). 

Accordingly, the final rules provide 

that an entity may calculate its exposure 

on a net basis by applying the terms of 

one or more master netting agreements 

with a counterparty. The entity may 

account for offsetting positions entered 

into with that particular counterparty 

involving swaps or security-based 

swaps as well as securities financing 

transactions (consisting of securities 

lending and borrowing, securities 

margin lending and repurchase and 

reverse repurchase agreements), and 

other financial instruments and 

agreements that are subject to netting 

offsets for purposes of applicable 

bankruptcy law, to the extent consistent 

with the offsets provided by those 

master netting agreements.870 These 

revisions should permit the current 

uncollateralized exposure test to more 

accurately reflect the degree of credit 

risk that an entity poses to its 

counterparty in the event of default. 

As discussed in the proposal, these 

netting provisions apply only to 

offsetting positions with a single 

counterparty.871 The provisions do not 

extend to the market risk offsets 

associated with an entity’s positions 

with multiple counterparties, because 

such offsets would not directly mitigate 

the risks that an individual counterparty 

would face in the event of the entity’s 

default.872

iii. Allocation of Uncollateralized 

Exposure Following Netting 

The final rules build upon the 

proposal by codifying the method, 

discussed in the Proposing Release, 

related to the allocation of any 

uncollateralized exposure that remains 

following netting and the posting of 

collateral. This type of allocation can be 

necessary because, with netting, it 

otherwise may not be possible to 

directly attribute residual 

uncollateralized exposure to a particular 

major category of swap or security-based 

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873Such allocation would not be necessary, of 

course, to the extent that an entity has no current 

uncollateralized exposure to a counterparty 

following netting and the posting of collateral. 

874See letters from SIFMA AMG II and Vanguard. 

875CFTC Regulation § 1.3(jjj)(2)(iii)(A); Exchange 

Act rule 3a67–3(b)(4). Under this formula, for 

example, if an entity’s exposure to a particular 

counterparty is $120 million after accounting for 

netting and the posting of collateral, and, subject to 

netting, the entity has $40 million in out-of-themoney positions in security-based credit 

derivatives, $90 million in out-of-the-money 

positions in other security-based swaps, and $120 

million in out-of-the money positions in swaps and 

other instruments subject to the netting agreements, 

then $19.2 million in net uncollateralized exposure 

would be attributed to the ‘‘security-based credit 

derivatives’’ category (equal to $120 million · ($40 

million/($40 million + $90 million + $120 million)), 

and $43.2 million in net uncollateralized exposure 

would be attributed to the ‘‘other security-based 

swaps’’ category (equal to $120 million · ($90 

million/($40 million + $90 million + $120 million)). 

876Although one commenter suggested that the 

analysis should further consider whether there are 

collateral posting requirements that are specific to 

a particular position, we believe that the test we are 

adopting is flexible enough to address that 

possibility. To the extent that the parties’ collateral 

arrangements provide that collateral be earmarked 

to particular swap or security-based swap positions, 

an entity may calculate its potential future exposure 

with respect to that counterparty with regard to the 

applicable major category of swaps or securitybased swaps, without accounting for netting across 

categories or instruments. 

877See letters from ICI I, SIFMA AMG II and 

Vanguard. 

878See Proposing Release, 75 FR at 80189 n.92. 

879Moreover, to the extent that such positions are 

associated with uncollateralized amounts, such as 

those that arise from thresholds or minimum 

transfer amounts pursuant to the applicable credit 

support annex, then those amounts present 

counterparty risk that should be considered as part 

of the major participant analysis. 

880Under that allocation approach, if none of the 

entity’s swap or security-based swap positions in a 

major category with that counterparty are out-ofthe-money, then none of the current exposure 

resulting from the netting agreement would be 

attributed to that major category. 

881CFTC Regulation § 1.3(jjj)(3); Exchange Act 

rule 3a67–3(c). 

882See Proposing Release, 75 FR at 80188. 

883See id. at 80191. 

884See letters from SIFMA AMG II and Vanguard. 

885See CFTC Regulation § 1.3(jjj)(3)(ii)(A)(1); 

Exchange Act rule 3a67–3(c)(2)(i). 

886See 12 CFR part 3, app. C, section 32 (Office 

of the Comptroller of the Currency capital adequacy 

guidelines for banks); 12 CFR part 325, app. D, 

section 32 (Federal Deposit Insurance Corp. capital 

adequacy guidelines for banks); 12 CFR part 208, 

app. F, section 32 (Federal Reserve System capital 

swap.873 Some commenters have 

requested that the final rules codify this 

method to provide more certainty to 

market participants.874

Accordingly, the final rules 

incorporate a formula which, for 

purposes of the substantial position 

analysis, provides that the amount of 

net uncollateralized exposure that is 

attributable to a particular major 

category of swap or security-based swap 

would be allocated pro rata in a manner 

that compares the amount of the entity’s 

out-of-the-money positions in that major 

category to its total out-of-the-money 

positions in all categories that are 

subject to the netting arrangements with 

that counterparty.875 This approach 

does not require that any collateral be 

specifically earmarked to particular 

swaps or security-based swaps, and can 

be followed so long as collateral is 

posted based on the net exposure 

associated with all instruments subject 

to the applicable netting agreements 

with that particular counterparty.876

iv. Application of Current Exposure Test 

to Cleared, Fully Collateralized or Net 

In-the-Money Positions 

Although certain commenters have 

requested that the current 

uncollateralized exposure test explicitly 

exclude swap or security-based swap 

positions that are cleared, fully 

collateralized or net in-the-money,877

the final rules do not provide such 

exclusions. As we recognized in the 

Proposing Release, centrally cleared 

swaps and security-based swaps are 

subject to mark-to-market margining 

that would largely eliminate the 

uncollateralized exposure associated 

with a position, effectively resulting in 

the cleared position being excluded 

from the analysis.878 Also, by definition, 

fully collateralized positions are not 

associated with current uncollateralized 

exposure, and thus would be excluded 

from the analysis. As such, we do not 

believe that it would be necessary to 

explicitly exclude such positions from 

the analysis.879

Similarly, we do not believe that it is 

necessary for the rules to explicitly 

exclude net in-the-money swap or 

security-based swap positions. If an 

entity does not have any current 

uncollateralized exposure to a particular 

counterparty—after accounting for the 

entity’s netting agreement with that 

counterparty and the posting of 

collateral—then the entity may 

disregard its positions with that 

counterparty for purposes of calculating 

current uncollateralized exposure. 

Otherwise, it is appropriate to consider 

the contribution of all swaps or securitybased swaps to current uncollateralized 

exposure, as determined by the 

allocation methodology discussed 

above.880

c. Potential Future Exposure Analysis 

The ‘‘substantial position’’ analysis 

also will consider an entity’s ‘‘aggregate 

potential outward exposure,’’ which 

would reflect the potential exposure of 

the entity’s swap or security-based swap 

positions in the applicable ‘‘major’’ 

category of swap or security-based 

swaps, subject to certain adjustments.881

The final rules implementing this test in 

general follow the proposed approach, 

but have been revised to address 

commenter concerns. 

i. Purpose Underlying the Potential 

Future Exposure Test 

As discussed in the proposal, a 

potential future exposure test addresses 

the fact that a sole focus on current 

uncollateralized exposure could fail to 

identify risky entities until some time 

after they begin to pose the level of risk 

that should subject them to regulation as 

major participants.882 A potential future 

exposure test would allow the 

substantial position analysis to account 

for this risk by addressing how the value 

of an entity’s swap or security-based 

swap positions may move against the 

entity over time.883

Accordingly, consistent with the 

proposal, the final rules incorporate a 

potential future exposure test that seeks 

to estimate how much the value of 

swaps or security-based swaps might 

change against an entity over the 

remaining life of the contract. Although 

some commenters took the view that 

this test should only address potential 

volatility during the period of time it 

would take for a non-defaulting party to 

close out positions and liquidate 

collateral,884 we believe that it is more 

appropriate for the analysis to consider 

the risks that swaps or security-based 

swap positions pose over the lives of 

those positions. An exclusive focus on 

short-term risks would fail to account 

for the possibility that an entity’s large 

swap or security-based swap positions 

can readily produce large losses in 

adverse market circumstances, 

potentially leading either to large 

uncollateralized exposure (if the posting 

of collateral is not required), or to large 

collateral calls that may lead to the 

entity’s default (or to calls for 

extraordinary action) and that can 

threaten non-defaulting parties with 

significant costs and challenges in 

connection with liquidating and 

replacing those positions. The analysis 

should give appropriate weight to those 

risks. 

ii. Risk Multipliers 

Subject to modifications addressed 

below, the final rules implementing the 

‘‘substantial position’’ analysis 

incorporate a potential future exposure 

test based on the proposal’s general 

approach of adjusting notional positions 

using risk multipliers.885 This approach 

incorporates and builds upon tests used 

by bank regulators for the purposes of 

setting prudential capital.886 Through 

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adequacy guidelines for banks); 12 CFR part 225, 

app. G, section 32 (Federal Reserve System capital 

adequacy guidelines for bank holding companies). 

887See letters from Riverside Risk Advisors and 

Better Markets I. 

888See, e.g., letters from Riverside Risk Advisors 

and MFA I. 

889We also are not following a commenter 

suggestion to incorporate the ‘‘standardized 

method’’ prescribed as part of the ‘‘Basel II’’ bank 

capital methodology. See letter from ISDA I. The 

standardized method relies on counterparty credit 

ratings provided by external credit rating agencies 

for purposes of calculating risk-weighted capital 

measurements. See ‘‘International Convergence of 

Capital Measurement and Capital Standards, A 

Revised Framework, Comprehensive Version,’’ the 

Basel Committee on Banking Supervision, June 

2006. Incorporating this reliance on credit ratings 

provided by external credit rating agencies into 

these final rules would be inconsistent with Section 

939A of the Dodd-Frank Act, which required all 

Federal agencies to review and modify existing 

regulations ‘‘to remove any reference to or 

requirement of reliance on credit ratings and to 

substitute in such regulations such standard of 

credit-worthiness as each respective agency shall 

determine as appropriate for such regulations.’’ 

890See Exchange Act rule 3a67–3(c)(2)(i). Aside 

from making the risk multipliers consistent with the 

‘‘major’’ categories of security-based swaps, this 

change also should allow total return swaps on debt 

to be subject to the same risk multipliers as total 

return swaps on equity, rather than causing the debt 

swaps to be subject to higher multipliers (which 

may not accurately reflect the comparative risks of 

those instruments). 

891See CFTC Regulation § 1.3(jjj)(3)(ii)(A)(3)(ii); 

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

892See CFTC Regulation § 1.3(jjj)(3)(ii)(A)(4); 

Exchange Act rule 3a67–3(c)(2)(i)(D). The proposed 

rules would have applied this net present value 

caps only to the purchase of credit protection. The 

final rules expand this provision by also capping 

the potential future exposure associated with the 

purchases of options in which an entity retains 

payment obligations, to reflect the reduced risk 

associated with those positions. 

893CFTC Regulation § 1.3(jjj)(3)(ii)(A)(3)(iii); 

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

exclusion of such positions from the major 

participant analysis may apply, for example, to 

certain swap or security-based swap positions of 

insurers where applicable law requires an amount 

equal to the maximum possible exposure of the 

insurer be segregated. 

894See letter from SIFMA AMG II. 

895Consistent with the proposal, the effects of 

netting are to be estimated using the formula: P Net 

= 0.4 × P Gross + 0.6 × NGR × P Gross. Under that 

equation, P Net is the potential exposure adjusted 

for bilateral netting; P Gross is that potential 

outward exposure without adjustment for bilateral 

netting; and NGR is the net to gross ratio. The final 

rule has been revised from the proposal to clarify 

that the net to gross ratio equals the current 

exposure associated with the major category as 

calculated using the pro rata methodology 

discussed above, divided by what the measure of 

current exposure in connection with those out-ofthe-money positions would be in the absence of that 

methodology. 

Accordingly, for the example set forth in note 

875, supra, the NGR for ‘‘security-based credit 

derivatives’’ and ‘‘other security-based swaps’’ both 

would equal 0.48 (equal to $19.2 million net 

Continued 

this methodology, the final rules 

implement an objective approach that 

readily can be replicated by market 

participants. 

Although some commenters have 

suggested the use of value-at-risk 

measures or internal models to evaluate 

potential future exposure,887 we do not 

believe that such approaches would be 

well tailored to be implemented by a 

range of market participants, or would 

lead to comparable results across market 

participants with identical swap or 

security-based swap portfolios. 

In adopting this approach, we are 

mindful of the significance of 

commenter concerns about the 

adequacy of the tables that set forth the 

risk multipliers that would be applied to 

notional positions. These comments 

address, among other issues: 

discontinuities in the tables; the failure 

to account for whether, and how much, 

a swap or security-based swap is in-themoney or out-of-the money; the failure 

of the multipliers applicable to interest 

rate swaps to distinguish between 

counterparties who pay floating rates 

and counterparties who pay fixed rates; 

the failure of the multipliers in the 

credit category to account for the 

volatility of the underlying instrument 

or the duration of the swap or securitybased swap; the failure of the 

multipliers for equity and commodity 

swaps to distinguish between highvolatility and low-volatility stocks and 

commodities; the adequacy of how the 

test addresses diversification and 

correlation; the fact that the approach 

does not provide for delta weighting of 

options positions; and the fact that the 

factors do not distinguish between 

index and single-name credit default 

swaps.888 While we acknowledge that it 

may be possible to develop revised risk 

multipliers that are more finely tuned to 

reflect relevant risk factors, at this time 

we believe that it would be most 

appropriate to implement the 

‘‘substantial position’’ analysis by 

building upon an existing regulatory 

approach that is comparatively simpler 

to implement and leads to reproducible 

results, rather than seeking to develop a 

brand new approach.889

The final rules implementing the 

‘‘major security-based swap participant’’ 

definition, however, modify the 

proposed risk multipliers in response to 

commenter concerns about how the 

‘‘major’’ categories of security-based 

swaps should be applied to the risk 

multiplier categories. In particular, the 

final risk multiplier category for 

security-based swaps in the ‘‘equity and 

other’’ category encompasses all 

security-based swaps that are not credit 

derivatives, and the final rules eliminate 

the proposed category for ‘‘other’’ types 

of security-based swaps.890

iii. Potential Future Exposure Measures 

for Certain Lower-Risk Positions 

Consistent with the proposal, the 

potential future exposure calculation 

will exclude purchases of options and 

other positions for which a person has 

prepaid or otherwise satisfied its 

payment obligations.891 Also, in 

response to commenter concerns, the 

final rules expand on the proposal with 

regard to capping the potential future 

exposure associated with certain lowerrisk swap and security-based swap 

positions. The final rules particularly 

cap—at the net present value of the 

unpaid premiums—the potential future 

exposure associated with positions by 

which a person buys credit protection 

using a credit default swap, and 

positions by which a person purchases 

an option for which the person retains 

additional payment obligations under 

the position.892 This reflects the 

reduced risk associated with such 

positions. The final rules do not 

prescribe a particular discount rate for 

purposes of this analysis, and market 

participants instead should use a 

commercially appropriate discount rate. 

In addition, to better align the results 

of the potential future exposure analysis 

with the risks that a person presents, the 

final rules have been modified from the 

proposal to also exclude swap or 

security-based swap positions for 

which, pursuant to regulatory 

requirement, a person has placed in 

reserve an amount of cash or Treasury 

securities that is sufficient to pay the 

person’s maximum possible liability 

under the position, when the person is 

prohibited from using that cash or those 

securities without also liquidating the 

swap or security-based swap 

position.893

iv. Adjustments for Netting 

Consistent with the proposal, and 

with the bank regulator standards that 

form the basis for these potential future 

exposure measures, the final rules 

provide that an entity may reduce the 

measure of its potential future exposure 

in a major category by up to 60 percent 

to reflect the risk mitigation effects of 

master netting agreements. We believe 

that this approach appropriately reflects 

the risk mitigating attributes of netting 

on potential future exposure. Moreover, 

in light of commenter requests for 

clarification of how these netting 

provisions would be applied,894 the 

final rules have been revised from the 

proposal to provide that the risk 

reduction associated with netting 

should be estimated using the same pro 

rata allocation methodology that will be 

used to measure current exposure.895

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30670 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

exposure divided by $40 million in out-of-themoney positions in the case of ‘‘security-based 

credit derivatives,’’ or $43.2 million net exposure 

divided by $90 million in out-of-the-money 

positions in the case of ‘‘other security-based 

swaps’’). If an entity has no current exposure to a 

counterparty following the application of netting 

arrangements and collateralization, the NGR for 

those positions would equal zero, and the potential 

exposure would equal 40 percent of what it would 

equal otherwise. 

896See CFTC Regulation § 1.3(jjj)(3)(iii)(A); 

Exchange Act rule 3a67–3(c)(3)(i). The final rules 

further have been revised to clarify that the 0.1 

factor applies to positions cleared by a registered 

clearing agency or by a clearing agency that has 

been exempted from registration. 

897See, e.g., letters from MFA I and SIFMA AMG 

II. 

898Central clearing helps to mitigate counterparty 

credit risk by improving risk management and, 

among other things, mutualizing the risk of 

counterparty failure. If multiple members of a 

central counterparty fail beyond the level to which 

such risk is managed, however, the central 

counterparty would also be at risk of failure. Cf. 

Basel Committee on Banking Supervision, 

Consultative Document, ‘‘Capitalisation of bank 

exposures to central counterparties,’’ Nov. 25, 2011 

(available at: http://www.bis.org/publ/bcbs206.pdf) 

(proposing that the capital charge for trade 

exposures to a qualifying central counterparty 

should carry a low risk weight, reflecting the 

relatively low risk of default of the qualifying 

central counterparty). In addition, as we discussed 

in the Proposing Release, see 75 FR at 80192 n.115, 

for example, central counterparties that clear credit 

default swaps do not necessarily become the 

counterparties of their members’ customers 

(although even absent direct privity those central 

counterparties benefit customers by providing for 

protection of collateral they post as margin, and by 

providing procedures for the portability of customer 

positions in the event of a member’s default). As a 

result, central clearing may not eliminate the 

counterparty risk that the customer poses to the 

member, although required mark-to-market 

margining should help control that risk, and central 

clearing would be expected to reduce the likelihood 

that an entity’s default would lead to broader 

market impacts. 

899See letter from Better Markets I; see also letter 

from AFR. 

900We do not believe that it is appropriate to have 

this type of discount when mark-to-market 

margining is done less than daily, however. 

901We recognize that at times, market 

participants whose agreements provide for the daily 

exchange of variation margin in connection with 

swaps or security-based swaps in practice may not 

exchange collateral daily, if the amounts at issue are 

relatively small (such as through the use of 

collateral thresholds and minimum transfer 

amounts). We do not believe that such practices 

would be inconsistent with providing a discount for 

daily margining practices. The proposed rules 

sought to accommodate those practices by 

providing that positions would be considered to be 

subject to daily mark-to-market margining for 

purposes of the ‘‘uncollateralized outward 

exposure’’ plus ‘‘potential outward exposure’’ 

analysis, so long as the total of such thresholds, and 

the total of such minimum transfer amounts above 

$1 million are deemed to be ‘‘uncollateralized 

outward exposure’’ for those purposes. 

In light of commenter concerns, which indicated 

that the proposal was not fully clear about the 

mechanics and purpose of this approach, the 

relevant rule language has been revised to clarify 

that this attribution of thresholds and minimum 

transfer amounts is solely for the purpose of 

determining whether certain positions are subject to 

daily mark-to-market margining for purposes of the 

analysis. In addition, the final rules have been 

revised from the proposal to provide that the 

attribution of thresholds as ‘‘uncollateralized 

outward exposure’’ for these purposes will be 

reduced by initial margin posted, up to the amount 

of the threshold. See CFTC Regulation 

§ 1.3(jjj)(iii)(B); Exchange Act rule 3a67–3(c)(3)(ii). 

902As discussed above, this may occur, for 

example, if the exchange of payments associated 

with an equity swap is based on a multiple of the 

return associated with the underlying equity. As is 

the case for measuring current exposure, the final 

rules do not prescribe any particular methodology 

for calculating the notional amount or effective 

notional amount used in the calculation of potential 

future exposure, but instead contemplate the use of 

industry standard practices. 

903See Proposing Release, 75 FR 80192 n.110. 

904The effective notional amount of the 

underlying instrument is used for these purposes 

because that amount fairly reflects the basis for 

measuring the potential counterparty risk 

associated with the instrument. The sum of the 

v. Adjustments for Cleared and 

Margined Positions 

The final rules also provide for the 

measure of potential future exposure to 

be adjusted in the case of swap and 

security-based swap positions that are 

centrally cleared or that are subject to 

daily mark-to-market margining. This is 

consistent with the purpose of the 

potential future exposure test, which is 

to account for the extent to which the 

current outward exposure of positions 

(though possibly low or even zero at the 

time of measurement) might grow to 

levels that can lead to high counterparty 

risk to counterparties or to the markets 

generally. The practice of the periodic 

exchange of mark-to-market margin 

between counterparties helps to mitigate 

the potential for large future increases in 

current exposure. 

Consistent with the proposal, the final 

rules reflect this ability to mitigate risk 

by providing that the potential future 

exposure associated with positions that 

are subject to daily mark-to-market 

margining will equal 0.2 times the 

amount that otherwise would be 

calculated. However, in response to 

commenters’ opinions about the riskmitigating effects of central clearing, 

and the additional level of rigor that 

clearing agencies may have with regards 

to the process and procedures for 

collecting daily margin, the final rules 

further provide that the potential future 

exposure associated with positions that 

are subject to central clearing will equal 

0.1 (rather than the proposed 0.2) times 

the potential future exposure that would 

otherwise be calculated.896

Although some commenters 

supported the complete exclusion of 

cleared positions from the potential 

future exposure analysis,897 and we are 

mindful of the risk mitigating attributes 

of central clearing, we also recognize 

that central clearing cannot reasonably 

be expected to entirely eliminate 

counterparty risk.898 We conclude, 

however, that the use of a 0.1 factor (in 

lieu of the proposed 0.2) would be 

appropriate for cleared positions, 

reflecting the strong risk mitigation 

features associated with central clearing, 

particularly the procedures regarding 

the collection of daily margin and the 

use of counterparty risk limits, while 

recognizing the presence of some 

remaining counterparty risk. 

Moreover, although some commenters 

opposed any deduction from the 

measure of potential future exposure for 

uncleared positions that are margined 

on a daily basis,899 we believe that the 

risk-mitigating attributes of daily 

margining warrant an adjustment given 

that the goal of the potential future 

exposure test is to account for price 

movements over the remaining life of 

the contract.900 The use of a 0.2 factor 

also reflects our expectation that the risk 

mitigation associated with uncleared 

but margined positions would be less 

than the risk mitigation associated with 

cleared positions. 

While higher or lower alternatives to 

the 0.1 and 0.2 factors may also be 

reasonable for positions that are cleared 

or margined on a daily basis, we believe 

that the factors of the final rules 

reasonably reflects the risk mitigating 

(but not risk eliminating) features of 

those practices. The final rules also 

retain and clarify provisions addressing 

when daily mark-to-market margining 

occurs for purposes of this discount.901

vi. Application of ‘‘Effective Notional’’ 

Amounts 

Consistent with the proposal (as well 

as the rules implementing the de 

minimis exception to the dealer 

definitions), the potential future 

exposure test is based on the ‘‘effective 

notional’’ amount of the swap or 

security-based swap when the stated 

notional is leveraged or enhanced by the 

structure of the swap or security-based 

swap.902

Moreover, as discussed in the 

Proposing Release,903 in the case of 

positions that represent the sale of an 

option on a swap or security-based swap 

(other than the sale of an option 

permitting the person exercising the 

option to purchase a credit default 

swap), we would view the effective 

notional amount of the option as being 

equal to the effective notional amount of 

the underlying swap or security-based 

swap, and in general we would view the 

duration used for purposes of the 

formula as being equal to the sum of the 

duration of the option and the duration 

of the underlying swap or securitybased swap.904

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duration of the option and the underlying 

instrument is used for these purposes because that 

sum reflects the length of time of the potential 

counterparty risk associated with the instrument. 

At the same time, we agree with a commenter’s 

view that if the underlying swap or security-based 

swap is cash settled, the calculation of duration will 

only include the duration of the option, and not the 

duration of the swap, because counterparty 

exposure would exist only until the option 

expiration date. See letter from MFA I. 

905For example, if a person writes a CDS that 

provides $10 billion in protection on a reference 

entity, with the CDS being subject to daily markto-market margining, then for purposes of the 

substantial position analysis that CDS would be 

associated with a potential future exposure measure 

of no more than $200 million (reflecting the 0.1 

conversion factor and the additional 0.2 multiplier 

for margined positions), even before accounting for 

netting. Yet if the reference entity were to default, 

the writer of the CDS could pose up to $10 billion 

in credit risk to its counterparty. 

906However, as discussed above, see note 901, 

supra, initial margin may be considered when 

determining if a collateral threshold is to be 

attributed to current uncollateralized exposure for 

purposes of determining whether certain positions 

are subject to daily mark-to-market margining for 

purposes of the substantial position analysis. 

907CFTC Regulation § 1.3(jjj)(1). 

908Exchange Act rule 3a67–3(a). 

909As discussed above, we do not believe it 

would be prudent to presume that entity failures 

will be separated in time during periods of financial 

stress. 

910See letters from BlackRock I and CCMR I. 

911See letter from ABC/CIEBA. One commenter’s 

analogy to Enron also is unpersuasive. See letter 

from BG LNG I. In particular, the $18.7 billion in 

Enron derivatives exposure cited by that commenter 

does not account for collateral posted in connection 

with those positions. Also, the market impact of 

Enron’s bankruptcy was substantially mitigated by 

the sale of Enron’s derivatives trading arm to a third 

party. 

Moreover, although one commenter generally 

alluded to corporate financial losses in the 

derivatives markets that exceeded the proposed $1 

billion and $2 billion thresholds, see letter from 

NCGA/NGSA II, the relevant question does not 

focus on losses that market participants have 

incurred, but instead focuses on what degree of 

credit risk to counterparties in the swap and 

security-based swap markets presents such a 

potential to cause significant market impact that it 

would be prudent to regulate persons who pose that 

degree of credit risk in connection with their swap 

or security-based swap positions. 

912Our discussion of how the major participant 

analysis may apply to an entity that has a portfolio 

of a size equivalent to that of AIG FP should not 

be read to imply that a person may engage in swap 

and security-based swap activities akin to those of 

AIG FP without registering as a swap dealer or 

security-based swap dealer. 

913See, e.g., Congressional Oversight Panel, The 

AIG Rescue, Its Impact on Markets, and the 

Government’s Exit Strategy 22–24 (2010) 

(discussing how the risk in AIG’s CDS business 

largely was the result of a ‘‘multi-sector’’ CDO book 

that amounted to $72 billion notional as of 

September 2008, and how the losses to AIG were 

driven by 125 of the roughly 44,000 contracts 

entered into by AIG FP). 

914For cleared security-based credit default 

swaps (in which we assume daily margining 

requirements result in no current uncollateralized 

exposure) achieving $2 billion of potential future 

exposure would require writing $200 billion 

notional of credit default swap protection 

(reflecting the 0.10 multiplier in the risk adjustment 

tables, and the additional 0.10 multiplier for 

positions that are cleared). Similarly, it would take 

a $100 billion notional portfolio of uncleared but 

marked-to-market security-based credit default 

swaps to meet that same threshold (reflecting the 

0.20 multiplier for positions that are subject to daily 

mark-to-market margining). The total might be even 

higher if such instruments were subject to 

counterparty netting agreements. 

Even in the absence of clearing or daily mark-tomarket margining, it would take a minimum $20 

billion notional portfolio of written protection on 

credit (reflecting the 0.10 multiplier in the risk 

adjustment tables) to meet the $2 billion potential 

future exposure threshold. Accounting for netting 

(which can reduce potential future exposure 

measures by up to 60 percent) could materially 

increase that required amount. 

915The case of Long-Term Capital Management 

(‘‘LTCM’’) also is instructive in connection with the 

current exposure thresholds of the major participant 

analysis. Had LTCM failed, its top 17 counterparties 

would have suffered estimated total losses of 

between $3 and $5 billion. See President’s Working 

Group on Financial Markets, Hedge Funds, 

Leverage, and the Lessons of Long-Term Capital 

Management (April 1999) at 17 (http:// 

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

Documents/hedgfund.pdf). The government acted 

in connection with LTCM because the rushed closeContinued 

vii. Treatment of Initial Margin or 

Overcollateralization 

The final rules retain the proposed 

approach of not modifying the measure 

of potential future exposure to reflect 

collateral that a person has posted to its 

counterparty in excess of current 

exposure. Although we recognize that 

the posting of excess collateral may 

mitigate the future credit risk that the 

potential future exposure measure is 

intended to estimate, that mitigating 

effect is not certain, and any such 

mitigation may not reflect the full value 

of the excess collateral. Moreover, while 

we believe that the measure of potential 

future exposure associated with swap or 

security-based swap positions 

reasonably estimates the credit risk that 

may be posed by those positions for 

purposes of the substantial position 

analysis, we also recognize that 

particular positions may prove to pose 

a far higher amount of credit risk.905

Given how the credit risk associated 

with a swap or security-based swap 

position can far exceed the associated 

measure of potential future exposure, 

we do not believe that it would be 

appropriate to offset that measure to 

account for overcollateralization.906

d. Thresholds 

The final rules retain the proposed 

thresholds for the amount of current 

uncollateralized exposure and potential 

future exposure that will cause an entity 

to be deemed to be a major participant. 

Accordingly, for a person to have a 

‘‘substantial position’’ in a major 

category of swaps, it would be necessary 

for that person to have a daily average 

current uncollateralized exposure of at 

least $1 billion (or $3 billion for the rate 

swap category), or a daily average 

current uncollateralized exposure plus 

potential future exposure of $2 billion 

(or $6 billion for the rate swap 

category).907 To have a ‘‘substantial 

position’’ in a major category of 

security-based swaps, it would be 

necessary for the person to have a daily 

average current uncollateralized 

exposure of at least $1 billion, or a daily 

average current uncollateralized 

exposure plus potential future exposure 

of at least $2 billion.908

As the Proposing Release noted, the 

proposed thresholds sought to reflect: (i) 

The financial system’s ability to absorb 

losses of a particular size; (ii) the 

recognition that it would not be 

appropriate for the substantial position 

test to encompass entities only after 

they pose significant risks to the market 

through their swap or security-based 

swap activity; and (iii) the need to 

account for the possibility that multiple 

market participants may fail close in 

time.909 While some commenters took 

the position that the proposed 

thresholds were inappropriately low, 

those commenters did not present 

empirical data or analysis in support of 

that view. Moreover, the Commissions 

do not concur with the suggestion 910

that the major participant definitions 

can reasonably be read to require that 

we defer this rulemaking until we have 

gathered additional data. Instead, the 

definitions direct us to set a standard 

that is ‘‘prudent,’’ which is what we 

have sought to do. 

Some commenters who supported an 

increase in the proposed thresholds 

attempted to support their positions via 

analogy to past events, with the most 

significant of these being an analogy to 

AIG Financial Products (‘‘AIG FP’’).911

The analogy to AIG FP 912 actually 

argues against an increase in these 

thresholds, however, particularly given 

that the credit derivative portfolio that 

significantly contributed to the liquidity 

problems that AIG FP faced amounted 

to $72 billion in notional amount.913

Under the final rules, in the presence of 

central clearing or daily marking to 

market it would take a credit derivative 

portfolio in excess of that amount to 

trigger the potential future exposure 

threshold under the ‘‘substantial 

position’’ analysis.914 This indicates 

that the thresholds are not 

inappropriately low, particularly given 

our view that the major participant 

definition is intended to encompass 

entities before their swap or securitybased swap positions pose significant 

market threats.915 Conversely, while 

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out of LTCM’s positions would have affected other 

market participants, and the spread of losses would 

have led to market uncertainty, likely causing a 

number of credit and interest rate markets to 

experience extreme price moves and possibly not 

function for a period of time. See Statement by 

William J. McDonough, President Federal Reserve 

Bank of New York before the Committee on Banking 

and Financial Services U.S. House of 

Representatives (October 1, 1998) (http:// 

www.newyorkfed.org/newsevents/speeches_archive/ 

1998/mcd981001.html). 

916See letter from FHLB I. 

917See letter from ISDA I. 

918See CEA section 1a(33)(A)(i)(I); Exchange Act 

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

919See Proposing Release, 75 FR at 80194. 

920See CEA section 2(h)(7)(A); Exchange Act 

section 3C(g)(1)(B). 

921As we discussed in the Proposing Release, had 

the Dodd-Frank Act intended the phrase ‘‘hedge or 

mitigate commercial risk’’ to apply only to activities 

of, or positions held by, non-financial entities, it 

would not have been necessary for the mandatory 

clearing exceptions to include additional provisions 

generally restricting the availability of the 

exceptions to non-financial entities. See Proposing 

Release, 75 FR at 80194. 

922As we discussed in the Proposing Release, the 

third statutory major participant test would be 

redundant if the hedging exclusion in the first 

major participant test were entirely unavailable to 

financial entities. See Proposing Release, 75 FR at 

80194 n.125. 

923See Proposing Release, 75 FR at 80194. 

924The scope of the proposed exclusion is based 

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

activities, the gains or losses associated with the 

swap or security-based swap itself will generally be 

offset by losses or gains in the person’s commercial 

activities, and hence the risks posed by the swap 

or security-based swap to counterparties or the 

industry will generally be mitigated. 

925See CEA section 2(h)(7)(A); Exchange Act 

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

clearing requirements when one or more 

counterparties are not ‘‘financial entities’’ and are 

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

mitigate commercial risk’’). 

926The presence of the third major participant 

test suggests that financial entities generally may 

not be precluded from taking advantage of the 

hedging exclusion in the first test. The third test, 

which does not account for hedging, specifically 

applies to non-bank financial entities that are 

highly leveraged and have a substantial position in 

a major category of swaps or security-based swaps. 

That test would be redundant if the hedging 

exclusion in the first major participant test were 

entirely unavailable to financial entities. 

additional data and analysis may 

warrant a reduction of these thresholds 

in the future, commenters who 

supported a reduction in those 

thresholds have not persuaded us that 

the proposed thresholds should be 

lowered. 

e. Additional Issues 

The final rules applying the 

‘‘substantial position’’ analysis and the 

major participant definitions generally 

apply to all types of swaps or securitybased swaps that a person maintains. 

Although one commenter suggested that 

swaps on government securities should 

be excluded from the analysis, the rules 

will not provide such an exclusion. To 

the extent that a person presents credit 

risk as a result of swaps referencing 

government securities, there is no basis 

for disregarding that risk when 

determining whether the person is a 

major participant. 

In addition, in light of one 

commenter’s concern,916 the 

Commissions believe that it is important 

to emphasize that these rules should not 

be interpreted to deter end-users from 

requesting margin from dealers or major 

participants who are their 

counterparties to swaps or securitybased swaps. 

Also, in light of a point raised by 

another commenter,917 the Commissions 

note that these rules implementing the 

major participant definitions do not 

place any independent calculation or 

other obligations upon counterparties to 

potential major participants, and that 

the rules do not preclude a potential 

major participant from seeking the 

assistance of a third party to perform the 

relevant calculation. 

C. ‘‘Hedging or Mitigating Commercial 

Risk’’ 

1. Proposed Approach 

a. General Availability of the Proposed 

Exclusion 

The first test of the major participant 

definitions excludes positions held for 

‘‘hedging or mitigating commercial risk’’ 

from the substantial position 

analysis.918 In the Proposing Release, 

we preliminarily concluded that 

positions that hedge or mitigate a 

person’s commercial risk may qualify 

for this exclusion regardless of whether 

the entity is financial or non-financial in 

nature.919 That conclusion in part was 

prompted by the fact that the statutory 

major participant definitions do not 

explicitly make the exclusion 

unavailable to financial entities; in 

contrast to the Title VII exceptions from 

mandatory clearing requirements in 

connection with hedging commercial 

risk,920 which explicitly are unavailable 

to financial entities.921 The conclusion 

also was prompted by the presence of 

the third major participant test—which 

specifically applies the substantial 

position analysis to certain non-bank 

financial entities but (unlike the first 

test) does not exclude commercial risk 

hedging positions from the analysis.922

In the Proposing Release, we also 

preliminarily concluded that the 

question of whether an activity is 

commercial in nature should not be 

determined solely by a person’s 

organizational status as a for-profit, nonprofit or governmental entity, but 

instead should depend on whether the 

underlying activity is commercial in 

nature.923

The proposal did not preclude the 

exclusion from being available in 

connection with hedges of a person’s 

‘‘financial’’ or ‘‘balance sheet’’ risks. In 

addition, the proposal solicited 

comment as to whether the exclusion 

should extend to activities in which a 

person hedges an affiliate’s risk. 

b. Proposed Definition Under the CEA 

Exception 

The proposed interpretation of 

‘‘hedging or mitigating commercial risk’’ 

for purposes of the CEA’s definition of 

‘‘major swap participant’’ premised the 

exclusion on the principle that swaps 

necessary to the conduct or management 

of a person’s commercial activities 

should not be included in the 

calculation of the entity’s substantial 

position.924

The CFTC noted first that the phrase 

‘‘hedging or mitigating commercial risk’’ 

as used with respect to the major swap 

participant definition is virtually 

identical to Dodd-Frank provisions 

granting an exception from the 

mandatory clearing requirement to nonfinancial entities that are using swaps to 

hedge or mitigate commercial risk.925

Also noted was that although only nonfinancial entities that use swaps or 

security-based swaps to hedge or 

mitigate commercial risk generally may 

qualify for the clearing exemption, no 

such statutory restriction applies with 

respect to the exclusion for hedging 

positions in the first test of a major 

participant. We therefore concluded that 

positions established to hedge or 

mitigate commercial risk may qualify for 

the exclusion, regardless of the nature of 

the entity—i.e., whether or not the 

entity is financial (including a bank) or 

non-financial.926

The CFTC preliminarily believed that 

whether a position hedges or mitigates 

commercial risk should be determined 

by the facts and circumstances at the 

time the swap is entered into, and 

should take into account the entity’s 

overall hedging and risk mitigation 

strategies. However, the swap could not 

be held for a purpose that is in the 

nature of speculation, investing or 

trading. We anticipated that a person’s 

overall hedging and risk management 

strategies would help inform whether or 

not a particular position is properly 

considered to hedge or mitigate 

commercial risk. Further, the exclusion 

under the Proposing Release included 

swaps hedging or mitigating any of a 

person’s business risks, regardless of the 

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927See proposed Exchange Act rule 3a67–4(a). 

928See Proposing Release, 75 FR at 80195 n.129. 

929See proposed Exchange Act rule 3a67–4(b)(1), 

and Proposing Release, 75 FR at 80195 n.131. 

930See proposed Exchange Act rule 3a67–4(b)(2). 

931See proposed Exchange Act rule 3a67–4(c). 

932See letters from ACLI, Barnard, CDEU, COPE 

I, EEI/EPSA, FSR I, ISDA I, Kraft, MetLife, NAIC, 

Philip Morris International Inc. (‘‘Philip Morris’’) 

and Utility Group. 

933See letter from CDEU. 

934See letter from Peabody. 

935See letter from ISDA I. 

936See letter from CDEU. 

937See letters from APG, CDEU and ISDA I. 

938See letter from SIFMA AMG II. 

939See letters from AFR and AFSCME. The CFTC 

also received submissions of a substantially 

identical letter from approximately 193 individuals 

and small businesses urging the CFTC to define 

commercial risk narrowly to include only risks 

arising from physical commodity price fluctuations, 

and not financial risks, and to construe the 

exception for captive finance companies narrowly. 

See, e.g., letter from Needham Oil & Air, LLC. In 

addition, the CFTC received submissions from 

approximately 535 individuals of a different letter, 

which also urged the CFTC to define commercial 

risk narrowly. See, e.g., letter from Christie Hakim. 

940See letters from Sen. Carl Levin (‘‘Senator 

Levin’’), Commodity Markets Oversight Coalition 

(‘‘CMOC’’) and Greenberger and meeting with MFA 

on February 14, 2011. 

941See meeting with SIFMA AMG on February 4, 

2011. 

942See meeting with AFR and Better Markets on 

March 17, 2011. 

943See letters from AFR and CMOC, and meeting 

with Duffie on February 2, 2011. 

944See letter from Senator Levin. 

945See letters from Senator Levin, NAIC and 

SIFMA AMG II. 

946See letter from Milbank, Tweed, Hadley & 

McCloy LLP (‘‘Milbank’’). 

947See letters from CDEU and NFPEEU. 

948See letter from Edison Int’l. 

swap’s status under accounting 

guidelines or the bona fide hedging 

exemption. 

c. Proposed Definition Under the 

Exchange Act Exception 

For purposes of the Exchange Act’s 

‘‘major security-based swap participant’’ 

definition, the proposed rule defining 

‘‘hedging or mitigating commercial risk’’ 

would require that a security-based 

swap position be ‘‘economically 

appropriate’’ to the reduction of risks in 

the conduct and management of a 

commercial enterprise, where those 

risks arise from the potential change in 

the value of assets, liabilities and 

services connected with the ordinary 

course of business of the enterprise.927

The Proposing Release stated that the 

SEC preliminarily planned to interpret 

the concept of ‘‘economically 

appropriate’’ based on whether a 

reasonably prudent person would 

consider the security-based swap to be 

appropriate for managing the identified 

commercial risk. It further stated that 

the SEC also preliminarily believed that 

for a security-based swap to be deemed 

‘‘economically appropriate’’ in this 

context, it should not introduce any 

new material quantum of risks (i.e., it 

could not reflect over-hedging that 

could reasonably have a speculative 

effect) and it should not introduce any 

basis risk or other new types of risk 

(other than the counterparty risk that is 

attendant to all security-based swaps) 

more than reasonably necessary to 

manage the identified risk.928

The proposed rules further provided 

that the security-based swap position 

could not be held for a purpose that is 

in the nature of speculation or trading— 

a limitation that would make the 

exclusion unavailable to security-based 

swap positions that are held 

intentionally for the short term and/or 

with the intent of benefiting from actual 

or expected short-term price movements 

or to lock in arbitrage profits, including 

security-based swap positions that 

hedge other positions that themselves 

are held for the purpose of speculation 

or trading.929 The proposal also 

provided that a security-based swap 

position could not be held to hedge or 

mitigate the risk of another securitybased swap position or swap position 

unless that other position itself is held 

for the purpose of hedging or mitigating 

commercial risk.930 Finally, the 

proposal would have conditioned the 

entity’s ability to exclude these securitybased swap positions on the entity 

engaging in certain specified activities 

related to documenting the underlying 

risks and assessing the effectiveness of 

the hedge in connection with the 

security-based swap positions.931

2. Commenters’ Views 

a. In General 

Several commenters generally 

supported the broad concepts 

underlying the proposed rules for 

identifying hedges of commercial risk, 

and particularly supported the proposed 

use of an ‘‘economically appropriate’’ 

standard instead of the ‘‘highly 

effective’’ standard that is used to 

identify hedges for accounting 

purposes.932 On the other hand, one 

commenter stated that the definition 

should incorporate all manner of risks 

associated with commercial operations, 

including interest rate and currency 

risks, risks from incidental activities to 

commercial activities and risks from 

financial commodities.933 One 

commenter further stated that the 

definition should encompass positions 

that facilitate asset optimization and 

dynamic hedging.934

Commenters further stated that the 

exception should include any position 

taken as part of a bona fide risk 

mitigation strategy,935 and that Congress 

included ‘‘mitigation’’ in the exception 

for the purpose of covering risk 

reduction strategies that may not clearly 

be hedges but mitigate risk.936 Some 

commenters also criticized the 

Proposing Release’s position equating 

the terms ‘‘hedging’’ and 

‘‘mitigating.’’ 937 One commenter also 

expressed concern that entities would 

find it difficult to analyze their 

positions with respect to the Proposing 

Release’s statement, in the context of the 

Exchange Act definition, that 

‘‘economically appropriate’’ securitybased swaps would not add a new 

quantum of risk.938

Conversely, some commenters 

suggested that the proposed 

interpretation was too broad,939 and that 

a broad interpretation could allow 

evasion,940 or permit corporate end 

users to accumulate very large positions 

without becoming major swap 

participants.941 One commenter stated 

that to include ‘‘financial risks’’ within 

the exclusion’s scope would be 

improper because a ‘‘commercial risk’’ 

is one that is inherent in a person’s 

commercial activities, while interest 

rate and currency risks arise from 

choices about how a person structures 

and finances its operations.942 Some 

commenters stated that the rule should 

not include hedging of financial risks 

because Congress deleted the reference 

in an earlier version of the Dodd-Frank 

Act to hedging of ‘‘balance sheet 

risk.’’ 943 One commenter urged that we 

consider using accounting hedge 

treatment or the bona fide hedging 

exemption as guideposts for 

determining the availability of the 

exclusion.944 Commenters also raised 

concerns about differences between the 

proposed approaches under the CEA 

and Exchange Act definitions of the 

terms.945

One commenter suggested that the 

definition should be expanded to 

include as commercial risks the risks 

faced by government entities because 

their need to manage risk is no different 

than the need of commercial firms.946

Additional commenters suggested that 

commercial risk be interpreted to 

include risks faced by non-profit 

firms.947

Some commenters also supported 

modification of the rule text for specific 

purposes such as including risks from 

‘‘transmitting’’ to cover activities of 

electricity companies,948 to encompass 

risks ‘‘arising from’’ an asset rather than 

just risks arising from changes in value 

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949See letter from Milbank. 

950See letter from American Securitization Forum 

(‘‘ASR’’). 

951See letters from ACLI, American Express 

Company (‘‘Amex’’), California State Teachers’ 

Retirement System (‘‘CalSTRS’’) dated Feb. 28, 2011 

(‘‘CalSTRS I’’), ISDA I, MetLife, NAIC and Peabody. 

952See letters from Amex, CalSTRS I and 

Peabody. 

953See letter from Amex. 

954See letters from ACLI and MetLife. 

955 Id. 

956See letter from Senator Levin (further 

highlighting the need to add strict standards and 

controls to prevent evasion). 

957See letters cited in note 939, supra. 

958See letter from AFR. 

959See letters from CDEU, EDF Trading, Kraft, 

Metlife and Philip Morris. 

960See letter from EDF Trading. 

961See meeting with Duffie on February 2, 2011. 

962See letters from EEI/EPSA and EDF Trading; 

see also letters from CDEU, Kraft Metlife, NRG 

Energy and Philip Morris (that such a test would 

be overly prescriptive). 

963See letters from FSR I and SIFMA AMG I. 

964See letter from Better Markets I. 

965See letter from Metlife (but opposing ongoing 

evaluation of hedge effectiveness). 

966See letters from AFR and Senator Levin. 

967See letters from CDEU, EDF Trading, EEI/ 

EPSA, Kraft, Metlife, NRG Energy and Philip 

Morris. 

968See letters from Better Markets I and Senator 

Levin. 

969See letters from BG LNG II, COPE I, EPSA, 

FSR I, Metlife, Peabody, Vitol and WGCEF dated 

February 22, 2011 regarding the major swap 

participant definition (‘‘WGECF II’’), and meeting 

with Bunge; see also letter from ISDA I (taking the 

view that swaps and security-based swaps used to 

hedge speculative positions should qualify as 

hedges and stating that failure to treat them as 

hedges would ‘‘invariably result in there being more 

unhedged speculative risk in the market’’). 

970See letters from Vitol and WGCEF II and 

meeting with Bunge. 

971See letters from BG LNG II, FSR I, ISDA I and 

Metlife. 

972See letters from COPE I, EPSA and Peabody. 

973See letters from Vitol and WGCEF dated June 

3, 2011 regarding the major swap participant 

definition (‘‘WGECF VI’’). 

974See letter from BG LNG II. 

of the asset,949 and to encompass the 

use of swaps by structured finance 

special purpose vehicles to hedge 

interest rate risk in structured 

financing.950

b. Availability of Exclusion to Financial 

Entities 

Several commenters supported 

making the exclusion available to 

financial companies.951 Some 

commenters further stated that there 

should be no special limits on financial 

entities with regard to the exclusion,952

and that commercial risk should be 

defined broadly to include all of the 

commercial activities of a person, 

whether or not those activities relate to 

financial or non-financial 

commodities.953 Two commenters 

discussing the use of swaps by 

insurance companies stated that making 

the exclusion available to financial 

companies is consistent with CFTC 

practice in the futures markets, that 

there is no fundamental difference in 

how an insurance company or a 

commercial enterprise uses swaps to 

reduce its risk, and that commercial risk 

encompasses financial risk.954 In 

addition, these commenters noted that 

insurance regulators allow insurance 

companies to use swaps to hedge 

risk.955

On the other hand, some commenters 

opposed allowing financial entities to 

avail themselves of the exclusion, 

arguing that there is no benefit from 

allowing a financial firm to avoid major 

participant regulation through the 

hedging exclusion,956 that the exclusion 

would allow financial companies to 

engage in risky trades,957 and that the 

exclusion should be narrowly 

interpreted to cover hedging of only 

risks related to products.958

c. Hedging Risks of Affiliates and Third 

Parties 

Some commenters expressed support 

for allowing persons to take advantage 

of the hedging exclusion when they use 

swaps to hedge the commercial risks of 

affiliates or third parties. Some 

commenters suggested that a person that 

aggregates and hedges risk within a 

corporate group should be allowed to 

use the exclusion despite the fact that it 

is the affiliates’ risks that are hedged.959

One commenter further stated that 

providers of risk management services 

should be allowed to take advantage of 

the exclusion because they are hedging 

commercial risk on behalf of their 

clients.960

One commenter, on the other hand, 

stated that the exclusion should be read 

narrowly for captive finance companies 

because the hedging entity may have to 

liquidate positions rapidly without 

access to affiliate’s funds.961

d. Hedge Effectiveness and 

Documentation 

Many commenters suggested that the 

rule should not test hedge effectiveness, 

explaining that requiring demonstration 

of hedge effectiveness would impose a 

subjective standard and would not 

reduce systemic risk.962 In this regard, 

some commenters that addressed the 

proposed procedural requirements in 

the Exchange Act definition argued that 

these procedures would place 

unnecessary regulatory burdens on 

entities not regulated under the DoddFrank Act.963 Conversely, one 

commenter that supported testing hedge 

effectiveness stated that the subdivided 

parts of a hedge should line up exactly 

with the subdivided parts of the risk.964

Some commenters agreed that the 

relationship between hedging and risk 

should be documented. One commenter 

expressed the view that documentation 

would facilitate audits.965 Others took 

the view that a person should be 

required to demonstrate that the hedge 

does not create additional risk, that the 

risk may be hedged by swaps, and that 

there is a link between the swap and the 

risk.966

Several commenters suggested that 

once initiated, a hedge should not be 

retested over time, regardless of whether 

the position continues to serve a 

hedging purpose.967 Other commenters 

disagreed, stating that a position that is 

no longer a hedge should not be covered 

by the exclusion.968

e. Swaps That Hedge Positions Held for 

Speculative, Investment or Trading 

Purposes 

Many commenters took the view that 

swaps or security-based swaps used to 

hedge positions held for speculative, 

investment or trading purposes should 

qualify as hedges of commercial risk.969

A few commenters stated that 

speculation, investment and trading are 

fundamental to commercial activity, and 

thus cannot be differentiated from other 

types of commercial activity.970 Other 

commenters suggested the exclusion 

should cover swap positions that hedge 

other swap or security-based swap 

positions that are not themselves 

hedging positions.971 Some commenters 

asserted that trading is different from 

speculating (taking an outright view on 

market direction) and investing 

(entering into a swap for appreciation in 

value of the swap position), and that 

swaps held for ‘‘trading’’ should be able 

to qualify for the exclusion.972

Some commenters requested that the 

definition under the CEA clarify how 

swaps that qualify as bona fide hedges 

are treated for the major swap 

participant definition if the underlying 

position had a speculative, investment 

or trading purpose,973 and clarify that 

while the hedging exclusion would not 

apply to swap positions that hedge other 

swap positions that are held for 

speculation or trading, the hedging 

provision would apply to swap 

positions that hedge other non-swap 

positions held for speculation or 

trading.974 Commenters also requested 

that the final rules provide that the 

hedging exclusion be available for 

physical positions in exempt or 

agricultural commodities and arbitrage 

positions relating to price differences 

between physical commodities at 

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975See letters from BGLNG II and WGCEF VI. 

976See letters from MetLife. 

977See letters from AFR, Better Markets I and 

Senator Levin and meeting with Duffie on February 

2, 2011. 

978See letter from Senator Levin. 

979See letter from Better Markets I. 

980See meeting with Duffie on February 2, 2011. 

981While we recognize that commenters have 

identified policy reasons as to why financial 

entities should be entirely excluded from being able 

to take advantage of the hedging exclusion, we 

continue to believe the language of the major 

participant definitions dictates a contrary approach. 

982See letters from AFR and Senator Levin. 

983We also do not believe that the size of an 

entity or an entity’s position is determinative of 

whether a position hedges commercial risk. 

Moreover, given that the major participant 

definitions implicitly require large swap or 

security-based swap positions as triggers, a rule that 

made the hedging exclusion unavailable to entities 

with large positions could negate the statutory 

hedging exclusion. 

984See notes 942 and 943, supra. 

985Moreover, it is questionable as to what types 

of security-based swap positions—if any—would 

fall within the exclusion for purposes of the ‘‘major 

security-based swap participant’’ definition if the 

exclusion did not extend to hedges of ‘‘financial’’ 

or ‘‘balance sheet’’ risks. Security-based swaps such 

as single-name credit default swaps and equity 

swaps would not appear amenable to hedging a 

commercial entity’s non-financial risks, such as 

price risks associated with non-financial inputs or 

sales. We do not believe that it would be 

appropriate to interpret the exclusion in such a way 

as to make it a nullity in the context of the ‘‘major 

security-based swap participant’’ definition. 

986See CFTC Regulation § 1.3(kkk)(1)(i); 

Exchange Act rule 3a67–4(a)(1). For these 

purposes—consistent with the standards regarding 

the application of the dealer and major participant 

definitions to inter-affiliate swaps and security 

based swaps, see parts II.C and IV.G—we would 

view the counterparties to be majority-owned 

affiliates if one party directly or indirectly holds a 

majority ownership interest in the other, or if a 

third party directly or indirectly holds a majority 

interest in both, based on holding a majority of the 

equity securities of an entity, or the right to receive 

upon dissolution or the contribution of a majority 

of the capital of a partnership. See note 348, supra. 

different locations.975 One commenter, 

on the other hand, suggested that even 

swap positions that hedge other swap 

positions which are not hedging 

positions should be treated as hedging 

commercial risk because they are risk 

reducing.976

Four commenters took the position 

that swaps held for a purpose that is in 

the nature of speculation, investing or 

trading should not qualify as hedges of 

commercial risk.977 One commenter 

pointed out that experience has shown 

that market participants sometimes 

inaccurately characterize positions as 

hedges (e.g., the inaccurate 

characterization occurs because the 

nature of positions change over time), 

and that excluding swap positions that 

hedge speculative, investment or trading 

positions would be especially 

inappropriate for financial firms that 

frequently use swaps to speculate, 

invest or trade.978 One commenter 

stated that any swap position hedging 

another swap position could never be 

considered to be hedging commercial 

risk because the second swap is only 

adjusting the first swap position, 

meaning that neither swap would be 

congruent with risk reduction.979

Another commenter stated that the 

hedging exclusion should not cover any 

swap hedging a speculative position.980

3. Final Rules—General Availability of 

the Exclusions 

As with the proposed rules, the final 

CEA and Exchange Act rules 

implementing this exclusion are 

different in certain regards to reflect the 

different ways that swaps and securitybased swaps may be expected to be used 

to hedge commercial risk, as well as 

differences in existing regulations under 

the CEA and the Exchange Act. 

Notwithstanding these differences, the 

two rules follow parallel approaches 

and address certain key issues in similar 

ways. 

a. Availability to Financial Entities 

Consistent with the position we took 

in the Proposing Release, the final rules 

with regard to both major participant 

definitions do not foreclose financial 

entities from being able to take 

advantage of the commercial risk 

hedging exclusion in the first major 

participant test. This conclusion in part 

is guided by the fact that the statutory 

text implementing this hedging 

exclusion does not explicitly foreclose 

financial entities from taking advantage 

of the exclusion—in contrast to Title 

VII’s exceptions from mandatory 

clearing requirements for commercial 

risk hedging activities. The conclusion 

also results from the need to avoid an 

interpretation that would cause the 

third major participant test to be 

redundant.981

In reaching this conclusion, we 

recognize that some commenters stated 

that there would be no benefit from 

allowing financial firms to avoid 

regulation as a major swap participant 

through the hedging exclusion, and that 

the exclusion should cover only risks 

related to non-financial commercial 

activities, or else the exclusion would 

allow financial companies to engage in 

risky transactions.982 We believe that 

not allowing the exclusion to cover 

swaps or security-based swaps used for 

speculation or trading (or investments, 

in the case of swaps) will be sufficient 

to limit financial entities’ ability to 

engage in risky transactions. We also are 

not persuaded that ‘‘commercial risk’’ 

should be limited to only risks related 

to non-financial activities. 

We nonetheless recognize the 

significance of concerns that financial 

entities may seek to depict speculative 

positions as hedges to take advantage of 

the exclusion. We also are mindful of 

the need to give appropriate meaning to 

the term ‘‘commercial risk’’ within the 

exclusion. We believe that the standard 

set forth in the final rules, including the 

provisions that make the exclusions 

unavailable to swap or security-based 

swap positions of a speculative or 

trading nature (or investment purposes, 

in the case of swaps), apply the 

statutory test in a manner that 

appropriately addresses those other 

concerns. As discussed below, those 

standards limit the ability of financial 

entities to take advantage of the 

exclusion.983

b. Availability to Non-Profit and 

Governmental Entities 

Under the final rules, a person’s 

organizational status will not determine 

the availability of this hedging 

exclusion. The exclusion thus may be 

available to non-profit or governmental 

entities, as well as to for-profit entities, 

if the underlying activity to which the 

swap or security-based swap relates is 

commercial in nature. 

c. Hedges of ‘‘Financial’’ or ‘‘Balance 

Sheet’’ Risks 

Under the final rules, the exclusion is 

available to positions that hedge 

‘‘financial’’ or ‘‘balance sheet’’ risks. 

While we recognize that some 

commenters oppose the exclusion of 

those positions,984 we nonetheless 

believe that the exclusion would be 

impermissibly narrow if it failed to 

extend to the ‘‘financial’’ or ‘‘balance 

sheet’’ risks that entities may face as 

part of their commercial operations, 

given that those types of risks (e.g., 

interest rate and foreign exchange risks) 

may be expected to arise from the 

commercial operations of non-financial 

end-users of swaps and security-based 

swaps. We do not believe the exclusion 

was intended to address those risks 

differently from other commercial risks, 

such as risks associated with the cost of 

physical inputs or the price received for 

selling products.985

d. Hedging on Behalf of an Affiliate 

The final rules further provide that 

the exclusion is not limited to the 

hedging of a person’s own risks, but also 

would extend to the hedging of the risks 

of a person’s majority-owned affiliate.986

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30676 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

987The exclusion, however, would not be 

available to the extent that a person enters into 

swaps or security-based swaps in connection with 

the hedging activities of an unaffiliated third party. 

Such activities, moreover, may indicate that the 

person is acting as a swap dealer or security-based 

swap dealer. 

988The final rule text of CFTC Regulation 

§ 1.3(kkk)(2) has been revised to include the 

conjunction ‘‘and’’ between clauses (i) and (ii). In 

the proposed text of this rule, there was no 

conjunction between these two clauses, while the 

conjunction ‘‘and’’ was used in the parallel rule, 

§ 240.3a67–4(b), under the Exchange Act. Thus, the 

revision of the final rule text conforms the CEA rule 

to the Exchange Act rule. 

Also, the final rule text of CFTC Regulation 

§ 1.3(kkk)(1)(E) has been revised to include interest 

and currency rates to be consistent with 

§ 1.3(kkk)(1)(F). Both provisions address similar 

financial risks arising from rate ‘‘movements’’ and 

‘‘exposures,’’ respectively. 

989Local government entities that use GASB 

accounting standards may not be able to use 

comparable FASB hedge accounting as a 

demonstration that a swap is a hedge. Although the 

two standards are not the same, they are similar in 

effect and degree in respect of determining whether 

a swap hedges a risk. 

990Although CEA section 1a(33)(A)(iii), 7 U.S.C. 

1a(33)(A)(iii) provides that financial entities that are 

highly leveraged and not subject to capital 

requirements established by a Federal banking 

agency are effectively precluded from applying the 

hedging exclusion, other financial entities are not 

so precluded. Thus, availability of the hedging 

exclusion to some financial entities for purposes of 

the major swap participant definition is 

contemplated in the statutory text. 

991See 75 FR at 80195 n.128. 

992 Id. 

993The Commissions note that the SEC interprets 

the availability of the hedging exclusion differently 

in the context of the ‘‘major security-based swap 

participant’’ definition, and that the SEC’s guidance 

in this area controls for purposes of that definition. 

994The CFTC further clarifies that merchandising 

activity in the physical marketing channel qualifies 

as commercial activity, consistent with the 

Commission’s longstanding bona fide hedging 

exemption to speculative position limits. See 

§ 1.3(kkk)(1)(ii). 

This approach reflects the fact that a 

corporate group may use a single entity 

to face the market to engage in hedging 

activities on behalf of entities within the 

group. In our view, it would not be 

appropriate for the swap or securitybased swap positions of the marketfacing entity to be encompassed within 

the first major participant test if those 

same positions could have been 

excluded from the analysis if entered 

into directly by the affiliate.987 Of 

course, the exclusion will only be 

available to the market-facing entity if 

the position would have been subject to 

the exclusion—e.g., not for a speculative 

or trading purpose—had the affiliate 

directly entered into the position. 

4. Final Rules—‘‘Major Swap 

Participant’’ Definition Under the CEA 

a. In General 

The general scope of the rule 

regarding ‘‘hedging or mitigating risk’’ 

will be adopted substantially as 

proposed.988 The CFTC, however, is 

adopting CFTC Regulation § 1.3(kkk) 

with a modification to paragraph (1)(iii) 

to include a reference to qualified 

hedging treatment for positions meeting 

Government Accounting Standards 

Board (‘‘GASB’’) Statement 53, 

Accounting and Financial Reporting for 

Derivative Instruments. The CFTC 

believes that this minor modification to 

CFTC Regulation § 1.3(kkk) is necessary 

in order to include swaps that qualify 

for hedging treatment issued by 

GASB.989

As noted above, the CFTC will not 

prohibit financial companies from using 

the hedging exclusion because the 

exclusion for positions held for hedging 

or mitigating commercial risk set forth 

in CEA section 1a(33)(A)(i)(1) does not 

limit its application based on the 

characterization or status of the person 

or entity. Unlike the end-user clearing 

exemption of section 2(h)(7), the major 

swap participant hedging exclusion is 

not foreclosed to financial entities.990 In 

addition, the hedging exclusion will 

extend to entities hedging the risks of 

affiliates in a corporate group, but not to 

third parties outside of a corporate 

group. 

Like the proposed rule, the final rule 

under the CEA does not require a 

demonstration of hedge effectiveness, 

periodic retesting or specific 

documentation in order to apply the 

hedging exclusion from the definition of 

major swap participant. 

b. Swaps That Hedge Positions Held for 

Speculation, Investment, or Trading 

Swaps that hedge positions held for 

speculation, investment or trading will 

not qualify for the exclusion. In the 

Proposing Release, the CFTC explained 

that swap positions held for the purpose 

of speculation, investment or trading are 

those held primarily to take an outright 

view on market direction, including 

positions held for short term resale, or 

to obtain arbitrage profits.991

Additionally, the Proposing Release 

stated that swap positions that hedge 

other positions that themselves are held 

for the purpose of speculation, 

investment or trading are also 

speculative, investment or trading 

positions.992

We note that some commenters 

suggested that swaps that hedge 

speculative, investment or trading 

positions should qualify for the 

exclusion because speculation, 

investment or trading are fundamental 

to commercial activity and cannot be 

differentiated from other types of 

commercial activity. Similarly, 

commenters that support allowing 

speculative, investment or trading 

positions to qualify for the exception 

stated that a swap hedging the risk of 

another swap (regardless of that swap’s 

nature) is risk reducing and therefore 

hedges commercial risk. We believe that 

these commenters’ interpretation of 

‘‘commercial’’ is not consistent with 

congressional intent or the meaning of 

‘‘commercial’’ in the Dodd-Frank Act 

with respect to the first test of the major 

participant definition or the end-user 

exception to the clearing mandate. We 

are unconvinced that allowing swap 

positions to qualify for the exception 

would be appropriate when used to 

hedge speculative, investment or trading 

positions because the swap would not 

hedge or mitigate the risks associated 

with the underlying position, or at least 

not in the manner intended by Congress. 

In addition, we believe that doing so 

would undermine the effectiveness of 

the major participant definition in that 

entities would be able to characterize 

positions for speculative, investment or 

trading purposes as hedges and 

therefore evade regulation as major 

participants. 

Under CFTC Regulation 

§ 1.3(kkk)(2)(i), swap positions executed 

for the purpose of speculating, 

investing, or trading are those positions 

executed primarily to take an outright 

view on market direction or to obtain an 

appreciation in value of the swap 

position itself, and not primarily for 

hedging or mitigating underlying 

commercial risks.993 For example, 

swaps positions held primarily for the 

purpose of generating profits directly 

upon closeout of the swap, and not to 

hedge or mitigate underlying 

commercial risk, are speculative or 

serve as investments. Further, as an 

alternative example, swaps executed for 

the purpose of offsetting potential future 

increases in the price of inputs that the 

entity reasonably expects to purchase 

for its commercial activities serve to 

hedge a commercial risk. 

The CFTC notes that the use of 

‘‘trading’’ in this context is not used to 

mean simply buying and selling. Rather, 

a party is using a swap for the purpose 

of trading under the rule when the party 

is entering and exiting swap positions 

for purposes that have little or no 

connection to hedging or mitigating 

commercial risks incurred in the 

ordinary course of business. ‘‘Trading,’’ 

as used in CFTC Regulation 

§ 1.3(kkk)(2)(i), therefore would not 

include simply the act of entering into 

or exiting swaps if the swaps are used 

for the purpose of hedging or mitigating 

commercial risks incurred in the 

ordinary course of business.994

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30677 

995 In the alternative to meeting the requirements 

of CFTC Regulation § 1.3(kkk)(1)(i), a swap may also 

be eligible for the hedging exclusion if the swap 

qualifies as a bona fide hedge for purposes of an 

exception from position limits under the CEA as 

provided in CFTC Regulation § 1.3(kkk)(1)(ii), or if 

it qualifies for hedging treatment under FASB 

Accounting Standards Codification Topic 815 or 

under GASB Statement 53 as provided in CFTC 

Regulation § 1.3(kkk)(1) (iii). Consequently, the 

universe of swaps that can qualify for the hedging 

exclusion is broader than the universe of swaps that 

qualify as bona fide hedges for purposes of an 

exception from position limits under the CEA as 

provided in CFTC Regulation § 1.3(kkk)(1)(ii). 

996 In the Proposing Release we stated that we did 

not believe the use of the term ‘‘mitigating’’ in the 

exclusion to mean something significantly more 

than ‘‘hedging.’’ See Proposing Release, 75 FR 

80194 n.127. As noted above, some commenters 

disagreed, and argued that ‘‘mitigating’’ should be 

interpreted more broadly to encompass general risk 

mitigation strategies. See, e.g., letters from ISDA 

and CDEU. In our view, the final rules we are 

adopting—including the use of ‘‘economically 

appropriate’’ standards and the exclusions for 

certain positions—encompass positions that may 

reasonably be described as ‘‘hedging’’ or 

‘‘mitigating’’ commercial risk. 

997Exchange Act rule 3a67–4(a)(1). Under this 

standard, the first major participant analysis need 

not account for security-based swap positions that 

pose limited risk to the market and to 

counterparties because the positions are 

substantially related to offsetting risks from a 

person’s commercial operations. These hedging 

positions would include activities, such as the 

management of receivables, that arise out of the 

ordinary course of a person’s commercial 

operations, including activities that are incidental 

to those operations. See Proposing Release, 75 FR 

at 80195. 

In addition, the security-based swap positions 

included within the rule would not be limited to 

those recognized as hedges for accounting purposes. 

See id. 

998 In the Proposing Release, we described the 

‘‘economically appropriate’’ standard as excluding 

positions that introduce ‘‘any new material 

quantum of risks.’’ See Proposing Release, 75 FR 

80194 n. 129. The interpretation in this release is 

consistent with that approach, but does not make 

use of the same ‘‘quantum of risks’’ terminology. 

999 In other words, the entity may determine that 

the use of a credit default swap for a term that is 

shorter than the lease is justified if that shorter-term 

instrument costs less or is more liquid than a 

bespoke instrument that matches the duration of the 

contract. While the shorter-term credit default swap 

does not eliminate the underlying commercial risk, 

the instrument’s use may be commercially 

reasonable for hedging purposes, and hence 

appropriately excluded from the first major 

participant test. 

1000The use of a credit default swap for an 

amount that is smaller than the underlying risk may 

be justified as part of an entity’s risk management 

strategy. For example, an entity may choose to 

engage in a partial hedge because a credit default 

swap for a smaller amount than the underlying risk 

may cost less or be more liquid than a bespoke 

instrument that more closely matches the amount 

of the risk. 

1001See letter from Senator Levin. 

1002See letters from AFR and AFSCME. 

1003See letter from Better Markets I. We 

nonetheless do not believe that such a requirement 

would be consistent with the exclusion’s 

Continued 

The CFTC acknowledges that some 

swaps that may be characterized as 

‘‘arbitrage’’ transactions in certain 

contexts may also reduce commercial 

risks enumerated in CFTC Regulation 

§ 1.3(kkk)(1). The discussion in footnote 

128 of the Proposing Release was 

intended to focus on clarifying that 

swaps are speculative for purposes of 

the rule if entered into principally and 

directly for profit and not principally to 

hedge or mitigate commercial risk. The 

reference to ‘‘arbitrage profits’’ in 

footnote 128 was intended to provide an 

example of what is commonly a 

speculative swap, not to characterize all 

arbitrage swaps as speculative. 

c. ‘‘Economically Appropriate’’ 

Standard 

The CFTC has determined to adopt 

the ‘‘economically appropriate’’ 

standard as proposed. We believe that 

this standard will help the CFTC and 

market participants distinguish which 

swaps are, or are not, commercial 

hedges thereby reducing regulatory 

uncertainty and helping prevent abuse 

of the hedging exclusion. CFTC 

Regulation 1.3(kkk)(1)(i) of the final 

rules enumerates specific risk shifting 

practices that are deemed to qualify for 

purposes of the hedging exclusion.995

Whether a swap is economically 

appropriate to the reduction of risks will 

be determined by the facts and 

circumstances applicable to the swap at 

the time a swap is entered into. While 

we acknowledge that this standard 

leaves room for judgment in its 

application, we believe this flexibility is 

needed given the wide variety of swaps 

and hedging strategies the rule applies 

to. We believe the economically 

appropriate standard together with the 

identification of the six different 

categories of permissible commercial 

risks listed in final CFTC Regulation 

§ 1.3(kkk)(1)(i) is specific enough, when 

reasonably applied, to distinguish 

whether a swap is being used to hedge 

or mitigate commercial risk. 

The Commission has determined not 

to adopt a ‘‘congruence’’ standard 

because that standard may be too 

restrictive and difficult to use given the 

range of potential types of swaps and 

hedging strategies available. 

5. Final Rules—‘‘Major Security-Based 

Swap Participant’’ Definition Under the 

Exchange Act 

a. ‘‘Economically Appropriate’’ 

Standard 

The final rules retain the proposed 

‘‘economically appropriate’’ standard, 

by which a security-based swap position 

that is used for hedging purposes 996

would be eligible for exclusion from the 

first major participant analysis if the 

position is economically appropriate to 

the reduction of risks in the conduct 

and management of a commercial 

enterprise, when those risks arise from 

the potential change in the value of 

assets, liabilities and services in 

connection with the ordinary course of 

business of the enterprise.997

Consistent with the Proposing 

Release, we interpret the concept of 

‘‘economically appropriate’’ to mean 

that the security-based swap position 

cannot materially over-hedge the 

underlying risk such that it could 

reasonably have a speculative effect,998

and that the position cannot introduce 

any new basis risk or other type of risk 

(other than counterparty risk that is 

attendant to all security-based swaps) 

more than reasonably is necessary to 

manage the identified risks. 

For example, a manufacturer that 

wishes to hedge the risk associated with 

a customer’s long-term lease of a 

product may purchase credit protection 

using a single-name credit default swap 

on which the customer is the reference 

entity. The credit default swap may be 

excluded from the first major 

participant analysis even if it is for a 

shorter term than the anticipated 

duration of the lease so long as the use 

of such a shorter-term instrument is 

reasonable as a hedge, such as due to 

cost or liquidity reasons.999 Also, the 

credit default swap may be excluded 

from the first major participant test if it 

hedges an amount of risk that is lower 

than the total amount of risk associated 

with the long-term contract.1000

In adopting this rule, we have 

considered commenter views that we 

should consider limiting the exclusion 

to positions that are recognized as 

hedges for accounting purposes.1001 We 

nonetheless do not believe that the 

requirements that are appropriate to 

identifying hedging for accounting 

purposes are needed to limit the 

availability of the hedging exclusion. 

Moreover, linking the availability of the 

exclusion to accounting standards— 

which themselves may evolve over 

time—may lead the availability of the 

exclusion to evolve over time in 

unforeseen ways. We accordingly 

believe that the exclusion should be 

available if a security-based swap 

position is economically appropriate for 

hedging purposes (and not otherwise 

precluded from taking advantage of the 

exclusion). 

We also have considered commenter 

concerns that the ‘‘economically 

appropriate’’ standard is too broad,1002

and the additional suggestion that the 

exclusion instead should be limited to 

circumstances in which the hedge is 

‘‘congruent’’ to the underlying risk.1003

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30678 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

‘‘commercial risk’’ terminology or underlying 

intent. A congruence standard particularly would 

not appear to adequately reflect the fact that 

commercially reasonable hedging activities can 

leave residual basis risk. 

1004See letter from SIFMA AMG II. 

1005For example, non-material basis risk or a nonmaterial over-hedge may occur due to the use of a 

standardized instrument. A commercial entity may 

reasonably determine that it is cost effective to use 

a standardized security-based swap to hedge the 

underlying risk, even if use of the standardized 

instrument introduces non-material basis risk or 

reflects a non-material amount of over-hedging 

compared to what would be the result of using a 

bespoke security-based swap to hedge that risk. 

1006Exchange Act rule 3a67–4(a)(2). We 

previously noted that the proposed definition 

would facilitate those types of security-based swap 

positions. See Proposing Release, 75 FR at 80196. 

1007As discussed in the Proposing Release, see 75 

FR at 80196 n.135, the references here to customers 

and counterparties do not include swap or securitybased swap counterparties. 

1008Exchange Act rule 3a67–4(b)(1). The 

commercial risk hedging exclusion for the purposes 

of the ‘‘major security-based swap participant’’ 

definition (in contrast to the commercial risk 

hedging exclusion in connection with the ‘‘securitybased swap dealer’’ definition) does not turn upon 

whether a position is ‘‘primarily’’ for speculative or 

trading purposes. For the ‘‘major security-based 

swap participant’’ definition, a security-based swap 

position with any speculative or trading purpose 

cannot take advantage of the commercial risk 

hedging exclusion regardless of whether 

speculation or trading constitutes the ‘‘primary’’ 

purpose of the position. 

1009See generally Basel Committee on Banking 

Supervision, ‘‘International Convergence of Capital 

Measurement and Capital Standards, A Revised 

Framework, Comprehensive Version’’ (June 2006) at 

¶¶ 685–689(iii) (defining the term ‘‘trading book’’ 

for purposes of international bank capital standards, 

and stating that positions that are held for shortterm resale and/or with the intent of benefiting from 

actual or expected short-term price movements or 

to lock in arbitrage profits are typically considered 

part of an entity’s trading book). 

In contrast to the CEA rule implementing the 

commercial risk hedging definition in the context 

of the ‘‘major swap participant’’ definition, the 

Exchange Act rule does not explicitly exclude 

security-based swaps held for the purpose of 

investing. We note, however, that security-based 

swaps held for the purpose of investing (i.e., held 

primarily to obtain an appreciation in value of the 

security-based swap position) would not meet the 

‘‘economically appropriate’’ standard set forth 

above, and hence would not be eligible for the 

exclusion. 

1010See, e.g., letters from FSR I and ISDA I. 

1011See, e.g., letter from CDEU. 

We recognize the significance of 

commenters’ concerns as to the practical 

application of the ‘‘economically 

appropriate’’ standard, particularly with 

regard to hedges that are not perfectly 

correlated with the underlying risk.1004

The standard embeds principles of 

commercial reasonableness that should 

assuage those implementation concerns, 

however. These principles necessarily 

account for the fact that the reasonable 

use of security-based swaps to hedge a 

person’s commercial risk may result in 

residual basis risk, and that the mere 

presence of this basis risk should not 

preclude the availability of the 

exclusion. Moreover, the mere presence 

of residual basis risk need not run afoul 

of the restriction against materially overhedging the underlying risk, which is 

instead intended to prevent the hedging 

exclusion from applying to positions 

that are entered into for speculative 

purposes or that have speculative effect 

(such as by being based on a notional 

amount that is disproportionate to the 

underlying risk).1005

We also acknowledge that an 

‘‘economically appropriate’’ standard 

does not provide the compliance 

assurance that would accompany 

quantitative tests or safe harbors. 

Nonetheless, grounding the hedging 

exclusion in principles of commercial 

reasonableness permits the standard to 

be sufficiently flexible to appropriately 

address an end-user’s particular 

circumstances and hedging needs. Use 

of an ‘‘economically appropriate’’ 

standard also is consistent with the fact 

that entities should be expected to use 

their reasonable business judgment 

when hedging their commercial risks. 

To provide additional guidance to 

entities hedging commercial risk, 

moreover, the final rule incorporates 

examples of security-based swap 

positions that, depending on the 

applicable facts and circumstances, may 

satisfy the ‘‘economically appropriate’’ 

standard.1006 These are: 

• Positions established to manage the 

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

counterparty’s potential default in 

connection with: financing provided to 

a customer in connection with the sale 

of real property or a good, product or 

service; a customer’s lease of real 

property or a good, product or service; 

a customer’s agreement to purchase real 

property or a good, product or service in 

the future; or a supplier’s commitment 

to provide or sell a good, product or 

service in the future.1007

• Positions established to manage the 

default risk posed by a financial 

counterparty (different from the 

counterparty to the hedging position at 

issue) in connection with a separate 

transaction (including a position 

involving a credit derivative, equity 

swap, other security-based swap, 

interest rate swap, commodity swap, 

foreign exchange swap or other swap, 

option, or future that itself is for the 

purpose of hedging or mitigating 

commercial risk pursuant to the rule or 

the counterpart rule under the 

Commodity Exchange Act); 

• Positions established to manage 

equity or market risk associated with 

certain employee compensation plans, 

including the risk associated with 

market price variations in connection 

with stock-based compensation plans, 

such as deferred compensation plans 

and stock appreciation rights; 

• Positions established to manage 

equity market price risks connected 

with certain business combinations, 

such as a corporate merger or 

consolidation or similar plan or 

acquisition in which securities of a 

person are exchanged for securities of 

any other person (unless the sole 

purpose of the transaction is to change 

an issuer’s domicile solely within the 

United States), or a transfer of assets of 

a person to another person in 

consideration of the issuance of 

securities of such other person or any of 

its affiliates; 

• Positions established by a bank to 

manage counterparty risks in 

connection with loans the bank has 

made; and 

• Positions to close out or reduce any 

of the positions addressed above. 

b. Treatment of Speculative or Trading 

Positions 

The final rule, consistent with the 

proposal, provides that this hedging 

exclusion does not extend to securitybased swap positions that are in the 

nature of speculation or trading.1008 The 

exclusion thus does not extend to 

security-based swap positions that are 

held for short-term resale and/or with 

the intent of benefiting from actual or 

expected short-term price movements or 

to lock in arbitrage profits, or to 

security-based swap positions that 

hedge other positions that themselves 

are held for the purpose of speculation 

or trading.1009

The Commissions recognize that some 

commenters take the position that the 

exclusion should extend to securitybased swap positions that hedge 

speculative or trading positions.1010 In 

support, these commenters have stated 

that the proposed approach would lead 

to more unhedged risk in the market, 

and that the proposed approach could 

lead entities that use security-based 

swaps to hedge speculative positions to 

be major participants, in contrast to 

unhedged (and presumably riskier) 

entities. Commenters further requested 

clarification regarding how entities may 

distinguish speculative or trading 

positions from other security-based 

swap positions.1011

The Commissions nonetheless do not 

believe that it would be appropriate to 

extend the hedging exclusion to 

speculative or trading positions, 

including security-based swap positions 

that themselves hedge other positions 

that are for speculative or trading 

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1012 In addition, this limitation is consistent with 

the exclusion from the first major participant test 

in connection with ERISA plans. That exclusion 

particularly addresses security-based swap 

positions with the primary purpose of ‘‘hedging or 

mitigating any risk directly associated with the 

operation of the plan.’’ It is not clear why that scope 

of the ERISA exclusion would need to be 

incorporated into the first major participant test if 

the ‘‘commercial risk’’ exclusion already were broad 

enough to encompass hedges of trading or 

speculative positions. 

1013As an example, one speculative/trading 

strategy involving security-based swaps can be to 

purchase short-dated credit protection in 

conjunction with a long-dated bond, to reflect a 

view that a particular company is likely to fail in 

the current credit environment. Combined, those 

positions can produce losses if the current credit 

environment did not change or if spreads were to 

widen, but could produce profits either if the 

company were to default or if spreads were to 

narrow and funding costs were to decrease. See 

Morgan Stanley, Credit Derivatives Insights 156–58 

(4th ed., 2008). In other words, under that strategy 

the purchase of the credit protection would offset 

a portion of the risks associated with the ownership 

of the bond, but for the purpose of taking a 

directional view of the market with the hope for 

profit if the purchaser’s view of future market 

dynamics is correct (and the reality of losses if the 

purchaser’s view of the market is wrong). It would 

require an extraordinarily liberal construction of 

‘‘commercial risk’’ to subsume this type of 

speculative security-based swap activity. 

At the same time, we recognize that an entity 

hedging a commercial risk (in contrast to a risk 

arising from a speculative or trading strategy) 

reasonably may choose to use a security-based swap 

that is shorter-dated than the underlying risk, with 

the security-based swap appropriately excluded 

from the first major participant definition. 

1014This approach does not reflect any value 

judgment about the role of speculation in the 

market for security-based swaps, or about the 

relative market benefits or risks associated with 

speculation. This position simply represents an 

attempt to give meaning to the statutory use of the 

term ‘‘commercial risk’’ in a way that reflects Title 

VII’s special treatment of commercial end-users, 

and (as discussed below) avoid an interpretation 

that effectively undermines the first major 

participant test. 

1015As noted by one participant to the roundtable 

on these definitions: ‘‘[B]eing a hedge fund 

manager, there’s nothing in my portfolio I can’t 

claim to be hedging a risk. There’s nothing. There’s 

not a trade I do ever that I can’t claim it to be a 

hedge against interest rates, or inflation, or against 

equity. You know, the fact of the matter is, if you’re 

a capital market participant, your business is taking 

risks.’’ Roundtable Transcript at 325 (remarks of 

Michael Masters, Better Markets). 

1016See letter from ISDA I. 

1017Of course, this would only be the case where 

the entity’s hedging and speculative activities 

combined were at a level in excess of the major 

participant thresholds. 

1018This is not to say that the purchase of credit 

protection on a security that a person owns would 

necessarily be entitled to the hedging exclusion. If 

the underlying security itself is held for speculative 

or trading purposes, the credit protection would not 

be excluded from the first major participant 

analysis, and in any event would not reasonably be 

construed as hedging ‘‘commercial risk.’’ 

1019Apart from that example, it is more difficult 

to foresee circumstances in which the sale of credit 

protection using a credit default swap would be 

expected to fall within the exclusion. We recognize, 

for example, that a person that has a short position 

in a security of a reference entity may have an 

incentive to sell credit protection on that reference 

entity to offset movements in the price or value of 

that short position (and/or lock in arbitrage profits 

in connection with that short position). While that 

sale of credit protection may mitigate the risks 

Continued 

purposes. Those limitations are 

appropriate to help give meaning to the 

concept of ‘‘commercial’’ risk, and to 

reflect the legislative intent to limit the 

impact of Title VII on commercial endusers of security-based swaps.1012

Indeed, the use of security-based swap 

positions in connection with 

speculative and trading activity often 

may be expected either to have the 

purpose of locking-in arbitrage profits 

associated with those activities or 

producing an adjusted risk profile in 

connection with perceptions of future 

market behavior—neither of which 

would eliminate the speculative or 

trading purpose of the activity.1013 We 

do not believe that it would be 

appropriate, or consistent with the 

Dodd-Frank Act, to interpret the term 

‘‘commercial risk’’ to accord the same 

regulatory treatment to security-based 

swap positions for speculative or 

trading purposes as is accorded to the 

use of security-based swap positions in 

connection with commercial activities 

such as producing goods or providing 

services to customers.1014

Moreover, the Commissions believe 

that it would undermine the major 

participant definition to attribute a nonspeculative or non-trading purpose to 

security-based swap positions that 

hedge speculative or trading positions. 

When a person uses a security-based 

swap position to help lock in profits or 

otherwise control the volatility 

associated with speculative or trading 

activity, or to cause that speculative or 

trading activity to reflect a particular 

market outlook or risk profile, the 

security-based swap position serves as 

an integral part of that speculative or 

trading activity. It thus would not 

appear appropriate or consistent with 

economic reality to seek to distinguish 

the security-based swap component 

from the other speculative or trading 

aspects of that activity. In fact, if 

‘‘hedges’’ of speculative or trading 

positions were excluded from the first 

major participant test, entities could 

readily label a wide range of securitybased swap positions entered into for 

speculative or trading purposes as being 

excluded hedges.1015 Taken to its 

natural conclusion, such an approach 

largely may exclude security-based 

swap positions from the first major 

participant test, effectively writing that 

test out of the statutory definition. 

We are aware of commenters’ views 

that regulation of major participants has 

the potential to create a disincentive 

against certain entities’ use of securitybased swaps to manage risk in 

connection with their speculative or 

trading activities.1016 Under this view, 

regulation potentially could result in 

those entities electing not to reduce the 

risks that they otherwise would seek to 

hedge, to avoid being regulated as major 

participants.1017 That potential result, 

however, is an unavoidable 

consequence of the legislative decision 

to regulate persons whose securitybased swap positions cause them to be 

major participants. It would not be 

appropriate to use the hedging 

exclusion to negate part of the 

underlying statutory definition simply 

to avoid disincentives that are an 

unavoidable consequence of the 

legislative decision to regulate major 

participants. 

At the same time, we are mindful that 

market participants have requested 

further guidance as to how to 

distinguish between hedging positions 

that are subject to this exclusion, and 

speculative or trading positions that fall 

outside the exclusion. In our view, 

analysis of this issue is simplified by the 

nature of security-based swaps, and by 

the limited circumstances in which a 

person may be expected to have a 

commercial risk such that the use of a 

security-based swap may be 

economically appropriate for managing 

that commercial risk (rather than being 

for speculation or trading purposes). 

In the case of security-based swaps 

that are credit derivatives, the final rule 

provides examples of the use of credit 

default swaps to purchase credit 

protection that, depending on the 

applicable facts and circumstances, may 

appropriately be excluded from the first 

major participant test (e.g., the use of a 

credit default swap to purchase credit 

protection in connection with the 

potential default of a customer, supplier 

or counterparty, or in connection with 

loans made by a bank). Certain other 

purchases of credit protection using 

credit default swaps—such as the 

purchase of credit protection to manage 

the risks associated with securities that 

a non-financial company holds in a 

corporate treasury and that are not held 

for speculative or trading purposes— 

may also meet the standard under these 

rules.1018 The sale of offsetting credit 

protection may also reasonably be 

expected to fall within the exclusion to 

the extent that this sale is reasonably 

necessary to address changes 

(particularly reductions) in the amount 

of underlying commercial risk hedged 

by the initial security-based swap 

position.1019

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associated with that short position, or produce an 

arbitrage profit in connection with that short 

position, that security-based swap position would 

not appear to constitute the hedging of ‘‘commercial 

risk’’ for purposes of the exclusion. 

1020Exchange Act rule 3a67–4(b)(2). 

1021Those proposed provisions would have 

conditioned the exclusion on the person identifying 

and documenting the underlying risks, establishing 

and documenting a method of assessing the hedge 

effectiveness, and regularly assessing the 

effectiveness of the security-based swap as a hedge. 

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

1022See, e.g., letter from FSR I. 

1023Factors that may be relevant to determining 

whether a security-based swap position is 

economically appropriate to the reduction of risk 

may include the costs associated with terminating 

or reducing that position. 

1024See part V, infra. 

1025Section 3(3) of Title I of ERISA defines the 

term ‘‘employee benefit plan’’ to include ‘‘an 

employee welfare benefit plan or an employee 

pension benefit plan or a plan which is both an 

employee welfare benefit plan and an employee 

pension benefit plan.’’ See 29 U.S.C. 1002(3). The 

terms ‘‘employee welfare benefit plan’’ and 

‘‘employee pension benefit plan’’ are further 

defined in Sections 3(1) and (2) of ERISA. See 29 

U.S.C. 1002(1) and (2). 

1026Section 3(32) of Title I of ERISA defines the 

term ‘‘governmental plan’’ to mean a plan that the 

U.S. government, state or political subdivision, or 

agencies and instrumentalities establish or maintain 

for its employees, as well as plans governed by the 

Railroad Retirement Acts of 1935 and 1937, plans 

of international organizations that are exempt from 

taxation pursuant to the International Organizations 

Immunities Act, and certain plans established and 

maintained by tribal governments or their 

subdivisions, agencies or instrumentalities. See 29 

U.S.C. 1002(32). 

1027CEA section 1a(33)(A)(i)(I); Exchange Act 

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

1028See proposed CFTC Regulation 

§ 1.3(hhh)(1)(ii)(A); proposed Exchange Act rule 

3a67–1(a)(2)(i). 

1029See Proposing Release, 75 FR at 80201, supra. 

1030See letters from BlackRock I (noting that the 

ERISA hedging exclusion applies to positions with 

the ‘‘primary purpose’’ of hedging, ‘‘which suggests 

plans may exclude swap positions even if they 

serve a purpose in addition to hedging or 

mitigating’’), the ERISA Industry Committee 

(‘‘ERISA Industry Committee’’) (stating that if 

ERISA Title I plans are not excluded from the major 

participant definition, the rules should clarify that 

the ERISA hedging exclusion is broader than the 

commercial hedging exclusion and encompasses a 

variety of risks associated with the value of a plan’s 

assets or the measures of its liabilities; also stating 

that the ERISA exclusion should not omit positions 

in the nature of investing, and particularly 

discussing the use of swaps to provide 

diversification), ABC/CIEBA (expressing the view 

As for security-based swaps that are 

not credit derivatives—such as equity 

swaps and total return swaps—the final 

rule provides examples of how the use 

of those security-based swaps in 

connection with certain business 

combinations may, depending on the 

applicable facts and circumstances, 

appropriately be excluded from the first 

major participant test. The use of equity 

swaps or total return swaps to manage 

the risks associated with securities that 

are held in a corporate treasury (and 

that are not held for speculative or 

trading purposes) may also 

appropriately be subject to the 

exclusion. Other uses of equity swaps or 

total return swaps to offset risks 

associated with long or short positions 

in securities, however, may not 

appropriately be excluded from the first 

major participant test, because such 

positions would be expected to have an 

arbitrage purpose or other speculative or 

trading purpose, and would be 

inconsistent with the ‘‘commercial risk’’ 

limitation to the hedging exclusion. 

c. Treatment of Positions That Hedge 

Other Swap or Security-Based Swap 

Positions 

The final rule, consistent with the 

proposal, provides that the hedging 

exclusion does not extend to a securitybased swap position that hedges another 

swap or security-based swap position, 

unless that other position itself is held 

for the purposing of hedging or 

mitigating commercial risk.1020 This 

provision allows the first major 

participant analysis to exclude a 

person’s purchase of credit protection to 

help address the risk of default by a 

counterparty in connection with an 

interest rate swap, foreign exchange 

swap or other swap or security-based 

swap that the person has entered into 

for the purpose of hedging or mitigating 

commercial risk. 

d. Procedural Conditions 

In contrast to the proposal, the final 

rule does not incorporate procedural 

requirements in connection with the 

hedging exclusion from the first test of 

the major security-based swap 

participant definition.1021 In making 

this change, we have been mindful of 

concerns that have been expressed that 

such procedural requirements would 

lead to undue costs in connection with 

hedging activity.1022

We understand, however, that many 

entities engaging in legitimate hedging 

of commercial risks do, as a matter of 

business practice, identify and 

document those risks and evaluate the 

effectiveness of the hedge from time to 

time. The presence of supporting 

documentation consistent with such 

procedures would help support a 

person’s assertion that a security-based 

swap position should be excluded from 

the first major participant analysis, 

should the legitimacy of the exclusion 

become an issue. 

Also, although we are not requiring 

the entity to monitor the effectiveness of 

the hedge over time, that absence of this 

requirement does not change the 

underlying need for a security-based 

swap position to be economically 

appropriate for the commercial risks 

facing the entity to be excluded from the 

first major participant definition. Thus, 

for example, if a person’s underlying 

commercial risk materially diminishes 

or is eliminated over time, a securitybased swap position that may have been 

economically appropriate to the 

reduction of risk at inception at a 

certain point in time may, depending on 

the facts and circumstances, no longer 

be reasonably included within the 

exclusion.1023 As part of the reports 

required in connection with possible 

future changes to the major participant 

definitions,1024 the staffs are directed to 

address whether the continued 

availability of the hedging exclusion 

should be conditioned on assessment of 

hedging effectiveness and related 

documentation. 

D. Exclusion for Positions Held by 

Certain Plans Defined Under ERISA 

1. Proposed Approach 

The first statutory test of the major 

participant definitions excludes swap 

and security-based swap positions that 

are ‘‘maintained’’ by any employee 

benefit plan as defined in sections 

3(3) 1025 and 3(32) 1026 of ERISA ‘‘for the 

primary purpose of hedging or 

mitigating any risk directly associated 

with the operation of the plan.’’ 1027

The proposed rules incorporated that 

statutory exclusion without additional 

interpretation or refinement.1028 In the 

Proposing Release, moreover, the 

Commissions expressed the preliminary 

view that we did not ‘‘believe that it is 

necessary to propose a rule to further 

define the scope of this exclusion.’’ We 

further noted that the exclusion for 

those plans identified in the statutory 

definition is not strictly limited to 

‘‘commercial’’ risk, and that this may be 

construed to mean that hedging by those 

ERISA plans should be broadly 

excluded. The Commissions also 

solicited comment as to whether this 

exclusion should be made available to 

additional types of entities.1029

2. Commenters’ Views 

Some commenters requested 

clarification that the ERISA hedging 

exclusion is broader than the 

commercial risk hedging exclusion, and 

that the ERISA hedging exclusion can 

encompass positions that are not solely 

for hedging purposes.1030 One 

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that the ERISA hedging exclusion extends beyond 

‘‘traditional’’ hedges, and stating that the exclusion 

should encompass swaps with purposes in addition 

to hedging, and that the exclusion should 

encompass positions for the purpose of rebalancing, 

diversification and gaining asset class exposure) 

and CalSTRS I (requesting that regulations provide 

for an ERISA hedging exclusion that is broader than 

the commercial risk hedging exclusion, and that 

encompasses positions for the purpose of 

investing). 

One commenter alluded to the incorporation of 

efficient portfolio theory principles within the 

exception. See letter from Russell Investments. 

1031See letter from AFSCME (stating that while 

the statutory exclusion may encompass swaps to 

mitigate currency risk of cash market investments, 

the exclusion should not encompass swaps used for 

investment purposes such as to gain asset class 

exposure or avoid transaction costs associated with 

a direct investment). 

1032See letters from ERISA Industry Committee 

(stating that the rules should provide that the 

exclusion applies to positions maintained by any 

trust holding plan assets) and ABC/CIEBA (stating 

that the rules should provide the relevant entity for 

purposes of the exclusion is the counterparty to the 

swap, further stating that if a trust enters into a 

swap as a counterparty, it is the trust that should 

be tested as a possible major participant, even if the 

trust also holds non-ERISA assets). 

1033See letters from BlackRock I (discussing how 

plan fiduciaries may invest plan assets ‘‘in pooled 

investment vehicles such as registered investment 

companies, private funds and bank maintained 

collective trust funds,’’ and stating that not 

including pooled funds within the exclusion would 

limit plans’ ability to avail themselves of the 

efficiencies associated with pooling), ERISA 

Industry Committee (stating that there is ‘‘no 

reason’’ why the exception should not also extend 

to position held by a pooled investment trust on 

behalf of multiple employee benefit plans) and 

ABC/CIEBA (stating that if a pool within a trust is 

the counterparty, it is that pool that should be 

tested as a possible major participant, and noting 

Department of Labor regulations providing that a 

collective investment vehicle would be viewed as 

holding plan assets if the vehicle is not a registered 

investment company, and plans hold at least 25 

percent of the interests in the vehicle). 

1034See letter from AFSCME (stating that ‘‘it is 

important to limit the exemption to plans 

themselves, not to entities holding ‘plan assets’ ’’). 

1035See letter from Russell Investments. 

1036See letter from Church Alliance (stating that 

the exclusion also should encompass church plans 

defined in paragraph 3(33) of ERISA, on the 

grounds that Congress would not have intended to 

discriminate against church plans, and that church 

plans are considered ‘‘special entities’’ that should 

be the beneficiaries of extra protection). 

1037See letters from ABC/CIEBA, APG and BTPS. 

The Commissions intend to issue separate 

releases that address the application of the major 

participant definitions, and Title VII generally, to 

non-U.S. entities. 

1038For example, we do not foresee that the use 

of a swap or security-based swap position to 

replicate exposure to a foreign market or to a 

particular asset class to be for the primary purpose 

of hedging risks directly associated with the 

operation of these types of plans. While we 

recognize that an asset manager may perceive 

benefits in using swaps or security-based swaps in 

that manner, it also is necessary to give effect to the 

statutory language limiting the exclusion to 

positions that have a ‘‘primary purpose’’ of hedging 

risks ‘‘directly associated’’ with the ‘‘operations’’ of 

a plan. We recognize that lack of diversification 

may be viewed as a risk, but it is not an 

‘‘operations’’ risk. 

1039This interpretive guidance is intended solely 

in the context of the interpretation of the first test 

of the statutory major participant definitions. The 

guidance is not based on or relevant to the 

interpretation of other regulations relating to 

ERISA. 

1040As appropriate, for purposes of the first major 

participant analysis an entity may need to allocate 

the exposure associated with swap or securitybased swap positions between the amount that is 

attributable to plan assets (and hence eligible for 

exclusion) and the amount that is attributable to 

other assets. 

1041As previously noted, the Commissions intend 

to issue separate releases that address the 

application of the major participant definitions, and 

Title VII generally, to non-U.S. entities. 

commenter cautioned against 

interpreting the ERISA hedging 

exclusion broadly.1031

Commenters also requested that the 

Commissions clarify that the ERISA 

hedging exclusion applies to positions 

maintained by trusts that hold plan 

assets,1032 or by pooled funds.1033 One 

commenter, in contrast, stated that the 

exclusion should not be available to 

trusts holding plan assets.1034

One commenter stated that the 

exception should be extended to all 

public pension plans,1035 and one 

commenter particularly took the view 

that the exclusion should be available to 

church plans.1036 Some commenters 

stated that the exclusion should be 

available to non-U.S. plans.1037

3. Final Rules 

Consistent with the position 

expressed in the Proposing Release, the 

Commissions interpret the ERISA 

hedging exclusion in the first statutory 

major participant test to be broader than 

that test’s commercial risk hedging 

exclusion. This reflects the facts that the 

ERISA hedging exclusion is not limited 

to ‘‘commercial’’ risk, and that the 

ERISA hedging exclusion addresses 

positions that have a ‘‘primary’’ hedging 

purpose (which suggests that those 

positions may have a secondary nonhedging purpose). 

a. Types of Excluded Hedging Activities 

The Commissions are mindful of 

commenters’ request for additional 

clarity regarding the scope of the ERISA 

hedging exclusion. In that regard, we 

note that we generally would expect 

swap or security-based swap positions 

to have a primary purpose of hedging or 

mitigating risks directly associated with 

the operation of the types of plans 

identified in the statutory definition— 

and hence eligible for the exclusion— 

when those positions are intended to 

reduce disruptions or costs in 

connection with, among others, the 

anticipated inflows or outflows of plan 

assets, interest rate risk, and changes in 

portfolio management or strategies. 

Conversely, we believe that certain 

other types of positions would less 

likely have the primary purpose of 

hedging or mitigating risks directly 

associated with the operation of the 

plan, as anticipated by the statutory 

definition.1038

b. Availability of Exclusion 

The Commissions recognize the 

significance of comments that these 

plans may use separate entities such as 

trusts or pooled vehicles to hold plan 

assets, and that the exclusion should not 

be interpreted in a way that deters the 

use of those vehicles. We believe that 

the same principles that underpin the 

exclusion for hedging positions directly 

entered into by the types of plans 

identified in the statutory definition 

also warrant making the exclusion 

applicable to plan hedging positions 

that are entered into by those other 

parties that hold assets of those types of 

plans. Otherwise, the major participant 

analysis would have the effect of 

deterring efficiencies in plan operations 

for no apparent regulatory purpose. 

Accordingly, the Commissions 

interpret the meaning of the term 

‘‘maintain’’—in the context of the 

statutory provision that the swap or 

security-based swap position be 

‘‘maintained by’’ an employee benefit 

plan—not only to include positions in 

which the plan is a counterparty, but 

also to include positions in which the 

counterparty is a trust or pooled vehicle 

that holds plan assets. Thus, for 

example, the exclusion would be 

available to trusts or pooled vehicles 

that solely hold assets of the types of 

plans identified in the statutory 

definition.1039 The exclusion further 

may be available to entities that hold 

such plan assets in conjunction with 

other assets, but only to the extent that 

the entity enters into swap or securitybased swap positions for the purpose of 

hedging risks associated with the plan 

assets. The exclusion does not extend to 

positions that hedge risks of other 

assets, even if those are managed in 

conjunction with plan assets.1040

The Commissions also are mindful of 

commenter concerns that the exclusion 

should explicitly be made available to 

other plans, such as church plans and 

non-U.S. plans.1041 In this regard, the 

Commissions believe that the 

boundaries of the exclusion are set by 

the explicit statutory language, which 

states that it applies to any employee 

benefit plan as defined in paragraphs (3) 

and (32) of section 3 of ERISA. This 

reference is disjunctive—that is, a plan 

is eligible for the exclusion if it is 

within the scope of paragraph (3) 

(which refers to employee benefit plans) 

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1042We are not taking a view as to whether 

church plans or non-U.S. plans constitute employee 

benefit plans as defined by section 3(3) of ERISA. 1043CEA section 1a(33)(A)(ii); Exchange Act 

section 3(a)(67)(A)(ii)(II). 1044CEA section 1a(33)(A)(i); Exchange Act 

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

1045See proposed CFTC Regulation § 1.3(lll). 

1046See proposed Exchange Act rule 3a67–5. 

1047Thus, these proposed thresholds in part 

would account for a person that has large positions 

in more than one major category of swaps or 

security-based swaps, but that does not meet the 

substantial position threshold for any single 

category of swaps or security-based swaps. 

1048See, e.g., letters from ATAA (supporting 

higher thresholds to measure substantial 

counterparty exposure), CCMR I (suggesting that the 

thresholds be set high initially, capturing only a few 

entities until the Commissions are able to collect 

and analyze data that supports lowering the 

thresholds), BG LNG I (stating that proposed 

threshold should be increased substantially), 

WGCEF II (stating that the Commissions should 

adopt substantial position and substantial 

counterparty exposure tests that account for current 

conditions in swap markets), ABC/CIEBA 

(requesting that the Commissions raise the 

thresholds to better target persons creating or 

causing systemic risk as set forth in the a major 

swap participant and major security-based swap 

participant definitions), BlackRock I (stating that 

proposed thresholds for the substantial 

counterparty exposure test are too low so that they 

could encompass market participants that do not 

have systemically important swap positions) and 

ACLI (supporting increasing the thresholds under 

the CEA definition to $7 billion in daily average 

aggregate uncollateralized outward exposure or $14 

billion in daily average aggregate uncollateralized 

outward exposure plus daily average aggregate 

potential outward exposure), and meeting with 

MFA on February 14, 2011 (requesting that the 

Commissions raise the thresholds for measuring 

substantial counterparty exposure until the 

Commissions conduct a market survey to determine 

how many entities would need to perform the 

calculations regularly and whether those entities 

have characteristics capable of causing systemic 

risk). 

1049See letters from ABC/CIEBA, BlackRock I, 

ISDA I, WGCEF II, and meeting with MFA on 

February 14, 2011. 

1050See letters from Greenberger (in connection 

with thresholds relating to substantial position) and 

AFR (Commissions should define a major swap 

participant or major security-based swap 

participant as any person that maintains $500 

million in daily average, uncollateralized exposure 

for any category of swaps other than rate swaps, for 

which the daily average could be up to $1.5 billion). 

1051See, e.g., letters from ATAA (supporting the 

proposed definitions of ‘‘substantial position’’ and 

‘‘substantial counterparty exposure,’’ with the 

caveat that higher thresholds be used to measure 

‘‘substantial counterparty exposure’’), Dominion 

Resources (supporting the Commissions proposed 

definitions of ‘‘substantial position’’ and 

‘‘substantial counterparty exposure’’), Fidelity 

(threshold levels set at appropriate levels but 

should be periodically reviewed for adjustment), 

and Kraft (thresholds as proposed are appropriate). 

1052See letters from MFA (stating that the 

calculation of substantial counterparty exposure 

should measure the exposure that a person has to 

each individual counterparty that is a systemically 

important financial institution excluding cleared 

swap transactions) and CCMR I (stating that the 

‘‘substantial counterparty exposure’’ and 

‘‘substantial position’’ thresholds should apply to 

the largest exposure that a person has to another 

market participant, with any aggregate test being set 

at a higher level). 

1053See letters from CDEU, COPE I, Fidelity, 

ISDA I, and MFA I. 

1054See letter from CDEU. 

1055See letter from NAIC (stating that the 

Commissions should defer to FSOC when 

considering the designation of insurers under the 

second test, and should exclude from the analysis 

swaps and security-based swap positions used for 

hedging provided that such positions are subject to 

state investment laws and ongoing monitoring by a 

state insurance regulatory authority). 

or of paragraph (32) (which applies to 

government plans). Accordingly, the 

scope of the cited definitions in 

paragraphs (3) and (32) should be 

determined in accordance with all law 

that applies in the interpretation of 

ERISA.1042

E. ‘‘Substantial Counterparty Exposure’’ 

1. Proposed Approach 

The major participant definitions’ 

second statutory test encompasses 

persons whose outstanding swaps or 

security-based swaps ‘‘create substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the U.S. banking system or 

financial markets.’’ 1043 In contrast to 

those definitions’ first statutory test, 

which relates to persons with a 

‘‘substantial position’’ in swaps or 

security-based swaps in a ‘‘major’’ 

category,1044 this second test is not 

limited to positions in a single category. 

Also, unlike the first test, the second 

statutory test does not explicitly exclude 

certain commercial risk hedging 

positions or ERISA hedging positions. 

For the ‘‘major swap participant’’ 

definition, the Proposing Release 

provided that a person’s swap positions 

pose ‘‘substantial counterparty 

exposure’’ if those positions present a 

daily average current uncollateralized 

exposure of $5 billion or more, or 

present daily average current 

uncollateralized exposure plus potential 

future exposure of $8 billion or 

more.1045 For the ‘‘major security-based 

swap’’ definition, the proposal provided 

that a person’s security-based swap 

positions pose ‘‘substantial counterparty 

exposure’’ if those positions present 

daily average current uncollateralized 

exposure of $2 billion or more, or 

present daily average current 

uncollateralized exposure plus potential 

future exposure of $4 billion or 

more.1046

Under the proposal, those measures 

would be calculated in the same manner 

as would be used for the first major 

participant test, except that the 

‘‘substantial counterparty exposure’’ 

analysis would consider all of a person’s 

swap or security-based swap positions 

rather than solely considering positions 

in a particular ‘‘major’’ category, and 

that the ‘‘substantial counterparty 

exposure’’ analysis would not exclude 

positions to hedge commercial risks or 

ERISA plan risks. 

The proposed ‘‘substantial 

counterparty exposure’’ thresholds were 

set higher than the proposed 

‘‘substantial position’’ thresholds in part 

to reflect the fact that the former test 

accounts for a person’s positions across 

four major swap categories or two major 

security-based swap categories.1047 The 

proposed ‘‘substantial counterparty 

exposure’’ thresholds also reflected the 

fact that this second test (unlike the first 

major participant test) encompasses 

certain hedging positions that, in 

general, we would expect to pose a 

lesser degree of risk to counterparties 

and the markets. 

2. Commenters’ Views 

a. General Comments 

In light of the similarity between the 

proposed tests, a number of the 

concerns that commenters expressed 

with regard to the proposed ‘‘substantial 

position’’ definition also apply to the 

proposed ‘‘substantial counterparty 

exposure’’ definition. In addition, some 

commenters took the view that the 

proposed ‘‘substantial counterparty 

exposure’’ thresholds were too low,1048

with several of those commenters 

stating that the thresholds should be 

raised to a level that reflects systemic 

risk.1049 A few commenters took the 

view that the proposed thresholds were 

too high.1050 Some commenters 

generally supported the approach to the 

definition of ‘‘substantial counterparty 

exposure’’ proposed by the 

Commissions.1051

Some commenters took the view that 

the ‘‘substantial counterparty exposure’’ 

test should focus on the size of an 

entity’s exposure to specific 

counterparties.1052 Several commenters 

suggested that the thresholds should be 

adjusted over time for inflation and 

changes in the swap and security-based 

swap markets.1053 One commenter 

urged that the analysis consider the 

interconnectedness of the entity.1054

One commenter addressed the 

application of the second major 

participant test to insurance companies, 

arguing that substantial counterparty 

exposure should be decided by the 

FSOC in consultation with the relevant 

state insurance commissioner, and that 

hedges should be excluded from the 

calculation for insurers.1055

b. Lack of Exclusion for Hedging 

Positions 

A number of commenters took the 

view that the second major participant 

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1056See letters from SIFMA AMG II (noting that 

the Commissions have suggested that hedging 

positions may not raise the same degree of risk as 

other swap positions), NAIC (supporting exclusion 

of commercial risk hedging positions subject to 

state investment laws and ongoing monitoring by 

state insurance regulators), AIA (supporting 

hedging exclusion to avoid capturing entities such 

as property-casualty insurers), CDEU (suggesting 

that inclusion of hedging positions is inconsistent 

with goal of mitigating systemic risk), APG 

(supporting exclusion of positions held by regulated 

foreign pension plans), and NRG Energy (suggesting 

that a lack of an exclusion would cause end-users 

to curtail hedging activities and increase systemic 

risk); see also letter from AIMA I (supporting an 

exemption or discount if the swap transaction is 

cleared, an off-set for the value and quality of any 

collateral, and consideration of the directional 

moves of particular swap contracts). 

1057See letters from ABC/CIEBA and SIFMA 

AMG II. One commenter further requested that 

ERISA Title I plans be explicitly excluded from the 

second test. See letter from ERISA Industry 

Committee. Another commenter requested an 

exclusion for ERISA plans generally. See letter from 

CalSTRS I. 

1058See letter from Better Markets I (stating that 

excluding hedging positions would be 

inappropriate because the Dodd-Frank Act did not 

provide for any such exclusion in the second test, 

hedge positions may still contribute to counterparty 

exposure, and the thresholds already reflect the 

lower level of risk posed by hedge positions). 

1059Accordingly, changes that the final rules 

made to the proposal with regard to the ‘‘substantial 

position’’ definition, see part IV.B.3, supra, also are 

carried over to the definition of ‘‘substantial 

counterparty exposure.’’ 

1060See CFTC Regulation § 1.3(lll); Exchange Act 

rule 3a67–5. 

1061Accordingly, consistent with the proposal, 

the threshold for the ‘‘major swap participant’’ 

definition is $5 billion or more in daily average 

current uncollateralized exposure, or $8 billion or 

more in daily average uncollateralized exposure 

plus potential future exposure. The threshold for 

the ‘‘major security-based swap participant’’ is $2 

billion or more in daily average current 

uncollateralized exposure, or $4 billion or more in 

daily average uncollateralized exposure plus 

potential future exposure. 1062See notes 1051 and 1052, supra. 

1063As with the ‘‘substantial position’’ analysis, 

our decision to adopt these thresholds is informed 

by events related to AIG Financial Products and 

LTCM. See part IV.B.3.d, supra. 

1064CEA section 1a(33); Exchange Act section 

3(a)(67). 

1065CEA section 2(h)(7); Exchange Act section 

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

1066See proposed CFTC Regulation 

§ 1.3(mmm)(1); proposed Exchange Act rule 3a67– 

6(a). For both sets of rules, the ‘‘financial entity’’ 

definition would include any: commodity pool (as 

defined in section 1a(10) of the CEA); private fund 

(as defined in section 202(a) of the Investment 

Advisers Act of 1940); employee benefit plan as 

defined in paragraphs (3) and (32) of section 3 of 

ERISA; and person predominantly engaged in 

activities that are in the business of banking or 

financial in nature (as defined in section 4(k) of the 

Bank Holding Company Act of 1956). 

To avoid circularity, the use of the term 

‘‘financial entity’’ in the context of the ‘‘major swap 

participant’’ definition also would encompass any 

‘‘security-based swap dealer’’ and ‘‘major securitybased swap participant,’’ but would not include any 

‘‘swap dealer’’ or ‘‘major swap participant’’ (even 

though the latter terms also are found in the 

Continued 

test should exclude commercial risk 

hedging positions from the analysis.1056

Some commenters also supported 

excluding ERISA hedging positions 

from the analysis.1057 One commenter 

opposed any such exclusions for 

hedging positions.1058

3. Final Rules 

Consistent with the Proposing 

Release, the final rules defining the term 

‘‘substantial counterparty exposure’’ 

generally are based on the same current 

uncollateralized exposure and potential 

future exposure tests that are used to 

identify a ‘‘substantial position.’’ 1059 As 

with the Proposing Release, moreover, 

the ‘‘substantial counterparty exposure’’ 

analysis addresses all of a person’s swap 

or security-based swap positions (rather 

than being limited to positions in a 

‘‘major’’ category), and does not exclude 

hedging positions.1060 The final rules 

also incorporate the quantitative 

thresholds that were proposed for those 

tests.1061

In adopting these final rules we have 

considered commenter views that the 

‘‘substantial counterparty exposure’’ 

analysis should exclude certain 

commercial risk and ERISA hedging 

positions. We nonetheless believe that 

the structure of the major participant 

definitions—particularly the fact that 

those definitions specifically exclude 

hedging positions from the first 

statutory test but not from the second 

test—necessitates the conclusion that 

the second test not exclude those 

hedging positions. 

We also have considered commenter 

views that the ‘‘substantial counterparty 

exposure’’ analysis should account for 

the maximum exposure that a person 

poses to any single counterparty. We 

nonetheless believe that the statutory 

test—particularly its focus on serious 

adverse effects on financial stability or 

financial markets—more appropriately 

is addressed by measures of the 

aggregate counterparty risk that an 

entity poses through its swap or 

security-based swap positions. Also, 

consistent with our views regarding the 

‘‘substantial position’’ definition, we 

believe that the ‘‘substantial 

counterparty exposure’’ analysis 

appropriately is addressed via objective 

and quantitative criteria (rather than a 

multi-tier approach), and appropriately 

takes into account current 

uncollateralized exposure and potential 

future exposure. 

Consistent with the Proposing 

Release, the thresholds to implement 

the second major participant test are 

higher than the corresponding 

thresholds for the first major participant 

test. These differences reflect the fact 

that the second test encompasses four 

‘‘major’’ categories of swaps or two 

‘‘major’’ categories of security-based 

swaps, as well as the fact that this 

second test does not exclude hedging 

positions that would appear to pose a 

lesser degree of counterparty risk than 

non-hedging positions. 

While we are mindful of commenter 

views that the proposed ‘‘substantial 

counterparty exposure’’ thresholds were 

too low,1062 we believe that the same 

principles that support the proposed 

standards in the context of the 

‘‘substantial position’’ definition also 

support the proposed standards for this 

second test. As with the ‘‘substantial 

position’’ analysis, the ‘‘substantial 

counterparty exposure’’ analysis seeks 

to reflect a standard that encompasses 

large market participants before the 

counterparty risk posed by their swap 

and security-based swap positions 

present too large a problem, as well as 

the financial system’s ability to absorb 

losses of a particular size, and the need 

to account for the possibility that 

multiple market participants may fail 

close in time.1063 Commenters have not 

presented empirical or analytical 

evidence in support of a different 

standard. In the future, the 

Commissions may review and 

potentially adjust these thresholds to 

reflect evolving market structures and 

additional data. 

F. ‘‘Highly Leveraged’’ and ‘‘Financial 

Entity’’ 

1. Proposed Approach 

The third statutory test of the major 

participant definitions encompasses any 

non-dealer that: (i) Is a ‘‘financial 

entity’’ (other than one that is ‘‘subject 

to capital requirements established by 

an appropriate Federal banking 

agency’’), (ii) is ‘‘highly leveraged 

relative to the amount of capital it 

holds,’’ and (iii) maintains a 

‘‘substantial position’’ in any ‘‘major’’ 

category of swaps or security-based 

swaps.1064 In contrast to the first 

statutory test—which also encompasses 

persons with a ‘‘substantial position’’ in 

swaps or security-based swaps in a 

‘‘major’’ category—this third test does 

not exclude positions that hedge 

commercial risk or ERISA risks. 

a. ‘‘Financial Entity’’ 

The Proposing Release defined the 

term ‘‘financial entity’’ for purposes of 

the major participant definition in the 

same general manner as Title VII defines 

that term for purposes of the end-user 

exemption from mandatory clearing,1065

but with certain technical changes to 

avoid circularity.1066

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‘‘financial entity’’ definition used for purposes of 

the end-user clearing exception). See proposed 

CFTC Regulation § 1.3(mmm)(1). In the context of 

the ‘‘major security-based swap participant’’ 

definition, the term ‘‘financial entity’’ also would 

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

participant,’’ but would not include any ‘‘securitybased swap dealer’’ and ‘‘major security-based swap 

participant.’’ See proposed Exchange Act rule 3a67– 

6(a). 

1067See proposed CFTC Regulation 

§ 1.3(mmm)(2); proposed Exchange Act rule 3a67– 

6(b). 

1068The Proposing Release particularly noted that 

the third statutory major participant test excludes 

financial institutions subject to capital requirements 

set by Federal banking agencies, and recognized the 

possibility those entities were excluded based on 

the presumption that they generally are highly 

leveraged. The Proposing Release noted, based on 

analysis of financial statements, that it appears that 

those institutions generally have a leverage ratio of 

10 to 1, and that this suggested that the ‘‘highly 

leveraged’’ threshold would have to be lower for 

those institutions to potentially be subject to the 

third test. See Proposing Release, 75 FR at 80199. 

1069The Proposing Release noted that Title I 

provides that the Board must require a bank holding 

company with total consolidated assets equal to or 

greater than $50 billion, or a nonbank financial 

company supervised by the Board, to maintain a 

debt to equity ratio of no more than 15 to 1 if the 

FSOC determines ‘‘that such company poses a grave 

threat to the financial stability of the United States 

and that the imposition of such requirement is 

necessary to mitigate the risk that such company 

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

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

Proposing Release further noted that this 15 to 1 

ratio may represent an upper limit to acceptable 

leverage and that the major participant analysis 

should use a lower threshold, or, alternatively, that 

the 15 to 1 ratio provides an appropriate test of 

whether an entity poses the systemic risk concerns 

implicated by the major participant definitions. See 

Proposing Release, 75 FR at 80199. 

1070The Proposing Release also stated that 

entities that file quarterly reports on Form 10–Q 

and annual reports on Form 10–K with the SEC 

would determine their total liabilities and equity 

based on the financial statements included with 

such filings while all other entities would calculate 

the value of total liabilities and equity consistent 

with the proper application of U.S. GAAP. See id. 

1071See id. at 80198–99. 

1072See id. at 80199–200. 

1073See, e.g., letters from CalSTRS dated June 15, 

2011 (‘‘CalSTRS II’’), Kraft, Newedge, NRU CFC I 

and Philip Morris. 

1074See letters from Kraft and Philip Morris. 

1075See letter from CalSTRS II (asserting that 

there is not a basis to treat ERISA plans as 

‘‘financial entities’’ for purposes of the major 

participant definitions solely to maintain 

consistency with an ‘‘anomalous’’ statutory 

provision). 

1076See letter from NRU CFC I. 

1077See letters from ACLI (requesting 

confirmation that the exclusion from the third 

statutory test extends to entities subject to bank or 

financial holding companies, entities deemed 

systemically important under Title I of the DoddFrank Act, and any other persons subject to capital 

regulation established by a Federal banking 

regulator) and MetLife (requesting clarification that 

the exclusion extends to persons subject to 

regulation and capital requirements on a 

consolidated basis under federal banking law, and 

persons that are individually or systemically 

important financial institutions under Title I). 

1078One commenter took the view that non-U.S. 

governments and their agencies should be excluded 

from the ‘‘financial entity’’ definition for purposes 

of the major participant definition and the Title VII 

end-user exemption from mandatory clearing. See 

letter from Milbank. On the other hand, one 

commenter favored the inclusion of non-U.S. 

governments in the ‘‘financial entity’’ definition. 

See meeting with Duffie on February 2, 2011 

(suggesting that foreign governments and other 

foreign jurisdictions, such as municipalities, should 

be treated as ‘‘financial entities’’ for purposes of the 

major swap participant definition and other 

requirements under the Dodd-Frank Act on the 

grounds that such entities could become sources of 

systemic risk). 

The Commissions intend to issue separate 

releases addressing the application of Title VII to 

non-U.S. persons. 

1079See letters from ISDA I (suggesting that the 

wide use of leverage by financial institutions means 

that the definition should capture only entities with 

the ‘‘very highest’’ leverage ratios, and that the 15 

to 1 ratio should be viewed as a floor for identifying 

highly leveraged entities given that it is used in 

Title I to address entities that have already been 

determined to pose a ‘‘grave threat’’ to the stability 

of the U.S. financial system), MFA I (stating that 15 

to 1 is the more appropriate of the two choices, and 

that the Commissions could subsequently adjust the 

ratio after receiving market data on the use of 

leverage), AIMA I (encouraging the Commissions to 

adopt the 15 to 1 leverage threshold until an 

assessment of the impact of the major participant 

definitions can be completed); Amex (supporting 

the use of the 15 to 1 ratio, noting that it is 

consistent with the maximum leverage allowed to 

entities designated as a grave threat to financial 

stability under Title I of the Dodd-Frank Act) and 

CDEU (recommending use of the 15 to 1 standard, 

based on its consistency with the leverage limit in 

Title I of the Dodd-Frank Act for entities posing a 

grave threat to the United States financial system 

and that ‘‘it would be unreasonable to propose a 

stricter leverage threshold under the major 

participant test for nonbank financial end-users,’’ 

and expressing concern that entities comfortably 

falling under the 8 to 1 ratio could unexpectedly 

exceed this threshold during periods of market 

stress and that sudden designation as a major 

participant ‘‘could seriously hinder a company from 

meeting its obligations’’). 

1080See letter from Better Markets I (stating that 

the 8 to 1 threshold would better serve the purposes 

b. ‘‘Highly Leveraged’’ 

The Proposing Release set forth two 

alternative approaches for determining 

whether a particular entity would be 

deemed ‘‘highly leveraged.’’ 1067 Under 

one approach, an entity would be 

‘‘highly leveraged’’ if the ratio of its 

liabilities to equity exceeded 8 to 1; this 

proposed alternative reflected the fact 

that the third statutory major participant 

test excludes certain types of 

entities.1068 Under the alternative 

approach, an entity would be ‘‘highly 

leveraged’’ if the ratio of its liabilities to 

equity exceeded 15 to 1; this proposed 

alternative reflected standards for 

maximum leverage in certain 

circumstances found in Title I of the 

Dodd-Frank Act.1069 The proposal 

further provided that leverage would be 

measured at the close of business on the 

last business day of the applicable fiscal 

quarter, and that liabilities and equity 

would be determined in accordance 

with U.S. generally accepted accounting 

principles (‘‘GAAP’’).1070

In proposing these alternative 

standards for identifying ‘‘highly 

leveraged’’ entities, the Commissions 

recognized that traditional balance sheet 

measures of leverage are limited as tools 

for evaluating an entity’s ability to meet 

its obligations—in part because such 

measures do not directly account for 

potential risks posed by specific 

instruments held on the balance sheet, 

or for financial instruments held off of 

the balance sheet. At the same time, the 

Commissions preliminarily concluded 

that it was not necessary to use more 

complex measures of risk-adjusted 

leverage for these purposes, in part 

because the third test’s ‘‘substantial 

position’’ analysis already accounts for 

such risks. The Commissions also noted 

the costs that would be associated with 

causing entities to engage in complex 

calculations of risk-adjusted 

leverage.1071

The Proposing Release solicited 

comment on a variety of issues related 

to the proposed leverage ratios, 

including the relative merits of the 

alternative 8 to 1 and 15 to 1 standards, 

and potential alternative standards.1072

2. Commenters’ Views 

a. ‘‘Financial Entity’’ 

Some commenters recommended that 

certain types of entities should be 

excluded from the definition of 

‘‘financial entity,’’ on the grounds that 

those types of entities are more 

appropriately treated as non-financial 

end users of swaps for purposes of the 

Dodd-Frank Act.1073 Commenters 

specifically suggested that the ‘‘financial 

entity’’ definition exclude: (i) 

Centralized hedging and treasury 

subsidiaries in corporate groups; 1074 (ii) 

employee benefit plans; 1075 and (iii) 

cooperative structures.1076 Commenters 

also requested clarification as to which 

entities would not be ‘‘subject to capital 

requirements established by an 

appropriate Federal banking agency,’’ 

and hence not subject to the third 

statutory test.1077 In addition, 

commenters addressed the application 

of the ‘‘financial entity’’ definition to 

non-U.S. persons.1078

b. ‘‘Highly Leveraged’’ 

A number of commenters supported 

the proposed 15 to 1 alternative leverage 

ratio over the 8 to 1 alternative, with 

some commenters further suggesting 

that the final rule should set a leverage 

ratio higher than 15 to 1, or that the 

ratio should be reconsidered when more 

information is available regarding 

leverage among swap users.1079 One 

commenter supported the proposed 8 to 

1 alternative,1080 and one commenter 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30685 

of the Dodd-Frank Act by ‘‘ensuring that more, 

rather than fewer, financial entities are covered by 

the risk mitigation and business conduct standards 

that Congress established’’ for major participants, 

and that use of the 15 to 1 leverage ratio from Title 

I of the Dodd-Frank Act is inappropriate because 

the Title I ratio is used for the ‘‘relatively 

draconian’’ purpose of imposing leverage limits, 

while this ratio would be used for ‘‘the more 

modest purpose of imposing registration 

requirements’’). 

1081See letter from Greenberger (suggesting that 

the leverage test should be set at a ratio that is lower 

than either of the two proposed levels). 

1082See meeting with MFA on February 14, 2011 

(MFA representatives making point that ‘‘highly 

leveraged’’ should be defined in coordination with 

other regulations under the Dodd-Frank Act, and for 

example, a requirement that banks hold 8% capital 

implies a leverage ratio of approximately 12:1). 

1083The suggested adjustments were: to measure 

the ratio of net current credit exposure to Tier I 

capital, in a manner similar to that used by bank 

regulators (see letter from Greenberger); to include 

as liabilities all unfunded exposures on swaps, both 

current and potential (see letter from Better Markets 

I); and to account for the different risk levels of 

various classes of assets and liabilities and for other 

factors affecting a person’s riskiness (see letters 

from CCMR I and MFA I). 

1084See letters from CalSTRS I (also stating that 

for purposes of determining leverage ratios, the 

value of the plan’s assets should be determined as 

of most recent annual valuation rather than 

quarterly) and APG (stating that only investmentrelated liabilities, rather than anticipated shortfalls 

in benefit obligations, should be considered in the 

leverage calculation, and the test should be adjusted 

to take into account legally binding investment 

restrictions and other constraints that could be just 

as effective, or more effective, at reducing 

insolvency risk as capital requirements that would 

limit leverage). 

1085See letter from NRU CFC I (stating that this 

application of the leverage test would be consistent 

with its financial statements). 

1086See letters from ACLI, FSR I, MetLife and 

NAIC. 

1087See letters from ACLI, FSR I and NAIC. 

1088See letter from MetLife. 

1089See letter from FSR I. 

1090See letter from NAIC. 

1091See CFTC Regulation § 1.3(mmm)(1); 

Exchange Act rule 3a67–6(a). Accordingly, this 

general definition encompasses commodity pools, 

private funds, ERISA plans, and persons 

predominately engaged in activities that are in the 

business of banking or financial in nature, as well 

as certain dealers or major participants. See note 

1066, supra. 

1092See letter from CalSTRS II (ERISA plans 

should not be included in the definition of 

‘‘financial entity’’ for purposes of the major 

participant definitions). 

1093See CEA section 2(h)(7)(D); Exchange Act 

section 3C(g)(4). 1094See CFTC Regulation § 1.3(mmm)(2); 

Exchange Act rule 3a67–6(b). 1095Consistent with the general inter-affiliate 

exceptions from the dealer and major participant 

definitions, see parts II.C and IV.G, for purposes of 

these rules, the counterparties are majority-owned 

affiliates if one party directly or indirectly holds a 

majority ownership interest in the other, or if a 

third party directly or indirectly holds a majority 

interest in both, based on holding a majority of the 

equity securities of an entity, or the right to receive 

upon dissolution or the contribution of a majority 

of the capital of a partnership. See CFTC Regulation 

§ 1.3(mmm)(1); Exchange Act rule 3a71–6(b)(2). 

1096We also note that this result is parallel to the 

Title VII end-user exception from mandatory 

clearing, which extends to hedging activities of 

financial entities on behalf of non-financial 

affiliates. See CEA section 2(h)(7)(D); Exchange Act 

section 3C(g)(4). 

suggested that the final rule should set 

a leverage ratio lower than 8 to 1.1081

One commenter suggested a ratio of 12 

to 1, consistent with certain capital 

requirements.1082

Commenters also suggested a variety 

of methods and adjustments for 

calculating leverage ratios.1083

Some commenters further suggested 

that specific leverage tests be applied to 

particular types of financial entities. For 

employee benefit plans, commenters 

particularly stated that a plan’s 

obligations to pay benefits should not be 

considered a liability for purposes of the 

analysis, and the value of the plan’s 

assets should be used as the 

denominator for the ratio in lieu of 

using the non-applicable term 

‘‘equity.’’ 1084 Another commenter— 

which obtains a substantial amount of 

funding by issuing subordinated debt, 

rather than equity—expressed the view 

that the leverage calculation should 

allow it to treat subordinated debt as 

equity.1085

Several commenters addressed the 

application of the leverage ratio to 

insurance companies in light of the 

applicable regulatory regimes and their 

use of statutorily required accounting 

methods rather than GAAP.1086 Those 

commenters took the view that an 

insurance company’s leverage should be 

tested based on its risk-based capital 

ratio or on its statutory accounting 

statements, with certain adjustments to 

account for different types of 

liabilities,1087 or based on whether its 

insurance regulator believes that it is 

adequately capitalized.1088 One 

commenter said that the leverage ratio 

test should not apply to insurance 

companies,1089 and another said that 

application of the leverage ratio test to 

insurance companies should be 

coordinated with the FSOC.1090

3. Final Rules 

a. ‘‘Financial Entity’’ 

Consistent with the Proposing 

Release, the final rules defining 

‘‘financial entity’’ for purposes of the 

third major participant test are based on 

the corresponding ‘‘financial entity’’ 

definition used in the Title VII 

exception from mandatory clearing for 

end users, with certain adjustments to 

avoid circularity.1091 In this regard, 

while we are mindful of one 

commenter’s views that the differences 

between the major participant 

definitions and the end-user clearing 

exception necessitate different 

‘‘financial entity’’ definitions,1092 we do 

not concur with the view that the term 

‘‘financial entity’’ should be interpreted 

independently in these two contexts. 

Both sets of provisions distinguish 

between financial and non-financial 

entities in a way that limits the impact 

of Title VII on the latter set of entities, 

and we believe that the definitions 

should be consistent in light of those 

parallel purposes. 

The Commissions are aware, however, 

that the major participant definitions 

differ from the mandatory clearing 

requirements in how they address 

affiliates. The mandatory clearing 

requirements include a provision that 

specifically addresses affiliates of 

persons that qualify for the exception 

from mandatory clearing for end 

users,1093 while no such specific 

provision is included in the major 

participant definitions. Given this 

absence, the Commissions believe it is 

appropriate to modify the final rules 

defining ‘‘financial entity’’ for purposes 

of the major participant definitions from 

the proposal to exclude certain 

centralized hedging and treasury 

entities.1094 The Commissions 

understand that a primary function of 

such centralized hedging and treasury 

entities is to assist in hedging or 

mitigating the commercial risks of other 

entities within their corporate groups. 

Although those entities’ activities could 

constitute being ‘‘in the business of 

banking or financial in nature,’’ we do 

not believe that it would be appropriate 

to treat a person as a ‘‘financial entity’’ 

for the purposes of the major participant 

definitions if the person would fall 

within that definition solely because it 

facilitates hedging activities involving 

swaps or security-based swaps by 

majority-owned affiliates that 

themselves are not ‘‘financial 

entities.’’ 1095 Absent this change, the 

major participant analysis would 

exclude hedging positions that do not 

use centralized hedging facilities, but 

would not exclude identical hedging 

positions that make use of a centralized 

hedging facility.1096 Such a result would 

inappropriately discourage the use of 

centralized hedging and treasury 

entities. 

While the Commissions also have 

considered the views of commenters 

that the ‘‘financial entity’’ definition 

should exclude certain other types of 

entities—such as employee benefit 

plans, and cooperatives—the final rules 

do not provide any such exclusions. As 

a general matter, the Commissions 

believe that the ‘‘financial entity’’ 

definition should be the same for 

purposes of the major participant 

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1097Similarly, the Commissions in general are not 

adopting categorical requests for exclusions from 

the major participant definitions. See part IV.J, 

infra. 

1098See CFTC Regulation § 1.3(mmm)(2); 

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

defining ‘‘highly leveraged’’ have been renumbered 

from the proposal for the sake of clarity. 

1099See note 1082, supra, and accompanying text. 

1100See, e.g., letters from Amex and CDEU. 

1101See Dodd-Frank Act section 165(j)(1). 

1102We also note that the use of the 15 to 1 ratio 

of Title I in this context could lead to potentially 

incongruous results. In particular, if the 

Commissions were to use the 15 to 1 leverage ratio 

for the ‘‘highly leveraged’’ definition, then an entity 

that is deemed to be such a threat to the United 

States financial system that its leverage has been 

capped pursuant to Title I also would effectively be 

excepted from the third statutory test of the major 

participant definitions due to that cap. The 12 to 

1 leverage ratio that we are adopting today does not 

give rise to the same result and therefore does not 

present the same question of interpretation as to 

whether this result would be appropriate. 

1103See Proposing Release, 75 FR at 80199 n.152. 

1104Exchange Act rule 15c3–1 provides that a 

broker-dealer may determine its required minimum 

net capital, among other ways, by applying a 

financial ratio that provides that its aggregate 

indebtedness shall not exceed 1500 percent of its 

net capital (i.e., a 15 to 1 aggregate indebtedness to 

net capital ratio). In addition, Exchange Act rule 

17a–11 further requires that broker-dealers that use 

such method to establish their required minimum 

net capital must provide notice to regulators if their 

aggregate indebtedness exceeds 1200 percent of 

their net capital (i.e., a 12 to 1 aggregate 

indebtedness to net capital ratio). 

1105The measure of aggregate indebtedness in 

rule 15c3–1 excludes certain secured liabilities, and 

the measure of net capital excludes certain illiquid 

assets but includes certain subordinated debt. As a 

result, the ratios discussed above would not 

necessarily be equivalent to 15:1 or 12:1 ratios 

when converted to a balance sheet ratio of liabilities 

to equity. 

definition as it is for purposes of the 

end-user exception from mandatory 

clearing.1097

We also have considered the views of 

some commenters that subsidiaries of 

bank holding companies, financial 

holding companies or systemically 

important financial institutions should 

be considered to be ‘‘subject to capital 

requirements established by an 

appropriate Federal banking agency,’’ 

and hence not subject to the third 

statutory major participant test. We 

nonetheless interpret the term ‘‘subject 

to capital requirements established by 

an appropriate Federal banking agency’’ 

to specifically apply to persons for 

whom a Federal banking agency directly 

sets capital requirements. We do not 

believe that the term should be 

interpreted to apply to other persons by 

virtue of their being part of a holding 

company that is subject to those capital 

requirements, or otherwise being 

affiliated with persons subject to those 

capital requirements, because we do not 

believe that the mere fact of that 

relationship is sufficient to control or 

mitigate the credit risk that those 

persons pose to their counterparties. 

b. ‘‘Highly Leveraged’’ 

i. Leverage Ratio Level 

After considering commenters’ views, 

the Commissions are adopting final 

rules that define ‘‘highly leveraged’’ to 

generally mean a ratio of liabilities to 

equity in excess of 12 to 1.1098 Our 

adoption of this 12 to 1 standard, rather 

than the proposed 8 to 1 or 15 to 1 

alternatives, takes into account 

commenters’ views on the alternatives, 

as well as one commenter’s support for 

a 12 to 1 ratio.1099

In general, we believe that the 

structure of the third statutory major 

participant test—which, unlike the first 

statutory test, does not permit the 

exclusion of certain hedging positions— 

reasonably may be interpreted as 

reflecting the determination that: (a) 

higher leverage indicates that an entity 

poses a heightened risk of being unable 

to meet its obligations; and (b) such 

entities should not be permitted to 

exclude hedging positions from the 

‘‘substantial position’’ analysis in light 

of the counterparty risks those positions 

pose (even recognizing that these may 

be lower than counterparty risks posed 

by comparable non-hedging positions). 

Commenters who addressed the 

proposed leverage ratio raised diverse 

points of view in support of the 8 to 1 

and 15 to 1 alternatives, or other 

standards. A number of those 

commenters, however, appeared to 

focus on the outcome of particular 

leverage ratios—i.e., that a lower 

leverage ratio likely would lead to more 

major participants, and that a higher 

leverage ratio likely would lead to fewer 

major participants—and to base their 

conclusions on their views of that 

outcome. In general, the comments did 

not reflect an attempt to identify typical 

leverage ratios for financial entities, or 

to address the link between leverage and 

risk. 

Some commenters specifically 

supported the use of a 15 to 1 leverage 

ratio in light of Title I’s use of that 

ratio.1100 While considering this 

perspective, we believe it also is 

appropriate to consider the different 

purposes for which leverage is 

addressed in the Title I and major 

participant contexts. The 15 to 1 

leverage provision in Title I reflects a 

maximum allowable threshold of 

leverage for certain bank holding 

companies and nonbank financial 

companies when a determination has 

been made that such entities pose a 

‘‘grave threat to the financial stability of 

the United States’’ and that the 

imposition of this limitation is 

necessary to mitigate the risks posed by 

such entities—in essence serving as a 

hard leverage cap for certain entities 

that have been deemed risky to the U.S. 

financial system.1101 In contrast, 

leverage serves a type of gatekeeper 

function in the major participant 

definitions by identifying the amount of 

leverage that will require a non-bank 

financial entity to engage in the 

‘‘substantial position’’ analysis without 

excluding hedging positions, rather than 

seeking to limit the maximum leverage 

available to those entities. Just as 

concepts of ‘‘maximum leverage’’ are 

distinct from concepts of ‘‘high 

leverage,’’ the use of a 15 to 1 maximum 

leverage ratio in Title I does not 

mandate the conclusion that the same 

15 to 1 ratio must be used for 

interpreting the meaning of ‘‘highly 

leveraged’’ in the major participant 

definitions.1102

In considering the definition of the 

term ‘‘highly leveraged’’ based on the 

reasoning outlined above, we also are 

mindful that, as the Proposing Release 

noted,1103 broker-dealer capital 

regulations include special provisions 

that apply when a broker-dealer’s 

leverage exceeds 12 to 1.1104 While we 

recognize that these capital regulations 

have limitations as tools for defining 

‘‘highly leveraged’’ for purposes of the 

major participant definitions due to 

differences in how leverage would be 

calculated,1105 we also believe that 

these regulations are informative 

regarding the use of leverage in the 

major participant context given that 

they highlight an existing link between 

increased regulatory oversight and the 

amount of leverage an entity maintains. 

In light of the reasons noted above for 

using a leverage ratio below 15 to 1, 

commenter concerns that a ratio of 8 to 

1 would be too low, one commenter’s 

suggestion of a 12 to 1 leverage ratio, 

and leverage tests found in brokerdealer capital regulations, the 

Commissions have determined that a 12 

to 1 leverage ratio reflects an 

appropriate basis for identifying ‘‘highly 

leveraged’’ financial entities. In making 

this determination we recognize that 

other approaches also may be 

reasonable (e.g., lower thresholds based 

on the analysis of the leverage of certain 

financial entities also may be 

reasonable, as may higher thresholds 

based on Title I and on other aspects of 

broker-dealer capital rules). We also 

recognize, however, that the need to 

implement the major participant 

definitions requires that we draw a line. 

In our view, a 12 to 1 ratio reflects a 

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1106See CFTC Regulation § 1.3(mmm)(2); 

Exchange Act rule 3a67–7(b). The accounting 

standard setters are currently working on a number 

of projects that may impact how leverage would be 

calculated using GAAP. The Commissions will 

review and potentially adjust their rules in the 

future to reflect changes in GAAP. 

1107See CFTC Regulation § 1.3(mmm)(2)(ii); 

Exchange Act rule 3a67–7(b). These provisions 

specifically apply to employee benefit plans as 

defined by paragraph (3) and (32) of section 3 of 

ERISA, consistent with the ERISA exclusion from 

the first statutory major participant test. 

1108Although commenters raised issues with 

regard to the application of leverage ratios to 

insurers, see, e.g., letter from FSR I, we do not 

believe that it would be appropriate to create a 

special leverage test for insurers. We note that 

insurers that are publicly traded companies already 

file financial statements consistent with GAAP. 

Also, smaller insurers that do not file GAAP-based 

financial statements would be able to take 

advantage of the safe harbor from the major 

participant calculations. See part IV.M, infra. 

1109See Proposing Release, 75 FR at 80202. 1110See, e.g., letters from COPE I, FSR I and 

Encana Marketing (USA) Inc. dated February 22, 

2011 (‘‘Encana I’’). 

Some commenters explained the widespread use 

of central hedging desks to allocate risk within 

affiliate groups or to gather risk from within a group 

and lay off that risk on the market. See, e.g., letters 

from CDEU, EEI/EPSA, Encana I and FSR I. Also, 

some commenters noted that including these interaffiliate transactions within the major participant 

analysis would result in many cases in doublecounting of an entity’s swap or security-based swap 

activity. See letters from CDEU and FSR I. 

1111See letter from Amex and CDEU. One 

commenter specifically suggested that we adopt the 

definition of ‘‘control’’ found in the Bank Holding 

Company Act. See joint letter from The Bank of 

Tokyo-Mitsubishi UFJ, Ltd., Mizuho Corporate 

Bank, Ltd. and Sumitomo Mitsui Banking 

Corporation. 1112See, e.g., letters from COPE I, EEI/EPSA, FSR 

I, Encana I and Utility Group. 1113See joint letter from ABA Securities 

Association, ACLI, FSR, FIA, Institute of 

International Bankers, ISDA and SIFMA. 

1114See CFTC Regulation § 1.3(hhh)(4); Exchange 

Act rule 3a67–3(e). A person’s market-facing swap 

or security-based swap positions, including those 

taken to lay off risk assumed from a majority-owned 

affiliate, must still be included in the person’s 

substantial position and counterparty exposure 

calculations. 

For the purposes of this rule, and consistent with 

the general inter-affiliate exception from the dealer 

definitions, see part II.C, supra, counterparties are 

majority-owned affiliates if one party directly or 

indirectly owns a majority interest in the other, or 

if a third party directly or indirectly owns a 

majority interest in both, based on the right to vote 

or direct the vote of a majority of a class of voting 

securities of an entity, the power to sell or direct 

the sale of a majority of a class of voting securities 

of an entity, or the right to receive upon dissolution 

or the contribution of a majority of the capital of 

a partnership. 

1115See part II.C.2, supra. 

reasonable location for this line that is 

appropriate for purposes of the third 

major participant test, and that 

reasonably accounts for commenter 

concerns and the other considerations 

discussed above. 

ii. Leverage Ratio Calculation 

Consistent with the proposal, the final 

rules defining ‘‘highly leveraged’’ 

generally measure leverage as a ratio of 

a person’s liabilities to equity, as 

determined in accordance with 

GAAP.1106 Also, consistent with the 

proposal, these leverage ratios should be 

calculated as of the close of business on 

the last business day of the applicable 

fiscal quarter, as we do not believe there 

is any relevant difference among 

financial entities that would require 

timing variations. 

In general, moreover, the 

Commissions believe that all types of 

financial entities should be subject to 

the same methods of measuring 

leverage, to facilitate the even 

application of the leverage test. At the 

same time, we are mindful of the 

significance of commenter concerns that 

calculating leverage as a ratio of 

liabilities to equity consistent with 

GAAP would lead to inappropriate 

results for certain types of financial 

instruments or financial entities. 

We believe that these concerns are 

significant enough to warrant one 

modification of the proposed approach 

to measuring leverage. In particular, the 

final rules provide that certain 

employee benefit plans may: (i) Exclude 

obligations to pay benefits to plan 

participants from their measure of 

liabilities for purposes of the leverage 

calculation; and (ii) substitute the total 

value of plan assets for equity for 

purposes of the leverage calculation.1107

We believe that this change will allow 

the measure of leverage to more 

appropriately reflect the risk that those 

entities pose. 

Otherwise, we do not believe that it 

would be appropriate to depart from 

GAAP measures of equity and liabilities 

for purposes of identifying highly 

leveraged entities.1108

G. Application to Inter-Affiliate Swaps 

and Security-Based Swaps 

1. Proposed Approach and Commenters’ 

Views 

In the Proposing Release, we stated 

that the major participant analysis 

should consider the economic reality of 

swaps and security-based swaps 

between affiliates, and preliminarily 

concluded that swaps or security-based 

swaps among wholly owned affiliates 

‘‘may not pose the exceptional risks to 

the U.S. financial system that are the 

basis for the major participant 

definitions.’’1109

A number of commenters concurred 

that swaps among affiliates should be 

excluded from the major participant 

analysis.1110 At the same time, no 

commenters expressed support for the 

Proposing Release’s suggestion that this 

interpretation be limited to transactions 

among wholly owned subsidiaries. 

Instead, several commenters expressed 

the view that the swaps or securitybased swaps should not be counted for 

purposes of the major participant 

analysis when the counterparties are 

under common control,1111 or otherwise 

are affiliates.1112 One commenter 

suggested that the analysis exclude 

swaps or security-based swaps between 

entities that are under common control 

and whose financial statements are 

consolidated.1113

2. Final Rule 

After considering commenters’ views, 

we have concluded that the major 

participant definitions should not 

encompass a person’s swaps or securitybased swaps for which the counterparty 

is a majority-owned affiliate. As noted 

in our discussion of inter-affiliate 

activities in the context of the dealer 

definitions, market participants may 

enter into such inter-affiliate swaps or 

security-based swaps for a variety of 

purposes. When swaps and securitybased swaps are entered into to allocate 

risk within a corporate group and do not 

pose a high likelihood of risk to the 

broader market—as we believe would be 

the case with majority ownership—we 

do not believe that their swaps and 

security-based swaps raise the systemic 

risk and other concerns that major 

participant regulation is intended to 

address. For this reason, we do not 

believe that this interpretation needs to 

be limited to swaps or security-based 

swaps among wholly owned affiliates, 

as the Proposing Release had indicated. 

Accordingly, the final rules provide 

that a person may exclude particular 

swaps or security-based swaps from the 

analysis of whether the person is a 

major participant, so long as the 

counterparties to those swaps or 

security-based swaps are majorityowned affiliates.1114

In taking this approach, we have also 

considered alternatives suggested by 

commenters. For example, while one 

commenter suggested that we allow the 

exclusion of all swaps or security-based 

swaps between entities under common 

control, we believe that such an 

approach would be overly inclusive for 

the purpose of identifying transactions 

that should be excluded from the major 

participant analysis, given that common 

control by itself does not ensure that 

two entities’ economic interests are 

sufficiently aligned.1115 Also, one 

commenter suggested that the interaffiliate exclusion should apply to 

swaps and security-based swaps 

between affiliates whose financial 

statements are consolidated, but, as we 

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1116See text accompanying note 350, supra. 

1117The Proposing Release further recognized 

that it may be appropriate at times to place the 

requirements upon the subsidiary to the extent the 

subsidiary is acting on behalf of the parent. See 

Proposing Release, 75 FR at 80202. 

1118See id. 

1119See letters from FSR I, ISDA, MetLife and 

Newedge. Certain of those commenters also warned 

of problems that could arise if the positions of 

international affiliates were aggregated, due to 

conflicting regulations potentially applicable to 

such entities. See letters from ISDA I, MetLife and 

Newedge. The Commissions are addressing issues 

related to the application of the major participant 

definitions to non-U.S. persons in separate releases. 

1120See letters from CDEU (suggesting that 

control should be interpreted narrowly for purposes 

of the major participant test such that affiliated 

positions would only be aggregated if there is whole 

ownership or consolidation for accounting 

purposes, and exercise of actual control in terms of 

ownership and management) and ACLI (suggesting 

flexibility such that an entity with independent 

credit and no guarantee or credit support from a 

parent could be treated separately, but a corporate 

group could consolidate its affiliates’ positions if 

that would accurately reflect its participation in the 

derivatives market). 

1121See letter from Newedge. 

1122See letters from APG (stating that the 

aggregation of inter-affiliate guaranteed transactions 

would raise costs without providing a 

corresponding benefit to the financial system, and 

that principal obligors and guarantors pose separate 

credit risks, which are already priced into the 

positions, and that guarantees are not traditionally 

regulated as swaps), CDEU (objecting to attributing 

the positions of an end-user affiliate that relies on 

a parent for credit support, primarily out of concern 

that an end-user that might otherwise avail itself of 

the end-user clearing exception might be forced to 

clear its transactions if they were attributed to the 

major participant parent), ISDA I and Twelve Firms 

(stating that the statutory major participant 

definitions do not indicate that they encompass 

contingent credit support arrangements, and that 

credit exposures of subsidiaries already will be 

addressed through regulation of the subsidiary). 

1123See letters from FSR I (suggesting that there 

may be some situations in which the positions of 

different entities in a corporate group should be 

aggregated, such as when ‘‘a parent entity 

guarantees the obligations of its subsidiaries that are 

engaging in swaps’’) and MetLife (stating that ‘‘it is 

not appropriate to require aggregation of 

subsidiaries’ swaps at the parent level unless the 

parent is providing a guarantee or credit support for 

the subsidiaries’ obligations’’); see also letter from 

ACLI (stating that the positions of entities that do 

not have a guarantee or credit support from a parent 

are entitled to an individualized determination of 

their status under the major participant test). 

1124See letters from AFGI (arguing against 

attribution on the grounds that the guarantors are 

typically not exposed to a fluctuating termination 

value of interest rate swaps for these types of 

transactions due to the fact that they do not 

guarantee that amount, but rather only guarantee 

continued payments of these policies, and also that 

they are subject to the standard underwriting 

process and thus are subject to comprehensive 

regulation) and joint letter from MBIA Inc., MBIA 

Insurance Corp. and National Public Finance 

Guarantee Corp. (‘‘MBIA’’) (arguing against 

attribution on the grounds that the economic 

exposure to the financial guarantor is the equivalent 

of having underwritten a fixed rate bond issued by 

the particular municipal entity, and such exposures 

are subject to the normal underwriting process and 

significant risk management and regulatory 

oversight). 

1125See letters from American Securitization 

Forum (suggesting that aggregation is not 

appropriate when the risk is contained within the 

special purpose vehicle, and noting that special 

purpose vehicles often bear the entire economic risk 

of a security-based swap transaction and are 

bankruptcy remote, so the failure of a special 

purpose vehicle to meet its obligations would not 

have a rippling effect onto its sponsor) and FSR I 

(stating that the major participant determination 

should focus on a special purpose entity itself, and 

not its sponsor or transferor, in circumstances 

where securitization vehicles have been 

consolidated with sponsors or transferors for 

financial accounting purposes but a counterparty 

would have to conduct a separate credit analysis on 

the special purpose entity, and its obligations are 

nonrecourse to the sponsor or transferor). 

1126See letter from CDEU (noting that nonconsolidated joint ventures typically enter into their 

own swaps and these transactions are not included 

on the balance sheet of a minority holder in a joint 

venture). 

1127See letters from CDEU and ERISA Industry 

Committee. 

1128See letter from FSR I (suggesting that a 

corporate group should be permitted to designate a 

single entity or a small number of entities as the 

registered major participant, with other entities in 

the group relying on that entity for compliance). 

addressed in the context of the dealer 

definitions, we do not believe that the 

scope of this exclusion should be 

exposed to the risk of future changes in 

accounting standards.1116

H. Application to Positions of Affiliated 

Entities and to Guarantees 

1. Proposed Approach 

The Proposing Release expressed the 

preliminary view that when a parent is 

the majority owner of a subsidiary 

entity, the subsidiary’s swap or securitybased swap positions may be aggregated 

at the parent for purposes of the major 

participant analysis, on the grounds that 

the parent effectively is the beneficiary 

of the transaction. At the same time, the 

Proposing Release acknowledged that 

there could remain questions as to 

whether the requirements applicable to 

major participants—such as capital, 

margin and business conduct 

requirements—should be placed upon 

the parent or the subsidiary.1117

The Proposing Release solicited 

comment on a number of aspects of 

these issues, including whether 

attribution would be appropriate when 

there is less than majority ownership, or 

when a parent provides guarantees on 

behalf of its subsidiaries. The Proposing 

Release also solicited comment with 

regard to implementation issues.1118

2. Commenters’ Views 

A number of commenters expressed 

the view that the Commissions should 

not aggregate the positions of affiliates 

to the parent, arguing that legal 

separation should be respected unless 

there is some evidence that separate 

affiliates are being used to evade 

regulation.1119 Other commenters took 

the view that aggregation of affiliates’ 

positions may be appropriate in some 

circumstances, such as when 

aggregation would accurately reflect the 

structure of a corporate group or its 

participation in the derivatives 

market.1120 One commenter 

recommended that if the Commissions 

choose to require the aggregation of 

affiliate positions for purposes of the 

major participant test, the Commissions 

also should provide a mechanism for 

entities to receive ‘‘disaggregation’’ 

relief upon a showing that the affiliates 

are acting autonomously.1121

Some commenters argued that 

positions should not be consolidated for 

purposes of the major participant 

analysis even when a parent guarantees 

the obligations of a subsidiary.1122 Other 

commenters, however, expressed less 

opposition to aggregation in the 

presence of a guarantee or credit 

support.1123

Commenters also addressed the 

application of these principles to 

particular types of entities. Some 

commenters took the view that positions 

guaranteed by financial guarantors 

should not be attributed to those entities 

for purposes of the major participant 

analysis.1124 Other commenters stated 

that the positions of a special purpose 

vehicle should not be aggregated with 

its sponsor where there is no recourse 

to the sponsor for the vehicle’s 

obligations.1125 One commenter 

requested clarification that positions of 

joint ventures would not be aggregated 

with those of another entity if the 

positions are not consolidated on the 

other entity’s balance sheet.1126

Commenters further took the view that 

ERISA plans should not be aggregated 

with those of plan sponsors for purposes 

of the major participant tests, noting 

that plans and sponsors are separate 

legal entities, file separate financial 

statements, are subject to separate 

regulatory schemes, and that plan 

sponsors are prohibited from providing 

credit support or guarantees to ERISA 

Title I plans.1127

Two commenters addressed 

operational compliance issues that 

would be raised if positions are 

aggregated for purposes of the major 

participant analysis. One commenter 

suggested that a corporate group that 

falls within the major participant 

definition due to its aggregate positions 

should be able to designate a single 

entity to undertake compliance on 

behalf of the other affiliates.1128 Another 

commenter stated that when the 

aggregated positions of a corporate 

group results in major participant 

designation, the Commissions should 

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1129See letter from CDEU. 

1130See part IV.I, infra. 

1131 In taking this position, we are not suggesting 

that the presence of a guarantee would be 

determinative of other issues arising under Title 

VII. For example, the fact that a parent that is a 

‘‘financial entity’’ guarantees a subsidiary’s swap or 

security-based swap positions would not foreclose 

the subsidiary from taking advantage of the 

exception from mandatory clearing that is available 

to commercial end-users. 

1132 In reaching this conclusion, we have been 

mindful of views expressed by some commenters 

that the mere fact of a guarantee should not be 

enough to require the attribution of a position to a 

guarantor. We believe, however, that this approach 

is best suited to address the risk focus of the major 

participant definitions. We further believe that the 

statutory definition’s language that addresses 

persons who ‘‘maintain’’ substantial positions or 

‘‘whose’’ positions create substantial counterparty 

exposure is consistent with this approach. 

We also have considered arguments that the 

major participant definition should not extend to 

financial guarantee insurers. We nonetheless 

believe that when an insurer guarantees the 

performance of other parties’ swap or securitybased swap positions, in an amount that is greater 

than the applicable major participant thresholds, it 

would be appropriate to regulate that entity as a 

major participant. When the guaranteed positions 

are large enough, the risks associated with those 

positions and the repercussions of the guarantor’s 

default would appear to be within the ambit of the 

risks that that the major participant definitions were 

intended to capture. In reaching this conclusion, 

the Commissions are not expressing a view 

regarding whether financial guarantee insurance is 

a swap or security-based swap. See Product 

Definitions Proposal, note 3, supra. 

1133 ‘‘AIGFP’s obligations were guaranteed by its 

highly-rated parent company * * * an arrangement 

that facilitated easy money via much lower interest 

rates from the public markets, but ultimately made 

it difficult to isolate AIGFP from its parent, with 

disastrous consequences.’’ The AIG Rescue, Its 

Impact on Markets, and the Government’s Exit 

Strategy, note 913, supra, at 20. 

1134As a result of this interpretation, holding 

companies will not be deemed to be major 

participants as a result of guarantees to certain U.S. 

entities that already are subject to capital 

regulation. The Commissions intend to address 

guarantees provided to non-U.S. entities, and 

guarantees by non-U.S. holding companies, in 

separate releases. 

1135This type of attribution may also be expected 

to raise special issues of application in the context 

of guarantees involving swap or security-based 

swap positions of non-U.S. entities. The 

Commissions intend to address those issues in 

separate releases. 

1136 In reaching this preliminary conclusion, we 

considered the text of the major participant 

definitions, as well as a colloquy on the Senate floor 

that addressed the status of managed accounts for 

purposes of the major participant definitions. See 

Proposing Release, 75 FR at 80201 & n.162. 

The Proposing Release also noted that the 

Commissions have anti-evasion authority to the 

extent that persons seek to allocate swaps or 

security-based swaps among different accounts to 

seek to evade the regulations applicable to major 

participants. See id. at 80201. 

1137See id. 

1138See, e.g., letters from BlackRock I and 

Fidelity. 

1139See letter from Fidelity (particularly 

addressing fund managers). 

1140See letter from BlackRock and joint letter 

from ICI and SIFMA AMG. 

exempt from major participant 

regulation all affiliates in the corporate 

group that otherwise would qualify for 

the end-user clearing exception.1129

3. Final Interpretation 

After considering commenter 

concerns and the underlying issues, we 

are revising certain of the preliminary 

views we expressed in the Proposing 

Release. In particular, we no longer take 

the position that a subsidiary’s swap or 

security-based swap position as a matter 

of course should be attributed to the 

subsidiary’s majority-owner parent. 

Instead, consistent with the approach 

discussed below with regard to managed 

accounts,1130 an entity’s swap or 

security-based swap positions in general 

would be attributed to a parent, other 

affiliate or guarantor for purposes of the 

major participant analysis to the extent 

that the counterparties to those 

positions would have recourse to that 

other entity in connection with the 

position. Positions would not be 

attributed in the absence of recourse.1131

We believe this approach in general 

appropriately reflects the risk focus of 

the major participant definitions by 

providing that entities will be regulated 

as major participants when they pose a 

high level of risk in connection with the 

swap and security-based swap positions 

they guarantee.1132 Indeed, the events 

surrounding the failure of AIG FP 

highlights how the guarantees can cause 

major risks to flow to the guarantor.1133

Even in the presence of a guarantee, 

however, we do not believe that it is 

necessary to attribute a person’s swap or 

security-based swap positions to a 

parent or other guarantor if the person 

already is subject to capital regulation 

by the CFTC or SEC (i.e., swap dealers, 

security-based swap dealers, major swap 

participants, major security-based swap 

participants, FCMs and broker-dealers) 

or if the person is a U.S. entity regulated 

as a bank in the United States. Positions 

of those regulated entities already will 

be subject to capital and other 

requirements, making it unnecessary to 

separately address, via major participant 

regulations, the risks associated with 

guarantees of those positions.1134

We recognize that attribution of swap 

or security-based swap positions to a 

parent or guarantor for purposes of the 

major participant analysis can raise 

special issues with regard to operational 

compliance. These include, for example, 

issues as to the application of the 

transaction-focused requirements 

applicable to registered major 

participants (e.g., certain requirements 

related to trading records and 

transaction confirmations), given that 

the entity that directly is the party to the 

swap or security-based swap may be 

better positioned to comply with those 

requirements. For those transactionfocused requirements, we believe that 

an entity that becomes a major 

participant by virtue of swaps or 

security-based swaps directly entered 

into by others must be responsible for 

compliance with all applicable major 

participant requirements with respect to 

those swaps or security-based swaps 

(and must be liable for failures to 

comply), but may delegate operational 

compliance with transaction-focused 

requirements to entities that directly are 

party to the transactions. The entity that 

is the major participant, however, 

cannot delegate compliance duties with 

the entity-level requirements applicable 

to major participants (e.g., requirements 

related to registration and capital).1135

I. Application to Managed Accounts 

1. Proposed Approach 

The Proposing Release expressed the 

preliminary view that the major 

participant definitions should not be 

interpreted to cause asset managers or 

investment advisers to be major 

participants by virtue of the swap and 

security-based swap positions of the 

accounts that they manage.1136 In 

addition, the Proposing Release 

expressed the preliminary view that the 

managed positions for which a person is 

a beneficial owner should be aggregated 

with the person’s other positions for the 

purpose of determining whether the 

beneficial owner is a major 

participant.1137

2. Commenters’ Views 

Numerous commenters supported the 

view that the major participant 

definitions should not be construed to 

aggregate the accounts managed by asset 

managers or investment advisers when 

determining whether a manager or 

adviser itself is a major participant.1138

One commenter requested that the final 

rules codify this principle.1139

Some commenters opposed the 

possibility that the swap or securitybased swap positions of mutual funds 

would be attributed to fund investors for 

purposes of the major participant 

analysis, emphasizing that the fund is 

the entity that bears the credit 

exposure.1140 Some commenters also 

opposed the possibility that a swap or 

security-based swap position of a 

managed account may be attributed to 

the account’s beneficial owner when the 

counterparty to the position does not 

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1141See letters from SIFMA AMG II (stating that 

ISDA Master Agreements commonly provide that 

the counterparty to the transaction does not have 

recourse to the accountholder’s other assets held in 

different accounts) and Fidelity (stating that when 

counterparties look solely to the credit and assets 

of an individual account, the actual risks to the 

counterparty are tied to and limited by the activities 

of the account; also stating that requiring 

aggregation of separate accounts based on beneficial 

ownership would be complicated, costly, and 

present substantial operational and legal 

complexities); see also letter from BlackRock I 

(stating the understanding that the Proposing 

Release’s reference to beneficial ownership to 

require that separate account positions be attributed 

to the owner of the separate account, and stating 

that this result would be consistent with the 

definitions’ focus on the persons whose positions 

create credit risk). 

Commenters also emphasized potential 

impracticalities of requiring asset managers to be 

responsible for making major participant 

determinations on behalf of beneficial owners. See, 

e.g., letter from SIFMA AMG II. 

1142See letter from AIMA I. 

1143See letter from SIFMA AMG II (arguing that 

it would be unlikely for this sort of evasion to 

actually occur since such tactics would be 

prohibitively expensive and operationally 

burdensome, and further stating that the 

Commissions could address such concerns through 

their anti-evasion authority). 

Also, one commenter suggested that major 

participant obligations should be limited in their 

territorial scope and should only apply to U.S. 

funds or those funds that are otherwise regulated in 

the U.S. See letter from AIMA I. The Commissions 

are addressing issues related to the application of 

the major participant definitions to non-U.S. 

persons in separate releases. 

1144See letters from ACLI, FSR I and MetLife. 

1145See letters from MFA I (stating that in masterfeeder fund structures, money that is invested flows 

to the master fund for actual investing or trading, 

and further explaining that the master fund: Is the 

party to the master trading agreements; negotiates 

the individual transactions; holds assets; receives 

the margin calls; is ultimately responsible for 

posting collateral; and is the entity to whom 

recourse is generally limited) and CCMR I. 

1146We do not believe that it is necessary to 

codify this interpretation. 

1147Thus, for example, there would not be 

recourse to the owners of shares in a registered 

investment company that maintains swap or 

security-based swap positions. 

1148For example, under some circumstances the 

positions within the managed account may make 

use of a credit support annex entered into by the 

beneficial owner. In that case, the counterparty to 

the account’s swaps and security-based swaps may 

have legal recourse to the beneficial owner, making 

it appropriate to attribute the position to the 

beneficial owner for purposes of the major 

participant analysis. 

1149These comments were submitted in response 

to the ANPRM. See notes 4 and 5, supra. 

1150See Proposing Release, 75 FR at 80202–03. 

1151See, e.g., letters from Canadian MAVs, ISDA 

I and MBIA. 

1152See letters from Fidelity and Vanguard and 

joint letter from ICI and SIFMA AMG. 

1153See letters from CDEU, ERISA Industry 

Committee and SIFMA AMG II (addressing ERISA 

plans); see also letters from ABC/CIEBA, CalSTRS 

I, Fidelity and SIFMA AMG II, (addressing 

government plans) and letter from Government of 

Singapore Investment Corp. (‘‘GIC’’) (addressing 

other pension plans and endowments). But see 

letter from AFSCME (urging caution with respect to 

have recourse to the beneficial owner’s 

assets.1141

One commenter encouraged the 

Commissions to consider developing 

anti-evasion measures if necessary, but 

cautioned that the rules should 

recognize that there are legitimate 

business reasons to structure separate, 

individually managed funds.1142

Another commenter dismissed concerns 

that entities may spread assets among 

many asset managers or use separate 

trading agreements to avoid 

regulation.1143

In addition, commenters raised 

related issues regarding the potential 

attribution of positions for purposes of 

the major participant analysis. Some 

commenters expressed the view that 

insurance company separate accounts 

should be excluded from the major 

participant determination for the 

insurer, because those separate accounts 

generally are segregated from the 

insurance company’s other 

accounts.1144 Two commenters 

requested clarification as to how swap 

and security-based swap positions of 

funds with a ‘‘master-feeder’’ structure 

should be allocated for the major 

participant determinations.1145

3. Final Interpretation 

Consistent with the approach set forth 

in the Proposing Release, the 

Commissions do not believe that it is 

necessary to consider the swap or 

security-based swap positions of the 

client accounts managed by asset 

managers or investment advisers when 

determining whether those entities are 

major participants. In reaching this 

conclusion we particularly are 

influenced by the fact that the statutory 

definitions specifically address entities 

that ‘‘maintain’’ substantial positions or 

‘‘whose’’ outstanding swaps and 

security-based swaps create substantial 

counterparty exposure. Our conclusion 

also is influenced by the fact that it 

would not appear appropriate to impose 

certain regulations applicable to major 

participants (e.g., capital) upon those 

entities.1146

Separately, after carefully considering 

commenters’ views and the purposes of 

major participant regulation, we are 

modifying the preliminary views 

expressed in the Proposing Release 

regarding the application of the major 

participant analyses to the beneficial 

owners of managed swap and securitybased swap positions. In particular, we 

conclude that the major participant 

analysis that applies to the beneficial 

owners of those positions should focus 

on where the risk associated with those 

positions ultimately resides, given how 

the statutory major participant 

definitions focus on the risks posed by 

large swap or security-based swap 

positions. Thus, for example, if the 

counterparties to a swap or securitybased swap position within a managed 

account have recourse only to the assets 

of that account in the event of default— 

and lack recourse to other assets of the 

beneficial owners—we do not believe 

that it would be appropriate to attribute 

that position to its beneficial owner. 1147

Conversely, to the extent that the 

counterparty to that position also has 

recourse to the beneficial owner, it 

would be appropriate to attribute the 

positions to the beneficial owner for 

purposes of the major participant 

analysis.1148

We believe that this general approach 

of attributing positions when recourse is 

possible also is applicable with respect 

to related issues raised by commenters, 

including issues related to insurance 

company separate accounts and masterfeeder fund arrangements. For those 

situations the same principle would 

apply—positions within an account or 

entity may be attributed to another 

entity for purposes of the major 

participant analysis if the counterparties 

to those positions can seek recourse 

from that other entity. 

J. Requests for Exclusion of Certain 

Entities From the Major Participant 

Definitions 

1. Proposed Approach 

In advance of the Proposing Release, 

a number of commenters argued that the 

Commissions should exclude various 

types of entities from the major 

participant definitions.1149 While the 

proposed rules did not incorporate any 

such exclusions, the Proposing Release 

solicited comment as to potential 

exclusions for: Entities that maintain 

legacy portfolios, investment 

companies, ERISA plans, registered 

broker-dealers and/or registered FCMs, 

sovereign wealth funds, banks, stateregulated insurers, private and state 

pension plans, and registered DCOs or 

clearing agencies.1150

2. Commenters’ Views 

Several commenters supported 

categorical exclusions from the major 

participant definitions for various types 

of entities. Commenters particularly 

urged the Commissions to provide 

exclusions for: 

• Entities that maintain legacy 

portfolios of swaps and security-based 

swaps that are in run-off;1151

• Registered investment companies 

and related investment advisers;1152

• ERISA plans, other pension funds, 

and endowments;1153

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a full exclusion of plan swaps from major 

participant consideration). 

1154See letters from AFGI (supporting exclusion 

for state-regulated insurers), NAIC (supporting 

exclusion for state-regulated insurers to the extent 

they are using derivatives for the purpose of 

hedging and not engaging in systemically 

significant derivatives activities determined by the 

Financial Stability Oversight Counsel), ACLI 

(supporting exclusion for life insurers) and AIA 

(supporting exclusion for property-casualty 

insurers). 

1155See letter from Newedge (supporting 

exclusion for registered FCMs and broker-dealers 

that engage principally in customer swap 

facilitation activities but not in other activities of 

swap or security-based swap dealers). 

1156Commenters making this point varied in their 

phrasing of the requested exclusion. One request 

asked for the exclusion of any company (regardless 

of its primary business) that uses swaps 

predominantly to hedge business risks and that 

does not pose systemic risk. See letter from CDEU. 

Another commenter asked for the exclusion of any 

end user employing prudent risk management. See 

letter from NAIC. And one commenter asked for the 

exclusion of energy companies that use swaps to 

hedge commercial risks. See letter from EDF 

Trading. 

1157See letters from Milbank Tweed and Norges 

Bank Investment Management and meeting with 

Kreditanstalt fu ̈r Wiederaufbau (‘‘KfW’’). 

1158See letter from World Bank Group. 

1159See letters from China Investment 

Corporation (‘‘CIC’’) and GIC. 

1160See letters from Newedge and SIFMA AMG 

II. 

1161See letters from AIMA I (addressing hedge 

fund managers registered as investment advisers); 

AIA (addressing property-casualty insurers) and 

Newedge (addressing FCMs and broker-dealers). 

1162See letters from Fidelity and Vanguard and 

joint letter from ICI and SIFMA AMG (addressing 

registered investment companies and their 

advisors), ABC/CIEBA, CDEU, ERISA Industry 

Committee and Fidelity (addressing ERISA plans 

and government benefit plans), ACLI (addressing 

life insurers), AIA (addressing property-casualty 

insurers), NAIC (addressing state-regulated 

insurers), Newedge (addressing FCMs and brokerdealers) and GIC (addressing sovereign wealth 

funds). 

1163See letters from ABC/CIEBA and CDEU 

(addressing ERISA plans), ICI I and Vanguard 

(addressing registered investment companies), ACLI 

(addressing life insurers), CDEU and NAIC 

(addressing end users), and letter from CIC and 

meeting with Weil (addressing sovereign wealth 

funds). 

1164See letters from CDEU and ERISA Industry 

Committee (addressing ERISA plans) and letter 

from GIC and meeting with Weil (addressing 

sovereign wealth funds). 

1165See letters from Vanguard (addressing 

registered investment companies), Newedge 

(addressing FCMs and broker-dealers), and CIC 

(addressing sovereign wealth funds). 

1166See letters from CIC, GIC, and Milbank 

Tweed and meeting with KfW (addressing foreign 

governments and their agencies and 

instrumentalities), meeting with Weil (addressing 

sovereign wealth funds)and letter from World Bank 

Group (addressing international organizations and 

multilateral development banks). 

1167See letter from AFSCME. 

1168See letters from AFGI, BlackRock I, Canadian 

MAVs, ISDA I and MBIA and meetings with 

Athilon Structured Investment Advisors 

(‘‘Athilon’’) on April 18, 2011 and with Cypress 

Group, Invicta Financial Group, Primus Asset 

Management, Inc., and Quadrant Structured 

Investment Advisors on April 7, 2011. 

Although the Proposing Release specifically 

addressed granting an exclusion in connection with 

legacy positions entered into by monoline insurers 

and credit derivative product companies, 

commenters expressed the view that such an 

exclusion should apply to other types of entities 

that maintain legacy portfolios, such as certain 

special purpose vehicles. See letters from 

BlackRock I, Canadian MAVs and ISDA. 

1169See letters from Athilon, BlackRock I, 

Canadian MAVs, and ISDA I. 

1170For example, in conjunction with the SEC’s 

proposed margin and capital rules applicable to 

major participants, the SEC expects to request 

comment on how the rules should apply to entities 

with legacy portfolios. 

• Insurance companies;1154

• Certain registered FCMs and brokerdealers.1155

• End users; 1156 and 

• Various types of non-U.S. persons, 

including: foreign governments and 

their agencies and instrumentalities 

(such as central banks, treasury 

ministries, export agencies and 

governmental financing authorities),1157

international organizations and 

multilateral development banks,1158

sovereign wealth funds,1159 and nonU.S. entities subject to comparable 

foreign regulation.1160

Commenters articulated a range of 

rationales in support of such exclusions. 

These included arguments that 

particular types of entities: (i) Are 

unlikely to meet one or more of the 

major participant tests; 1161 (ii) already 

are subject to regulation (and in some 

cases are subject to prudential limits on 

their use of swaps or security-based 

swaps);1162 (iii) do not pose systemic 

risk 1163 and/or the type of counterparty 

risk contemplated by Title VII; 1164 or 

(iv) do not raise concerns given that 

they would remain subject to the 

clearing, exchange trading, and 

reporting requirements of Title VII.1165

Also, some commenters maintained that 

regulating non-U.S. entities as major 

participants would raise issues with 

respect to extra-territoriality, 

international comity and 

sovereignty.1166

In contrast to these requests, one 

commenter urged that the benefits 

arising from regulation of major 

participants be considered in 

determining whether to create carveouts from the participant definitions 

that are not provided in the statute.1167

3. Final Rules 

After considering the comments 

received and the underlying issues, the 

Commissions have determined not to 

provide categorical exclusions from the 

major participant definitions for the 

types of entities discussed by 

commenters. 

a. Entities That Maintain Legacy 

Portfolios 

Commenters that supported the 

exclusion of entities with legacy 

portfolios of swaps or security-based 

swaps emphasized that those portfolios 

are in run-off, and that those entities 

generally do not engage in ongoing swap 

or security-based swap activity.1168

Several of those commenters further 

expressed concerns that imposing the 

regulations applicable to major 

participants—particularly margin and 

capital rules—upon these entities could 

cause them to default on their 

obligations and lead to market 

disruption.1169

In the view of the Commissions, the 

fact that these entities no longer engage 

in new swap or security-based swap 

transactions does not overcome the fact 

that entities that are major participants 

will have portfolios that are quite large 

and could pose systemic risk to the U.S. 

financial system. 

We are mindful of the significance of 

concerns that regulating entities that 

maintain legacy portfolios has the 

potential to lead to defaults and 

disruption. We do not believe, however, 

that these concerns are best addressed 

by excluding those entities from major 

participant regulation. Instead, in 

adopting substantive rules applicable to 

major participants, the Commissions 

intend to pay particular attention to the 

special issues raised by the application 

of those rules to legacy portfolios.1170

Moreover, to the extent that these types 

of concerns remain following the 

promulgation of those final substantive 

rules, the Commissions may entertain 

requests for relief or guidance on a caseby-case basis. 

b. Other Domestic Entities 

Commenters also raised concerns 

regarding duplicative regulation for 

entities that already are subject to other 

types of regulation (e.g., state-regulated 

insurers, SEC-regulated registered 

investment companies and brokerdealers, and CFTC-regulated registered 

FCMs). The final rules nonetheless 

provide no such exclusion. The DoddFrank Act provided for the regulation of 

major participants against the backdrop 

of existing state and federal regulation, 

without opting to categorically exclude 

particular types of entities. Indeed, the 

definitions explicitly anticipate that 

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1171The first major participant test (but not the 

second or third tests) excludes positions maintained 

by certain employee benefit plans for the primary 

purpose of hedging or mitigating any risk directly 

associated with the operation of the plan. See CEA 

section 1a(33)(A)(i)(II); Exchange Act section 

3(a)(67)(A)(ii)(I). This tailored exclusion of certain 

pension plan positions suggests that Congress did 

not intend to broadly exclude such plans from the 

other two prongs or from the major participant 

definitions as a whole. The fact that, as two 

commenters noted (see letters from ABC/CIEFA and 

CDEU), the CFTC previously has relied on the 

regulatory structure already governing ERISA plans 

as a basis to not regulate these plans in other certain 

unrelated contexts does not alter this conclusion. 

1172The third major participant test excludes 

entities that are subject to bank capital standards, 

which suggests that such entities may be eligible to 

be major participants under the first and second 

tests. Also, the capital and margin requirements 

applicable to major swap participants and major 

security-based swap participants (see Dodd-Frank 

Act sections 731 and 764, respectively) do not 

apply to major participants subject to capital rules 

set by bank regulators, which further indicates that 

such entities may be major participants. 

1173As some commenters noted, entities excluded 

from the major participant definitions nonetheless 

may be subject to other requirements of general 

applicability imposed by Title VII, such as clearing, 

trade execution, and reporting requirements. Even 

where that is the case, though, these requirements 

serve separate and independent purposes. They do 

not stand as a substitute for the protections that 

Congress has prescribed with respect to major 

participants in particular. 

1174For example, as noted above, some 

commenters stated that the major participant 

definitions should not apply to investment 

companies registered under the ICA. See, e.g., 

letters from Fidelity, ICI I and Vanguard. However, 

we are not adopting any such exclusions in part 

because the major participant definitions focus on 

the market impacts of an entity’s swap and securitybased swap positions and the risk to the U.S. 

financial system generally, areas that are not the 

focus of the regulation of investment companies 

under the ICA. Moreover, based on our 

understanding of the swap and security-based swap 

activity of registered investment companies, we 

believe that registered investment companies 

generally are not likely to meet the thresholds of the 

major participant definitions. We will continue to 

monitor the effects of the rules we are adopting 

today to help ensure that they do not result in any 

inadvertent consequences for registered investment 

companies, or other entities registered with the SEC 

or CFTC. 

1175The Commissions also sought comment as to 

whether the major participant definitions should 

apply to derivatives clearing organizations or 

clearing agencies, but received no comments in 

response to this inquiry. Nonetheless, the 

Commissions do not believe that Congress intended 

derivatives clearing organizations registered with 

the CFTC or clearing agencies registered with the 

SEC to be registered or regulated as major 

participants. The CFTC and the SEC already 

exercise substantive regulatory oversight over these 

clearinghouses, authority that was enhanced by 

Title VII. Further, Title VIII of the Dodd-Frank Act 

provides for the supervision of systemically 

important derivatives clearing organizations and 

clearing agencies. See Dodd-Frank Act Title VIII. 

We do not believe that Congress intended to place 

a third layer of oversight on those entities by 

subjecting them to additional regulation as major 

participants, and we do not interpret the major 

participant definitions to do so. 

1176For many years, the Commissions have 

coordinated their examination of dually-registered 

FCM/BDs through working groups including the 

Joint Audit Committee and the Intermarket 

Financial Surveillance Group. Moreover, pursuant 

to Title IV of the Dodd-Frank Act, the CFTC and 

SEC have issued joint reporting rules for advisors 

to private funds that are dually registered with the 

SEC as investment advisers and with the CFTC as 

commodity pool operators or commodity trading 

advisors. See CFTC and SEC, Reporting by 

Investment Advisers to Private Funds and Certain 

Commodity Pool Operators and Commodity 

Trading Advisors on Form PF; Final Rule, 76 FR 

71127 (Nov. 16, 2011). 

1177See letters from CIC, GIC, Milbank Tweed, 

Norges Bank Investment Management and the 

World Bank, and meetings with KfW and Weil. 

1178For this purpose, we consider that the term 

‘‘foreign government’’ includes KfW, which is a 

non-profit, public sector entity responsible to and 

owned by the federal and state authorities in 

Germany, mandated to serve a public purpose, and 

backed by an explicit, full, statutory guarantee 

provided by the German federal government. 

1179For this purpose, we consider the Bank for 

International Settlements, in which the Federal 

Reserve and foreign central banks are members, to 

be a foreign central bank. See http://www.bis.org/

about/orggov.htm. 

1180For this purpose, we consider the 

‘‘international financial institutions’’ to be those 

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

and the institutions defined as ‘‘multilateral 

development banks’’ in the Proposal for the 

Regulation of the European Parliament and of the 

Council on OTC Derivative Transactions, Central 

Counterparties and Trade Repositories, Council of 

the European Union Final Compromise Text, 

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

between the two definitions, but together they 

include the following institutions: the International 

Monetary Fund, International Bank for 

Reconstruction and Development, European Bank 

for Reconstruction and Development, International 

Development Association, International Finance 

Corporation, Multilateral Investment Guarantee 

Agency, African Development Bank, African 

Development Fund, Asian Development Bank, 

Inter-American Development Bank, Bank for 

Economic Cooperation and Development in the 

Middle East and North Africa, Inter-American 

Investment Corporation, Council of Europe 

Development Bank, Nordic Investment Bank, 

Caribbean Development Bank, European Investment 

Bank and European Investment Fund. (The term 

international financial institution includes entities 

referred to as multilateral development banks. The 

International Bank for Reconstruction and 

Development, the International Finance 

Corporation and the Multilateral Investment 

Guarantee Agency are parts of the World Bank 

Group.) 

1181The SEC intends to address issues related to 

the application of the major security-based swap 

participant definition to non-U.S. entities as part of 

a separate release that the SEC is issuing in 

connection with the application of Title VII to nonU.S. persons. The SEC is also able to address 

concerns related to the individual substantive rules 

applicable to major security-based swap 

participants on a case-by-case basis. 

1182See Foreign Sovereign Immunities Act of 

1976, 28 U.S.C. 1602 (‘‘under international law, 

states are not immune from the jurisdiction of 

foreign courts insofar as their commercial activities 

are concerned * * * Claims of foreign states to 

pension plans 1171 and banks 1172—both 

of which are subject to existing 

regulation—may be major participants. 

Major participant regulation provides a 

regulatory structure prescribed by the 

Dodd-Frank Act to address the risks 

posed by entities whose swap or 

security-based swap positions are large 

enough to satisfy the major participant 

definitions. Other types of regulations to 

which these entities may be subject 

serve different objectives 1173 that are 

not substitutes for major participant 

regulation.1174

The Commissions expect that only a 

very few entities within a given category 

may meet the test of being a major swap 

participant—or even be close to the 

various thresholds for meeting that test. 

Entities that do not meet the thresholds 

of the major participant definitions do 

not need an exclusion from those 

definitions. Further, as noted elsewhere 

in this Adopting Release, the 

Commissions are permitting entities to 

rely on a ‘‘safe harbor’’ when their 

positions are far below any threshold for 

any particular quarter. Some of the 

entities for which exclusion has been 

sought may be expected to fall within 

the safe harbor. Those comparatively 

fewer entities that will be closer to a 

particular threshold, by contrast, should 

not be excused on a per se basis from 

completing the calculations set forth in 

these rules and, if the calculations 

demonstrate that the entity meets the 

test of a major participant, from 

compliance with the requirements for 

major participants set forth by Congress. 

At the same time, the Commissions 

recognize the benefits of efficiently 

regulating major participants that are 

separately registered with and regulated 

by the CFTC or SEC (such as registered 

FCMs or broker-dealers).1175 If any such 

registrants are required also to register 

as major participants, the CFTC and SEC 

would seek to coordinate their 

regulatory oversight as appropriate to 

achieve the independent purposes of 

major participant regulation and those 

separate regulatory requirements, while 

avoiding unnecessary duplication.1176

c. Foreign Entities 

Commenters 1177 discussed the major 

participant definitions in the context of 

foreign governments and various 

entities related to foreign 

governments 1178 (i.e., foreign central 

banks,1179 international financial 

institutions 1180 and sovereign wealth 

funds). The CFTC provides the 

following guidance with respect to the 

major swap participant definition and 

the swap dealer definition.1181

As an initial matter, foreign entities 

are not necessarily immune from U.S. 

jurisdiction for commercial activities 

undertaken with U.S. counterparties or 

in U.S. markets.1182 In accordance with 

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immunity should henceforth be decided by courts 

of the United States and of the States in conformity 

with the principles set forth in this chapter.’’). See 

also Mendaro v. World Bank, 717 F.2d 610 (DC Cir. 

1983) (multilateral development banks generally do 

not have immunity in connection with their 

commercial dealings in the United States); Osseiran 

v. International Financial Corp., 552 F.3d 836 (DC 

Cir. 2009) (same); Vila v. Inter-American Investment 

Corp., 570 F.3d 274 (DC Cir. 2009) (same). 

1183Such a registration requirement would have 

to satisfy the requirements of CEA section 2(i), 7 

U.S.C. 2(i), which provides that the provisions of 

Title VII relating to swaps ‘‘shall not apply to 

activities outside the United States unless those 

activities—(1) Have a direct and significant 

connection with activities in, or effect on, 

commerce of the United States; or (2) contravene 

such rules or regulations as the Commission may 

prescribe or promulgate as are necessary or 

appropriate to prevent the evasion of any provision 

of [the CEA] that was enacted by’’ Title VII of the 

Dodd-Frank Act. 

1184See F. Hoffman-LaRoche, Ltd. v. Empagran 

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

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

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

construed to violate the law of nations if any other 

possible construction remains’’); Hartford Fire 

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

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

Foreign Relations Law § 403 (scope of a statutory 

grant of authority must be construed in the context 

of international law and comity including, as 

appropriate, the extent to which regulation is 

consistent with the traditions of the international 

system). 

1185To the contrary, section 752(a) of the DoddFrank Act requires the CFTC to consult and 

coordinate with other regulators ‘‘on the 

establishment of consistent international standards 

with respect to the regulation (including fees) of 

swaps [and] swap entities * * *’’ 

1186 7 U.S.C. 1a(33)(D). 

1187See letters from CDEU, U.S. Chamber of 

Commerce, Center for Capital Markets 

Competiveness (‘‘Chamber’’) dated December 30, 

2011 (‘‘Chamber II’’) and NRU CFC I. 

1188See meeting with Duffie on February 2, 2011. 

In addition, another commenter also suggested that 

the exception not be interpreted broadly due to 

concerns regarding potential abuse. See letter from 

CMOC. 

1189Commenters generally did not focus on this 

initial requirement instead commenting on other 

issues relating to application of the exception. 

1190See letters from CDEU and Chamber II. 

Another commenter suggested that it should be 

viewed as a captive finance subsidiary of the 

entities that own it in a cooperative structure. See 

letter from NRU CFC I. This commenter also 

discussed whether the captive finance company 

exception should be available when it provides 

financing to its member-owners to support their 

general business activities, rather than to finance 

purchases from its member-owners. The CFTC does 

not believe it would be appropriate to apply the 

captive finance company exception in this 

situation. 

the general rule, a per se exclusion for 

foreign entities from the CEA’s major 

swap participant or swap dealer 

definition, therefore, is inappropriate. A 

foreign entity’s swap activity may be 

commercial in nature and may qualify it 

as a swap dealer or major swap 

participant. Registration and regulation 

as a swap dealer or major swap 

participant under such circumstances 

may be warranted.1183 This is 

particularly true for foreign corporate 

entities and sovereign wealth funds, 

which act in the market in the same 

manner as private asset managers. 

On the other hand, the sovereign or 

international status of foreign 

governments, foreign central banks and 

international financial institutions that 

themselves participate in the swap 

markets in a commercial manner is 

relevant in determining whether such 

entities are subject to registration and 

regulation as a major swap participant 

or swap dealer. Canons of statutory 

construction ‘‘assume that legislators 

take account of the legitimate sovereign 

interests of other nations when they 

write American laws.’’ 1184 There is 

nothing in the text or history of the 

swap-related provisions of Title VII to 

establish that Congress intended to 

deviate from the traditions of the 

international system by including 

foreign governments, foreign central 

banks and international financial 

institutions within the definitions of the 

terms ‘‘swap dealer’’ or ‘‘major swap 

participant,’’ thereby requiring that they 

affirmatively register as swap dealers or 

major swap participants with the CFTC 

and be regulated as such.1185 The CFTC 

does not believe that foreign 

governments, foreign central banks and 

international financial institutions 

should be required to register as swap 

dealers or major swap participants. 

K. Financing Subsidiary Exclusion From 

Major Swap Participant Definition 

In connection with the definition of 

major swap participant, CEA section 

1a(33)(D) excludes certain entities from 

the definition of a major swap 

participant whose primary business is 

providing financing and uses 

derivatives for the purpose of hedging 

underlying commercial risks related to 

interest rate and foreign currency 

exposures, 90 percent or more of which 

arise from financing that facilitates the 

purchase or lease of products, 90 

percent or more of which are 

manufactured by the parent company or 

another subsidiary of the parent 

company (the ‘‘captive finance company 

exception’’).1186 This provision of the 

Dodd-Frank Act is not applicable to 

major security-based swap participants. 

1. Proposal 

The Proposing Release restated the 

statutory captive finance company 

exception but did not further define or 

detail its scope or parameters. 

Accordingly, the CFTC did not propose 

a specific rule excluding certain 

financing subsidiaries from the 

definition of major swap participant in 

the Proposing Release. 

2. Commenters’ Views 

Commenters generally believed that 

the captive finance company exception 

should be broadly construed to cover 

financing of products being sold by the 

parent company or its authorized 

dealers, financing of service and labor, 

financing of component parts and 

attachments, and other general 

financing of the distribution 

network.1187 One commenter said the 

exception should be read narrowly, 

because the physical positions (in 

inventory, etc.) related to swaps may not 

be able to be liquidated to mitigate the 

risks of the swaps.1188

3. Final Rules 

The CFTC believes that the exception 

set forth in CEA section 1a(33)(D) 

should be construed (consistent with 

the statute) to provide practical relief to 

those captive finance companies whose 

‘‘primary business’’ is financing and 

who uses swaps for the purpose of 

hedging named underlying commercial 

risks related to interest rate and foreign 

currency exposures. As an initial matter, 

the Commission notes that a captive 

finance subsidiary or other similar 

entity is required to provide financing 

as its primary business, i.e., this is not 

a supplementary or complementary 

activity of the entity.1189

In connection with the exception, 

commenters generally focused on the 

second part of Section 1a(33)(D) of the 

CEA, requesting the CFTC to interpret 

the phrase ‘‘90% or more of which are 

manufactured by the parent company or 

another subsidiary of the parent 

company’’ to include component parts, 

attachments, systems and other 

products that may be manufactured by 

others but sold together with the 

company’s products as well as 

attachments and labor costs that are 

incidental to the primary purchase.1190

The CFTC believes that the captive 

finance exception must be interpreted in 

a manner consistent with the intention 

of Congress. As a result, a person that 

seeks to fall within the exemption must 

be in the ‘‘primary business’’ of 

providing financing of purchases from 

its parent company. Consistent with this 

initial requirement, the CFTC maintains 

that the captive finance exception can 

be applied when this financing activity 

finances the purchase of the products 

sold by the parent company in a broad 

sense, including service, labor, 

component parts and attachments that 

are related to the products. 

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30694 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1191See proposed CFTC Regulation § 1.3(hhh)(3); 

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

1192See proposed CFTC Regulation § 1.3(hhh)(4); 

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

1193See proposed CFTC Regulation § 1.3(hhh)(5); 

proposed Exchange Act rule 3a67–7(c). 

1194See letters from BlackRock I (requesting that 

market participants have eight months after they 

have exceeded any of the applicable thresholds to 

complete the registration process and come into 

compliance with applicable rules) and MetLife 

(suggesting that one year would be an adequate 

amount of time to come into compliance with the 

applicable rules); see also letters from ISDA I 

(suggesting a grace period of three quarters 

following the effectiveness of the proposed rules to 

permit analysis of whether a person is a major 

participant) and Capital One (recommending 

establishment of an 18 month provisional 

registration period for major participants and for 

dealers, as well as a phase-in period for applicable 

regulatory requirements). 

1195See letter from MFA I. 

1196See, e.g., letters from ACLI, BG LNG I, 

MetLife and MFA I (also suggesting that there be an 

alternative method of termination if an entity falls 

below an applicable threshold by more than 20 

percent). 

1197See CFTC Regulation § 1.3(hhh)(3); Exchange 

Act rule 3a67–8(a). 

1198The proposed rules regarding the registration 

of major security-based swap participants would 

provide that a person who files a completed 

registration application will be conditionally 

registered as a major security-based swap 

participant for four months (unless a person files a 

certification with the SEC, which would extend the 

conditional registration for an additional 30 days). 

See proposed Exchange Act rules 15Fb2–1(d)(1) and 

15Fb3–1(b)(2), 76 FR 65784, 65821, 65823 (Oct. 24, 

2012). In other words, under this proposal, a person 

who meets the criteria for being a major securitybased swap participant may have up to six months, 

or longer, to come into compliance with the 

requirements applicable to major security-based 

swap participants. 

1199The SEC has estimated that it would take an 

entity approximately one week to be able to 

complete and file Form SBSE, the most complex 

application form for registration as a major securitybased swap participant. The other forms for 

application as a major security-based swap 

participant are simpler, and the SEC estimates that 

they would take less time to complete. See 76 FR 

at 65814 at nn.130, 131, 133. 

1200See CFTC Regulation § 1.3(hhh)(4); Exchange 

Act rule 3a67–8(b). 1201While we are mindful that one commenter 

suggested that this standard be extended from one 

quarter to four quarters, see letter from ISDA I, we 

do not believe that approach would be consistent 

with the goal of not causing persons to become 

major participants as a result of short-term unusual 

activity. 1202See CFTC Regulation § 1.3 (hhh)(5); Exchange 

Act rule 3a67–8(c). 1203For example, in connection with the major 

security-based swap participant definition, we 

preliminarily estimated that no more than ten 

entities that would not otherwise be security-based 

swap dealers would have uncollateralized mark-tomarket positions or combined uncollateralized 

exposure and potential future exposure that may 

rise close enough to the proposed thresholds to 

necessitate monitoring to determine whether they 

meet those thresholds. See Proposing Release, 75 

FR at 80207–08. 

1204See letters from MFA I and Vanguard. 

L. Implementation Standard, ReEvaluation Period and Minimum Period 

of Status 

1. Proposed Approach 

The proposed rules provided that a 

person would be deemed to be a major 

participant upon the earlier of: (i) The 

date on which it submits a complete 

application for registration, or (ii) two 

months after the end of the quarter in 

which a person meets the definition of 

major participant.1191

The proposed rules also provided that 

a person that has met the criteria for 

designation as a major participant as a 

result of its swap or security-based swap 

activities in a fiscal quarter, but without 

exceeding any applicable threshold by 

more than 20 percent, would not 

immediately be subject to the timing 

requirements discussed above. Instead, 

the person would be subject to the 

timing requirements noted above as 

soon as its daily average swap or 

security-based swap positions over any 

fiscal quarter exceed any of the 

applicable daily average thresholds.1192

Finally, the proposed rules provided 

that a person would retain the status of 

a major participant if its swap positions 

or security-based swap positions do not 

fall below all of the thresholds for four 

consecutive quarters.1193 At that time, 

such entity may de-register as a major 

swap participant or major securitybased swap participant. 

2. Commenters’ Views 

Some commenters took the view that 

the time for compliance should be more 

than two months.1194 One commenter 

suggested that entities be given the 

flexibility to have an additional 

evaluation period if abnormal market 

events or price movements cause the 

failure of the first reevaluation.1195

Some commenters further expressed the 

view that the minimum amount of time 

a person would have to be registered as 

a major participant would be two 

quarters, rather than four quarters.1196

3. Final Rules 

a. Timing 

Consistent with the proposal, the final 

rules provide that a person would be 

deemed to be a major participant upon 

the earlier of the date on which it 

submits a complete application for 

registration, or two months after the end 

of the quarter in which it meets the 

criteria to be a major participant.1197 In 

adopting these rules, the Commissions 

are mindful of commenters’ concerns 

that market entities be given an 

adequate amount of time to come into 

compliance with the requirements 

applicable to major participants. At the 

same time, it is important to recognize 

that a person may submit a completed 

application for major participant 

registration prior to the time in which 

it must come into compliance with the 

requirements applicable to major 

participants.1198 We believe that two 

months provides a reasonable amount of 

time for a person to submit a completed 

application for registration as a major 

participant.1199

b. Re-Evaluation Period 

Consistent with the proposal, the final 

rules provide that if any entity meets the 

criteria for qualifying as a major 

participant, but does not exceed any 

applicable threshold by more than 20 

percent in that particular quarter, the 

entity will not immediately be subject to 

the timing requirements noted above, 

but will become subject to the timing 

requirements at the end of the next 

fiscal quarter if such entity exceeds any 

of the applicable daily average 

thresholds in that next fiscal quarter.1200

We believe that this standard will 

appropriately help to avoid applying 

major participant requirements to 

entities that meet the major participant 

criteria for only a short time due to 

unusual activity.1201

c. Minimum Period of Status 

Consistent with the proposal, the final 

rules provide that a person would retain 

major participant status until it does not 

exceed any of the applicable thresholds 

for four consecutive quarters following 

registration.1202 We believe that this 

time period appropriately addresses the 

concern that persons may move in and 

out of major participant status on a 

rapid basis. While we recognize that 

some commenters requested that this 

period be reduced to two quarters, we 

believe that a shorter period likely 

would lead to administrative confusion 

and burdens, as a shorter time period 

may be expected to lead entities to move 

in and out of major participant status 

more frequently. 

M. Calculation Safe Harbor 

1. Proposed Approach and Commenters’ 

Views 

In the Proposing Release, we 

expressed the understanding that only a 

limited number of persons currently 

have swap or security-based swap 

positions of a size that potentially could 

cause them to fall within the major 

participant definitions.1203 Without 

disagreeing with that view, some 

commenters expressed concern about 

the costs and burdens associated with 

performing the applicable calculations 

on a daily basis, particularly citing the 

calculations’ complex nature.1204

Certain commenters further suggested 

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1205See letters from SIFMA AMG I 

(recommending safe harbor when the notional 

amount of a person’s positions is less than the 

applicable thresholds for current uncollateralized 

exposure plus potential future exposure, or when a 

person’s end-of-month analysis indicates exposures 

that are at least 50 percent below the definitions’ 

applicable current exposure plus potential future 

exposure thresholds), Association of Institutional 

Investors (‘‘AII’’) and Vanguard. 

1206See CFTC Regulation § 1.3(hhh)(6)(i)(A); 

Exchange Act rule 3a67–8(a)(1)(i). 

1207See CFTC Regulation § 1.3(hhh)(6)(i)(B); 

Exchange Act rule 3a67–8(a)(1)(ii). For purposes of 

this second condition, the measure of swap or 

security-based swap positions in a major category 

shall include all positions in that major category. 

This measure shall not exclude the hedging or 

ERISA positions that are excluded from the first 

major participant test. 

1208See CFTC Regulation § 1.3(hhh)(6)(ii)(A); 

Exchange Act rule 3a67–8(a)(2)(i). 

1209See CFTC Regulation § 1.3(hhh)(6)(ii)(B); 

Exchange Act rule 3a67–8(a)(2). In the case of 

security-based swaps, for example, the monthly test 

must indicate that the person has no more than $1 

billion in aggregate uncollateralized current 

exposure plus potential future exposure in a major 

category (equal to one-half the thresholds of the first 

and third major participant tests). A person also 

must have no more than $2 billion in aggregate 

uncollateralized current exposure plus potential 

future exposure with regard to all of its securitybased swap positions (equal to one-half the 

thresholds of the second major participant test). 

For purposes of conducting this analysis with 

regard to positions in a major category, if the person 

is subject to the third major participant test (i.e., the 

person is a highly leveraged financial entity that is 

not subject to bank capital requirements), the 

analysis must account for all of the person’s swap 

or security-based swap positions in that major 

category (without excluding hedging positions). If 

the person is not subject to the third major 

participant test (i.e., the person is not ‘‘highly 

leveraged’’ or is not a ‘‘financial entity’’ potentially 

subject to the test) the analysis may exclude those 

hedging positions that also are excluded from the 

first major participant test. 

For purposes of conducting this analysis with 

regard to all of its swap or security-based swap 

positions, the analysis may not exclude hedging 

positions (consistent with the lack of a hedging 

exclusion in the second major participant test). 

1210See CFTC Regulation § 1.3(hhh)(6))iii)(A); 

Exchange Act rule 3a67–9(a)(3). The simplifications 

and assumptions applied to this portion of the safe 

harbor include the fact that a person must use the 

exposure reports of its dealer counterparties when 

calculating aggregate uncollateralized outward 

exposure to such entities, and that potential future 

exposure must be calculated without taking into 

account offsets for clearing, mark-to-market 

margining, or netting. 

1211See CFTC Regulation § 1.3(hhh)(6)(iii)(A); 

Exchange Act rule 3a67–9(a)(3)(i)(A). 

1212As identified above, three commenters 

requested that the Commissions provide a ‘‘safe 

harbor’’ in connection with the status of a major 

participant. See letters from AII, SIFMA AMG II and 

Vanguard. For example, one commenter stated that 

‘‘market participants that are otherwise required to 

perform the calculations should be able to do so on 

a less frequent basis if the entity is below every 

applicable threshold by at least 50%.’’ See letter 

from SIFMA AMG I at 5. 

1213See CFTC Regulation § 1.3(hhh)(6)(iii)(B); 

Exchange Act rule 3a67–9(a)(3)(i)(B). The 

thresholds for this version of the safe harbor are 

consistent with the thresholds for the safe harbor 

set forth in CFTC Regulation § 1.3(hhh)(6)(iii)(A) 

and Exchange Act rule 3a67–9(a)(3)(i)(A), other 

than with respect to interest rate swaps. We 

recognize that the major participant thresholds for 

swaps and security-based swaps across all major 

categories (i.e., substantial counterparty exposure) 

are much larger than those for each individual 

major category (i.e., substantial position). However, 

given the purposes of the safe harbor, we do not 

believe that it is appropriate to use a higher level 

for the test related to all major categories as 

compared to the test for each individual category. 

that participants in the swap and 

security-based swap markets may 

perceive an obligation to conduct the 

relevant calculations on a daily basis 

even if they are not reasonably likely to 

be major participants. Those 

commenters requested that the 

Commission adopt a safe harbor by 

which persons with swap or securitybased swap positions below a certain 

notional threshold would not have to 

perform the major participant 

calculations, or by which persons would 

not have to perform those calculations 

more than monthly when the results of 

those calculations are significantly 

below the levels required to be a major 

participant.1205

2. Final Rule 

We continue to believe that under the 

rules we are adopting only a limited 

number of persons potentially may be 

major participants. Nonetheless, we 

recognize the significance of commenter 

concerns that some persons may 

perceive an obligation to conduct the 

major participant calculations as part of 

their compliance procedures even when 

there is not a significant likelihood that 

they would be major participants. We 

thus believe that a safe harbor can 

promote certainty and regulatory 

efficiency by helping market 

participants appropriately focus their 

compliance efforts and avoid undue 

compliance costs in circumstances 

when they would be highly unlikely to 

be major participants. 

Accordingly, the Commissions are 

adopting a rule to incorporate a safe 

harbor into the major participant 

analysis. A person may take advantage 

of this safe harbor in any of three 

situations. First, a person will not be 

deemed to be a major participant if: (i) 

the express terms of the person’s 

arrangements relating to swaps and 

security-based swaps with its 

counterparties at no time would permit 

the person to maintain a total 

uncollateralized exposure of more than 

$100 million to all such counterparties, 

including any exposure that may result 

from the application of thresholds or 

minimum transfer amounts established 

by credit support annexes or similar 

arrangements; 1206 and (ii) the person 

does not maintain notional swap or 

security-based swap positions of more 

than $2 billion in any major category of 

swaps or security-based swaps, or more 

than $4 billion in aggregate.1207

Alternatively, a person will not be 

deemed to be a major participant if: (i) 

The express terms of the person’s 

arrangements relating to swaps and 

security-based swaps with its 

counterparties at no time would permit 

the person to maintain a total 

uncollateralized exposure of more than 

$200 million to all such counterparties, 

including any exposure that may result 

from thresholds or minimum transfer 

amounts; 1208 and (ii) the person 

performs the major participant 

calculations (e.g., the ‘‘substantial 

position’’ and ‘‘substantial counterparty 

exposure’’ calculations associated with 

the major participant tests) as of the end 

of every month, and the results of each 

of those monthly calculations indicate 

that the person’s swap or security-based 

swap positions lead to no more than 

one-half of the level of current exposure 

plus potential future exposure that 

would cause the person to be a major 

participant.1209

Finally, a person will not be deemed 

to be a major participant if the person’s 

current uncollateralized exposure is in 

connection with a major category of 

swaps or security-based swaps is less 

than $500 million (or less than $1.5 

billion with regard to the rate swap 

category) and the person performs 

certain modified major participant 

calculations (e.g., the ‘‘substantial 

position’’ and ‘‘substantial counterparty 

exposure’’ calculations, simplified 

based on assumptions that are adverse 

to the person) 1210 as of the end of every 

month, and the results of each of those 

monthly calculations indicate that the 

person’s swap or security-based swap 

positions in each major category of 

swaps or security-based swaps are less 

than one-half of the substantial position 

threshold.1211 This test addresses the 

commenter suggestion that a safe harbor 

be set at one-half of the threshold 

triggering major participant 

designation.1212 In addition, we have 

provided a more simplified alternate 

version of this test whereby a person 

will not be deemed to be a major 

participant if its monthly calculations 

indicate that the person’s swap or 

security-based swap positions across all 

major categories of swaps or securitybased swaps are significantly less than 

the substantial counterparty exposure 

threshold.1213 This alternative provides 

a simple safe harbor for entities to apply 

without undertaking additional analysis 

to divide their swap or security-based 

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30696 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1214When calculating its potential future 

exposure across all major swap or security-based 

swap categories for purposes of this portion of the 

safe harbor, the person must use the same specified 

conversion factor for all swaps or security-based 

swaps, with such factor reflecting the highest risk 

weight applied to a major category of swaps or 

security-based swaps, as applicable. See CFTC 

Regulation § 1.3(hhh)(6)(iii)(B)(2); Exchange Act 

rule 3a67–9(a)(3)(i)(B)(2). 

Also, for all three tests within the safe harbor, the 

person should use the effective notional amount of 

a position rather than the stated notional amount 

of that position if the stated notional amount is 

leveraged or enhanced by the structure of the 

position. See CFTC Regulation § 1.3(hhh)(6)(iv); 

Exchange Act rule 3a67–9(b). 

1215Although commenters suggested a safe harbor 

based on a notional standard or on monthly testing, 

the rule we are adopting also accounts for the 

maximum exposure that is possible under a 

person’s counterparty arrangements (including the 

aggregate amount of thresholds and minimum 

transfer amounts provided for by the applicable 

credit support annexes). This is intended to better 

focus the application of the safe harbor toward 

those entities that are highly unlikely to be, or 

become, major participants. 

1216See CFTC Regulation § 1.3(hhh)(6)(v); 

Exchange Act rule 3a67–8(c). 

1217See CEA section 1a(33)(C); Exchange Act 

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

1218See proposed CFTC Regulation § 1.3(hhh)(2); 

proposed Exchange Act rule 3a71–1(c). 

1219See Proposing Release, 75 FR at 80200– 

80201. 

1220See part II.E.2, supra. 

1221See letter from ICI I (recommending that 

entities that exceed the thresholds of the first major 

participant test be registered as major participants 

only for the relevant major category, while those 

entities qualifying as major participants under the 

other tests would be designated as major 

participants for all categories, but would still be 

able to apply for limited designations). 

1222See letter from BG LNG I (recommending that 

if 50 percent of a major participant’s swaps fall 

within one category of swaps, and its swaps in 

other categories would not separately exceed any of 

the proposed thresholds, that should be presumed 

to be a major participant for only that one category 

of swap). 

1223See letters from BG LNG I (specifically 

addressing energy firms); and NCGA/NGSA I 

(asserting that while the major participant 

definition is to be based on the major categories, the 

limited designations should be based on a finer set 

of categories). 

1224See CFTC Regulation § 1.3(hhh)(2); Exchange 

Act rule 3a71–1(c). 

1225See Proposing Release, 75 FR at 80200. The 

SEC expects to address the process for submitting 

an application for limited designation as a major 

security-based swap participant, along with 

principles to be used by the SEC in analyzing such 

applications, as part of separate rulemakings. 

swap positions into major 

categories.1214

In each of these circumstances, we 

believe that a safe harbor would be 

warranted because it would be 

sufficiently unlikely that the person’s 

swap or security-based swap positions 

would cause the entity to be a major 

participant.1215 The Commissions 

believe that for compliance purposes, 

persons should be able to rely on the 

proposed safe harbors noted above. This 

would benefit the swap and securitybased swap marketplace and related 

market participants by avoiding 

unnecessary costs for various entities 

that, because of compliance concerns, 

would engage in major participant 

calculations even though it would be 

very unlikely that the major participant 

thresholds would be met. 

The rule further provides that even if 

a person does not meet the conditions 

required to take advantage of the safe 

harbor, that fact by itself will not lead 

to a presumption that a person is 

required to perform the calculations 

required to determine if it is a major 

participant.1216 This is consistent with 

the safe harbor’s intent to promote 

certainty and efficiency in compliance 

efforts. While we are not prescribing 

when a person should perform the 

major participant calculations, 

participants in the swap and securitybased swap markets should be mindful 

that they are responsible for 

determining whether they meet the 

major participant definitions, and that 

they will face liability if they knowingly 

or unknowingly meet one of those 

definitions without registering as a 

major participant. 

N. Limited Designation as a Major Swap 

Participant or Major Security-Based 

Swap Participant 

1. Proposed Approach 

The ‘‘major swap participant’’ and 

‘‘major security-based swap participant’’ 

definitions provide that the 

Commissions may designate a person as 

a major participant for a single category 

of swap or security-based swap.1217

Unlike the limited designation 

provisions of the dealer definitions, the 

major participant definitions do not 

refer to limited designations in 

connection with particular swap and 

security-based swap activities. Also, 

unlike the dealer definitions (which 

refer to limited designations in 

connection with a particular ‘‘type,’’ 

‘‘class’’ or ‘‘category’’ of swap or 

security-based swap), the major 

participant definitions specifically state 

that a person may be designated as a 

major participant for one or more 

‘‘categories’’ of swap or security-based 

swap, without being a major participant 

for all ‘‘classes’’ of swap or securitybased swap. 

The proposal provided that a person 

who is a major participant in general 

would be considered to be a major 

participant with respect to all categories 

of swaps or security-based swaps, 

unless the person’s designation is 

limited.1218 We further stated that we 

anticipated that a major participant 

could seek a limited designation at the 

same time as its initial registration or at 

a later time, and we observed the 

difficulty of setting out the conditions 

that would allow a person to receive a 

major participant limited 

designation.1219

2. Commenters’ Views 

As discussed above, commenters 

generally addressed concerns regarding 

limited purpose major participant 

designations in conjunction with 

comments regarding limited purpose 

dealer designations.1220 A few 

comments addressed these issues 

specifically in the context of the major 

participant definitions. 

One commenter recommended that 

persons that exceed the first major 

participant threshold in a major 

category should presumptively be 

considered a limited major participant 

only for those categories of swaps or 

security-based swaps for which they 

crossed the threshold.1221 Another 

suggested a similar approach when a 

major participant’s swaps are 

concentrated in one major category.1222

Two commenters suggested that limited 

major participant designations should 

not be confined to the proposed major 

swap categories.1223

3. Final Rules and General Principles 

Applicable to Limited Major Participant 

Designations 

Consistent with the proposal, the final 

rules retain the presumption that a 

person that meets one of the major 

participant definitions will be deemed 

to be a major participant in connection 

with all categories of swaps or securitybased swaps.1224 As discussed in the 

Proposing Release, a person may apply 

for a limited designation when it 

submits a registration application, or 

later.1225 The final rules also contain 

one change from the proposal, in that 

the provisions of the final rules related 

to limited major participant designation 

do not refer to the major participant’s 

activities in connection with swaps or 

security-based swaps, in contrast to the 

proposal, because the relevant statutory 

provisions do not refer to limited 

designations related to activities. 

Many of the principles discussed 

above in the context of limited 

designation of dealers also are relevant 

to the limited designation of major 

participants. Significantly, as with 

limited dealer designations, it is 

appropriate for major participants to be 

subject to a default presumption that 

they should be regulated as major 

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1226See part II.E.3.a, supra, discussing the 

statutory and policy basis for this presumption. 

1227See letter from ICI I. 

1228The CFTC has designated a period of 30 

months to ensure that the report reflects two years 

of security-based swap transaction data, and six 

months for the staff to analyze the data and prepare 

the report. The Commissions expect that swap data 

repositories and security-based swap data 

repositories will begin to receive data at different 

times. Currently, swap data repositories are 

expected to begin to receive swap data 

approximately 60 days after publication of the rules 

further defining the term ‘‘swap.’’ See CFTC, Final 

Rule: Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136 (Jan. 13, 2012); CFTC, 

Final Rule: Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR 54538 

(Sept. 1, 2011). The SEC has not yet adopted final 

rules for the receipt of security-based swap data by 

security-based swap data repositories. Because of 

this difference, the timing of the changes to the de 

minimis thresholds for swaps and security-based 

swaps will be different. 

1229The SEC has designated a period of three 

years to ensure that the report reflects two years of 

security-based swap transaction data, and one year 

for the staff to analyze the data and prepare the 

report. 

participants for all of their swaps or 

security-based swaps.1226

Although a commenter suggested that 

different principles should apply in the 

context of the first major participant 

test 1227—which is based on an entity’s 

swap or security-based swap position in 

a single major category—we do not 

concur. The substantive requirements 

applicable to major participants do not 

contemplate treating entities that exceed 

the first and third thresholds of the 

major participant definition differently 

than those exceeding the second 

threshold. Instead, those requirements 

indicate that each entity that falls 

within the major participant definition 

must comply with registration and other 

substantive requirements triggered by 

such designation for all of its swap or 

security-based swap positions and 

activities. This conclusion also is 

supported by the fact that the limited 

designation authority provided to the 

Commissions is permissive rather than 

mandatory, and by the challenges of 

demonstrating compliance with the 

substantive requirements applicable to 

major participants in the context of a 

limited designation. 

Indeed, as with limited dealer 

designation, one of the key requirements 

to overcoming the default presumption 

of full designation is an applicant’s 

ability to comply with major participant 

regulation in the context of a limited 

designation. As with limited dealer 

designation, the Commissions will not 

designate a person as a limited purpose 

major participant unless the person can 

demonstrate compliance with the 

statutory and regulatory requirements 

applicable to major participants. 

Accordingly, an applicant to limited 

purpose designations must not only 

demonstrate the ability to comply with 

the transaction-level major participant 

requirements (e.g., certain business 

conduct standards and requirements 

related to trading records, 

documentation and confirmations) in 

the context of a limited designation, but 

also to entity-level major participant 

requirements (e.g., requirements related 

to registration, capital, risk 

management, supervision, and chief 

compliance officer). 

V. Commission Staff Reports 

To review and evaluate the operation 

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

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

and ‘‘major security-based swap 

participant’’ definitions, the CFTC and 

SEC are directing their respective staffs 

to undertake future studies regarding 

the rules being adopted in connection 

with these definitions and the related 

interpretations. These studies will 

include the analysis of market data and 

the input of public comment. 

The CFTC staff is further directed to 

report the results of this study to the 

CFTC on a date that is no later than 30 

months following the date that a swap 

data repository first receives swap data 

under the CFTC’s regulations.1228 The 

SEC staff is further directed to report the 

results of this study to the SEC no later 

than three years following the later of: 

(i) the last compliance date for the 

registration and regulatory requirements 

for security-based swap dealers and 

major security-based swap participants 

under Section 15F of the Exchange Act; 

and (ii) the first date on which 

compliance with the trade-by-trade 

reporting rules for credit-related and 

equity-related security-based swaps to a 

registered security-based swap data 

repository is required.1229 These staff 

reports will be made available for public 

comment. 

A. Objectives of the CFTC Staff Report 

In general, the CFTC’s staff report— 

together with the associated public 

comment—is intended to help the CFTC 

thoroughly evaluate the practical 

implications and effects of the ‘‘swap 

dealer’’ and ‘‘major swap participant’’ 

definitions following the regulation of 

dealers and major participants under 

Title VII. In addition, the staff report is 

intended to assist the CFTC in 

evaluating whether new or revised tests 

or approaches would be appropriate for 

identifying swap dealers and major 

swap participants or for providing 

greater clarity as to whether particular 

entities do or do not fall within these 

definitions. The staff report is also 

intended to assist the CFTC more 

specifically in evaluating the potential 

implications of terminating the phase-in 

thresholds associated with the de 

minimis exception to the definition of a 

‘‘swap dealer.’’ 

To this end, the staff report generally 

should review each significant aspect of 

the rules being adopted in connection 

with the definitions and related 

interpretations. With respect to the 

‘‘swap dealer’’ definition, such aspects 

include: (i) the factors associated with 

the definition (including the application 

of the dealer-trader distinction for 

identifying swap dealing activity); (ii) 

the extent of the exclusion of swaps 

entered into in connection with the 

origination of loans; (iii) the exclusion 

of certain swaps from the dealer 

analysis (i.e., swaps between affiliated 

parties, swaps between a cooperative 

and its members and swaps entered into 

for the purpose of hedging as defined in 

the rule); and (iv) the tests and 

thresholds used to implement the de 

minimis exception. With respect to the 

‘‘major swap participant’’ definition, 

such aspects include: (i) The tests and 

thresholds associated with the 

‘‘substantial position’’ definition; (ii) the 

definition of ‘‘hedging or mitigating 

commercial risk’’; (iii) the tests and 

thresholds associated with the 

‘‘substantial counterparty exposure’’ 

definition; and (iv) the definition of 

‘‘highly leveraged’’. 

To facilitate this review, the CFTC 

staff report should address—as may be 

practicable in light of the data made 

available under the swap regulatory 

reporting regime or otherwise—a range 

of descriptive analytics that may be 

helpful in characterizing the nature of 

the swap market, its participants, and 

their activities. Such descriptive 

analytics could help inform the CFTC as 

to how the definitions in the final rules 

are being applied in practice and 

whether any adjustments to such 

definitions should be considered. For 

example, these analytics could indicate 

whether the population of registered 

swap dealers and major swap 

participants is substantially larger or 

smaller than expected, and, to some 

extent, what elements of the definitions 

are responsible for any significant 

differences. These analytics could also 

illuminate dynamics in the market that 

may require new or different treatment 

in the definitions. These analytics may 

also assist the CFTC in considering 

whether it would be practical and 

appropriate to apply new or different 

objective and readily verifiable tests or 

standards for determining whether 

particular entities are or are not swap 

dealers or major swap participants, 

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30698 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1230The Dodd-Frank Act mandates that market 

participants publicly report certain security-based 

swap transaction and pricing data. See Exchange 

Act section 13(m). The SEC has proposed rules to 

implement these requirements, which will give the 

Commissions and the general public additional 

insight into the security-based swap markets. See 

Regulation SBSR—Reporting and Dissemination of 

Security-Based Swap Information, 75 FR 75208 

(Dec. 2, 2010). 

1231Such characteristics could include: (i) The 

types of market participants in each segment; (ii) 

their activity and positions (in terms of notional 

value, number of transactions, average aggregate 

uncollateralized outward exposures, and average 

aggregate potential outward exposure); (iii) the type 

and number of their counterparties (including the 

registered/unregistered status of such 

counterparties); and (iv) a network analysis of the 

concentration of activity by counterparty. 

1232Such characteristics could include: (i) The 

types of market participants in each segment, 

including their registration status; (ii) the amount 

of their activity (in terms of notional value and 

number of transactions); and (iii) the type and 

number of their counterparties. 

1233Such characteristics could include a range of 

quantitative criteria indicative of apparent dealing 

activity, similar in some respects to the approach 

taken in the CDS Data Analysis. Differences that 

could be reviewed include variations in the number 

and size of trades and counterparties. 

including through the possible use of 

safe harbors, presumptions, thresholds, 

or defaults based on these tests or 

standards. 

Depending on the availability and 

reliability of data and the developments 

in the market and regulatory framework, 

among other factors, the CFTC staff 

report could consider: how swaps differ 

among registered swap dealers, 

registered major swap participants and 

unregistered entities; differences among 

swaps in the major swap categories; 

differences among swap dealing activity 

of entities at various levels, including 

around the de minimis threshold; and 

estimates of quantitative information 

regarding use of swaps, including 

notional values, effective notional 

values, and collateralized and 

uncollateralized exposure. 

The CFTC staff report should also 

address, as may be practicable, the 

nature and extent of the impact that the 

final rules and interpretations 

implementing the definitions have had 

on certain aspects of the swap market. 

Depending on the available information 

and other factors, the CFTC staff report 

could address the impact of these final 

rules and interpretations on competition 

in the swap market, market participants’ 

ability to enter into swaps with various 

registered and unregistered entities, 

including IDIs, and the terms of swaps. 

B. Objectives of the SEC Staff Report 

In general, the report of the SEC 

staff—together with the associated 

public comment—is intended to help 

the SEC thoroughly evaluate the 

practical implications and effects of the 

dealer and major participant definitions 

following the regulation of dealers and 

major participants pursuant to Title VII. 

In addition, the staff report is intended 

to assist the SEC in evaluating whether 

new or revised tests or approaches 

would be appropriate for identifying 

dealers and major participants or for 

providing greater clarity as to whether 

particular entities do or do not fall 

within these definitions. The staff report 

also is intended to assist the SEC more 

specifically in evaluating whether it is 

necessary or appropriate to set higher or 

lower thresholds for the de minimis 

exception to the definition of ‘‘securitybased swap dealer.’’ 

To this end, the staff report generally 

should review each significant aspect of 

the rules being adopted in connection 

with the definitions and related 

interpretations. With respect to the 

security-based swap dealer definition, 

such aspects include: (i) The factors 

associated with the definition 

(including the application of the dealertrader distinction for identifying dealing 

activity); (ii) the exclusion of interaffiliate transactions from the dealer 

analysis (including the provisions 

limiting that exclusion to transactions 

among majority-owned affiliates); and 

(iii) the tests and thresholds used to 

implement the de minimis exception. 

With respect to the major security-based 

swap participant definition, such 

aspects include: (i) The tests and 

thresholds associated with the 

‘‘substantial position’’ and ‘‘substantial 

counterparty exposure’’ definitions; (ii) 

the definition of ‘‘hedging or mitigating 

commercial risk’’ (including whether 

the definition inappropriately permits 

the exclusion of certain positions from 

the first test of the major participant 

definitions, and whether the continued 

availability of the exclusion should be 

conditioned on assessments of hedging 

effectiveness and related 

documentation); (iii) the definition of 

‘‘highly leveraged’’; and (iv) the 

exclusion of inter-affiliate transactions 

from the major participant analysis 

(including the provision limiting that 

exclusion to transactions among 

majority-owned affiliates). 

C. Descriptive Analytics in the SEC 

Report 

To facilitate this review, the report of 

the SEC staff should address—as may be 

practicable in light of the data made 

available under the applicable 

regulatory reporting regime or 

otherwise 1230—a range of descriptive 

analytics that may be helpful in 

characterizing the nature of the securitybased swap market, as well as entities 

within that market and those entities’ 

activities. Such descriptive analytics 

could help inform the SEC as to how the 

definitions in the final rules are being 

applied in practice and whether any 

adjustments to such definitions should 

be considered. For example, these 

analytics could indicate whether the 

populations of dealers and major 

participants are substantially larger or 

smaller than expected, and, to some 

extent, what elements of the definitions 

are responsible for any significant 

differences. These analytics could also 

illuminate dynamics in the securitybased swap market that may require 

new or different treatment in the 

definitions. For example, the analytics 

could indicate that the activity in 

certain segments of the security-based 

swap market—e.g., equity swaps—has 

significantly increased or decreased 

since the adoption of the final rules. 

These analytics may also assist the SEC 

in considering whether it would be 

practical and appropriate to apply new 

or different objective and readily 

verifiable tests or standards for 

determining whether particular entities 

are or are not dealers or major 

participants, including through the 

possible use of safe harbors, 

presumptions, thresholds or defaults 

based on these tests or standards. 

The precise nature of the descriptive 

analytics included in the SEC staff 

report of course will depend on a 

number of considerations, including the 

availability and reliability of data and 

the developments in the market and 

regulatory framework. However, some 

salient candidates for descriptive 

analysis that could be considered at the 

time of the staff report include: 

• Characteristics of, and differences 

among, the security-based swap 

transactions and positions of three 

segments of participants in those 

respective markets—registered dealers, 

any registered major participants, and 

unregistered entities.1231

• Characteristics of, and differences 

among, security-based swap 

transactions and positions connected 

with the broad product segments 

identified in the final rules (e.g., credit 

default swaps and other security-based 

swaps).1232

• Characteristics of, and differences 

among, the apparent dealing activity of 

entities at various levels (including the 

$3 billion and $150 million de minimis 

levels established in the final rule in 

connection with the security-based 

swap dealer definition) based on their 

transactions and positions; 1233

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1234Such characteristics could include: (i) The 

size and nature of their counterparties; (ii) the 

registration status of their counterparties; and (iii) 

the size and number of their transactions. 

1235Such characteristics could include: (i) The 

extent to which those entities bear indicia of 

dealing activity, including those identified in the 

CDS Data Analysis; and (ii) the extent to which 

those entities have registered as security-based 

swap dealers. Potential baseline could include, for 

example: (i) The adoption of these final rules; (ii) 

December 31, 2011, the end of the time period 

considered by the CDS Data Analysis; and (iii) the 

last effective date of the registration and regulatory 

requirements for security-based swap dealers and 

major security-based swap participants under 

Section 15F of the Exchange Act. 

1236Such estimates could be useful in 

ascertaining the application of the various 

‘‘substantial position’’ thresholds used in 

connection with the ‘‘major security-based swap 

participant’’ definition. 

1237Such estimates could be useful in connection 

with evaluating the operation of the third prong of 

the major participant definition. 

1238See notes 478 through 485 and accompanying 

text, supra. 

• Characteristics of the security-based 

swap trading activity of ‘‘special 

entities’’; 1234

• Characteristics of entities entering 

and exiting the security-based swap 

markets, using a variety of 

baselines; 1235

• Estimates of security-based swap 

entities’ current uncollateralized 

exposure and potential future exposure 

at various levels of security-based swap 

positions; 1236 and 

• Estimates of security-based swap 

entities’ ratios of total liabilities to 

equity.1237

D. Additional Analyses in the SEC Staff 

Report 

To further facilitate this review, the 

SEC staff report should also address, as 

may be practicable, the nature and 

extent of the impact that the final rules 

and interpretations implementing the 

definitions have had on certain aspects 

of the security-based swap market. 

However, many economic, regulatory, 

and other factors—both related and 

unrelated to the implementation of Title 

VII—could impact the market going 

forward. The extent to which the staff 

report will be able to provide 

retrospective analyses regarding the 

effect of the definitions on the securitybased swap markets (and the robustness 

of any such analysis) in significant part 

will be based on the nature and role of 

future exogenous factors that have also 

affected the market. Depending on these 

future factors and the potential 

challenges associated with addressing 

them in the staff reports, some salient 

candidates for retrospective impact 

analysis that could be considered at the 

time of the report include: 

• Effects on competition. The report 

may be able to explore connections 

between the definitions and the entry 

and exit of various entities in the 

security-based swap markets. For 

example, to what extent is an entity’s 

entry or exit correlated with its 

registration status or its approaching or 

crossing any of the thresholds 

established by the definitions (e.g., the 

de minimis thresholds for dealers or the 

‘‘substantial position’’ thresholds for 

major participants)? Has the current 

concentration of the dealer market 

dissipated, persisted, or strengthened 

over time? 1238

• Effects on investor protection. The 

report may be able to explore 

connections between the definitions and 

the nature and scope of transactions 

with certain classes of counterparties. 

For example, to what extent do 

unregistered entities in the securitybased swap markets transact with 

counterparties such as ‘‘special 

entities,’’ natural persons, small 

businesses, or commercial entities? 

Have the nature and scope of trades by 

special entities or other classes of 

counterparties changed since 2011? 

Have unregistered entities—such as 

dealers operating under the de minimis 

threshold—emerged to engage in 

transactions with special entities or 

other particular classes of 

counterparties? 

• Effects on access. The report may be 

able to explore connections between the 

definitions and the ability of certain 

classes of counterparties to access 

products in the security-based swap 

market. For example, to what extent is 

an entity’s registration status or its 

approaching or crossing any of the 

thresholds established by the definitions 

correlated with the entity ceasing 

transactions with certain classes or sizes 

of counterparties? 

• Effects of the dealer-trader 

distinction. The report may be able to 

explore connections between market 

dynamics and quantifiable metrics 

indicative of dealing activity. For 

example, are there identifiable, objective 

differences between the registered 

security-based swap dealers and 

unregistered market participant 

populations in terms of number of 

counterparties, buy/sell ratios, posting 

of initial margin, concentrations by 

counterparty or otherwise? If so, how 

does the amount of the activity (in terms 

of notional value and number of 

transactions) of those entities change 

when they move above or below the 

thresholds implied by those differences? 

How do the characteristics of their 

counterparties (in terms of number and 

nature) change? 

• Effects of de minimis thresholds. 

The report may be able to explore 

connections between market dynamics 

and the de minimis thresholds 

established by the definitions. For 

example, how does the amount of the 

activity (in terms of notional value and 

number of transactions) of securitybased swap entities change when they 

move above or below the de minimis 

thresholds? How do the characteristics 

of their counterparties (in terms of 

number and nature) change? 

• Effects of major participant 

thresholds. The report may be able to 

explore connections between market 

dynamics and the major participant 

thresholds established by the 

definitions. For example, how have total 

notional security-based swap positions 

changed over time for large market 

participants that are not registered and 

that do not bear any indicia of dealing 

activity? For those large participants, 

have overall notional levels moved 

toward, or away from, the levels 

required to trigger the major participant 

thresholds? 

• Other effects of the definitions. To 

what extent do entities registered 

security-based swap dealers have 

overall trading characteristics suggesting 

that they may not be dealers? To what 

extent have entities not registered as 

dealers have trading characteristics 

suggesting that they may be acting as 

dealers? In either case, do any 

discrepancies between firms’ 

registration status and their trading 

characteristics suggest any gaps or areas 

of uncertainty regarding the scope of the 

dealer definitions that may require 

potential modifications? 

VI. Effective Date and Implementation 

Consistent with sections 754 and 774 

of the Dodd-Frank Act, these final rules 

will be effective on 60 days following 

publication in the Federal Register. The 

Commissions, however, are providing 

for a phase-in period for persons 

engaged in dealing activity below 

certain amounts. 

If any provision of these joint rules, or 

the application thereof to any person or 

circumstance, is held to be invalid, such 

invalidity shall not affect other 

provisions or application of such 

provisions to other persons or 

circumstances that can be given effect 

without the invalid provision or 

application. 

A. CEA Rules 

As explained below and as noted 

elsewhere in this Adopting Release, the 

compliance date for various regulatory 

requirements is contingent upon the 

adoption and effectiveness of other, 

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30700 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1239See CFTC, Reopening and Extension of 

Comment Periods for Rulemakings Implementing 

the Dodd-Frank Wall Street Reform and Consumer 

Protection Act, 76 FR 25274 (May 4, 2011). 

1240See CFTC, Final Rule: Registration of Swap 

Dealers and Major Swap Participants, 775 FR 

713792613 (Jan. 19, 2012). 

1241CPO/CTA Compliance Release at 11265. 

1242 7 U.S.C. 2(c)(2)(E)(i). 1243See CPO/CTA Compliance Release. 

1244See Securities Exchange Act Release No. 

64678 (June 15, 2011), 76 FR 36287 (June 22, 2011) 

(‘‘Effective Date Release’’) (granting exemptive relief 

and providing guidance in connection with 

Exchange Act provisions concerning security-based 

swaps that were added or amended by Title VII). 

1245See part II.D.5, supra. 

1246 15 U.S.C. 78f(l). 

1247See Effective Date Release, 76 FR at 36307. 

1248Because the exemptive relief that the SEC 

granted in connection with section 6(l) will expire 

as of the effectiveness of the ECP definition, the 

relief that the SEC provided from the rescission 

provisions of Exchange Act section 29(b) in 

connection with section 6(l) also will expire at that 

time. See id. 

related, regulatory provisions and 

definitions. Because the CFTC believes 

that the suite of rules implementing the 

Dodd-Frank Act are complex and 

interconnected, it has determined that 

implementation in certain cases can best 

be accomplished through separate 

rulemakings. The Commissions received 

comments related to implementation 

and phase-in that largely resulted from 

the CFTC’s re-opening of the comment 

period for several rulemakings, and a 

request for comment on the order in 

which it should consider final 

rulemakings made under the DoddFrank Act.1239 The CFTC notes that 

swap dealers and major swap 

participants will require an 

implementation or compliance period 

based on separate registration and 

regulatory requirements that are the 

subject of separate rulemakings by the 

Commission.1240

As the CFTC stated recently in 

another rulemaking related to CPOs: 

[while t]he [CFTC] recognizes that entities 

will need time to come into compliance with 

the [CFTC]’s regulations * * * [b]ased on the 

comments received indicating that a certain 

portion of entities currently claiming relief 

[from CPO registration] under § 4.13(a)(4) 

already have robust controls in place 

independent of [CFTC] oversight, the [CFTC] 

believes that entities currently claiming relief 

under § 4.13(a)(4) should be capable of 

becoming registered and complying with the 

[CFTC]’s regulations within 12 months 

following the issuance of the final rule. For 

entities that are formed after the effective 

date of the rescission, the Commission 

expects the CPOs of such entities to comply 

with the Commission’s regulations upon 

formation and commencement of 

operations.1241

The Commissions are taking the same 

approach with respect to implementing 

CFTC Regulations §§ 1.3(m)(5) and 

1.3(m)(6). The loss of ECP status for 

Forex Pools currently operating other 

than pursuant to the retail forex regime 

of a federal regulator described in CEA 

section 2(c)(2)(E)(i) 1242 may involve 

significant structural and operational 

changes. The loss of a commodity pool’s 

ability to rely on CEA section 

1a(18)(A)(v) if it does not fall within 

CEA section 1a(18)(A)(iv) may require 

significant structural and operational 

changes. Because additional time may 

enable a Forex Pool affected by CFTC 

Regulation § 1.3(m)(5) to restructure to 

avoid being subject to the retail forex 

regime (e.g., by redeeming U.S. non-ECP 

participants) and may allow a 

commodity pool affected by CFTC 

Regulation § 1.3(m)(6) time to satisfy the 

terms of CEA section 1a(18)(A)(iv) (e.g., 

by the pool’s CPO registering as such or 

claiming an exemption therefrom or by 

the pool raising its level of total assets 

above $5 million), the Commissions are 

delaying the effective date of CFTC 

Regulations §§ 1.3(m)(5) and 1.3(m)(6) 

until December 31, 2012, which is the 

compliance date for commodity pools 

no longer permitted to claim exemption 

from CPO registration pursuant to 

recently withdrawn CFTC Regulation 

4.13(a)(4).1243

CFTC Regulation § 1.3(m)(8) 

conditions ECP status in part on a 

requirement that a commodity pool be 

‘‘formed and operated’’ by a registered 

CPO or by a CPO who is exempt from 

registration as such pursuant to CFTC 

Regulation § 4.13(a)(3). Due to the 

revocation of CFTC Regulation 

§ 4.13(a)(4), the Commissions anticipate 

that many CPOs will be registering as 

such in the future. However, the 

compliance date for registration for 

CPOs required to register as such due to 

the withdrawal of CFTC Regulation 

§ 4.13(a)(4) is December 31, 2012. 

Furthermore, such CPOs may have 

formed the commodity pools that they 

currently operate when such CPOs were 

not registered as such. 

Consequently, compliance with the 

formation element of CFTC Regulation 

§ 1.3(m)(8)(iii) is not required with 

respect to a commodity pool formed 

prior to December 31, 2012. To be clear, 

however, while pools in existence 

before December 31, 2012 need not have 

been formed by a registered CPO, or by 

a CPO who is exempt from registration 

as such pursuant to CFTC Regulation 

§ 4.13(a)(3), in order to satisfy the 

formation aspect of CFTC Regulation 

§ 1.3(m)(8)(iii), such commodity pools 

nevertheless must be operated by a 

registered CPO, or by a CPO who is 

exempt from registration as such 

pursuant to CFTC Regulation 

§ 4.13(a)(3), on December 31, 2012 to 

satisfy the ‘‘operated by a registered 

CPO’’ element of CFTC Regulation 

§ 1.3(m)(8)(iii). 

B. Exchange Act Rules 

Because the SEC has not yet 

promulgated final rules implementing 

the substantive requirements imposed 

on dealers and major participants by 

Title VII of the Dodd-Frank Act, persons 

determined to be dealers or major 

participants under the regulations 

adopted in this Adopting Release need 

not register as such until the dates 

provided in the SEC’s final rules 

regarding security-based swap dealer 

and major security-based swap 

participant registration requirements, 

and will not be subject to the 

requirements applicable to those dealers 

and major participants until the dates 

provided in the applicable final 

rules.1244

Moreover, as discussed above in the 

context of the de minimis exception to 

the security-based swap dealer 

definition,1245 the SEC is making an 

extended compliance period available to 

persons engaged in dealing activity 

involving credit default swaps between 

$3 billion and $8 billion in trailing 

annual notional amount, and to persons 

engaged in dealing activity involving 

other types of security-based swaps 

between $150 million and $400 million 

in trailing annual notional amount. 

Persons taking advantage of that 

extended compliance period will be 

deemed not to be security-based swap 

dealers during that period, and will not 

be subject to registration requirements 

and other requirements associated with 

status as a security-based swap dealer 

during that period. 

The SEC previously provided limited 

exemptive relief in connection with 

Exchange Act section 6(l),1246 added by 

the Dodd-Frank Act, which prohibits 

any person from effecting a securitybased swap transaction with a person 

that is not an ECP, unless effected on a 

national securities exchange. That relief 

expires as of the effective date of final 

rules further defining ECP.1247

Accordingly, following the effective 

date of these final rules, dealers and 

major participants—and all other 

persons—will be subject to the 

prohibition of section 6(l) under the 

definition of ECP as amended by Title 

VII and as further defined by the 

rules.1248

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1249 5 U.S.C. 601 et seq. 

1250 5 U.S.C. sections 601(2), 603, 604 and 605. 

1251 75 FR 80203. 

1252See letter from NFPEEU. 

1253See letter from NFPEEU and meeting with 

NFPEEU on January 19, 2011. 

1254See letter from NFPEEU. 

1255See letter from Dominion Resources. 

1256The number of small entities that could 

conceivably be covered by the definition of swap 

dealer is likely to be further reduced if transactions 

between entities described in section 201(f) of the 

Federal Power Act (which generally includes rural 

electric cooperatives) are exempted from the 

requirements of the CEA, as contemplated by 

section 4(c)(6) of the CEA. 

1257 44 U.S.C. 3501 et seq. 

1258 75 FR 80203. 

1259See letter from Dominion Resources. 

1260See id. at 6. 

1261See letter from NFPEEU. 

VII. Administrative Law Matters—CEA 

Revisions (Definitions of ‘‘Swap 

Dealer’’ and ‘‘Major Swap Participant,’’ 

and Amendments to Definition of 

‘‘Eligible Contract Participant’’) 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(‘‘RFA’’) requires Federal agencies to 

consider the impact of its rules on 

‘‘small entities.’’ 1249 A regulatory 

flexibility analysis or certification 

typically is required for ‘‘any rule for 

which the agency publishes a general 

notice of proposed rulemaking pursuant 

to’’ the notice-and-comment provisions 

of the Administrative Procedure Act, 5 

U.S.C. 553(b).1250 In its proposal, the 

CFTC stated that ‘‘[t]he rules proposed 

by the CFTC provide definitions that 

will largely be used in future 

rulemakings and which, by themselves, 

impose no significant new regulatory 

requirements. Accordingly, the 

Chairman, on behalf of the CFTC, 

hereby certifies pursuant to 5 U.S.C. 

605(b) that the proposed rules will not 

have a significant economic impact on 

a substantial number of small 

entities.’’1251

In response to the Proposing Release, 

one commenter stated that the CFTC’s 

‘‘rule-makings [are] an accumulation of 

interrelated regulatory burdens and 

costs on non-financial small entities like 

the NFPEEU members, who seek to 

transact in energy commodity swaps 

only to hedge the commercial risks of 

their not-for-profit public service 

activities.’’ 1252 In general, the 

commenter said that since the Small 

Business Administration (‘‘SBA’’) has 

determined that many rural electric 

cooperatives are ‘‘small entities’’ for 

purposes of the RFA, if the definition of 

swap dealer were to cover a substantial 

number of rural electric cooperatives the 

rule further defining swap dealer may 

have a significant economic impact on 

a substantial number of small 

entities.1253 Thus, the commenter 

concluded that the CFTC should 

conduct a regulatory flexibility analysis 

for each of its rulemakings under the 

Dodd-Frank Act, including this 

rulemaking. 

The commenter also said that the 

requirement in section 2(e) of the CEA, 

as amended by the Dodd-Frank Act, that 

a person who is not an ECP must 

execute swaps on a designated contract 

market would have the potential to have 

a significant economic impact on a 

substantial number of small entities if a 

substantial number of rural electric 

cooperatives were not covered by the 

definition of ECP.1254 Another 

commenter said that in considering the 

economic impact on small entities of the 

swap dealer definition rules, the CFTC 

should consider whether the availability 

and cost of swaps to small entities could 

be affected by potential uncertainty 

among persons who engage in the 

activities covered by the definition 

about whether they are required to 

register as swap dealers.1255

The commenters did not provide 

specific information on how the further 

defining swap dealer would have a 

significant economic effect on a 

substantial number of small entities. 

Nonetheless, the CFTC has reevaluated 

this rulemaking in light of the 

statements made to it by these 

commenters. After further consideration 

of those statements, the CFTC has again 

determined that this final rulemaking 

will not have a significant economic 

effect on a substantial number of small 

businesses. With regard to the definition 

of swap dealer, the CFTC expects that if 

any small entity were to engage in the 

activities covered by the definition, 

most such entities would be eligible for 

the de minimis exception from the 

definition.1256 Additionally, the 

Commission does not expect that the 

small entities identified by NFPEEU 

will be subject to registration with the 

Commission as a major swap 

participant, as most entities with total 

electric output not exceeding 4 million 

megawatt hours are not expected to 

maintain outstanding swap positions 

that would exceed the applicable 

thresholds. In general, the major swap 

participant definition applies only to 

persons with very large swap positions, 

and therefore the definition of major 

swap participant is incompatible with 

small entity status. 

With regard to the definition of ECP, 

the CFTC notes that the costs of 

executing swaps on a designated 

contract market raised by the 

commenter arise from a requirement of 

the CEA, and not from any rule 

promulgated by the CFTC. Last, 

regarding the comment that there may 

be an economic impact on small entities 

in terms of the availability and cost of 

swaps, the definition of swap dealer is 

being adopted to limit uncertainty with 

respect to which entities will be 

required to register as a swap dealer. 

Thus, the definition of swap dealer is 

intended to avoid creating the 

substantial economic effect which 

concerns the commenter. 

Accordingly, the Chairman, on behalf 

of the CFTC, certifies, pursuant to 5 

U.S.C. 605(b), that the actions to be 

taken herein will not have a significant 

economic impact on a substantial 

number of small entities. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(‘‘PRA’’) 1257 imposes certain 

requirements on Federal agencies in 

connection with their conducting or 

sponsoring any collection of 

information as defined by the PRA. The 

Proposing Release stated that the 

proposed rules would not impose any 

new recordkeeping or information 

collection requirements, or other 

collections of information that require 

approval of the Office of Management 

and Budget (‘‘OMB’’) under the PRA, 

and invited public comment on the 

accuracy of the CFTC’s estimate that no 

additional recordkeeping or information 

collection requirements or changes to 

existing collection requirements would 

result from the proposed rules.1258

One commenter said that the 

regulatory requirements imposed on 

swap dealers and major swap 

participants (including swap end users 

that may potentially be misclassified as 

swap dealers or major swap 

participants) will entail reporting and 

record keeping requirements.1259

Specifically, the commenter noted that 

the CFTC stated in the Proposing 

Release that ‘‘any entity determined to 

be a swap dealer or major swap 

participant would be subject to 

registration, margin, capital, and 

business conduct requirements * * * 

all activities that will have associated 

reporting and additional recordkeeping 

requirements.’’ 1260 Another commenter 

said that the CFTC should consider the 

implications under the PRA of all of its 

rulemakings under the Dodd-Frank Act 

as a whole.1261

As with the proposed rules, these 

final rules will not impose any new 

information collection requirements that 

require approval of OMB under the 

PRA. All reporting and recordkeeping 

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30702 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1262See, e.g., 75 FR 71379, 71386 (Nov. 23, 2010) 

(proposed registration rules); 75 FR 70881, 70884 

(Nov. 19, 2010), 75 FR 71397, 71401 (Nov. 23, 

2010), 75 FR 71391, 71394 (Nov. 23, 2010), 75 FR 

80638, 80656 (Dec. 22, 2010), and 76 FR 33066, 

33076 (Jun. 7, 2011); and 76 FR 27802, 27819 (May 

12, 2011) (collectively, the information collection 

requests for the proposed business conduct rules). 

1263See 44 U.S.C. 3506 (PRA program 

requirements) and 3507 (PRA submission 

requirements). 

1264See, e.g., 75 FR 80638, 80656 (Dec. 22, 2010). 

1265 7 U.S.C. 19(a). 

1266See, e.g., S.Rep. 111–176, The Restoring 

American Financial Stability Act of 2010 at 29. 

1267See letters from API I, Atmos Energy, BG LNG 

I, Dominion Resources, Hess, NCGA/NGSA I, 

NFPEEU, Vitol and WGCEF VIII. 

1268See letters from AFR, Better Markets I and 

Greenberger. 

requirements applicable to swap dealers 

and major swap participants instead 

result from other rulemakings, for which 

the CFTC has sought OMB approval. 

The CFTC submitted an information 

collection request to OMB for each 

proposed rulemaking containing 

reporting or recordkeeping 

requirements, including the 

recordkeeping and reporting 

requirements referenced by the first 

commenter,1262 which estimated the 

implications of the proposed collections 

on prospective respondents.1263

Moreover, in appropriate 

rulemakings, the CFTC sought to rely 

upon information collections that 

already had been proposed, in order to 

avoid imposing unnecessary additional 

burdens upon prospective 

respondents.1264 Parties wishing to 

review the CFTC’s information 

collections on a global basis may do so 

at www.reginfo.gov, at which OMB 

maintains an inventory aggregating each 

of the CFTC’s currently approved 

information collections, as well as the 

information collections that presently 

are under review. 

C. Cost Benefit Considerations 

CEA section 15(a) requires the CFTC 

to consider the costs and benefits of its 

action before promulgating a regulation 

under the CEA, specifying that the costs 

and benefits shall be evaluated in light 

of five broad areas of market and public 

concern: (i) Protection of market 

participants and the public; (ii) 

efficiency, competitiveness and 

financial integrity of futures markets; 

(iii) price discovery; (iv) sound risk 

management practices; and (v) other 

public interest considerations.1265

1. Introduction 

The terms ‘‘major swap participant’’ 

and ‘‘swap dealer’’ are defined in CEA 

sections 1a(33) and 1a(49), as added by 

the Dodd-Frank Act, to include any 

person that holds swap positions above 

a certain level (in the case of the term 

‘‘major swap participant’’) or that 

engages in certain activities (in the case 

of the term ‘‘swap dealer’’), with certain 

exclusions and exceptions, all as 

discussed in parts II and IV of this 

Adopting Release. Section 712(d)(1) of 

the Dodd-Frank Act directs the CFTC 

and the SEC, in consultation with the 

Board, jointly to further define these 

and other terms. Also, CEA section 

1a(49)(D) directs the CFTC to 

promulgate regulations to establish 

factors with respect to the making of the 

determination to apply the de minimis 

exception to the definition of the term 

‘‘swap dealer.’’ 

The provisions of the Dodd-Frank Act 

that direct the further definition of the 

terms ‘‘swap dealer’’ and ‘‘major swap 

participant’’ should be viewed in the 

context of Congress’ consideration of the 

consequences that would arise from 

regulating persons and activities that 

were previously free from regulation. 

The Dodd-Frank Act is, in part, a 

response to a financial crisis in which 

unregulated swaps played a major 

role.1266 It includes provisions to 

regulate swap dealers and major swap 

participants in order to address 

concerns about this previously 

unregulated market. In this context, the 

Dodd-Frank Act requires that rules 

should ‘‘further define’’ the terms ‘‘swap 

dealer’’ and ‘‘major swap participant’’ 

by establishing and providing guidance 

with respect to the criteria for 

determining if a person is covered by 

one of the statutory definitions and 

therefore should be subject to certain 

regulatory requirements under Title VII; 

the Dodd-Frank Act does not direct the 

Commissions to define those terms in a 

vacuum. So, even in the absence of 

these rules, Title VII would require the 

regulation of persons that act as swap 

dealers or hold positions causing them 

to be major swap participants. 

Consequently, a large part of the costs 

and benefits resulting from the 

regulation of swap dealers and major 

swap participants result from the DoddFrank Act itself and not from these 

definitional rules. 

2. General Cost and Benefit 

Considerations 

In considering the comments on the 

proposed rules and the various 

alternatives available for the final rules, 

the CFTC sought to promulgate final 

rules that will help swap market 

participants and the public to apply the 

statutory definitions of the terms ‘‘swap 

dealer’’ and ‘‘major swap participant’’ in 

an efficient, uniform and accurate 

manner. We believe that doing so will 

protect market participants and the 

public, promote the efficiency, 

competitiveness and financial integrity 

of the swap markets, facilitate price 

discovery, encourage sound risk 

management practices and advance the 

public interest in general. That is, by 

providing direction and guidance as to 

which factors are relevant in applying 

the statutory definitions, and how to 

apply those factors to particular 

situations in the swap markets, the 

CFTC believes the final rules will 

provide benefits by reducing the cost of 

determining whether a particular person 

is covered by the statutory definitions, 

helping to make similar determinations 

for persons that are similarly situated, 

and promoting application of the terms 

‘‘swap dealer’’ and ‘‘major swap 

participant’’ in conformity with the 

statutory definitions. 

The costs and benefits considered in 

this final rule fall in two categories: 

First, those an entity will experience in 

determining whether it is a ‘‘swap 

dealer’’ or ‘‘major swap participant’’ as 

further defined in this rulemaking; and 

second, those attributable to the fact 

that, as interpreted in this rule, a greater 

or fewer number of entities at the 

boundaries of the statutory definitions 

may be deemed within them. 

With respect to the first category, and 

as discussed further in sections V.A.3.j. 

and V.A.4.b. below, the CFTC has 

endeavored to approximate the costs of 

making these determinations. At the 

same time, the CFTC believes that the 

careful consideration of, and detailed 

response in this Adopting Release to, 

comments regarding the application of 

the statutory definitions will provide 

useful, practical guidance, yielding a 

substantial if unquantifiable benefit to 

entities making such determinations. 

The costs and benefits in the second 

category—those associated with the 

rules being more or less inclusive—were 

a primary concern of the CFTC and 

commenters throughout this 

rulemaking. Commenters stated that if 

the CFTC’s final rules were to lead to 

interpretations of the statutory 

definitions that are over-inclusive, the 

result would be that entities would 

likely incur significant, unjustifiable 

costs attributable to various regulatory 

requirements intended for actual swap 

dealers and major swap participants.1267

Other commenters were concerned that 

if the rules were to lead to underinclusive interpretations, the benefits 

expected from Title VII would be 

dampened.1268

The CFTC does not dismiss these 

potential unintended results and we 

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1269See, e.g., parts II.A.4.g, II.D.3.a and IV.B.3.a. 

1270For example, the final rules specify criteria 

related to application of the de minimis exception, 

the range of transactions that are eligible for the 

exclusion of swaps in connection with the 

origination of loans, and the requirements for 

limited designation as a swap dealer, each of which 

will impact the total number of entities that are 

subject to swap dealer regulation. The final rules 

also specify criteria related to the thresholds for 

major swap participant status, factors that may be 

considered in the major swap participant 

calculations, and the threshold for ‘‘highly 

leveraged’’ status, each of which will impact the 

number of entities that are major swap participants. 

1271 It is likely that a swap dealer or major swap 

participant would incur direct compliance costs 

related to technology, personnel and capital. See 

CFTC, Registration of Swap Dealers and Major 

Swap Participants; Final Rule, 77 FR 2613 (January 

19, 2012); CFTC, Business Conduct Standards for 

Swap Dealers and Major Swap Participants With 

Counterparties; Final Rule, 77 FR 9733 (February 

17, 2012) and CFTC, Swap Dealer and Major Swap 

Participant Recordkeeping, Reporting, and Duties 

Rules; Futures Commission Merchant and 

Introducing Broker Conflicts of Interest Rules; and 

Chief Compliance Officer Rules for Swap Dealers, 

Major Swap Participants, and Futures Commission 

Merchants; Final Rule, 77 FR 20128 (April 3, 2012). 

1272For example, those entities would lose the 

profits they may have gained from those activities, 

and potentially from related business activities if 

their customers cut back their business 

relationships because the abstaining entities no 

longer engage in those swap activities. 

We recognize that small entities are more likely 

than large entities to abstain from swap activities in 

order to avoid being covered by the swap dealer 

definition. Smaller entities are less likely to have 

existing technology and procedures that would 

comply with new regulations and therefore their 

initial costs of compliance with the requirements 

applicable to swap dealers are likely to be larger. 

Moreover, the same fixed costs will have a 

proportionally greater effect on small entities. 

Other market participants may also bear some 

costs if entities abstain from dealing activities or if 

large users of swaps reduce their activities to avoid 

major swap participant status. These costs could 

include transition costs as the other market 

participants identify new counterparties with 

which to enter into the same swaps. In addition, 

and likely more important, as more entities abstain 

from swap activities, other entities that are seeking 

to enter into swaps may have a reduced choice of 

counterparties, which may lead to unfavorable 

financial terms for swaps and imperfect matches 

between risks and the swaps that are available. 

These factors may increase the cost of risk 

mitigation in general, as entities use more costly 

risk management strategies in place of swaps. 

See generally letters from API I, BG LNG I, BOK 

dated February 22, 2011 (‘‘BOK III’’), COPE I, 

Midsize Banks, NEM, NCGA/NGSA I, NGFA I, 

Chevron Federal Credit Union, M&T I, Sidley and 

WGCEF I. See also Roundtable Transcript at 39 

(remarks of Eric Chern, Chicago Trading Company), 

133–34 (remarks of Brenda Boultwood, 

Constellation). 1273More uniform compliance with regulations 

leads to more uniform expectations that market 

participants may reasonably have about the 

financial integrity of various swap dealers and 

major swap participants. Less uniform compliance, 

on the other hand, could introduce additional 

uncertainty about the financial integrity of an 

individual swap dealer or major swap participant. 

This could result in reduced market efficiency. 

Moreover, foreseeable ‘‘network effects’’ could 

magnify these costs. That is, since requirements 

promoting transparency and orderly documentation 

are expected to increase market participants’ 

general level of certainty about the swap positions 

held by others in the market, the wider the market 

application the greater the benefit. For example, in 

the 2008 financial crisis, uncertainty about the 

potential obligations of various market participants 

led to actions to restrict credit and reduce leverage 

that may not have been taken if there was greater 

confidence about market participants in general; 

this uncertainty also hampered regulatory efforts. 

Significant pockets of unregulated swap activity 

attributable to less inclusive definitions of the terms 

‘‘swap dealer’’ and ‘‘major swap participant’’ may 

result in costs related to uncertainty and lack of 

information. 

1274The extent of any such competitive advantage 

would depend on the number of entities that are 

inaccurately not covered by the definitions and the 

extent of their swap activities relative to the market 

in which they are active. 

have responded to these comments in 

the policy determinations made 

above.1269 We recognize that these 

definitional rules are ‘‘gating’’ rules, and 

that this gating function will affect 

whether entities at the boundaries of the 

statutory definitions incur costs 

attributable to the regulatory regime that 

Congress has prescribed and the CFTC 

has implemented through other 

substantive regulations. 

Correspondingly, these definitional 

rules will also affect the extent of 

benefits for the swap market and the 

public resulting from those regulations. 

It is important to also recognize, 

however, that as stated above, the 

regulation of persons acting as swap 

dealers or who hold positions causing 

them to be major swap participants is 

required by the Dodd-Frank Act. For 

entities that are not on the boundaries 

of the statutory definitions, but rather 

squarely within them or entirely outside 

of them, these rules will not affect the 

costs and benefits that result from their 

inclusion or exclusion. The latter group 

of costs and benefits are a consequence 

of the statutory definitions prescribed 

by Congress. 

In this rulemaking, we considered 

that more inclusive rules and guidance 

would cause some entities at the 

boundaries of the definitions to be 

covered by one of the definitions and 

therefore incur both initial and 

recurring direct costs of complying with 

Dodd-Frank Act requirements, while 

less inclusive rules and guidance would 

have the opposite effect.1270 Thus, as 

more or fewer entities are covered by 

the definitions, the amount of such 

direct compliance costs incurred by 

entities in the aggregate will vary. 

However, this variance in the aggregate 

compliance costs resulting from the 

CFTC’s definitional guidance in this 

rulemaking must be distinguished from 

the compliance costs that any particular 

entity will incur stemming from the 

other rulemakings prescribing 

regulations applicable to swap dealers 

and major swap participants. 

Consideration of the specific costs and 

benefits attendant to various substantive 

regulations applicable to swap dealers 

and major swap participants is beyond 

the limited scope of this rulemaking. 

Moreover, the variance in aggregate 

compliance costs resulting from this 

rulemaking will not track, on a ‘‘one for 

one’’ basis, the number of entities 

included in the definitions as the rules 

are more or less inclusive. This is 

because the initial and recurring 

compliance costs for any particular 

swap dealer or major swap participant 

will depend on the size, existing 

infrastructure, level of swap activity, 

practices and cost structure of the entity 

designated as such.1271 Another reason 

that the aggregate costs resulting as 

more or fewer entities are included in 

the definitions will not precisely track 

the number of such entities is that 

indirect costs are likely to result as 

market participants seek to avoid the 

regulations attendant to swap dealer or 

major swap participant status by, among 

other things, reducing their swap 

activities.1272 We do not expect that the 

extent of these indirect costs will be 

directly related to the number of entities 

included in the definitions. 

The CFTC likewise acknowledges that 

more or less inclusive definitions may 

increase or decrease the systemic 

benefits expected from the composite 

regulation of swap dealers and major 

swap participants. These include 

improved transparency and market 

orderliness, as well as the reduction of 

excess leverage and systemic risk. The 

CFTC believes that less inclusive final 

rules could negatively impact these 

interests in several ways: Those who 

engage in swaps with entities that elude 

swap dealer or major swap participant 

status and the attendant regulations 

could be exposed to increased 

counterparty risk; customer protection 

and market orderliness benefits that the 

regulations are intended to provide 

could be muted or sacrificed, resulting 

in increased costs through reduced 

market integrity and efficiency; 1273 and 

entities that elude swap dealer or major 

swap participant status may gain an 

unwarranted competitive advantage 

over other market participants.1274

Generally, rules that capture more 

entities are likely to increase these 

benefits, while rules that capture fewer 

entities are likely to have the opposite 

effect, though there are several 

additional factors that also have a 

bearing on the presence and magnitude 

of increased or decreased benefits. 

These factors include the number and 

size of entities whose status changes 

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30704 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1275Currently, prior to the implementation of 

Title VII, the U.S. swap market generally is not 

subject to substantive regulation, and market 

participants generally do not disclose detailed 

information about their swap activities and 

positions. This lack of data reduces our ability to 

analyze the swap activities of individual market 

participants, as well as the market as a whole, and 

thus impacts our ability to analyze the costs and 

benefits of these rules. Our analysis, out of 

necessity, is based on data that currently is 

available. 

1276See letters from API I, NFPEEU, Regional 

Banks, Sidley and WGCEF I, II and VIII; see also 

letter from FSR III. 

1277See letters from WGCEF I and II. 

1278See letter from Dominion Resources. 

1279See letters from NextEra I and NFPEEU. 

1280See letters from WGCEF I and II. 

1281See letter from NFPEEU. 

1282See letter from Better Markets II. 

1283Better Markets cited estimates that the 

worldwide cost of the 2008 financial crisis in terms 

of lost output was between $60 trillion and $200 

trillion, depending primarily on the long term 

persistence of the effects. See id. 

1284Although by its terms, CEA section 

15(a)(2)(B) applies to the futures (not swaps) 

markets, the CFTC finds this factor useful in 

analyzing the costs and benefits of these regulations 

further defining the terms ‘‘swap dealer,’’ ‘‘major 

swap participant’’ and ‘‘eligible contract 

participant’’ as well. 

under more or less inclusive rules, the 

number of swaps they engage in, their 

connectedness to other institutions and 

role in the financial system, and the 

types of financial instruments they 

would have utilized in the absence of 

swap dealer and major swap participant 

regulations. 

At this time, it is also not possible to 

quantify the impact of these rules on the 

direct and indirect costs and benefits 

that result from changing the status of 

an entity that is on the boundaries of the 

Dodd-Frank Act’s definitions of the 

terms ‘‘swap dealer’’ or ‘‘major swap 

participant.’’ The CFTC does not have 

adequate information about market 

participants’ swap activities to 

determine which entities will change 

their activities in response to the 

definitions, which would be necessary 

in order to determine the significance of 

the impact on costs and benefits of 

including or excluding those entities 

from the regulations pertaining to swap 

dealers and major swap participants. 

Costs may not be estimated in an 

accurate or meaningful way for many 

reasons, including because all of the 

regulations pertaining to swap dealers 

and major swap participants have not 

yet been issued in their final form, and 

because the CFTC does not have 

adequate information about market 

participants’ existing technology, 

infrastructure, use of swaps, or cost 

structure.1275 Changes in the total 

benefits resulting from the definitional 

regulations are also difficult to quantify, 

since many of the benefits of the swap 

dealer and major swap participant 

regulations are indirect, rather than 

direct. As a consequence, the CFTC may 

recognize and describe the impact of 

these rules on the overall costs and 

benefits deriving from swap dealer and 

major swap participant regulations, but 

it is not possible to quantify them at this 

time. 

The applicable provisions of the 

Dodd-Frank Act regarding the term 

‘‘eligible contract participant’’ are 

somewhat different, in that the statute 

modifies a particular clause in the preexisting statutory definition of the term 

and also provides general authority to 

further define the term. The final rules 

adopted in this regard provide guidance 

for the application of these provisions. 

3. Comments on the Discussion of Costs 

and Benefits in the Proposing Release 

Some commenters suggested that the 

discussion in the Proposing Release of 

the costs and benefits of the proposed 

rules further defining the terms ‘‘swap 

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

‘‘eligible contract participant’’ was 

inaccurate or inadequate.1276 For 

example, commenters suggested that in 

considering the final rules, the CFTC 

should consider empirical data 

regarding the costs and benefits flowing 

from the rules,1277 opportunity costs 

associated with regulatory 

uncertainty,1278 and alternatives that 

would impose fewer costs.1279 One 

commenter suggested that the CFTC 

should issue a second analysis of the 

costs and benefits of the rules for public 

comment,1280 while another commenter 

said that the consideration of cost and 

benefits should include the cumulative 

cost of interrelated regulatory burdens 

arising from all the rules proposed 

under the Dodd-Frank Act.1281

Another commenter said that the costbenefit analyses in the Proposing 

Release may have understated the 

benefits of the proposed rules, because 

focusing on individual aspects of all the 

rules proposed under the Dodd-Frank 

Act prevents consideration of the full 

range of benefits that arise from the 

rules as a whole, in terms of providing 

greater financial stability, reducing 

systemic risk and avoiding the expense 

of assistance to financial institutions in 

the future.1282 This commenter said the 

consideration of benefits of the 

proposed rules should include the 

mitigated risk of a financial crisis.1283

We have endeavored to address the 

commenters’ concerns in this Adopting 

Release by undertaking careful 

consideration of various alternatives 

proposed by commenters as described 

in this section. With regard to the 

comments suggesting that we consider 

empirical data, the CFTC found that no 

comprehensive, publicly available 

empirical data related to the usage of 

swaps in all markets is available, and 

commenters provided very little 

empirical data to aid us in this 

rulemaking. 

4. Costs and Benefits of the Rules 

Further Defining ‘‘Swap Dealer’’ 

The Proposing Release proposed 

certain factors that could be relevant to 

market participants when determining 

whether they are covered by the 

statutory definition of the term ‘‘swap 

dealer.’’ The CFTC received comments 

in response to numerous issues and 

considered a variety of alternatives in 

light of those comments, weighing the 

costs and benefits of each. In particular, 

we considered alternatives with respect 

to the activities indicative of holding 

oneself out as, or being commonly 

known as, a dealer in swaps, making a 

market in swaps, entering into swaps as 

a ‘‘regular business,’’ the exclusion 

available to IDIs for swaps offered in 

connection with the origination of 

loans, inter-affiliate swaps, swaps 

hedging physical positions, limited 

dealer status, and the possibility of 

providing particularized treatment 

under the definition for various types of 

entities. 

As noted above, in considering these 

alternatives the CFTC’s primary 

objective was to promulgate a rule 

under which market participants could 

efficiently and accurately determine 

whether they are engaged in any of the 

activities that are included in the 

statutory definition of swap dealer, and 

whether they are covered by any of the 

exclusions in the statutory definition. 

The scope of our consideration of these 

alternatives included the five factors 

specified in section 15(a) of the CEA. 

That is, we considered how the 

promulgation of final rules that would 

promote application of the definition of 

the term ‘‘swap dealer’’ in a manner that 

is consistent with the statutory 

definition would protect market 

participants and the public, promote the 

efficiency, competitiveness and 

financial integrity of the markets,1284

facilitate price discovery, encourage 

sound risk management practices and 

serve the public interest. Rather than 

describing in a separate section how we 

applied the elements of section 15(a) in 

the final rule further defining the term 

‘‘swap dealer,’’ the discussion below 

highlights the application of those 

elements where appropriate. 

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1285See part II.A.1, supra. 

1286See part II.A.2.a, supra. 

1287See part VII.C.2, supra. 

1288See part II.A.2.b, supra. 

1289See letters cited in notes 52 to 54, supra. 

1290See letters from Newedge and Traders 

Coalition. The commenters said that considering 

cleared swaps in determining if an entity is a swap 

dealer may cause entities to reduce their use of 

cleared swaps, which would be contrary to the 

general purpose of the Dodd-Frank Act to encourage 

clearing. 

1291See letters from CMC and Traders Coalition. 

1292See part II.A.4.c, supra. 

1293See id. 

1294For example, commenters suggested that 

these types of activities are indicative of swap 

dealing. See letters from EEI/EPSA, Hess, NextEra 

I, Utility Group and Vitol. 

a. Indicia of Holding Oneself Out as a 

Dealer in Swaps or Being Commonly 

Known in the Trade as a Dealer in 

Swaps 

As discussed above, the Proposing 

Release set forth activities that could 

indicate that a person is holding oneself 

out as a dealer or is commonly known 

in the trade as a dealer in swaps.1285

Commenters on this point said that 

persons who are not swap dealers also 

engage in some of the activities 

identified in the proposed rule. In other 

words, these commenters asserted that 

these activities are not accurate 

indicators of swap dealer status.1286

Commenters were concerned that if 

the rule included, as bright-line tests of 

swap dealer status, the proposed 

indicators of holding oneself out as, or 

being commonly known as, a swap 

dealer, then the rule would lead to an 

interpretation of the statutory definition 

that would be more inclusive. This, in 

turn, would lead to the costs of a more 

inclusive rule, and possibly the costs of 

entities abstaining from swap activities 

to avoid being covered by the definition, 

as discussed above.1287

While we are cognizant that providing 

no guidance about how to apply the 

statutory provision stating that the term 

‘‘swap dealer’’ includes any person who 

holds itself out as a dealer in swaps or 

is commonly known in the trade as a 

dealer or market maker in swaps would 

deprive market participants of 

interpretive guidance—thus increasing 

the direct and indirect costs to apply the 

rule—we considered the commenters’ 

concern that use of the proposed 

characteristics as bright-line indicators 

of swap dealer status could potentially 

result in significant costs. Therefore, to 

mitigate the costs of applying the rule 

and the costs that would result if the 

rule were more inclusive, the Adopting 

Release clarifies that the identified 

activities are not per se conclusive, and 

could be countered by other facts and 

circumstances indicating that an entity 

is not a swap dealer. The CFTC believes 

that providing guidance about the 

factors that are correlated with holding 

oneself out as or being commonly 

known as a swap dealer—even if not 

perfectly so—mitigates the risk that the 

rule would include entities that are not 

actually covered by the statutory 

definition and provides benefits in 

reducing the costs of application of the 

rule. 

b. Making a Market in Swaps 

Commenters on this point provided 

several perspectives on what does and 

does not constitute market making.1288

With those comments in view, we 

considered a number of characteristics 

for potential inclusion in the rule, and 

evaluated potential costs and benefits of 

each before determining that making a 

market in swaps is best described as 

‘‘routinely standing ready to enter into 

swaps at the request or demand of a 

counterparty.’’ We also further 

described various activities that 

constitute routinely standing ready, 

such as routinely quoting bid or offer 

prices for swaps, routinely responding 

to requests made directly by potential 

counterparties for bid or offer prices, 

etc. The alternative options we 

considered are discussed below in light 

of the five broad areas specified in 

section 15(a) of the CEA. 

Offer swaps on both sides of the 

market. The proposed rule stated our 

view that an entity may be a market 

maker in swaps even if the entity does 

not enter into swaps on both sides of the 

market. Several commenters suggested 

the rule should require that an entity 

enter into swaps on both sides of the 

market as a prerequisite to market maker 

status.1289 We have considered these 

comments and concluded that an entity 

could be a market maker by offering 

swaps on one side of the market, while 

entering into transactions on the other 

side of the market using other financial 

instruments. 

Accordingly, using presence on both 

sides of the market as a determinative 

factor in applying the definition of the 

term ‘‘swap dealer’’ could cause the 

final rule to be under-inclusive by 

excluding entities that function as 

market makers by entering into swaps 

on one side of the market. In addition, 

some entities may limit their swap 

dealing activities to one side of the 

market in an attempt to avoid being 

covered by the definition, again leading 

to the rule being under-inclusive. 

Excluding cleared swaps from 

consideration. Some commenters said 

cleared swaps should not be considered 

in determining whether an entity is a 

swap dealer.1290 Moreover, they 

suggested that dealers operating through 

clearinghouses might choose to exit the 

market if required to register as swap 

dealers, which would reduce 

liquidity.1291

It is possible that some entities whose 

swap dealing activities are limited to 

cleared swaps will abstain from those 

activities in order to avoid being 

covered by the definition, leading to 

costs associated with entities abstaining 

from the market, as described above. 

Other such entities may continue their 

swap dealing activities and incur the 

initial and ongoing costs of compliance 

with swap dealer regulations. Benefits 

are linked to these compliance costs, 

however. For example, the swap dealer 

business conduct requirements are 

expected to provide benefits in terms of 

protecting market participants and the 

public. In any case, we note that the 

statutory definition of the term ‘‘swap 

dealer’’ does not include any factor 

considering whether the swaps that an 

entity enters into are cleared as opposed 

to not cleared. Therefore, the costs 

raised by commenters resulting from the 

absence of an exclusion of cleared 

swaps are costs that result from the 

statutory definition and not the final 

rule. 

c. Regularly Entering Into Swaps With 

Counterparties as an Ordinary Course of 

Business 

The final rule incorporates the 

statutory provisions that the term swap 

dealer includes a person that ‘‘regularly 

enters into swaps with counterparties as 

an ordinary course of business for its 

own account’’ and ‘‘does not include a 

person that enters into swaps for such 

person’s own account, either 

individually or in a fiduciary capacity, 

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

The CFTC believes that the 

determinative issue in interpreting these 

provisions is whether an entity’s 

activity of entering into swaps is part of 

its usual and normal course of business 

and is identifiable as a swap dealing 

business, as discussed above.1292 This 

Adopting Release also describes certain 

activities that constitute both entering 

into swaps ‘‘as an ordinary course of 

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

business.’’1293

The CFTC believes that dealers 

frequently engage in the activities 

described in this Adopting Release, 

while non-dealers do not.1294 As a 

consequence, such activities are useful 

indicators of swap dealing activity and 

it is appropriate to incorporate them in 

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1295See letters from CCMR I and MFA I. 

1296See letter from AFSCME. 

1297See part II.E.2.a, supra. Several commenters 

stated that it is unduly burdensome to require swap 

dealers to apply swap dealer requirements to all of 

their swaps (including swaps not resulting from 

dealing activity) while they pursue limited 

designation. See, e.g., letters from Capital One, 

Farm Credit Council I and FHLB I. Another 

commenter suggested that not allowing for a 

presumptive limited designation could cause some 

community lenders to cease offering swaps. See 

letter from Capital One. 

Another commenter suggested that to reduce 

costs, presumptive limited designation should be 

available for any formal division of an entity, to 

avoid the costs that would arise if any entity were 

to reorganize its operations without certainty that 

limited designation would be available to the 

reorganized entity. See letter from WGCEF VII. 

1298Entities that apply for limited designation as 

a swap dealer will be required to prepare a 

submission to the CFTC demonstrating their 

compliance with swap dealer regulations in the 

context of limited designation. 

1299See letters from Capital One and FHLB I. 

1300Some swap dealer regulations may be applied 

at the transactional level, while others may affect 

the operations and capital structure of the entity 

beyond the swaps or activities for which it has a 

limited designation. On this topic, some 

commenters suggested that limited designation 

should allow the swap dealer to limit operational 

compliance with swap dealer requirements to the 

portion of the business that is designated as a swap 

dealer. See letters from FSR I and WGCEF VII. 

Another commenter stated that the CFTC should 

not require additional reporting regarding the nondealing activities. See letter from Cargill. 

1301CEA section 1a(49)(D), 7 U.S.C. 1(a)(49)(D). 

1302See part II.D.1, supra. 

the guidance interpreting the final rule 

in order to properly apply the statutory 

definition. 

d. The Dealer-Trader Distinction 

The Adopting Release incorporates 

the dealer-trader distinction as a 

consideration when identifying swap 

dealers. While not dispositive, the CFTC 

anticipates that the dealer-trader 

distinction will be useful as a 

consideration, particularly in light of 

the degree to which it overlaps with 

many of the other characteristics 

identified in the Adopting Release that 

are indicative of dealing activity. The 

dealer-trader distinction is likely to be 

familiar to some market participants 

that must determine whether they are 

swap dealers, and to the extent that this 

is true, the CFTC believes that its 

incorporation as a factor in the swap 

dealer analysis will help to reduce 

uncertainty for those entities, thereby 

reducing their costs of determining 

whether they are dealers.1295 By 

incorporating the dealer-trader 

distinction as one consideration within 

a broader facts and circumstances 

approach, the CFTC has minimized the 

costs of under inclusion that could arise 

if the distinction were used as a bright 

line test to exempt entities that would 

otherwise be subject to regulation as 

swap dealers.1296

e. Limited Designation as a Swap Dealer 

The Proposing Release provided that 

‘‘a person who is a swap dealer shall be 

deemed to be a swap dealer with respect 

to each swap it enters into’’ but 

explained that an entity could apply for 

limited designation. Several 

commenters suggested that the CFTC 

should allow for the possibility of 

‘‘presumptive limited designation’’ as a 

swap dealer in order to reduce costs.1297

We have decided, however, not to 

provide for a presumptive limited 

designation in the final rule. While a 

presumptive limited designation would, 

for the entities that seek it, mitigate the 

costs of applying for limited designation 

and any costs related to uncertainty 

about whether limited designation will 

be granted,1298 it could also lead to costs 

arising from the rule being less 

inclusive. Persons engaged in a broad 

range of activities that are all covered by 

the definition of the term ‘‘swap dealer’’ 

would have a significant incentive to 

improperly claim eligibility for a 

presumptive limited designation. This 

would hinder the application of swap 

dealer regulations to all of their swap 

dealing activities and thereby increase 

costs in terms of lesser protection of 

market participants and the public, as 

well as impairment of sound risk 

management practices. 

Commenters suggested that to reduce 

the costs of determining whether a 

particular person is eligible for a limited 

designation as a swap dealer, the CFTC 

should set out certain criteria that 

would be relevant to that determination, 

such as the degree of complexity of an 

entity’s swap activities, what percentage 

of an entity’s total swap activities are 

dealing activities, the relationship 

between the entity and its swap 

counterparties, and how difficult it 

would be to distinguish between its 

‘‘designated’’ and ‘‘non-designated’’ 

swaps.1299

Rather than setting forth specific 

factors to be considered with respect to 

limited designation as a swap dealer, 

this Adopting Release takes a facts and 

circumstances approach, stating that all 

relevant factors will be considered in 

the determination. This Adopting 

Release also states that an important 

factor in determining whether a swap 

dealer qualifies for a limited designation 

is whether the swap dealer can 

demonstrate that the internal structure 

to which the limited designation applies 

(e.g., a division or business unit) 

complies with the swap dealer 

requirements. If such a structure is not 

pre-existing, the swap dealer will incur 

costs in creating a structure for its swap 

dealing activity in a manner that would 

qualify for limited designation. These 

costs depend on the circumstances of 

that swap dealer and cannot be 

quantified at this time; however, such 

costs are likely to be significant for at 

least some swap dealers. On the other 

hand, swap dealers who do qualify for 

the limited designation will benefit from 

reduced ongoing compliance costs since 

some swap dealer requirements are 

expected to apply to only those 

activities encompassed by the limited 

designation.1300 This flexible approach 

will allow entities to organize 

themselves in a manner that allows 

them to maximize the value of limited 

designation, so long as they are able to 

demonstrate that they will comply with 

swap dealer requirements. In settling on 

this flexible approach, we considered 

how the use of a limited designation 

would allow entities to minimize the 

effect of swap dealer registration on 

their swap activities, which fosters 

efficiency while also promoting sound 

risk management practices through 

swap dealer regulation. 

The facts and circumstances approach 

to limited designation will likely lead to 

some costs arising from uncertainty 

among market participants about 

whether steps they have taken or may 

take will permit them to qualify for a 

limited designation. However, we 

believe that market participants may 

mitigate such uncertainty costs by 

contacting staff to discuss changes 

under consideration, or by applying for 

limited designation on the basis of 

planned changes (rather than making 

the changes and then submitting the 

application). 

f. De Minimis Exception 

The Dodd-Frank Act requires that the 

CFTC exempt from designation as a 

swap dealer any entity ‘‘that engages in 

a de minimis quantity of swap dealing 

in connection with transactions with or 

on behalf of customers,’’ and that the 

CFTC ‘‘promulgate regulations to 

establish factors with respect to the 

making of this determination to 

exempt.’’ 1301

The proposed rule set out certain 

quantitative standards for identifying 

those entities whose swap activities 

were sufficiently small that applying 

swap dealer regulations to them would 

not be warranted.1302 Commenters 

raised several points regarding the 

potential costs and benefits of the 

proposed approach. We considered 

these points, addressed below, in 

preparing the final rule, which provides 

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1303See CFTC Regulation § 1.3(ggg)(4)(ii). 

1304See, e.g., letters and meetings cited in notes 

377 to 381, supra. 

1305See, e.g., letters and meetings cited in note 

378, supra. See also Roundtable Transcript at 201 

(remarks of John Janney, Large Public Power 

Council). 

1306See letters from API I, FSR VI, Midsize Banks, 

Regional Banks and WGCEF I. 

1307See memorandum to the public comment file 

from the CFTC Office of the Chief Economist. 

1308See id. 1309See part II.D.3.a, supra. In particular, we note 

here that the higher notional amount standard in 

the final rule, as compared to the proposed rule, 

should reduce the number entities that will face the 

choice described by the commenters. 

1310As noted above, it is not possible to quantify 

these potential costs with mathematical precision. 

See note 421, supra. The commenters on these 

points did not provide quantifications of such costs. 

1311Commenters expressed various views as to 

what level of benefits flow from dealer regulation. 

See, e.g., Roundtable Transcript at 137–43 (remarks 

of John Janney, Large Public Power Council, Bella 

Sanevich, NISA Investment Advisors, LLC, and 

Brenda Boultwood, Constellation) 

1312See letters cited in notes 384 and 385, supra. 

1313See letters from COPE I, Farm Credit Council 

I and MFX II and meeting with Electric Companies 

on April 13, 2011. 

1314See letters from Gavilon II and ISDA I. 

1315See letters from Farm Credit Council I, FHLB 

I and MFX II. 

1316We considered the proposed options in terms 

of whether they would promote: protection of 

market participants and the public; financial 

integrity and efficiency of swap markets; price 

discovery; sound risk management principles; and 

other public interest considerations. The 

commenters suggesting other measures did not offer 

Continued 

that an entity qualifies for the de 

minimis exception if the notional 

amount of its swap positions or 

security-based swap positions over the 

prior 12 months arising from its dealing 

activity is $3 billion or less, and the 

notional amount of such positions with 

‘‘special entities’’ is $25 million or less. 

However, during a phase-in period 

following the effective date of the final 

rules, an entity will not be required to 

register as a swap dealer if the notional 

amount of the swap positions it enters 

into over the prior 12 months arising 

from its dealing activities is $8 billion 

or less.1303

In determining the level of the 

notional amount thresholds for the de 

minimis exception, we considered 

comments stating that if the thresholds 

were set inappropriately low, persons 

engaged in a smaller quantity of swap 

dealing would face a choice between 

reducing their swap dealing activities to 

a level below the thresholds or 

registering as a swap dealer and 

incurring the costs of compliance with 

swap dealer regulation.1304 It follows 

from these comments that these entities 

would incur costs in making a decision 

about the extent to which they should 

engage in swap dealing, although none 

of the commenters specifically 

quantified the costs of making that 

decision. Commenters also expressed a 

concern that if many entities chose to 

reduce or cease their swap dealing 

activities in response to the de minimis 

thresholds, the availability of swaps 

may be reduced, particularly to the 

smaller swap users that typically engage 

in swaps with such entities, which 

could lead to costs for those smaller 

swap users.1305 Some commenters said 

that the CFTC should justify the final 

thresholds for the de minimis exception 

with an economic analysis; however, 

these commenters did not propose 

specific analyses the CFTC should 

perform or provide specific information 

that should be included in the 

analysis.1306

The CFTC evaluated data regarding 

index CDS that was provided by the 

SEC, and made that analysis available to 

the public.1307 The data showed that 

80.8% of all participants in the index 

CDS market entered into index CDS 

with an aggregate notional amount of 

less than $3 billion during 2011, and 

88.7% of such market participants 

entered into index CDS with an 

aggregate notional amount of less than 

$8 billion during the same period of 

time. However, the 19.2% and 11.3% of 

market participants above those 

respective thresholds, accounted for 

98.9% and 97.8% of the total notional 

amount of index CDS entered into 

during that time, which suggests that a 

relatively small number of entities are 

responsible for a large majority of 

activity in the index CDS market. The 

data also showed that 91.7% of all 

entities with 3 or more counterparties 

that are not recognized by ISDA as 

dealers entered into index CDS with an 

aggregate notional amount of $9 billion 

or more during 2011, suggesting that a 

large majority of dealers in index CDS 

likely enter into index CDS with an 

aggregate notional amount of $9 billion 

or more per year. 

These observations, and any 

conclusions derived from them, 

however, must be qualified by 

limitations of the data, including: (i) 

Although we expect that the data covers 

a very large part of the index CDS 

market, we cannot verify what 

percentage of all index CDS are 

represented in the data; (ii) the data is 

not filtered to reflect activity that would 

constitute swap dealing under the 

Dodd-Frank Act, so it is not possible to 

use the data to draw conclusions 

regarding any specific entity’s status as 

a swap dealer and (iii) the data does not 

cover other classes of swaps that are 

relevant to the de minimis threshold for 

swap dealers, such as interest rate 

swaps, equity swaps, foreign exchange 

swaps or other commodity swaps.1308 In 

light of these limitations, any 

conclusions drawn from the index CDS 

data must be regarded as provisional. 

We note that no matter the level at 

which the de minimis thresholds are set, 

there will always be some entities 

engaged in a quantity of swap dealing at 

or above the threshold level that will 

face the choice described by the 

commenters. As noted above, we 

considered the costs and benefits of 

dealer regulation in determining the 

notional amount standards in the final 

rule.1309 Among the costs we considered 

were those that would result if entities 

reduce or cease their swap dealing 

activities in response to the de minimis 

threshold and swaps become less 

available in smaller or niche markets. 

We considered that this could impact 

the competitiveness of those markets 

and undermine the ability of market 

participants to practice sound, costeffective risk management.1310 In 

principle, a higher threshold would 

promote a larger pool of swap-dealing 

entities (since entities with swap 

dealing activity below the threshold 

need not incur costs to comply with 

swap dealer regulations), meaning more 

potential counterparties available to 

swap users. On the other hand, a greater 

quantity of swap dealing would be 

undertaken without the customer 

protection, market orderliness and 

market transparency benefits of dealer 

regulation. This, in turn would impair 

the protection of market participants 

and the public, and undermine sound 

risk management practices, as described 

above.1311 We considered these factors 

in determining the level of the notional 

amount standard in the final rule. 

Some commenters advocated use of 

alternative measures (such as an entity’s 

current uncollateralized exposure from 

swaps, or the number or frequency of 

swaps) as the de minimis gauge.1312

Some commenters suggested that 

various types of entities should be 

subject to different de minimis 

thresholds,1313 or that the rule should 

vary the de minimis threshold by type 

of swap.1314 Some commenters 

suggested that the de minimis exception 

should take into account the purpose of 

an entity’s swap dealing activities or the 

entity’s general characteristics.1315

The CFTC believes that these 

proposed alternatives are unlikely to 

better promote the efficiency, 

competitiveness and financial integrity 

of the markets, or yield other benefits to 

a greater extent than the approach 

adopted in the final rule.1316 On the 

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a systematic analysis of whether the measures 

would lead to more accurate determinations in all 

or even most cases, and we do not believe such an 

analysis would be possible at this time due to the 

lack of information regarding how swaps are used 

in all markets. See generally part II.D.4.a, supra. 

1317See part II.D.3.e, supra. 

1318See Roundtable Transcript at 193–94 

(remarks of James Cawley, Javelin Capital Markets, 

and Camille Rudge, The PrivateBank and Trust 

Company). 

1319See letter from NCFC I. 

1320See letter from NYCBA Committee. 

1321See generally Roundtable Transcript at 210– 

15 (remarks of Mary-Margaret Collier, Tennessee 

Comptroller of the Treasury, John Janney, Large 

Public Power Council and Bella Sanevich, NISA 

Investment Advisors, LLC). 

1322Some commenters suggested that the number 

of counterparties and the number of swaps are not 

indicators of systemic risk. See letters cited in note 

387, supra. Others claimed that the de minimis 

standard should not limit the number of an entity’s 

counterparties for policy reasons. See letters from 

Chesapeake Energy and Land O’Lakes I. 

Commenters also suggested that using number of 

counterparties or number of swaps as a factor 

would create an uneven playing field because it 

would discourage provision of swaps to small end 

users. See letters from EEI/EPSA and NMPF. 

1323See CEA section 1a(49)(A), 7 U.S.C. 

1a(49)(A). 

1324See, e.g., letter from B&F Capital I. 

other hand, requiring market 

participants to consider more variables 

in evaluating application of the de 

minimis exception would likely 

increase their costs to make this 

determination. In light of these 

considerations, we concluded that to 

establish a single notional threshold for 

all of an entity’s swap dealing would 

best protect the markets and the public, 

foster efficiency and competitiveness 

and serve the public interest. 

We believe that using a de minimis 

threshold based on current 

uncollateralized exposure would lead to 

costs of calculation, which are 

discussed below in connection with the 

definition of major swap participant. 

Also, while current uncollateralized 

exposure may be a useful measure of the 

risk arising from a swap position, it fails 

to address the significance of an entity’s 

swap dealing activity in terms of 

customer protection and market 

orderliness, which are significant 

elements in the determination of 

whether an entity is engaged in a de 

minimis quantity of swap dealing.1317

In response to commenters’ 

suggestions, we considered the 

feasibility of assessing the breakeven 

point at which a potential swap dealer 

would earn enough profit from its swap 

dealing to support the costs to comply 

with swap dealer regulation.1318

However, this assessment would require 

access to non-public, proprietary data 

regarding the gross margins associated 

with the swap dealing activity of a wide 

variety of market participants. Such data 

is not available to the CFTC. 

One commenter suggested that the de 

minimis threshold for swaps related to 

a particular physical commodity should 

increase if the general price of the 

commodity increases, so that a constant 

quantity of the commodity could be 

hedged through a particular swap 

dealing entity without that entity 

exceeding the threshold.1319 However, 

this approach, which eschews reliance 

on the dollar value of swaps, would 

raise the complex question of when the 

level of dealing in swaps relating to the 

physical quantity of various 

commodities becomes more than de 

minimis. We do not believe that this 

approach would provide sufficient 

additional benefits beyond those 

resulting from the final rule to justify 

the additional costs of application. 

Commenters also suggested that, in 

order to simplify application of the de 

minimis exception and thereby reduce 

costs, the final rule should include an 

overall threshold that considers an 

entity’s swaps and its security-based 

swaps.1320 However, the statute 

includes two different de minimis 

exceptions regarding the quantity of an 

entity’s swap dealing and its securitybased swap dealing. Therefore, the 

suggested approach would be contrary 

to the statute. 

The final rule provides for a lower de 

minimis gross notional threshold (i.e., 

$25 million over the course of twelve 

months) for swaps in which the 

counterparty is a ‘‘special entity,’’ as 

that term is defined in CEA section 

4s(h)(2)(C) and CFTC Regulation 

§ 23.401(c)). While it is possible that, for 

the reasons noted above, this lower 

threshold could reduce the number of 

potential providers of swaps to special 

entities, which may constrain the ability 

of special entities to practice sound risk 

management strategies in a costeffective manner, we note that the 

Dodd-Frank Act provides special 

entities with additional protections from 

market practices that could increase the 

risks they face in using swaps.1321 We 

believe the threshold in the final rule 

reflects an appropriate consideration of 

these potential costs and the benefits 

that result in terms of serving the public 

interest. 

Several commenters responded to the 

proposed de minimis thresholds 

limiting the number of an entity’s 

counterparties and swaps, suggesting 

that the factors would not be useful in 

identifying entities engaged in a de 

minimis quantity of swap dealing.1322

The final rule omits these factors. We 

believe that, in general, entities which 

will restrict their activities so as to 

remain under the de minimis notional 

amount threshold are likely to be those 

entities that are most willing to provide 

swaps with lower notional values. 

Counting an entity’s number of 

counterparties or swaps as de minimis 

factors could inappropriately discourage 

entities from providing swaps in smaller 

notional amounts. This, in turn, would 

likely make it more difficult for persons 

seeking small notional amount swaps to 

find dealers willing to provide them, 

which may increase their costs of 

hedging and discourage sound risk 

management practices. 

g. Exclusion of Swaps Entered Into by 

IDIs in Connection With the Origination 

of Loans 

The statutory definition of the term 

‘‘swap dealer’’ excludes an IDI ‘‘to the 

extent it offers to enter into a swap with 

a customer in connection with 

originating a loan with that 

customer.’’ 1323 The proposed rule 

would implement this statutory 

exclusion by providing that an IDI’s 

swaps with a customer in connection 

with originating a loan to that customer 

are disregarded in determining if the IDI 

is a swap dealer. To prevent evasion, the 

proposed rule further provided that the 

statutory exclusion does not apply 

where the purpose of the swap is not 

linked to the financial terms of the loan, 

the IDI enters into a ‘‘sham’’ loan, or the 

purported ‘‘loan’’ is actually a synthetic 

loan such as a loan credit default swap 

or loan total return swap. 

Commenters on the costs and benefits 

of the proposed approach focused on 

the benefits of a flexible application of 

the exclusion, which they asserted 

would promote the offering of swaps by 

IDIs in connection with loans and 

thereby more closely tailor the risks of 

a loan to the borrower’s and the lender’s 

needs, and promote the risk-mitigating 

effects of swaps.1324 In terms of costs, 

commenters were concerned that a 

narrow application of the loan 

origination exclusion would cause IDIs 

to seek to avoid being covered by the 

definition of the term ‘‘swap dealer’’ by 

limiting their offering of swaps in 

connection with the origination of 

loans. Commenters said that the IDIs’ 

limitation of their swap offerings could 

lead borrowers to take steps with 

negative ramifications, such as reduced 

usage of swaps for risk mitigation 

(which could lead to costs from an 

increased risk of default by the 

borrower), shifting from the lending 

institution to another institution for the 

swap (which could lead to inefficiency 

costs since two different institutions 

would be involved), or shifting to 

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1325Commenters said that if, because of concern 

about triggering the de minimis threshold, IDIs were 

not willing to offer swaps at times when the 

borrower’s hedging needs change due to loan 

related events, borrowers would have an incentive 

to seek out lenders who are not so constrained, and 

this incentive would be particularly strong if a 

borrower was not able to provide collateral to 

secure both a loan and a related swap from two 

separate counterparties. See letters from BOKIII, 

FSR VI and Rabobank, New York Branch. One 

commenter suggested that the impact of a narrow 

loan origination exclusion should be considered in 

tandem with the de minimis exception, because an 

expansion of one of the exceptions could offset 

some of the costs that result from a narrow 

interpretation of the other. See letter from FSR VI. 

1326See letters cited in notes 308 to 313, supra. 

1327See letters cited in notes 299 to 301313, 

supra. 

1328See letters cited in notes 302 to 304313, 

supra. 

1329See letters cited in notes 314 to 317304313, 

supra. 1330See letters cited in note 305313, supra. 

1331See letters cited in note 341, supra. 

1332See letters from Kraft, ONEOK and Shell 

Trading II. 

another institution for both the loan and 

the swap (which could increase risk by 

increasing concentration in the markets 

for loans and swaps).1325 To mitigate 

these costs, commenters suggested that 

the loan origination exclusion should be 

construed broadly, particularly with 

respect to the range of loans 

covered,1326 the type of swaps 

covered,1327 the required timing for 

entering into a swap relative the 

corresponding loan’s origination,1328

and which financial institutions could 

be eligible for this exclusion.1329

The final rule limits the loan 

origination exclusion to swaps with 

terms that are directly related to the 

financial terms of the associated loan, or 

are required by loan underwriting 

criteria to to be in place as a condition 

of the loan in order to hedge commodity 

price risks incidental to the borrower’s 

business. We believe that extending the 

loan origination exclusion further, to 

encompass a broader range of swaps 

connected to a borrower’s other 

business activities would expand the 

exclusion beyond its statutory limits. 

This would lead to the costs associated 

with the rule becoming less inclusive, 

such as decreased protection of market 

participants and the public, as well as 

impaired risk management practices and 

market efficiency, as described above. 

This Adopting Release also includes 

guidance that the term ‘‘loan’’ should be 

construed for this purpose in 

accordance with the common law 

definition of the term, in order to 

efficiently allow all interested parties to 

determine which transactions and 

instruments are eligible to be a basis for 

the exclusion. The CFTC believes that a 

detailed definition of the term ‘‘loan’’ 

covering all of the potential variations 

in how loans may be structured would 

be both costly to apply (because of the 

level of analysis required to determine 

if a particular instrument qualifies as a 

loan) and unnecessary (because a 

common law definition of the term 

‘‘loan’’ has already been established). 

We believe that extending the loan 

origination exclusion to cover any swap 

entered into by an IDI and a borrower 

at any point during the life of the loan 

would be contrary to the statutory terms 

of the exclusion, which focuses 

specifically on swaps entered into in 

connection with the ‘‘origination’’ of 

loans, and could lead to the costs of the 

rule being less inclusive described 

above. Rather, since a primary element 

of a loan is the transfer of money from 

the lender to the borrower, the final rule 

provides that the loan origination 

exclusion can cover an otherwise 

eligible swap if the swap is entered into 

during a specified period around either 

the execution of the loan agreement or 

any draw of principal under the loan. 

We believe that this aspect of the final 

rule accurately reflects the statutory 

terms of the exclusion and will serve the 

public interest by being neither overinclusive nor under-inclusive. 

Commenters generally agreed with the 

statement in the Proposing Release that 

the exclusion should be available to IDIs 

in a loan syndicate, purchasers of a 

loan, assignees of a loan, and 

participants in a loan.1330 We believe 

that allowing the loan origination 

exclusion to extend to IDIs that 

participate in loans accurately reflects 

the statutory terms of the exclusion, so 

long as the IDIs’ participations are 

meaningful. Therefore, the rule includes 

a minimum participation requirement in 

order to avoid inappropriate 

exploitation of the exclusion—i.e., IDIs 

participating minimally in a loan 

syndication to gain eligibility for the 

exclusion — which could lead to costs 

of under-inclusion. The final rule allows 

the exclusion to be applied to a swap 

(which is otherwise covered by the 

exclusion) even if the notional amount 

of the swap is different from the amount 

of the loan tranche assigned to the IDI, 

so long as the IDI meets the minimum 

participation requirements in the loan. 

This provision is expected to facilitate 

minimization of the number of swaps 

borrowers enter into, and the number of 

counterparties they face with respect to 

those swaps, when entering swaps in 

connection with loans, thereby reducing 

the operational costs and risks born by 

borrowers. 

h. Inter-Affiliate Swaps 

The Proposing Release stated that the 

dealer analysis should consider the 

economic reality of swaps between 

affiliates, and preliminarily concluded 

that swaps ‘‘between persons under 

common control may not involve the 

interaction with unaffiliated persons 

that we believe is a hallmark of the 

elements of the definitions that refer to 

holding oneself out as a dealer or being 

commonly known as a dealer.’’ 

Commenters generally agreed with the 

proposed approach.1331 Some 

commenters expressed the view that the 

proposed approach would facilitate the 

use by affiliated corporate groups of 

centralized market-facing conduits, 

which would promote efficient risk 

management.1332

The final rule interprets the dealer 

definition not to encompass a person’s 

activities with respect to swaps between 

legal entities that are under common 

majority ownership. The final rule also 

provides that the swap dealer definition 

does not encompass the activities of a 

cooperative with respect to swaps 

between the cooperative and its 

members. We believe that such swaps 

generally serve to allocate or transfer 

risks within an affiliated group, rather 

than to move those risks out of the 

group to an unaffiliated third party, and 

therefore to include such swaps in the 

determination of whether an entity is a 

swap dealer would not be consistent 

with the statutory definition, nor would 

it serve the public interest or promote 

the protection of markets or the public. 

We also agree with commenters that the 

use of conduit structures to enter into 

swaps on behalf of commonly 

controlled entities has the potential to 

promote sound risk management 

practices and the efficiency of the swap 

markets. Therefore, including these 

swaps in the determination of whether 

a person is covered by the definition of 

‘‘swap dealer’’ is not likely to provide 

significant benefits, but to include 

entities in the definition by virtue of 

these swaps would lead to the costs of 

the rule being overinclusive, as 

described above. 

i. Exclusions of Swaps Entered Into for 

Hedging Physical Positions 

Several commenters said that swaps 

used to hedge risks should not be 

considered in determining whether a 

person is a swap dealer. While the 

statutory definition of the term ‘‘swap 

dealer’’ does not specifically address 

hedging activity, the Commissions 

believe that in certain situations, 

entering into a swap for the purpose of 

hedging a physical position is not 

indicative of, and is not, swap dealing. 

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30710 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1333See part II.A.2.f, supra. 

1334See id. 

1335 In addition, comments along these lines 

asserted that to apply dealer regulation to certain 

persons who are already subject to different 

financial regulations would be duplicative and 

could create additional costs. See letters from Farm 

Credit Council I, FERC Staff, Fidelity, GIC, MFA I, 

and NARUC and joint letter from ICI and SIFMA 

AMG. 

1336This is so because the commenters requested 

per se exemptions for broad classes of persons and 

activities, rather than for specific persons. Whether 

a particular type of market participant, as a group, 

can be the source of systemic risk depends on, 

among other things, the financial strength of each 

entity in the group, the number and financial 

strength of their counterparties, the total amount of 

swap business conducted, the amount and types of 

margin posted by the entities in question as well as 

by their counterparties, what portion of their swap 

positions are cleared, the volatility of each swap’s 

value as well as the covariance in value for all the 

swaps in their portfolio, and numerous other 

economic factors. 

An interim final rule provides that the 

determination of whether a person is a 

swap dealer will not consider a swap 

that the person enters into for the 

purpose of offsetting or mitigating 

certain price risks as defined in the rule, 

if the swap meets conditions specified 

in the rule. 

When a person enters into a swap for 

the purpose of hedging the person’s own 

risks in specified circumstances, an 

element of the swap dealer definition— 

the accommodation of the 

counterparty’s needs or demands—is 

absent. Therefore, consistent with our 

overall interpretive approach to the 

definition, the activity of entering into 

such swaps (in the particular 

circumstances defined in the rule) does 

not constitute swap dealing. Providing 

an exclusion of such swaps from the 

swap dealer analysis reduces costs that 

persons using such swaps would incur 

in determining if they are swap dealers. 

j. Exclusions of Certain Swaps Entered 

Into by Floor Traders 

The CFTC believes that it would be 

inappropriate to require persons who 

are registered with the CFTC as floor 

traders to include in the swap dealer 

analysis swaps that they enter into, 

using only proprietary funds, on or 

subject to the rules of a DCM or SEF and 

submit for clearing to a DCO, and that 

meet certain other conditions specified 

in the rule. The CFTC believes that a 

requirement that these persons register 

as swap dealers (if the swap dealer 

registration requirement were to apply) 

could lead to duplicative regulation, 

since they are already registered as floor 

traders. 

Providing an exclusion of such swaps 

from the swap dealer analysis reduces 

costs that persons using such swaps 

would incur if such swap activity were 

to require them to register as swap 

dealers. Since the swaps are entered 

into on an exchange, by a person who 

is registered with the CFTC and cleared, 

we expect that the potential impact on 

the transparency, market orderliness 

and other goals of dealer registration 

from excluding these swaps from the 

dealer analysis would be minimal. 

Importantly, the rule requires that the 

person comply with the record keeping 

and risk management requirements of 

CFTC Regulation §§ 23.201, 23.202, 

23.203, and 23.600 with respect to each 

such swap as if the person. were a swap 

dealer. The requirement to comply with 

these important provisions reduces the 

potential for negative consequences 

from this rule. 

k. Exclusions for Particular Types of 

Entities 

Several commenters said the CFTC 

should interpret the statutory definition 

of ‘‘swap dealer’’ to include per se 

exemptions from the definition for 

certain types of persons or persons who 

engage in certain activities.1333 These 

commenters argued, in general, that 

there would be little or no benefit from 

construing the statute as covering these 

persons or activities because they did 

not contribute to the causes of the recent 

financial crisis or they do not pose 

systemic risk.1334 These commenters 

also asserted that to interpret the 

statutory definition to cover these types 

of persons or activities would lead to 

the costs of the rule being more 

inclusive, as noted above.1335

As stated previously, we note that the 

statutory definition of the term ‘‘swap 

dealer’’ applies to ‘‘any person’’ who 

engages in the activities described in the 

statute and who does not fall within the 

specific exceptions and exclusions in 

the statute. Therefore, the costs of 

applying the statutory definition to 

certain types of persons identified by 

the commenters arise from the 

provisions of the statute and not from 

the CFTC’s rulemaking. In addition, to 

provide the requested per se exemptions 

from the statutory definition could also 

introduce the costs of the rule being less 

inclusive discussed above, such as 

decreased protection of market 

participants and the public, as well as 

impaired risk management practices and 

market efficiency. 

Regarding the argument that there is 

no or little economic benefit from 

interpreting the statutory definition to 

cover persons whose failure would not 

create systemic risk, the commenters 

making this point did not provide 

evidence or analysis to indicate whether 

there would be systemic risk concerns if 

they were to fail. While some of these 

commenters asserted that their swap 

activities are not comparable to the 

activities of the financial institutions 

that are generally considered to have 

had a significant role in the recent 

crisis, and some asserted that persons 

eligible for the claimed exemptions did 

not play a role in the crisis, even if these 

assertions are taken as true they are not 

determinative of whether persons of this 

type could in fact be a source of 

systemic risk. We emphasize that the 

relevant question in this regard would 

not be whether the failure of any one 

person within the class covered by a 

suggested exemption would be the 

source of systemic risk, but rather 

whether a failure of several or many 

such persons would impact the 

efficiency, competitiveness and 

financial integrity of the markets, impair 

sound risk management practices or 

otherwise affect the protection of 

markets and the public.1336 To be clear, 

we do not believe and we are not 

asserting that any of the types of persons 

discussed by the commenters in this 

regard necessarily could be the source of 

systemic risk concerns, but rather we 

point out that the comments in this 

regard were general assertions rather 

than a presentation of specific evidence 

or analysis to support the claimed 

exemptions from the statutory 

definition. Thus, even if the statute 

allowed for such exemptions, which we 

do not believe it does, none of the 

commenters provided substantial 

support for their assertions. Also, as 

noted above we believe that the dealer 

definitions should be construed in the 

light of several benefits of dealer 

regulation (including protection of the 

markets and the public, encouraging the 

efficiency, competitiveness and 

financial integrity of the swap markets, 

and the overall public interest) and not 

just in terms of mitigating potential 

systemic risk. 

In any case, we believe that the final 

rule and the guidance in the Adopting 

Release provide clarifications that in 

many respects mitigate the costs that 

were raised by some of the commenters 

seeking per se exemptions from the 

definition. 

l. Other Comments on the Rule Further 

Defining the Term ‘‘Swap Dealer’’ 

Commenters cited other potential 

costs that could arise from the proposed 

approach to interpreting the statutory 

definition of the term ‘‘swap dealer,’’ 

suggesting that the proposed approach 

was not sufficiently clear, may result in 

multiple interpretations, and risks 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30711 

1337See letters from AIMA I, API I, Dominion 

Resources, FSR III, NRG Energy, Peabody and 

Utility Group. 

1338See letters from API I, Dominion Resources, 

FERC Staff, NextEra I and WGCEF VIII. 

1339See letters from API I, FSR III, M&T I, Utility 

Group and Vitol. 

1340One area cited by commenters as a potential 

source of such costs is the application for limited 

designation as a swap dealer. Commenters were 

concerned that if the parameters of the limited 

designation were uncertain, entities may incur 

opportunity costs from avoiding activities that may 

be incompatible with a limited designation, 

planning and operational costs from changing 

corporate structure in ways that are not actually 

necessary to obtain a limited designation, and other 

costs from modifying swap activities in response to 

uncertainty about the steps necessary for a limited 

designation. See letters from API I, BG LNG I, 

Dominion Resources, NextEra I, Vitol and WGCEF 

VII. 

1341See letters from BG LNG I, FSR III, NCGA/ 

NGSA I, and WGCEF I, II and VIII. 

1342See letters from API I, Atmos Energy, BG LNG 

I, Dominion Resources, Hess, NCGA/NGSA Iand 

Vitol, and WGCEF VIII. 

1343For example, an entity using swaps to hedge 

price risks may choose not to hedge or to use a 

different instrument to hedge similar positions. If it 

chooses not to hedge, its risk management 

objectives may be compromised. If it chooses to 

hedge using futures or some other instrument, that 

instrument may be less suitable for various reasons 

(e.g., basis risk, rollover risk, liquidity risk, less 

customizability, different fee structure, etc.). 

However, it is not possible to quantify the costs and 

benefits resulting from these choices without 

knowing the terms of the individual swaps the 

entities would have used and the available 

alternatives for each of those swaps. 

1344On the other hand, entities may find that they 

can achieve their risk management goals using 

forward contracts, futures and other financial 

instruments, or they may determine that their 

financial risks can be reduced in other ways. 

1345See letters from API I, Capital One, COPE 

dated March 14, 2011 (‘‘COPE II’’), FSR III,Socie ́te ́

Ge ́ne ́rale, and Vitol and WGCEF dated March 22, 

2011 (‘‘WGCEF III’’). 

1346See letters from ABA Securities Association, 

BlackRock dated June 3, 2011 (‘‘BlackRock III’’), 

CDEU, Hess and WGCEF dated March 23, 2011 

(‘‘WGCEF IV’’). 

covering entities that would not actually 

be covered by the statutory definition, if 

it were correctly interpreted.1337 Other 

commenters suggested that there could 

be high costs from application of the 

swap dealer regulations due to 

erroneous interpretation of the statutory 

definition of the term ‘‘swap dealer,’’ 

including high costs of regulatory 

uncertainty,1338 and therefore it is 

particularly important that the final rule 

provide guidance on the application of 

the statutory definition.1339 For 

example, these commenters said that if 

the final rule does not adequately clarify 

application of the statutory definition, 

market participants may incur 

unnecessary costs to avoid being 

covered by the definition of ‘‘swap 

dealer,’’ including by avoiding swap 

activities that are associated with areas 

of uncertainty under the rule.1340

Some commenters said that the 

proposed rule captures too broad a 

range of entities in its further definition 

of the term ‘‘swap dealer,’’ 1341 and that 

the asserted over-inclusiveness of the 

proposed rule could lead to direct costs 

for covered entities as well as indirect 

costs for covered entities, other swap 

market participants, and the public.1342

For example, the commenters assert that 

as entities change their swap activities 

in reaction to the rule, the objectives 

they previously achieved through swaps 

may either be compromised, 

accomplished through less suitable 

means, or both.1343 As another example, 

the commenters assert that changes in 

swap activities may reduce the choice of 

counterparties available to market 

participants, which may lead to 

unfavorable financial terms for swaps 

and imperfect matches between risks 

and swaps, which could in turn lead to 

reduced usage of swaps and lower 

liquidity in the swap markets, resulting 

ultimately in increased costs of risk 

mitigation in general.1344

The commenters did not quantify the 

extent of these costs that may arise 

when entities change their swap 

activities in reaction to the rule further 

defining the term ‘‘swap dealer.’’ 

We believe that by addressing the 

concerns regarding the costs and 

benefits of specific aspects of the rule, 

discussed above in section V.C.5., the 

final rule will also mitigate the indirect 

costs that may arise from the rule. While 

it is impossible to completely eliminate 

the costs that entities will incur in 

interpreting the rule and applying it to 

their particular swap activities, we 

believe the final rule mitigates these 

costs by providing detailed guidance. 

Also, these costs may decrease over time 

as precedents are established to provide 

further guidance on the application of 

the statutory definition. 

For example, the final rule and the 

guidance in this Adopting Release 

mitigate the costs of uncertainty in 

application of the statutory definition by 

providing more detail about the 

interpretation of the statute’s inclusion 

of any person who ‘‘makes a market in 

swaps’’ and the statute’s exclusion of a 

person that enters into swaps, ‘‘but not 

as a part of a regular business.’’ The 

guidance describes activities that are 

indicative of making a market in swaps 

and of entering into swaps as a part of 

a regular business. The final rule also 

provides details regarding the scope of 

the statutory exclusion of swaps in 

connection with the origination of loans 

and the de minimis exception. Also, the 

final rule provides that swaps between 

majority-owned affiliates, swaps entered 

into by a cooperative with its members, 

swaps entered into for hedging physical 

positions as defined in the rule, and 

certain swaps entered into by floor 

traders, are excluded from the swap 

dealer determination. These provisions 

will reduce the costs that market 

participants incur in determining 

whether they are covered by the 

statutory definition of the term ‘‘swap 

dealer.’’ 

While it is possible that some entities 

could choose to cease or reduce their 

swap dealing activities to avoid the 

costs of compliance with swap dealer 

regulations, which could impair the 

efficiency and competitiveness of the 

swap markets, there are also likely to be 

significant benefits derived from swap 

dealer regulation, including reduced 

counterparty risk, better protection of 

the markets and the public, and more 

assured financial integrity of the 

markets and improved market 

transparency. Moreover, whether such 

reductions in activity will lead to 

reduced liquidity in the swap markets, 

as some commenters assert, is not 

certain. For example, if such reductions 

in swap activity occur, new swap 

dealers may organize themselves or 

existing swap dealers may expand to 

accommodate the demand for swaps, 

although the time that would be 

required for this to occur and the extent 

to which it would occur are uncertain. 

In addition, indirect costs could arise 

from the rule being less inclusive. For 

example, if the rule considered factors 

that are not relevant to whether an 

entity is actually covered by the 

definition, such as by providing that 

only entities that make a two-sided 

market in swaps are makers of markets 

in swaps, then it is possible that entities 

could change their behavior in response 

to that aspect of the rule. For example, 

entities that previously made a twosided market in swaps may decide to 

make only a one-sided market in swaps, 

potentially leading to the types of costs 

that commenters said would arise if 

entities reduce their swap activities. 

Last, several commenters raised 

questions and offered suggestions about 

the timeline for implementation of swap 

dealer requirements 1345 and the 

sequencing of the CFTC’s 

rulemaking.1346 While we understand 

that appropriate timing of rulemaking 

and the implementation of the 

requirements applicable to swap dealers 

will play a significant role in mitigating 

inappropriate or avoidable costs flowing 

from those requirements, this 

rulemaking is limited to the 

interpretation of the statutory definition 

of the term ‘‘swap dealer,’’ and so these 

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30712 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1347This estimate is based on the following staff 

requirements for this determination: 20 hours for a 

financial analyst at $161/hour, 5 hours of a 

financial manager at $325/hour, 2 hours of a 

controller or chief financial officer at $722/hour, 10 

hours of a compliance attorney at $355/hour, 2 

hours of a senior attorney at $992/hour, and 2 hours 

of a chief compliance officer at $664/hour. We 

round to two significant digits. The multiplier of 

5.35, which was used in the Proposing Release, is 

higher than the multiplier that the CFTC has used 

for similar purposes in other final rules adopted 

under the Dodd-Frank Act. See, e.g., CFTC, Swap 

Data Recordkeeping and Reporting Requirements; 

Final Rule, 77 FR 2135, 2173 (Jan. 13, 2012) 

(adjustment factor of 1.3 for overhead and other 

benefits). The CFTC believes that use of a higher 

multiplier here is appropriate because some persons 

may retain outside advisors to assist in making the 

determinations under the rules. 

The estimates of the hourly cost for these 

personnel are from SIFMA’s Management & 

Professional Earnings in the Securities Industry 

2010, modified by CFTC staff to account for an 

1800-hour work-year and multiplied by 5.35 to 

account for firm size, employee benefits, and 

overhead. These estimates are intended to reflect 

averages for compiling and analyzing the 

information necessary to apply the definition of the 

term ‘‘swap dealer.’’ We recognize that particular 

entities within each range of complexity may, based 

on their circumstances, incur costs substantially 

greater or less than the estimated averages. 

1348This estimate is based on the following staff 

requirements for this determination: 40 hours for a 

financial analyst at $161/hour, 10 hours of a 

financial manager at $325/hour, 5 hours of a 

controller or chief financial officer at $722/hour, 30 

hours of a compliance attorney at $355/hour, 20 

hours of a mid-level attorney at $608/hour, 15 hours 

of a senior attorney at $992/hour, and 5 hours of 

a chief compliance officer at $664/hour. 

1349This estimate is based on the following staff 

requirements for this determination: 120 hours for 

a financial analyst at $161/hour, 40 hours of a 

financial manager at $325/hour, 20 hours of a 

controller or chief financial officer at $722/hour, 80 

hours of a compliance attorney at $355/hour, 60 

hours of a mid-level attorney at $608/hour, 50 hours 

of a senior attorney at $992/hour, and 20 hours of 

a chief compliance officer at $664/hour. 

comments are beyond the scope of this 

rulemaking. 

In sum, we are cognizant that both 

direct and indirect costs would arise if 

the rule further defining the term ‘‘swap 

dealer’’ did not appropriately reflect the 

statutory definition of the term. Such 

costs, which would arise as the rule is 

either more or less inclusive, are 

detailed above. The Adopting Release 

provides benefits by interpreting the 

term ‘‘swap dealer’’ in a manner that is 

as close as possible to the statutory 

definition of the term, thereby 

mitigating the potential costs of both 

over-inclusiveness and underinclusiveness. 

m. Costs of Applying the Rules Further 

Defining the Term ‘‘Swap Dealer’’ 

In order to apply the rules further 

defining the term ‘‘swap dealer’’ and 

determine whether or not it is covered 

by the definition, an entity will incur 

direct costs in the form of personnel 

hours devoted to analyzing the entity’s 

activities with respect to swaps and 

determining whether the entity is 

covered by the definition. These costs 

will depend on the nature of the entity’s 

swap activities in the relevant situation. 

For some entities, it will be relatively 

clear that they are covered by the 

definition and they will incur relatively 

few costs in confirming that. It is 

expected that for many entities it will be 

relatively clear that they are not covered 

by the definition and they will incur 

little or no cost in confirming that 

determination. However, for some 

entities, especially those that enter into 

swaps in a variety of different ways and 

circumstances, the determination will 

be more complex and will require that 

personnel with financial and legal 

expertise review the circumstances of 

the entity’s swap activities to make the 

determination of whether the entity is 

covered by the definition. 

It is important to recognize that this 

would be the case in the absence of any 

rule further defining the term ‘‘swap 

dealer,’’ or regardless of the terms of the 

rule, because entities would have to 

interpret the statutory definition to 

determine whether they are covered. 

Thus, at a minimum, a significant 

portion of the costs discussed below is 

attributable to the inclusion in the 

Dodd-Frank Act of a definition of the 

term ‘‘swap dealer’’ and not from any 

aspect of the final rules further defining 

that term. Indeed, the final rule provides 

benefits by minimizing these costs by 

providing guidance about the 

application of the statutory definitions 

in various situations. 

The amount of time and resources 

that must be expended by an entity in 

order to determine whether it qualifies 

as a dealer will vary considerably 

depending on the complexity of the 

entity’s operations. In addition, the 

direct costs will vary depending on the 

determinations the entity must make— 

reviewing whether or not it is covered 

by the definition of the term ‘‘swap 

dealer,’’ whether it qualifies for the de 

minimis exception, or whether it seeks 

to obtain a limited purpose registration 

as a swap dealer. Depending on an 

entity’s situation, it may incur some or 

all of these costs. We did not receive 

any comments quantifying the costs that 

an entity may incur in applying any 

aspect of the definition of ‘‘swap 

dealer,’’ nor are we aware of any studies 

or surveys regarding this particular 

issue. Therefore, the CFTC staff has 

estimated the amount of time that 

entities may require to apply the 

definition in various situations. These 

estimations are for informational 

purposes and require the CFTC to 

consider the aforementioned highly 

uncertain criteria. 

Regarding the determination of 

whether an entity is covered by the 

definition of the term ‘‘swap dealer,’’ an 

entity with a relatively low degree of 

complexity in its organizational 

structure (i.e., one legal entity) and in its 

swap activities (i.e., little variation in 

the types of swaps they use and the 

purposes for which they use them) 

might expect the direct cost of such a 

determination to be approximately 

$13,000.1347 We estimate that 

approximately 250 entities of this type 

would be engaged in swap activities that 

create sufficient uncertainty regarding 

the application of the definition that 

they would have to incur these costs. 

An entity with a moderate degree of 

complexity in its organizational 

structure (i.e., a few legal entities) and 

its swap activities (i.e., some variation 

in the types of swaps they use and the 

purposes for which they use them) 

might expect the cost of such a 

determination to be approximately 

$54,000.1348 We estimate that 

approximately 150 entities of this type 

would be sufficiently uncertain 

regarding the application of the 

definition that they would have to incur 

these costs. An entity with a high degree 

of complexity in its organizational 

structure (i.e., multiple affiliates in the 

corporate group) and its swap activities 

(i.e., using diverse types of swaps for 

various purposes) could spend 

approximately $170,000 when making a 

determination as to whether it is 

covered by the definition of swap 

dealer.1349 We estimate that 

approximately 50 entities of this type 

would be sufficiently uncertain 

regarding the application of the 

definition that they would have to incur 

these costs. Thus, the total direct cost 

for all entities to determine the coverage 

of the definition of the term ‘‘swap 

dealer’’ would be approximately 

$20,000,000. 

As noted above, we estimate that 

approximately 450 entities (i.e., 250 

with relatively low complexity, 150 

with moderate complexity and 50 with 

high complexity) would be sufficiently 

uncertain about the application of the 

definition of the term ‘‘swap dealer’’ 

that they would incur costs in applying 

the definition. This estimate includes 

IDIs that apply the loan origination 

exclusion. It is important to emphasize 

that since there is no definitive publicly 

available information about how many 

entities are engaged in swap activities 

and how they use swaps in particular 

situations, it is impossible to be sure 

how many entities may be uncertain 

about whether the definition covers 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30713 

1350CFTC, President’s Budget and Performance 

Plan Fiscal Year 2012, p. 13–14 (Feb. 2011), 

available at http://www.cftc.gov/ucm/groups/ 

public/@newsroom/documents/file/ 

cftcbudget2012.pdf. The estimated 140 swap 

dealers includes ‘‘[a]pproximately 80 global and 

regional banks currently known to offer swaps in 

the United States;’’ ‘‘[a]pproximately 40 non-bank 

swap dealers currently offering commodity and 

other swaps;’’ and ‘‘[a]pproximately 20 new 

potential market makers that wish to become swap 

dealers.’’ Id. 

1351See CFTC, Registration of Swap Dealers and 

Major Swap Participants, 77 FR 2613, 2622 (Jan. 19, 

2012). The number of persons covered by the 

definition of ‘‘major swap participant’’ is estimated 

to be quite small, at six or fewer. 

1352The estimate of approximately 625 entities 

that will apply the de minimis exception is based 

on our assumption that significantly more (i.e., five 

times as many) entities will apply the exception as 

compared to the number of entities registered as 

swap dealers (which we assume to be 

approximately 120). This estimate is also in line 

with information provided by commenters that 

approximately 100 community and regional banks 

would potentially apply the de minimis exception 

(i.e., the estimate reflects 100 such banks along with 

525 other entities that are involved in the swap 

markets to a similar extent). 

1353This estimate is based on the following staff 

requirements for this determination: 80 hours for a 

financial analyst at $161/hour, 20 hours of a 

financial manager at $325/hour, 10 hours of a 

controller or chief financial officer at $722/hour, 20 

hours of a compliance attorney at $355/hour, 5 

hours of a senior attorney at $992/hour, and 5 hours 

of a chief compliance officer at $664/hour. 

1354This estimate is based on the following staff 

requirements for this determination: 20 hours for a 

financial analyst at $161/hour, 5 hours of a 

financial manager at $325/hour, 5 hours of a 

controller or chief financial officer at $722/hour, 10 

hours of a compliance attorney at $355/hour, 2 

hours of a senior attorney at $992/hour, and 2 hours 

of a chief compliance officer at $664/hour. 

1355This estimate is based on the following staff 

requirements for this determination: 10 hours for a 

financial analyst at $161/hour, 5 hours of a 

financial manager at $325/hour, 2 hours of a 

controller or chief financial officer at $722/hour, 5 

hours of a compliance attorney at $355/hour, 1 hour 

of a senior attorney at $992/hour, and 1 hour of a 

chief compliance officer at $664/hour. 

1356This estimate is based on the following staff 

requirements for this determination: 200 hours for 

a financial analyst at $161/hour, 120 hours of a 

financial manager at $325/hour, 40 hours of a 

controller or chief financial officer at $722/hour, 

100 hours of a compliance attorney at $355/hour, 

60 hours of a mid-level attorney at $608/hour, 50 

hours of a senior attorney at $992/hour, and 40 

hours of a chief compliance officer at $664/hour. 

The estimate of approximately 20 entities applying 

the limited designation reflects an estimate that 

about one in six swap dealers would apply the 

designation. 

them to the point that they would incur 

such costs. However, we believe that the 

number of such entities may be 

estimated based on certain assumptions 

as discussed below. 

In meetings with commenters since 

publication of the Proposing Release, 

the CFTC has discussed extensively the 

universe of potential entities that may 

be covered by the definition of the term 

‘‘swap dealer’’ and gathered information 

on the swap market and its participants. 

In its FY 2012 budget drafted in 

February 2011, the CFTC estimated that 

140 entities may be covered by the 

definition of ‘‘swap dealer,’’ 1350 and 

after receiving additional information 

the CFTC estimates that approximately 

125 entities will be covered by the 

definitions of the terms ‘‘swap dealer’’ 

and ‘‘major swap participant.’’ 1351 With 

these assumptions in mind, we believe 

it is reasonable to estimate that for every 

entity covered by the definitions, there 

will be about four entities (i.e., 

approximately four times 120, or about 

450) that are sufficiently uncertain 

about the coverage of the definitions 

that they would incur costs in applying 

the definitions. 

Our estimate that there would be 

about 450 such entities is also in line 

with the number of entities that were 

sufficiently interested in the Proposing 

Release that they submitted substantive 

comments to the CFTC. As noted above, 

we received about 300 substantive 

comment letters in response to the 

proposal. Of these, some reflected more 

than one letter from a single commenter, 

comments from persons who did not 

expect to be swap dealers, or comments 

from persons who were not uncertain 

about their status under the definition. 

On the other hand, several letters were 

from multiple commenters that 

submitted their comments jointly. Thus, 

we estimate that about 225 entities were 

sufficiently interested in the proposed 

rule further defining the term ‘‘swap 

dealer’’ that they submitted a 

substantive comment, and for each such 

entity there was another entity that 

would also be similarly uncertain about 

the definition, which supports our 

estimate that 450 entities in total would 

incur costs in applying the definition. 

Regarding the determination of 

whether an entity is eligible for the de 

minimis exception from the definition 

of the term ‘‘swap dealer,’’ we note that 

only an entity that is engaged in some 

swap dealing activity would be required 

to make this determination, but it would 

be required to make the determination 

regardless of whether it is uncertain 

about whether its swap activities 

constitute dealing (e.g., it would incur 

costs even if there were no doubt that 

it is engaged in swap dealing). We also 

note that the number of entities that will 

apply the de minimis exception is 

expected to be significantly greater than 

the number of entities that are required 

to register as swap dealers. Again, we 

believe that the entities making this 

determination would have situations 

that are highly complex (we believe 

approximately 25 entities would fall in 

this category), moderately complex 

(approximately 200 entities) and of low 

complexity (approximately 400 

entities).1352 The direct cost of making 

the determination for these entities 

would be approximately $42,000 in 

highly complex situations,1353 $15,000 

in moderately complex situations 1354

and $8,000 in situations of low 

complexity.1355 The total direct costs for 

all entities would be approximately 

$7,300,000. 

Third, regarding the determination of 

whether an entity should apply for a 

limited purpose swap dealer 

registration, we believe that relatively 

few entities would make such an 

application but that the situation of each 

of these entities would be highly 

complex. We believe approximately 20 

entities would fall in this category, and 

the direct cost of making the 

determination for each would be 

approximately $250,000,1356 resulting in 

a total direct cost of approximately 

$5,000,000. 

Thus, the total initial direct cost of 

applying the rules further defining the 

term ‘‘swap dealer’’ (including the de 

minimis exception and the possibility of 

limited purpose registration) for all 

entities would be approximately 

$32,000,000. 

In addition to these initial costs, we 

believe that entities would incur 

recurring costs in applying the 

definition. Regarding the application of 

the term ‘‘swap dealer,’’ we estimate 

that approximately 10 percent of the 

entities noted above would, each year, 

experience significant changes in their 

usage of swaps (such as beginning or 

ending a new line of business) that 

would require reconsideration of the 

application of the definition, which 

would result in costs amounting to onehalf of the direct cost of making the 

initial determination. Applying these 

factors to the costs noted above, the total 

recurring direct costs for all entities 

associated with the application of the 

term ‘‘swap dealer’’ are estimated to be 

approximately $1,000,000 per year. 

Regarding the de minimis exception, we 

estimate that entities would have to 

incur ongoing costs of review to 

determine whether the exception 

applies on a yearly basis, and that the 

annual cost of this review would 

amount to one-half of the direct cost of 

making the initial determination. That 

is, the total recurring direct costs for all 

entities associated with the de minimis 

exception are estimated to be 

approximately $3,700,000. Last, we 

estimate that entities that qualify for a 

limited purpose swap dealer registration 

would incur ongoing review costs 

amounting to one-quarter of the direct 

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30714 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1357The Dodd-Frank Act provides for the 

registration and regulation of major swap 

participants under CEA section 4s. The particular 

requirements applicable to major swap participants 

will be established in separate rulemakings. See 

notes 1240 and 425, supra. 

cost of making the initial determination, 

or approximately $1,300,000 per year. 

Thus, the total recurring direct cost of 

applying the swap dealer definition 

(including the de minimis exception 

and the possibility of limited purpose 

registration) would be approximately 

$6,000,000. 

5. Costs and Benefits of the Rules 

Further Defining ‘‘Major Swap 

Participant’’ 

This Adopting Release further defines 

a ‘‘major swap participant’’ by setting 

out quantitative thresholds against 

which a market participant can compare 

its swaps activities to determine 

whether it is encompassed by the 

definition. The rule requires potential 

major swap participants to analyze their 

swaps in detail to determine, for 

example, which of their swaps are 

subject to netting agreements or markto-market collateralization, and the 

amount of collateral posted with respect 

to the swaps. The rule includes a 

general, qualitative definition of the 

swaps that may be excluded from the 

calculation because they are used to 

‘‘hedge or mitigate commercial risk.’’ 

Like the swap dealer definition, there is 

a voluntary process by which a person 

may request that the CFTC limit the 

major swap participant designation to 

certain categories of swaps. 

a. Background 

The definition set forth in CEA 

section 1a(33) provides that the term 

‘‘major swap participant’’ means any 

person who is not a swap dealer and (i) 

maintains a substantial position in 

swaps for any of the major swap 

categories as determined by the CFTC; 

(ii) whose outstanding swaps create 

substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the U.S. 

banking system or financial markets; or 

(iii) is a financial entity that is highly 

leveraged relative to the amount of 

capital it holds, is not subject to capital 

requirements established by an 

appropriate Federal banking agency, 

and maintains a substantial position in 

outstanding swaps in any major swap 

category as determined by the CFTC. In 

connection with the calculation of 

‘‘substantial position’’ noted above, the 

statutory definition specifically 

excludes positions held for hedging or 

mitigating commercial risk, and 

positions maintained by any employee 

benefit plan as defined in sections 3(3) 

and (32) of ERISA for the primary 

purpose of hedging or mitigating any 

risk directly associated with the 

operation of the plan. The statutory 

definition also provides that major swap 

participant designations may be limited 

in scope so that a person may be 

designated as a major swap participant 

in certain, but not all, swap categories. 

CEA section 1a(33)(D) excludes from 

the definition of the term ‘‘major swap 

participant’’ certain entities whose 

primary business is providing financing 

and who use derivatives for the purpose 

of hedging underlying commercial risks 

related to interest rate and foreign 

currency exposures, 90 percent or more 

of which arise from financing that 

facilitates the purchase or lease of 

products, 90 percent or more of which 

are manufactured by the parent 

company or another subsidiary of the 

parent company. There is no analogous 

statutory provision applicable to major 

security-based swap participants. 

As detailed in this Adopting Release, 

the definition of the term ‘‘major swap 

participant’’ focuses on the market 

impacts and risks associated with a 

person’s swap positions. This contrasts 

to the definition of the term ‘‘swap 

dealer,’’ which focuses on a person’s 

activities and accounts for the amount 

or significance of those activities only in 

the context of the de minimis exception. 

Persons that meet the major swap 

participant definition would, in large 

part, follow the same statutory 

requirements applicable to swap 

dealers.1357 In this manner, the DoddFrank Act regulates entities whose swap 

activities do not cause them to be swap 

dealers, but nonetheless could pose a 

high degree of risk to the U.S. financial 

system. This regulation of major swap 

participants is intended to facilitate 

financial stability by reducing risk, 

increasing transparency, and promoting 

market integrity. 

b. Costs of Applying the Rules Further 

Defining the Term ‘‘Major Swap 

Participant’’ 

The actual cost of applying the rule 

further defining the term ‘‘major swap 

participant’’ to determine if a person is 

covered by the definition will depend, 

in large part, on the nature of the 

person’s swap activities as well as the 

infrastructure such person already has 

in place for the analysis and reporting 

of its swap activities. Many persons will 

be clearly outside the definition (and a 

few persons may be clearly covered by 

the definition) and will incur little cost 

to confirm that status. However, it is 

reasonable to expect that a few persons 

that are not swap dealers but 

nonetheless engage in significant swap 

activity will be required to incur costs 

to determine whether they are covered 

by the definition. The direct costs such 

a person would incur would result from 

the incremental expense of personnel 

with financial and accounting expertise 

who would be required to devote time 

to the review of the size and nature of 

the person’s swap positions to 

determine whether the person is 

covered by the definition. Moreover, 

there will also be technology and legal 

review costs related to the 

determination of whether a person is a 

major swap participant. As is the case 

for the definition of the term ‘‘swap 

dealer,’’ it is important to recognize that 

even in the absence of any rule further 

defining the term ‘‘major swap 

participant,’’ or regardless of the terms 

of the rule, entities would incur costs in 

interpreting the statutory definition to 

determine whether they are covered. 

Thus, at a minimum, a significant 

portion of the costs discussed below is 

attributable to the inclusion in the 

Dodd-Frank Act of a definition of the 

term ‘‘major swap participant’’ and not 

from any aspect of the final rules further 

defining that term. Indeed, the final 

rules provide benefits by mitigating 

these costs by providing guidance about 

the application of the statutory 

definitions in different situations. 

The amount of time and resources 

that must be expended by a person in 

order to determine whether it qualifies 

as a major swap participant may vary 

considerably depending on the 

complexity of such person’s operations. 

In addition, direct costs will vary 

depending on the determinations the 

person must make relating to the 

definition, including, but not limited to, 

whether it engages in swap activity near 

the thresholds for ‘‘substantial position’’ 

and ‘‘substantial counterparty 

exposure,’’ and whether it is subject to 

a ‘‘safe harbor’’ provision as set forth in 

the definition. The CFTC did not receive 

any comments quantifying the costs that 

a person may incur in applying any 

aspect of the definition of the term 

‘‘major swap participant,’’ nor are we 

aware of any studies or surveys 

regarding this particular issue. 

Therefore, the CFTC staff has estimated, 

based on its experience, the amount of 

time that a person may require to 

determine whether it meets the 

definition. These estimations are for 

informational purposes and require the 

CFTC to consider the aforementioned 

highly uncertain criteria. 

The CFTC estimates that 

approximately 20 persons that are not 

swap dealers will initially be engaged in 

swap activity to such an extent that they 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30715 

1358As is the case with respect to the definition 

of the term ‘‘swap dealer,’’ we believe that the 

number of persons that may incur costs in 

reviewing their activities and the rules will be 

significantly greater than the number of entities that 

actually are covered by the definition and will be 

required to register as major swap participants. 

Similarly, since there is no definitive publicly 

available information about how many entities are 

engaged in swap activities and how they use swaps 

in particular situations, it is impossible to be sure 

how many entities may be uncertain about whether 

the definition covers them to the point that they 

would incur such costs. Our estimate that 

approximately 20 entities would be sufficiently 

uncertain about the application of the definition of 

the term ‘‘major swap participant’’ that they would 

incur costs in applying the definition is based on 

our assumption that about six entities would be 

covered by the definition, and that for each such 

entity there will be about four entities that will be 

uncertain about the coverage of the definition. See 

note 1351, supra. 

1359This estimate is based on the following staff 

requirements for this determination: 200 hours for 

a financial analyst at $161/hour, 80 hours for a 

programmer analyst at $196/hour; 120 hours of a 

financial manager at $325/hour, 40 hours of a 

controller or chief financial officer at $722/hour, 

100 hours of a compliance attorney at $355/hour, 

60 hours of a mid-level attorney at $608/hour, 50 

hours of a senior attorney at $992/hour, and 40 

hours of a chief compliance officer at $664/hour. 

The estimates of the hourly cost for these 

personnel are from SIFMA’s Management & 

Professional Earnings in the Securities Industry 

2010, modified by CFTC staff to account for an 

1800-hour work-year and multiplied by 5.35 to 

account for firm size, employee benefits, and 

overhead. As is the case for the application of the 

definition of the term ‘‘swap dealer,’’ we believe 

that that use of a higher multiplier here is 

appropriate because some persons may retain 

outside advisors to assist in making the 

determinations under the rules. These estimates are 

intended to reflect averages for compiling and 

analyzing the information necessary to apply the 

definition of the term ‘‘major swap participant.’’ We 

recognize that particular entities within each range 

of complexity may, based on their circumstances, 

incur costs substantially greater or less than the 

estimated averages. We round to two significant 

digits. 

1360See part IV.M, supra. 

1361This estimate is based on the following staff 

requirements for this determination: 5 hours for a 

financial analyst at $161/hour, 2 hours for a 

financial manager at $325/hour, 1 hour for a 

comptroller or chief financial officer at $722/hour, 

2 hours for a compliance attorney at $355/hour. 

1362Our estimate of the number of entities that 

will make the safe harbor calculation includes the 

following: one-half of the approximately 700 

investment company sponsors that are active in the 

U.S. (see the 2011 Investment Company Factbook 

published by the ICI, page 14, available at http:// 

www.ici.org/pdf/2011_factbook.pdf), a similar 

number of entities (i.e., 350) that have large 

positions in swaps as part of other investment 

management activities, one half of the corporate 

entities in the ‘‘Fortune 500’’ (representing 

corporate entities that have large positions in 

swaps) and an additional 250 entities representing 

other holders of large positions in swaps. 

1363See parts IV.B.3.d. and IV.E.3. 1364See, e.g., letters cited in notes 796 and 798, 

supra. 1365See letters from Dominion Resources and 

Fidelity. 1366See letters from AFR and Greenberger. 

1367See letters from BlackRock I, ISDA I, MFA I 

and WGCEF II. 

1368See letter from CCMR I. In addition, ACLI 

commented that thresholds for rate swaps should be 

increased to $4 billion for current uncollateralized 

exposure and $8 billion for current uncollateralized 

exposure plus potential future exposure, with 

corresponding increases to substantial counterparty 

exposure thresholds to $7 billion for current 

uncollateralized exposure and $14 billion for 

current uncollateralized exposure plus potential 

future exposure. See letter from ACLI. 

1369See letters from CDEU, COPE I, Fidelity, 

ISDA I, and MFA I. 

would be required to apply the 

calculations in the final rule in 

determining whether they are covered 

by the definition.1358 The direct cost of 

making such determination for each 

such person is estimated to be 

approximately $260,000,1359 resulting in 

an initial aggregate direct cost of 

approximately $5,200,000. We note that 

the relatively low estimate of only 20 

persons that would be required to incur 

costs at this level, as compared to the 

many thousands of swap market 

participants, reflects the relatively high 

thresholds for major swap participant 

status. As noted above, the large 

majority of market participants will be 

able to readily conclude that they are 

not covered by the definition. 

In addition to these initial costs, we 

believe that approximately 20 entities 

would incur recurring direct costs in 

applying the definition of major swap 

participant on a daily basis, and such 

costs would amount to one-third of the 

direct cost of making the initial 

determination. Thus, the total recurring 

direct costs for all entities associated 

with the application of the term ‘‘major 

swap participant’’ are estimated to be 

approximately $1,700,000 per year or 

approximately $83,000 per year for each 

person. 

Although the CFTC believes there will 

only be a limited number of persons that 

potentially may be major participants, 

we recognize the concerns raised by 

several commenters that major swap 

participant calculations will be 

conducted as part of the person’s overall 

compliance function even when there is 

not a significant likelihood that such 

person would be a major swap 

participant. As a result of the potential 

expense and effort that a person would 

be required to incur in connection with 

determining whether it meets the 

definition of major swap participant, the 

final rule includes three alternative 

‘‘safe harbor’’ provisions.1360 These safe 

harbor provisions relieve persons that 

are clearly not major swap participants 

from incurring the expense of the 

calculations otherwise required under 

the final rule. 

To apply the safe harbor provisions of 

the rule, the CFTC estimates that a 

person would have to incur initial direct 

costs of approximately $2,900 to 

determine whether its swap positions 

are within the safe harbor.1361 In 

addition, a person would incur costs of 

reviewing its swap positions on a 

monthly basis to monitor whether the 

safe harbor continues to apply, at an 

annual cost equal to one-third of the 

direct cost of making the initial 

determination, or $960. Our assumption 

that approximately 1,200 entities would 

apply the safe harbor provisions of the 

rule yields an aggregate direct initial 

cost of approximately $3,500,000 and 

aggregate annual costs of approximately 

$1,200,000.1362

c. Major Swap Participant Thresholds 

The final rule adopts the general 

approach in the proposed rule of 

determining whether a person is a major 

swap participant by comparing the 

exposure resulting from a person’s swap 

positions to specific, quantitative 

thresholds. The proposed thresholds for 

substantial position were $3 billion in 

current uncollateralized exposure or $6 

billion in current uncollateralized 

exposure plus potential future exposure 

for rate swaps, and $1 billion in current 

uncollateralized exposure or $2 billion 

in current uncollateralized exposure 

plus potential future exposure for each 

of the other categories of swaps. The 

proposed thresholds for substantial 

counterparty exposure are $5 billion in 

current uncollateralized exposure across 

all categories or $8 billion in current 

uncollateralized exposure plus potential 

future exposure across all categories.1363

However, there is a change for the 

weight in the PFE calculations from the 

proposal to the final rule of 0.2 to 0.1 

for cleared swaps. 

Commenters generally did not oppose 

the proposed thresholds although 

several thought the thresholds should be 

raised.1364 Two commenters supported 

the adoption of the thresholds as 

proposed.1365 In addition, a few other 

commenters thought that the thresholds 

were set too high.1366 Other commenters 

suggested that the thresholds be raised 

to a level that reflects systemic risk 

without suggesting a specific numerical 

threshold.1367 One commenter, 

however, suggested that the threshold 

be increased to $10 billion.1368 Several 

commenters also said that the 

thresholds should be adjusted for 

inflation and other changes over time in 

the swap market.1369

As discussed in part IV.B.3.d., the 

CFTC is adopting the thresholds as 

proposed. We recognize that the level of 

the thresholds will have a significant 

effect on whether the rules further 

defining the term ‘‘major swap 

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30716 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1370See letter from WGCEF II. 

1371See CFTC Regulation § 1.3(jjj)(3)(iii)(A); 

Exchange Act rule 3a67–3(c)(3)(i). The final rules 

further have been revised to clarify that the 0.1 

factor applies to positions cleared by a registered 

clearing agency or by a clearing agency that has 

been exempted from registration. 1372See, e.g., letters from MFA I and SIFMA AMG 

II. 1373Central clearing helps to mitigate 

counterparty credit risk by improving risk 

management and, among other things, mutualizing 

the risk of counterparty failure. If multiple members 

of a central counterparty fail beyond the level to 

which such risk is managed, however, the central 

counterparty would also be at risk of failure. Cf. 

Basel Committee on Banking Supervision, 

Consultative Document, ‘‘Capitalisation of bank 

exposures to central counterparties,’’ Nov. 25, 2011 

(available at: http://www.bis.org/publ/bcbs206.pdf) 

(proposing that the capital charge for trade 

exposures to a qualifying central counterparty 

should carry a low risk weight, reflecting the 

relatively low risk of default of the qualifying 

central counterparty). In addition, as the CFTC and 

SEC discussed in the Proposing Release, see 75 FR 

at 80192 n. 115, for example, central counterparties 

that clear credit default swaps do not necessarily 

become the counterparties of their members’ 

customers (although even absent direct privity 

those central counterparties benefit customers by 

providing for protection of collateral they post as 

margin, and by providing procedures for the 

portability of customer positions in the event of a 

member’s default). As a result, central clearing may 

not eliminate the counterparty risk that the 

customer poses to the member, although required 

mark-to-market margining should help control that 

risk, and central clearing would be expected to 

reduce the likelihood that an entity’s default would 

lead to broader market impacts. 

1374See letter from Better Markets I; see also letter 

from AFR. 

1375The CFTC does not believe that it is 

appropriate to have this type of discount when 

mark-to-market margining is done less than daily, 

however. 

1376The CFTC recognizes that at times, market 

participants whose agreements provide for the daily 

exchange of variation margin in connection with 

swaps in practice may not exchange collateral daily, 

if the amounts at issue are relatively small (such 

through the use of collateral thresholds and 

minimum transfer amounts). We do not believe that 

such practices would be inconsistent with 

providing a discount for daily margining practices. 

The proposed rules sought to accommodate those 

practices by providing that positions would be 

considered to be subject to daily mark-to-market 

margining for purposes of the ‘‘uncollateralized 

outward exposure’’ plus ‘‘potential outward 

exposure’’ analysis, so long as the total of such 

thresholds, and the total of such minimum transfer 

amounts above $1 million are deemed to be 

‘‘uncollateralized outward exposure’’ for those 

purposes. 

In light of commenter concerns, which indicated 

that the proposal was not fully clear about the 

mechanics and purpose of this approach, the 

relevant rule language has been revised to clarify 

that this attribution of thresholds and minimum 

transfer amounts is solely for the purpose of 

determining whether certain positions are subject to 

daily mark-to-market margining for purposes of the 

analysis. In addition, the final rules have been 

revised from the proposal to provide that the 

attribution of thresholds as ‘‘uncollateralized 

outward exposure’’ for these purposes will be 

reduced by initial margin posted, up to the amount 

of the threshold. See CFTC Regulation 

§ 1.3(jjj)(iii)(B); Exchange Act rule 3a67–3(c)(3)(ii). 

participant’’ are applied in a manner 

that is more or less inclusive, and that 

in setting the thresholds it is possible 

that we may err on the side of over- or 

under-inclusion. As noted above in part 

V.C.2., if the rule were more inclusive, 

costs could arise when the persons that 

are classified as major swap participants 

incur compliance costs, while if the rule 

is less inclusive the benefits of 

regulating major swap participants (in 

terms of reduced risk, increased 

transparency and market integrity) 

could be reduced. We also recognize 

that a more inclusive rule could lead to 

costs if it causes persons to make 

changes to their use of swaps in order 

to avoid being covered by the rule. 

One commenter said that the CFTC 

should conduct an empirical analysis of 

the proposed thresholds and whether 

they are suitable for identifying persons 

whose swap positions entail the risks 

enumerated in the statutory definition 

of the term ‘‘major swap 

participant.’’ 1370 However, the CFTC 

believes it is not feasible to perform 

such an analysis because the 

comprehensive and detailed 

information about how very active swap 

market participants use swaps that it 

would require is not available. 

The CFTC believes that the threshold 

levels in the final rule are appropriate 

to effectively monitor and oversee 

entities that are systemically important 

or could significantly impact the U.S. 

financial system. The CFTC and SEC are 

consistent in their approach to 

thresholds. As more data regarding the 

use of swaps and the importance of very 

large swap positions in the swap 

markets become available, the CFTC 

may consider adjusting the thresholds. 

The final rules also provide for the 

measure of potential future exposure to 

be adjusted in the case of swap and 

security-based swap positions that are 

centrally cleared or that are subject to 

daily mark-to market margining. This is 

consistent with the purpose of the 

potential future exposure test, which is 

to account for the extent to which the 

current outward exposure of positions 

(though possibly low or even zero at the 

time of measurement) might grow to 

levels that can lead to high counterparty 

risk to counterparties or to the markets 

generally. The practice of the periodic 

exchange of mark-to-market margin 

between counterparties helps to mitigate 

the potential for large future increases in 

current exposure. 

Consistent with the proposal, the final 

rules reflect this ability to mitigate risk 

by providing that the potential future 

exposure associated with positions that 

are subject to daily mark-to-market 

margining will equal 0.2 times the 

amount that otherwise would be 

calculated. However, in response to 

commenters assertions about the riskmitigating effects of central clearing, 

and the additional level of rigor that 

clearing agencies may have with regards 

to the process and procedures for 

collecting daily margin, the final rules 

further provide that the potential future 

exposure associated with positions that 

are subject to central clearing will equal 

0.1 (rather than the proposed 0.2) times 

the potential future exposure that would 

otherwise be calculated.1371

Although some commenters 

supported the complete exclusion of 

cleared positions from the potential 

future exposure analysis,1372 the CFTC 

recognizes that central clearing cannot 

reasonably be expected to entirely 

eliminate counterparty risk.1373

Accordingly, the CFTC concluded that 

the use of a 0.1 factor (in lieu of the 

proposed 0.2) is appropriate for cleared 

positions, reflecting the strong risk 

mitigation features associated with 

central clearing, particularly the 

procedures regarding the collection of 

daily margin and the use of 

counterparty risk limits, while 

recognizing the presence of some 

remaining counterparty risk. 

Moreover, although some commenters 

opposed any deduction from the 

measure of potential future exposure for 

uncleared positions that are margined 

on a daily basis,1374 the CFTC believes 

that the risk-mitigating attributes of 

daily margining warrant an adjustment 

given that the goal of the potential 

future exposure test is to account for 

price movements over the remaining life 

of the contract.1375 The use of a 0.2 

factor also reflects the CFTC’s 

expectation that the risk mitigation 

associated with uncleared but margined 

positions would be less than the risk 

mitigation associated with cleared 

positions. 

While higher or lower alternatives to 

the 0.1 and 0.2 factors may also be 

reasonable for positions that are cleared 

or margined on a daily basis, the CFTC 

believes that the factors of the final rules 

reasonably reflects the risk mitigating 

(but not risk eliminating) features of 

those practices. The final rules also 

retain and clarify provisions addressing 

when daily mark-to-market margining 

occurs for purposes of this discount.1376

d. Difficulty in Applying the Major 

Swap Participant Calculations 

While commenters generally 

acknowledged that the proposed 

quantitative threshold tests are 

objective, some said that the proposed 

tests are difficult to understand and 

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1377See, e.g., letters from Fidelity, Freddie Mac, 

ISDA I and SIFMA AMG II. 

1378See letter from WGCEF II at 11. 

1379See letters from AII, Vanguard and SIFMA 

AMG II. Another commenter submitted that swap 

dealers will require counterparties to run the major 

swap participant calculations in order to certify that 

they are not major swap participants, even in cases 

where it is readily evident that they are not major 

swap participants. See meeting with CalSTRS on 

April 15, 2011. 

1380See letter from ISDA I. 

1381See id. 

1382See part IV.B.3.b, supra. 

1383See part IV.M.2, supra. 

1384See part IV.B.3.e, supra. 

1385See part IV.J.2, supra. 

1386See id. For example, commenters said that 

registered investment companies and corresponding 

registered investment advisers should be excluded 

from the definition of major swap participant 

because they are highly regulated by the SEC 

pursuant to the ICA and the Investment Advisers 

Act of 1940, and therefore major swap participant 

regulation would be duplicative. See joint letter 

from ICI and SIFMA AMG. 

1387See letter from MetLife. 

1388See letters from CIC and GIC and meeting 

with Weil. 

1389See letter from ISDA I. 

1390See id. 

1391See letters from Athilon, Berkshire Hathaway, 

ISDA I, MBIA and Newedge. As noted in part 

IV.J.3.a, supra, the CFTC understands that legacy 

portfolios are no longer entering into new 

transactions other than to novate, amend and hedge 

their existing positions. In connection with any 

potential exclusion, however, legacy portfolios 

would still be required to report to SDRs 

information about their swap transactions and 

positions. See letters from BlackRock I and 

Canadian MAVs. 

1392See CFTC, Swap Data Recordkeeping and 

Reporting Requirements: Pre-Enactment and 

Transition Swaps; Final Rule, 77 FR 2136 (Jan. 13, 

2012). 

1393See part VII.C.2, supra. 

hard to apply.1377 Another commenter 

submitted that ‘‘[the CFTC] should 

solicit feedback from market 

participants prior to final rule given the 

complexity of tests and likely 

interpretive issues; proposed tests are 

highly technical, and more challenging 

to use than may appear at first glance; 

could also request volunteers to walkthrough the tests to ensure they actually 

function in practice.’’1378 Several 

commenters suggested means of 

reducing the costs of applying the 

proposed tests. Some commenters 

requested that the CFTC adopt a ‘‘safe 

harbor’’ provision in the final rules for 

swap users with positions that are 

substantially below the thresholds.1379

Another commenter opined that the rule 

should allow persons to rely on thirdparty service providers to conduct the 

required calculations.1380 In addition, a 

commenter said the rule should allow 

swap users to apply standard industry 

practices in valuing their positions.1381

We believe that the guidance in this 

Adopting Release reduces the costs of 

determining if a person is covered by 

the definition. For example, in response 

to commenters’ concerns we clarify that 

a person may determine the value of its 

exposure using industry standard 

practices.1382 Also, we believe that the 

daily calculation burdens associated 

with the proposed thresholds will be 

addressed by safe harbors that are 

available if a simplified calculation 

shows that a person’s exposure from its 

swap position is far below any threshold 

for any particular month. The final rule 

includes safe harbors to reduce 

unnecessary costs for entities that, 

because of compliance concerns, would 

engage in major swap participant 

calculations even though it would be 

very unlikely that the major swap 

participant thresholds would be 

met.1383 Also, the CFTC will permit 

third-party service providers to perform 

major swap participant calculations, 

although a person that may be a major 

swap participant is not relieved of 

potential liability for violations of the 

CEA if there is a calculation or other 

error by the third-party.1384

e. Exclusions for Particular Types of 

Entities 

Commenters said that exclusions from 

the major swap participant definition 

should be available for certain entities 

including insurance companies, 

registered investment companies, 

entities that maintain legacy portfolios 

of swaps, ERISA plans, and sovereign 

wealth funds.1385 Some commenters 

cited, as the underlying basis for 

excluding these entities, the existing 

regulatory regime to which these 

entities are subject and the potential for 

dual regulation if they were covered by 

the definition of the term ‘‘major swap 

participant.’’1386 One commenter 

asserted that a lack of clarity with 

respect to proposed exemptive relief 

will impose additional costs on market 

participants due to the uncertainty in 

determining major swap participant 

status.1387

Several commenters said that 

sovereign wealth funds should be 

excluded from the definition of major 

swap participant based on international 

principles of comity and sovereign 

immunity.1388 These commenters 

asserted that sovereign wealth funds are 

regulated in their home country and do 

not represent the type of counterparty 

risk contemplated by the Dodd-Frank 

Act. A commenter asserted that special 

purpose vehicles for structured finance 

or securitization should be exempted 

from the definition of major swap 

participant so as to not harm liquidity 

in asset securitizations.1389 That 

commenter based its recommendation 

on the understanding that special 

purpose vehicles have limited 

functionality and resources and would 

accordingly be unable to comply with 

the burden of regulation as a major swap 

participant.1390

The final rule does not have specific 

exclusions for certain types of entities. 

The CFTC believes that a more level 

playing field is desirable to ensure no 

particular type of entity gains an unfair 

competitive advantage in the market. 

The appropriate treatment of ‘‘legacy 

portfolios’’ (e.g., the monoline insurers 

or their special purpose vehicles) will 

be determined on a case-by-case basis 

by the CFTC. Legacy portfolio operators 

specifically commented that they are in 

‘‘run-off’’/wind down mode, thereby 

undertaking no new swaps that would 

increase their risk, with an expectation 

to shut down or cease operations once 

their portfolio expires.1391 As a result, 

these commenters maintain that margin 

or capital requirements would likely 

lead to their insolvency because they do 

not have the assets to satisfy the 

proposed requirements. The CFTC notes 

that many of the compliance obligations 

imposed by the Dodd-Frank Act and/or 

the business conduct rules promulgated 

thereunder will not apply to operators 

of legacy portfolios because such 

obligations will not be applicable to 

swaps executed prior to the enactment 

of the Dodd-Frank Act such as the 

swaps in legacy portfolios.1392

Consequently, the CFTC expects legacy 

portfolio operators’ primary compliance 

obligation to be related to reporting and 

risk management. 

f. CEA Section 15(a) Discussion 

The costs and benefits of the rule 

further defining the term ‘‘major swap 

participant’’ are evaluated in light of the 

section 15(a) five broad areas of market 

and public concern. 

Protection of market participants and 

the public. The rule helps parties to 

identify when they have substantial 

positions or substantial counterparty 

exposures in swap markets that would 

cause them to be covered by the 

definition of major swap participant. 

Under the Dodd-Frank Act, major swap 

participants are subject to regulations 

enacted to protect market participants 

and the public. The costs and benefits 

of the statutory and regulatory 

requirements for major swap 

participants are addressed in the various 

rulemakings in which they are 

promulgated.1393

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30718 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1394 7 U.S.C. 1a(18)(A)(iv)(II). 

1395 7 U.S.C. 1a(18)(A)(vii). 

1396See letters from AIMA I, Akin Gump, Sidley, 

and Willkie Farr. 

1397See id. 

1398See letter from AIMA I. 

1399See letter from Sidley. 

1400See id. 

1401See letters from AIMA I, Akin Gump, and 

Sidley. 

1402See letter from Sidley. 

Efficiency, competitiveness, and 

financial integrity of markets. To date, 

potential major swap participants have 

engaged in swaps in an off-exchange 

marketplace that has been largely 

unregulated. Once the regulations 

required under the Dodd-Frank Act are 

adopted and effective, major swap 

participants will be subject to CFTC 

oversight and comprehensive 

regulation. The CFTC believes these 

regulations will improve the financial 

integrity of swap markets and the U.S. 

financial system generally. Since the 

number of persons that are expected to 

be major swap participants is small, the 

CFTC believes that these regulations 

will not have a significant effect on the 

efficiency or competitiveness of the 

markets. 

Price discovery. The CFTC does not 

perceive any direct effect on price 

discovery from the rule further defining 

the term ‘‘major swap participant.’’ 

Sound risk management practices. 

The level of the major swap participant 

thresholds may discourage persons from 

engaging in swap activities that might 

cause them to exceed the major swap 

participant thresholds. This reduction 

in the use of swaps could be costly if 

other alternatives are not as suitable for 

the underlying risks (e.g., futures might 

have different contract sizes or 

expiration, and forward contracts 

introduce physical risks not present in 

cash settled transactions). The CFTC 

notes that this concern is mitigated by 

the relatively high threshold levels for 

major swap participant status. 

Other public interest considerations. 

The specific quantitative thresholds in 

the rule set forth definitive tests for 

determining if a person is covered by 

the definition of the term ‘‘major swap 

participant.’’ This specific, quantitative 

threshold serves the public interest by 

promoting efficient application of the 

rule. Also, as noted above, major swap 

participants will be subject to CFTC 

oversight and comprehensive 

regulation, which we believe will 

improve the financial integrity of swap 

markets and the U.S. financial system 

generally. 

6. Costs and Benefits of the Rules 

Relating to the Definition of ‘‘Eligible 

Contract Participant’’ 

a. Background 

The ECP regulations and 

interpretation fall within the following 

six categories: 

• CFTC Regulation § 1.3(m)(5)(i) 

prevents a commodity pool (i) in which 

any of the pool’s direct participants is 

not an ECP in its own right and (ii) that 

directly enters into retail forex 

transactions from being an ECP under 

CEA section 1a(18)(A)(iv) or (v), for 

purposes of retail forex transactions 

only. CFTC Regulation § 1.3(m)(5)(ii) 

provides that the CFTC would look 

through a commodity pool participant 

that directly participates in a 

transaction-level commodity pool only 

if such direct commodity pool 

participant, any entity holding an 

interest in such direct commodity pool 

participant, or any entity in which such 

direct commodity pool participant holds 

an interest were structured to evade 

subtitle A of Title VII of the Dodd-Frank 

Act by permitting persons that are not 

ECPs to participate in retail forex 

transactions. The look-through in CFTC 

Regulation § 1.3(m)(5)(ii) does not apply 

to a non-commodity pool participant in 

a commodity pool. 

• CFTC Regulation § 1.3(m)(6) 

excludes a commodity pool from ECP 

status if it does not have total assets 

exceeding $5,000,000 or is not operated 

by a person described in CEA section 

1a(18)(A)(iv)(II).1394

• CFTC Regulations § 1.3(m)(1)–(4) 

define major swap participants, swap 

dealers, major security-based swap 

participants and security-based swap 

dealers, respectively, as ECPs. 

• CFTC Regulation § 1.3(m)(7) 

permits an otherwise non-ECP to qualify 

as an ECP, with respect to certain 

swaps, based on the collective net worth 

of its owners, subject to several 

conditions, including that the owners 

are ECPs. 

• CFTC Regulation § 1.3(m)(8) 

permits a Forex Pool to qualify as an 

ECP notwithstanding that it has one or 

more direct participants that are not 

ECPs if the Forex Pool (a) is not formed 

for the purpose of evading regulation 

under CEA sections 2(c)(2)(B) or (C) or 

related rules, regulations or orders, (b) 

has total assets exceeding $10 million 

and (c) is formed and operated by a 

registered CPO or by a CPO who is 

exempt from registration as such 

pursuant to CFTC Regulation 

§ 4.13(a)(3). 

• Finally, the Commissions have 

provided an interpretation to address an 

incorrect statutory cross-reference 

preventing certain government entities 

from qualifying as ECPs under CEA 

section 1a(18)(A)(vii).1395

b. Summary of Comments 

Commenters stated that commodity 

pools will incur costs to comply with 

statutory and regulatory requirements 

made applicable as a result of the 

Commissions’ narrowing of the ECP 

definition.1396 Commenters argued that 

to apply the look-through at any 

investment level would be 

unnecessarily burdensome and 

disruptive to how commodity pools are 

structured, with resulting costs.1397 One 

commenter advised that, if a trading 

advisor cannot be sure that all pool 

participants are ECPs, then it must be 

cautious and either register as a CPO or 

decide not to engage in Retail Forex 

Transactions on behalf of its advised 

pools.1398 Another commenter stated 

that while many existing commodity 

pools have already obtained accredited 

investor and QEP representations from 

participants, virtually none currently 

obtain ECP representations from their 

investors.1399 This commenter argued 

that obtaining such a representation 

would impose an operational burden 

and additional costs, as well as require 

commodity pools to redeem non-ECPs. 

The commenter further points out that, 

given the estimated $1.9 trillion of 

assets invested in hedge funds, the 

portion of those assets that use OTC 

forex is likely to be substantial, and 

therefore substantial time and expense 

would be expended in determining 

eligibility requirements for the 

thousands of investors in funds that use 

OTC forex.1400

Commenters explained that there are 

costs to losing ECP status and that the 

enumerated counterparty list is unclear 

and subject to uncertainty because it 

relies on other regulators.1401 One 

commenter argues that funds would 

incur compliance and transaction costs 

if categorized as non-ECPs because they 

would have to enter into forex 

transactions through a DCM and their 

operators would have to register as 

CPOs.1402 That commenter also states 

that the markets for exchange-traded 

futures are less liquid than OTC forex 

markets, and that posting initial margin 

on a DCM is costly, since it cannot be 

used to invest in riskier assets and a 

FOF would have to invest in liquid and 

low risk (and, commensurately, lower 

yielding) assets necessary to post 

variation margin. As another commenter 

points out, the resulting increased 

expenses from the requirement to trade 

on a DCM and comply with retail forex 

rules may result in higher expenses for 

hedge and private equity funds, which 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30719 

1403See letter for Akin Gump. This commenter 

also said that these increased expenses could cause 

funds to terminate their foreign currency hedging, 

which would increase their investors’ currency risk, 

causing higher volatility in the investment industry. 

1404See letter from AIMA I. See generally part 

III.B.3, supra. 

1405See letter from AIMA I. 

1406See letters from Greenberger and Sidley. 

1407See letters from B&F I, CDEU and Capstar. 

One element of the Swap Policy Statement required 

that the swap be entered into in connection with 

each swap counterparty’s line of business. See 

Swap Policy Statement at 30697. The CFTC stated 

when issuing the Swap Policy Statement that it 

‘‘reflects the [CFTC]’s view that at this time most 

swap transactions, although possessing elements of 

futures or options contracts, are not appropriately 

regulated as such under the [CEA] and [CFTC] 

regulations.’’ Swap Policy Statement at 30694. 

1408See, e.g., letter from Rabobank, New York 

Branch (relating that ‘‘[f]or a variety of estate 

planning and regulatory purposes, farmers 

commonly hold their ownership interests in land, 

buildings and farm equipment indirectly, through a 

network of legal entities’’). 

1409See, e.g., letter from Fifth Third Bank and 

Union Bank, N.A. (advising that ‘‘[i]t is common for 

an operating business to organize a separate limited 

liability company (for tax and legal reasons) to 

acquire * * * assets * * * and to lease these assets 

to the operating company[, which] becomes the 

borrow[er] * * * for the loan used to acquire those 

assets’’ and that ‘‘[t]he limited liability company 

often does not maintain sufficient capital to qualify 

as an ECP’’). 

1410See, e.g., letters from BB&T I, B&F I and 

Midsize Banks. 

1411See letters from BB&T I and B&F I. 

Commenters said that these businesses may 

intentionally maintain less than $1 million in 

equity primarily for tax and legal reasons. See 

letters from Capital One and Columbia State Bank 

(stating that over 65% of its borrowers are 

structured as limited liability companies or S 

corporations and intentionally maintain less than 

$1 million in equity at the entity entering into the 

swap). 

1412See letter from Columbia State Bank. See also 

letter from BB&T I. 

1413See letters from BB&T I, Capital One, Capstar, 

Columbia State Bank, Midsize Banks, NAREIT and 

Wells Fargo II. 

1414See letter from FSR I. 

1415See letters from BB&T I, Midsize Banks and 

Wells Fargo II. 

1416See letters from CDEU and Regional Banks. 

1417See letter from NAREIT. 

1418See letters from APGA, Capital One and 

Gavilon dated October 28, 2010. 

1419See letters from Millburn and Sidley. 

1420See letters from GXFD I and Sidley. 

1421See letter from GFXD II. 

1422See letters from GFXD II and Skadden. 

1423See meeting with SIFMA on January 20, 

2012. 

1424See letter from Sidley. 

1425See id. 

1426See letter from GFXD I. 

they would likely pass along to their 

investors.1403

A commenter asserted that the 

characteristics necessary to avoid nonECP status may prevent free investment 

and could reduce liquidity and create 

volatility in these markets.1404

With respect to CFTC Regulation 

§ 1.3(m)(6), a commenter expressed 

concerns with the expected costs 

associated with the proposal that 

commodity pools that do not qualify as 

ECPs under clause (A)(iv) should not be 

able to qualify under clause (A)(v), 

stating that the proposal would be 

difficult to comply with and would 

adversely impact investment.1405

Two commenters agreed that the 

proposed addition of swap dealers, 

security-based swap dealers, major swap 

participants, and major security-based 

swap participants to the ECP definition 

provided a benefit with little or no 

costs.1406 No commenter objected. 

With respect to CFTC Regulation 

§ 1.3(m)(7), commenters said that nonECPs have entered into swaps in 

reliance on the Swap Policy 

Statement.1407 Commenters emphasized 

the importance of the Swap Policy 

Statement to pass-through entities used 

by farmers,1408 operating companies 1409

and commercial property 

developers,1410 noting that such entities 

may not meet the ECP criteria. 

According to these commenters, these 

pass-through entities often are small and 

medium-sized businesses that enter into 

interest rate swaps with lending 

financial institutions in reliance on the 

Swap Policy Statement.1411 The 

commenters explained that the loans 

usually are guaranteed by the principals 

of the entity entering into the swap, and 

that the borrower would qualify as an 

ECP if structured as a single-level 

corporate entity or sole 

proprietorship.1412 Commenters said 

that if these non-ECP entities were 

limited to swaps that are available on or 

subject to the rules of a DCM, many 

regional bank borrowers would lose the 

ability to use swaps, real estate 

companies would have less flexibility in 

risk management, and smaller lenders 

would be at a competitive 

disadvantage.1413 Another commenter 

said that Dodd-Frank Act provisions 

such as the end-user clearing exception 

indicate that Congress intended to 

preserve the availability of swaps used 

for managing risks rather than for 

investment or speculation.1414

To mitigate the impact of restricting 

non-ECPs to swaps that are available on 

or subject to the rules of DCMs, some 

commenters said that an entity should 

be able to qualify as an ECP based on 

the financial qualifications of related 

entities, so long as various conditions 

proposed by the commenters are 

satisfied. Some commenters said that an 

entity should be eligible to be an ECP 

if its swap obligations are guaranteed by 

an ECP,1415 or if its controlling entity 

qualifies as an ECP under clause (A)(v) 

of the statutory definition.1416 Another 

commenter suggested revisions to the 

ECP definition that included looking to 

the ECP status or sophistication of the 

majority owner of an entity in 

determining if the entity itself is an 

ECP.1417 Other commenters suggested 

other provisions to allow non-ECPs to 

enter into swaps other than on or 

subject to the rules of a DCM, so long 

as the non-ECP meets various 

conditions indicating that the swap is 

used in connection with its line of 

business.1418

With respect to CFTC Regulation 

§ 1.3(m)(8), several commenters asserted 

that many Forex Pools are operated by 

sophisticated, professional managers 

that do not need the protections of a 

retail forex regime designed to protect 

non-ECPs that are engaging in retail 

forex transactions.1419 More specifically, 

some commenters, based on CFTC 

enforcement actions involving Forex 

Pools, suggested that commodity pools 

of a sufficient size, and/or operated by 

a registered or exempt CPO, do not pose 

the risks of fraud and abuse of non-ECP 

customers that the statutory lookthrough provision is intended to 

address.1420

As a result, commenters suggested 

that the look-through provision should 

not apply in determining ECP status of 

commodity pools that meet certain 

conditions. For example, commenters 

suggested that the look-through not be 

applied to a commodity pool with $10 

million in total assets if other factors 

were present—e.g., not structured to 

evade,1421 subject to regulation under 

the CEA 1422 and/or operation by a 

registered CPO.1423 Another commenter 

suggested requiring the total assets or 

minimum initial investment of a Forex 

Pool to be sufficiently large that, in 

general, only legitimate pools would 

exceed such thresholds.1424 This 

commenter suggested a total asset 

threshold of $50 million.1425

Separately, one commenter also 

claimed that the statutory look-through, 

if strictly implemented, might 

inappropriately preclude Forex Pools 

and their CPOs, many of whom are 

registered, from engaging in retail forex 

transactions with swap dealers because 

swap dealers are not Enumerated 

Counterparties (and some swap dealers 

also may not be Enumerated 

Counterparties in a different capacity, 

such as being a U.S. financial 

institution).1426 This commenter stated 

that such a result could reduce close out 

netting opportunities in the event of the 

insolvency of a counterparty. 

Finally, to reduce the adverse effects 

on government entities that may need to 

qualify as ECPs based on their swap 

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30720 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1427See letter from Wells Fargo I. 

1428While the Commissions are adding additional 

detail explaining the scope of CEA section 

1a(18)(A)(iv)(II), the Commissions also provide 

guidance on that explanation. As a result, the CFTC 

does not believe that the upfront costs of 

determining ECP status under CEA section 

1a(18)(A)(iv) will significantly increase. 

1429The CFTC computed these totals by assuming 

from 5 to 20 hours of legal review by a compliance 

attorney at $355/hour based on the 2010 SIFMA 

survey. See SIFMA, Report on Management and 

Professional Earnings in the Securities Industry— 

2010. If we assume that 5,000 potential commodity 

pools need to make this determination and round 

to two significant digits, this results in a total 

approximate cost of $8.9 million to $36 million. As 

is the case for the application of the definitions of 

the terms ‘‘swap dealer’’ and ‘‘major swap 

participant,’’ these costs reflect a higher multiplier 

because some persons may retain outside advisors 

to assist in making the determinations under the 

rules. 

counterparties but that would be 

foreclosed from doing so due to an 

erroneous reference in the definition of 

ECP, a commenter requested the 

correction of that erroneous 

reference.1427

c. Response to Comments and 

Consideration of Costs and Benefits in 

the Final Rule 

CFTC Regulation § 1.3(m)(5)(i) 

reduces the number of pools that need 

to determine the ECP status of their 

natural person participants, and thus 

reduces related costs, because it limits, 

absent evasion, the pools the CFTC 

considers for look-through purposes to 

transaction-level retail forex pools. The 

guidance the Commissions provide in 

the preamble also reduces the scope of 

the potential look-through, with 

attendant cost-reductions, by stating 

expressly that a Retail Forex Pool using 

retail forex transactions solely to hedge 

or mitigate currency risk would not be 

considered structured to evade. Thus, 

such hedging or mitigation would not be 

the basis of a look-through. In 

particular, because, according to a 

commenter, the typical FOF uses retail 

forex transactions solely to hedge 

currency risk related to fluctuations in 

the exchange rate between non-U.S. 

dollar subscription currencies and the 

U.S. dollar, most, if not all, FOFs would 

not be covered by the look-through. To 

the extent other commodity pools use 

retail forex transactions solely to hedge 

or mitigate their currency risk, such 

pools also would not be subject to the 

CFTC Regulation § 1.3(m)(5)(ii) lookthrough provision. Because Regulation 

§ 1.3(m)(5)(ii) provides a look through 

only in cases of evasion and the 

Commissions’ guidance narrows 

considerably the scope of what might 

otherwise be considered evasion, the 

CFTC expects the CPO of the typical 

pool to be able to determine at little or 

no cost the ECP status of their direct 

participant commodity pools; such 

status will be based on CEA section 

1a(18)(iv), an analysis with which such 

CPOs are familiar.1428

While the CFTC has provided 

guidance to reduce the costs of applying 

the rule, it estimates that each affected 

CPO may have to spend between 5 and 

20 hours of legal time, representing a 

cost between $1,800 and $7,100,1429

initially to determine the ECP status of 

the pools that they operate, and up to 

5 hours ($1,800) of additional legal time 

to determine such status upon each 

change to the fund’s structure, operating 

guidelines, etc. that might implicate 

ECP status. Commenters noted that 

drafting ECP representations and 

contacting existing participants are part 

of the costs of determining ECP status. 

While the CFTC acknowledges such 

costs, CFTC Regulation § 1.3(m)(5) also 

provides investor protection benefits to 

non-ECP participants in pools that are 

not ECPs by requiring such pools to 

enter into retail forex transactions with 

an Enumerated Counterparty. This 

provides non-ECP participants in such 

pools the protections of the retail forex 

regime imposed by such counterparty’s 

federal regulator. 

The CFTC also notes that the number 

of categories of enumerated 

counterparties available as 

counterparties to non-ECP commodity 

pools has increased since the 

Commissions proposed the regulations, 

because other regulators have finalized 

their retail forex regimes, as discussed 

in greater detail above. While trading 

with Enumerated Counterparties will 

entail doing so pursuant to the retail 

forex regulations of the relevant federal 

regulator, such regulations will apply to 

the counterparties, not the CPO. While 

CPOs of Retail Forex Pools generally 

must register as such with the CFTC, to 

the extent an exemption from 

registration is available under the 

CFTC’s rules, such CPOs need not 

register as a result of their retail forex 

transactions, further reducing the 

potential costs of Regulations 

§§ 1.3(m)(5)(i) and (ii). Further, 

commodity pools will not incur any 

costs to change counterparties (with the 

accompanying costs of, for example, 

putting in place new trading 

documentation) to the extent they 

already trade with Enumerated 

Counterparties. Commenters noted that 

non-ECP pools would incur costs to 

negotiate new trading documentation 

with Enumerated Counterparties to the 

extent that such pools do not currently 

enter into retail forex transactions with 

Enumerated Counterparties and wish to 

continue to engage in retail forex 

transactions other than on or subject to 

the rules of a DCM. However, 

Regulation § 1.3(m)(5) also provides 

investor protection benefits to non-ECP 

participants in pools that enter into 

retail forex transactions by requiring 

such pools to trade with Enumerated 

Counterparties and to be operated by 

registered CPOs, absent an applicable 

exemption. 

To the extent that a commodity pool 

is precluded by CFTC Regulation 

§ 1.3(m)(6) from achieving ECP status 

based on prong (A)(v) of the ECP 

definition, the pool will be limited to 

trading swaps, if at all, on or subject to 

the rules of a DCM. This could result in 

costs to affected commodity pools, 

including margin, the costs of 

establishing relationships with future 

commission merchants (e.g., reviewing 

new account opening documentation) 

and opportunity costs from losing the 

ability to trade swaps customized to 

pools’ needs. Preventing commodity 

pools that do not qualify under clause 

(A)(iv) from qualifying pursuant to 

clause (v), however, closes a loophole 

that would allow smaller commodity 

pools that are not able to satisfy the 

requirements of clause (A)(iv) of the 

ECP definition to qualify as ECPs. 

Moreover, by providing additional 

clarification in the preamble regarding 

the meaning of CEA section 

1a(18)(A)(iv)(II), the Commissions 

substantially reduced the potential 

number of commodity pools affected by 

CFTC Regulation § 1.3(m)(6). 

CFTC Regulations §§ 1.3(m)(1)–(4) 

define major swap participants, swap 

dealers, major security-based swap 

participants and security-based swap 

dealers, respectively, as ECPs. Stating 

explicitly in regulations that these 

entities are ECPs avoids the potentially 

anomalous result of such entities, which 

are some of the largest and/or most 

active swap market participants, not 

being ECPs and is in line with 

expectations in the market that these 

entities may engage in a full range of 

swap and security-based swap activities. 

The CFTC believes that these 

regulations will not result in any 

significant economic costs or benefits. 

The CFTC is persuaded by 

commenters that allowing participants 

to continue to rely on the line of 

business element of the Swaps Policy 

Statement will mitigate unnecessary 

costs from the regulation but is adding 

various conditions to retain adequate 

protection for market participants and 

the public. As noted above, CFTC 

Regulation § 1.3(m)(7) permits an entity, 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30721 

1430CEA section 1a(18)(A)(v)(III) provides that ‘‘a 

corporation, partnership, proprietorship, 

organization, trust, or other entity * * * that (aa) 

has a net worth exceeding $1,000,000; and (bb) 

enters into an agreement, contract, or transaction in 

connection with the conduct of the entity’s business 

or to manage the risk associated with an asset or 

liability owned or incurred or reasonably likely to 

be owned or incurred by the entity in the conduct 

of the entity’s business’’ is an ECP. 7 U.S.C. 

1a(18)(A)(v)(III). 

1431CFTC Regulation § 1.3(m)(8) as adopted 

requires that the CPO of the Forex Pool be 

registered as a CPO with the CFTC. The 

Commissions believe that this condition is 

appropriate because it will ensure that the NFA 

oversees compliance by those CPOs relying on this 

new regulation. 

1432 In addition, one of those CPOs relied on the 

CFTC Regulation § 4.13(a)(4) CPO registration 

exemption. As discussed above, the CFTC has 

withdrawn that exemption. 1433Accord letter from AIMA I. 

in determining its net worth for 

purposes of subclause (A)(v)(III) of the 

ECP definition,1430 to include the net 

worth of its owners, solely for purposes 

of determining its ECP status for swaps 

used to hedge or mitigate commercial 

risk, provided that all of its owners are 

themselves ECPs (disregarding shell 

companies, as defined above). Under 

CFTC Regulation § 1.3(m)(7) as adopted, 

an entity seeking to qualify under 

subclause (A)(v)(III) of the ECP 

definition in order to enter into a swap 

used to hedge or mitigate commercial 

risk is permitted to count the net worth 

of its owners in determining its own net 

worth, so long as all its owners are 

ECPs. Accordingly, CFTC Regulation 

§ 1.3(m)(7) will allow qualified 

participants the flexibility to enter into 

customized swaps. 

By limiting the line of business ECP 

prong to entities owned solely by ECPs, 

the CFTC is preserving the intent 

behind the ECP requirement, which is to 

limit the availability of customized 

swaps to market participants of 

sufficient financial sophistication and 

with sufficient assets or net worth to 

assess, appreciate and bear the 

implications and risks of swap 

transactions. Although commenters 

proposed various solutions to address 

the loss of the Swap Policy Statement, 

the CFTC believes the approach adopted 

is the best approach; it substantively 

preserves the ECP requirement and 

protects the real parties in interest (i.e., 

the owners). Although banks and nonECP borrowers might be able to 

restructure or more highly capitalize 

borrowing entities or borrow at a higher 

level in the ownership structure, this 

regulation will allow banks and 

qualified businesses to continue to 

conduct their loan arrangements as 

usual without incurring the costs, which 

could include undesirable tax treatment, 

of such operational changes. Further, 

because commenters focused on swap 

related risks, the Commissions limited 

this regulation’s application narrowly, 

i.e., it does not apply for purposes of 

determining ECP status for: swaps not 

meeting the conditions set forth in 

Regulation § 1.3(m)(7); security-based 

swaps; security-based swap agreements; 

mixed swaps; or agreements, contracts 

or transactions that are not swaps 

(regardless of the purpose for which 

they are used). 

CFTC Regulation § 1.3(m)(8) permits a 

Forex Pool to qualify as an ECP 

notwithstanding that it has one or more 

direct participants that are not ECPs if 

the Forex Pool (a) is not formed for the 

purpose of evading regulation under 

CEA sections 2(c)(2)(B) or (C) or related 

rules, regulations or orders, (b) has total 

assets exceeding $10 million and (c) is 

formed and operated by a registered 

CPO or by a CPO who is exempt from 

registration as such pursuant to CFTC 

Regulation § 4.13(a)(3). The data 

presented by commenters, discussed 

above, demonstrate that registered 

CPOs 1431 of commodity pools over a 

certain size ($10 million in total assets) 

historically have engaged in retail forex 

misconduct to a much less significant 

degree than other CPOs. Only one of the 

45 unique cases presented by 

commenters involved a pool with more 

than $10 million in total assets and a 

registered CPO. Only two of those cases 

involved a pool operated by CPOs 

exempt from registration: in both of 

those cases, however, the CPO raised 

less than $10 million.1432 The CFTC 

also recognizes that subjecting such 

commodity pools to the statutory lookthrough provision to protect non-ECP 

customers from fraud and abuse would 

cause them to incur higher costs (e.g., 

CPO compliance costs for those CPOs 

required to register as such, and 

redocumenting trading relationships 

with new counterparties who are 

Enumerated Counterparties), for 

intangible pool participant protections. 

To further protect pool participants, the 

Commissions added a requirement that, 

to be an ECP under the line of business 

prong, the Forex Pool must not be 

formed for the purpose of evading CFTC 

regulation of Retail Forex Pools and 

retail forex transactions under CEA 

Section 2(c)(2)(B) or (C). Accordingly, 

the Commissions have tailored CFTC 

Regulation § 1.3(m)(8) in a manner they 

believe preserves its ability to 

effectively protect market participants 

and the public, while avoiding 

significant costs. 

As noted above, CEA section 

1a(18)(A)(vii)(cc) contains a statutory 

cross-reference rendered incorrect due 

to a legislative drafting oversight. 

Failing to address such error would 

inappropriately deprive such entities of 

ECP status, imposing undue costs (e.g., 

the opportunity costs of being unable to 

execute a desired hedge or trading 

strategy using standardized exchangetraded swaps) on such entities. 

Allowing a government entity the ability 

to qualify as an ECP based on its 

counterparty’s status will provide, at 

little or no cost, the benefit of 

effectuating Congressional intent that 

government entities satisfying the 

conditions of CEA section 

1a(18)(A)(vii)(cc) be ECPs. Therefore, 

the CFTC included in the preamble an 

interpretation treating as an ECP 

government entities satisfying the 

conditions of CEA section 

1a(18)(A)(vii)(cc) as if such section 

incorporated the correct cross-reference. 

The CFTC believes that correcting this 

incorrect cross-reference will not result 

in any significant economic costs or 

benefits. 

d. CEA Section 15(a) Discussion 

Protection of market participants and 

the public. Congress determined to 

protect retail foreign exchange investors 

from fraudsters by amending the ECP 

definition to require a pool’s 

participants to qualify as ECPs for the 

pool to be an ECP under subsection 

(A)(iv).1433 As discussed above, this 

protection, as implemented by CFTC 

Regulation § 1.3(m)(5) may raise the 

costs of legitimate foreign exchange 

transactions. To mitigate these potential 

increased costs, CFTC Regulations 

§ 1.3(m)(5)(i) limits the look-through to 

the level of the commodity pool 

structure that engages in retail forex 

transactions, subject to CFTC Regulation 

§ 1.3(m)(5)(ii). This limitation provides 

that, if any level of the pool has been 

structured to evade, the CFTC would 

look through the transaction-level 

commodity pool’s direct commodity 

pool participants indefinitely until 

reaching non-commodity pool 

participants. CFTC Regulation 

§ 1.3(m)(5), therefore, protects non-ECP 

members of the public in appropriate 

instances. 

By limiting the line of business ECP 

prong to entities owned solely by ECPs, 

the CFTC is preserving the intent 

behind the ECP requirement, which is to 

limit the availability of customized 

swaps to market participants of 

sufficient financial sophistication to 

assess and appreciate the risk and 

implications of the transactions. 

Although commenters proposed various 

solutions to address the loss of the Swap 

Policy Statement, the CFTC believes the 

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30722 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1434CFTC Regulation § 1.3(m)(8) as adopted 

requires that the CPO of the Forex Pool be 

registered as a CPO with the CFTC. This condition 

is appropriate because it will ensure that the NFA 

oversees compliance by those CPOs relying on this 

new regulation. 

1435CFTC Regulations § 1.3(m)(1)–(4) and the 

interpretive guidance regarding certain 

governmental ECPs have the opposite effect, making 

investment opportunities available to certain ECPs 

that might otherwise not have qualified as ECPs. 1436 7 U.S.C. 1a(18)(A)(vii). 

1437See Proposing Release, 75 FR at 80206. 

1438See Proposing Release, 75 FR at 80206–07. 

1439See, e.g., letters from Representatives Bachus 

and Lucas (‘‘Casting an overly-broad net in defining 

these terms could force some smaller participants 

to leave the marketplace as a result of increased 

costs, or eliminate certain types of contracts used 

for hedging. If either occurs, businesses will be left 

exposed to market volatility and the consequences 

will ultimately be felt by Americans in the forms 

of increased consumer costs.’’); ISDA (suggesting 

that imposing dealer regulation beyond persons 

whose business is to make markets would be 

inconsistent with the Dodd-Frank Act’s intent to 

preserve growth and innovation in the swap 

markets); ABC/CIEBA (stating that major participant 

thresholds will cause persons who pose no systemic 

risk to incur substantial costs associated with major 

participant registration and regulation); SIFMA– 

AMG (addressing complexity and burden of 

analyzing potential status as a major participant, 

and urging implementation of a calculation safe 

harbor). 

1440We expect that the benefits resulting from the 

identification and registration of dealers and major 

security-based participants will likely accrue 

primarily at the programmatic level. To the extent 

appropriate given the purposes of Title VII, we have 

sought to mitigate the costs entities will incur in 

connection with such identification and 

registration. 

approach adopted is the best approach 

because it preserves the substance of the 

ECP requirement and protects the real 

parties in interest (i.e., the owners). 

Because registered CPOs,1434 and 

CPOs exempt from registration, who 

operate commodity pools over a certain 

size ($10 million in total assets) 

historically have engaged in retail forex 

misconduct to a much less significant 

degree than CPOs of commodity pools 

below that threshold, the CFTC believes 

that imposing this size threshold 

requirement as a condition of ECP status 

pursuant to Regulation § 1.3(m)(8) 

provides some protection to pool 

participants. The additional 

requirement that to be an ECP under the 

line of business prong the Forex Pool 

must not be formed for the purpose of 

evading CFTC regulation of Retail Forex 

Pools and retail forex transactions under 

CEA Section 2(c)(2)(B) or (C) will 

further protect pool participants. 

Efficiency, competitiveness, and the 

financial integrity of the market. With 

respect to CFTC Regulation §§ 1.3(m)(5) 

and (6), commodity pools that do not 

qualify as ECPs may have to use 

products listed on or subject to the rules 

of a DCM that might not precisely (or at 

all) match such parties’ needs. This may 

reduce or eliminate a commodity pool’s 

ability to engage in some transactions, 

but these regulations also seek to 

prevent unsophisticated parties from 

entering into certain transactions to 

prevent repeated abuses and protect 

members of the public. We believe 

CFTC Regulations §§ 1.3(m)(1)–(8) do 

not significantly impact competitiveness 

or the financial integrity of markets. 

Price discovery. CFTC Regulations 

§§ 1.3(m)(1)–(8) only clarify the status of 

entities. They do not affect price 

discovery. 

Sound risk management practices. 

CFTC Regulations §§ 1.3(m)(5) and (6) 

may restrict investment opportunities 

for certain non-ECPs that might have 

otherwise qualified as ECPs.1435 This 

may discourage the use of some sound 

risk management practices and/or 

investment strategies. For instance, it 

may become more expensive for CPOs 

operating non-ECP pools to use such 

practices and/or strategies if such pools 

must enter into swaps on or subject to 

the rules of a DCM or come into 

compliance with a retail forex regime or 

choose to redeem non-ECPs to avoid 

such results. On the other hand, CPOs 

may not incur the increased expense of 

such sound risk management practices 

and/or investment strategies if they are 

able to pass such costs on to the 

participants in the pools. Also, with 

respect to swaps, pools that are not 

ECPs due to CFTC Regulation 

§ 1.3(m)(6) can enter swaps on or subject 

to the rules of a DCM to the extent an 

appropriate swap is listed by such DCM. 

In contrast, CFTC Regulations 

§§ 1.3(m)(7) and (8) allow qualified 

participants to engage in swaps that are 

not on a DCM. This gives qualified 

participants more choices for their 

hedges, and may provide an opportunity 

for better risk management. 

Other public interest considerations. 

CFTC Regulations §§ 1.3(m)(1)–(4) state 

that major swap participants, swap 

dealers, major security-based swap 

participants, and security-based swap 

dealers, respectively, are ECPs. The 

interpretive guidance regarding certain 

governmental ECPs remedies an 

incorrect statutory cross-reference with 

respect to the ability of a subset of 

governmental entities to qualify as ECPs 

under CEA section 1a(18)(A)(vii).1436

VIII. Administrative Law Matters— 

Exchange Act Revisions (Definitions of 

‘‘Security-Based Swap Dealer’’ and 

‘‘Major Security-Based Swap 

Participant’’) 

A. Economic Analysis 

1. Overview 

The SEC is sensitive to the costs and 

benefits of our rules. Some of these costs 

and benefits stem from statutory 

mandates, while others are affected by 

the discretion we exercise in 

implementing the mandates. We have 

requested comment on all aspects of the 

costs and benefits of the proposal, 

including any effect our proposed rules 

may have on efficiency, competition, 

and capital formation. In considering 

the economic consequences of these 

final rules, moreover, we have been 

mindful of the link between the scope 

of the persons who are deemed to be 

dealers or major participants pursuant 

to these rules and the costs and benefits 

associated with the regulatory 

requirements that are applicable to 

dealers and major participants, as well 

as the direct assessment costs (as 

defined below) these rules will impose 

on certain market participants. 

As the SEC noted in the Proposing 

Release, the definitions of ‘‘securitybased swap dealer’’ and ‘‘major securitybased swap participant’’ implicate two 

categories of potential costs. First, there 

are costs that arise from the regulatory 

requirements that will apply to those 

types of entities (e.g., the registration, 

margin, capital and business conduct 

requirements that would apply to 

dealers and major participants).1437 The 

Proposing Release also noted that there 

are costs that entities will incur in 

determining whether they fall within 

the definitions of ‘‘security-based swap 

dealer’’ and ‘‘major security-based swap 

participant.’’ 1438 Commenters that 

addressed these issues discussed both 

types of costs.1439 Our consideration of 

these issues has been informed by the 

comments we received. 

In adopting these final rules, we have 

sought to take into account the broader 

costs and benefits associated with the 

regulation of security-based swap 

dealers and major security-based swap 

participants, which we refer to in this 

section as ‘‘programmatic’’ costs and 

benefits. We have also considered the 

direct costs that persons would incur to 

assess whether they fall within the 

dealer or major participant definitions 

or to assess the potential availability of 

limited registration as a dealer or major 

participant. We refer to these costs as 

‘‘assessment’’ costs.1440 The 

programmatic costs and benefits and the 

assessment costs raise distinct analytic 

issues. 

We discuss below certain of the costs 

and benefits—both programmatic and 

assessment-related—that we have 

considered in adopting these rules. 

These costs and benefits have informed 

the policy choices described above. 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30723 

1441For example, dealers and major participants 

will be subject to business conduct requirements of 

section 15F of the Exchange Act, and thus will be 

required, among other things, to determine that 

their counterparty meets certain eligibility 

standards before entering into security-based swaps 

with them and to disclose information about 

material risks and characteristics, material 

incentives, conflicts of interest, the daily mark, and 

clearing rights. See Securities Exchange Act Release 

No. 64766 (June 29, 2011), 76 FR 42396, 42406, 

42410 (July 18, 2011). Also, for example, in 

connection with registration requirements we 

expect security-based swap dealers and major 

security-based swap participants to incur costs in 

connection with completing and filing forms, 

providing related certifications, addressing 

additional requirements in connection with 

associated persons, as well as certain additional 

costs. See Securities Exchange Act Release No. 

65543 (Oct. 12, 2011), 76 FR 65784, 65813–18 (Oct. 

24, 2011). The costs associated with these and other 

substantive rules applicable to dealers and major 

participants are being addressed in more detail in 

connection with the applicable rulemakings. 

1442See part VIII.A.4, infra. 

1443See part II.D.3.a, supra. 

1444 In application, the programmatic 

requirements applicable to security-based swap 

dealers may differ from the programmatic 

requirements applicable to major security-based 

swap participants. For example, the proposed 

business conduct rules applicable to dealers 

include ‘‘know your customer,’’ suitability and 

‘‘pay to play’’ requirements that would not also 

apply to major participants. See Exchange Act 

Release No. 64766 (June 29, 2011), 76 FR 42396, 

42399–401 (July 18, 2011). 

1445See Exchange Act section 15F(e). 

Accordingly, the analysis below 

includes references throughout to the 

earlier discussions of the policy 

decisions taken by the Commissions. 

In considering the costs and benefits 

of these rules, we are mindful of the 

various considerations that must be 

taken into account in establishing the 

baseline against which those costs and 

benefits may be evaluated. A key 

consideration is that the definitions, 

while integral to the regulatory 

requirements that will be imposed on 

dealers and major participants pursuant 

to Title VII, do not themselves establish 

the scope or nature of those substantive 

requirements or their related costs and 

benefits. In light of this consideration 

associated with definitional rulemaking, 

the baseline we are using to consider the 

costs and benefits associated with the 

definitions presumes that the other Title 

VII rules that implement the statutory 

requirements applicable to securitybased swap dealers and major securitybased swap participants will be adopted 

(and will be the subject of their own 

economic analysis), but as yet there are 

no dealers or major participants subject 

to any of these requirements. The costs 

and benefits described below are 

therefore those that may arise in 

connection with (1) identifying a subset 

of current and future market 

participants as either security-based 

swap dealers or major security-based 

swap participants (i.e., the assessment 

costs) and (2) subjecting that subset, 

through the definitional lines we are 

drawing, to a complete, fully effective 

complement of Title VII statutory and 

regulatory requirements (i.e., the 

programmatic costs and benefits). 

Accordingly, in determining the 

appropriate scope of the definitions 

being adopted in these rules, we 

considered what type of persons should 

be regulated as dealers and major 

participants under Title VII, in light of 

the purposes of the statute, the overall 

regulatory framework, and the data 

currently available to us. We thus have 

sought to adopt regulations that would 

include entities within the scope of the 

dealer and major participant definitions 

to the extent that encompassing persons 

with their level of security-based swap 

activities or positions would be 

necessary and appropriate given the 

purposes of the statute (for example, 

because the institution may pose market 

or other risks of the type addressed by 

Title VII). Conversely, to the extent that 

we expect that the regulation of certain 

types of market participants would not 

serve the statutory purposes, we have 

sought to exclude them from the scope 

of the definitions, thereby reducing 

unnecessary burdens on entities whose 

regulation may not be necessary or 

appropriate to further the purposes of 

the statute. 

We recognize that the costs and 

benefits arising from these rules will 

affect competition, efficiency, and 

capital formation in the security-based 

swap market broadly, with the impact 

not being limited to the specific entities 

that fall within the meaning of the terms 

‘‘security-based swap dealer’’ and 

‘‘major security-based swap 

participant.’’ In the sections that follow 

we begin with a consideration of the 

costs and benefits of the rule that affect 

the regulated market participants that 

fall within the meaning of these terms, 

and conclude with a consideration of 

the potential effects of this rule on 

competition, efficiency, and capital 

formation. 

2. Programmatic Costs and Benefits 

Associated With These Definitions’ 

Scope 

a. Programmatic Costs 

The scope of these definitions will 

directly affect the number of market 

participants subject to Title VII and the 

rules thereunder and thus will directly 

affect the overall costs associated with 

the regulation of dealers and major 

participants pursuant to Title VII. 

Persons who fall within the statutory 

definitions of security-based swap 

dealer and major security-based swap 

participant, as further defined by these 

rules, will incur a number of upfront 

costs and ongoing costs in connection 

with their status as dealers or major 

participants. Those include, but are not 

limited to, costs of complying with 

requirements related to: registration; 

reporting, recordkeeping, confirmation 

and documentation; sales practices; 

margin, capital and segregation of 

customer collateral; and maintaining a 

chief compliance officer.1441 We expect 

that the significance of those 

programmatic costs will outstrip the 

more discrete and entity-specific 

assessment costs (discussed in more 

detail below) that individual entities 

will incur in determining whether they 

fall within the dealer and major 

participant definitions. 

The programmatic costs linked to 

compliance by regulated entities with 

specific requirements are not the only 

overall costs associated with the 

regulation of dealers and major 

participants. Other potential costs 

associated with the establishment of a 

new regulatory structure over dealers 

and major participants, such as costs 

related to the potential reduction of 

competition in the market, the 

deterrence of new entrants, or 

reductions in capital formation, are 

discussed more fully below.1442

b. Programmatic Benefits 

The regulation of dealers and major 

participants also will provide a number 

of programmatic benefits to the securitybased swap market and to market 

participants. As discussed above,1443

registered security-based swap dealers 

and major participants will be subject to 

a number of entity-level and 

transaction-level requirements that we 

expect to produce a broad array of 

benefits consistent with the purposes of 

Title VII.1444

For example, section 15F(e) of the 

Exchange Act and related rules impose 

capital and margin requirements on 

dealers and major participants,1445

which will reduce the financial risks of 

these institutions and contribute to the 

stability of the security-based swap 

market in particular and the U.S. 

financial system more generally. Section 

3E of the Exchange Act, among other 

things, requires security-based swap 

dealers that collect margin from 

counterparties to cleared security-based 

swap transactions to maintain that 

collateral in segregated accounts, as well 

as providing counterparties to uncleared 

security-based swap transactions with 

security-based swap dealers and major 

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30724 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1446See Exchange Act section 3E. 

1447See Exchange Act section 15F(j)(2). 

1448See Exchange Act section 15F(h)(3)(B). 

1449See Exchange Act section 15F(h)(3)(C). 

1450See Exchange Act section 15F(j)(5). 

1451See Exchange Act sections 15F(h)(2), (h)(4), 

(h)(5). 

1452See Exchange Act section 15F(f) (reporting 

and recordkeeping requirements); Exchange Act 

section 15F(g) (daily trading records requirements); 

and Exchange Act section 15F(j)(3) (requirements 

related to the disclosure of information to 

regulators). 

1453See Exchange Act section 15F(i). 

1454Prior to the enactment of the Dodd-Frank Act, 

a Treasury Department blueprint for financial 

reform articulated benefits of comprehensive 

regulation of derivatives: ‘‘OTC derivatives markets, 

including CDS markets, should be subject to 

comprehensive regulation that addresses relevant 

public policy objectives: (1) preventing activities in 

those markets from posing risk to the financial 

system; (2) promoting the efficiency and 

transparency of those markets; (3) preventing 

market manipulation, fraud, and other market 

abuses; and (4) ensuring that OTC derivatives are 

not marketed inappropriately to unsophisticated 

parties.’’ Department of the Treasury, Financial 

Regulatory Reform—A New Foundation 46–47 

(2009). 

1455See note 421, supra. The significance of these 

potential benefits is suggested by the 2008 financial 

crisis. Better Markets cited estimates that the 

worldwide cost of the 2008 financial crisis in terms 

of lost output was between $60 trillion and $200 

trillion, depending primarily on the long-term 

persistence of the effects. See letter from Better 

Markets. We recognize, however, that this estimate 

addresses the aggregate cost of the financial crisis, 

and that Title VII is directed to only one aspect of 

the factors that contributed to the crisis. 

1456The lack of market data is particularly 

significant in the context of total return swaps on 

equity and debt. We do not have the same amount 

of information regarding those products as we have 

in connection with the present market for singlename credit default swaps. 

security-based swap participants with 

the right to require the segregation of 

assets held as collateral with an 

independent third-party custodian. 

These protections provide market 

participants who enter into transactions 

with these entities confidence that their 

collateral accounts will remain separate 

from the dealer or major participant’s 

assets in the event of bankruptcy.1446

Title VII also requires registered entities 

to implement risk management policies 

and procedures that should allow them 

to avoid taking on excessive risk and to 

better deal with market fluctuations that 

might otherwise endanger the financial 

health of the entity.1447

Title VII further imposes a range of 

business conduct requirements upon 

these registered entities, which should 

deter fraudulent or deceptive conduct 

and increase information transparency 

for customers and counterparties 

seeking to access the security-based 

swap market. For example, section 

15F(h)(3)(B) of the Exchange Act and 

related rules establish certain disclosure 

requirements for dealers and major 

participants,1448 while section 

15F(h)(3)(C) of the Act and related rules 

require that communications by these 

entities meet certain standards of 

fairness and balance.1449 Section 

15F(j)(5) of the Act and related rules 

introduce requirements intended to 

address potential conflicts of interest 

that may arise in transactions between 

a dealer or major participant and its 

counterparty.1450 Title VII also 

establishes higher levels of protection 

for special entities entering into 

transactions with dealers or major 

participants.1451 As we discuss in more 

detail in our analysis of the competitive 

effects of these rules, these protections, 

and the related increase in transparency 

in dealings with registered entities may 

be expected to improve the 

competitiveness and efficiency of the 

market. 

Finally, Title VII also imposes 

requirements that are designed to 

promote effective market operation and 

transparency. Sections 15F(f), (g), and 

(j)(3) of the Exchange Act and related 

rules impose certain reporting, 

recordkeeping, and regulatory 

disclosure requirements upon registered 

entities, which should enhance the 

volume and quality of information 

available in the market and facilitate 

effective oversight by the 

Commission.1452 Section 15F(i) 

establishes regulatory standards related 

to the confirmation, processing, netting, 

documentation and valuation of 

security-based swaps, which should 

enhance the efficiency of the procedures 

surrounding the execution of securitybased swap transactions.1453

We expect that the regulation of 

security-based swap dealers and major 

participants through these provisions 

will advance the transparency, risk 

reduction and counterparty protection 

purposes of Title VII.1454 While these 

benefits will be significant, they will not 

be entirely measurable, as it is not 

possible to quantify the benefits of 

mitigating or avoiding a future financial 

crisis, or the benefits of avoiding an 

unsuitable security-based swap 

transaction.1455 Those benefits, 

moreover, can be expected to manifest 

themselves over the long-term and be 

distributed over the market as a whole. 

c. The Relation Between These Rules 

and the Programmatic Costs and 

Benefits 

In adopting these final rules, we 

recognize that: (a) The choices reflected 

by these rules will affect how many 

persons and which persons ultimately 

will be deemed to be dealers or major 

participants; and (b) those results, 

combined with the substantive 

requirements that are to be adopted in 

connection with the dealer and major 

participant regulatory regime, ultimately 

will determine the programmatic costs 

and benefits that will be associated with 

the substantive regulation of dealers and 

major participants. 

This is not to say that there would be 

a one-to-one correlation between the 

regulation (or non-regulation) of any 

particular entity as a dealer or major 

participant and the additional (or 

reduced) programmatic costs and 

benefits that would be associated with 

the regulation (or non-regulation) of that 

entity. Some of the costs of regulating a 

particular person as a dealer or major 

participant, such as costs of registration, 

may largely be fixed. At the same time, 

other costs associated with regulating 

that person as a dealer or major 

participant (e.g., costs associated with 

margin and capital requirements) may 

be variable, reflecting the level of the 

person’s security-based swap activity. 

Similarly, the regulatory benefits that 

would arise from deeming that person to 

be a dealer or major participant (e.g., 

benefits associated with increased 

transparency and efficiency, and 

reduced risks faced by customers and 

counterparties), although not 

quantifiable, may be expected to be 

variable in a way that reflects the 

person’s security-based swap activity. In 

addition, it is reasonable to believe that 

the implementation of Title VII itself 

will change the security-based swap 

market, and, with the full 

implementation of Title VII—which in 

part is conditioned on these 

definitions—more information will be 

available for this analysis.1456

Given these limitations on our ability 

to conduct a quantitative assessment of 

the programmatic costs and benefits 

associated with these definitional terms, 

we have considered these costs and 

benefits primarily in qualitative terms. 

In that framework it is possible to 

identify a subset of such entities that, 

because of the volume of their dealing 

activity or the size of their securitybased swap exposure, appear to be the 

types of entities for which the other 

statutory requirements of Title VII were 

created. We have therefore sought to 

adopt definitions that would capture 

these entities, as the statute requires us 

to do, without imposing the costs of 

Title VII on those entities for which 

regulation currently may not be justified 

in light of those purposes. We believe 

that this approach will maximize the 

benefits provided by Title VII while 

minimizing costs to the extent 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30725 

1457This estimate—which potentially overstates 

the number of potential dealers—is consistent with 

the data considered in the CDS Data Analysis. That 

analysis implied a range of alternative estimates— 

from 16 possible dealers to 93 possible dealers— 

based on currently available data and reflecting a 

$3 billion de minimis level. Compare CDS Data 

Analysis at table 2a (identifying 16 potential dealers 

above the $3 billion level based on the criterion of 

having 20 or more unique counterparties) with CDS 

Data Analysis at table 2c (identifying 93 potential 

dealers above that level based on the criterion of 

having 10 or more unique counterparties). However, 

most of the criteria applied by the CDS Data 

Analysis as potentially indicative of dealer activity 

suggested estimates of fewer than 50 possible 

dealers after accounting for the $3 billion de 

minimis level. See id. at table 2b (identifying 32 

possible dealers based on the criterion of having 15 

or more unique counterparties); id. at table 3 

(identifying 16, 19, or 25 possible dealers based on 

the criterion of having a certain number of 

counterparties not identified as dealers by ISDA); 

id. at table 4 (identifying 32 possible dealers based 

on the criterion of having a ‘‘flat notional book’’); 

id. at table 5 (identifying 33 possible dealers based 

on the criterion of having ‘‘flat transaction 

volume’’); id. at table 7 (identifying 40 possible 

dealers that meet two or more of the other criteria 

cited in the analysis); id. at table 8 (identifying 27 

possible dealers that meet three or more of the other 

criteria cited in the analysis). Only two criteria 

suggested estimates in excess of 50 possible dealers 

above the $3 billion level. See id. at table 2c 

(identifying 93 possible dealers based on the 

criterion of having 10 or more unique 

counterparties, which may also be explained by the 

fact that non-dealers may maintain trading relations 

with multiple dealers); id. at table 6 (identifying 52 

possible dealers based on the criterion of posting 

initial margin with low frequency, which may also 

be explained by underreporting of margin due to 

the fact that such reporting was voluntary with 

respect to the data underlying the CDS Data 

Analysis). 

While recognizing that alternative criteria for 

identifying possible dealing activity produced 

varied results, we believe that the results largely are 

consistent with the estimate of 50 or fewer securitybased swap dealer registrants. We further believe 

that it is appropriate to place particular weight on 

one criterion that identified possible dealing 

activity based on whether an entity engaged in 

security-based swap transactions with three or more 

counterparties that themselves were not identified 

as dealers by ISDA. That analysis identified 28 

entities possibly engaged in dealing activity (with 

25 of those with trailing notional transactions that 

exceed the $3 billion de minimis threshold we are 

adopting). See CDS Data Analysis at table 3c. We 

believe that this metric serves as a useful proxy for 

the application of the dealer-trader distinction, 

given that persons with the business model of 

seeking to profit by providing liquidity in general 

may reasonably be expected to engage in 

transactions with persons who are not themselves 

recognized as dealers. 

In estimating that 50 or fewer entities ultimately 

may have to register as dealers, we are seeking to 

take a conservative approach that recognizes both 

the limitations on the conclusions that may be 

drawn from available data and the potential for 

changes in the security-based swap market. We 

recognize that the criteria applied in the CDS Data 

Analysis are imperfect in that they do not directly 

apply the dealer-trader distinction, and that some 

alternative criteria may prove to be superior 

predictors of actual dealing activity. We also 

recognize that the estimate may overstate the 

number of possible registered dealers insofar as not 

all of the activity of persons identified as potential 

dealers based on the CDS Data Analysis necessarily 

reflects dealing activity, meaning that in practice a 

greater number of entities may be able to take 

advantage of the de minimis exception, and fewer 

entities would have to register as dealers, than 

estimates implied by that analysis may suggest. 

This estimate of 50 potential dealers further seeks 

to reflect the potential for growth in the size of the 

security-based swap market, as well as growth in 

the number of registered dealers as a result of 

competition promoted by the policies contemplated 

by the Dodd-Frank Act, and the possibility that 

some business groups that are identified as a single 

entity for purposes of this data ultimately may 

register multiple legal entities as security-based 

swap dealers. 

1458The proposal estimated approximately 50 

entities would be required to register as securitybased swap dealers, based on discussions with 

industry. See Proposing Release, 75 FR at 80209, 

n.188. Commenters did not contradict this estimate. 

To the extent that the actual number of registrants 

differs from this estimate, it is reasonable to assume 

that the actual number will be lower than the 

Continued 

consistent with the purposes of the 

statute. 

Moreover, as discussed above, the 

SEC has directed the staff to report to 

the Commission on all aspects of the 

dealer and major participant definitions 

no later than three years following the 

later of: (i) the last compliance date for 

the registration and regulatory 

requirements for security-based swap 

dealers and major security-based swap 

participants under Section 15F of the 

Exchange Act; and (ii) the first date on 

which compliance with the trade-bytrade reporting rules for credit-related 

and equity-related security-based swaps 

to a registered security-based swap data 

repository is required. This report will 

provide the SEC and market participants 

with more information about the 

security-based swap market following 

the implementation of Title VII— 

including information regarding the 

business of dealers and major 

participants, the characteristics of 

positions they and other market 

participants hold, the structure of the 

market, and how Title VII has affected 

those aspects of the market. This report, 

which will take into account the 

additional data from our observations of 

the security-based swap market and the 

functioning of the associated regulatory 

requirements, is intended to help the 

SEC assess whether to make changes to 

the scope of the dealer and major 

participant definitions (as well as to 

assess future actions related to the 

extended compliance period in 

connection to the de minimis exception 

to the security-based swap dealer 

definition). 

d. Analysis of the Effect of Specific 

Rules on Programmatic Costs and 

Benefits 

We have sought to establish 

definitions that capture the types of 

entities whose security-based swap 

activity or whose security-based swap 

positions warrant regulation under Title 

VII as dealers or major participants, and 

to exclude the types of entities whose 

activity or positions may not warrant 

such regulation. The relationship 

between a given rule and the scope of 

the persons that ultimately will fall 

within the dealer or major participant 

definitions—along with the related costs 

and benefits—manifests itself in 

different ways depending on the rule at 

issue. Some of these rules may be 

expected to have a close link to the 

overall programmatic costs and benefits 

associated with dealer and major 

participant regulation because they play 

a significant role in determining the 

overall scope of the definitions (for 

example, because they are relevant to 

the status of relatively more entities). 

Other rules may be expected to affect 

the status of relatively fewer entities and 

thus have a smaller effect on those 

programmatic costs and benefits. 

We anticipate that the report that the 

SEC staff will make to the Commission 

following the full implementation of 

Title VII with regard to these definitions 

will help us more fully evaluate the 

programmatic impact of all of these 

rules, both in terms of the number of 

potential major participants and dealers 

that would result from the definition we 

are adopting as well as potential 

alternatives, and in terms of the 

associated programmatic costs and 

benefits. 

i. Core Rules That Implicate 

Programmatic Costs and Benefits 

The core definitional terms with 

respect to establishing the scope of the 

dealer and major participant definitions 

are those relating to: (i) the core dealer 

definition, (ii) the dealer de minimis 

exception, and (iii) the definitions of 

‘‘substantial position’’ and ‘‘substantial 

counterparty exposure’’ within the 

major participant definition. 

A. Dealer Definition 

Exchange Act rule 3a71–1 defines 

‘‘security-based swap dealer’’ and thus 

plays a central role in determining the 

scope of the Title VII regulatory regime 

going forward. Based on the available 

data regarding activity in the market for 

single-name credit default swaps, 

including the application of various 

criteria that may be indicative of dealing 

activity in that market, and taking into 

account the availability of the de 

minimis exception to the dealer 

definition, we estimate that 50 or fewer 

entities ultimately may have to register 

with the SEC as security-based swap 

dealers.1457 This is consistent with the 

estimate that accompanied the 

proposal.1458

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30726 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

estimate in the proposal because the de minimis 

level established by the final rules for credit default 

swaps that are security-based swaps—as described 

above, by far the overwhelming majority of the 

security-based swap market—is higher than the 

level that was proposed (i.e., $3 billion vs. $100 

million). 

1459See part II.A.2, supra. 

1460See part II.A.5, supra (discussing the 

application of the dealer-trader distinction to the 

security-based swap market). 

1461See note 1457, supra. 

1462See parts II.D, supra. Regardless of the 

criterion used for identifying entities engaged in 

dealing activity, analysis of 2011 transaction data 

for single-name credit default swaps indicates that 

possible dealers with $3 billion or more in trailing 

notional activity account for over 98 percent of all 

the trailing notional activity by such entities. See 

CDS Data Analysis at 8–17. 

1463See part II.D.2, supra. Conversely, some 

commenters suggested lower thresholds than those 

provided in the final rule, an approach that 

reasonably would be expected to lead more entities 

to have to register as security-based swap dealers. 

We did not adopt these lower thresholds because 

we determined that, given our understanding of the 

current structure of the market, it was unnecessary 

to do so to achieve the purposes of Title VII. Under 

any of the metrics used in the CDS Data Analysis 

(with the exception of the metrics relying on the 

posting of margin, which are, for reasons provided 

in the analysis, particularly unreliable), for 

example, retaining the proposed de minimis 

threshold of $100 million would have captured at 

most an additional 0.75 percent of transaction 

activity engaged in by entities captured by the 

respective analysis. See CDS Data Analysis at 8–17. 

In adopting this rule we also considered 

alternative approaches and thresholds suggested by 

some commenters that potentially may lead fewer 

entities to have to register as security-based swap 

dealers. For example, while some commenters 

supported the use of an exposure-based threshold 

rather than a notional threshold, we declined to 

adopt this approach because the use of an exposure 

threshold could permit a virtually unlimited 

amount of dealing activity within the de minimis 

exception so long as exposures are collateralized (or 

offset, as generally occurs with dealing activity), a 

result inconsistent with the purposes of Title VII. 

1464As noted above, a sufficiently high de 

minimis threshold could allow a significant amount 

of unregulated security-based swap dealing activity 

to develop among entities whose dealing activity 

does not exceed the de minimis threshold. See part 

II.D.5.b, supra. 

1465As noted above, an extended compliance 

period will be available to entities that engage in 

$8 billion or less in annual notional dealing activity 

in security-based swaps that are credit default 

swaps (or $400 million in dealing activity in other 

types of security-based swaps), to help facilitate the 

orderly implementation of Title VII and to afford 

the SEC additional time to study the security-based 

swap market as it evolves in the new regulatory 

framework. See part II.D.5.c.ii, supra. 

1466See part II.D.5.d, supra. 

1467See id. (discussing rationale for use of $150 

million threshold and $400 million phase-in level 

in connection with those types of security-based 

swaps). 

Alternative approaches to identifying 

dealer activity, including those 

suggested by commenters, may have led 

to a lower or higher number of potential 

dealers out of the over 1,000 total 

participants in the security-based swap 

market. For example, commenters 

variously suggested, among other 

approaches, that the dealer definition 

should be interpreted to be coextensive 

with the concept of market making 

activity, that dealer status should be 

limited to persons available to take 

either side of the market at any time, or 

that dealer status should be limited to 

transactions arising from a ‘‘customer’’ 

relationship.1459 Following those 

alternative approaches potentially 

would reduce the ultimate number of 

persons required to register as dealers. 

In adopting the final rules and 

providing interpretive guidance that 

adapts our traditional dealer-trader 

analysis for the security-based swap 

market, we have sought to capture those 

entities whose security-based swap 

activity is warranted due to the nature 

of their interactions with counterparties, 

or is warranted to promote market 

stability and transparency. In this 

respect, we have sought to limit the 

costs imposed by regulation under Title 

VII to those entities whose regulation 

would serve the transparency, customer 

protection, and market stability 

purposes of the statute while not 

imposing those costs on entities whose 

regulation may not produce sufficient 

benefit in terms of those purposes. The 

core dealer analysis that we have 

adopted here focuses on activity that 

characterizes dealers, as the statutory 

text requires, and does so while drawing 

on a well-established approach used in 

an analogous securities dealer context 

by a wide range of financial 

intermediaries.1460

B. De Minimis Exception to the Dealer 

Definition 

Exchange Act rule 3a71–2 implements 

the de minimis exception to the dealer 

definition. This rule will directly affect 

the scope of the dealer definition by 

excepting certain entities that otherwise 

would be encompassed by the dealer 

definition but whose security-based 

swap dealing activities fall below a 

specified notional threshold. As above, 

we believe that the application of the 

final rule implementing the de minimis 

exception, in combination with 

application of the dealer-trader 

distinction, reasonably may be expected 

to result in 50 or fewer entities 

ultimately registering with the SEC as 

security-based swap dealers.1461

As discussed above, the final rule 

implementing the de minimis exception 

reflects our attempt to focus the 

application of dealer regulation onto 

those entities for which that regulation 

would be appropriate, taking into 

account the comparative costs and 

benefits of dealer regulation, and the 

high degree of concentration of dealing 

activity in the security-based swap 

market.1462 The final rule particularly 

provides that a dealer may take 

advantage of the exception if the 

notional amount of its dealing activity 

involving security-based swaps that are 

credit default swaps over the trailing 12 

months is no more than $3 billion. For 

other types of swaps, a dealer may take 

advantage of the exception if the 

notional amount of its dealing activity is 

no more than $150 million. The 

threshold for dealing activity with 

counterparties that are ‘‘special 

entities,’’ regardless of the type of 

security-based swap, is $25 million. The 

final rule also eliminates proposed tests 

based on the number of an entity’s 

dealing counterparties and on the 

number of its dealing security-based 

swaps. This approach also mitigates 

concerns raised by some commenters 

about the exception being overly 

narrow.1463

We have concluded that a $3 billion 

threshold for security-based swaps that 

are credit default swaps would 

appropriately apply dealer regulatory 

requirements to entities that comprise 

the vast majority of domestic dealing 

activities in these products, while not 

imposing the fixed costs of dealer 

regulation upon those entities 

responsible for only a small portion of 

total dealing activity, and avoiding the 

threat of leaving an excessive amount of 

dealing activity outside the ambit of 

dealer regulation.1464 We believe that 

this approach strikes a balance that 

appropriately maximizes the benefits of 

dealer regulation while avoiding the 

application of the fixed costs of dealer 

regulation onto those entities for which 

dealer regulation may not significantly 

contribute to those benefits and 

avoiding the threat of allowing an 

excessive volume of unregulated dealing 

activity.1465

Similar considerations influenced our 

determination that a $3 billion de 

minimis threshold would be 

inappropriate for persons engaged in 

dealing activity involving other types of 

security-based swaps, given the 

comparatively smaller size of that 

market.1466 We instead have set the 

threshold at a level that reflects the 

relative volume in the security-based 

swap market of security-based swaps 

that are not credit default swaps.1467

The final rule implementing the de 

minimis exception also sets forth a 

lower notional threshold for dealing 

activities involving ‘‘special entities,’’ 

consistent with the special protections 

that Title VII affords those entities. 

While we recognize that this lower 

threshold may deter certain entities that 

are not registered as dealers from 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30727 

1468We expect any such effect will likely be 

minimal. An analysis of 2011 transaction data 

regarding single-name credit default swap 

transactions involving special entities shows that 16 

counterparties account for all transactions with 

special entities. Although all but one of these 

entities engaged in more than $25 million in 

transactions with such entities in 2011, all of these 

entities engaged in total single-name credit default 

swap activity well in excess of the $3 billion de 

minimis threshold that applies to dealers generally. 

See CDS Data Analysis, Table 9 and note 8. 

Consequently, it is possible that all 16 entities 

would have been required to register as dealers 

under the standard de minimis threshold of $3 

billion, regardless of the lower de minimis 

threshold for special entities. 

1469See note 179, supra (discussing business 

conduct requirements applicable to dealing 

activities involving special entities). 

1470See note 437, supra (discussing use of 

common control standard in this anti-evasion 

context, rather than the majority ownership 

standard used in connection with the inter-affiliate 

exclusions from the dealer and major participant 

definitions). 

1471As detailed above in part IV.B.3, an entity 

will generally be required to register as a major 

security-based swap participant if its current 

security-based swap exposure exceeds $1 billion in 

a single major category of security-based swaps or 

to a single counterparty or if its current securitybased swap exposure plus its potential future 

exposure exceeds $2 billion in a single major 

category of security-based swaps or to a single 

counterparty. The current exposure test looks to an 

entity’s current uncollateralized exposure posed by 

its security-based swap positions in a given 

category; the potential future exposure test looks to 

the effective notional exposure represented by an 

entity’s security-based swap positions, with certain 

adjustments for cleared or margined positions and 

netting. 1472See parts IV.C.3 and IV.E.3, supra. 1473See note 914, supra. Although it is possible 

that a notional position of $20 billion could cause 

an entity to be a major participant in the absence 

of central clearing or mark-to-market margining 

(and assuming that there is no risk reduction 

associated with netting or with certain positions 

that pose lower credit risk), we expect that those 

entities (such as hedge funds) that may be expected 

to have large positions would, as a matter of course, 

post mark-to-market margin in connection with 

positions that are not cleared. See Proposing 

Release, 75 FR 80207–08 n.181 (stating our 

understanding that banks, securities firms, and 

hedge funds typically collateralize most or all of 

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

matter of practice). Accordingly, we believe that 

$100 billion provides a reasonable focus for the 

analysis. 

1474See CDS Data Analysis at table 10. 

1475See part IV.B.3.c.iii, supra. 

1476See id. Although this data describes aggregate 

notional positions only for single-name credit 

default swaps and does not include analysis of 

positions in other types of security-based swaps, as 

noted above, credit default swaps appear to account 

for approximately 95 percent of the security-based 

swap market. That fact reduces the likelihood that 

positions involving security-based swaps that are 

not credit-related would cause a person to be a 

major security-based swap participant, or lead any 

entity to find it necessary to perform the major 

participant analysis in connection with those 

instruments. 

1477See part IV.B.2, supra. 

1478See CDS Analysis at tables 10 through 12. 

entering into security-based swap 

transactions with special entities, and 

hence may have the effect of reducing 

the availability of security-based swaps 

to those entities or increasing their 

costs,1468 we believe that this lower 

threshold is appropriate to avoid 

undermining those separate Title VII 

protections.1469

The final rule implementing the de 

minimis exception further provides that 

security-based swap activities of 

affiliates under common control with an 

entity should be considered when 

determining whether the entity can 

avail itself of the de minimis exception. 

That is intended to avoid evasion of the 

dealer registration requirement; thus, 

while a contrary approach might be 

expected to reduce the number of 

registered dealers, such an approach 

would not be consistent with the 

purposes of Title VII.1470

C. ‘‘Substantial Position’’ and 

‘‘Substantial Counterparty Exposure’’ 

Definitions 

Exchange Act rules 3a67–3 and 3a67– 

5 define ‘‘substantial position’’ and 

‘‘substantial counterparty exposure,’’ 

which constitute key terms within the 

major participant definition. The rules 

defining these thresholds—including 

the use of current exposure and 

potential future exposure tests, the 

specific features of those tests, and the 

thresholds associated with those 

tests1471—can be expected to directly 

influence the overall number of persons 

who may fall with the major participant 

definition. 

These tests seek to capture persons 

whose security-based swap positions 

pose sufficient risk to counterparties 

and the markets generally that 

regulation as a major participant is 

warranted.1472 Based on available data 

regarding the single-name credit default 

swap market—which we believe will 

comprise the majority of security-based 

swaps—we estimate that the number of 

major security-based swap participants 

likely will be fewer than five and, in 

actuality, may be zero. As discussed 

above, an entity that posts daily 

variation margin in connection with 

those positions generally would need to 

have security-based swap positions 

approaching $100 billion to reach the 

levels of potential future exposure 

required to meet the substantial position 

threshold, even before accounting for 

the impact of netting, while an entity 

that clears its security-based swaps 

generally would need to have positions 

approaching $200 billion.1473 The 

available data shows that as of 

December 2011 a single entity had 

aggregate gross notional positions (i.e., 

aggregate buy and sell notional 

positions) in single-name credit default 

swaps exceeding $100 billion, and three 

others had aggregate gross notional 

positions between $50 and $100 

billion.1474 However, as discussed 

above, the purchase of credit protection 

is weighed less heavily than the sale of 

credit protection for purposes of the 

analysis,1475 meaning that an entity’s 

positions reflecting single-name credit 

protection sold to its counterparties may 

be expected to be more of a key 

determinant of the entity’s potential 

future exposure level under the rules we 

are adopting. The data shows that no 

entities have more than $100 billion in 

positions arising from selling singlename credit protection and that only 

two have between $50 and $100 billion 

in positions arising from such 

transactions.1476

While a ‘‘substantial position’’ or 

‘‘substantial counterparty exposure’’ 

also can be established by a sufficiently 

high amount of current uncollateralized 

exposure, the available data does not 

provide information about individual 

entities’ uncollateralized exposure in 

connection with security-based swap 

positions. We note, however, our 

understanding that certain of the 

financial entities that may have large 

security-based swap positions, such as 

hedge funds, tend to collateralize their 

security-based swap exposures as a 

matter of course, which would reduce 

the potential impact of this aspect of the 

test. 

As noted above, commenters 

suggested both higher and lower 

thresholds, as well as different 

discounts or risk multipliers for certain 

positions.1477 If the final rules defining 

‘‘substantial position’’ and ‘‘substantial 

counterparty exposure’’ incorporated 

higher major participant thresholds, 

potentially fewer entities may be major 

participants. Conversely, lower 

thresholds may have led to a higher 

number of major participants, with the 

upper bound being represented by the 

over 1,000 non-dealer entities that 

participate in the security-based swap 

market.1478

By potentially capturing more or 

fewer major participants, such 

alternatives would have 

correspondingly increased or decreased 

the programmatic costs and benefits 

associated with Title VII regulation of 

major participants. As discussed above, 

however, the tests incorporated into the 

final rules, and the thresholds 

associated with those tests, are in our 

view tailored to capture only those 

entities that pose the risks that major 

participant regulation in Title VII seeks 

to address; in other words, these 

thresholds and related calculations 

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1479See part IV.B.3, supra (discussing the 

decisions made regarding the substantial position 

definition and the reasoning behind the adopted 

approach). For example, we have concluded that 

the proposed thresholds are set prudently in a 

manner that takes into account the financial 

system’s ability to absorb losses of a particular size, 

the need for major participant regulation not to 

encompass entities only after they pose significant 

risks to the market, and the need to account for the 

possibility that multiple market participants may 

fail close in time. In addition, as discussed above, 

we believe that this threshold is tailored to address 

the types of events associated with the failure of 

AIG FP. See part IV.B.3.d, supra. 

1480Central clearing helps to mitigate 

counterparty credit risk by improving risk 

management and, among other things, mutualizing 

the risk of counterparty failure. If multiple members 

of a central counterparty fail beyond the level to 

which such risk is managed, however, the central 

counterparty would also be at risk of failure. Cf. 

Basel Committee on Banking Supervision, 

Consultative Document, ‘‘Capitalisation of bank 

exposures to central counterparties,’’ Nov. 25, 2011 

(available at: http://www.bis.org/publ/bcbs206.pdf) 

(proposing that the capital charge for trade 

exposures to a qualifying central counterparty 

should carry a low risk weight, reflecting the 

relatively low risk of default of the qualifying 

central counterparty). 

1481See part IV.B.3, supra. 

1482See ‘‘Registration of Security-Based Swap 

Dealers and Major Security-Based Swap 

Participants,’’ Exchange Act Rel. No. 34–65543 

(‘‘Registration Proposing Release’’), 76 FR 65784, 

65814–65818 (describing various costs associated 

with registration, including $11,800 per entity to 

complete and file form SBSE and between 

approximately $94,000 and $610,000 per entity to 

certify to the capabilities of the entity seeking 

registration). 

1483These costs may include the costs of 

identifying how the entity would be able, as a 

limited designation entity, to comply with the 

various entity-level requirements of Title VII. 

1484We will consider applications for limited 

purpose designation in the context of the 

registration requirements for major participants and 

dealers. In that context, we could consider 

applications on a case-by-case basis, pursuant to 

requests by specific major participants or dealers. 

This could help to ensure that any person that is 

designated as a limited purpose major participant 

or dealer is able to comply with the regulatory 

requirements applicable to major participants or 

dealers. Accordingly, we intend to further consider 

issues regarding limited designations, including 

associated costs, in a release relating to the specific 

registration requirements (for example, the form 

used for registration) for major participants and 

dealers. Furthermore, as noted above, the SEC is 

directing the staff to prepare a report on all aspects 

of the dealer and major participant definitions. 

Upon completion of this report, the SEC may 

further assess whether changes to the presumption 

against limited designation are warranted in light of 

the then-current state of the security-based swap 

market and the types of business in which securitybased swap dealers are engaged. 

1485The study that will be conducted in 

connection with the dealer and major participant 

definitions may also provide relevant information 

regarding limited designations of dealers and major 

participants. 

incorporate the risk criteria embedded 

in the major participant definition.1479

For example, we have declined to 

exclude centrally cleared positions from 

the potential future exposure test, 

instead permitting entities to discount 

those positions for purposes of the 

analysis, because central clearing cannot 

reasonably be expected to fully 

eliminate all counterparty risk that may 

affect the broader markets. Based on this 

fact, we conclude that it would be 

inappropriate, given the purposes of 

Title VII, to exclude an entity from the 

major participant definition simply 

because all of its security-based swap 

positions arise from cleared 

transactions.1480 Similar considerations 

informed our approach to other aspects 

of the substantial position and 

substantial counterparty position tests, 

as discussed more fully above.1481

ii. Rules That May Be Expected To Have 

a Lesser Effect on Programmatic Costs 

and Benefits 

Several of the final rules may be 

expected to have relatively smaller 

effects on the scope of the major 

participant and dealer definitions 

because they are likely to affect 

relatively fewer entities. By extension, 

they will also have a smaller effect on 

the programmatic costs and benefits 

arising from these definitions. 

A. Limited Purpose Dealer and Major 

Participant Designations 

Exchange Act rules 3a67–1 and 3a71– 

1 retain the presumption that a person 

that is encompassed within the major 

participant or dealer definitions will be 

deemed to be a dealer or major 

participant with respect to all of its 

security-based swap activities or 

positions, unless the SEC exercises its 

authority to limit the person’s 

designation as a dealer to specified 

categories of swaps or security-based 

swaps, or to specified activities. This 

presumption may affect programmatic 

costs in at least two ways. 

First, by not providing for registration 

as a limited purpose major participant 

or dealer as a matter of course, the final 

rules may be expected to increase the 

costs associated with the registration of 

those entities that seek designation as 

dealers or major participants or dealers. 

Aside from the costs of registration 

described in the SEC’s proposal related 

to the registration of dealers and major 

participants,1482 we expect that entities 

seeking to register as a limited purpose 

major participant or dealer would incur 

some additional marginal costs 

associated with making applications for 

limited designation.1483

In addition, the presumption against 

limited purpose designation may be 

expected to reduce the number of 

limited purpose major participants and 

dealers below the number that would 

otherwise register as limited purpose 

entities absent the presumption. In 

concept, broader availability of limited 

purpose registration of major 

participants or dealers may be expected 

to reduce the programmatic costs 

associated with regulation under Title 

VII, without necessarily reducing 

certain programmatic benefits if 

appropriately crafted. In particular, any 

programmatic effects of an appropriately 

scoped limited designation likely would 

affect only the transaction-level 

requirements applicable to dealers and 

major participants (e.g., certain business 

conduct standards and requirements 

related to trading records, 

documentation and confirmations), 

potentially reducing costs and benefits 

that would otherwise arise from such 

requirements with respect to 

transactions that occur outside the 

limited designation. At the same time, 

certain of the entity-level regulatory 

requirements applicable to dealers and 

major participants as a whole (such as 

requirements related to capital) would 

continue to apply in the context of 

limited designation, ensuring that a 

limited purpose designation would not 

undermine the counterparty protection 

and systemic risk concerns of Title VII. 

Notwithstanding these effects, we 

believe that the presumption against 

limited purpose designations is 

appropriate. This conclusion reflects the 

statutory language, the difficulty of 

separating a dealer’s activities from its 

non-dealing activities (or a major 

participant’s security-based swap 

positions taken under its limited 

purpose designation from other of its 

security-based swap positions) for 

compliance purposes, and the 

challenges of applying dealer or major 

participant regulatory requirements to 

only a portion of the entity’s securitybased swap business. Instead, we will 

consider limited purpose applications 

on an individual basis through analysis 

of the unique circumstances of each 

applicant.1484

We note that the available data does 

not indicate how many, or which, 

entities may have business models that 

conceivably could make limited 

purposed designations appropriate (e.g., 

large positions in one major category of 

security-based swaps accompanied by 

minor positions in the other).1485

B. Inter-Affiliate Exclusions From Dealer 

and Major Participant Definitions 

Exchange Act rules 3a67–3 and 3a71– 

1 respectively exclude inter-affiliate 

security-based swaps from the 

calculation of substantial position and 

substantial counterparty position 

thresholds under the major participant 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30729 

1486See parts II.C.2.b and IV.G.2, supra 

(discussing nature of inter-affiliate security-based 

swap transactions). 

1487See parts IV.C.5.a and IV.C.5.b, supra 

(discussing rationale for excluding hedges of 

speculative and trading positions from the 

definition). 

1488See Federal Reserve Bank of New York staff 

reports, ‘‘An Analysis of CDS Transactions: 

Implications for Public Reporting’’ (2011) at table 3 

(‘‘NY Fed analysis’’) (available at http:// 

www.newyorkfed.org/research/staff_reports/ 

sr517.pdf) (discussing credit default swap trade 

frequency by market type, and indicating that most 

activity is done by entities of a financial nature). 

1489See part IV.F.2.b, supra. 

1490See part IV.F.3.b, supra (discussing the 

rationale for using a 12 to 1 ratio for purposes of 

defining the term ‘‘highly leveraged’’ in the context 

of the major participant definitions). 

definition, and from the de minimis 

calculation under the dealer definition. 

The inter-affiliate exclusion from the 

major participant and dealer definitions 

has the potential to affect the scope of 

these definitions for those entities that 

engage in inter-affiliate transactions by 

leading some entities not to meet the 

major participant or dealer de minimis 

thresholds when they otherwise would 

have met those thresholds (or by 

allowing certain centralized hedging 

facilities to look only at their marketfacing activities in conducting the 

dealer-trader analysis). The exclusion or 

inclusion of certain inter-affiliate 

transactions thus may have some impact 

on the programmatic costs and benefits 

associated with dealer and major 

participant regulation. 

We are adopting a majority-ownership 

standard for determining whether 

transactions between affiliates can be 

excluded from these threshold 

calculations because such transactions 

between entities whose economic 

interests are aligned to a degree 

represented by majority ownership do 

not appear to pose the kinds of 

counterparty and market risks that Title 

VII addresses.1486 Some commenters 

suggested lower levels of control (such 

as common control) that may be 

expected to lead to fewer entities being 

registered as dealers or major 

participants, with associated impacts on 

programmatic costs and benefits. In our 

view, however, such alternative 

standards would not be consistent with 

the scope of the interactions to which 

dealer regulation is intended to apply, 

or with an alignment of economic 

interests consistent with an exclusion 

from the major participant definitions. 

We also note that the data upon 

which the staff assessment of credit 

default swap transactions and positions 

is based excludes certain inter-affiliate 

credit default swap transactions. As a 

result, estimates of market concentration 

and the distribution of dealing activity 

or credit default swap positions derived 

from this data should reflect to some 

extent the effect of the inter-affiliate 

exclusions we are adopting in this rule. 

C. Commercial Risk Hedging Exclusion 

Exchange Act rule 3a67–4 defines 

‘‘hedging or mitigating commercial risk’’ 

as that term is used in the major 

participant definition. The scope of this 

definition has the potential to determine 

whether certain market participants will 

be major participants by virtue of the 

first statutory major participant test, and 

will therefore affect the scope of the 

programmatic costs and benefits 

associated with major participant 

regulation. In application, this effect 

may be limited in light of the fact that 

we estimate that, as discussed above, 

only five or fewer entities—perhaps as 

few as zero—may have to register as 

major security-based swap participants. 

The final rule adopts an 

‘‘economically appropriate’’ standard 

for determining whether a securitybased swap position hedges or mitigates 

commercial risk, and sets forth 

exclusions for security-based swap 

positions that have a speculative or 

trading purpose. As we discuss above, 

we carefully considered the alternative 

approaches suggested by some 

commenters, including the suggestion 

that the definition should encompass 

positions that hedge speculative or 

trading positions and the suggestion that 

the definition should incorporate a 

‘‘congruence’’ standard. We concluded, 

however, that these approaches are 

inconsistent with the focus of the 

statutory text, which is on ‘‘commercial 

risk.’’ 1487 We also concluded that 

broadening the exclusion as some 

commenters suggested could largely 

exclude security-based swap positions 

from the first major participant test. 

This would produce a result that we 

believe to be contrary to the purposes of 

that part of the statutory definition, 

which envisions that entities might be 

required to register as major participants 

by virtue of their security-based swap 

positions. 

D. ‘‘Financial Entity’’ Definition 

Exchange Act rule 3a67–6 defines 

‘‘financial entity’’ for purposes of the 

third test of the major participant 

definition, which applies to certain 

highly leveraged non-bank financial 

entities and does not prevent them from 

excluding commercial risk hedging 

positions when conducting the 

substantial position analysis (in contrast 

to the first test within the major 

participant definition, which permits 

exclusion of those hedging positions). 

Although the scope of the financial 

entity definition has the potential to 

affect the number of persons who are 

captured by the third test of the 

statutory major participant definition 

(and thus, by extension, the 

programmatic costs and benefits 

associated with major participant 

regulation), we believe that as a 

practical matter such an effect would be 

minimal. This is based on our view that 

persons that have security-based swap 

positions large enough and risky enough 

to potentially lead to major participant 

status to be financial in nature and thus 

would likely fall within any reasonable 

interpretation of the term ‘‘financial 

entity,’’ 1488 thus making such entities 

potentially subject to the third major 

participant test (to the extent that such 

entities are subject to bank capital 

requirements). 

E. ‘‘Highly Leveraged’’ Definition 

Exchange Act rule 3a67–7 defines 

‘‘highly leveraged’’ for purposes of the 

third prong of the major participant 

definition, which applies to certain nonbanks as described above. In adopting 

the final rule, we have considered 

alternative approaches suggested by 

commenters. For example, a number of 

commenters favored the use of a 15 to 

1 leverage ratio, which may be expected 

to reduce the number of persons who 

are deemed to be ‘‘highly leveraged’’ 

and thus subject to the third test. 

Conversely, some commenters favored a 

ratio that is lower than the one found in 

the final rule, which may be expected to 

increase the number of entities deemed 

to be highly leveraged.1489

The final rule defines ‘‘highly 

leveraged’’ as a leverage ratio of 12 to 1 

or higher. In our view, this ratio 

reasonably sets forth objective criteria 

for identifying entities that pose a 

heightened risk of being unable to meet 

their obligations through their use of 

leverage. This 12 to 1 ratio reflects a 

number of factors, including the use of 

a 12 to 1 ratio in connection with 

certain broker-dealer capital rules, as 

well as reasons to distinguish the use of 

a 15 to 1 ratio in Title I of the DoddFrank Act.1490

As with the financial entity definition 

in rule 3a67–6, as a practical matter we 

do not believe that expanding or 

narrowing the leverage ratio within any 

reasonable definition of ‘‘highly 

leveraged’’ for purposes of the third 

major participant test will have a 

significant impact on the programmatic 

costs and benefits of major participant 

regulation. In part, this is because we 

believe that in many circumstances the 

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1491See note 1019, supra. 

1492See part IV.A.3 (discussing rationale for final 

‘‘major’’ categories). 

1493 In other words, the dividing line that the rule 

sets between the major category of debt-based 

security-based swaps and the major category for 

other security-based swaps (or other dividing lines 

based on different or additional major categories) 

could determine whether an entity’s security-based 

swap positions exceed or fall below the major 

participant thresholds for a particular major 

category, and hence whether the entity will be 

deemed to be a major participant. 

1494See note 476, supra. 

1495For example, an alternative approach might 

divide narrow-based index CDS and single-name 

CDS into separate major categories. We believe, 

however, that single-name CDS account for the 

large majority of debt-based security-based swaps, 

see id., suggesting that most entities’ status as major 

participants would turn on their single-name CDS 

exposures under any reasonable approach to 

defining major categories and that the subtraction 

of narrow-based index CDS exposures in the 

calculation of substantial exposure would, given 

their relatively small market volume, have little 

effect on whether most entities meet the substantial 

exposure threshold. Thus, we believe that the 

decision to classify all debt-based security-based 

swaps in a single category will likely have minimal 

effect, if any, on any entity’s status as a major 

participant, as compared to dividing debt-based 

security-based swaps into two categories. 

1496See part IV.M.2, supra. 

1497See part IV.H.3, supra. 1498See parts II.A.6 and IV.J, supra (stating that 

such exclusions from the dealer definition would 

have no basis in the statutory text and would be 

inconsistent with the activity focus of the dealer 

definition, and not providing entity exclusions from 

the major participant definition because entities 

that meet the thresholds of the rules may pose high 

risk to the U.S. financial system regardless of how 

they are organized). 

sales of credit protection cannot 

reasonably be interpreted to constitute 

the hedging of commercial risk,1491

meaning that such positions in any 

event may be expected to be considered 

as part of the analysis of the first major 

participant test. The programmatic 

impact of this definition further is 

mitigated by the fact that we believe that 

there will be relatively few entities 

whose security-based swap positions 

would cause them to be major 

participants. 

F. ‘‘Major’’ Categories of Security-Based 

Swaps 

Exchange Act rule 3a67–2 defines 

‘‘major’’ categories of security-based 

swaps, a term that plays a role in the 

two statutory major participant tests that 

turn upon the presence of a substantial 

position in a ‘‘major’’ category of 

security-based swaps. The final rule 

retains the proposal’s division of those 

instruments into debt-based and other 

categories. As discussed above, these 

major categories are broadly consistent 

with market usage and statistics, and we 

believe that it is reasonable for entities 

undertaking this analysis to use these 

categories in calculating whether they 

have a substantial position.1492

In theory, it is possible that the 

categorization of security-based swaps 

for these purposes could result in a 

particular entity exceeding the 

applicable thresholds in a major 

category, causing it to be a major 

security-based swap participant and 

triggering the Title VII registration and 

regulatory requirements.1493 The 

relationship between the major securitybased swap categories as we have 

defined them in this rule and the 

programmatic costs and benefits 

associated with major participant 

regulation will depend largely on how 

the security-based swap positions of 

entities with security-based swap 

exposures approaching these thresholds 

are distributed between these categories. 

The available data suggests that the 

debt-based major category (i.e., credit 

default swaps) accounts for the vast 

majority of security-based swap 

positions.1494 Absent an approach that 

breaks single-name credit default swaps 

in to multiple ‘‘major’’ categories— 

which itself would not appear to be 

justified based on current information— 

this suggests that this categorization as 

a practical matter will not have a 

significant effect on the programmatic 

costs and benefits of major participant 

regulation.1495

G. Registration Period 

Exchange Act rules 3a67–8 and 3a71– 

2 establish periods for registration as a 

dealer and major participant, as well as 

periods for revaluating or terminating 

one’s status as a registered entity. As 

such, these provisions may affect the 

length of time that particular entities 

may be deemed to be major participants 

or dealers, and hence subject to the 

requirements applicable to those 

entities. However, any effect of delaying 

or accelerating dealer or major 

participant status on the programmatic 

costs and benefits associated with major 

participant or dealer status likely will be 

negligible compared to the overall 

programmatic costs and benefits 

associated with major participant or 

dealer regulation. 

H. Calculation Safe Harbor 

Exchange Act rule 3a67–9 establishes 

a calculation safe harbor for the major 

participant threshold tests. We do not 

believe that this safe harbor changes the 

scope of the major participant 

definition, as it should not exclude from 

the major participant definition any 

entity that would otherwise fall within 

the definition if that entity performed 

the substantial position calculations.1496

Accordingly, we do not believe that the 

safe harbor would have a material effect 

on the programmatic costs and benefits 

associated with major participant 

regulation. 

I. Interpretation Related to Guarantees 

In adopting these final rules, we also 

have finalized an interpretation 

regarding when a person will have 

security-based swap positions attributed 

to it by virtue of having guaranteed the 

positions of another party. In general, 

we have clarified that an entity’s 

security-based swap positions need not 

be attributed to its parent unless the 

counterparty has recourse to the parent. 

We also clarified that, even in the 

presence of a guarantee, positions of 

certain regulated entities—including 

swap dealers, security-based swap 

dealers, major participants, brokerdealers, FCMs and certain entities 

subject to U.S. bank capital 

requirements—will not be attributed to 

the guarantor.1497

We recognize that attributing securitybased swap positions to the entity 

guaranteeing another entity’s securitybased swap transactions may increase 

the number of major participants. At the 

same time, excluding certain regulated 

entities from the attribution requirement 

even in the presence of a guarantee may 

help prevent a guarantor, such as a 

holding company, from being deemed to 

be a major participant when the risks 

associated with those positions already 

are subject to regulation. 

We do not currently possess data 

relating to the existence of guarantees of 

the security-based swap positions of 

other parties and thus cannot reasonably 

estimate the number of additional 

entities that may be brought within the 

ambit of major participant regulation by 

virtue of this interpretation. However, 

we note that, to the extent that 

guarantees of another entity’s securitybased swap positions creates the level of 

exposure—and corresponding risk to the 

market and to counterparties—that 

warrants regulation under Title VII, it 

would appear inconsistent with the 

purposes of the statute not to subject 

that entity to major participant 

regulation. 

J. Other Interpretations 

Finally, in this release we also have 

provided a number of additional 

interpretations and discussions in 

connection with the dealer and major 

participant definitions. These include, 

among others: the rejection of requests 

for entity-specific exclusions from the 

dealer and major participant 

definitions; 1498 interpretations 

regarding the application of the ERISA 

exclusion from the first major 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30731 

1499See part IV.D, supra (interpreting the 

provision to exclude security-based swap positions 

entered into for the primary purpose of hedging or 

mitigating risks associated with operation of the 

plan, consistent with the statutory language that 

does not limit the hedging exclusion for ERISA 

plans to commercial risk; also clarifying that such 

positions may be eligible for exclusion even if they 

are held by a non-plan entity that holds plan 

assets). 

1500See part IV.I, supra (clarifying that the 

position will be attributed to the client account 

rather than to the investment advisers or asset 

managers and that a beneficial owner should be 

required to treat the positions of such an account 

as its own only if the security-based swap 

counterparty has recourse to the beneficial owner). 

1501For example, attributing security-based swap 

positions to investment advisors would have 

increased the likelihood of advisers being deemed 

to be major participants. Our interpretations do not 

take that approach, however, as we believe that it 

would be inconsistent with the focus of the 

statutory definition. 

1502These costs are distinguishable from the costs 

associated with registration as a dealer or major 

participant (which for purposes of this analysis we 

treat programmatic costs) and the other 

programmatic costs discussed above. 

1503See part II.A.5, supra. 

1504These include suggestions that: the dealer 

definition should be interpreted to be coextensive 

with the concept of market making activity; the 

dealer definition requires that a person be available 

to take either side of the market at any time; the 

dealer definition should not extend to persons 

solely engaged in security-based swap activity on 

swap execution facilities; the dealer definition 

should exclude persons whose security-based swap 

dealing activity is relatively small compared to its 

other activities; and dealing activity requires the 

presence of a ‘‘customer’’ relationship. See id. 

(discussing interpretive approach to ‘‘security-based 

swap dealer’’ definition). Conversely, a few 

commenters suggested rejection of the dealer-trader 

distinction, and implied that the dealer definition 

should be applied more broadly. See id. 

These also include suggestions that the dealer 

analysis incorporate particular per se exclusions. 

Although we recognize that such approaches may 

be simpler for market participants to implement, we 

nonetheless do not believe that such per se 

exclusions would be consistent with the statutory 

definition, which identifies dealers based on their 

security-based swap activities. See part II.A.6, supra 

(discussing reasons not to include per se exclusions 

from the dealer definitions). 

1505See parts II.D.3 and II.D.5, supra. 

1506Of 1,084 entities with single-name credit 

default swap transaction activity over the 12 

months ending in December 2011, 961 entities, or 

88.7 percent, engaged in less than $3 billion 

notional in such activity. These 961 entities were 

responsible for approximately 3.2 percent of the 

notional value of all single-name credit default 

swap transactions during that period. See CDS Data 

Analysis, table 1. 

1507The use of the $8 billion phase-in level in 

connection with these activities may also be 

expected to temporarily mitigate such costs. 

1508See CDS Data Analysis, table 1. The Federal 

Reserve Bank of New York has published data that 

is consistent with this analysis. See NY Fed 

analysis at 10 (noting that for a three month period 

spanning from May through July of 2010, there were 

933 unique market participants in the credit default 

swap market). 

As noted above, see note 148, supra, in relying 

on the available data we are not indicating our 

views as to the application of Title VII to non-U.S. 

Continued 

participant test,1499 and interpretations 

regarding the application of the major 

participant analysis to managed 

accounts.1500 In theory, each of these 

interpretations potentially has a 

programmatic impact.1501 For the 

reasons discussed above, we believe that 

these interpretations reflect reasonable 

choices. 

3. Analysis of Assessment Costs 

Certain persons engaged in securitybased swap activity are likely to incur 

costs in connection with evaluating 

whether they fall within the dealer or 

major participant definitions.1502 As 

detailed below, we have considered 

these assessment costs in adopting 

definitional rules and interpretations 

that seek to capture entities whose 

security-based swap activity or whose 

security-based swap positions warrant 

regulation under Title VII as dealers or 

major participants, while excluding 

entities whose activity or positions do 

not warrant such regulation. 

a. Assessment Costs Associated With 

the ‘‘Security-Based Swap Dealer’’ 

Definition 

i. Core Dealer Analysis and De Minimis 

Exception 

A. Overview 

Exchange Act rule 3a71–1 in part 

restates the statutory definition of 

‘‘security-based swap dealer’’ to 

consolidate the definition and related 

interpretations for market participants’ 

ease of reference. In conjunction with 

these final rules the SEC has set forth 

interpretations to provide additional 

guidance to implement the statutory 

approach of capturing persons that 

engage in certain security-based swap 

activities while excluding persons that 

do not engage in those activities as part 

of a ‘‘regular business.’’ 1503 We believe 

that this guidance—including its 

reliance on the distinction between 

dealing activity and non-dealing activity 

such as hedging or trading—will allow 

a number of market participants to 

readily conclude that their securitybased swap activities will not cause 

them to be security-based swap dealers. 

In adopting this approach, we have 

considered alternative views, expressed 

by some commenters, that would have 

had the effect of narrowing the statutory 

definition’s scope.1504

Exchange Act rule 3a71–2 specifies 

when a person that otherwise would be 

a security-based swap dealer can take 

advantage of the de minimis exception. 

In adopting the rule’s tests and 

thresholds—including the use of a $3 

billion notional threshold in connection 

with dealing activity involving credit 

default swaps that are security-based 

swaps, a $150 million notional 

threshold in connection with other 

types of security-based swaps, higher 

phase-in levels in connection with those 

thresholds, and a separate $25 million 

threshold in connection with dealing 

activity involving ‘‘special entities’’— 

we have considered a range of 

alternative approaches and thresholds 

suggested by commenters.1505

In application, the assessment costs 

associated with the core dealer test and 

de minimis exception are linked. 

B. Assessment Costs Associated With 

the Final Rules and Interpretations 

We recognize that certain participants 

in the security-based swap market may 

incur costs in connection with the factsand-circumstances analysis of whether 

they are security-based swap dealers as 

defined in the statute and in the final 

rules, particularly with regard to the 

application of the dealer-trader 

distinction and the de minimis 

exception. 

As noted above, analysis of market 

data indicates that the overwhelming 

number of participants in the singlename credit default swap market in 

2011 had total activities (dealing or nondealing) of significantly less than $3 

billion notional amount over the prior 

12 months.1506 In general—aside from 

potential dealing activity involving 

other types of security-based swaps and 

dealing activity involving ‘‘special 

entities’’—such persons likely would 

not be deemed to be security-based 

swap dealers regardless of whether their 

current level of security-based swap 

activities constitutes dealing (apart from 

those entities that increase their dealing 

activity following the implementation of 

Title VII). 

On the other hand, some market 

participants whose security-based swap 

activities exceed, or are not materially 

below, the $3 billion de minimis 

threshold may be expected to incur 

costs in connection with the dealer 

analysis. Those entities reasonably may 

conclude that they need to incur costs 

to analyze their security-based swap 

activities to determine whether those 

activities are non-dealing in nature (e.g., 

hedging or trading), or whether those 

activities instead are dealing in nature 

(e.g., part of a business purpose of 

providing liquidity in connection with 

security-based swaps), consistent with 

the statute and the rules and guidance 

provided in this release.1507

There are over 1,000 entities (U.S. and 

non-U.S.) that from time to time may 

engage in single-name credit default 

swap transactions.1508 Of this number, 

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30732 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

persons. Issues regarding the extraterritorial 

application of Title VII instead will be addressed in 

a separate release. 

1509See CDS Data Analysis, table 1. This 

approach potentially overstates the number of 

entities that would need to engage in the analysis. 

Of entities with more than $3 billion in activity 

over the trailing 12 month period, some number can 

be expected to determine, given the nature of their 

business, that they are (or are not) dealers under the 

definition without having to engage in this analysis. 

For example, the NY Fed analysis discussed above 

found that so-called G14 dealers were responsible 

for roughly 78 percent of CDS transactions as buyer 

and 85 percent of CDS transactions as sellers, and 

that so-called ‘‘other dealers’’ were responsible for 

approximately an additional seven percent of CDS 

transactions as sellers and six percent as buyers. 

See NY Fed analysis at 9, table 3. Many of these 

entities would likely determine that performing this 

analysis was unnecessary. 

1510For the reasons stated above, we also believe 

that this number potentially overstates the number 

of entities with less than $3 billion in activity over 

the trailing 12 month period that would be likely 

to engage in this analysis. Because it appears that 

all entities engaged in security-based swap 

transactions with special entities engaged in more 

than $8 billion in security-based swap transactions 

in 2011, see CDS Data Analysis at 21 n.8, we do 

not expect that the de minimis threshold for dealing 

activity involving special entities to cause market 

participants to incur costs independent of those 

associated with the general de minimis threshold. 

1511The CDS Data Analysis uses criteria that 

screen for likely characteristics of entities engaged 

in dealing activity. See CDS Data Analysis at 2. 

However, the available data does not permit 

identification of which of these entities’ 

transactions arise from dealing activity and which 

arise from non-dealing activity (such as proprietary 

trading or hedging). It is therefore likely that the 

notional amounts provided in each table of the data 

analysis include both dealing and non-dealing 

activity. For purposes of the economic analysis of 

our rules further defining ‘‘security-based swap 

dealer,’’ we have assumed that the entire notional 

amount for each entity appearing in Tables 2–9 

represents dealing activity. Although this 

potentially results in an overestimate of dealing 

activity for these entities—and thus in an 

overestimate of the costs associated with 

conducting the dealer analysis—we believe that this 

represents a conservative approach to evaluating 

the assessment costs of these rules. 

1512This total is based on the assumption that 166 

market participants would seek outside legal 

counsel to determine their status under the 

security-based swap dealer definition, with such 

analysis costing an average of $25,000 per entity. 

The average cost incurred by such entities in 

connection with outside counsel is based on staff 

experience in undertaking legal analysis of status 

under federal securities laws, and assumes that the 

legal analysis for a complex entity on average may 

cost $30,000, and that the legal analysis for a less 

complex entity on average may cost $20,000. The 

use of inside counsel in lieu of outside counsel 

would reduce this upper bound. 

We recognize that the complexity of market 

participants may vary greatly, and that we do not 

have insight into market participants such that we 

could reasonably determine how many entities may 

be considered more or less complex for these 

purposes. Thus, based on our understanding of the 

market we believe that an average of the costs 

associated with more complex and less complex 

entities equaling $25,000 would reasonably 

approximate the average costs for entities across the 

credit default swap market, assuming that all such 

participants perceive a need to retain outside 

counsel for purposes of the analysis. 

1513We note that different cost estimates have 

been used for purposes of the ‘‘swap dealer’’ 

definition under the CEA. We do not believe that 

the estimate of the number of persons who would 

have to engage in a dealer analysis under the CEA 

would be germane to the analysis of the costs 

associated with the Exchange Act’s ‘‘security-based 

swap dealer’’ definition, given the wide range of 

markets that are exclusive to the ‘‘swap’’ definition. 

We also do not believe that the basis that underpins 

the CFTC’s estimate of the cost of performing the 

dealer analysis under the definition of swap as set 

forth in the CEA would be relevant to the Exchange 

Act definition. In part, this is because we believe 

that the entities whose security-based swap 

activities may cause them to be dealers likely would 

have businesses that are financial in nature. We 

thus expect that those entities would be particularly 

sensitive to the link between the business purpose 

of their activities and the dealer definition. In many 

cases those entities also should be familiar with the 

use of the dealer-trader distinction in connection 

with their activities involving other types of 

securities. 

We also note that different cost estimates have 

been used for purposes of the de minimis exception 

under the CEA. We expect, however, that entities 

whose security-based swap activities may cause 

them to be dealers likely would have businesses 

that are financial in nature. We thus expect that 

those entities would: (a) be well placed to 

distinguish their security-based swap dealing 

activities from their non-dealing activities under the 

dealer-trader distinction; and (b) would be familiar 

with the notional amount of their security-based 

swap activities over the prior year. 

1514See, e.g., OCC Quarterly Report at tables 1 

and 10 (listing notional credit and equity 

derivatives for largest U.S. banks and trust 

companies). See also note 429, supra. 

1515We believe that any such costs would be 

modest, in light of data indicating that persons who 

are counterparties to special entities in the singlename credit default swap market may otherwise 

have to register as dealers notwithstanding the 

lower threshold connected with special entities. See 

note 1510, supra. 

however, only 123 entities engaged in 

more than $3 billion in single-name 

credit default swap transactions over the 

previous 12 months. For purposes of 

analyzing the assessment costs of this 

rule, we have assumed that all of these 

entities would perform the dealer 

analysis.1509 We also recognize that 

some entities whose activities fall below 

the de minimis threshold may opt to 

engage in this analysis out of an 

abundance of caution or to meet internal 

compliance requirements, and for 

purposes of this analysis have assumed 

that the 43 entities whose activity 

during the trailing 12 month period fell 

between $2 and $3 billion also would 

engage in the dealer analysis, leading to 

a total of 166.1510

This estimate of 166 entities, although 

derived from data about total (dealing 

and non-dealing) transactions,1511

illustrates a potential upper bound for 

the total costs arising from securitybased swap dealer determinations, to 

the extent that all market participants 

whose security-based swap activity 

approaches or exceeds the $3 billion de 

minimis threshold identify a need to 

retain outside counsel to analyze their 

status under the security-based swap 

dealer definition. In that context, this 

estimate suggests that the costs of 

analysis may approach $4.2 million.1512

In accounting for the de minimis 

exception in estimating these costs, we 

note our expectation that market 

participants generally would be aware 

of the notional amount of their activity 

involving security-based swaps as a 

matter of good business practice. 

Consequently, we would not expect 

market participants to incur costs in 

determining the availability of the de 

minimis exception significantly in 

excess of the costs associated with the 

general dealer determination.1513

We recognize that additional market 

participants may be expected to incur 

these types of assessment costs to the 

extent that they engage in activity 

involving other types of security-based 

swaps in an amount close to, or in 

excess of, $150 million annually. 

Because the market for these other types 

of security-based swaps appears to be 

highly concentrated (like the singlename credit default swap market) and to 

involve many of the same entities,1514

we expect the number of entities that 

will incur assessment costs solely by 

virtue of this lower threshold also to be 

small. 

In addition, we recognize that some 

market participants potentially may 

incur these types of assessment costs to 

the extent they engage in security-based 

swap activities in an amount close to, or 

in excess of, $25 million annually.1515

For the reasons discussed above we 

believe that the approach we are 

adopting in the final rules is necessary 

and appropriate given the goals of Title 

VII and the statute’s express 

requirement that we implement a de 

minimis exception to the dealer 

definition. 

ii. Additional Issues Related to the 

Dealer Analysis 

A. Limited Designation of Dealers 

Exchange Act rule 3a71–1(c) 

implements the portion of the ‘‘securitybased swap dealer’’ definition that 

provides for limited purpose registration 

of dealers. The rule provides for a 

presumption that a person that acts as 

a security-based swap dealer is a dealer 

with regard to all of its security-based 

swaps or security-based swap activities, 

unless the SEC limits its designation. 

While we recognize that permitting 

persons to more broadly take advantage 

of limited dealer designations 

potentially would lower the cumulative 

costs that individual dealers otherwise 

would incur to determine whether to 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30733 

1516A default presumption in favor of the 

availability of limited designations may be expected 

to reduce the costs associated with an entity 

determining whether it qualifies for such relief, 

such as the costs of hiring outside legal counsel to 

undertake this analysis to determine that they could 

take advantage a limited designation relief. 

1517 In this regard we note the relative lack of data 

about the types of security-based swap positions 

held by particular entities that will fall within the 

dealer definition. Our decision takes into account 

the difficulty of separating a dealer’s activities from 

its non-dealing activities for compliance purposes, 

and the challenges of applying dealer requirements 

to only a portion of the entity’s security-based swap 

activities. In reaching our decision, we have 

especially been influenced by the statutory 

definition’s discretionary language in connection 

with the potential for limited designations, and by 

the need for persons subject to limited designations 

to be able to comply with the statutory and 

regulatory requirements applicable to major 

participants. See part II.E.3, supra (discussing 

limited designation principles applicable to 

dealers). 

We note that the discussion of limited 

designation of ‘‘swap dealers’’ under the CEA 

generally seeks to quantify the costs associated with 

applications for limited designations. However, we 

believe that the costs of applying for a limited 

designation are dependent upon the application 

process for this type of registration category. As 

noted previously, the SEC expects to address the 

limited designation application process for securitybased swap dealers in separate rulemakings. See id. 

As such, we believe that the costs associated with 

security-based swap dealer limited designation 

applications under the Exchange Act are more 

appropriately addressed in the context of those 

separate rulemakings. 

1518As discussed above, see note 1457, supra, we 

have estimated that 50 or fewer entities ultimately 

may have to register as security-based swap dealers. 

1519See part II.C.2, supra. 

1520See part II.D.6, supra (discussing rational for 

final rule addressing registration period for entities 

that exceed the de minimis threshold). 

1521For example, a shorter period for registration 

might be expected to cause some entities to incur 

over-time costs arising from the need to complete 

the registration process within a short time frame, 

whereas a longer time period could have enabled 

such an entity to avoid those costs. 

1522See part IV.B.3, supra (discussing basis for 

the substantial position analysis we are adopting). 

1523See part IV.E.3, supra (discussing basis for 

the substantial counterparty exposure analysis we 

are adopting). 

seek a limited designation,1516 after 

careful consideration of commenter 

concerns we have determined that it is 

appropriate to adopt a presumption 

against limited designation.1517

Certain persons who satisfy the dealer 

definition may incur costs in 

determining whether to seek a limited 

designation. We believe that such costs 

would affect no more than the 166 

entities that potentially may be expected 

to engage in the dealer analysis,1518 and 

expect these costs to be included in the 

estimated costs of seeking outside legal 

counsel described above. 

B. Exclusion of Inter-Affiliate SecurityBased Swaps 

Exchange Act rule 3a71–1 also 

provides that security-based swaps 

between majority-owned affiliates will 

be excluded for purposes of the dealer 

analysis. After consideration of 

commenter views, we are adopting this 

standard, rather than potential 

alternatives such as a common control 

test, because we believe that it is 

appropriate, in light of the goals of Title 

VII, that the dealer definition not 

capture entities by virtue of securitybased swap transactions with affiliated 

entities that have a sufficient alignment 

of economic interests to avoid raising 

systemic risk, customer protection, and 

other concerns that dealer regulation is 

intended to address.1519 Moreover, we 

note that a majority-ownership test 

should, given its objective nature, 

impose fewer assessment costs on 

market participants than a more 

subjective common control test. 

Some market entities may need to 

incur costs in connection with 

determining whether particular 

security-based swap positions may be 

excluded from the dealer analysis by 

virtue of the inter-affiliate exclusion. 

Such costs potentially could be incurred 

by any of the approximately 166 entities 

that we believe may engage in the dealer 

analysis. The costs specifically 

associated with that assessment may 

vary depending on factors including the 

extent to which those entities engage in 

inter-affiliate security-based swaps, but 

we expect these costs to be included in 

the estimated costs of seeking outside 

legal counsel described above. 

C. Timing Issues Connected to the De 

Minimis Exception 

In response to commenter concerns, 

Exchange Act rule 3a71–2 specifies that 

an entity that no longer may rely on the 

de minimis exception, because its 

dealing activity has exceeded the 

exception’s thresholds, has two months 

to submit a completed application to 

register as a dealer.1520 The final rule 

also specifies that a person who has 

been registered as a dealer for at least 12 

months may withdraw from registration 

while continuing to engage in a limited 

amount of dealing activity under the 

exception. 

In adopting these rules we have 

carefully considered alternatives that 

would lead to slower entry and faster 

exit from dealer status, and we 

recognize that providing particular 

entities with additional time to register 

as a dealer may have the potential to 

reduce the costs associated with the 

registration process.1521 We believe, 

however, that a two-month period for 

registration should provide entities with 

sufficient time to register without 

incurring additional expenses—both for 

large firms with security-based swap 

businesses well above the $3 billion 

threshold, and for mid-sized firms that 

fluctuate near the $3 billion threshold 

amount. We also conclude that this 

approach will appropriately help to 

avoid applying dealer requirements to 

entities that no longer meet the dealer 

criteria, and will avoid the prospect of 

persons moving in and out of dealer 

status overly frequently. 

b. Assessment Costs Associated With 

the ‘‘Major Security-Based Swap 

Participant’’ Definition 

i. ‘‘Substantial Position’’ and 

‘‘Substantial Counterparty Exposure’’ 

Definitions 

A. Overview of ‘‘Substantial Position’’ 

and ‘‘Substantial Counterparty 

Exposure’’ Definitions 

Exchange Act rule 3a67–3 defines the 

term ‘‘substantial position’’ for purposes 

of the first and third tests of the 

statutory major participant definition 

(which address whether a person has a 

‘‘substantial position’’ in a major 

category of security-based swaps). The 

final rule sets forth two tests for 

identifying the presence of a substantial 

position—one test based on a $1 billion 

daily average measure of 

uncollateralized mark-to-market 

exposure, and one based on a $2 billion 

daily average measure of combined 

uncollateralized mark-to-market 

exposure and potential future exposure. 

Both of those daily measures would be 

calculated and averaged over a calendar 

quarter. In developing the ‘‘substantial 

position’’ tests and their associated 

thresholds, we have sought to capture 

those entities whose security-based 

swap positions have the potential to 

pose significant risks to financial 

markets, while not capturing other 

entities for which major participant 

regulation and its associated costs 

would be unwarranted.1522

Exchange Act rule 3a67–5 defines 

‘‘substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets,’’ a phrase that comprises part 

of the second test of the ‘‘major securitybased swap participant’’ definition. The 

analysis set forth in this rule parallels 

the ‘‘substantial position’’ analysis, but: 

(i) Contains higher thresholds; (ii) 

examines an entity’s security-based 

swap positions as a whole (rather than 

focusing on a particular ‘‘major’’ 

category); and (iii) would not exclude 

certain hedging positions.1523

In adopting these definitions, we 

carefully considered alternative 

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30734 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1524See parts IV.B.2 and IV.E.2, supra. 

1525See part IV.B.3, supra (discussing the 

decisions made regarding the substantial position 

definition and the reasoning behind the adopted 

approach). For example, we have concluded that 

the proposed thresholds are set prudently in a 

manner that takes into account the financial 

system’s ability to absorb losses of a particular size, 

the need for major participant regulation not to 

encompass entities only after they pose significant 

risks to the market, and the need to account for the 

possibility that multiple market participants may 

fail close in time. In addition, as discussed above, 

we believe that this threshold is tailored to address 

the types of events associated with the failure of 

AIG FP. See part IV.B.3.d, supra. 

As discussed above, for an entity with no current 

uncollateralized exposure—and before accounting 

for netting—it would take a $100 billion notional 

portfolio of marked-to-market security-based swaps 

that reflect written protection on credit to meet the 

$2 billion potential future exposure threshold for 

security-based credit derivatives, and it would take 

a $200 billion notional portfolio of cleared positions 

to meet that threshold. Even in the absence of 

clearing or daily mark-to-market margining, it 

would take a minimum $20 billion notional 

portfolio of written protection on credit (reflecting 

the 0.10 multiplier in the risk adjustment tables) to 

meet the $2 billion potential future exposure 

threshold. Accounting for netting (which can 

reduce potential future exposure measures by up to 

60 percent) could materially increase that required 

amount. See note 914, supra. 

1526For example, because value-at-risk measures 

typically account only for market risk and not for 

other types of risk, an approach based on such 

measures would likely require separate calculations 

for these other risks, as well as calculations to 

account for possible losses in the event of a severe 

market downturn; such an approach would also 

require the selection of appropriate parameters for 

the test. See Concept Release: Net Capital, Exchange 

Act Rel. No. 39456, at 13–19 (comparing value-atrisk and haircut approaches to net capital 

calculations). 

1527See part IV.B.3.c, supra. 

1528 In the Proposing Release, we stated that based 

on our understanding of the market, we concluded 

that only 10 entities had security-based swap 

positions of a size to necessitate performing the 

calculations to determine whether they meet those 

thresholds. See Proposing Release, 75 FR at 80207– 

08. Some commenters challenged the assumption 

that only approximately 10 entities would engage 

in the requisite calculations. Those commenters 

took the view that certain entities with smaller 

security-based swap positions would perceive a 

need to conduct the relevant calculations on a daily 

basis even if they are not reasonably likely to be 

major participants, and, to address that concern, 

requested a safe harbor from having to perform the 

major participant calculations. See letters from 

SIFMA AMG I and Vanguard. 

1529As discussed above, an entity that margins its 

positions daily generally would need to have 

security-based swap positions approaching $100 

billion notional to meet the substantial position 

threshold, assuming no current uncollateralized 

exposure, while an entity that clears those positions 

generally would need positions approaching $200 

billion notional to meet the threshold. See note 914, 

supra. We believe that it is reasonable to assume 

that most entities that will have security-based 

swap positions large enough to potentially cause 

them to be major participants in practice will post 

variation margin in connection with those positions 

that they do not clear, making $100 billion the 

relevant measure. The available data shows that as 

of December 2011 a single entity had aggregate 

gross notional positions from bought and sold credit 

protection exceeding $100 billion, four had 

aggregate gross notional single-name credit default 

swap positions exceeding $50 billion, and 12 had 

aggregate gross notional single-name credit default 

swap positions exceeding $25 billion. See CDS Data 

Analysis at table 10. Making allowances for certain 

entities that may determine, due to internal policies 

or other reasons, that they need to conduct this 

analysis and cannot rely on the calculation safe 

harbor we also are adopting, we believe that it is 

reasonable to assume that entities with aggregate 

gross notional single-name credit default swap 

positions exceeding $25 billion may identify a need 

to perform the major participant analysis. (In the 

Proposing Release, we stated that based on our 

understanding of the market, we thought that fewer 

than ten entities had security-based swap positions 

of a size to necessitate performing the calculations 

to determine whether they meet those thresholds. 

See Proposing Release, 75 FR at 80207–08.) 

We believe, moreover, that the estimate that 12 

entities will perceive a need to perform this 

analysis in practice may overstate the number of 

entities that reasonably will find it necessary to 

perform the major participant analysis, given that 

only four entities had $25 billion or more of 

aggregate gross notional single-name credit default 

swap positions arising from the selling of credit 

protection. See id. As discussed above, moreover, 

we believe that fewer than five entities ultimately 

may be required to register as major security-based 

swap participants. See part VIII.A.2.d.i.C, supra. 

Finally, we note that this estimate may also 

overstate the size of positions held by individual 

legal entities, thus further overstating the number 

of legal entities that have security-based swap 

positions of such a size as to potentially trigger 

major participant status. This is because the data in 

the analysis at times aggregates multiple affiliated 

accounts—which may reflect the legal entities that 

are counterparties to the security-based swap—at 

the parent level. While such aggregation is 

appropriate for these purposes given that parents 

may be deemed to be major participants by virtue 

of security-based swap positions that they 

guarantee, the aggregation in fact may tend to 

overstate the extent to which a legal entity bears 

credit risk in connection with security-based swaps. 

To the extent that an entity’s security-based swap 

transactions are not cleared or associated with the 

posting of variation margin, security-based swap 

positions of $20 billion may lead to sufficient 

potential future exposure to cause the entity to be 

a major participant. As we have noted, we believe 

that few if any entities with significant securitybased swap positions will have a significant 

number of such transactions. Even then, the data 

indicates that only a total of 32 entities have 

notional credit default swap positions in excess of 

$10 billion. See CDS Data Analysis at table 10 

(showing that 32 entities have aggregate gross 

single-name credit default swap positions of $10 

billion or greater). 

1530E.g., letter from WGCEF II (addressing 

technical complexity of the proposed major 

participant calculations). 

1531Based on industry discussions, in the 

Proposing Release we estimated that those 10 

entities would incur one-time programming costs of 

approximately $13,444 per entity, or $134,440 in 

total, and that these entities would incur annual 

ongoing costs of $7,260 per entity, or $72,600 in 

total. See Proposing Release, 75 FR at 80207–08, 

nn.183–86 and accompanying text (providing a 

summary of the methodology used to estimate these 

costs). The hourly cost figures in the Proposing 

Release for the positions of Compliance Attorney, 

Compliance Manager, Programmer Analyst, and 

Senior Internal Auditor were based on data from 

SIFMA’s Management & Professional Earnings in 

the Securities Industry 2009. For purposes of the 

cost estimates in this release, we have updated 

these figures with more recent data as follows: the 

figure for a Compliance Attorney is $322/hour, the 

figure for a Compliance Manager is $279/hour, the 

figure for a Programmer Analyst is $196/hour, and 

the figure for a Senior Internal Auditor is $198/ 

approaches suggested by commenters, 

including suggestions that the 

thresholds should be raised or lowered, 

and that certain positions should be 

excluded from the potential future 

exposure test, or that the test should 

discount certain positions 

differently.1524 We have retained the 

tests largely as proposed, however, as 

we believe that the tests appropriately 

address the risk criteria embedded in 

the major participant definition.1525 We 

also believe that the tests minimize the 

assessment costs to these entities in a 

manner consistent with the statutory 

definition. For example, the decision to 

base the potential future exposure 

analysis on tests used by bank regulators 

for purposes of setting prudential 

capital reflects our view that it would be 

appropriate to implement the analysis 

by building upon an existing regulatory 

approach that is less subjective—and 

thus less costly—for market participants 

to utilize (as compared to, for example, 

a VaR approach 1526) and would lead to 

reproducible results, rather than seeking 

to develop a brand new approach.1527

B. Assessment Costs Associated With 

the Final Rules Defining ‘‘Substantial 

Position’’ and ‘‘Substantial 

Counterparty Exposure’’ 

Certain market participants may be 

expected to incur costs in connection 

with the determination of whether they 

have a ‘‘substantial position’’ in 

security-based swaps or pose 

‘‘substantial counterparty exposure’’ in 

connection with security-based swaps. 

Based on a review of notional 

positions maintained in 2011 by entities 

with single-name credit default swap 

positions, we estimate that 

approximately 12 entities have securitybased swap positions of such an amount 

that, as a matter of prudence, they may 

reasonably find it necessary to engage in 

the requisite calculations, particularly 

given the additional availability of the 

calculation safe harbor.1528 In our view, 

the data indicates that other than 

approximately 12 entities, the nondealer market participants in the 

security-based swap market use these 

products in such limited amounts that 

they reasonably would conclude that 

they do not need to undertake the 

calculations used to determine whether 

they have a ‘‘substantial position.’’ 1529

Although some commenters noted 

concerns about the complexity of the 

major participant calculation,1530

commenters did not appear to directly 

question the Proposing Release’s perentity cost estimates.1531 After further 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30735 

hour, each from SIFMA’s Management & 

Professional Earnings in the Securities Industry 

2011, modified by SEC staff to account for an 1800- 

hour work-year and multiplied by 5.35 to account 

for bonuses, firm size, employee benefits, and 

overhead. We have also updated the Proposing 

Release’s $450/hour figure for a Chief Financial 

Officer, which was based on data from 2010. Using 

the consumer price index to make an inflation 

adjustment to this figure, we have multiplied the 

2010 estimate by 1.03 and arrived at a figure of 

$464/hour for a Chief Financial Officer in 2011. 

Incorporating these new cost figures, the updated 

one-time programming costs based upon our 

assumptions regarding the number of hours 

required in the proposing release would be $13,692 

per entity, or $136,920 in total, and the annual 

ongoing costs would be $7,428 per entity, or 

$74,280 in total. 

1532This revision in part is based on the addition 

of an ongoing cost of a Programmer Analyst who 

we estimate would spend an additional 40 hours 

annually on software maintenance attributable to 

the modifications made to an automated system to 

undertake these tests. We further estimate that the 

hourly wage of a Programmer Analyst would be 

approximately $196. The $196/hour figure for a 

Programmer Analyst is from SIFMA’s Management 

& Professional Earnings in the Securities Industry 

2011, modified by SEC staff to account for an 1800- 

hour work-year and multiplied by 5.35 to account 

for bonuses, firm size, employee benefits, and 

overhead. Based on these assumptions, we estimate 

these additional costs as $7,840 per year per entity 

and $94,080 per year for all entities as follows: 

(Programmer Analyst at $196 per hour for 40 hours) 

× (12 entities) = $94,080. 

1533These adjustments do not materially change 

the estimated costs associated with performing 

these calculations. 

To the extent that additional entities perceive a 

need to perform the major participant calculations 

provided by the rules, notwithstanding a relatively 

low position in security-based swaps, these costs 

would differ. For example, if we assume that 32 

entities will perceive the need to conduct the major 

participant analysis, see note 1529, supra, initial 

legal costs will total approximately $960,000 (based 

on the per-entity cost estimate of $30,000); one-time 

industry-wide costs would total approximately 

$440,000 (based on the per-entity cost estimate of 

$13,692); and annual industry-wide costs would 

total approximately $490,000 (based on the perentity cost estimate of $15,268 addressed below). 

At the extreme, available data indicates that 1,188 

participants have single-name credit default swap 

positions in the security-based swap market 

(excluding ISDA-recognized dealers and ICE Trust). 

See CDS Data Analysis at table 10, To the extent 

that none of these 1,188 entities avail themselves 

of the calculation safe harbor we are adopting, and 

that all of them engage in the full major participant 

analysis, then there potentially will be initial legal 

costs of approximately $35.6 million (based on the 

per-entity cost estimate of $30,000), one-time 

industry-wide costs of approximately $16.3 million 

(based on the per-entity cost estimate of $13,692), 

and annual industry-wide costs of approximately 

$18.1 million (based on the per-entity cost estimate 

of $15,268 addressed below). 

In practice, however, we think that the estimates 

for 12 entities more fairly assesses the relevant costs 

for the reasons discussed above. See note 1529, 

supra. In our view, a large number of participants 

in the market have notional security-based swap 

positions low enough to permit them to conclude 

that they do not have to engage in the relevant 

calculations. See id. 

1534See part VIII.A.3.b.i.A, supra. These costs 

would differ if additional entities perceive a need 

to perform the major participant calculations 

provided by the rules, notwithstanding a relatively 

low position in security-based swaps. Commenters 

have taken the view that more than 10 entities may 

identify a need to perform the requisite 

calculations. As already noted, based on the 

analysis of 2011 transaction data, we have revised 

this estimate upward to 12 entities, though we 

believe that the actual number is likely to be 

smaller. In any event, these concerns should be 

addressed by the calculation safe harbor that we are 

adopting as part of these final rules. 

1535See Proposing Release, 75 FR at 80209. 

1536We note that higher cost estimates have been 

used for purposes of the ‘‘major swap participant’’ 

definition under the CEA. We expect, however, that 

the entities that may have security-based swap 

positions of a size that could lead them to be major 

participants likely would have businesses that are 

financial in nature (rather than being non-financial 

entities that use security-based swaps as part of 

their commercial activities). As such, we would 

expect those entities to generally be cognizant of, 

or in a good position to obtain information about: 

their uncollateralized exposure with counterparties 

(to the extent that those financial entities have any 

material amount of uncollateralized exposure); the 

total notional amount of their security-based swap 

positions; the notional amount of those positions 

that are subject to central clearing or daily mark-tomarket margining; and the extent to which those 

positions are in-the-money or out-of-the-money (for 

purposes of calculating the netting discount to the 

potential future exposure calculation). We also 

expect that security-based swaps will be used less 

frequently for hedging purposes than swaps. See, 

e.g., Bernadette A. Minton, Rene ́ Stulz & Rohan 

Williamson, ‘‘How Much Do Banks Use Credit 

Derivatives to Hedge Loans?,’’ 35 J. Fin. Serv. Res. 

1 (2008) (noting that the ‘‘net notional amount of 

credit derivatives used for hedging of loans in 2005 

represents less than 2% of the total notional amount 

of credit derivatives held by banks’’). Accordingly, 

there is reason to believe that the costs of 

calculation associated with the ‘‘major securitybased swap participant’’ assessment will be lower 

than the costs associated with the ‘‘major swap 

participant’’ assessment. 

1537The average cost incurred by such entities in 

connection with outside counsel is based on staff 

experience in undertaking legal analysis of status 

under federal securities laws. The staff believes that 

costs associated with obtaining outside legal 

counsel relating to such determinations range from 

$20,000 to $30,000 depending on the complexity of 

the entity. We believe that an entity that maintains 

security-based swap exposures of the size that 

would necessitate undergoing this analysis will 

generally be large, complex financial organizations. 

We also recognize that, while the major participant 

test may be more objective and quantitative than the 

dealer test (and therefore require a less involved 

legal analysis), the test is novel (unlike the core 

dealer test, which draws on the dealer-trader 

distinction familiar to many market participants) 

and, as such, may cause entities to incur additional 

costs in interpreting and applying the test. 

Together, these factors lead us to estimate that 

entities undertaking this analysis will incur legal 

costs at the upper end of our estimated range. The 

use of inside counsel in lieu of outside counsel 

would reduce this upper bound. 

Continued 

consideration, however, we are 

modifying that estimate, in that we 

believe that the annual per-entity costs 

associated with the assessment will 

amount to $15,268, and the annual onetime per-entity costs associated with the 

assessment will amount to 

approximately $13,692.1532 The total 

industry-wide assessment costs 

associated with the major participant 

definition, given our expectation that 12 

entities will need to engage in this 

analysis, is $183,216 for annual costs 

and $164,304 for annual one-time 

costs.1533

We believe that these estimates also 

address the assessment costs under the 

‘‘substantial counterparty exposure’’ 

test. Because credit default swaps may 

be expected to constitute the bulk of the 

likely security-based swap market, it is 

possible that participants in the market 

may be more likely to have a 

‘‘substantial position’’ in debt-related 

security-based swaps than they would 

be to meet this second test. Nonetheless, 

we conservatively estimate that the 

same approximately 12 entities would 

engage in the ‘‘substantial counterparty 

exposure’’ calculation as would 

undertake the ‘‘substantial position’’ 

calculation.1534 Given the link between 

this rule and the ‘‘substantial position’’ 

calculations, however, we do not 

anticipate that the ‘‘substantial 

counterparty exposure’’ test would 

create incremental costs additional to 

those associated with the definition of 

‘‘substantial position.’’ 1535 We thus 

believe that the estimate of assessment 

costs in connection with the 

‘‘substantial position’’ analysis 

(consisting of one-time programming 

costs of approximately $13,692 per 

entity, and annual costs of $15,268 per 

entity) also adequately addresses the 

costs of assessment under this statutory 

test.1536

At the same time, upon further 

consideration we believe these rules 

also may impose certain interpretive 

costs, including those related to 

obtaining legal counsel, on market 

participants. Given the size and 

complexity of the entities that may find 

it necessary to analyze their status 

under the major participant definition, 

we believe that it is reasonable to 

conclude that at least some entities with 

security-based swap positions that 

approach the major participant 

thresholds are likely to seek legal 

counsel for interpretation of various 

aspects of the rules pertaining to the 

major participant definition. The costs 

associated with obtaining such legal 

services would vary depending on the 

relevant facts and circumstances, 

including the size and complexity of the 

person’s security-based swap positions, 

and the extent to which these 

interpretations may be germane to 

whether the entity ultimately is deemed 

to be a major participant. We believe, 

however, that $30,000 represents a 

reasonable estimate of the upper end of 

the range of the costs of obtaining the 

services of outside counsel in 

undertaking the legal analysis of the 

entity’s status as a major participant.1537

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30736 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

The legal costs associated with the major 

participant analysis may include, among other 

things, legal advice with respect to whether an 

affiliate with which the entity enters into securitybased swap transactions qualifies as an ‘‘affiliate’’ 

under rule 3a67–3, whether particular transactions 

fall within the definition of security-based swap, 

whether certain types of security-based swap 

transactions fall within the debt-based securitybased swap or other security-based swap category, 

whether the entity falls within the definition of 

‘‘financial entity,’’ and whether certain types of 

security-based swap transactions qualify for the 

hedging exclusion under the substantial exposure 

tests. We recognize that the complexity of the 

analysis required for any of these issues may vary 

considerably across entities, depending on each 

entity’s individual business model. 

The major participant test is based on daily 

average exposures over the course of the previous 

quarter, and, as discussed further below, some 

number of entities may decide to establish a system 

that will monitor their exposure on an ongoing 

basis. To the extent that the entity does so, we 

expect that any initial legal analysis should permit 

the entity to make determinations about these 

calculations on an ongoing basis. As such, we 

assume that any additional costs associated with 

outside counsel with respect to ongoing monitoring 

of positions would be negligible. 

1538See note 1529, supra. 

1539 If 32 entities were to perform this analysis, 

as discussed above, the market-wide legal costs 

associated with the analysis would total $960,000. 

1540 In particular, some commenters challenged 

the assumption in the Proposing Release that only 

approximately 10 entities had security-based swap 

positions large enough to lead them to engage in the 

major participant calculations. Those commenters 

took the view that certain entities with smaller 

security-based swap positions would perceive a 

need to conduct the relevant calculations on a daily 

basis even if they are not reasonably likely to be 

major participants, and, to address that concern, 

requested a safe harbor from having to perform the 

major participant calculations. See letters from 

SIFMA AMG I and Vanguard. 

1541See part IV.M, supra (discussing rationale for 

safe harbor). 1542See part IV.M.2, supra (discussing rationale 

for final rule implementing safe harbor). 1543As noted previously in part VIII.A.3.b.i.B, 

supra, we expect that approximately 12 entities 

may have security-based swap positions in an 

amount such that it may be reasonably necessary for 

them to undertake the major participant 

calculations. To the extent, however, that entities 

with smaller positions nonetheless identify a reason 

to perform a major participant analysis, the safe 

harbor would permit those entities to conclude that 

they are not major participants without the need to 

engage in the full set of calculations otherwise 

anticipated by the rules. 

1544See CDS Data Analysis at table 10. 

1545We expect that the outer bounds of the 

assessment costs associated with this safe harbor 

will be no higher than the one-time costs associated 

with conducting the major participant analysis, 

given that, to the extent that an entity determines 

that performing the safe harbor analysis is more 

expensive, it would likely choose to perform the 

less-costly major participant analysis. As such, the 

upper bound of costs associated with the safe 

harbor is not likely to exceed our estimates of the 

costs associated with the full major participant 

analysis, and should in fact be considerably lower. 

We estimate that one-time costs associated with 

establishing a system to identify and monitor 

security-based swap positions, as may be necessary 

to perform the monthly assessments anticipated by 

two of the three alternative tests that comprise the 

safe harbor, would be similar to the one-time costs 

associated with the major participant analysis, and 

that, therefore, up to 1,188 entities may incur onetime industry-wide costs of approximately $16.3 

million. See note 1533 and accompanying text, 

supra. The annual costs associated with monthly 

assessment would be expected to be less than the 

costs of daily assessment, and $9.1 million— 

approximately half of the estimated $18.1 million 

estimated annual costs if all 1,188 entities found it 

necessary to perform the daily assessment required 

by the substantial position test (see id.)—may be a 

reasonable estimate of that amount, given the 

relative simplicity of the test and the less frequent 

assessments that it requires. In practice, however, 

we believe that the costs associated with this safe 

harbor will be less because we expect that far fewer 

entities would perceive a need to rely on these 

aspects of the safe harbor, particular given that, as 

Based on the conclusion that no more 

than 12 entities have security-based 

swap positions that they would face 

enough of a possibility of being a major 

participant that they would need to 

engage in such analysis,1538 we estimate 

that the total legal costs associated with 

evaluating the various elements of this 

definition may approach $360,000.1539

ii. Calculation Safe Harbor 

We also are adopting Exchange Act 

rule 3a67–9, which provides a safe 

harbor from the definition of ‘‘major 

security-based swap participant’’ for 

market participants whose securitybased swap positions fall below certain 

thresholds. This safe harbor responds to 

concerns raised by commenters that— 

based on internal compliance policies 

and procedures, out of an abundance of 

caution, or for other reasons—certain 

entities may feel compelled to perform 

the full major participant calculations 

even if their security-based swap 

positions did not rise to a level near the 

thresholds in the ‘‘substantial position’’ 

or ‘‘substantial counterparty exposure’’ 

definitions.1540

The safe harbor makes use of three 

alternative tests. The first of these is 

based on the maximum possible 

uncollateralized exposure under the 

applicable credit support arrangements, 

and on the notional amount of a 

participant’s security-based swap 

positions. The two other alternatives 

entail monthly calculations, with the 

second alternative using calculations 

based on the maximum possible 

uncollateralized exposure under the 

applicable credit support arrangements 

and monthly adaptations of the 

substantial position and substantial 

counterparty exposure calculations, and 

the third alternative using calculations 

based on uncollateralized exposure and 

a modified version of the potential 

future exposure calculation. 

Although the provisions of the safe 

harbor we are adopting do not mirror 

the safe harbors suggested by 

commenters,1541 the inclusion of this 

safe harbor should help address 

commenter concerns regarding entities 

with small positions that would 

nonetheless feel compelled (due to their 

own internal compliance programs, or 

otherwise) to undertake the major 

participant calculations. While 

recognizing that more liberal standards 

for this safe harbor 1542 could further 

mitigate costs of assessing major 

participant status, the safe harbor may 

be expected to help some entities avoid 

the costs associated with assessing if 

they are major participants. 

It is not clear how many firms may 

ultimately seek to rely on the 

calculation safe harbor.1543 Participants 

in the security-based swap market vary 

greatly in the size of their positions, and 

may be expected to vary greatly in the 

complexity of their operations, and in 

the requirements of their internal 

compliance and risk management 

policies. As a result, it is possible that 

some firms with relatively small 

positions may choose to undertake the 

safe harbor analysis while significantly 

larger firms may determine that such 

analysis is unnecessary. 

The first of the three alternatives 

within the safe harbor would be based 

on the maximum possible 

uncollateralized exposure under the 

applicable credit support arrangements, 

and on the notional amount of a 

participant’s security-based swap 

positions. We believe that as a matter of 

good business practice large participants 

in the security-based swap market 

already would be aware of that 

information, making the test relatively 

simple to implement. We also note that 

available data indicates that 1,073 of the 

1,188 entities with single-name credit 

default swap positions (other than 

ISDA-recognized dealers and ICE Trust), 

have notional positions less than $2 

billion, potentially making the first test 

of the safe harbor available to them.1544

The other alternatives within the safe 

harbor would also entail monthly 

calculations, with such calculations for 

the second alternative based on the 

maximum possible uncollateralized 

exposure under the applicable credit 

support arrangements and monthly 

adaptations of the substantial position 

and substantial counterparty exposure 

calculations, while the monthly 

calculation for the third alternative is 

based on uncollateralized exposure and 

a modified version of the potential 

future exposure calculation. Both of 

these would entail additional analysis 

beyond current industry practices, 

causing entities to incur higher costs 

than the first alternative, but no more 

than would be required to complete the 

full major participant test.1545

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30737 

noted above, approximately 1,073 entities have 

aggregate gross notional single-name credit default 

swap positions under $2 billion. See note 1544 and 

accompanying discussion, supra. 

We note that our analysis of the safe harbor in 

connection with the ‘‘major security-based swap 

participant’’ definition differs from that of the CFTC 

with regard to the ‘‘major swap participant’’ safe 

harbor. This, in part, reflects the differences 

between the markets for swaps and security-based 

swaps. We also note our expectation that many of 

the entities that may opt to avail themselves of the 

safe harbor likely would have businesses that are 

financial in nature (rather than being non-financial 

entities that use security-based swaps as part of 

their commercial activities). As such, we would 

expect those entities to generally be cognizant of, 

or in a good position to obtain information about: 

Their maximum potential uncollateralized exposure 

with security-based swap counterparties; the total 

notional amount of their security-based swap 

positions; the notional amount of those positions 

that are subject to central clearing or daily mark-tomarket margining; and the extent to which those 

positions are in-the-money or out-of-the-money (for 

purposes of calculating the netting discount to the 

potential future exposure calculation). Other nonfinancial entities seeking to take advantage of the 

safe harbor may minimize their costs by utilizing 

whichever safe harbor option may be expected to 

most closely align with the security-based swap 

information that readily is available to such entities. 

1546 In particular, the major categories of securitybased swaps adopted in these final rules are 

consistent with how bank derivatives data is 

presented by the Office of the Comptroller of the 

Currency, as well as with categories used by 

derivatives market infrastructure such as The 

Depository Trust & Clearing Corporation. See part 

IV.A.3, supra. 

1547Entities may also incur programming and 

other costs related to recording the classification of 

their security-based swap transactions in systems 

designed to monitor current exposure and potential 

future exposure, but we expect these costs to be one 

component of entities’ overall system costs relating 

to its substantial position calculations, which we 

discuss in further detail above. See part 

VIII.A.3.b.i.B, supra. 

1548See parts IV.C.5.a and IV.C.5.b, supra 

(discussing rationale for excluding positions 

hedging speculative and trading positions from the 

definition). 

1549See parts IV.C.3 and IV.C.5, supra. 

1550We have incorporated provisions into the 

final rule designed to provide guidance to market 

participants as to which types of security-based 

swap positions could be expected to fall within this 

exclusion. This release also provides further 

guidance as to the scope of the exclusion. 

1551The transaction-related costs of making a 

hedging determination would apply only to entities 

with security-based swap positions that are near to 

or exceed the substantial position threshold prior to 

taking advantage of the hedging exclusion. This 

may be expected to mitigate costs associated with 

making this determination. 

1552Separately, the proposed rule defining this 

term would have included certain documentation 

and assessment conditions that commenters stated 

could lead to significant costs. Commenters 

expressed concerns regarding the application of 

these conditions and the associated costs. As 

discussed previously in this release, we have 

determined not to include these conditions in the 

final rule. See part IV.C.5.d, supra. 

1553See Exchange Act section 3C(g). 

1554 In addition, we considered, but do not 

incorporate, some commenters’ suggestion that 

‘‘financial entity’’ be defined more narrowly, such 

as by excluding employee benefit plans. See part 

IV.F.3.a, supra, (discussing rationale for final rule 

defining ‘‘financial entity’’). 

iii. Additional Issues Related to the 

Major Participant Analysis 

A. ‘‘Major’’ Categories of Security-Based 

Swaps 

Exchange Act rule 3a67–2 sets forth 

two ‘‘major’’ categories of security-based 

swaps for purposes of the first and third 

tests of the major participant 

definitions—one consisting of debtbased security-based swaps and the 

other consisting of other security-based 

swaps (including equity swaps). These 

categories are consistent with our 

understanding of the ways in which 

those products are used, as well as 

market statistics and current market 

infrastructures,1546 and we believe it is 

appropriate that those market categories 

be reflected in the major participant 

definition. 

The consistency of the rule with 

current market practices should help 

mitigate any assessment costs incurred 

by market participants. Moreover, we do 

not expect that market participants will 

be required to incur costs to determine 

the major category with respect to a 

large majority of their security-based 

swap positions, given that the vast 

majority of security-based swaps likely 

fall within the debt-based security-based 

swap major category. Also, in adopting 

the final rules we also have provided 

additional guidance related to the 

categorization of certain types of 

instruments in response to commenter 

concerns. Nonetheless, given the factspecific nature of any such assessment, 

we recognize that some entities may 

seek the opinion of legal counsel as to 

how specific security-based swap 

transactions should be categorized for 

purposes of this rule (such as legal costs 

associated with having counsel analyze 

a particular security-based swap to 

determine its status under these rules, to 

the extent that certain types of securitybased swaps with complex, novel or 

bespoke structures are not readily 

categorized within one of the two 

identified major categories). We expect 

that these costs would be included in 

the estimated costs of seeking outside 

legal counsel in connection with the 

major participant analysis, as described 

above.1547

B. Definition of ‘‘Hedging or Mitigating 

Commercial Risk’’ 

Exchange Act rule 3a67–4 defines the 

term ‘‘hedging or mitigating commercial 

risk’’ for purposes of the exclusion from 

the first major participant test. Among 

other aspects, this rule makes use of an 

‘‘economically appropriate’’ standard, 

and sets forth exclusions for securitybased swap positions that have a 

speculative or trading purpose. 

As discussed above, we carefully 

consider alternative approaches 

suggested by some commenters, 

including the suggestion that the 

definition should encompass positions 

that hedge speculative or trading 

positions and the suggestion that the 

definition should incorporate a 

‘‘congruence’’ standard.1548 We 

concluded, however, that these 

approaches are inconsistent with the 

focus of the statutory text, which is on 

‘‘commercial risk,’’ and in adopting this 

definition we have sought to set forth 

criteria that reasonably distinguish 

hedging positions from other positions. 

We believe that the approach we are 

adopting, which seeks to exclude 

positions that hedge commercial risk 

without also excluding other types of 

positions, is necessary and appropriate 

in light of the statute.1549

Some market participants may be 

expected to incur costs in connection 

with determining whether certain 

security-based swap positions fall 

within this hedging exclusion.1550 Any 

such costs of analyzing the status of 

particular security-based swaps as a 

hedge of commercial risk would reflect 

the unique character of individual 

positions and the business purpose 

associated with the position. Such costs 

may be particularly relevant for 

security-based swaps of a more complex 

nature, or for security-based swaps that 

introduce some degree of basis risk in 

connection with the hedge. Because of 

the facts-and-circumstances nature of 

this analysis,1551 we believe that some 

entities may seek the opinion of legal 

counsel as to whether certain 

transactions qualify for the commercial 

hedging exclusion at the time they 

conduct their initial analysis, and these 

costs would likely be encompassed 

within the estimated costs of legal 

services related to the major participant 

definition.1552

C. Definitions of ‘‘Financial Entity’’ and 

‘‘Highly Leveraged’’ 

Exchange Act rule 3a67–6 defines the 

term ‘‘financial entity’’ for purposes of 

the third major participant test. This 

definition is largely consistent with the 

statutory ‘‘financial entity’’ definition 

used in Title VII’s exception from 

mandatory clearing for commercial endusers.1553 However, in response to 

commenter concerns, the final rules 

exclude centralized hedging facilities 

from the ‘‘financial entity’’ definition (in 

a way that itself is consistent with that 

Title VII hedging exception).1554

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30738 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1555See part IV.F.3.b, supra (addressing leverage 

ratio calculation for certain employee benefit 

plans). 

1556See note 1107, supra (providing special rules 

related to the calculation of leverage for certain 

employee benefit plans). 

1557We note that many large insurers of the type 

that maintain security-based swap positions in an 

amount that would require them to perform the 

major participant calculations may be publicly 

traded companies, in which case they would 

already calculate their financial statements 

according to GAAP for purposes of public 

disclosure, and thus would not incur additional 

costs due to our decision not provide special 

methodologies for insurers to calculate their 

leverage. We also expect that the concerns of many 

smaller insurers that are not publicly traded and 

thus may not use GAAP will be addressed by our 

inclusion of the safe harbor for major participant 

calculations. 

In addition, publicly available information 

regarding insurer use of derivatives suggests that 

the potential costs to insurers arising from the 

definition of ‘‘major security-based swap 

participant’’ may be negligible. As of the end of 

2010, U.S. insurers as a whole had enter into 

roughly $33.5 billion in notional amount of credit 

default swaps (not distinguishing between credit 

default swaps that fall within the ‘‘security-based 

swap’’ definition and those that are ‘‘swaps’’). See 

National Association of Insurance Commissioners, 

‘‘Insights into the Insurance Industry’s Derivatives 

Exposure’’ (available at http://www.naic.org/ 

capital_markets_archive/110610.htm) (stating that 

life insurers had entered into roughly $27.1 billion 

of that amount, and that property and casualty 

insurers had entered into roughly $6.4 billion of 

that amount). Even if those positions were 

concentrated within single entity, they would not 

necessarily lead that entity to exceed the thresholds 

that could cause it to be a major participant, see 

note 914, supra, suggesting that, given the likely 

distribution of these positions across a significant 

number of insurers, few or no insurers may have 

exposures that approach the thresholds. 

1558Such an approach may be expected to lower 

the cumulative costs that major participants would 

incur in determining whether to seek a limited 

designation. For example, a default presumption in 

favor of the availability of limited designations may 

be expected to reduce the costs that certain entities 

would incur to determine that they could take 

advantage of limited designation relief, and thus 

reduce the costs associated with an entity 

determining whether it qualifies for such relief, 

such as the costs of hiring outside legal counsel to 

undertake this analysis to determine that they could 

take advantage a limited designation relief. A 

default presumption in favor of limited 

designations also would be expected to reduce costs 

in connection with the registration process for 

entities seeking limited designation status, as 

discussed above. See part VIII.A.2.d.ii.A, supra. 

1559See part IV.N.3, supra (discussing limited 

designation principles applicable to major 

participants). We note that the discussion of limited 

designation of ‘‘swap dealers’’ under the CEA 

generally seeks to quantify the costs associated with 

applications for limited designations. However, we 

believe that the costs of applying for a limited 

designation are dependent upon the application 

process for this type of registration category. As 

noted previously, the SEC expects to address the 

limited designation application process for major 

security-based swap participants in separate 

rulemakings. See id. As such, we believe that the 

costs associated with major security-based swap 

participant limited designation applications under 

the Exchange Act are more appropriately addressed 

in the context of that separate rulemaking. 

1560See note 1529, supra. 

1561This exclusion also applies to the 

‘‘substantial counterparty exposure’’ analysis. 

1562See part IV.G.2, supra (discussing rationale 

for the approach we are adopting, and considering 

alternative approaches). 

Although particular market participants 

may incur costs in connection with 

determining whether they fall within 

the ‘‘financial entity’’ definition, we 

believe that such costs would be 

minimal in light of the objective nature 

of the definition, and its consistency 

with the use of the term elsewhere in 

Title VII. We also recognize that entities 

may seek the opinion of legal counsel as 

to whether the entity falls within the 

scope of this ‘‘financial entity’’ 

definition, but believe that these costs 

would likely be encompassed within the 

estimated costs of legal services related 

to the major participant definition. 

Exchange Act rule 3a67–7 defines the 

term ‘‘highly leveraged,’’ also for 

purposes of the third statutory major 

participant test. After considering 

commenters’ views, the final rule 

defines that term based on a 12 to 1 

leverage ratio, as discussed in greater 

detail above. In adopting this leverage 

ratio, we also modify the proposed 

method of calculating leverage in 

certain respects,1555 but conclude that it 

would not be appropriate to provide 

special methodologies for insurers to 

measure leverage.1556 It is possible that 

certain market participants will incur 

costs in connection with determining 

whether they are ‘‘highly leveraged’’ for 

purposes of the major participant 

definitions. In part, we believe that 

those costs are mitigated by the fact that 

the final rules identify ‘‘highly 

leveraged’’ entities based on a ratio of 

liabilities to equity, which we expect are 

simpler for entities to implement than 

alternative methods for measuring 

leverage, such as risk-adjusted methods. 

We recognize that the unavailability 

of an alternative method of calculation 

for insurers may have the effect of 

increasing certain insurers’ cost of 

calculating leverage for purposes of 

determining whether they fall within 

the major participant definition, to the 

extent that insurers have security-based 

swap positions that are close enough to 

the relevant thresholds that they have to 

perform the required calculations.1557

We believe, however, that a uniform 

approach to defining ‘‘highly leveraged’’ 

is appropriate here given that the large 

insurance firms that are most likely to 

meet the major participant definition 

would be expected already to use GAAP 

in preparing their financial statements. 

This should mitigate any additional 

costs arising from the absence of an 

alternative calculation method for 

insurers. 

D. Limited Designations of Major 

Participants 

Exchange Act rule 3a67–1 in part 

implements the portion of the ‘‘major 

security-based swap participant’’ 

definition that provides for limited 

purpose registration of major 

participants. The rule sets forth a 

presumption that a person that acts as 

a major security-based swap participant 

in general will be deemed to be a major 

participant with regard to all of its 

security-based swaps, unless the SEC 

limits its designation. 

In adopting this rule we have 

considered the alternative, suggested by 

some commenters, of permitting persons 

to more broadly take advantage of 

limited major participant 

designations.1558 Our decision to use 

this presumption takes into account the 

difficulty of separating a major 

participant’s positions taken under its 

limited purpose designation from other 

of its positions for purposes of 

compliance, and the challenges of 

applying major participant regulatory 

requirements to only a portion of the 

entity’s security-based swap activities. 

The presumption further reflects the 

statutory definition’s discretionary 

language in connection with the 

potential for limited designations, and 

the need for persons subject to limited 

designations to be able to comply with 

the statutory and regulatory 

requirements applicable to major 

participants.1559

Certain persons who satisfy the major 

participant definition may incur costs in 

determining whether to seek a limited 

designation. Consistent with the 

discussion above, in general we believe 

that such costs would affect no more 

than 12 entities.1560 These costs could, 

however, vary significantly depending 

on the structure or other characteristics 

of an entity’s business. 

E. Exclusion of Inter-Affiliate SecurityBased Swaps 

Exchange Act rule 3a67–3 provides 

that security-based swap transactions 

between majority-owned affiliates will 

be excluded for purposes of the 

substantial position test.1561 We have 

concluded that majority ownership 

represents an alignment of interests 

appropriate to justify an inter-affiliate 

exclusion.1562 Moreover, we note that a 

majority-ownership test should, given 

its objective nature, impose fewer 

assessment costs on market participants 

than a more subjective common control 

test. 

Some market entities may incur costs 

in connection with determining whether 

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1563The data underlying this assessment already 

excludes certain inter-affiliate credit default swaps. 

1564See part IV.L.3, supra (discussing rationale 

for the final rules addressing timing, reevaluation 

and termination). 

1565Registration Proposing Release, 76 FR at 

65814–65818. 

1566For example, it is possible that an entity may 

perceive the steps associated with the registration 

process as requiring it to take additional steps to 

complete the registration process within the time 

frame we are adopting, whereas a longer time 

period could have enabled such an entity to avoid 

those costs. 

1567Specific costs associated with the registration 

process will be addressed by the SEC in final rules 

related to the registration of major security-based 

swap participants that have not yet been adopted. 

However, we expect any additional costs arising 

from the timing provisions of this rule to be 

insignificant. 

1568 15 U.S.C. 78c(f). 

1569 15 U.S.C. 78w(a)(2). 

1570The SEC is also acting pursuant to its 

rulemaking authority provided by Exchange Act 

sections 3 and 23(a). 

1571See, e.g., letters from Representatives Bachus 

and Lucas (‘‘Casting an overly-broad net in defining 

these terms could force some smaller participants 

to leave the marketplace as a result of increased 

costs, or eliminate certain types of contracts used 

for hedging.’’), SIFMA—Regional Dealers (stating 

that the proposed de minimis exception ‘‘is 

unnecessarily narrow, will discourage smaller 

dealers from competing in the market and will limit 

the availability of efficient and cost-effective 

intermediation services to small- and medium-sized 

organizations’’) and Midsize Banks (stating that a 

reduction in small dealers due to an overly narrow 

de minimis exception would ‘‘curtail economic 

development going forward and would leave endusers less options for hedging risks with community 

and smaller regional dealers’’). 

particular security-based swap positions 

may be excluded from the major 

participant analysis by virtue of the 

inter-affiliate exclusion. It is possible 

that such costs could be incurred by any 

of the approximately 12 entities that we 

believe reasonably may have to engage 

in the major participant 

calculations.1563 We believe that any 

costs arising out of such an analysis 

would be encompassed within the 

$30,000 estimated for legal services 

related to the major participant 

definition as a whole. 

F. Timing Requirements, Reevaluation 

Period and Termination of Status 

Exchange Act rule 3a67–8 specifies 

the time at which an entity that satisfies 

the major participant tests would be 

deemed to be a ‘‘major security-based 

swap participant,’’ and also addresses 

the time at which an entity’s status as 

a major security-based swap participant 

would be terminated. In adopting this 

rule we have considered alternatives 

that would lead to slower entry and 

faster exit from major participant status, 

and we believe that the approach that 

we are adopting provides a reasonable 

amount of time for registration based on 

the proposed registration process, will 

appropriately help to avoid applying 

major participant requirements to 

entities that meet the major participant 

criteria for only a short time due to 

unusual activity, and will avoid the 

prospect of persons moving in and out 

of major participant status overly 

frequently.1564

Persons falling within the major 

participant definitions will incur costs 

in connection with the registration 

process,1565 and it is possible that 

alternative timing approaches could 

allow such persons to register at a more 

deliberate pace, potentially reducing the 

associated costs.1566 Such cost 

differences may affect the up-to-twelve 

entities that we believe reasonably may 

have to engage in the major participant 

calculations. Moreover, altering the 

timing requirements may not 

significantly decrease costs associated 

with registration because in all cases we 

would expect the same preparatory 

actions to be taken, and we believe that 

the final rules provide sufficient time 

for entities to perform the activities 

necessary for compliance.1567

4. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition, and Capital 

Formation 

Section 3(f) of the Exchange Act 

requires the SEC, whenever it engages in 

rulemaking and is required to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, to consider, in addition to the 

protection of investors, whether the 

action would promote efficiency, 

competition, and capital formation.1568

In addition, section 23(a)(2) of the 

Exchange Act 1569 requires the SEC, 

when adopting rules under the 

Exchange Act, to consider the impact 

such rules would have on competition. 

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

also prohibits the SEC from adopting 

any rule that would impose a burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. 

We are adopting these rules and 

interpretive guidance pursuant to 

authority under section 712(d) of the 

Dodd-Frank Act, which requires the 

Commissions to further define several 

terms, including ‘‘security-based swap 

dealer’’ and ‘‘major security-based swap 

participant.’’ 1570 In the Proposing 

Release, we stated that we preliminarily 

believed that the proposed Exchange 

Act rules would not result in any 

burden on competition that is not 

necessary or appropriate in furtherance 

of the purposes of the Act, that they 

would not significantly affect capital 

formation, and that they would improve 

efficiency. We requested comment on 

each of these issues, and certain 

commenters raised concerns that 

overbroad definitions would lead to 

undue competitive impacts.1571

In adopting these final rules, we 

recognize that the most significant 

impact of the dealer and major 

participant definitions will derive from 

those definitions’ role in implementing 

Title VII, particularly given the 

significant impacts that Title VII will 

have on the security-based swap market. 

Many of these impacts may be expected 

to be positive, because Title VII 

imposes, among other measures, 

requirements that may be expected to 

promote safety and soundness, 

transparency, and competition within 

the security-based swap market. We 

recognize, however, that regulation also 

can pose costs that have negative 

impacts on the markets. 

In adopting these definitional rules 

and interpretations, moreover, we have 

sought to fairly reflect the statutory 

definitions and their underlying intent. 

Given the link between these 

definitional rules and interpretations 

and the Title VII framework, the scope 

of the definitions will affect the ultimate 

regulatory benefits and costs that will 

accompany the full implementation of 

Title VII. Definitions that capture more 

entities will tend to promote the Title 

VII benefits, but will also risk increasing 

the accompanying costs. Definitions that 

capture fewer entities may be expected 

to lead to the converse result. 

a. Competitive Impacts 

As noted above, the SEC is required 

to consider the effect of these rules and 

interpretations on competition. The SEC 

also is prohibited from adopting any 

rule that would impose a burden on 

competition that is not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. Because 

these definitional rules and 

interpretations will help determine 

which entities within the market are 

subject to the Title VII requirements that 

govern dealers and major participants, 

they may also affect competition within 

the security-based swap market. 

In enacting Title VII, Congress set 

forth a regulatory framework for OTC 

derivatives; security-based swaps 

represent one segment of the overall 

OTC derivatives market. Within the 

security-based swap market, dealers 

compete for business from 

counterparties, while non-dealers that 

participate in the market use securitybased swaps for purposes that can 

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30740 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1572 Data from the credit default swap trade 

information warehouse operated by DTCC indicates 

that as of the week ending October 7, 2011, singlename credit default swaps involving two 

counterparties that are not dealers (as identified by 

DTCC) constitutes roughly 0.2 percent of the 

notional amount of all open positions involving 

single-name credit default swaps (amounting to 

$24.6 billion gross notional out of a total of $15.2 

trillion gross notional). Conversely, single-name 

credit default swaps involving two dealers (as 

identified by DTCC) constitute roughly 74.2 percent 

of the total notional amount (amounting to $11.3 

trillion gross notional out of the $15.2 trillion total). 

See http://www.dtcc.com/products/derivserv/data/ 

index.php (as of October 7, 2011). We have no 

reason to believe that the market for other types of 

security-based swaps exhibits different amounts of 

concentration with regard to dealer activity. 

1573As discussed above in the context of the de 

minimis exception to the security-based swap 

dealer definition, analysis of available data shows 

that, under any metric used to screen for dealers in 

our CDS Data Analysis, over 90 percent of activity 

in single-name credit default swaps among entities 

identified as dealers is attributable to the fourteen 

or fifteen largest of those entities. We have no 

reason to believe that the concentration of dealing 

activity involving other types of security-based 

swaps significantly differs from the concentration of 

dealers in the single-name credit default swap 

market. 

1574See Pirrong, note 487, supra, at 17–18 (noting 

that counterparties seek to reduce risk of default by 

engaging in credit derivative transactions with well 

capitalized firms). 

1575See id., at 18–19 (noting lack of success 

among new entrants into derivatives dealing market 

due to perception that AAA rating for subsidiary is 

less desirable than a slightly lower rating for a 

larger entity, and suggesting that there are 

‘‘economies of scale in bearing default risk’’ that 

may induce ‘‘substantial concentration in dealer 

activities’’). 

1576See letter from FSR I. 

1577See, e.g., notes 478 and 485, supra, and 

accompanying text. 

1578We expect that implementation of Title VII 

will provide both the SEC and market participants 

with more information about the business of dealers 

and major participants, the characteristics of 

positions they and other market participants hold, 

the structure of the market, and how each of these 

have changed under the Title VII framework. For 

that reason the SEC has directed the staff to report 

to the Commission on all aspects of the dealer and 

major participant definitions. See part V, supra. 

1579See Acharya, Pedersen, Philippon, and 

Richardson, Measuring Systemic Risk (May 2010) 

(available at http://vlab.stern.nyu.edu/public/static/ 

SR-v3.pdf) (working paper that derives an empirical 

measure of a financial entity’s expected 

contribution to an aggregate capital shortfall that 

scales with the size of the institution, and that 

shows using historical data that their measure 

predicted the risks that emerged during the recent 

financial crisis). 

1580As discussed above, for example, securitybased swap dealers and major security-based swap 

participants will have to meet minimum capital and 

margin requirements, maintain specified business 

and transaction records and adhere to certain 

standards of business conduct, along with other 

obligations. See, e.g., notes 178 to 180, supra. 

1581See part VIII.A.3, supra. 

include speculation and hedging. To 

date, security-based swaps primarily 

have traded in the over-the-counter 

market, and have not been subject to 

comprehensive regulation in the U.S. 

We understand that entities engaged in 

dealing activity within this market 

facilitate the vast majority of securitybased swap transactions.1572 Dealing 

activity within the market also is highly 

concentrated.1573 This concentration in 

large part appears to reflect the fact that 

larger entities possess competitive 

advantages in engaging in over-thecounter security-based swap dealing 

activities, particularly with regard to 

having sufficient financial resources to 

provide potential counterparties with 

adequate assurances of financial 

performance.1574 As such, it is 

reasonable to conclude that there are 

high barriers to entry in connection with 

security-based swap dealing activity.1575

At the same time, commenters have 

noted that some entities engage in 

smaller volumes of security-based swap 

dealing activity. Some small and midsize banks, for example, routinely 

provide such services involving 

relatively small notional amounts to 

their customers.1576 Although these 

relatively smaller dealers in general may 

not compete directly with the largest 

dealers (because they service a different 

segment of the market), they may be 

expected to play a role in helping 

certain types of customers (such as 

customers with a relatively smaller need 

for security-based swaps) enter into 

security-based swaps, thus promoting 

the availability of these products. 

Fundamentally, in considering the 

competitive impacts associated with 

Title VII regulation of dealers and major 

participants—and hence the competitive 

impacts associated with the dealer and 

major participant definitions—we 

recognize that one consequence of the 

current concentrated market 

structure 1577 is the potential for risk 

spillovers and systemic risk, which can 

occur when the financial sector as a 

whole (or certain key segments) 

becomes undercapitalized. Risk 

spillovers emerge when losses and 

financial distress at one firm lead to 

losses and financial distress for the 

financial sector as a whole, either 

through direct counterparty 

relationships or the deterioration of 

asset values. As financial distress 

spreads, the aggregate financial system 

may become undercapitalized, 

hindering its ability to provide financial 

intermediation services. If firms do not 

internalize this aggregate cost, the 

financial system may end up holding 

more risk than its aggregate capital can 

manage. 

In enacting Title VII, Congress set 

forth a framework that will impose new 

costs and regulatory burdens, including 

capital, margin, and registration 

requirements, on persons who act as 

security-based swap dealers, and on 

persons whose security-based swap 

positions are large enough to cause them 

to be major security-based swap 

participants. While the substantive rules 

associated with capital, margin, and 

registration requirements have yet to be 

finalized, we have sought to set the 

dealer and major participant definitions 

in such a way as to impose the 

substantive rules on those entities most 

likely to contribute to an aggregate 

capital shortfall without imposing 

unnecessary burdens on those who do 

not pose similar risks to the market.1578

It is reasonable to expect that it is the 

largest security-based swap entities that 

are more likely to contribute to an 

aggregate capital shortfall than smaller 

participants, as more risk is likely to be 

concentrated within these entities.1579

As discussed above, persons who fall 

within the statutory definitions of 

security-based swap dealer and major 

security-based swap participant will 

incur a range of one-time costs and 

ongoing costs by virtue of that 

status.1580 Also, as discussed above, 

market participants may incur costs in 

connection with determining whether 

their security-based swap activities or 

positions will cause them to be dealers 

or major participants.1581 To the extent 

the costs associated with these 

statutorily mandated requirements are 

relatively fixed or large enough, they 

may negatively affect competition 

within the market. This may, for 

example, lead smaller dealers or entities 

for whom dealing is not a core business 

to exit the market, which could cause 

smaller customers to have less access to 

the market or to incur higher costs in 

accessing the market. Such costs might 

also deter the entry of new firms into 

the market. If sufficiently high, these 

costs of compliance may increase 

concentration among dealers. We also 

recognize that some market participants 

may be expected to incur costs in 

connection with determining their 

status as a dealer or major participant, 

but such costs can be expected to be 

significantly less than the costs 

associated with the various rules 

applicable to dealers or major 

participants. 

Conversely, certain aspects of Title 

VII may enhance competition in the 

market. For example, the business 

conduct and other requirements of Title 

VII may enhance the availability of 

information to market participants. 

Measures designed to equalize access to 

information through disclosure 

requirements should promote 

participation, which may intensify price 

competition among dealers, and thus 

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1582We do think it unlikely that the costs 

associated with determining an entity’s status, 

considered on their own, would have any 

measurable effect on competition. As noted above, 

we estimate that the cost of making this 

determination to be $30,000 at most, and likely 

significantly less for most entities. See note 1537, 

supra. In other words, the costs would amount to, 

at most, 0.1 percent of the de minimis threshold, 

and it is likely that few firms would feel compelled 

to conduct this analysis until their dealing volume 

approached the de minimis threshold. 

1583At the same time, it is possible that these 

additional costs associated with dealer regulation 

will be comparatively small compared to the 

existing barriers to entry in the market (particularly 

the need for resources to provide counterparties 

with sufficient assurance of performance). Cf. 

Pirrong, note 487, supra, at 18–19 (noting that firms 

with smaller balance sheets, relative to largest 

dealers, ‘‘have largely failed to make major inroads 

as derivatives dealers despite concerted efforts to do 

so’’). It thus is possible the incremental costs 

associated with dealer regulation may not be of the 

magnitude to cause persons who currently engage 

in security-based swap dealing activity to exit the 

market. 

1584As noted above, we have declined to adopt 

per se exclusions or overly simple tests, even 

though they might impose fewer assessment costs 

on market participants conducting the dealer 

analysis because we do not believe that such 

exclusions or tests would capture the full range of 

entities that should be regulated as dealers under 

Title VII. Moreover, the nature of the tests being 

adopted are straightforward to implement and rely 

on information that already should be readily 

available to market participants. 

may increase participation in the 

security-based swap market. Other 

aspects of Title VII, such as rules 

promoting access of dealers to central 

clearing facilities, also may be expected 

to enhance competition in the market. 

i. Security-Based Swap Dealer 

Definition 

Persons who are deemed to be dealers 

may be expected to incur costs in 

connection with the substantive rules 

applicable to dealers, and to incur 

comparatively smaller costs in 

connection with determining whether 

they fall within the dealer definition. 

We cannot rule out the possibility that 

the prospects of these aggregate costs 

might deter new entrants from engaging 

in security-based swap activity that 

potentially could lead them to be 

dealers.1582 We also cannot rule out the 

possibility that the imposition of those 

costs could lead some persons who 

currently engage in dealing activity 

involving security-based swaps to lessen 

or cease that activity. Those effects—if 

they were to occur—would be expected 

to reduce competition in the market. 

Conversely, the application of the Title 

VII requirements applicable to dealers, 

such as, for example, the business 

conduct requirements related to 

disclosures to counterparties, may be 

expected to enhance the availability of 

information to market participants. The 

resulting reduction in information 

asymmetries may be expected to 

promote participation, and therefore 

competition, in the market. 

Accordingly, the scope of the rules and 

interpretations defining security-based 

swap dealer, including the scope of the 

de minimis exception to the dealer 

definition, can be expected to affect 

competition in the market in a variety 

of ways.1583

As discussed above, in rule 3a71–1 

we have codified the statutory 

definition of security-based swap dealer 

and provided guidance to interpret the 

contours of this definition in the context 

of the dealer-trader distinction. After 

considering commenters’ views, we 

believe that this guidance interprets the 

statute to give effect to the four dealer 

tests and the ‘‘regular business’’ 

exclusion in a way that reflects the 

features of the security-based swap 

market. This use of the dealer-trader 

distinction—which parallels the 

analysis that securities market 

participants currently use in the context 

of the Exchange Act’s ‘‘dealer’’ 

definition—also should help reduce the 

potential competitive effects associated 

with the costs that market participants 

incur to analyze their possible status as 

a dealer by imposing fewer costs than a 

more novel approach.1584

Moreover, as discussed above, in rule 

3a71–2 we have adopted a de minimis 

test and thresholds that will impose the 

costs associated with dealer regulation 

upon entities that engage in the bulk of 

dealing activity in the market, without 

imposing those costs upon persons who 

account for a small portion of dealing 

activity (and for which dealer regulation 

may be accompanied by comparatively 

modest benefits). We believe this will 

mitigate some of the potential 

competitive burdens associated with 

dealer status that could fall on entities 

engaged in a smaller amount of dealing 

activity, without leaving an undue 

amount of dealing activity outside of the 

ambit of dealer regulation. As discussed 

in detail above, we believe we have set 

the threshold in a way that 

appropriately considers this risk along 

with the benefits afforded to smaller 

entities by a higher threshold. 

Furthermore, after considering 

commenters’ views, we believe that this 

approach strikes a balance that 

appropriately will implement the 

transparency, risk, and customer and 

counterparty protection goals of Title 

VII. This approach, including the 

general use of a $3 billion threshold, 

also can facilitate the initial entrance of 

dealers into the market, and permit 

persons to engage in limited dealing 

activity that helps smaller entities 

participate in the market. While we 

recognize that the lower threshold 

associated with dealing activity 

involving ‘‘special entities’’ has the 

potential to reduce competition to 

provide dealing services to those 

entities, we believe that this lower 

threshold is appropriate to preserve the 

protections that Title VII affords to those 

entities. 

In rule 3a71–1, we also have set forth 

a presumption that a person that acts as 

a dealer in the security-based swap 

market will be a dealer with regard to 

all of its security-based swaps. We 

recognize that this presumption may 

have competitive impacts: on the one 

hand, by imposing regulatory costs on a 

wider range of activities, certain entities 

concentrated in discrete security-based 

swap segments may face higher costs 

than they might without the 

presumption; on the other hand, the 

presumption suggests a single, uniform 

baseline for competition across dealers. 

While these impacts may bear out in a 

number of ways, we believe that the 

presumption is appropriate in light of 

the statutory language and the need to 

help ensure that security-based swap 

dealers comply with all applicable legal 

requirements. 

In rule 3a71–1, we also have provided 

an exclusion from dealer status in 

connection with security-based swaps 

involving majority-owned affiliated 

counterparties. To the extent that the 

scope of this exclusion may have 

competitive impacts—such as in 

connection with dealing activity 

involving affiliates that are not majorityowned, and that hence cannot take 

advantage of the exclusion—we believe 

that the exclusion appropriately applies 

the Title VII dealer requirements in a 

way that reflects the economic reality of 

swaps among affiliates, which generally 

does not raise the customer protection 

or market risk concerns addressed by 

Title VII. 

In sum, to the extent that the 

application of Title VII dealer 

requirements to certain persons were to 

pose a net burden on competition in the 

security-based swap market, we believe 

those effects would be a necessary or 

appropriate consequence of 

implementing the statutory definitions 

consistent with the purposes of the Title 

VII amendments to the Exchange Act. 

ii. Major Security-Based Swap 

Participant Definition 

As we discuss above, we have 

estimated that entities approaching the 

level of exposure required to be a major 

participant may incur certain costs in 

connection with analyzing their 

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1585See text accompanying note 1532, supra 

(estimating assessment costs as roughly $44,000 in 

the first year, and $15,268 in subsequent years). 

1586The extent of such possible deterrence is 

mitigated by the fact that major participant status 

is a prospect only for those persons with very large 

security-based swap positions. 

1587See part VIII.A.2, supra. 

status.1585 Given the size of the 

exposures and notional amounts 

required to trigger the major participant 

test (e.g., $1 billion in daily average 

current uncollateralized exposure in a 

major category), we do not believe that 

these costs of assessment would 

materially impact the competitive role 

played in the security-based swap 

market by persons who have positions 

large enough that they potentially may 

be major participants. 

We expect that the programmatic 

costs associated with the rules 

applicable to major participants will be 

more significant. Presumably, a market 

participant will weigh the costs of 

complying with the rules against the 

benefit it expects from maintaining 

security-based swap positions of a 

magnitude that would require 

registration as a major participant, in 

deciding whether to continue to 

maintain such positions. We cannot rule 

out the possibility that the prospect of 

those costs could deter persons from 

maintaining security-based swap 

positions of such a magnitude, and that 

this may reduce competition in the 

market.1586

As discussed above, Exchange Act 

rules 3a67–1 through 3a67–9 and the 

accompanying interpretations reflect 

choices that we believe are reasonably 

designed to satisfy the risk criteria set 

forth in the major participant 

definition.1587 In reaching these 

conclusions we considered commenters’ 

views on a variety of issues, including 

suggested alternative approaches that 

would lessen the likelihood of 

particular entities being deemed to be 

major participants (e.g., alternative tests, 

higher thresholds, a broader hedging 

exclusion, and a higher leverage test). 

We believe that the choices reflected in 

the final rules and interpretations are 

necessary or appropriate in furtherance 

of the purposes of the Exchange Act and 

reasonably reflect the criteria set forth 

by the statutory definition. 

b. Efficiency and Capital Formation 

As noted above, in adopting these 

final rules and interpretations we also 

are required to consider whether these 

actions would promote efficiency and 

capital formation. 

In significant part, the effect of these 

rules on efficiency and capital formation 

are linked to the effect of these rules on 

competition. For example, markets that 

are competitive, with fair and 

transparent pricing and equal access to 

security-based swaps, may be expected 

to promote the efficient allocation of 

capital. Similarly, definitional rules that 

promote, or do not unduly restrict, 

competition can be accompanied by 

regulatory benefits that minimize the 

risk of market failure and thus promote 

efficiency within the market. Such 

competitive markets would increase the 

efficiency by which market participants 

could transact in security-based swaps 

for speculative, trading, hedging and 

other purposes. 

Definitional rules and interpretations 

of an appropriate scope also can be 

expected to promote capital formation 

by facilitating the appropriate use of 

security-based swaps for hedging 

purposes, and thus by contributing to 

liquidity and reducing costs in 

connection with the issuance of equity 

and debt securities. In the context of 

credit default swaps based on loans, 

moreover, definitional rules and 

interpretations of an appropriate scope 

can be expected to promote capital 

formation by facilitating loans to 

businesses that may not otherwise be 

made absent such a swap. Since credit 

risk is correlated, lenders may find it 

desirable to hedge credit risks on their 

loan portfolios by purchasing protection 

through single-name or index credit 

default swaps. Even though there is 

basis risk in this type of trade, it should 

be particularly effective at reducing 

exposure to systemic credit events. 

More generally, security-based swaps 

can be expected to promote risk transfer 

to persons better positioned and more 

willing to bear certain risks (e.g., the 

transfer of risks from hedgers to 

speculators). 

Conversely, definitional rules that are 

accompanied by too many competitive 

burdens pose the risk of imposing 

excessive costs of regulation that could 

deter the efficient allocation of capital to 

security-based swaps. Such rules also 

may be expected to reduce the capital 

formation benefits that otherwise would 

be associated with security-based 

swaps. Definitional rules of an 

inappropriate scope further may reduce 

the availability of security-based swaps 

and thus direct market participants not 

to seek to address certain business 

needs, or to use less effective financial 

instruments to meet their business 

needs. For example, major participant 

thresholds that broadly capture much of 

the security-based swap market would 

discourage certain entities from 

participating in the market, particularly 

if the regulatory costs for major 

participants are high. This could make 

it difficult for hedgers to find a 

counterparty, which would make it 

more expensive to hedge risks and 

hinder efficient risk-sharing in the 

broader economy. In addition, 

definitional rules that pose the risk of 

creating a market that contains an 

undue amount of unregulated dealing 

activity—as may be the result of a de 

minimis threshold that is too high— 

would lead to disparate treatment of 

dealers and could undermine the 

benefits of Title VII. 

The rules and interpretations that we 

are adopting in connection with the 

dealer and major participant definitions 

are designed to apply the statutory 

definitions in a way that reasonably 

effects the goals of Title VII. For 

example, the rule implementing the de 

minimis exception to the dealer 

definition is designed to focus the 

application of the dealer definition in a 

way that implements the benefits 

associated with the regulation of 

security-based swap dealers under Title 

VII, without imposing the costs 

associated with those regulations on 

those entities responsible for only a 

small portion of total dealing activity. In 

addition, the rules and interpretations 

in connection with the major participant 

definition are geared to focus major 

participant regulation on entities whose 

security-based swap positions pose a 

particularly high degree of credit risk to 

the market, without applying those 

regulations on persons who pose a 

lesser degree of risk. 

In conclusion, we believe that the 

rules and interpretations may be 

expected to promote efficiency in the 

allocation of capital to security-based 

swaps, and to promote the capital 

formation benefits of security-based 

swaps, by helping to focus the costs and 

burdens of the regulation of dealers and 

major participants under Title VII upon 

those persons for whom the imposition 

of those costs are most appropriate 

given their overall activity and positions 

in the security-based swap market. The 

rules and interpretations similarly may 

be expected to apply certain Title VII 

requirements (e.g., counterparty 

disclosure requirements that can be 

expected to reduce information 

asymmetries) to those entities that 

engage in activities or maintain 

positions in the security-based swap 

market such that their compliance with 

these requirements may promote the 

efficiency and capital allocation benefits 

associated with such regulation. 

B. Paperwork Reduction Act Analysis 

The Proposing Release addressed a 

potential new ‘‘collection of 

information’’ requirement, within the 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30743 

1588 44 U.S.C. 3501. 

1589Consistent with the discussion above, we 

recognize that the substantive rules applicable to 

dealers and major participants may contain 

collections of information, and that these 

definitions will affect which entities are subject to 

those collections of information. We believe that 

these Paperwork Reduction Act issues are more 

appropriately addressed in connection with the 

substantive rules applicable to dealers and major 

participants. 

1590 5 U.S.C. 601 et seq. 

1591 5 U.S.C. 603(a). 

1592 5 U.S.C. 551 et seq. 

1593Although Section 601(b) of the RFA defines 

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

Commissions to formulate their own definitions. 

The SEC has adopted definitions for the term small 

entity for the purposes of SEC rulemaking in 

accordance with the RFA. Those definitions, as 

relevant to this proposed rulemaking, are set forth 

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

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

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

1594See 5 U.S.C. 605(b). 

1595See 17 CFR 240.0–10(a). 

1596See 17 CFR 240.17a–5(d). 

1597See 17 CFR 240.0–10(c). 

1598See 13 CFR 121.201 (Subsector 522). 

1599See id. at Subsector 522. 

1600See id. at Subsector 523. 

1601See id. at Subsector 524. 

1602See id. at Subsector 525. 

1603See Proposing Release, 75 FR at 80211. 

meaning of the Paperwork Reduction 

Act of 1995,1588 because the proposed 

definition of the term ‘‘hedging or 

mitigating commercial risk’’ included 

documentation and assessment 

conditions. 

As discussed above, final rule 

defining ‘‘hedging or mitigating 

commercial risk’’ does not contain those 

proposed documentation and 

assessment conditions. Accordingly, the 

Paperwork Reduction Act does not 

apply to these definitions.1589

C. Regulatory Flexibility Act 

Certification 

The Regulatory Flexibility Act 

(‘‘RFA’’) 1590 requires Federal agencies, 

in promulgating rules, to consider the 

impact of those rules on small entities. 

Section 603(a) 1591 of the Administrative 

Procedure Act,1592 as amended by the 

RFA, generally requires the SEC to 

undertake a regulatory flexibility 

analysis of all proposed rules, or 

proposed rule amendments, to 

determine the impact of such 

rulemaking on ‘‘small entities.’’ 1593

Section 605(b) of the RFA provides that 

this requirement shall not apply to any 

proposed rule or proposed rule 

amendment, which if adopted, would 

not have a significant economic impact 

on a substantial number of small 

entities.1594

For purposes of SEC rulemaking in 

connection with the RFA, a small entity 

includes: (i) When used with reference 

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

an investment company, an ‘‘issuer’’ or 

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

recent fiscal year, had total assets of $5 

million or less,1595 or (ii) a broker-dealer 

with total capital (net worth plus 

subordinated liabilities) of less than 

$500,000 on the date in the prior fiscal 

year as of which its audited financial 

statements were prepared pursuant to 

Rule 17a–5(d) under the Exchange 

Act,1596 or, if not required to file such 

statements, a broker-dealer with total 

capital (net worth plus subordinated 

liabilities) of less than $500,000 on the 

last day of the preceding fiscal year (or 

in the time that it has been in business, 

if shorter); and is not affiliated with any 

person (other than a natural person) that 

is not a small business or small 

organization.1597 Under the standards 

adopted by the Small Business 

Administration, small entities in the 

finance and insurance industry include 

the following: (i) For entities engaged in 

credit intermediation and related 

activities, entities with $175 million or 

less in assets; 1598 (ii) for entities 

engaged in non-depository credit 

intermediation and certain other 

activities, entities with $7 million or 

less in annual receipts; 1599 (iii) for 

entities engaged in financial 

investments and related activities, 

entities with $7 million or less in 

annual receipts; 1600 (iv) for insurance 

carriers and entities engaged in related 

activities, entities with $7 million or 

less in annual receipts; 1601 and (v) for 

funds, trusts, and other financial 

vehicles, entities with $7 million or less 

in annual receipts.1602

The Proposing Release stated that 

based on feedback from industry 

participants about the security-based 

swap markets, the SEC preliminarily 

believes that any entities that would 

qualify as security-based swap dealers 

and major security-based swap market 

participants would exceed the 

thresholds defining ‘‘small entities,’’ 

and that the SEC believes it is unlikely 

that the proposed rules would have a 

significant economic impact on any 

small entity. As a result, the SEC 

certified that the proposed rules would 

not have a significant economic impact 

on a substantial number of small entities 

for purposes of the RFA, and requested 

written comments regarding this 

certification.1603

While we received comment letters 

that addressed cost issues in connection 

with the proposed rules, we did not 

receive any comments that specifically 

addressed whether the rules defining 

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

security-based swap participant’’ would 

have a significant economic impact on 

small entities. 

The SEC continues to believe that the 

types of entities that would engage in 

more than a de minimis amount of 

dealing activity involving security-based 

swaps—which generally would be major 

banks—would not be ‘‘small entities’’ 

for purposes of the RFA. Similarly, the 

SEC continues to believe that the types 

of entities that may have security-based 

swap positions above the level required 

to be a ‘‘major security-based swap 

participant’’ would not be a ‘‘small 

entity’’ for purposes of the RFA. 

Accordingly, the SEC certifies that the 

final rules defining ‘‘security-based 

swap dealer’’ or ‘‘major security-based 

swap participant’’ would not have a 

significant economic impact on a 

substantial number of small entities for 

purposes of the RFA. 

Statutory Basis and Text of the 

Amendments 

List of Subjects in 17 CFR Part 1 

Brokers, Commodity futures, 

Consumer protection, Reporting and 

recordkeeping requirements. 

Commodity Futures Trading 

Commission 

For the reasons stated in the 

preamble, the CFTC is adopting the 

following amendments to 17 CFR part 1. 

PART 1—GENERAL REGULATIONS 

UNDER THE COMMODITY EXCHANGE 

ACT 

■ 1. The authority citation for part 1 is 

revised to read as follows: 

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

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

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

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

Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, Pub. L. 

111–203, 124 Stat. 1376 (2010). 

■ 2. Amend § 1.3 by revising paragraph 

(m) and adding paragraphs (ggg) through 

(mmm) to read as follows: 

§ 1.3 Definitions. 

* * * * * 

(m) Eligible contract participant. This 

term has the meaning set forth in 

Section 1a(18) of the Act, except that: 

(1) A major swap participant, as 

defined in Section 1a(33) of the Act and 

paragraph (hhh) of this section, is an 

eligible contract participant; 

(2) A swap dealer, as defined in 

Section 1a(49) of the Act and paragraph 

(ggg) of this section, is an eligible 

contract participant; 

(3) A major security-based swap 

participant, as defined in Section 

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

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30744 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

of 1934 and § 240.3a67–1 of this title, is 

an eligible contract participant; 

(4) A security-based swap dealer, as 

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

Securities Exchange Act of 1934 and 

§ 240.3a71–1 of this title, is an eligible 

contract participant; 

(5)(i) A transaction-level commodity 

pool with one or more direct 

participants that is not an eligible 

contract participant is not itself an 

eligible contract participant under either 

Section 1a(18)(A)(iv) or Section 

1a(18)(A)(v) of the Act for purposes of 

entering into transactions described in 

Sections 2(c)(2)(B)(vi) and 2(c)(2)(C)(vii) 

of the Act; and 

(ii) In determining whether a 

commodity pool that is a direct 

participant in a transaction-level 

commodity pool is an eligible contract 

participant for purposes of paragraph 

(m)(5)(i) of this section, the participants 

in the commodity pool that is a direct 

participant in the transaction-level 

commodity pool shall not be considered 

unless the transaction-level commodity 

pool, any commodity pool holding a 

direct or indirect interest in such 

transaction-level commodity pool, or 

any commodity pool in which such 

transaction-level commodity pool holds 

a direct or indirect interest, has been 

structured to evade subtitle A of Title 

VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act by 

permitting persons that are not eligible 

contract participants to participate in 

agreements, contracts, or transactions 

described in Section 2(c)(2)(B)(i) or 

Section 2(c)(2)(C)(i) of the Act; 

(6) A commodity pool that does not 

have total assets exceeding $5,000,000 

or that is not operated by a person 

described in subclause (A)(iv)(II) of 

Section 1a(18) of the Act is not an 

eligible contract participant pursuant to 

clause (A)(v) of such Section; 

(7)(i) For purposes of a swap (but not 

a security-based swap, security-based 

swap agreement or mixed swap) used to 

hedge or mitigate commercial risk, an 

entity may, in determining its net worth 

for purposes of Section 1a(18)(A)(v)(III) 

of the Act, include the net worth of any 

owner of such entity, provided that all 

the owners of such entity are eligible 

contract participants; 

(ii)(A) For purposes of identifying the 

owners of an entity under paragraph 

(m)(7)(i) of this section, any person 

holding a direct ownership interest in 

such entity shall be considered to be an 

owner of such entity; provided, 

however, that any shell company shall 

be disregarded, and the owners of such 

shell company shall be considered to be 

the owners of any entity owned by such 

shell company; 

(B) For purposes of paragraph 

(m)(7)(ii)(A) of this section, the term 

shell company means any entity that 

limits its holdings to direct or indirect 

interests in entities that are relying on 

this paragraph (m)(7); and 

(C) In determining whether an owner 

of an entity is an eligible contract 

participant for purposes of paragraph 

(m)(7)(i) of this section, an individual 

may be considered to be a 

proprietorship eligible contract 

participant only if the individual— 

(1) Has an active role in operating a 

business other than an entity; 

(2) Directly owns all of the assets of 

the business; 

(3) Directly is responsible for all of the 

liabilities of the business; and 

(4) Acquires its interest in the entity 

seeking to qualify as an eligible contract 

participant under paragraph (m)(7)(i) of 

this section in connection with the 

operation of the individual’s 

proprietorship or to manage the risk 

associated with an asset or liability 

owned or incurred or reasonably likely 

to be owned or incurred by the 

individual in the operation of the 

individual’s proprietorship; and 

(iii) For purposes of paragraph 

(m)(7)(i) of this section, a swap is used 

to hedge or mitigate commercial risk if 

the swap complies with the conditions 

in paragraph (kkk) of this section; and 

(8) Notwithstanding Section 

1a(18)(A)(iv) of the Act and paragraph 

(m)(5) of this section, a commodity pool 

that enters into an agreement, contract, 

or transaction described in Section 

2(c)(2)(B)(i) or Section 2(c)(2)(C)(i)(I) of 

the Act is an eligible contract 

participant with respect to such 

agreement, contract, or transaction, 

regardless of whether each participant 

in such commodity pool is an eligible 

contract participant, if all of the 

following conditions are satisfied: 

(i) The commodity pool is not formed 

for the purpose of evading regulation 

under Section 2(c)(2)(B) or Section 

2(c)(2)(C) of the Act or related 

Commission rules, regulations or orders; 

(ii) The commodity pool has total 

assets exceeding $10,000,000; and 

(iii) The commodity pool is formed 

and operated by a registered commodity 

pool operator or by a commodity pool 

operator who is exempt from 

registration as such pursuant to 

§ 4.13(a)(3) of this chapter. 

* * * * * 

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

term swap dealer means any person 

who: 

(i) Holds itself out as a dealer in 

swaps; 

(ii) Makes a market in swaps; 

(iii) Regularly enters into swaps with 

counterparties as an ordinary course of 

business for its own account; or 

(iv) Engages in any activity causing it 

to be commonly known in the trade as 

a dealer or market maker in swaps. 

(2) Exception. The term swap dealer 

does not include a person that enters 

into swaps for such person’s own 

account, either individually or in a 

fiduciary capacity, but not as a part of 

regular business. 

(3) Scope of designation. A person 

who is a swap dealer shall be deemed 

to be a swap dealer with respect to each 

swap it enters into, regardless of the 

category of the swap or the person’s 

activities in connection with the swap. 

However, if a person makes an 

application to limit its designation as a 

swap dealer to specified categories of 

swaps or specified activities of the 

person in connection with swaps, the 

Commission shall determine whether 

the person’s designation as a swap 

dealer shall be so limited. If the 

Commission grants such limited 

designation, such limited designation 

swap dealer shall be deemed to be a 

swap dealer with respect to each swap 

it enters into in the swap category or 

categories for which it is so designated, 

regardless of the person’s activities in 

connection with such category or 

categories of swaps. A person may make 

such application to limit the categories 

of swaps or activities of the person that 

are subject to its swap dealer 

designation at the same time as, or after, 

the person’s initial registration as a 

swap dealer. 

(4) De minimis exception. (i) Except as 

provided in paragraph (ggg)(4)(vi) of this 

section, a person that is not currently 

registered as a swap dealer shall be 

deemed not to be a swap dealer as a 

result of its swap dealing activity 

involving counterparties, so long as the 

swap positions connected with those 

dealing activities into which the 

person—or any other entity controlling, 

controlled by or under common control 

with the person—enters over the course 

of the immediately preceding 12 months 

(or following the effective date of final 

rules implementing Section 1a(47) of 

the Act, 7 U.S.C. 1a(47), if that period 

is less than 12 months) have an 

aggregate gross notional amount of no 

more than $3 billion, subject to a phase 

in level of an aggregate gross notional 

amount of no more than $8 billion 

applied in accordance with paragraph 

(ggg)(4)(ii) of this section, and an 

aggregate gross notional amount of no 

more than $25 million with regard to 

swaps in which the counterparty is a 

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

in Section 4s(h)(2)(C) of the Act, 7 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30745 

U.S.C. 6s(h)(2)(C), and § 23.401(c) of this 

chapter). For purposes of this paragraph, 

if the stated notional amount of a swap 

is leveraged or enhanced by the 

structure of the swap, the calculation 

shall be based on the effective notional 

amount of the swap rather than on the 

stated notional amount. 

(ii) Phase-in procedure and staff 

report. (A) Phase-in period. For 

purposes of paragraph (ggg)(4)(i) of this 

section, except as provided in paragraph 

(ggg)(4)(vi) of this section, a person that 

engages in swap dealing activity that 

does not exceed the phase-in level set 

forth in paragraph (ggg)(4)(i) shall be 

deemed not to be a swap dealer as a 

result of its swap dealing activity until 

the ‘‘phase-in termination date’’ 

established as provided in paragraph 

(ggg)(4)(ii)(C) or (D) of this section. The 

Commission shall announce the phasein termination date on the Commission 

Web site and publish such date in the 

Federal Register. 

(B) Staff report. No later than 30 

months following the date that a swap 

data repository first receives swap data 

in accordance with part 45 of this 

chapter, the staff of the Commission 

shall complete and publish for public 

comment a report on topics relating to 

the definition of the term ‘‘swap dealer’’ 

and the de minimis threshold. The 

report should address the following 

topics, as appropriate, based on the 

availability of data and information: the 

potential impact of modifying the de 

minimis threshold, and whether the de 

minimis threshold should be increased 

or decreased; the factors that are useful 

for identifying swap dealing activity, 

including the application of the dealertrader distinction for that purpose, and 

the potential use of objective tests or 

safe harbors as part of the analysis; the 

impact of provisions in paragraphs 

(ggg)(5) and (6) of this section excluding 

certain swaps from the dealer analysis, 

and potential alternative approaches for 

such exclusions; and any other analysis 

of swap data and information relating to 

swaps that the Commission or staff 

deem relevant to this rule. 

(C) Nine months after publication of 

the report required by paragraph 

(ggg)(4)(ii)(B) of this section, and after 

giving due consideration to that report 

and any associated public comment, the 

Commission may either: 

(1) Terminate the phase-in period set 

forth in paragraph (ggg)(4)(ii)(A) of this 

section, in which case the phase-in 

termination date shall be established by 

the Commission by order published in 

the Federal Register; or 

(2) Determine that it is necessary or 

appropriate in the public interest to 

propose through rulemaking an 

alternative to the $3 billion amount set 

forth in paragraph (ggg)(4)(i) of this 

section that would constitute a de 

minimis quantity of swap dealing in 

connection with transactions with or on 

behalf of customers within the meaning 

of section 1(a)(47)(D) of the Act, 7 U.S.C. 

1(a)(47)(D), in which case the 

Commission shall by order published in 

the Federal Register provide notice of 

such determination, which order shall 

also establish the phase-in termination 

date. 

(D) If the phase-in termination date 

has not been previously established 

pursuant to paragraph (ggg)(4)(ii)(C) of 

this section, then in any event the 

phase-in termination date shall occur 

five years after the date that a swap 

repository first receives swap data in 

accordance with part 45 of this chapter. 

(iii) Registration period for persons 

that can no longer take advantage of the 

exception. A person that has not 

registered as a swap dealer by virtue of 

satisfying the requirements of this 

paragraph (ggg)(4), but that no longer 

can take advantage of that de minimis 

exception, will be deemed not to be a 

swap dealer until the earlier of the date 

on which it submits a complete 

application for registration pursuant to 

Section 4s(b) of the Act, 7 U.S.C. 6s(b), 

or two months after the end of the 

month in which that person becomes no 

longer able to take advantage of the 

exception. 

(iv) Applicability to registered swap 

dealers. A person who currently is 

registered as a swap dealer may apply 

to withdraw that registration, while 

continuing to engage in swap dealing 

activity in reliance on this section, so 

long as that person has been registered 

as a swap dealer for at least 12 months 

and satisfies the conditions of paragraph 

(ggg)(4)(i) of this section. 

(v) Future adjustments to scope of the 

de minimis exception. The Commission 

may by rule or regulation change the 

requirements of the de minimis 

exception described in paragraphs 

(ggg)(4)(i) through (iv) of this section. 

(vi) Voluntary registration. 

Notwithstanding paragraph (ggg)(4)(i) of 

this section, a person that chooses to 

register with the Commission as a swap 

dealer shall be deemed to be a swap 

dealer. 

(5) Insured depository institution 

swaps in connection with originating 

loans to customers. Swaps entered into 

by an insured depository institution 

with a customer in connection with 

originating a loan with that customer 

shall not be considered in determining 

whether the insured depository 

institution is a swap dealer. 

(i) An insured depository institution 

shall be considered to have entered into 

a swap with a customer in connection 

with originating a loan, as defined in 

paragraphs (ggg)(5)(ii) and (iii) of this 

section, with that customer only if: 

(A) The insured depository institution 

enters into the swap with the customer 

no earlier than 90 days before and no 

later than 180 days after the date of 

execution of the applicable loan 

agreement, or no earlier than 90 days 

before and no later than 180 days after 

any transfer of principal to the customer 

by the insured depository institution 

pursuant to the loan; 

(B)(1) The rate, asset, liability or other 

notional item underlying such swap is, 

or is directly related to, a financial term 

of such loan, which includes, without 

limitation, the loan’s duration, rate of 

interest, the currency or currencies in 

which it is made and its principal 

amount; 

(2) Such swap is required, as a 

condition of the loan under the insured 

depository institution’s loan 

underwriting criteria, to be in place in 

order to hedge price risks incidental to 

the borrower’s business and arising from 

potential changes in the price of a 

commodity (other than an excluded 

commodity); 

(C) The duration of the swap does not 

extend beyond termination of the loan; 

(D) The insured depository institution 

is: 

(1) The sole source of funds to the 

customer under the loan; 

(2) Committed to be, under the terms 

of the agreements related to the loan, the 

source of at least 10 percent of the 

maximum principal amount under the 

loan; or 

(3) Committed to be, under the terms 

of the agreements related to the loan, the 

source of a principal amount that is 

greater than or equal to the aggregate 

notional amount of all swaps entered 

into by the insured depository 

institution with the customer in 

connection with the financial terms of 

the loan; 

(E) The aggregate notional amount of 

all swaps entered into by the customer 

in connection with the financial terms 

of the loan is, at any time, not more than 

the aggregate principal amount 

outstanding under the loan at that time; 

and 

(F) If the swap is not accepted for 

clearing by a derivatives clearing 

organization, the insured depository 

institution reports the swap as required 

by section 4r of the Act, 7 U.S.C. 6r 

(except as otherwise provided in section 

4r(a)(3)(A), 7 U.S.C. 6r(a)(3)(A), or 

section 4r(a)(3)(B), 7 U.S.C. 6r(a)(3)(B) of 

the Act). 

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30746 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

(ii) An insured depository institution 

shall be considered to have originated a 

loan with a customer if the insured 

depository institution: 

(A) Directly transfers the loan amount 

to the customer; 

(B) Is a part of a syndicate of lenders 

that is the source of the loan amount 

that is transferred to the customer; 

(C) Purchases or receives a 

participation in the loan; or 

(D) Otherwise is the source of funds 

that are transferred to the customer 

pursuant to the loan or any refinancing 

of the loan. 

(iii) The term loan shall not include: 

(A) Any transaction that is a sham, 

whether or not intended to qualify for 

the exclusion from the definition of the 

term swap dealer in this rule; or 

(B) Any synthetic loan, including, 

without limitation, a loan credit default 

swap or loan total return swap. 

(6) Swaps that are not considered in 

determining whether a person is a swap 

dealer. (i) Inter-affiliate activities. In 

determining whether a person is a swap 

dealer, that person’s swaps with 

majority-owned affiliates shall not be 

considered. For these purposes the 

counterparties to a swap are majorityowned affiliates if one counterparty 

directly or indirectly owns a majority 

interest in the other, or if a third party 

directly or indirectly owns a majority 

interest in both counterparties to the 

swap, where ‘‘majority interest’’ is the 

right to vote or direct the vote of a 

majority of a class of voting securities of 

an entity, the power to sell or direct the 

sale of a majority of a class of voting 

securities of an entity, or the right to 

receive upon dissolution or the 

contribution of a majority of the capital 

of a partnership. 

(ii) Activities of a cooperative. (A) 

Any swap that is entered into by a 

cooperative with a member of such 

cooperative shall not be considered in 

determining whether the cooperative is 

a swap dealer, provided that: 

(1) The swap is subject to policies and 

procedures of the cooperative requiring 

that the cooperative monitors and 

manages the risk of such swap; 

(2) The cooperative reports the swap 

as required by Section 4r of the Act, 7 

U.S.C. 6r (except as otherwise provided 

in Section 4r(a)(3)(A) of the Act, 7 

U.S.C. 6r(a)(3)(A) or Section 4r(a)(3)(B) 

of the Act, 7 U.S.C. 6r(a)(3)(B)); and 

(3) if the cooperative is a cooperative 

association of producers, the swap is 

primarily based on a commodity that is 

not an excluded commodity. 

(B) For purposes of this paragraph 

(ggg)(6)(ii), the term cooperative shall 

mean: 

(1) A cooperative association of 

producers as defined in section 1a(14) of 

the Act, 7 U.S.C. 1a(14), or 

(2) A person chartered under Federal 

law as a cooperative and predominantly 

engaged in activities that are financial in 

nature as defined in section 4(k) of the 

Bank Holding Company Act of 1956, 12 

U.S.C. 1843(k). 

(C) For purposes of this paragraph 

(ggg)(6)(ii), a swap shall be deemed to be 

entered into by a cooperative 

association of producers with a member 

of such cooperative association of 

producers when the swap is between a 

cooperative association of producers 

and a person that is a member of a 

cooperative association of producers 

that is itself a member of the first 

cooperative association of producers. 

(iii) Swaps entered into for the 

purpose of hedging physical positions. 

In determining whether a person is a 

swap dealer, a swap that the person 

enters into shall not be considered, if: 

(A) The person enters into the swap 

for the purpose of offsetting or 

mitigating the person’s price risks that 

arise from the potential change in the 

value of one or several— 

(1) Assets that the person owns, 

produces, manufactures, processes, or 

merchandises or anticipates owning, 

producing, manufacturing, processing, 

or merchandising; 

(2) Liabilities that the person owns or 

anticipates incurring; or 

(3) Services that the person provides, 

purchases, or anticipates providing or 

purchasing; 

(B) The swap represents a substitute 

for transactions made or to be made or 

positions taken or to be taken by the 

person at a later time in a physical 

marketing channel; 

(C) The swap is economically 

appropriate to the reduction of the 

person’s risks in the conduct and 

management of a commercial enterprise; 

(D) The swap is entered into in 

accordance with sound commercial 

practices; and 

(E) The person does not enter into the 

swap in connection with activity 

structured to evade designation as a 

swap dealer. 

(iv) Swaps entered into by floor 

traders. In determining whether a 

person is a swap dealer, each swap that 

the person enters into in its capacity as 

a floor trader as defined by section 

1a(23) of the Act or on or subject to the 

rules of a swap execution facility shall 

not be considered for the purpose of 

determining whether the person is a 

swap dealer if the person: 

(A) Is registered with the Commission 

as a floor trader pursuant to § 3.11 of 

this chapter; 

(B) Enters into swaps with proprietary 

funds for that trader’s own account 

solely on or subject to the rules of a 

designated contract market or swap 

execution facility and submits each 

such swap for clearing to a derivatives 

clearing organization; 

(C) Is not an affiliated person of a 

registered swap dealer; 

(D) Does not directly, or through an 

affiliated person, negotiate the terms of 

swap agreements, other than price and 

quantity or to participate in a request for 

quote process subject to the rules of a 

designated contract market or a swap 

execution facility; 

(E) Does not directly or through an 

affiliated person offer or provide swap 

clearing services to third parties; 

(F) Does not directly or through an 

affiliated person enter into swaps that 

would qualify as hedging physical 

positions pursuant to paragraph 

(ggg)(6)(iii) of this section or hedging or 

mitigating commercial risk pursuant to 

paragraph (kkk) of this section (except 

for any such swap executed opposite a 

counterparty for which the transaction 

would qualify as a bona fide hedging 

transaction); 

(G) Does not participate in any market 

making program offered by a designated 

contract market or swap execution 

facility; and 

(H) Notwithstanding the fact such 

person is not registered as a swap 

dealer, such person complies with 

§§ 23.201, 23.202, 23.203, and 23.600 of 

this chapter with respect to each such 

swap as if it were a swap dealer. 

(hhh) Major Swap Participant. (1) In 

general. The term major swap 

participant means any person: 

(i) That is not a swap dealer; and 

(ii)(A) That maintains a substantial 

position in swaps for any of the major 

swap categories, excluding both 

positions held for hedging or mitigating 

commercial risk, and positions 

maintained by any employee benefit 

plan (or any contract held by such a 

plan) as defined in paragraphs (3) and 

(32) of Section 3 of the Employee 

Retirement Income Security Act of 1974, 

29 U.S.C. 1002, for the primary purpose 

of hedging or mitigating any risk 

directly associated with the operation of 

the plan; 

(B) Whose outstanding swaps create 

substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets; or 

(C) That is a financial entity that: 

(1) Is highly leveraged relative to the 

amount of capital such entity holds and 

that is not subject to capital 

requirements established by an 

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appropriate Federal banking agency (as 

defined in Section 1a(2) of the Act, 7 

U.S.C. 1a(2)); and 

(2) Maintains a substantial position in 

outstanding swaps in any major swap 

category. 

(2) Scope of designation. A person 

that is a major swap participant shall be 

deemed to be a major swap participant 

with respect to each swap it enters into, 

regardless of the category of the swap or 

the person’s activities in connection 

with the swap. However, if a person 

makes an application to limit its 

designation as a major swap participant 

to specified categories of swaps, the 

Commission shall determine whether 

the person’s designation as a major 

swap participant shall be so limited. If 

the Commission grants such limited 

designation, such limited designation 

major swap participant shall be deemed 

to be a major swap participant with 

respect to each swap it enters into in the 

swap category or categories for which it 

is so designated, regardless of the 

person’s activities in connection with 

such category or categories of swaps. A 

person may make such application to 

limit its designation at the same time as, 

or after, the person’s initial registration 

as a major swap participant. 

(3) Timing requirements. A person 

that is not registered as a major swap 

participant, but that meets the criteria in 

this rule to be a major swap participant 

as a result of its swap activities in a 

fiscal quarter, will not be deemed to be 

a major swap participant until the 

earlier of the date on which it submits 

a complete application for registration 

as a major swap participant pursuant to 

Section 4s(a)(2) of the Act, 7 U.S.C. 

6s(a)(2), or two months after the end of 

that quarter. 

(4) Reevaluation period. 

Notwithstanding paragraph (hhh)(3) of 

this section, if a person that is not 

registered as a major swap participant 

meets the criteria in this rule to be a 

major swap participant in a fiscal 

quarter, but does not exceed any 

applicable threshold by more than 

twenty percent in that quarter: 

(i) That person will not be deemed a 

major swap participant pursuant to the 

timing requirements specified in 

paragraph (hhh)(3) of this section; but 

(ii) That person will be deemed a 

major swap participant pursuant to the 

timing requirements specified in 

paragraph (hhh)(3) of this section at the 

end of the next fiscal quarter if the 

person exceeds any of the applicable 

daily average thresholds in that next 

fiscal quarter. 

(5) Termination of status. A person 

that is deemed to be a major swap 

participant shall continue to be deemed 

a major swap participant until such time 

that its swap activities do not exceed 

any of the daily average thresholds set 

forth within this rule for four 

consecutive fiscal quarters after the date 

on which the person becomes registered 

as a major swap participant. 

(6) Calculation of status. A person 

shall not be deemed to be a ‘‘major swap 

participant,’’ regardless of whether the 

criteria paragraph (hhh)(1) of this 

section otherwise would cause the 

person to be a major swap participant, 

provided the person meets the 

conditions set forth in paragraphs 

(hhh)(6)(i), (ii) or (iii) of this section. 

(i) Caps on uncollateralized exposure 

and notional positions. 

(A) Maximum potential 

uncollateralized exposure. The express 

terms of the person’s agreements or 

arrangements relating to swaps with its 

counterparties at no time would permit 

the person to maintain a total 

uncollateralized exposure of more than 

$100 million to all such counterparties, 

including any exposure that may result 

from thresholds or minimum transfer 

amounts established by credit support 

annexes or similar arrangements; and 

(B) Maximum notional amount of 

swap positions. The person does not 

maintain swap positions in a notional 

amount of more than $2 billion in any 

major category of swaps, or more than 

$4 billion in the aggregate across all 

major categories; or 

(ii) Caps on uncollateralized exposure 

plus monthly calculation. 

(A) Maximum potential 

uncollateralized exposure. The express 

terms of the person’s agreements or 

arrangements relating to swaps with its 

counterparties at no time would permit 

the person to maintain a total 

uncollateralized exposure of more than 

$200 million to all such counterparties 

(with regard to swaps and any other 

instruments by which the person may 

have exposure to those counterparties), 

including any exposure that may result 

from thresholds or minimum transfer 

amounts established by credit support 

annexes or similar arrangements; and 

(B) Calculation of positions. (1) At the 

end of each month, the person performs 

the calculations prescribed by paragraph 

(jjj) of this section with regard to 

whether the aggregate uncollateralized 

outward exposure plus aggregate 

potential outward exposure as of that 

day constitute a ‘‘substantial position’’ 

in a major category of swaps, or pose 

‘‘substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets’’; these calculations shall 

disregard provisions of those rules that 

provide for the analyses to be 

determined based on a daily average 

over a calendar quarter; and 

(2) Each such analysis produces 

thresholds of no more than: 

(i) $1 billion in aggregate 

uncollateralized outward exposure plus 

aggregate potential outward exposure in 

any major category of swaps; if the 

person is subject to paragraph (jjj) of this 

section, by virtue of being a highly 

leveraged financial entity that is not 

subject to capital requirements 

established by an appropriate Federal 

banking agency, this analysis shall 

account for all of the person’s swap 

positions in that major category 

(without excluding hedging positions), 

otherwise this analysis shall exclude the 

same hedging and related positions that 

are excluded from consideration 

pursuant to paragraph (jjj)(1)(i) of this 

section; or 

(ii) $2 billion in aggregate 

uncollateralized outward exposure plus 

aggregate potential outward exposure 

(without any positions excluded from 

the analysis) with regard to all of the 

person’s swap positions. 

(iii) Calculations based on certain 

information. (A)(1) At the end of each 

month, the person’s aggregate 

uncollateralized outward exposure with 

respect to its swap positions in each 

major swap category is less than $1.5 

billion with respect to the rate swap 

category and less than $500 million 

with respect to each of the other major 

swap categories; and 

(2) At the end of each month, the sum 

of the amount calculated under 

paragraph (hhh)(6)(iii)(A)(1) of this 

section with respect to each major swap 

category and the total notional principal 

amount of the person’s swap positions 

in each such major swap category, 

adjusted by the multipliers set forth in 

paragraph (jjj)(3)(ii)(1) of this section on 

a position-by-position basis reflecting 

the type of swap, is less than $3 billion 

with respect to the rate swap category 

and less than $1 billion with respect to 

each of the other major swap categories; 

or 

(B)(1) At the end of each month, the 

person’s aggregate uncollateralized 

outward exposure with respect to its 

swap positions across all major swap 

categories is less than $500 million; and 

(2) The sum of the amount calculated 

under paragraph (hhh)(6)(iii)(B)(1) of 

this section and the product of the total 

effective notional principal amount of 

the person’s swap positions in all major 

security-based swap categories 

multiplied by 0.15 is less than $1 

billion. 

(C) For purposes of the calculations 

set forth in this paragraph (hhh)(6)(iii): 

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30748 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

(1) The person’s aggregate 

uncollateralized outward exposure for 

positions held with swap dealers shall 

be equal to such exposure reported on 

the most recent reports of such exposure 

received from such swap dealers; and 

(2) The person’s aggregate 

uncollateralized outward exposure for 

positions that are not reflected in any 

report of exposure from a swap dealer 

(including all swap positions it holds 

with persons other than swap dealers) 

shall be calculated in accordance with 

paragraph (jjj)(2) of this section. 

(iv) For purposes of the calculations 

set forth in this paragraph (hhh)(6), the 

person shall use the effective notional 

amount of a position rather than the 

stated notional amount of the position if 

the stated notional amount is leveraged 

or enhanced by the structure of the 

position. 

(v) No presumption shall arise that a 

person is required to perform the 

calculations needed to determine if it is 

a major swap participant, solely by 

reason that the person does not meet the 

conditions specified in paragraph 

(hhh)(6)(i), (ii) or (iii) of this section. 

(7) Exclusions. A person who is 

registered as a derivatives clearing 

organization with the Commission 

pursuant to section 5b of the Act and 

regulations thereunder, shall not be 

deemed to be a major swap participant, 

regardless of whether the criteria in this 

paragraph (hhh) otherwise would cause 

the person to be a major swap 

participant. 

(iii) Category of swaps; major swap 

category. For purposes of Section 1a(33) 

the Act, 7 U.S.C. 1a(33), and paragraph 

(hhh) of this section, the terms major 

swap category, category of swaps and 

any similar terms mean any of the 

categories of swaps listed below. For the 

avoidance of doubt, the term swap as it 

is used in this paragraph (iii) has the 

meaning set forth in Section 1a(47) of 

the Act, 7 U.S.C. 1a(47), and the rules 

thereunder. 

(1) Rate swaps. Any swap which is 

primarily based on one or more 

reference rates, including but not 

limited to any swap of payments 

determined by fixed and floating 

interest rates, currency exchange rates, 

inflation rates or other monetary rates, 

any foreign exchange swap, as defined 

in Section 1a(25) of the Act, 7 U.S.C. 

1a(25), and any foreign exchange option 

other than an option to deliver currency. 

(2) Credit swaps. Any swap that is 

primarily based on instruments of 

indebtedness, including but not limited 

to any swap primarily based on one or 

more broad-based indices related to debt 

instruments or loans, and any swap that 

is an index credit default swap or total 

return swap on one or more indices of 

debt instruments. 

(3) Equity swaps. Any swap that is 

primarily based on equity securities, 

including but not limited to any swap 

based on one or more broad-based 

indices of equity securities and any total 

return swap on one or more equity 

indices. 

(4) Other commodity swaps. Any 

swap that is not included in the rate 

swap, credit swap or equity swap 

categories. 

(jjj) Substantial position. (1) In 

general. For purposes of Section 1a(33) 

of the Act, 7 U.S.C. 1a(33), and 

paragraph (hhh) of this section, the term 

‘‘substantial position’’ means swap 

positions that equal or exceed any of the 

following thresholds in the specified 

major category of swaps: 

(i) For rate swaps: 

(A) $3 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $6 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(ii) For credit swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(iii) For equity swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(iv) For other commodity swaps: 

(A) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(B) $2 billion in: 

(1) Daily average aggregate 

uncollateralized outward exposure plus 

(2) Daily average aggregate potential 

outward exposure. 

(2) Aggregate uncollateralized 

outward exposure. (i) In general. 

Aggregate uncollateralized outward 

exposure in general means the sum of 

the current exposure, obtained by 

marking-to-market using industry 

standard practices, of each of the 

person’s swap positions with negative 

value in a major swap category, less the 

value of the collateral the person has 

posted in connection with those 

positions. 

(ii) Calculation of aggregate 

uncollateralized outward exposure. In 

calculating this amount the person 

shall, with respect to each of its swap 

counterparties in a given major swap 

category, determine the dollar value of 

the aggregate current exposure arising 

from each of its swap positions with 

negative value (subject to the netting 

provisions described below) in that 

major category by marking-to-market 

using industry standard practices; and 

deduct from that dollar amount the 

aggregate value of the collateral the 

person has posted with respect to the 

swap positions. The aggregate 

uncollateralized outward exposure shall 

be the sum of those uncollateralized 

amounts across all of the person’s swap 

counterparties in the applicable major 

category. 

(iii) Relevance of netting agreements. 

(A) If the person has one or more master 

netting agreement in effect with a 

particular counterparty, the person may 

measure the current exposure arising 

from its swaps in any major category on 

a net basis, applying the terms of those 

agreements. Calculation of net current 

exposure may take into account 

offsetting positions entered into with 

that particular counterparty involving 

swaps (in any swap category) as well as 

security-based swaps and securities 

financing transactions (consisting of 

securities lending and borrowing, 

securities margin lending and 

repurchase and reverse repurchase 

agreements), and other financial 

instruments that are subject to netting 

offsets for purposes of applicable 

bankruptcy law, to the extent these are 

consistent with the offsets permitted by 

the master netting agreements. 

(B) Such adjustments may not take 

into account any offset associated with 

positions that the person has with 

separate counterparties. 

(iv) Allocation of uncollateralized 

outward exposure. If a person calculates 

current exposure with a particular 

counterparty on a net basis, as provided 

by paragraph (jjj)(2)(iii) of this section, 

the portion of that current exposure that 

should be attributed to each ‘‘major’’ 

category of swaps for purposes of the 

substantial position analysis should be 

calculated according to the formula: 

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Where: ES(MC) equals the amount of 

aggregate current exposure attributable to the 

entity’s swap positions in the ‘‘major’’ swap 

category at issue; Enet total equals the entity’s 

aggregate current exposure to the 

counterparty at issue, after accounting for the 

netting of positions and the posting of 

collateral; OTMS(MC) equals the exposure 

associated with the entity’s out-of-the-money 

positions in swaps in the ‘‘major’’ category at 

issue, subject to those netting arrangements; 

and OTMS(O) equals the exposure associated 

with the entity’s out-of-the-money positions 

in the other ‘‘major’’ categories of swaps, 

subject to those netting arrangements; and 

OTMnon-S equals the exposure associated with 

the entity’s out-of-the-money positions 

associated with instruments, other than 

swaps, that are subject to those netting 

arrangements. 

(3) Aggregate potential outward 

exposure. (i) In general. Aggregate 

potential outward exposure in any 

major swap category means the sum of: 

(A) The aggregate potential outward 

exposure for each of the person’s swap 

positions in a major swap category that 

are not subject to daily mark-to-market 

margining and are not cleared by a 

registered or exempt clearing agency or 

derivatives clearing organization, as 

calculated in accordance with paragraph 

(jjj)(3)(ii) of this section; and 

(B) The aggregate potential outward 

exposure for each of the person’s swap 

positions in such major swap category 

that are either subject to daily mark-tomarket margining or are cleared by a 

registered or exempt clearing agency or 

derivatives clearing organization, as 

calculated in accordance with paragraph 

(jjj)(3)(iii) of this section. 

(ii) Calculation of potential outward 

exposure for swaps that are not subject 

to daily mark-to-market margining and 

are not cleared by a registered or 

exempt clearing agency or derivatives 

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

For positions in swaps that are not 

subject to daily mark-to-market 

margining and are not cleared by a 

registered or exempt clearing agency or 

a derivatives clearing organization, 

potential outward exposure equals the 

total notional principal amount of those 

positions, multiplied by the following 

factors on a position-by-position basis 

reflecting the type of swap. For any 

swap that does not appropriately fall 

within any of the specified categories, 

the ‘‘other commodities’’ conversion 

factors set forth in the following Table 

1 are to be used. If a swap is structured 

such that on specified dates any 

outstanding exposure is settled and the 

terms are reset so that the market value 

of the swap is zero, the remaining 

maturity equals the time until the next 

reset date. 

TABLE 1—CONVERSION FACTOR MATRIX FOR SWAPS

Residual maturity Interest rate Foreign exchange 

rate and gold 

Precious metals 

(except gold) Other commodities 

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

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

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

Residual maturity Credit Equity 

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

Over one to five years ...... 0.10 0.08 

Over five years ................. 0.10 0.10 

(2) Use of effective notional amounts. 

If the stated notional amount on a 

position is leveraged or enhanced by the 

structure of the position, the calculation 

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

section shall be based on the effective 

notional amount of the position rather 

than on the stated notional amount. 

(3) Exclusion of certain positions. The 

calculation in paragraph (jjj)(3)(ii)(A)(1) 

of this section shall exclude: 

(i) Positions that constitute the 

purchase of an option, if the purchaser 

has no additional payment obligations 

under the position; 

(ii) Other positions for which the 

person has prepaid or otherwise 

satisfied all of its payment obligations; 

and 

(iii) Positions for which, pursuant to 

law or a regulatory requirement, the 

person has assigned an amount of cash 

or U.S. Treasury securities that is 

sufficient at all times to pay the person’s 

maximum possible liability under the 

position, and the person may not use 

that cash or those Treasury securities for 

other purposes. 

(4) Adjustment for certain positions. 

Notwithstanding paragraph 

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

potential outward exposure associated 

with a position by which a person buys 

credit protection using a credit default 

swap or index credit default swap, or 

associated with a position by which a 

person purchases an option for which 

the person retains additional payment 

obligations under the position, is 

capped at the net present value of the 

unpaid premiums. 

(B) Adjustment for netting 

agreements. Notwithstanding paragraph 

(jjj)(3)(ii)(A) of this section, for positions 

subject to master netting agreements the 

potential outward exposure associated 

with the person’s swaps with each 

counterparty equals a weighted average 

of the potential outward exposure for 

the person’s swaps with that 

counterparty as calculated under 

paragraph (jjj)(3)(ii)(A) of this section, 

and that amount reduced by the ratio of 

net current exposure to gross current 

exposure, consistent with the following 

equation as calculated on a 

counterparty-by-counterparty basis: 

PNet = 0.4 * PGross + 0.6 * NGR * PGross

Where: PNet is the potential outward 

exposure, adjusted for bilateral netting, of the 

person’s swaps with a particular 

counterparty; PGross is the potential outward 

exposure without adjustment for bilateral 

netting as calculated pursuant to paragraph 

(jjj)(3)(ii)(A) of this section; and NGR is the 

ratio of the current exposure arising from its 

swaps in the major category as calculated on 

a net basis according to paragraphs (jjj)(2)(iii) 

and (iv) of this section, divided by the 

current exposure arising from its swaps in 

the major category as calculated in the 

absence of those netting procedures. 

(iii) Calculation of potential outward 

exposure for swaps that are either 

subject to daily mark-to-market 

margining or are cleared by a registered 

or exempt clearing agency or derivatives 

clearing organization. For positions in 

swaps that are subject to daily mark-tomarket margining or that are cleared by 

a registered or exempt clearing agency 

or derivatives clearing organization: 

(A) Potential outward exposure equals 

the potential exposure that would be 

attributed to such positions using the 

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

this section multiplied by: 

(1) 0.1, in the case of positions cleared 

by a registered or exempt clearing 

agency; or 


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(2) 0.2, in the case of positions that 

are subject to daily mark-to-market 

margining but that are not cleared by a 

registered or exempt clearing agency. 

(B) Solely for purposes of calculating 

potential outward exposure: 

(1) A swap shall be considered to be 

subject to daily mark-to-market 

margining if, and for so long as, the 

counterparties follow the daily practice 

of exchanging collateral to reflect 

changes in the current exposure arising 

from the swap (after taking into account 

any other financial positions addressed 

by a netting agreement between the 

counterparties). 

(2) If the person is permitted by 

agreement to maintain a threshold for 

which it is not required to post 

collateral, the position still will be 

considered to be subject to daily markto-market margining for purposes of 

calculating potential outward exposure, 

but the total amount of that threshold 

(regardless of the actual exposure at any 

time), less any initial margin posted up 

to the amount of that threshold, shall be 

added to the person’s aggregate 

uncollateralized outward exposure for 

purposes of paragraph (jjj)(1)(i)(B), 

(ii)(B), (iii)(B) or (iv)(B) of this section, 

as applicable. 

(3) If the minimum transfer amount 

under the agreement is in excess of $1 

million, the position still will be 

considered to be subject to daily markto-market margining for purposes of 

calculating potential outward exposure, 

but the entirety of the minimum transfer 

amount shall be added to the person’s 

aggregate uncollateralized outward 

exposure for purposes of paragraph 

(jjj)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of 

this section, as applicable. 

(4) A person may, at its discretion, 

calculate the potential outward 

exposure of positions in swaps that are 

subject to daily mark-to-market 

margining in accordance with paragraph 

(jjj)(3)(ii) of this section in lieu of 

calculating the potential outward 

exposure of such swap positions in 

accordance with this paragraph 

(jjj)(3)(iii). 

(4) Calculation of daily average. 

Measures of daily average aggregate 

uncollateralized outward exposure and 

daily average aggregate potential 

outward exposure shall equal the 

arithmetic mean of the applicable 

measure of exposure at the close of each 

business day, beginning the first 

business day of each calendar quarter 

and continuing through the last 

business day of that quarter. 

(5) Inter-affiliate activities. In 

calculating its aggregate uncollateralized 

outward exposure and its aggregate 

potential outward exposure, the person 

shall not consider its swap positions 

with counterparties that are majorityowned affiliates. For these purposes the 

counterparties to a swap are majorityowned affiliates if one counterparty 

directly or indirectly owns a majority 

interest in the other, or if a third party 

directly or indirectly owns a majority 

interest in both counterparties to the 

swap, where ‘‘majority interest’’ is the 

right to vote or direct the vote of a 

majority of a class of voting securities of 

an entity, the power to sell or direct the 

sale of a majority of a class of voting 

securities of an entity, or the right to 

receive upon dissolution or the 

contribution of a majority of the capital 

of a partnership. 

(kkk) Hedging or mitigating 

commercial risk. For purposes of 

Section 1a(33) of the Act, 7 U.S.C. 

1a(33) and paragraph (hhh) of this 

section, a swap position is held for the 

purpose of hedging or mitigating 

commercial risk when: 

(1) Such position: 

(i) Is economically appropriate to the 

reduction of risks in the conduct and 

management of a commercial enterprise 

(or of a majority-owned affiliate of the 

enterprise), where the risks arise from: 

(A) The potential change in the value 

of assets that a person owns, produces, 

manufactures, processes, or 

merchandises or reasonably anticipates 

owning, producing, manufacturing, 

processing, or merchandising in the 

ordinary course of business of the 

enterprise; 

(B) The potential change in the value 

of liabilities that a person has incurred 

or reasonably anticipates incurring in 

the ordinary course of business of the 

enterprise; or 

(C) The potential change in the value 

of services that a person provides, 

purchases, or reasonably anticipates 

providing or purchasing in the ordinary 

course of business of the enterprise; 

(D) The potential change in the value 

of assets, services, inputs, products, or 

commodities that a person owns, 

produces, manufactures, processes, 

merchandises, leases, or sells, or 

reasonably anticipates owning, 

producing, manufacturing, processing, 

merchandising, leasing, or selling in the 

ordinary course of business of the 

enterprise; 

(E) Any potential change in value 

related to any of the foregoing arising 

from interest, currency, or foreign 

exchange rate movements associated 

with such assets, liabilities, services, 

inputs, products, or commodities; or 

(F) Any fluctuation in interest, 

currency, or foreign exchange rate 

exposures arising from a person’s 

current or anticipated assets or 

liabilities; or 

(ii) Qualifies as bona fide hedging for 

purposes of an exemption from position 

limits under the Act; or 

(iii) Qualifies for hedging treatment 

under: 

(A) Financial Accounting Standards 

Board Accounting Standards 

Codification Topic 815, Derivatives and 

Hedging (formerly known as Statement 

No. 133); or 

(B) Governmental Accounting 

Standards Board Statement 53, 

Accounting and Financial Reporting for 

Derivative Instruments; and 

(2) Such position is: 

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

nature of speculation, investing or 

trading; and 

(ii) Not held to hedge or mitigate the 

risk of another swap or security-based 

swap position, unless that other 

position itself is held for the purpose of 

hedging or mitigating commercial risk 

as defined by this rule or § 240.3a67–4 

of this title. 

(lll) Substantial counterparty 

exposure. (1) In general. For purposes of 

Section 1a(33) of the Act, 7 U.S.C. 

1a(33), and paragraph (hhh) of this 

section, the term substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the United States banking 

system or financial markets means a 

swap position that satisfies either of the 

following thresholds: 

(i) $5 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(ii) $8 billion in: 

(A) Daily average aggregate 

uncollateralized outward exposure plus 

(B) Daily average aggregate potential 

outward exposure. 

(2) Calculation methodology. For 

these purposes, the terms daily average 

aggregate uncollateralized outward 

exposure and daily average aggregate 

potential outward exposure shall be 

calculated the same way as is prescribed 

in paragraph (jjj) of this section, except 

that these amounts shall be calculated 

by reference to all of the person’s swap 

positions, rather than by reference to a 

specific major swap category. 

(mmm) Financial entity; highly 

leveraged. (1) For purposes of Section 

1a(33) of the Act, 7 U.S.C. 1a(33), and 

paragraph (hhh) of this section, the term 

financial entity means: 

(i) A security-based swap dealer; 

(ii) A major security-based swap 

participant; 

(iii) A commodity pool as defined in 

Section 1a(10) of the Act, 7 U.S.C. 

1a(10); 

(iv) A private fund as defined in 

Section 202(a) of the Investment 

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Advisers Act of 1940, 15 U.S.C. 80b– 

2(a); 

(v) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

Section 3 of the Employee Retirement 

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

1002; and 

(vi) A person predominantly engaged 

in activities that are in the business of 

banking or financial in nature, as 

defined in Section 4(k) of the Bank 

Holding Company Act of 1956, 12 

U.S.C. 1843(k). 

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

the Act, 7 U.S.C. 1a(33), and paragraph 

(hhh) of this section, the term highly 

leveraged means the existence of a ratio 

of an entity’s total liabilities to equity in 

excess of 12 to 1 as measured at the 

close of business on the last business 

day of the applicable fiscal quarter. For 

this purpose, liabilities and equity 

should each be determined in 

accordance with U.S. generally accepted 

accounting principles; provided, 

however, that a person that is an 

employee benefit plan, as defined in 

paragraphs (3) and (32) of Section 3 of 

the Employee Retirement Income 

Security Act of 1974, 29 U.S.C. 1002, 

may exclude obligations to pay benefits 

to plan participants from the calculation 

of liabilities and substitute the total 

value of plan assets for equity. 

Securities and Exchange Commission 

Pursuant to the Exchange Act, 15 

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

Sections 3 and 23 thereof, and Sections 

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

the SEC is adopting Rules 3a67–1, 3a67– 

2, 3a67–3, 3a67–4, 3a67–5, 3a67–6, 

3a67–7, 3a71–1, and 3a71–2 under the 

Exchange Act. 

For the reasons stated in the 

preamble, the SEC is amending Title 17, 

Chapter II, of the Code of the Federal 

Regulations, as follows: 

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

■ 3. The authority citation for part 240 

is amended by adding the following 

citation in numerical order: 

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

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

77kkk, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j– 

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

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

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

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

1350; 12 U.S.C. 5221(e)(3), and Pub. L. 111– 

203, § 939A, 124 Stat. 1376 (2010), unless 

otherwise noted. 

* * * * * 

Sections 3a67–1 through 3a67–9 and 3a71– 

1 and 3a71–2 are also issued under Pub. L. 

111–203, §§ 712, 761(b), 124 Stat. 1841 

(2010). 

* * * * * 

■ 4. Add an undesignated center 

heading and §§ 240.3a67–1 through 

240.3a67–9 and §§ 240.3a71–1 and 

240.3a71–2 to read as follows: 

Security-Based Swap Dealer and 

Participant Definitions 

Sec. 

240.3a67–1 Definition of ‘‘major securitybased swap participant.’’ 

240.3a67–2 Categories of security-based 

swaps. 

240.3a67–3 Definition of ‘‘substantial 

position.’’ 

240.3a67–4 Definition of ‘‘hedging or 

mitigating commercial risk.’’ 

240.3a67–5 Definition of ‘‘substantial 

counterparty exposure.’’ 

240.3a67–6 Definition of ‘‘financial entity.’’ 

240.3a67–7 Definition of ‘‘highly 

leveraged.’’ 

240.3a67–8 Timing requirements, 

reevaluation period and termination of 

status. 

240.3a67–9 Calculation of major participant 

status by certain persons. 

240.3a71–1 Definition of ‘‘security-based 

swap dealer.’’ 

240.3a71–2 De minimis exception. 

240.3a71–2A Report regarding the 

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

security-based swap participant’’ 

definitions (Appendix A to 17 CFR 

240.3a71–2). 

* * * * * 

§ 240.3a67–1 Definition of ‘‘major securitybased swap participant.’’ 

(a) General. Major security-based 

swap participant means any person: 

(1) That is not a security-based swap 

dealer; and 

(2)(i) That maintains a substantial 

position in security-based swaps for any 

of the major security-based swap 

categories, excluding both positions 

held for hedging or mitigating 

commercial risk, and positions 

maintained by any employee benefit 

plan (or any contract held by such a 

plan) as defined in paragraphs (3) and 

(32) of section 3 of the Employee 

Retirement Income Security Act of 1974 

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

of hedging or mitigating any risk 

directly associated with the operation of 

the plan; 

(ii) Whose outstanding security-based 

swaps create substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets; or 

(iii) That is a financial entity that: 

(A) Is highly leveraged relative to the 

amount of capital such entity holds and 

that is not subject to capital 

requirements established by an 

appropriate Federal banking agency (as 

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

(B) Maintains a substantial position in 

outstanding security-based swaps in any 

major security-based swap category. 

(b) Scope of designation. A person 

that is a major security-based swap 

participant in general shall be deemed 

to be a major security-based swap 

participant with respect to each 

security-based swap it enters into, 

regardless of the category of the 

security-based swap or the person’s 

activities in connection with the 

security-based swap, unless the 

Commission limits the person’s 

designation as a major security-based 

swap participant to specified categories 

of security-based swaps. 

§ 240.3a67–2 Categories of security-based 

swaps. 

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

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

thereunder, the terms major securitybased swap category, category of 

security-based swaps and any similar 

terms mean either of the following 

categories of security-based swaps: 

(a) Debt security-based swaps. Any 

security-based swap that is based, in 

whole or in part, on one or more 

instruments of indebtedness (including 

loans), or on a credit event relating to 

one or more issuers or securities, 

including but not limited to any 

security-based swap that is a credit 

default swap, total return swap on one 

or more debt instruments, debt swap, 

debt index swap, or credit spread. 

(b) Other security-based swaps. Any 

security-based swap not described in 

paragraph (a) of this section. 

§ 240.3a67–3 Definition of ‘‘substantial 

position.’’ 

(a) General. For purposes of section 

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

and § 240.3a67–1, the term substantial 

position means security-based swap 

positions that equal or exceed either of 

the following thresholds in any major 

category of security-based swaps: 

(1) $1 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(2) $2 billion in: 

(i) Daily average aggregate 

uncollateralized outward exposure; plus 

(ii) Daily average aggregate potential 

outward exposure. 

(b) Aggregate uncollateralized 

outward exposure. (1) General. 

Aggregate uncollateralized outward 

exposure in general means the sum of 

the current exposure, obtained by 

marking-to-market using industry 

standard practices, of each of the 

person’s security-based swap positions 

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

the collateral the person has posted in 

connection with those positions. 

(2) Calculation of aggregate 

uncollateralized outward exposure. In 

calculating this amount the person 

shall, with respect to each of its 

security-based swap counterparties in a 

given major security-based swap 

category: 

(i) Determine the dollar value of the 

aggregate current exposure arising from 

each of its security-based swap 

positions with negative value (subject to 

the netting provisions described below) 

in that major category by marking-tomarket using industry standard 

practices; and 

(ii) Deduct from that dollar amount 

the aggregate value of the collateral the 

person has posted with respect to the 

security-based swap positions. 

(iii) The aggregate uncollateralized 

outward exposure shall be the sum of 

those uncollateralized amounts across 

all of the person’s security-based swap 

counterparties in the applicable major 

category. 

(3) Relevance of netting agreements. 

(i) If a person has one or more master 

netting agreements with a counterparty, 

the person may measure the current 

exposure arising from its security-based 

swaps in any major category on a net 

basis, applying the terms of those 

agreements. Calculation of current 

exposure may take into account 

offsetting positions entered into with 

that particular counterparty involving 

security-based swaps (in any securitybased swap category) as well as swaps 

and securities financing transactions 

(consisting of securities lending and 

borrowing, securities margin lending 

and repurchase and reverse repurchase 

agreements), and other financial 

instruments that are subject to netting 

offsets for purposes of applicable 

bankruptcy law, to the extent these are 

consistent with the offsets permitted by 

the master netting agreements. 

(ii) Such adjustments may not take 

into account any offset associated with 

positions that the person has with 

separate counterparties. 

(4) Allocation of uncollateralized 

outward exposure. If a person calculates 

current exposure with a particular 

counterparty on a net basis, as provided 

by paragraph (b)(3) of this section, the 

amount of current uncollateralized 

exposure attributable to each ‘‘major’’ 

category of security-based swaps should 

be calculated according to the following 

formula: 

Note to paragraph (b)(4). Where: ESBS(MC)

equals the amount of aggregate current 

exposure attributable to the entity’s securitybased swap positions in the ‘‘major’’ category 

at issue (either security-based credit 

derivatives or other security-based swaps); 

Enet total equals the entity’s aggregate current 

exposure to the counterparty at issue, after 

accounting for the netting of positions and 

the posting of collateral; OTMSBS(MC) equals 

the current exposure associated with the 

entity’s out-of-the-money positions in 

security-based swaps in the ‘‘major’’ category 

at issue, subject to those netting 

arrangements; and OTMSBS(O) equals the 

current exposure associated with the entity’s 

out-of-the-money positions in the other 

‘‘major’’ category of security-based swaps, 

subject to those netting arrangements; and 

OTMnon-SBS equals the current exposure 

associated with the entity’s out-of-the-money 

positions associated with instruments, other 

than security-based swaps, that are subject to 

those netting arrangements. 

(c) Aggregate potential outward 

exposure. (1) General. Aggregate 

potential outward exposure means the 

sum of: 

(i) The aggregate potential outward 

exposure for each of the person’s 

security-based swap positions in a major 

security-based swap category that are 

neither cleared by a registered or 

exempt clearing agency nor subject to 

daily mark-to-market margining, as 

calculated in accordance with paragraph 

(c)(2) of this section; and 

(ii) The aggregate potential outward 

exposure for each of the person’s 

security-based swap positions in a major 

security-based swap category that are 

either cleared by a registered or exempt 

clearing agency or subject to daily markto-market margining, as calculated in 

accordance with paragraph (c)(3) of this 

section. 

(2) Calculation of potential outward 

exposure for security-based swaps that 

are not cleared by a registered or 

exempt clearing agency or subject to 

daily mark-to-market margining. (i) 

General. (A)(1) For positions in securitybased swaps that are not cleared by a 

registered or exempt clearing agency or 

subject to daily mark-to-market 

margining, potential outward exposure 

equals the total notional principal 

amount of those positions, multiplied 

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

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

type, the ‘‘equity and other’’ conversion 

factors are to be used: 

Residual maturity Debt 

Equity 

and 

other 

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

Over one to five years ...... 0.10 0.08 

Over five years ................. 0.10 0.10 

(2) If a security-based swap is 

structured such that on specified dates 

any outstanding exposure is settled and 

the terms are reset so that the market 

value of the security-based swap is zero, 

the remaining maturity equals the time 

until the next reset date. 

(B) Use of effective notional amounts. 

If the stated notional amount on a 

position is leveraged or enhanced by the 

structure of the position, the calculation 

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

shall be based on the effective notional 

amount of the position rather than on 

the stated notional amount. 

(C) Exclusion of certain positions. The 

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

this section shall exclude: 

(1) Positions that constitute the 

purchase of an option, such that the 

person has no additional payment 

obligations under the position; 

(2) Other positions for which the 

person has prepaid or otherwise 

satisfied all of its payment obligations; 

and 

(3) Positions for which, pursuant to 

regulatory requirement, the person has 

assigned an amount of cash or U.S. 

Treasury securities that is sufficient to 

pay the person’s maximum possible 

liability under the position, and the 

person may not use that cash or those 

Treasury securities for other purposes. 

(D) Adjustment for certain positions. 

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

of this section, the potential outward 

exposure associated with a position by 

which a person buys credit protection 

using a credit default swap, or 

associated with a position by which a 

person purchases an option for which 

the person retains additional payment 

obligations under the position, is 

capped at the net present value of the 

unpaid premiums. 

(ii) Adjustment for netting 

agreements. Notwithstanding paragraph 

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

subject to master netting agreements the 


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potential outward exposure associated 

with the person’s security-based swaps 

with each counterparty equals a 

weighted average of the potential 

outward exposure for the person’s 

security-based swaps with that 

counterparty as calculated under 

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

that amount reduced by the ratio of net 

current exposure to gross current 

exposure, consistent with the following 

equation as calculated on a 

counterparty-by-counterparty basis: 

PNet = 0.4 × PGross + 0.6 × NGR × PGross

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

the potential outward exposure, adjusted for 

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

PGross is the potential outward exposure 

without adjustment for bilateral netting, as 

calculated pursuant to paragraph (c)(2)(i) of 

this section; and NGR is the ratio of: 

1. The current exposure arising from its 

security-based swaps in the major category as 

calculated on a net basis according to 

paragraphs (b)(3) and (4) of this section, 

divided by 

2. The current exposure arising from its 

security-based swaps in the major category as 

calculated in the absence of those netting 

procedures. 

(3) Calculation of potential outward 

exposure for security-based swaps that 

are either cleared by a registered or 

exempt clearing agency or subject to 

daily mark-to-market margining. For 

positions in security-based swaps that 

are cleared by a registered or exempt 

clearing agency or subject to daily markto-market margining: 

(i) Potential outward exposure equals 

the potential outward exposure that 

would be attributed to such positions 

using the procedures in paragraph (c)(2) 

of this section, multiplied by: 

(A) 0.1, in the case of positions 

cleared by a registered or exempt 

clearing agency; or 

(B) 0.2, in the case of positions that 

are subject to daily mark-to-market 

margining but that are not cleared by a 

registered or exempt clearing agency. 

(ii) Solely for purposes of calculating 

potential outward exposure: 

(A) A security-based swap shall be 

considered to be subject to daily markto-market margining if, and for as long 

as, the counterparties follow the daily 

practice of exchanging collateral to 

reflect changes in the current exposure 

arising from the security-based swap 

(after taking into account any other 

financial positions addressed by a 

netting agreement between the 

counterparties). 

(B) If the person is permitted by 

agreement to maintain a threshold for 

which it is not required to post 

collateral, the position still will be 

considered to be subject to daily markto-market margining for purposes of 

calculating potential outward exposure, 

but the total amount of that threshold 

(regardless of the actual exposure at any 

time) less any initial margin posted up 

to the amount of that threshold, shall be 

added to the person’s aggregate 

uncollateralized outward exposure for 

purposes of paragraph (a)(2) of this 

section. 

(C) If the minimum transfer amount 

under the agreement is in excess of $1 

million, the position still will be 

considered to be subject to daily markto-market margining for purposes of 

calculating potential outward exposure, 

but the entirety of the minimum transfer 

amount shall be added to the person’s 

aggregate uncollateralized outward 

exposure for purposes of paragraph 

(a)(2) of this section. 

(D) A person may, at its discretion, 

calculate the potential outward 

exposure of positions in security-based 

swaps that are subject to daily mark-tomarket margining in accordance with 

paragraph (c)(2) of this section in lieu of 

calculating the potential outward 

exposure of such positions in 

accordance with this paragraph (c)(3). 

(d) Calculation of daily average. 

Measures of daily average aggregate 

uncollateralized outward exposure and 

daily average aggregate potential 

outward exposure shall equal the 

arithmetic mean of the applicable 

measure of exposure at the close of each 

business day, beginning the first 

business day of each calendar quarter 

and continuing through the last 

business day of that quarter. 

(e) Inter-affiliate activities. In 

calculating its aggregate uncollateralized 

outward exposure and its aggregate 

potential outward exposure, a person 

shall not consider its security-based 

swap positions with counterparties that 

are majority-owned affiliates. For these 

purposes the parties are majority-owned 

affiliates if one party directly or 

indirectly owns a majority interest in 

the other, or if a third party directly or 

indirectly owns a majority interest in 

both counterparties to the securitybased swap, where ‘‘majority interest’’ is 

the right to vote or direct the vote of a 

majority of a class of voting securities of 

an entity, the power to sell or direct the 

sale of a majority of a class of voting 

securities of an entity, or the right to 

receive upon dissolution or the 

contribution of a majority of the capital 

of a partnership. 

§ 240.3a67–4 Definition of ‘‘hedging or 

mitigating commercial risk.’’ 

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

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

§ 240.3a67–1, a security-based swap 

position shall be deemed to be held for 

the purpose of hedging or mitigating 

commercial risk when: 

(a)(1) Such position is economically 

appropriate to the reduction of risks that 

are associated with the present conduct 

and management of a commercial 

enterprise (or of a majority owned 

affiliate of the enterprise), or are 

reasonably expected to arise in the 

future conduct and management of the 

commercial enterprise, where such risks 

arise from: 

(i) The potential change in the value 

of assets that a person owns, produces, 

manufactures, processes, or 

merchandises or reasonably anticipates 

owning, producing, manufacturing, 

processing, or merchandising in the 

ordinary course of business of the 

enterprise (or of an affiliate under 

common control with the enterprise); 

(ii) The potential change in the value 

of liabilities that a person has incurred 

or reasonably anticipates incurring in 

the ordinary course of business of the 

enterprise (or of an affiliate under 

common control with the enterprise); or 

(iii) The potential change in the value 

of services that a person provides, 

purchases, or reasonably anticipates 

providing or purchasing in the ordinary 

course of business of the enterprise (or 

of an affiliate under common control 

with the enterprise); 

(2) Depending on the applicable facts 

and circumstances, the security-based 

swap positions described in paragraph 

(a)(1) of this section may be expected to 

encompass, among other positions: 

(i) Positions established to manage the 

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

counterparty’s potential default in 

connection with: Financing provided to 

a customer in connection with the sale 

of real property or a good, product or 

service; a customer’s lease of real 

property or a good, product or service; 

a customer’s agreement to purchase real 

property or a good, product or service in 

the future; or a supplier’s commitment 

to provide or sell a good, product or 

service in the future; 

(ii) Positions established to manage 

the default risk posed by a financial 

counterparty (different from the 

counterparty to the hedging position at 

issue) in connection with a separate 

transaction (including a position 

involving a credit derivative, equity 

swap, other security-based swap, 

interest rate swap, commodity swap, 

foreign exchange swap or other swap, 

option, or future that itself is for the 

purpose of hedging or mitigating 

commercial risk pursuant to this section 

or 17 CFR 1.3(kkk)); 

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(iii) Positions established to manage 

equity or market risk associated with 

certain employee compensation plans, 

including the risk associated with 

market price variations in connection 

with stock-based compensation plans, 

such as deferred compensation plans 

and stock appreciation rights; 

(iv) Positions established to manage 

equity market price risks connected 

with certain business combinations, 

such as a corporate merger or 

consolidation or similar plan or 

acquisition in which securities of a 

person are exchanged for securities of 

any other person (unless the sole 

purpose of the transaction is to change 

an issuer’s domicile solely within the 

United States), or a transfer of assets of 

a person to another person in 

consideration of the issuance of 

securities of such other person or any of 

its affiliates; 

(v) Positions established by a bank to 

manage counterparty risks in 

connection with loans the bank has 

made; and 

(vi) Positions to close out or reduce 

any of the positions described in 

paragraphs (a)(2)(i) through (a)(2)(v) of 

this section; and 

(b) Such position is: 

(1) Not held for a purpose that is in 

the nature of speculation or trading; and 

(2) Not held to hedge or mitigate the 

risk of another security-based swap 

position or swap position, unless that 

other position itself is held for the 

purpose of hedging or mitigating 

commercial risk as defined by this 

section or 17 CFR 1.3(kkk). 

§ 240.3a67–5 Definition of ‘‘substantial 

counterparty exposure.’’ 

(a) General. For purposes of section 

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

and § 240.3a67–1, the term substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the United States banking 

system or financial markets means a 

security-based swap position that 

satisfies either of the following 

thresholds: 

(1) $2 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(2) $4 billion in: 

(i) Daily average aggregate 

uncollateralized outward exposure; plus 

(ii) Daily average aggregate potential 

outward exposure. 

(b) Calculation. For these purposes, 

daily average aggregate uncollateralized 

outward exposure and daily average 

aggregate potential outward exposure 

shall be calculated the same way as is 

prescribed in § 240.3a67–3, except that 

these amounts shall be calculated by 

reference to all of the person’s securitybased swap positions, rather than by 

reference to a specific major securitybased swap category. 

§ 240.3a67–6 Definition of ‘‘financial 

entity.’’ 

(a) General. For purposes of section 

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

and § 240.3a67–1, the term financial 

entity means: 

(1) A swap dealer; 

(2) A major swap participant; 

(3) A commodity pool as defined in 

section 1a(10) of the Commodity 

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

(4) A private fund as defined in 

section 202(a) of the Investment 

Advisers Act of 1940 (15 U.S.C. 80b– 

2(a)); 

(5) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

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

1002); and 

(6) A person predominantly engaged 

in activities that are in the business of 

banking or financial in nature, as 

defined in section 4(k) of the Bank 

Holding Company Act of 1956 (12 

U.S.C. 1843k). 

(b) Exclusion for centralized hedging 

facilities. (1) General. Notwithstanding 

paragraph (a) of this section, for 

purposes of this section the term 

financial entity shall not encompass a 

person that would be a financial entity 

solely as a result of the person’s 

activities that facilitate hedging and/or 

treasury functions on behalf of one or 

more majority-owned affiliates that 

themselves do not constitute a financial 

entity. 

(2) Meaning of majority-owned. For 

these purposes the counterparties to a 

security-based swap are majority-owned 

affiliates if one counterparty directly or 

indirectly owns a majority interest in 

the other, or if a third party directly or 

indirectly owns a majority interest in 

both counterparties to the securitybased swap, where ‘‘majority interest’’ 

includes, but is not limited to, the right 

to vote or direct the vote of a majority 

of a class of voting securities of an 

entity, the power to sell or direct the 

sale of a majority of a class of voting 

securities of an entity, or the right to 

receive upon dissolution or the 

contribution of a majority of the capital 

of a partnership. 

§ 240.3a67–7 Definition of ‘‘highly 

leveraged.’’ 

(a) General. For purposes of section 

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

and § 240.3a67–1, the term highly 

leveraged means the existence of a ratio 

of an entity’s total liabilities to equity in 

excess of 12 to 1 as measured at the 

close of business on the last business 

day of the applicable fiscal quarter. 

(b) Measurement of liabilities and 

equity. For purposes of this section, 

liabilities and equity generally should 

each be determined in accordance with 

U.S. generally accepted accounting 

principles; provided, however, that a 

person that is an employee benefit plan, 

as defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

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

1002), may, for purposes of this 

paragraph (b): 

(1) Exclude obligations to pay benefits 

to plan participants from the calculation 

of liabilities; and 

(2) Substitute the total value of plan 

assets for equity. 

§ 240.3a67–8 Timing requirements, 

reevaluation period, and termination of 

status. 

(a) Timing requirements. A person 

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

the criteria in § 240.3a67–1 to be a major 

security-based swap participant as a 

result of its security-based swap 

activities in a fiscal quarter, will not be 

deemed to be a major security-based 

swap participant until the earlier of the 

date on which it submits a complete 

application for registration pursuant to 

section 15F of the Act (15 U.S.C. 78o– 

10) or two months after the end of that 

quarter. 

(b) Reevaluation period. 

Notwithstanding paragraph (a) of this 

section, if a person that is not registered 

as a major security-based swap 

participant meets the criteria in 

§ 240.3a67–1 to be a major securitybased swap participant in a fiscal 

quarter, but does not exceed any 

applicable threshold by more than 

twenty percent in that quarter: 

(1) That person will not immediately 

be deemed a major security-based swap 

participant pursuant to the timing 

requirements specified in paragraph (a) 

of this section; but 

(2) That person will be deemed a 

major security-based swap participant 

pursuant to the timing requirements 

specified in paragraph (a) of this section 

at the end of the next fiscal quarter if the 

person exceeds any of the applicable 

daily average thresholds in that next 

fiscal quarter. 

(c) Termination of status. A person 

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

be deemed a major security-based swap 

participant until such time that its 

security-based swap activities do not 

exceed any of the daily average 

thresholds set forth within § 240.3a67– 

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1 for four consecutive fiscal quarters 

after the date on which the person 

becomes registered as a major securitybased swap participant. 

§ 240.3a67–9 Calculation of major 

participant status by certain persons. 

A person shall not be deemed to be 

a major security-based swap participant, 

regardless of whether the criteria in 

§ 240.3a67–1 otherwise would cause the 

person to be a major security-based 

swap participant, provided the person 

meets the conditions set forth in 

paragraph (a) of this section. 

(a) Conditions. (1) Caps on 

uncollateralized exposure and notional 

positions. (i) Maximum potential 

uncollateralized exposure. The express 

terms of the person’s agreements or 

arrangements relating to security-based 

swaps with its counterparties at no time 

would permit the person to maintain a 

total uncollateralized exposure of more 

than $100 million to all such 

counterparties, including any exposure 

that may result from thresholds or 

minimum transfer amounts established 

by credit support annexes or similar 

arrangements; and 

(ii) Maximum notional amount of 

security-based swap positions. The 

person does not maintain security-based 

swap positions in an effective notional 

amount of more than $2 billion in any 

major category of security-based swaps, 

or more than $4 billion in aggregate; or 

(2) Caps on uncollateralized exposure 

plus monthly calculation. (i) Maximum 

potential uncollateralized exposure. The 

express terms of the person’s 

agreements or arrangements relating to 

security-based swaps with its 

counterparties at no time would permit 

the person to maintain a total 

uncollateralized exposure of more than 

$200 million to all such counterparties 

(with regard to security-based swaps 

and any other instruments by which the 

person may have exposure to those 

counterparties), including any exposure 

that may result from thresholds or 

minimum transfer amounts established 

by credit support annexes or similar 

arrangements; and 

(ii) Calculation of positions. (A) At the 

end of each month, the person performs 

the calculations prescribed by 

§§ 240.3a67–3 and 240.3a67–5 with 

regard to whether the aggregate 

uncollateralized outward exposure plus 

aggregate potential outward exposure as 

of that day constitute a substantial 

position in a major category of securitybased swaps, or pose substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the United States banking 

system or financial markets; these 

calculations shall disregard provisions 

of those rules that provide for the 

analyses to be determined based on a 

daily average over a calendar quarter; 

and 

(B) Each such analysis produces 

thresholds of no more than: 

(1) $1 billion in aggregate 

uncollateralized outward exposure plus 

aggregate potential outward exposure in 

any major category of security-based 

swaps; if the person is subject to 

§ 240.3a67–3(a)(2)(iii), by virtue of being 

a highly leveraged financial entity that 

is not subject to capital requirements 

established by an appropriate Federal 

banking agency, this analysis shall 

account for all of the person’s securitybased swap positions in that major 

category (without excluding hedging 

positions), otherwise this analysis shall 

exclude the same hedging and related 

positions that are excluded from 

consideration pursuant to § 240.3a67– 

3(a)(2)(i); or 

(2) $2 billion in aggregate 

uncollateralized outward exposure plus 

aggregate potential outward exposure 

(without any positions excluded from 

the analysis) with regard to all of the 

person’s security-based swap positions. 

(3) Calculations based on certain 

information. (i) At the end of each 

month: 

(A)(1) The person’s aggregate 

uncollateralized outward exposure with 

respect to its security-based swap 

positions is less than $500 million with 

respect to each of the major securitybased swap categories; and 

(2) The sum of the amount calculated 

under paragraph (a)(3)(i)(A)(1) of this 

section with respect to each major 

security-based swap category and the 

total notional principal amount of the 

person’s security-based swap positions 

in each such major security-based swap 

category, adjusted by the multipliers set 

forth in § 240.3a67–3(c)(2)(i)(A) on a 

position-by-position basis reflecting the 

type of security-based swap, is less than 

$1 billion with respect to each of the 

major security-based swap categories; or 

(B)(1) The person’s aggregate 

uncollateralized outward exposure with 

respect to its security-based swap 

positions across all major security-based 

swap categories is less than $500 

million; and 

(2) The sum of the amount calculated 

under paragraph (a)(3)(i)(B)(1) of this 

section and the product of the total 

effective notional principal amount of 

the person’s security-based swap 

positions in all major security-based 

swap categories multiplied by 0.10 is 

less than $1 billion. 

(ii) For purposes of the calculations 

set forth in paragraph (a)(3)(i) of this 

section: 

(A) The person’s aggregate 

uncollateralized outward exposure for 

positions held with security-based swap 

dealers shall be equal to such exposure 

reported on the most recent reports of 

such exposure received from such 

security-based swap dealers; and 

(B) The person’s aggregate 

uncollateralized outward exposure for 

positions that are not reflected in any 

report of exposure from a security-based 

swap dealer (including all securitybased swap positions it holds with 

persons other than security-based swap 

dealers) shall be calculated in 

accordance with § 240.3a67–3(b)(2). 

(b) For purposes of the calculations 

set forth by this section, the person shall 

use the effective notional amount of a 

position rather than the stated notional 

amount of the position if the stated 

notional amount is leveraged or 

enhanced by the structure of the 

position. 

(c) No presumption shall arise that a 

person is required to perform the 

calculations needed to determine if it is 

a major security-based swap participant, 

solely by reason that the person does 

not meet the conditions specified in 

paragraph (a) of this section. 

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

swap dealer.’’ 

(a) General. The term security-based 

swap dealer in general means any 

person who: 

(1) Holds itself out as a dealer in 

security-based swaps; 

(2) Makes a market in security-based 

swaps; 

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

ordinary course of business for its own 

account; or 

(4) Engages in any activity causing it 

to be commonly known in the trade as 

a dealer or market maker in securitybased swaps. 

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

person that enters into security-based 

swaps for such person’s own account, 

either individually or in a fiduciary 

capacity, but not as a part of regular 

business. 

(c) Scope of designation. A person 

that is a security-based swap dealer in 

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

security-based swap it enters into, 

regardless of the type, class, or category 

of the security-based swap or the 

person’s activities in connection with 

the security-based swap, unless the 

Commission limits the person’s 

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30756 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

designation as a security-based swap 

dealer to specified types, classes, or 

categories of security-based swaps or 

specified activities of the person in 

connection with security-based swaps. 

(d) Inter-affiliate activities. (1) 

General. In determining whether a 

person is a security-based swap dealer, 

that person’s security-based swaps with 

majority-owned affiliates shall not be 

considered. 

(2) Meaning of majority-owned. For 

these purposes the counterparties to a 

security-based swap are majority-owned 

affiliates if one counterparty directly or 

indirectly owns a majority interest in 

the other, or if a third party directly or 

indirectly owns a majority interest in 

both counterparties to the securitybased swap, where ‘‘majority interest’’ is 

the right to vote or direct the vote of a 

majority of a class of voting securities of 

an entity, the power to sell or direct the 

sale of a majority of a class of voting 

securities of an entity, or the right to 

receive upon dissolution or the 

contribution of a majority of the capital 

of a partnership. 

§ 240.3a71–2 De minimis exception. 

(a) Requirements. For purposes of 

section 3(a)(71) of the Act (15 U.S.C. 

78c(a)(71)) and § 240.3a71–1, a person 

that is not currently registered as a 

security-based swap dealer shall be 

deemed not to be a security-based swap 

dealer, and, therefore, shall not be 

subject to section 15F of the Act (15 

U.S.C. 78o–10) and the rules, 

regulations and interpretations issued 

thereunder, as a result of security-based 

swap dealing activity that meets the 

following conditions: 

(1) Notional thresholds. The securitybased swap positions connected with 

the dealing activity in which the 

person—or any other entity controlling, 

controlled by or under common control 

with the person—engages over the 

course of the immediately preceding 12 

months (or following the effective date 

of final rules implementing section 

3(a)(68) of the Act (15 U.S.C. 78c(a)(68)) 

if that period is less than 12 months) 

have: 

(i) An aggregate gross notional amount 

of no more than $3 billion, subject to a 

phase-in level of an aggregate gross 

notional amount of no more than $8 

billion applied in accordance with 

paragraph (a)(2)(i) of this section, with 

regard to credit default swaps that 

constitute security-based swaps; 

(ii) An aggregate gross notional 

amount of no more than $150 million, 

subject to a phase-in level of an 

aggregate gross notional amount of no 

more than $400 million applied in 

accordance with paragraph (a)(2)(i) of 

this section, with regard to securitybased swaps not described in paragraph 

(a)(1)(i) of this section; and 

(iii) An aggregate gross notional 

amount of no more than $25 million 

with regard to all security-based swaps 

in which the counterparty is a special 

entity (as that term is defined in section 

15F(h)(2)(C) of the Act (15 U.S.C. 78o– 

10(h)(2)(C)). 

(2) Phase-in procedure. (i) Phase-in 

period. For purposes of paragraphs 

(a)(1)(i) and (ii) of this section, a person 

that engages in security-based swap 

dealing activity that does not exceed 

either of the phase-in levels set forth in 

paragraphs (a)(1)(i) and (ii) of this 

section, as applicable, shall be deemed 

not to be a security-based swap dealer, 

and, therefore, shall not be subject to 

Section 15F of the Act (15 U.S.C. 78o– 

10) and the rules, regulations and 

interpretations issued thereunder, as a 

result of its security-based swap dealing 

activity, until the ‘‘phase-in termination 

date’’ established as provided in 

paragraph (a)(2)(ii) of this section; 

provided, however, that this phase-in 

period shall not be available to the 

extent that a person engages in securitybased swap dealing activity with 

counterparties that are natural persons, 

other than natural persons who qualify 

as eligible contract participants by 

virtue of section 1a(18)(A)(xi)(II) of the 

Commodity Exchange Act, (7 U.S.C. 

1a(18)(A)(xi)(II)). The Commission shall 

announce the phase-in termination date 

on the Commission Web site and 

publish such date in the Federal 

Register. 

(ii) Establishment of phase-in 

termination date. (A) Nine months after 

the publication of the staff report 

described in Appendix A of this section, 

and after giving due consideration to 

that report and any associated public 

comment, the Commission may either: 

(1) Terminate the phase-in period set 

forth in paragraph (a)(2)(i) of this 

section, in which case the phase-in 

termination date shall be established by 

the Commission by order published in 

the Federal Register; or 

(2) Determine that it is necessary or 

appropriate in the public interest to 

propose through rulemaking an 

alternative to the $3 billion and $150 

million amounts set forth in paragraphs 

(a)(1)(i) and (ii) of this section, as 

applicable, that would constitute a de 

minimis quantity of security-based swap 

dealing in connection with transactions 

with or on behalf of customers within 

the meaning of section 3(a)(71)(D) of the 

Act, (15 U.S.C. 78c(a)(71)(D)), in which 

case the Commission shall by order 

published in the Federal Register 

provide notice of such determination to 

propose through rulemaking an 

alternative, which order shall also 

establish the phase-in termination date. 

(B) If the phase-in termination date 

has not been previously established 

pursuant to paragraph (a)(2)(ii)(A) of 

this section, then in any event the 

phase-in termination date shall occur 

five years after the data collection 

initiation date defined in paragraph 

(a)(2)(iii) of this section. 

(iii) Data collection initiation date. 

The term ‘‘data collection initiation 

date’’ shall mean the date that is the 

later of: the last compliance date for the 

registration and regulatory requirements 

for security-based swap dealers and 

major security-based swap participants 

under Section 15F of the Act (15 U.S.C. 

78o–10); or the first date on which 

compliance with the trade-by-trade 

reporting rules for credit-related and 

equity-related security-based swaps to a 

registered security-based swap data 

repository is required. The Commission 

shall announce the data collection 

initiation date on the Commission Web 

site and publish such date in the 

Federal Register. 

(3) Use of effective notional amounts. 

For purposes of paragraph (a)(1) of this 

section, if the stated notional amount of 

a security-based swap is leveraged or 

enhanced by the structure of the 

security-based swap, the calculation 

shall be based on the effective notional 

amount of the security-based swap 

rather than on the stated notional 

amount. 

(b) Registration period for persons 

that no longer can take advantage of the 

exception. A person that has not 

registered as a security-based swap 

dealer by virtue of satisfying the 

requirements of paragraph (a) of this 

section, but that no longer can take 

advantage of the de minimis exception 

provided for in paragraph (a) of this 

section, will be deemed not to be a 

security-based swap dealer under 

section 3(a)(71) of the Act (15 U.S.C. 

78c(a)(71)) and subject to the 

requirements of section 15F of the Act 

(15 U.S.C. 78o–10) and the rules, 

regulations and interpretations issued 

thereunder until the earlier of the date 

on which it submits a complete 

application for registration pursuant to 

section 15F(b) (15 U.S.C. 78o–10(b)) or 

two months after the end of the month 

in which that person becomes no longer 

able to take advantage of the exception. 

(c) Applicability to registered securitybased swap dealers. A person who 

currently is registered as a securitybased swap dealer may apply to 

withdraw that registration, while 

continuing to engage in security-based 

swap dealing activity in reliance on this 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30757 

section, so long as that person has been 

registered as a security-based swap 

dealer for at least 12 months and 

satisfies the conditions of paragraph (a) 

of this section. 

(d) Future adjustments to scope of the 

de minimis exception. The Commission 

may by rule or regulation change the 

requirements of the de minimis 

exception described in paragraphs (a) 

through (c) of this section. 

(e) Voluntary registration. 

Notwithstanding paragraph (a) of this 

section, a person that chooses to register 

with the Commission as a securitybased swap dealer shall be deemed to be 

a security-based swap dealer, and, 

therefore, shall be subject to Section 15F 

of the Act (15 U.S.C 78o–10) and the 

rules, regulations and interpretations 

issued thereunder. 

§ 240.3a71–2A Report regarding the 

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

security-based swap participant’’ 

definitions (Appendix A to 17 CFR 

240.3a71–2). 

Appendix A to § 240.3a71–2 sets forth 

guidelines applicable to a report that the 

Commission has directed its staff to 

make in connection with the rules and 

interpretations further defining the Act’s 

definitions of the terms ‘‘security-based 

swap dealer’’ (including the de minimis 

exception to that definition) and ‘‘major 

security-based swap participant.’’ The 

Commission intends to consider this 

report in reviewing the effect and 

application of these rules based on the 

evolution of the security-based swap 

market following the implementation of 

the registration and regulatory 

requirements of Section 15F of the Act 

(15 U.S.C. 78o–10). The report may also 

be informative as to potential changes to 

the rules further defining those terms. In 

producing this report, the staff shall 

consider security-based swap data 

collected by the Commission pursuant 

to other Title VII rules, as well as any 

other applicable information as the staff 

may determine to be appropriate for its 

analysis. 

(a) Report topics. As appropriate, 

based on the availability of data and 

information, the report should address 

the following topics: 

(1) De minimis exception. In 

connection with the de minimis 

exception to the definition of ‘‘securitybased swap dealer,’’ the report generally 

should assess whether any of the de 

minimis thresholds set forth in 

paragraph (a)(1) of § 240.3a71–2 should 

be increased or decreased; 

(2) General security-based swap 

dealer analysis. In connection with the 

definition of ‘‘security-based swap 

dealer,’’ the report generally should 

consider the factors that are useful for 

identifying security-based swap dealing 

activity, including the application of the 

dealer-trader distinction for that 

purpose, and the potential use of more 

objective tests or safe harbors as part of 

the analysis; 

(3) General major security-based swap 

participant analysis. In connection with 

the definition of ‘‘major security-based 

swap participant,’’ the report generally 

should consider the tests used to 

identify the presence of a ‘‘substantial 

position’’ in a major category of 

security-based swaps, and the tests used 

to identify persons whose securitybased swap positions create ‘‘substantial 

counterparty exposure,’’ including the 

potential use of alternative tests or 

thresholds; 

(4) Commercial risk hedging 

exclusion. In connection with the 

definition of ‘‘major security-based 

swap participant,’’ the report generally 

should consider the definition of 

‘‘hedging or mitigating commercial 

risk,’’ including whether that latter 

definition inappropriately permits 

certain positions to be excluded from 

the ‘‘substantial position’’ analysis, and 

whether the continued availability of 

the exclusion for such hedging positions 

should be conditioned on a person 

assessing and documenting the hedging 

effectiveness of those positions; 

(5) Highly leveraged financial entities. 

In connection with the definition of 

‘‘major security-based swap 

participant,’’ the report generally should 

consider the definition of ‘‘highly 

leveraged,’’ including whether 

alternative approaches should be used 

to identify highly leveraged financial 

entities; 

(6) Inter-affiliate exclusions. In 

connection with the definitions of 

‘‘security-based swap dealer’’ and 

‘‘major security-based swap 

participant,’’ the report generally should 

consider the impact of rule provisions 

excluding inter-affiliate transactions 

from the relevant analyses, and should 

assess potential alternative approaches 

for such exclusions; and 

(7) Other topics. Any other analysis of 

security-based swap data and 

information the Commission or the staff 

deem relevant to this rule. 

(b) Timing of report. The report shall 

be completed no later than three years 

following the data collection initiation 

date, established pursuant to 

§ 240.3a71–2(a)(2)(iii). 

(c) Public comment on the report. 

Following completion of the report, the 

report shall be published in the Federal 

Register for public comment. 

Dated: April 27, 2012. 

By the Commodity Futures Trading 

Commission. 

David A. Stawick, 

Secretary. 

Dated: April 27, 2012. 

By the Securities and Exchange 

Commission. 

Elizabeth M. Murphy, 

Secretary. 

Note: The following appendices will not 

appear in the Code of Federal Regulations: 

Appendices by the Commodity Futures 

Trading Commission to Joint Final Rule 

Entitled ‘‘Further Definition of ‘Swap 

Dealer,’ ‘Security-Based Swap Dealer,’ 

‘Major Swap Participant,’ ‘Major 

Security-Based Swap Participant’ and 

‘Eligible Contract Participant.’ ’’— 

Commission Voting Summary and 

Statements of Commissioners 

Appendix 1—Commodity Futures 

Trading Commission Voting Summary 

On this matter, Chairman Gensler and 

Commissioners Sommers, Chilton and 

Wetjen voted in the affirmative; 

Commissioner O’Malia voted in the negative. 

Appendix 2—Statement of Chairman 

Gensler 

I support the final rule to further define 

entities, which is pivotal to lowering risk that 

swap dealers may pose to the rest of the 

economy. The entities rule fulfills Congress’ 

direction to further define the terms ‘‘swap 

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

‘‘eligible contract participant’’ and 

appropriately addresses the many comments 

we received. It will provide essential 

direction to market participants on whether 

they will be required to register. 

Regulating banks and other firms that deal 

in derivatives as swap dealers is central to 

financial reform. Leading up to the financial 

crisis, it was assumed by many that swap 

dealers were largely regulated. The 2008 

crisis revealed the inadequacy of this 

approach: While banks were regulated for 

safety and soundness, including their lending 

activities, there was no comprehensive 

regulation of their swap dealing activity. 

Similarly, bank affiliates dealing in swaps, 

and subsidiaries of insurance and investment 

bank holding companies dealing in swaps, 

were not subject to specific regulation of 

their swap dealing activities under U.S. law, 

and thus often had ineffective or no 

oversight. 

A prime example of this fact was AIG. AIG 

was a holding company with a number of 

regulated insurance companies, but its 

unregulated swaps subsidiary brought down 

the company and helped to nearly topple the 

U.S. economy. 

The final rule gives market participants 

guidance on the Dodd-Frank Wall Street 

Reform and Consumer Protection Act (DoddFrank Act) definition of swap dealer: 

• First, it does so by allowing market 

participants to draw on useful precedents 

developed by the SEC in the traditional 

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30758 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

1Further Definition of ‘‘Swap Dealer,’’ ‘‘SecurityBased Swap Dealer,’’ ‘‘Major Swap Participant,’’ 

‘‘Major Security-Based Swap Participant,’’ and 

‘‘Eligible Contract Participant;’’ Final Rule, (to be 

codified at 17 CFR part 1), available at [______]. As 

stated below, this final rule and interim final rule 

is joint between the Commission and the SEC. 

Therefore, within this dissent, (i) the term ‘‘Entities 

Rule’’ refers to the entire rule, (ii) the term ‘‘CFTC 

Entities Rule’’ refers to only the CFTC portion of 

such rule, and (iii) the term ‘‘SEC Entities Rule’’ 

refers to the SEC portion of such rule. 

2 Dodd-Frank Wall Street Reform and Consumer 

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

(2010). 

3See Further Definition of ‘‘Swap Dealer,’’ 

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

Participant,’’ ‘‘Major Security-Based Swap 

Participant,’’ and ‘‘Eligible Contract Participant;’’ 

Proposed Rule, 75 FR 80174 (Dec. 21, 2010) (the 

‘‘Proposal’’). 

4The canons of statutory construction are 

‘‘important rules and conventions’’ that the 

judiciary applies to determine the meaning of 

statutory provisions. Congressional Research 

Service, Report for Congress, Statutory 

Interpretation: General Principles and Recent 

Trends, updated August 31, 2008 (the ‘‘CRS 

Report’’) (Summary). In general, it behooves 

agencies (such as the Commission) to adhere to 

such canons so that its regulations, if subject to 

legal challenge, would be more likely to survive 

judicial scrutiny. In the CFTC Entities Rule, the 

Commission acknowledges the importance of 

canons of statutory construction, since it cites to 

certain canons in determining the application of its 

‘‘eligible contract participant’’ definition. See 

Section III(B)(4) of the CFTC Entities Rule. 

5The statutory definition of ‘‘swap dealer’’ can be 

found in section 1a(49) of the Commodity Exchange 

Act (the ‘‘CEA’’), 7 U.S.C. 1a(49). For purposes of 

reference, the text of CEA section 1a(49) is as 

follows: 

‘‘(49) SWAP DEALER.— 

‘‘(A) IN GENERAL.—The term ‘swap dealer’ 

means any person who— 

‘‘(i) holds itself out as a dealer in swaps; 

‘‘(ii) makes a market in swaps; 

‘‘(iii) regularly enters into swaps with 

counterparties as an ordinary course of business for 

its own account; or 

‘‘(iv) engages in any activity causing the person 

to be commonly known in the trade as a dealer or 

market maker in swaps, provided however, in no 

event shall an insured depository institution be 

considered to be a swap dealer to the extent it offers 

to enter into a swap with a customer in connection 

with originating a loan with that customer. 

‘‘(B) INCLUSION.—A person may be designated 

as a swap dealer for a single type or single class or 

category of swap or activities and considered not to 

be a swap dealer for other types, classes, or 

categories of swaps or activities. 

‘‘(C) EXCEPTION.—The term ‘swap dealer’ does 

not include a person that enters into swaps for such 

person’s own account, either individually or in a 

fiduciary capacity, but not as a part of a regular 

business. 

‘‘(D) DE MINIMIS EXCEPTION.—The 

Commission shall exempt from designation as a 

swap dealer an entity that engages in a de minimis 

quantity of swap dealing in connection with 

transactions with or on behalf of its customers. 

The Commission shall promulgate regulations to 

establish factors with respect to the making of this 

determination to exempt.’’ 

securities market to help distinguish between 

dealing and trading. 

• Second, it does so by providing further 

clarity on the Dodd-Frank Act’s term ‘‘makes 

a market in swaps’’ by focusing on entities 

that routinely seek to profit by 

accommodating other market participants’ 

demand for swaps. 

• Third, it does so by clarifying another 

key term ‘‘regular business,’’ focusing on 

whether a person has an identifiable swap 

dealing business. 

• Fourth, it does so by fulfilling Congress’ 

mandate that swaps entered into by an 

insured depository institution in connection 

with originating a loan are not to be 

considered dealing activity. 

• Fifth, it does so by providing direction 

on the distinction between hedging and 

dealing and within this provides a specific 

rule for swaps that hedge price risk 

associated with a physical commodity. 

• Sixth, it does so by clarifying that a swap 

between an agricultural cooperative or a 

cooperative financial institution and its 

members does not constitute dealing. 

• Seventh, it does so by setting a de 

minimis threshold for swap dealing, as 

directed by Congress. The threshold is $3 

billion total, across all asset classes, subject 

to a phase in level of $8 billion. As we 

proposed, the final rule would define as a 

swap dealer any entity with more than $25 

million of dealing activity with pension 

funds and municipals—so-called ‘‘special 

entities.’’ 

True to congressional intent, end-users 

other than those genuinely making markets 

in swaps won’t be required to register as 

swap dealers. The swap dealer definition 

benefited from the many comments from 

end-users who use swaps to hedge their risk. 

As the swap dealing market is dominated 

by large entities, though, I believe that the 

final swap dealer definition will encompass 

the vast majority of swap dealing activity, as 

Congress had intended. For those who 

question the level of the de minimis, we 

considered the threshold in the context of an 

overall $300 trillion notional amount U.S. 

swaps market. Further, the statute defines 

swap dealing by referencing ‘‘making a 

market in swaps’’ and conducting a ‘‘regular 

business’’ in swaps. The $3 billion threshold 

in the rule represents, on average, $12 

million a trading day, with the phase-in of $8 

billion representing, on average, $32 million 

notional amount per trading day. Putting this 

in perspective, the interest rate swap market, 

transacts, on average, over $500 billion 

notional amount per day. As further 

reference, the futures markets for crude oil 

traded this year, on average, $65 billion of 

notional amount per day. 

During this phase-in period the 

Commissions will collect and analyze data to 

evaluate the appropriate de minimis 

threshold. 

Another question that has been raised is 

whether the swap dealer definition should 

appropriately be activities-based or relate to 

how an entity is classified. The final rule is 

consistent with Congressional intent that we 

take an activities-based approach. 

Though many of these large swap dealers 

are financial entities, Congress anticipated 

that some non-banks would be registered as 

swap dealers. Congress provided in DoddFrank that capital and margin for bank swap 

dealers would be set by the bank regulators, 

but for non-bank swap dealers, by the CFTC. 

Instructive in this regard is the list of primary 

dealers on the International Swaps and 

Derivatives Association’s (ISDA) Web site, 

which includes a number of non-bank 

dealers. The Association describes as meeting 

that designation an entity ‘‘that deals in 

derivatives as part of its business.’’ Congress 

closed the so-called ‘‘Enron loophole,’’ which 

let traders evade oversight by using 

electronic trading platforms. But it is 

important to recall that Enron was also a 

swap dealer. Congress did not intend to 

create a new type of loophole in its place. 

Congress drafted the swap dealer definition 

recognizing the fact that some entities are 

involved in swap dealing activities, as well 

as other lines of business. Section 1a(49)(C) 

provides that an entity is a swap dealer only 

if it engages in swap dealing as ‘‘a regular 

business.’’ But it does not say that swap 

dealing must be its only regular business. 

Further, section 1a(49)(B) specifically 

provides for the regulation of a single entity 

as a swap dealer for one part of its business 

and not for the other part of its business. 

Given the business realities reflected in the 

statutory language, there is no compelling 

reason to think that an entities-based 

approach would better interpret the statute or 

that it would, in practice, be simpler than an 

approach based on what a business actually 

does. 

The rule also further defines the term 

‘‘major swap participant.’’ Relying on 

Congress’ three-prong test, this category is 

clearly limited to only those entities with 

swaps positions that pose a risk large enough 

to threaten the U.S. financial system. 

The further definition of the term ‘‘eligible 

contract participant’’ provides guidance 

regarding who is eligible to transact swaps off 

of an exchange. Based upon the many 

comments received, we incorporated further 

guidance to ensure that small businesses and 

real estate developers can continue to have 

access to swaps to hedge commercial risks. 

The final rule also clarifies how the eligible 

contract participant definition applies to 

certain foreign exchange transactions 

conducted by commodity pools. 

Appendix 3—Statement of 

Commissioner O’Malia 

In General 

I respectfully dissent from the Commodity 

Futures Trading Commission’s (the 

‘‘Commission’’ or ‘‘CFTC’’) approval today of 

the Entities Rule,1 which is a joint final and 

interim final rule with the Securities and 

Exchange Commission (‘‘SEC’’) under the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (the ‘‘Dodd-Frank 

Act’’).2 I have a number of concerns with 

each definition in the CFTC Entities Rule. 

However, this dissent focuses on the ‘‘swap 

dealer’’ definition. 

Preliminarily, in its proposal,3 the 

Commission ignored basic canons of 

statutory construction 4 in defining ‘‘swap 

dealer.’’ 5 Specifically, the statutory 

definition has four clauses, lettered (A) 

through (D). As discussed below, the 

Commission defined ‘‘swap dealer’’ as 

encompassed only within CEA section 

1a(49)(A). Thus, the Commission advanced a 

definition focusing on activities, rather than 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30759 

6See Proposed Rule; 75 FR at 80175, 80179 

(stating that ‘‘The Dodd-Frank Act defines the terms 

‘swap dealer’ * * * in terms of whether a person 

engages in certain types of activities involving 

swaps or security-based swaps * * * Based on the 

plain meaning of the statutory definition, so long 

as a person engages in dealing activity that is not 

de minimis, as discussed below, the person is a 

swap dealer * * *’’). 

7The following example illustrates the difference 

between (i) an ‘‘exception’’ and (ii) an ‘‘exclusion.’’ 

Imagine a circle entitled ‘‘swap dealer.’’ 

‘‘Exceptions’’ are circles within the ‘‘swap dealer’’ 

circle. In essence, entities within those circles are 

subcategories of ‘‘swap dealer’’ permitted special 

treatment. ‘‘Exclusions’’ are circles entirely separate 

from the ‘‘swap dealer’’ circle. In essence, entities 

within those circles are not ‘‘swap dealers’’ in the 

first instance. As described below, CEA section 

1a(49)(C), 7 U.S.C. 1a(49)(C), provides a mandatory 

‘‘exclusion’’ from the ‘‘swap dealer’’ definition for— 

at a minimum—non-financial entities that do not 

have ‘‘a regular business’’ of entering into swap 

transactions. To be clear, this ‘‘exclusion’’ applies 

to entities, and not solely to their activities. 

Similarly, CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B), 

provides a discretionary ‘‘exclusion’’ from the 

‘‘swap dealer’’ definition (rather than just ‘‘limited 

designation,’’ as the Commission contends). 

8See, e.g., Opening Statement, Sixth Series of 

Proposed Rulemakings under the Dodd-Frank Act, 

Dec. 1, 2010, available at http://www.cftc.gov/ 

PressRoom/SpeechesTestimony/ 

omaliastatement120110; and Jobs on Main Street 

vs. Wall Street: The Choice Should be Clear, 2011 

Futures Industry Association Energy Forum, New 

York, Keynote Address, Sept. 14, 2011, available at 

http://www.cftc.gov/PressRoom/ 

SpeechesTestimony/opaomalia-8. 

9See supra note 5 for the exact text of CEA 

section 1a(49)(C), 7 U.S.C. 1a(49)(C). See also supra 

note 7 for an explanation of the difference between 

(i) an ‘‘exception’’ and (ii) an ‘‘exclusion.’’ The 

collapse of CEA section 1a(49)(C) (referencing ‘‘a 

regular business’’) into CEA section 1a(49)(A)(iii), 7 

U.S.C. 1a(49)(A)(iii) (referencing ‘‘an ordinary 

course of business’’), illustrates that the 

Commission still considers entities within CEA 

section 1a(49)(C) as subcategories of ‘‘swap 

dealers,’’ absent Commission largesse. 

10 Id. for the exact text of CEA section 1a(49)(B), 

7 U.S.C. 1a(49)(B). 

11 In the CFTC Entities Rule, the Commission 

departs from the Proposal in the following ways, 

among others: (i) acknowledging that there is a 

difference between dealing, trading, and hedging; 

(ii) setting forth an explicit exception for swaps that 

an entity enters into in its capacity as a floor trader 

(as defined in CEA section 1a(23), 7 U.S.C. 1a(23)); 

(iii) providing another explicit exception for certain 

hedging activities; (iv) providing an exception for 

swaps between majority-owned affiliates; and (iv) 

setting forth a phase-in period with a higher de 

minimis threshold. 

12See, e.g., the CRS Report, p. CRS–2. 

13 Id. 

14As mentioned above, CEA section 1a(49)(A), 7 

U.S.C. 1a(49)(A), states that the term ‘‘swap dealer’’ 

means ‘‘any person who—(i) holds itself out as a 

dealer in swaps; (ii) makes a market in swaps; (iii) 

regularly enters into swaps with counterparties as 

an ordinary course of business for its own account; 

or (iv) engages in any activity causing the person 

to be commonly known in the trade as a dealer or 

market maker in swaps.’’ 

15See supra note 9. 

16Section II of the CFTC Entities Rule. 

17 Id. 

18 Id. 

19The CRS Report, p. CRS–14 (stating that ‘‘A 

basic principle of statutory construction is that 

courts should ‘give effect, if possible to every clause 

and word of a statute, avoiding, if it may be, any 

construction which implies that the legislature was 

ignorant of the meaning of the language it 

employed.’’ (quoting Montclair v. Ramsdell, 107 

U.S. 147, 152 (1883)). See also the CRS Report, 

CRS–12, footnote 62 (discussing the ‘‘modern 

variant’’ of this canon). 

20As mentioned below, certain financial entities 

may also satisfy these criteria, such as ‘‘special 

entities’’ (as defined in CEA section 4s(h)(2)(C), 7 

U.S.C. 6s(h)(2)(C) (e.g., certain employee benefit 

plans covered by the Employee Retirement Income 

Security Act of 1974 (‘‘ERISA’’)). If the Commission 

wanted to prevent other financial entities from 

abusing CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C), 

the Commission could have preliminarily limited 

Continued 

the entities conducting these activities.6 The 

Commission then minimized the other 

clauses of the definition. Specifically, the 

Commission characterized CEA section 

1a(49)(C) as an ‘‘exception’’ for certain 

activities. The Commission also 

characterized CEA section 1a(49)(B) as only 

authorizing ‘‘limited designation.’’ 7

I have always disagreed with the Proposal. 

By focusing on the activities in CEA section 

1a(49)(A), the Commission essentially used 

the ‘‘swap dealer’’ definition to capture 

commercial end-users.8 Congress clearly 

precluded this result. As described below, 

CEA section 1a(49)(C) provides a mandatory 

exclusion for commercial end-users.9

Alternatively, CEA section 1a(49)(B) permits 

the Commission to exercise its discretion to 

exclude commercial end-users, so long as the 

Commission articulates a rational basis for 

such differential treatment.10 The 

Commission has many reasons for exercising 

its discretion, including certain statutory 

reasons. 

Today, the Commission has erected the 

CFTC Entities Rule on the infirm scaffold of 

the Proposal. To be sure, the Commission has 

performed astonishing contortions to afford 

greater certainty to commercial end-users.11

However, the Commission could have 

provided equivalent or superior certainty by 

properly construing CEA sections 1a(49)(C) 

and (B), either initially or in a re-proposal. 

By preserving and furthering the statutory 

misconstructions in the Proposal, the CFTC 

Entities Rule may ultimately provide illusory 

comfort. Therefore, I cannot support the 

CFTC Entities Rule. 

The ‘‘Swap Dealer’’ Definition: Fundamental 

Misconstruction 

• CEA section 1a(49)(A): Not the Entire 

‘‘Swap Dealer’’ Definition 

A statute should be read as a ‘‘harmonious 

whole.’’ 12 This statement is a basic canon of 

statutory construction.13 The Commission 

has failed to follow such canon in defining 

‘‘swap dealer.’’ 

As mentioned above, in the CFTC Entities 

Rule (as in the Proposal), the Commission 

insists that CEA section 1a(49)(A) is the 

entirety of the ‘‘swap dealer’’ definition. 

According to the Commission, any entity 

engaged in any activity enumerated in CEA 

section 1a(49)(A) is a ‘‘swap dealer’’ 14

(unless otherwise ‘‘excepted’’).15

Specifically, the Commission states: ‘‘The 

Dodd-Frank Act definitions of the term ‘swap 

dealer’ * * * focus on whether a person 

engages in particular types of activities 

involving swaps * * *.’’ 16 Also, the 

Commission states: ‘‘The CEA * * * 

[definition] in general encompass persons 

that engage in any of the [activities in CEA 

section 1a(49)(A)].’’ 17 Finally, the 

Commission characterizes the activities in 

CEA section 1a(49)(A) as ‘‘dealer 

activities.’’ 18

• CEA section 1a(49)(C): Mandatory 

Exclusion for Entities 

CEA section 1a(49) contradicts in both its 

language and structure the Commission’s 

focus on the activities of CEA section 

1a(49)(A). Specifically, CEA section 

1a(49)(C), when properly construed, sets 

forth a mandatory exclusion that focuses on 

the characteristics of an entity, and not 

exclusively on its activities. CEA section 

1a(49)(C) states: ‘‘The term ‘swap dealer’ does 

not include a person that enters into swaps 

for such person’s own account, either 

individually or in a fiduciary capacity, but 

not as part of a regular business.’’ 

First, CEA section 1a(49)(C) is as central to 

the ‘‘swap dealer’’ definition as CEA section 

1a(49)(A). CEA section 1a(49)(C) begins with 

‘‘The term ‘swap dealer’ does not include 

* * *’’. In comparison, CEA section 

1a(49)(A) begins with ‘‘The term ‘swap 

dealer’ means * * *’’. Therefore, according 

to their plain language, CEA section 1a(49)(C) 

and CEA section 1a(49)(A) are equal and 

opposite of each other. In essence, CEA 

section 1a(49)(C) sets forth the exclusion 

criteria for the ‘‘swap dealer’’ definition, 

whereas CEA section 1a(49)(A) sets forth the 

inclusion criteria. 

Second, CEA section 1a(49)(C) focuses on 

the characteristics of entities, and not solely 

on their activities. CEA section 1a(49)(C) 

states that ‘‘[t]he term ‘swap dealer’ does not 

include a person that enters into swaps 

* * * not as part of a regular business.’’ In 

contrast, CEA section 1a(49)(A)(iii) states that 

the ‘‘swap dealer’’ definition encompasses 

any person that ‘‘regularly enters into swaps 

with counterparties as an ordinary course of 

business for its own account.’’ If the 

Commission is correct in presuming that CEA 

section 1a(49)(A) focuses on activities, then 

the phrase ‘‘regularly enters into swaps 

* * * as an ordinary course of business’’ 

must refer to an activity. However, Congress 

used different words in CEA section 

1a(49)(C). According to a basic canon of 

statutory construction, when Congress uses 

different words, it intends different 

meanings. In other words, a court should 

strive to give effect to every word of a 

statute.19

The Commission could have easily given 

effect to every word of CEA section 1a(49)(C), 

while according the same respect to CEA 

section 1a(49)(A)(iii). Juxtaposing CEA 

section 1a(49)(C) and CEA section 

1a(49)(A)(iii), the following construction 

emerges: a ‘‘person’’ (i.e., an entity) is not a 

‘‘swap dealer’’ if it enters into swaps for ‘‘its 

own account’’ (i.e., as principal) in the 

‘‘ordinary course of business’’ (i.e., normally 

while conducting business), provided that 

entering into these swaps is not its ‘‘regular 

business’’ (i.e., entering into swaps is 

ancillary to its core business).20

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30760 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

the exclusion to commercial end-users (or other 

entities that the Commission determines could be 

excluded based on a holistic reading of the DoddFrank Act and the CEA, including small financial 

institutions as delineated in CEA section 2(h)(7)(C), 

7 U.S.C. 2(h)(7)(C)). Additionally, if the 

Commission wanted to prevent commercial endusers (or such other entities) from abusing CEA 

section 1a(49)(C) (by, e.g., entering into nonancillary transactions in swaps), the Commission 

has anti-evasion authority under section 721(c) of 

the Dodd-Frank Act. 

The regulations that the Commission promulgates 

under the Dodd-Frank Act will irrevocably change 

the structure of the swap markets. Such changes 

have benefits and costs. To properly weigh the 

benefits and costs of its regulations under CEA 

section 15(a), 7 U.S.C. 19(a), it would have 

behooved the Commission to have discussed (i) 

categorically excluding certain entities from the 

‘‘swap dealer’’ definition within the phase-in 

period, and (ii) exercising anti-evasion authority, if 

the Commission found it necessary based on its 

surveillance of the swaps market. 

21Letter from Chairman Christopher Dodd, 

Committee on Banking, Housing, and Urban Affairs, 

United States Senate, and Chairman Blanche 

Lincoln, Committee on Agriculture, Nutrition, and 

Forestry, United States Senate, to Chairman Barney 

Frank, Financial Services Committee, United States 

House of Representatives, and Chairman Collin 

Peterson, Committee on Agriculture, United States 

House of Representatives (June 30, 2010) (the 

‘‘Dodd-Lincoln Letter’’). 

The Dodd-Lincoln Letter (as well as the 

Stabenow-Lucas Letter (as defined below)) appears 

to have embraced a broader conception of 

‘‘commercial risk’’ than the Commission. See infra 

note 42. 

22Letter from Chairwoman Debbie Stabenow, 

Committee on Agriculture, Nutrition, and Forestry, 

United States Senate, and Chairman Frank D. Lucas, 

Committee on Agriculture, United States House of 

Representatives to Chairman Gary Gensler, United 

States Commodity Futures Trading Commission 

(March 29, 2012) (the ‘‘Stabenow-Lucas Letter’’). 

23 7 U.S.C. 1a(38). 

24 In Section II(A)(4)(d) of CFTC Entities Rule, the 

Commission states: ‘‘We recognize, as noted by one 

commenter (see letter from ISDA I), that the ‘regular 

business’ exclusion is not limited solely to the 

‘ordinary course of business’ test of the swap dealer 

definition. Our interpretations of the other three 

tests are, and should be read to be, consistent with 

the exclusion of activities that are not part of a 

regular business.’’ 

Preliminarily, I would note that more than one 

commenter observed the collapse. 

Secondarily, as noted above, CEA section 

1a(49)(C), 7 U.S.C. 1a(49)(C), applies to entities (and 

not solely to activities). Therefore, the Commission 

does not (and really cannot) argue that the collapse 

of CEA section 1a(49)(C) into CEA section 

1a(49)(A)(iii), 7 U.S.C. 1a(49)(A)(iii), has little to no 

impact on its construction of CEA sections 

1a(49)(A)(i), (ii), and (iv), 7 U.S.C. 1a(49)(A)(i), (ii), 

and (iv). 

Finally, although it is ambiguous in the CFTC 

Entities Rule (and not contemplated in the 

Proposal), it seems like the Commission may be 

indirectly relying on its reference to the dealertrader distinction to justify its collapse of CEA 

section 1a(49)(C) and 1a(49)(A)(iii). Interestingly, 

the SEC does not state that ‘‘regular business’’ in 

Exchange Act section 3(a)(71)(C), 15 U.S.C. 

78c(a)(71)(C)) (parallel to CEA section 1a(49)(C)), is 

‘‘synonymous’’ with ‘‘ordinary course of business’’ 

in Exchange Act section 3(a)(71)(A)(iii), 15 U.S.C. 

78c(a)(71)(A) (parallel to CEA section 1a(49)(A)(iii)). 

Of course, it may have been understood that the 

SEC would hew more closely to the dealer-trader 

distinction, as historically applicable to securities, 

and thus would focus on activities and not entities. 

See Section II(A)(3) of the Entities Rule. However, 

one wonders that of all the distinctions that the 

Commission makes or attempts to preserve between 

the swaps and securities-based swaps markets, the 

Commission does not acknowledge (i) the ‘‘high 

degree of concentration’’ of dealing in the 

securities-based swaps markets among the largest 

financial entities and (ii) the lack of similar 

concentration in the swaps markets (particularly 

with respect to markets that commercial end-users 

frequent, such as the physical commodity swaps 

markets). Compare generally Section II(D)(5) of the 

SEC Entities Rule (which repeatedly references 

‘‘high degree of concentration’’) with Section 

II(D)(4) of the CFTC Entities Rule (which does not 

contain such references). See also Section 

II(A)(2)(e)(iii) of the CFTC Entities Rule (describing 

comments with respect to electricity swaps). The 

If the Commission had adopted this 

construction, the Commission would have 

per se excluded commercial end-users. Such 

exclusion would have permitted these 

entities to freely hedge their business risks, 

whether financial or physical, without fear of 

becoming a ‘‘swap dealer.’’ Just to provide 

some context, commercial end-users include 

Caterpillar, John Deere, and ConAgra Foods. 

These entities have ‘‘a regular business’’ of 

supplying energy, food, and other tangible 

products to America. To these entities, swaps 

are ancillary tools that they can use to 

manage risk. These entities suffered from— 

rather than perpetrated—the 2008 financial 

crisis. Yet, these entities (either individually 

or through trade associations) took the time 

to draft and submit comment letters to the 

Commission—sometimes multiple letters— 

because they were afraid of being defined as 

‘‘swap dealers.’’ 

If the Commission had any doubt regarding 

the above construction, the Commission 

could have referred to various letters from 

members of Congress. Such letters explicitly 

state that Congress intended to exclude 

commercial end-users. For example, former 

Chairman Christopher Dodd and 

Chairwoman Blanche Lincoln circulated a 

joint letter stating: ‘‘Congress does not intend 

to regulate end-users as Major Swap 

Participants or Swap Dealers just because 

they use swaps to hedge or manage the 

commercial risks associated with their 

business.’’ 21 Both senators Dodd and Lincoln 

were instrumental in shaping the legislation 

that became the Dodd-Frank Act. 

Recently, Chairwoman Debbie Stabenow 

and Chairman Frank Lucas reiterated this 

point: [I]t is important for the Commission to 

finalize the swap dealer definition in a 

manner that is not overly broad, and that will 

not impose significant new regulations on 

entities that Congress did not intend to be 

regulated as swap dealers. The Commission’s 

final rulemaking further defining ‘swap 

dealing’ should clearly distinguish swap 

activities that end-users engage in to hedge 

or mitigate the commercial risks associated 

with their businesses, including swaps 

entered into by end-users to hedge physical 

commodity price risk, from swap dealing.22

It is important to note that Chairwoman 

Stabenow and Chairman Lucas lead the 

Congressional committees charged with 

overseeing the Commission. 

Æ CEA section 1a(49)(B): Discretionary 

Exclusion for Entities 

In the alternative (assuming that the 

Commission rejects the above construction), 

CEA section 1a(49)(B) also contradicts the 

Commission’s focus on the activities in CEA 

section 1a(49)(A). Specifically, CEA section 

1a(49)(B), when properly construed, sets 

forth a permissive exclusion focused on 

entities, with respect to either their activities 

or their swaps. CEA section 1a(49)(B) states: 

‘‘A person may be designated as a swap 

dealer for a single type or single class or 

category of swap or activities and considered 

not to be a swap dealer for other types, 

classes, or categories of swaps or activities.’’ 

First, CEA section 1a(49)(B) references ‘‘[a] 

person.’’ CEA section 1a(38) 23 defines 

‘‘person’’ as ‘‘import[ing] the plural or 

singular.’’ Read together, the sections 

indicate that CEA section 1a(49)(B) focuses 

on either (i) an entity or (ii) multiple entities. 

Second, CEA section 1a(49)(B) states that 

‘‘[a] person’’ (or ‘‘persons’’) could be 

‘‘considered not to be’’ a ‘‘swap dealer’’ for 

‘‘types, classes, or categories of swaps.’’ So, 

an entity could be excluded from the ‘‘swap 

dealer’’ definition with respect to, e.g., 

physical commodity swaps, regardless of its 

activity with respect to such swaps. That 

indicates that the ‘‘swap dealer’’ definition 

does not solely focus on activity, as the 

Commission maintains. Instead, the 

characteristics of the entity and the 

underlying swaps are also relevant. 

Third, CEA section 1a(49)(B) states that 

‘‘[a] person’’ (or ‘‘persons’’) could be 

‘‘considered not to be’’ a ‘‘swap dealer’’ for 

certain ‘‘activities.’’ So, even if an entity 

engages in ‘‘activities’’ in CEA section 

1a(49)(A), that entity may nevertheless not be 

a ‘‘swap dealer.’’ That indicates that the 

‘‘swap dealer’’ definition may not even 

predominantly focus on activity. 

Finally, CEA section 1a(49)(B) permits the 

Commission to include one ‘‘person’’ (or a 

group of ‘‘persons’’) engaging in certain 

activities in the ‘‘swap dealer’’ definition, but 

to exclude another ‘‘person’’ (or group of 

‘‘persons’’) engaging in the same activities. Of 

course, the Commission has to articulate a 

rational basis for differential treatment. As 

discussed below, there may be certain 

statutory bases for differentiation (including 

the reference to ‘‘financial entity’’ in the enduser exception). Nothing in CEA section 

1a(49)(B) prevents the Commission from so 

differentiating through rulemaking (rather 

than individual determinations). 

Æ Unnecessary Statutory Contortions 

Instead of following the canons of statutory 

construction and properly interpreting CEA 

section 1a(49)(C) and CEA section 1a(49)(B), 

the Commission engages in a series of 

contortions with seemingly opposing 

purposes. Upon review, these contortions 

appear to stem from a desire of the 

Commission to provide a measure of 

certainty to commercial end-users in the 

CFTC Entities Rule, without explicitly 

contradicting the Proposal. 

Preliminarily, the Commission appears to 

broadly define ‘‘swap dealer’’ to capture 

commercial end-users. For example, both the 

Proposal and the CFTC Entities Rule 

obfuscate the application of CEA section 

1a(49)(C) to entities (rather than solely to 

activities) by collapsing CEA section 

1a(49)(C) into CEA section 1a(49)(A)(iii).24 In 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30761 

Commission should have accorded greater 

consideration to differences in market structure 

before dismissing a construction of CEA section 

1a(49)(C) as focusing on entities (and as 

independent of CEA section 1a(49)(A)(iii)). 

25Section II(A)(4)(d) of the CFTC Entities Rule. 

26The Commission characterizes CEA section 

1a(49)(B), 7 U.S.C. 1a(49)(B), as ‘‘limited 

designation’’ based on a series of misconstructions. 

First, as noted above, the Commission insists that 

CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A), is the 

entirety of the ‘‘swap dealer’’ definition. Second, 

the Commission then interprets CEA section 

1a(49)(B) to apply to the registration of an entity as 

a ‘‘swap dealer,’’ and not to the ‘‘swap dealer’’ 

definition. Third, because CEA section 1a(49)(B) 

applies to registration, the Commission concludes 

that it would be appropriate to apply an 

individualized, facts-and-circumstances analysis. 

In actuality, CEA section 1a(49)(B) does more 

than provide for ‘‘limited designation.’’ First, as 

discussed above, CEA section 1a(49)(A) sets forth 

general parameters for defining ‘‘swap dealer.’’ The 

entirety of the ‘‘swap dealer’’ definition is actually 

CEA sections 1a(49)(A), (B), (C), and (D), 7 U.S.C. 

1a(49)(A), (B), (C), and (D). Second, CEA section 

1a(49)(B) is in the definition of ‘‘swap dealer.’’ It is 

not in CEA section 4s(a), 7 U.S.C. 6s(a), which 

pertains to registration of ‘‘swap dealers.’’ 

Therefore, the Commission should have considered 

the effect of CEA section 1a(49)(B) in delineating 

the universe of entities that need to seek registration 

with the Commission, and not solely the effect of 

CEA section 1a(49)(B) in determining the scope of 

registration that the Commission would afford such 

entities. Third, because CEA section 1a(49)(B) 

relates to the definition and not the registration of 

‘‘swap dealers,’’ the Commission articulates no 

basis for an individualized, facts-and-circumstances 

determination. 

27Section II(A)(4)(a) of the CFTC Entities Rule. 

28The Commission acknowledges such departure, 

but attempts to mitigate its legal effect by 

emphasizing that (i) the dealer-trader framework 

overlaps with the functional approach in the 

Proposal, and (ii) the Commission has changed its 

interpretative approach to the ‘‘swap dealer’’ 

definition in response to comments. See Section 

II(A)(4)(a) of the CFTC Entities Rule. 

29As described below, this exception only applies 

to physical commodity swaps. Therefore, 

commercial end-users would not be able to rely on 

this exception for swaps to hedge financial risks. 

Moreover, small financial institutions would not be 

able to rely on this exception (as they most likely 

would be hedging financial risk), even if the 

Commission were to permit them to use the enduser exception. Finally, even financial entities 

(such as ‘‘special entities’’) may engage in 

‘‘hedging’’ without ‘‘dealing.’’ The CFTC Entities 

Rule does not provide much clarity on how such 

financial entities could demonstrate that they are 

not ‘‘dealing’’ (other than the amorphous 

distinction between ‘‘purpose’’ and 

‘‘consequences’’). 

30The final ‘‘floor trader’’ exclusion has many 

limitations. For example, an entity cannot rely on 

this exclusion if it participates in a market-making 

program offered by a designated contract market 

(‘‘DCM’’) or swap execution facility. One wonders 

what would happen if an entity participates in a 

DCM market-making program for futures, and then 

the Commission requires such futures to be 

converted to swaps in a forthcoming rulemaking. 

See, e. g., Core Principles and Other Requirements 

for Designated Contract Markets, 75 FR 80572 (Dec. 

22, 2010). 

31Section II(A)(4)(a) of the CFTC Entities Rule. 

32Section II(A)(5)(a) of the SEC Entities Rule. 

33Section II(A)(3) of the Entities Rule. 

34For example, in Section II(A)(4)(a) of the CFTC 

Entities Rule, the Commission sets forth a list of 

indicia that are either ‘‘particularly similar to’’ or 

‘‘generally consistent with * * * the dealer-trader 

distinction as it will be applied to determine 

whether a person is a security-based swap dealer.’’ 

However, the Commission immediately undermines 

any comfort that such list could provide by stating 

‘‘[t]o clarify, the activities listed in the text are 

indicative of acting as a swap dealer. Engaging in 

one or more of these activities is not a prerequisite 

to a person being covered by the swap dealer 

definition.’’ 

35Section II(A)(4)(a) of the CFTC Entities Rule. 

36 Id. 

performing such collapse, the Commission 

states that it ‘‘continue[s] to believe, as stated 

in the [Proposal], that the phrases ‘ordinary 

course of business’ and ‘a regular business’ 

are, for purposes of the definition of ‘swap 

dealer’ essentially synonymous.’’ 25 Neither 

the Proposal nor the CFTC Entities Rule fully 

supports collapsing CEA section 1a(49)(C)— 

one of four clauses in the statutory ‘‘swap 

dealer’’ definition—into CEA section 

1a(49)(A)(iii)—a subparagraph of one clause. 

Further, neither the Proposal nor the CFTC 

Entities Rule fully supports interpreting two 

separate phrases (i.e., ‘‘ordinary course of 

business’’ and ‘‘regular business’’) as 

meaning the same thing. The Commission 

similarly minimizes CEA section 1a(49)(B) as 

providing for ‘‘limited designation’’ only, 

rather than an alternate source of authority 

for the Commission to exclude certain 

entities from the ‘‘swap dealer’’ definition.26

However, after appearing to broadly define 

‘‘swap dealer’’, the Commission then cobbles 

together various measures that aim—with 

differing levels of success—to provide a 

measure of certainty to commercial endusers. The most important (and successful) of 

these measures is a higher de minimis 

threshold. Two other important measures are: 

(i) referencing the dealer-trader distinction 

and (ii) incorporating an explicit hedging 

exception. 

Although these measures reflect positive 

policy choices, they also reflect various 

compromises that may ultimately diminish 

the certainty that they seek to provide. As 

mentioned above, the Commission could 

have provided equivalent or superior 

certainty by properly construing CEA 

sections 1a(49)(C) and (B), either initially or 

in a re-proposal. 

Æ Reference to the Dealer-Trader 

Distinction 

In the CFTC Entities Rule, the Commission 

states that it ‘‘believe[s] that the dealer-trader 

distinction—which already forms a basis for 

identifying which persons fall within the 

longstanding Exchange Act definition of 

‘dealer’—in general provides an appropriate 

framework for interpreting the statutory 

definition of the term ‘swap dealer.’’’ 27 In so 

recognizing, the Commission departs from 

the Proposal.28 I have always argued that 

differences exist among (i) dealing, (ii) 

trading, and (iii) hedging. I have also 

recommended that the Commission provide 

guidance to clearly distinguish among the 

three categories. Such guidance would aid 

market participants in determining whether 

to register as a ‘‘swap dealer.’’ Although the 

CFTC Entities Rule contains (i) an interim 

final hedging exception 29 and (ii) a final 

‘‘floor trader’’ exclusion, 30 both provisions 

are limited in scope. Therefore, market 

participants will still need clear guidance on 

Commission interpretation of the dealertrader distinction, in order to determine 

whether their trading or hedging transactions 

may cause them to be deemed ‘‘swap 

dealers.’’ 

Unfortunately, the Commission has missed 

its opportunity in the CFTC Entities Rule. 

After reading the relevant portions of the 

rulemaking multiple times, it is still unclear 

to me exactly how the Commission intends 

to distinguish among (i) dealing, (ii) trading 

(outside of the limited ‘‘floor trader’’ 

exclusion), and (iii) hedging (outside of the 

specific hedging exception, which I discuss 

below). For example, the Commission states: 

‘‘[t]he principles embedded within the 

‘dealer trader distinction’ are also applicable 

to distinguishing dealers from non-dealers 

such as hedgers or investors.’’ 31 I agree with 

this statement. The Commission also cites to 

more support from the SEC Entities Rule— 

specifically the fact that ‘‘[t]he ‘dealer-trader’ 

nomenclature has been used for decades.’’ 32

I also agree with this statement. However, the 

Commission then states: ‘‘These same 

principles, though instructive, may be 

inapplicable to swaps in certain 

circumstances or may be applied differently 

in the context of dealing activities involving 

commodity, interest rate, or other types of 

swaps.’’ 33 I do not know whether to agree or 

disagree with this statement, given its 

ambiguity. Thus, for all of its girth, the CFTC 

Entities Rule fails to answer a basic 

question—namely, under which 

circumstances would an entity be deemed a 

dealer (rather than a trader or hedger) with 

respect to specific swap transactions? 34

The Commission appears to argue that 

inherent differences between the swaps 

markets and securities markets (other than 

security-based swaps) justify its selective 

incorporation of dealer-trader elements 

(which elements, in themselves, apparently 

vary according to unknown facts and 

circumstances). For example, the 

Commission states that an entity need not 

engage in two-way transactions in order to 

fall within the ‘‘swap dealer’’ definition. One 

justification that the Commission advances is 

that ‘‘swaps thus far are not significantly 

traded on exchanges or other trading 

systems’’ and that this ‘‘[attribute]—along 

with the lack of ‘buying and selling’ language 

in the swap dealer definition * * *— suggest 

that concepts of what it means to make a 

market need to be construed flexibly in the 

contexts of the swap market.’’ 35 However, in 

the same section of the CFTC Entities Rule, 

the Commission states: ‘‘many cash market 

securities also are not significantly traded on 

those systems.’’ 36 Therefore, the Commission 

advances a justification for selective 

incorporation of dealer-trader elements and 

then contradicts its justification in the same 

paragraph. Thus, even if market participants 

wished to understand Commission reasoning 

to determine whether they need to register as 

‘‘swap dealers,’’ they may not be able to do 

so. 

Finally, the Commission and the SEC 

appear to emphasize different dealer-trader 

elements. For example, the Commission 

tends to emphasize ‘‘accommodating demand 

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37See generally Section II(A)(4) of the CFTC 

Entities Rule. 

38See generally Section II(A)(5) of the SEC 

Entities Rule. 

The CFTC Entities Rule does acknowledge that 

seeking to profit from providing liquidity is one 

indicia of dealing. However, the CFTC Entities Rule 

limits its discussion of this indicia to CEA section 

1a(49)(A)(ii), 7 U.S.C. 1a(49)(A)(ii), which 

emphasizes market-making. The Commission 

appears to rely more heavily on ‘‘accommodating 

demand or facilitating interest’’ (without 

necessarily emphasizing a ‘‘business model that 

seeks to profit from providing liquidity’’) in its 

interpretation of the remainder of CEA section 

1a(49)(A), 7 U.S.C. 1a(49)(A). Therefore, a 

dissonance still exists between the CFTC Entities 

Rule and the SEC Entities Rule. 

39See supra note 24. The Commission could have 

focused on differences in market composition. 

Unfortunately, such focus could have raised other 

issues with Commission construction of CEA 

section 1a(49), 7 U.S.C. 1a(49). 

40See Section II(A)(4)(e) of the CFTC Entities 

Rule. 

41The Commission relies on its misconstruction 

of the statutory ‘‘swap dealer’’ definition to justify 

such a narrow exclusion. In Section II(A)(4)(e) of 

the CFTC Entities Rule, the Commission states: ‘‘In 

terms of the statutory definition of the term ‘swap 

dealer,’ the CFTC notes as an initial matter that 

there is no specific provision addressing hedging 

activity. Thus, the statutory definition leaves the 

treatment of hedging swaps to the CFTC’s 

discretion; it neither precludes consideration of a 

swap’s hedging purpose, nor does it require an 

absolute exclusion of all swaps used for hedging.’’ 

As noted above, whereas CEA section 1a(49) does 

not specifically refer to ‘‘hedging,’’ CEA section 

1a(49)(C), 7 U.S.C. 1a(49)(C), (as well as CEA 

section 1a(49)(B), 7 U.S.C. 1a(49)(B))—as properly 

construed—would have excluded commercial endusers that engage in swaps for purposes of hedging. 

It is interesting that the SEC did not endorse these 

specific sentences. 

42As mentioned above, the Commission contorts 

itself in the CFTC Entities Rule to provide an 

interim hedging exception that applies only to 

physical commodity risks. This approach runs 

contrary to the Dodd-Lincoln Letter (as well as the 

Stabenow-Lucas Letter). Both letters emphasize 

exclusions for entities—such as commercial endusers—so that they could freely hedge their risks— 

whether financial or physical. 

The Dodd-Lincoln Letter begins by referencing 

hedging of interest rate risk. It specifically states: 

‘‘Whether swaps are used by an airline hedging its 

fuel costs or a global manufacturing company 

hedging interest rate risk, derivatives are an 

important tool businesses use to manage costs and 

market volatility. This legislation will preserve that 

tool.’’ Moreover, the Dodd-Lincoln Letter states: 

‘‘The end user exemption may also apply to our 

smaller financial entities—credit unions, 

community banks, and farm credit institutions.’’ If 

such institutions could be categorized as ‘‘swap 

dealers,’’ then they would be prohibited from 

relying on the end-user exception. Such institutions 

would likely seek to hedge financial risk. 

As mentioned above, the Stabenow-Lucas Letter 

states: ‘‘The Commission’s final rulemaking further 

defining ‘swap dealing’ should clearly distinguish 

swap activities that end-users engage in to hedge or 

mitigate the commercial risks associated with their 

businesses, including swaps entered into by endusers to hedge physical commodity price risk, from 

swap dealing.’’ In using the term ‘‘including,’’ the 

Stabenow-Lucas Letter acknowledges that end-users 

may use swaps to hedge or mitigate risks—such as 

financial risks—other than those related to physical 

commodities. 

By focusing only physical commodity risks, 

therefore, the interim hedging exception fails to 

fully satisfy Congressional intent. 

43See Regulation 1.3(z), 17 CFR 1.3(z); (ii) 

Regulation 151.5(a)(1) (in Position Limits in Futures 

and Swaps; Final Rule, 76 FR 71626, 71688 (Nov. 

18, 2011) (to be codified at 17 CFR parts 1, 150, and 

151)); (iii) Regulation 1.3(hhh) (as set forth in the 

CFTC Entities Rule); and (iv) Regulation 39.6(c) (in 

End-User Exception to Mandatory Clearing of 

Swaps; Proposed Rule, 75 FR 80747, 80757 (Dec. 

23, 2010)). 

44See Exec. Order No. 13563, 76 FR 3821, Jan. 21, 

2011; see also Exec. Order No. 13579, 76 FR 41587, 

July 14, 2011. 

45 In Section II(A)(4)(e) of the CFTC Entities Rule, 

the Commission attempts to distinguish between 

‘‘purpose’’ and ‘‘effect.’’ Market participants may 

find such an attempt to be less than clear. 

46Section II(A)(4)(e) of the CFTC Entities Rule 

(stating ‘‘* * *The definition of the term ‘‘major 

swap participant,’’ which applies only to persons 

who are not swap dealers, is premised on the prior 

identification, by the swap dealer definition, of 

persons who accommodate demand for swaps, 

make a market in swaps, or otherwise engage in 

swap dealing activity. The major swap participant 

definition performs the subsequent function of 

identifying persons that are not swap dealers, but 

hold swap positions that create an especially high 

level of risk that could significantly impact the U.S. 

financial system.’’). 

47See CEA section 2(h)(7), 7 U.S.C. 2(h)(7). See 

also supra note 43. 

48See supra note 42. 

49As mentioned above, the Commission has 

authority to discretionarily exclude certain entities 

pursuant to CEA section 1a(49)(B), 7 U.S.C. 

1a(49)(B). 

50CEA section 2(h)(7)(A), 7 U.S.C. 2(h)(7)(A), 

states: ‘‘In General.—The requirements of paragraph 

(1)(A) shall not apply to a swap if 1 of the 

or facilitating interest in the instrument.’’ 37

In contrast, the SEC tends to emphasize ‘‘a 

business model that seeks to profit by 

providing liquidity.’’ 38 The Commission fails 

to provide a rationale for its difference in 

focus.39 On its face, ‘‘accommodating 

demand or facilitating interest’’ seems to 

capture more traders and hedgers than 

having ‘‘a business model that seeks to profit 

by providing liquidity.’’ 

Æ Interim Final Rule on Hedging 

In the CFTC Entities Rule, the Commission 

has included an interim final rule excepting 

certain hedging transactions from the ‘‘swap 

dealer’’ definition (i.e., Regulation 

1.3(ggg)(6)(iii)).40 I agree that hedging is not 

dealing. However, I find the interim final rule 

excessively narrow. First, the interim final 

rule only applies to a limited set of physical 

commodity hedges. I am not sure why the 

Commission does not wish to allow 

commercial end-users to hedge financial 

risks (e.g., through interest rate swaps) 

without fearing that they could be deemed 

‘‘swap dealers.’’ 41 Permitting such hedging 

would be consonant with Congressional 

intent, as expressed in the letters from 

members of Congress.42 Conversely, I am not 

sure why the Commission wants to 

encourage, e.g., banking entities—like 

Barclays—to own physical commodities and 

claim the hedge exception. 

Second, there are four other hedging 

definitions that are either (i) currently 

effective or (ii) the subject of a Dodd-Frank 

Act proposal.43 Given the call by President 

Obama to simplify regulation,44 I would have 

expected the Commission to refrain from 

proposing a fifth hedging definition, unless 

strictly necessary. In the CFTC Entities Rule, 

the Commission does not cogently explain 

the necessity for a fifth hedging exception. 

For example, the Commission spends a 

considerable amount of effort to differentiate 

the interim final rule from bona fide hedging 

in Regulations 1.3(z) and 151.5(a)(1). The 

Commission’s rationale may be distilled into 

one circular sentence: the Commission 

believes that certain bona fide hedging 

transactions may constitute swap dealing, 

due to reasons that the Commission declines 

to fully explain.45 Additionally, the 

Commission spends one paragraph 

attempting to differentiate between the 

interim final rule and the ‘‘major swap 

participant’’ definition (which contains a 

hedging or mitigating commercial risk 

exception). In that paragraph, the central 

argument appears to be that the ‘‘swap 

dealer’’ definition determines the parameters 

of the ‘‘major swap participant’’ definition— 

but not also vice versa.46 Preliminarily, the 

Commission declines to cite where exactly 

the Dodd-Frank Act states that the ‘‘swap 

dealer’’ definition is determinative. 

Secondarily, even assuming that the 

Commission is correct in characterizing the 

interconnection, the Commission does not 

clearly explain why it thinks that those 

transactions (i) falling outside the interim 

final rule but (ii) falling within hedging or 

mitigating commercial risk are more likely to 

constitute swap dealing. 

Finally, the Commission is silent on the 

manner in which the interim final rule 

interacts with the proposed Regulation 39.6 

(detailing hedging or mitigating commercial 

risk for the end-user exception). If an entity 

is a ‘‘swap dealer,’’ then it cannot rely on the 

end-user exception to clearing.47 Therefore, if 

the Commission overreaches in defining 

‘‘swap dealer,’’ it may narrow the end-user 

exception in a way not congruent with 

Congressional intent.48

Other Provisions of the Dodd-Frank Act and 

the CEA: Further Misconstructions 

As mentioned above, the Commission fails 

to properly construe the various clauses of 

CEA section 1a(49). As detailed in this 

section, the Commission also fails to consider 

other provisions of the CEA or the DoddFrank Act in determining the parameters of 

‘‘swap dealer.’’ The Commission appears to 

assume that the ‘‘swap dealer’’ definition is 

determinative for all such provisions, rather 

than also vice versa. The Commission does 

not provide much (if any) rationale for this 

assumption. Removing this assumption, it 

becomes clear that other provisions of the 

CEA or the Dodd-Frank Act may suggest 

further limitations on ‘‘swap dealer.’’ 49

• End-User Exemption: Who can take 

advantage of it? 

CEA section 2(h)(7) sets forth what is 

commonly known as the ‘‘end-user clearing 

exception.’’ As mentioned above, the ‘‘swap 

dealer’’ definition is crucial to determining 

which entities could use the end-user 

clearing exception. That is because CEA 

section 2(h)(7) only applies if one 

counterparty to a swap is not a ‘‘financial 

entity.’’ 50 CEA section 2(h)(7)(C) defines 

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Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 30763 

counterparties to the swap—(i) is not a financial 

entity; (ii) is using swaps to hedge or mitigate 

commercial risk; and (iii) notifies the Commission, 

in a manner set forth by the Commission, how it 

generally meets its financial obligations associated 

with entering into non-cleared swaps.’’ 

51Notably, CEA section 2(h)(7)(C)(i), 7 U.S.C. 

2(h)(7)(C)(i), also lists commodity pools, certain 

private funds, certain employee benefit plans, and 

certain banking and financial entities separately 

from ‘‘swap dealer.’’ Does this separate listing 

imply that those entities are not ‘‘swap dealers’’? 

Why or why not? 

52The Commission discusses the end-user 

clearing exception more fully in that portion of the 

CFTC Entities Rule defining ‘‘major swap 

participant.’’ 

53Comment from ABC/CIEBA, dated February 22, 

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

Comments/ViewComment.aspx?id=27944&Search

Text=American%20Benefits%20Council. 

54Business Conduct Standards for Swap Dealers 

and Major Swap Participants with Counterparties; 

Final Rule, 77 FR 9734 (Feb. 17, 2012). 

55See supra note 51. 

56See Section II(D) of the Entities Rule. 

57Swap Dealer and Major Swap Participant 

Recordkeeping, Reporting, and Duties Rules; 

Futures Commission Merchant and Introducing 

Broker Conflicts of Interest Rules; and Chief 

Compliance Officer Rules for Swap Dealers, Major 

Swap Participants, and Futures Commission 

Merchants; Final Rule, 77 FR 20128 (Apr. 3, 2012). 

58Prohibitions and Restrictions on Proprietary 

Trading and Certain Interests in, and Relationships 

With, Hedge Funds and Covered Funds; Proposed 

Rule, 77 FR 8332 (Feb. 14, 2012). 

59Section II(A)(4)(c) of the CFTC Entities Rule. 

‘‘financial entity’’ as including a ‘‘swap 

dealer.’’ 51 Therefore, if the Commission 

defines ‘‘swap dealer’’ expansively, then the 

Commission will limit the number and types 

of end-users that may use the clearing 

exception. 

Given the importance of the 

interconnections between the ‘‘swap dealer’’ 

definition and the end-user clearing 

exception, I would have expected the 

Commission to discuss such interconnections 

in great detail. Surprisingly, in that portion 

of the CFTC Entities Rule defining ‘‘swap 

dealer,’’ the Commission only discusses enduser clearing in a footnote.52

Footnote 213 illustrates in a particularly 

poignant manner the Commission’s failure to 

properly consider the interaction between the 

‘‘swap dealer’’ definition and the end-user 

exception. In that footnote, the Commission 

attempts to dismiss the argument that the 

‘‘swap dealer’’ definition should only apply 

to financial entities. The Commission states: 

Similarly, the absence of any limitation in 

the statutory definition of the term ‘‘swap 

dealer’’ to financial entities, when such 

limitation is included elsewhere in Title VII, 

indicates that no such limitation applies to 

the swap dealer definition. CEA section 

2(h)(7), 7 U.S.C. 2(h)(7), specifically limits 

the application of the clearing mandate, in 

certain circumstances, to only ‘‘financial 

entities.’’ That section also provides a 

detailed definition of the term ‘‘financial 

entity.’’ See CEA section 2(h)(7)(C), 7 U.S.C. 

2(h)(7)(C). That such a limitation is included 

in this section, but not in the swap dealer 

definition, does not support the view that the 

statutory definition of the term ‘‘swap 

dealer’’ should encompass only financial 

entities. 

In actuality, Footnote 213 raises more 

questions than it answers. In Footnote 213, 

the Commission presumes that the 

interaction between the ‘‘swap dealer’’ 

definition and the end-user exception only 

goes one way—namely, that the ‘‘swap 

dealer’’ definition fixes the scope of the enduser exception, but not also vice versa. The 

Commission provides no basis for this 

presumption, especially since a basic canon 

of statutory is that the Commission should 

construe a statute as a ‘‘harmonious whole.’’ 

From that perspective, it becomes clear that 

Footnote 213 raises a series of fundamental 

questions. Why did Congress use the term 

‘‘financial entity’’ in CEA section 2(h)(7)(C)? 

Does use of this term imply in any way that 

Congress presumed that the ‘‘swap dealer’’ 

definition would exclude commercial 

entities? Why or why not? Surely, Congress 

need not have specified financial entity in 

CEA section 2(h)(7)(C) if it had intended to 

permit the Commission to vitiate the 

reference to financial by simply defining 

‘‘swap dealers’’ to include commercial 

entities. If Congress intended to so permit, 

then Congress could have simply used the 

term ‘‘entity’’ in CEA section 2(h)(7)(C). 

• Employee Benefit Plans: ‘‘Swap Dealers?’’ 

In Section II(A)(2)(f) of the CFTC Entities 

Rule, the Commission describes comments 

requesting categorical exclusions from the 

‘‘swap dealer’’ definition. One such comment 

was from American Benefits Council 

(‘‘ABC’’) and the Committee on the 

Investment of Employee Benefit Assets 

(‘‘CIEBA’’).53 In their comments, ABC/CIEBA 

requested that the Commission exclude (or 

interpret CEA section 1a(49) to exclude) 

certain employee benefit plans from the 

‘‘swap dealer’’ definition. In Section II(A)(6) 

of the CFTC Entities Rule, the Commission 

denies this request, mainly on the basis of its 

misguided construction of CEA section 

1a(49). 

In so denying, the Commission fails to 

consider CEA section 4s(h). Specifically, CEA 

sections 4s(h)(2), (4), and (5) prescribe 

heightened business conduct standards for 

‘‘swap dealers’’ interacting with ‘‘special 

entities.’’ In fact, the Commission recently 

promulgated a final rulemaking on these 

standards.54 CEA section 4s(h)(2)(C) defines 

‘‘special entity’’ as, among other things, ‘‘any 

employee benefit plan, as defined in section 

3 of the Employee Retirement Income 

Security Act of 1974 (29 U.S.C. 1002).’’ CEA 

section 4s(h) raises another series of 

fundamental questions. Did Congress 

presume that employee benefit plans would 

not constitute ‘‘swap dealers’’? 55 Why or 

why not? Indeed, how does the Commission 

reconcile its denial of the ABC/CIEBA 

request with its own de minimis requirement, 

which seems to recognize a per se difference 

between a ‘‘special entity’’ and a ‘‘swap 

dealer’’? 56

• Internal Business Conduct Standards: 

Indication of the Scope of ‘‘Swap Dealer?’’ 

In addition to failing to account for 

external business conduct standards, the 

Commission fails to account for certain 

internal business conduct standards in 

defining ‘‘swap dealer.’’ For example, CEA 

section 4s(j)(5) requires ‘‘swap dealers’’ to 

have systems and procedures to mitigate 

conflicts of interest resulting from 

interactions between (i)(A) any person 

engaged in ‘‘research or analysis of the price 

or market for any commodity or swap’’ or (B) 

any person ‘‘acting in a role of providing 

clearing activities or making determinations 

as to accepting clearing customers’’ and (ii) 

certain persons involved in ‘‘pricing, trading, 

or clearing activities.’’ The Commission 

recently promulgated a final rulemaking on 

this requirement.57 CEA section 4s(j)(5) raises 

another fundamental question. Did Congress 

presume that ‘‘swap dealers’’ generally 

engage in either ‘‘research or analysis’’ or 

‘‘providing clearing activities or making 

determinations’’ and ‘‘pricing, trading, or 

clearing activities’’? Why or why not? 

• Volcker: How does the CFTC Entities Rule 

Fit? 

As I have noted previously, the ‘‘Volcker 

Rule’’ 58 sets forth detailed metrics to 

differentiate between (i) market-making and 

(ii) proprietary trading. To say that the CFTC 

Entities Rule does not replicate such detail 

would be an understatement. Worse, the 

CFTC Entities Rule does not even attempt to 

explain why the metrics in the Volcker Rule 

are inapplicable to the ‘‘swap dealer’’ 

definition. In fact, the Commission addresses 

the interaction between the Volcker Rule and 

the CFTC Entities Rule only in one footnote. 

This footnote states in relevant part: 

The Commissions have proposed an 

approach to the Volcker Rule under which a 

person could seek to avoid the Volcker Rule 

in connection with swap activities by 

asserting the availability of that market 

making exception * * * Under this 

approach, such a person would likely also be 

required to register as a swap dealer (unless 

the person is excluded from the swap dealer 

definition, such as by the exclusion of certain 

swaps entered into in connection with the 

origination of a loan).59

Of course, this footnote provides no useful 

clarification, since the operative question is 

whether an entity engaging in activities that 

would not be ‘‘market-making’’ under the 

Volcker Rule could nonetheless be engaging 

in ‘‘market-making’’ under the CFTC Entities 

Rule (and, solely by virtue of such 

characterization, be required to register as a 

‘‘swap dealer’’). 

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30764 Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations 

60 Generally, because the vast body of 

administrative law provides guideposts to the road 

more traveled. 

Conclusion 

In the CFTC Entities Rule, the Commission 

has made many positive policy changes. To 

enable these changes, however, the 

Commission engages in a series of statutory 

contortions. Moreover, the Commission 

ignores a number of important questions. 

Witnessing these statutory gymnastics, I am 

reminded of the Robert Frost poem, ‘‘The 

Road Not Taken.’’ In its eagerness to adopt 

the CFTC Entities Rule, the Commission 

opted for one road. Specifically, the 

Commission opted for providing more relief 

to market participants, without contradicting 

the fundamental premises of the Proposal. 

However, once market participants have 

examined the rulemaking, will the 

Commission have wished that it had properly 

construed CEA section 1a(49) instead? Given 

the Proposal and the final CFTC Entities Rule 

(and their respective differences), the 

Commission may well conclude that ‘‘* * * 

it took the one less traveled by * * * And 

that has made all the difference.’’ 60

[FR Doc. 2012–10562 Filed 5–22–12; 8:45 am] 

BILLING CODE 6351–01–P 

mstockstill on DSK4VPTVN1PROD with RULES2