```

[Federal Register Volume 78, Number 70 (Thursday, April 11, 2013)]
[Rules and Regulations]
[Pages 21749-21785]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-07970]

[[Page 21749]]

Vol. 78

Thursday,

No. 70

April 11, 2013

Part III

Commodity Futures Trading Commission

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17 CFR Part 50

Clearing Exemption for Swaps Between Certain Affiliated Entities; Final 
Rule

Federal Register / Vol. 78 , No. 70 / Thursday, April 11, 2013 / 
Rules and Regulations

[[Page 21750]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD47

Clearing Exemption for Swaps Between Certain Affiliated Entities

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is adopting regulations to exempt swaps between certain affiliated 
entities within a corporate group from the clearing requirement under 
the Commodity Exchange Act (CEA or Act), enacted by Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act). The regulations include specific conditions, as well as reporting 
requirements, that affiliated entities must satisfy in order to elect 
the inter-affiliate exemption from required clearing.

DATES: This final rule is effective June 10, 2013.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director, 
202-418-5684, sjosephson@cftc.gov; Nadia Zakir, Associate Director, 
202-418-5720, nzakir@cftc.gov; Eric Lashner, Special Counsel, 202-418-
5393, elashner@cftc.gov; Meghan Tente, Law Clerk, 202-418-5785, 
mtente@cftc.gov; Division of Clearing and Risk, Erik Remmler, Associate 
Director, 202-418-7630, eremmler@cftc.gov; Camden Nunery, Economist, 
202-418-5723, cnunery@cftc.gov, Office of the Chief Economist, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Comments on the Notice of Proposed Rulemaking
    A. Overview of Comments Received
    B. Section 4(c) Authority
    C. Definition of Affiliate Status
    D. Inter-Affiliate Swap Documentation
    E. Centralized Risk Management Program
    F. Variation Margin
    G. Treatment of Outward-Facing Swaps and Relief
    H. Reporting Requirements and Annual Election
    I. Implementation
III. Cost-Benefit Considerations
    A. Statutory and Regulatory Background
    B. Costs and Benefits of Exemption for Eligible Affiliate 
Counterparties
    C. Costs and Benefits of Exemption's Conditions
    D. Costs and Benefits to Market Participants and the Public
    E. Costs and Benefits Compared to Alternatives
    F. Consideration of CEA Section 15(a) Factors
IV. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

    On August 21, 2012, the Commission published a notice of proposed 
rulemaking proposing to exempt swaps between certain affiliated 
entities from the clearing requirement under section 2(h)(1)(A) of the 
CEA (NPRM).\1\ As proposed, Sec.  39.6(g) provides that counterparties 
to a swap may elect an inter-affiliate exemption from the clearing 
requirement if: (1) The financial statements of both counterparties are 
reported on a consolidated basis, and either one counterparty directly 
or indirectly holds a majority ownership interest in the other, or a 
third party directly or indirectly holds a majority ownership interest 
in both counterparties; (2) both counterparties comply with the 
conditions set forth in the proposed rule; and (3) one of the 
counterparties provides certain information on behalf of both 
affiliated counterparties to either a registered swap data repository 
(SDR) or the Commission if a registered SDR does not accept the 
information. The Commission is hereby adopting proposed Sec.  39.6(g), 
finalized as Sec.  50.52,\2\ subject to the changes discussed below.
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    \1\ Clearing Exemption for Swaps Between Certain Affiliated 
Entities, 77 FR 50425 (Aug. 21, 2012).
    \2\ For ease of reference, the Commission is re-codifying 
proposed Sec.  39.6(g) as Sec.  50.52 so that market participants 
are able to locate all rules related to the clearing requirement in 
one part of the Code of Federal Regulations.
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    Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide, 
under new section 2(h)(1)(A) of the CEA, that it shall be unlawful for 
any person to engage in a swap unless that person submits such swap for 
clearing to a derivatives clearing organization (DCO) that is 
registered under the CEA or a DCO that is exempt from registration 
under the CEA if the swap is required to be cleared.\3\ Section 2(h)(2) 
of the CEA charges the Commission with the responsibility for 
determining whether a swap is required to be cleared, through one of 
two means: (1) Pursuant to a Commission-initiated review; or (2) 
pursuant to a submission from a DCO of each swap, or any group, 
category, type, or class of swaps that the DCO ``plans to accept for 
clearing.'' On November 29, 2012, the Commission adopted its first 
clearing requirement determination, requiring that swaps meeting the 
specifications outlined in four classes of interest rate swaps and two 
classes of credit default swaps (CDS) are required to be cleared.\4\
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    \3\ Section 2(h)(7) of the CEA provides an exception to the 
clearing requirement when one of the counterparties to a swap (i) is 
not a financial entity, (ii) is using the swap to hedge or mitigate 
commercial risk, and (iii) notifies the Commission how it generally 
meets its financial obligations associated with entering into a non-
cleared swap.
    \4\ Clearing Requirement Determination Under Section 2(h) of the 
CEA, 77 FR 74284 (Dec. 13, 2012) (hereinafter ``Clearing Requirement 
Determination'').
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    The Clearing Requirement Determination adopting release provided a 
specific compliance schedule for market participants to bring their 
swaps into compliance with the clearing requirement.\5\ Swap dealers 
(SDs), major swap participants (MSPs), and private funds active in the 
swaps market were required to comply beginning on March 11, 2013, for 
swaps they enter into on or after that date.\6\ Accounts managed by 
third-party investment managers, as well as ERISA pension plans, have 
until September 9, 2013, to begin clearing swaps entered into on or 
after that date. All other financial entities are required to clear 
swaps beginning on June 10, 2013, for swaps entered into on or after 
that date. With regard to the CDS indices on European corporate names, 
iTraxx, the Clearing Requirement Determination provided that, if no DCO 
offered iTraxx for client clearing by February 11, 2013, the Commission 
would delay compliance for those swaps until 60 days after an eligible 
DCO offers iTraxx indices for client clearing. On February 25, 2013, 
the Commission received notice from ICE Clear Credit LLC that it had 
begun offering customer clearing of the iTraxx CDS indices that are 
subject to the clearing requirement under Sec.  50.4(b). In accordance 
with the timeframe previously set forth by the Commission,\7\ the 
following compliance

[[Page 21751]]

dates shall apply to the clearing of iTraxx indices: Category 1 
Entities: Friday, April 26, 2013; Category 2 Entities: Thursday, July 
25, 2013; and all other entities: Wednesday, October 23, 2013.\8\
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    \5\ See Clearing Requirement Determination at 74319-21.
    \6\ The first compliance date for required clearing applies to 
Category 1 Entities, as defined in Sec.  50.25(a). SDs and MSPs and 
private funds active in the swaps market are defined as Category 1 
Entities. Security-based swap dealers and major security-based 
participants also are included in the definition. However, as the 
Commission has stated, if a security-based swap dealer or a major 
security-based swap participant is not yet required to register with 
the Securities and Exchange Commission (SEC) at such time as the 
Commission issues a clearing determination, then the security-based 
swap dealer or a major security-based swap participant would be 
treated as a Category 2 Entity, as defined in Sec.  50.25(a). See 
Swap Transaction Compliance Implementation Schedule: Clearing and 
Trade Execution Requirements under Section 2(h) of the CEA, 76 FR 
58186, 58190 n.38 (Sept. 20, 2011).
    \7\ Clearing Requirement Determination at 74319-21.
    \8\ See Press Release, CFTC's Division of Clearing and Risk 
Announces Revised Compliance Schedule for Required Clearing of 
iTraxx CDS Indices (Feb. 25, 2013), available at http://www.cftc.gov/PressRoom/PressReleases/pr6521-13.
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II. Comments on the Notice of Proposed Rulemaking

    The Commission received 13 comments during the 30-day public 
comment period following publication of the NPRM on August 21, 2012, 
and one additional comment after the comment period ended. The 
Commission considered each of these comments in formulating the final 
regulation, Sec.  39.6(g) (finalized as Sec.  50.52).
    During the process of proposing and finalizing this rule, the 
Chairman and Commissioners, as well as Commission staff, participated 
in informational meetings with market participants, trade associations, 
public interest groups, and other interested parties. In addition, the 
Commission has consulted with other U.S. financial regulators 
including: (i) The SEC; (ii) the Board of Governors of the Federal 
Reserve System; (iii) the Office of the Comptroller of the Currency; 
and (iv) the Federal Deposit Insurance Corporation (FDIC). Staff from 
each of these agencies has had the opportunity to provide oral and/or 
written comments to this adopting release, and the final regulations 
incorporate elements of the comments provided.
    The Commission is mindful of the benefits of harmonizing its 
regulatory framework with that of its counterparts in foreign 
countries. The Commission has therefore monitored global advisory, 
legislative, and regulatory proposals, and has consulted with foreign 
authorities in developing the final regulations.

A. Overview of Comments Received

    Of the 14 comment letters received by the Commission in response to 
its NPRM, ten commenters expressed general support for the concept of 
an inter-affiliate exemption from the clearing requirement.\9\ These 
commenters offered comments addressing the proposed rule generally and 
comments addressing specific provisions of the proposed rule. Comments 
addressing specific provisions of the proposed rule are discussed in 
detail below.
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    \9\ Cravath, Swaine & Moore LLP (Cravath), the Coalition for 
Derivatives End-Users (CDEU), the Financial Services Roundtable 
(FSR), Chris Barnard, the Commercial Energy Working Group (The 
Working Group), the Edison Electric Institute (EEI), The Prudential 
Insurance Company of America (Prudential), Metropolitan Life 
Insurance Company (MetLife), the International Swaps and Derivatives 
Association and Securities Industry and Financial Markets 
Association, (together, ISDA & SIFMA), and DLA Piper.
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    A number of commenters requested a broader exemption with few or no 
conditions. Cravath and DLA Piper requested that the Commission exempt 
swaps between affiliates from all clearing, margining, and reporting 
obligations. The Working Group, Cravath, CDEU, ISDA & SIFMA, DLA Piper, 
and EEI \10\ recommended that the Commission eliminate, simplify or 
minimize the conditions imposed, or unconditionally exempt inter-
affiliate swaps from clearing. These commenters stated that inter-
affiliate swaps pose little or no risk to the U.S. financial system and 
do not increase the interconnectedness between major financial 
institutions, particularly if affiliates' financial statements are 
consolidated for accounting purposes. The Working Group commented that 
entities use inter-affiliate trades not only to net risk related to 
market-facing swaps, but also to transfer physical commodity or futures 
exposure between affiliates for compliance with international tax law, 
customs, or accounting laws. Similarly, MetLife and Prudential 
supported the proposed exemption and noted that transactions between 
affiliates do not present the same risks as market-facing swaps.
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    \10\ EEI commented that ``corporate families typically face 
bankruptcy together'' and that it is ``unusual for only one member 
of a corporate group to go bankrupt.'' EEI also noted that a 
bankruptcy could cause increased risk to clearinghouses that would 
face multiple entities going into default at the same time if all 
affiliates of one corporate group were required to clear their 
inter-affiliate swaps.
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    ISDA & SIFMA commented that inter-affiliate swaps provide important 
benefits to corporate groups by enabling centralized management of 
market, liquidity, capital, and other risks, and allowing affiliated 
groups to realize associated hedging efficiencies and netting benefits. 
Imposing mandatory clearing on inter-affiliate swaps, according to ISDA 
& SIFMA, could compromise the ability of affiliated groups to realize 
these benefits.\11\ ISDA & SIFMA also commented that third parties face 
no increased risk from inter-affiliate swaps. In their view, the credit 
risks faced by a third party entering into an uncleared swap with a 
group member are a function of the group member's entire portfolio of 
assets and liabilities and other credit factors.
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    \11\ ISDA & SIFMA commented that inter-affiliate swaps do not 
introduce risk into a corporate group, stating, ``[b]ecause capital, 
liquidity and risk allocation decisions, as well as the exercise of 
default remedies between group members are under unified management, 
group entities do not face default risk of other group entities, so 
long as the group as a whole is solvent.''
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    Along the same lines, CDEU commented that non-financial entities 
typically enter into external swaps with swap dealers and other large 
banks that typically evaluate the risks of entering into swaps based on 
the overall creditworthiness of their counterparties. These financial 
entity counterparties, according to CDEU, have the opportunity to 
review financial statements, the creditworthiness of any guarantor, and 
a number of other credit-related items. After the credit review, 
according to CDEU, the counterparties may request credit risk mitigants 
such as corporate parent guarantees, collateral, and credit-based legal 
terms.
    On the other hand, Americans for Financial Reform (AFR) commented 
that a wide-ranging exemption for inter-affiliate swaps could create 
systemic risk and threaten the U.S. financial system. AFR cited a 
number of reasons for its concern such as: the risk transfer between 
separate corporate entities; the possibility for financial contagion to 
be transferred from one part of a large financial institution to 
different groups within the institution; restrictions on access to 
affiliate assets across national boundaries; and reduction in volumes 
at DCOs that could hurt liquidity and risk management. AFR further 
noted that because the end-user exception is available for non-
financial and small financial entities in connection with swaps that 
hedge or mitigate systemic risk, the inter-affiliate exemption is 
primarily available for large financial institutions and speculative 
trades by large commercial institutions with many affiliates.
    Better Markets Inc. (Better Markets) also expressed concern that an 
inter-affiliate exemption could be contrary to Congressional intent, as 
expressed in the Dodd-Frank Act, if it is not a very narrow and 
strictly implemented exemption.
    Two individual persons commented against the proposed exemption. 
Steve Wentz requested that the Commission not issue any exemptions 
because the exemptions ``would just open the door to divert trades 
through that open door to avoid protective oversight.'' Aaron D. Small 
commented that the ``unregulated derivatives market has been a disaster 
for the U.S. and world economy and must be reined in.''
    Having considered these comments, and the specific comments 
discussed below, the Commission is adopting the

[[Page 21752]]

proposed inter-affiliate exemption rule, subject to several important 
modifications. The Commission recognizes the need for an exemption from 
clearing for inter-affiliate swaps, but believes it is important to 
establish certain conditions for entities electing the exemption. In 
reaching this conclusion, the Commission considered the benefits of 
clearing as recognized by the fact that Congress included a clearing 
requirement in the Dodd-Frank Act, against the benefit to market 
participants of being able to continue entering into inter-affiliate 
swaps on an uncleared basis. The Commission believes it has reached an 
appropriate balance by allowing an exemption from required clearing for 
certain inter-affiliate swaps while imposing necessary conditions on 
that exemption in order to ensure that all inter-affiliate swaps 
exempted from required clearing meet certain risk-mitigating 
conditions.
1. Benefits of Clearing and Its Role in the Dodd-Frank Act
    As the Commission has previously stated,\12\ in the fall of 2008, a 
series of large financial institution failures triggered a financial 
and economic crisis that led to unprecedented governmental intervention 
to ensure the stability of the U.S. financial system. The financial 
crisis made clear that an uncleared, over-the-counter (OTC) derivatives 
market can pose significant risks to the U.S. financial system.\13\
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    \12\ See Clearing Requirement Determination at 74284-86; Cross-
Border Application of Certain Swaps Provisions of the Commodity 
Exchange Act, 77 FR 41214, 41215-17 (July 12, 2012) (hereinafter 
``Proposed Cross-Border Interpretive Guidance'').
    \13\ See Financial Crisis Inquiry Commission, ``The Financial 
Crisis Inquiry Report: Final Report of the National Commission on 
the Causes of the Financial and Economic Crisis in the United 
States,'' Jan. 2011, at 386, available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (``The scale and nature of the [OTC] 
derivatives market created significant systemic risk throughout the 
financial system and helped fuel the panic in the fall of 2008: 
millions of contracts in this opaque and deregulated market created 
interconnections among a vast Web of financial institutions through 
counterparty credit risk, thus exposing the system to a contagion of 
spreading losses and defaults.'').
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    One of the most significant examples of this risk was the 
accumulation of uncleared CDS entered into by an affiliate in the AIG 
corporate group providing default protection on more than $440 billion 
in bonds, leaving it with obligations that the AIG corporate family 
could not cover as a result of changed market conditions.\14\ As a 
result of the CDS exposure of this one affiliate, the U.S. Federal 
government bailed out the AIG corporate group with over $180 billion of 
taxpayer money in order to prevent AIG's failure and a possible 
contagion event in the broader economy.\15\ While the downfall of AIG 
was not caused by inter-affiliate swaps, the events surrounding AIG 
during the 2008 crisis demonstrate how the risks of uncleared swaps at 
one affiliate can have significant ramifications for the entire 
affiliated business group.
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    \14\ Adam Davidson, ``How AIG fell apart,'' Reuters, Sept. 18, 
2008, available at http://www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.
    \15\ Hugh Son, ``AIG's Trustees Shun `Shadow Board,' Seek 
Directors,'' Bloomberg, May 13, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aaog3i4yUopo&refer=us.
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    Recognizing the peril that the U.S. financial system faced during 
the financial crisis, Congress and the President came together to pass 
the Dodd-Frank Act in 2010. Title VII of the Dodd-Frank Act establishes 
a comprehensive new regulatory framework for swaps, and the requirement 
that certain swaps be cleared by DCOs is one of the cornerstones of 
that reform. The CEA, as amended by Title VII, now requires a swap to 
be cleared through a DCO if the Commission has determined that the 
swap, or group, category, type, or class of swaps, is required to be 
cleared, unless an exception to the clearing requirement applies. As 
noted above, the only exception to the clearing requirement provided by 
Congress was the end-user exception in section 2(h)(7) of the CEA.\16\
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    \16\ Congress did not provide for an exception or exemption for 
inter-affiliate swaps in the Dodd-Frank Act. However, commenters 
have pointed to legislative history and statements made by members 
of Congress supporting such an exemption at the time the Dodd-Frank 
Act was enacted.
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    The benefits of clearing derivatives have been recognized 
internationally, as well. In September 2009, leaders of the Group of 20 
(G-20)--whose membership includes the United States, the European 
Union, and 18 other countries--agreed that: (1) OTC derivatives 
contracts should be reported to trade repositories; (2) all 
standardized OTC derivatives contracts should be cleared through 
central counterparties by the end of 2012; and (3) non-centrally 
cleared contracts should be subject to higher capital requirements.
    The Commission believes that required clearing through a DCO is the 
best means of mitigating counterparty credit risk and providing an 
organized mechanism for collateralizing the risk exposures posed by 
swaps. By clearing a swap, each counterparty no longer needs to rely on 
the individual creditworthiness of the other counterparty for payment. 
Both original counterparties now look to the DCO that has cleared their 
swap to ensure that the payment obligations associated with the swap 
are fulfilled. The DCO manages the risk of failure of a counterparty 
through appropriate margining, a mutualized approach to default 
management among clearinghouse members, and other risk management 
mechanisms that have been developed over the more than 100 years that 
modern clearinghouses have been in operation. Clearing can avert the 
development of systemic risk by reducing the potential knock-on, or 
domino, effect resulting from counterparties with large outstanding 
exposures defaulting on their swap obligations and causing their 
counterparties--counterparties that would otherwise be financially 
sound if they had been paid--to default. Failure of those 
counterparties could lead to the failure of yet other counterparties, 
cascading through the economy and potentially causing systemic harm to 
the U.S. financial system. Required clearing reduces this risk by 
ensuring that uncollateralized risk does not accumulate in the 
financial system.
2. Risks and Benefits Posed by Inter-affiliate Swaps
    The Commission is not persuaded by comments suggesting that inter-
affiliate swaps pose no risk to the financial system or that clearing 
would not mitigate those risks. Entities that are affiliated with each 
other are separate legal entities notwithstanding their affiliation. As 
separate legal entities, affiliates generally are not legally 
responsible for each other's contractual obligations. This legal 
reality becomes readily apparent when one or more affiliates become 
insolvent.\17\ Affiliates, as separate legal entities, are managed in 
bankruptcy as separate estates and the trustee for each debtor estate 
has a duty to the creditors of the affiliate, not the corporate family, 
the parent of the affiliates, or the corporate family's creditors.\18\ 
This potential for separate

[[Page 21753]]

treatment in bankruptcy, calls into question commenters' claims that 
third parties can rely on the creditworthiness of the entire corporate 
group when entering into swaps with affiliates.
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    \17\ Note, for example, that while the Rule 1015 of the Federal 
Rules of Bankruptcy Procedure (FRBP) permits a court to consolidate 
bankruptcy cases between a debtor and affiliates, FRBP Rule 2009 
provides that, among other things, if the court orders a joint 
administration of two or more estates under FRBP Rule 1015, the 
trustee shall keep separate accounts of the property and 
distribution of each estate. See Federal Rules of Bankruptcy 
Procedure (2011).
    \18\ See In re L & S Indus., Inc., 122 B.R. 987, 993-994 (Bankr. 
N.D. Ill. 1991), aff'd 133 B.R. 119, aff'd 989 F.2d 929 (7th Cir. 
1993) (``A trustee in bankruptcy represents the interests of the 
debtor's estate and its creditors, not interests of the debtor's 
principals, other than their interests as creditors of estate.''); 
In re New Concept Housing, Inc., 951 F.2d 932, 938 (8th Cir. 1991) 
(quoting In re L & S Indus., Inc.). While the concept of 
``substantive consolidation'' of affiliates in a business enterprise 
when they all enter into bankruptcy is sometimes used by a 
bankruptcy court, substantive consolidation is generally considered 
an extraordinary remedy to be used in limited circumstances. See 
Substantive Consolidation--A Post-Modern Trend, 14 Am. Bankr. Inst. 
L. Rev. 527 (Winter 2006).
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    On the other hand, inter-affiliate swaps offer certain risk-
mitigating, hedging, and netting benefits as described by several 
commenters including ISDA & SIFMA, The Working Group, CDEU, and EEI. 
Furthermore, because affiliates in a corporate family generally 
internalize the risks of inter-affiliate transactions in the affiliated 
group, as described in the NPRM, the corporate family could face 
serious reputational harm if affiliates default on their swaps. 
Consequently, the entities within an affiliated group are incentivized 
to fulfill their inter-affiliate swap obligations to each other, to 
support each other to prevent outward-facing failures, and to resolve 
any disagreements about the terms of inter-affiliate swaps more quickly 
and amicably. As noted by ISDA & SIFMA, when an affiliated business 
group is fiscally sound, the capital, liquidity, and risk allocation 
decisions and default remedies between group members may be centrally 
managed thereby reducing the likelihood of group entities facing 
default risk of other group entities, ``so long as the group as a whole 
is solvent.''
    While in many circumstances, these characteristics of inter-
affiliate swaps may mitigate the risk of an affiliate defaulting on its 
obligations--particularly when the group as a whole is financially 
healthy--they do not constitute legally enforceable obligations pre-
bankruptcy or in bankruptcy.\19\ Accordingly, despite the existence of 
mutual support incentives, a corporate group facing insolvency risk may 
ultimately make the decision to allow some affiliates to fail and 
default on their swap obligations so that other affiliates can survive 
without becoming insolvent.\20\ In cases where an insolvent affiliate 
has multiple obligations to third parties (swap-related or otherwise), 
those third parties may be subject to a pro rata distribution along 
with other creditors if the trust estate of the defaulting affiliate 
does not have sufficient liquid assets to cover losses on its uncleared 
swaps. It is at such times of financial stress that central clearing 
serves as the most effective systemic risk mitigant.
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    \19\ See Bankrupt Subsidiaries: The Challenges to the Parent of 
Legal Separation, 25 Emory Bankr. Dev. J. 65 (2008); Liability of a 
Parent Corporation for the Obligations of an Insolvent Subsidiary 
Under American Case Law and Argentine Law, 10 Am. Bankr. Inst. L. 
Rev. 217 (Spring 2002).
    \20\ See, e.g., the bankruptcy of Residential Capital (ResCap) 
and its subsidiaries. ResCap was a mortgage subsidiary of Ally 
Financial Inc. ResCap declared bankruptcy independent of Ally 
Financial Inc., which is not part of the bankruptcy proceeding and 
continues to operate as a legally separate, solvent entity. See In 
re Residential Capital, LLC, No. 12-12020 (MG) (Bankr. S.D.N.Y. 
2012), available at http://www.kccllc.net/rescap. While the 
bankruptcy of ResCap was not the direct result of inter-affiliate 
swaps, ResCap's bankruptcy demonstrates that an affiliate can be put 
into bankruptcy without forcing the affiliated parent to declare 
bankruptcy or to be legally responsible for the affiliate's debts.
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3. The Commission's Consideration of the Risks and Benefits
    In providing an inter-affiliate exemption from required clearing, 
the Commission has considered the benefits that inter-affiliate swaps 
offer corporate groups against the risk of allowing an exemption from 
required clearing for swaps entered into by separate, but affiliated, 
legal entities. In considering the risks and benefits, the Commission 
was guided, in part, by comments pointing to the risk-mitigating 
characteristics of inter-affiliate swaps and the sound risk management 
practices of corporate groups that rely on inter-affiliate swaps. In 
crafting the rule, the Commission sought to codify these 
characteristics as eligibility criteria, or conditions, for the 
exemption from required clearing. The conditions imposed are designed 
to increase the likelihood that affiliates will take into consideration 
their mutual interests when entering into, and fulfilling, their inter-
affiliate swap obligations. For example, the inter-affiliate exemption 
may be elected only if the affiliates are majority owned and their 
financial statements are consolidated, thereby increasing the 
likelihood that entities will be mutually obligated to meet the group's 
swap obligations. Additionally, the affiliates must be subject to a 
centralized risk management program, the swaps and the trading 
relationship between affiliates must be documented, and outward-facing 
swaps must be cleared or subject to an exemption or exception from 
clearing.
    Despite the conditions to the exemption adopted in this final rule, 
the Commission reminds market participants that the conditions included 
in the final rule do not mitigate potential losses between inter-
affiliates to the extent that clearing would, particularly if one or 
more affiliated entities become insolvent.

B. Section 4(c) Authority

    Section 4(c)(1) of the CEA grants the Commission the authority to 
exempt any transaction or class of transactions, including swaps, from 
certain provisions of the CEA, including the clearing requirement, in 
order to ``promote responsible economic or financial innovation and 
fair competition.'' Section 4(c)(2) of the Act further provides that 
the Commission may not grant exemptive relief unless it determines 
that: (1) The exemption is appropriate for the transaction and 
consistent with the public interest; (2) the exemption is consistent 
with the purposes of the CEA; (3) the transaction will be entered into 
solely between ``appropriate persons''; and (4) the exemption will not 
have a material adverse effect on the ability of the Commission or any 
contract market to discharge its regulatory or self-regulatory 
responsibilities under the CEA.\21\ In enacting section 4(c), Congress 
noted that the purpose of the provision is to give the Commission a 
means of providing certainty and stability to existing and emerging 
markets so that financial innovation and market development can proceed 
in an effective and competitive manner.\22\
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    \21\ 7 U.S.C. 6(c)(2).
    \22\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179, 
3213.
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    In the NPRM, the Commission requested comment as to whether 
exempting inter-affiliate swaps from the clearing requirement under 
certain terms and conditions would be an appropriate exercise of its 
section 4(c) authority.\23\ A number of commenters supported the 
Commission's use of its section 4(c) authority to exempt inter-
affiliate swaps from clearing. According to MetLife and Prudential, the 
inter-affiliate exemption as proposed promotes responsible economic or 
financial innovation and fair competition by allowing corporate groups 
to use inter-affiliate swaps to engage in effective and efficient risk 
management activities. As an example, MetLife and Prudential explained 
that corporate groups can use a single conduit in the market on behalf 
of multiple affiliates within the group, which permits the corporate 
group to net affiliates' trades. This netting effectively reduces the 
overall risk of the corporate group and the number of open positions 
with external market participants, which in turn reduces operational, 
market, counterparty credit, and settlement risk. MetLife and 
Prudential both expressed the view that inter-affiliate swaps do not 
pose risks to

[[Page 21754]]

corporate groups and third parties, and both stated that inter-
affiliate swaps may pose less risk to corporate groups given efficient 
netting across the corporate group. EEI also supported the Commission's 
use of its section 4(c) authority for similar reasons to those stated 
by MetLife and Prudential.
---------------------------------------------------------------------------

    \23\ See NPRM at 50428.
---------------------------------------------------------------------------

    ISDA & SIFMA stated that the Commission's proposed exemption meets 
the requirements of section 4(c) of the CEA by promoting innovation and 
competition, and the exemption serves the public interest. ISDA & SIFMA 
noted that inter-affiliate swaps are integral to the strategies 
consolidated financial institutions rely upon to meet customer needs in 
an efficient, competitive, and sound manner. According to ISDA & SIFMA, 
inter-affiliate swaps maximize hedging efficiencies and allow customers 
to transact with a single client-facing entity in the customer's 
jurisdiction, which increases the scope of risk-reducing netting with 
individual customers as well as risk-reducing netting of offsetting 
positions within the financial group. This allows the institution to 
meet customer needs across jurisdictions and provide improved pricing 
or other risk management benefits to customers, thereby promoting 
financial innovation and competition. ISDA & SIFMA also commented that 
inter-affiliate swaps allocate and transfer risks among members of a 
corporate group rather than increasing risks.
    CDEU also supported the Commission's use of its section 4(c) 
authority. CDEU stated that the inter-affiliate exemption would promote 
financial innovation, fair competition, and the public interest by 
preserving the ability of corporate entities to centrally hedge the 
risks of their affiliates. CDEU stated that without such an exemption 
firms that currently use a central hedging model will be disadvantaged 
as compared to direct competitors that do not use the same, efficient 
risk management model. CDEU also noted the additional costs that would 
be incurred from subjecting inter-affiliate swaps to clearing.
    In the NPRM, the Commission requested comments on whether the 
inter-affiliate exemption would be in the public interest. In addition 
to responses noted above with regard to the public interest,\24\ the 
Commission received two comment letters questioning whether the 
proposed exemption serves the public interest.
---------------------------------------------------------------------------

    \24\ As noted above, CDEU, MetLife, Prudential, and ISDA & SIFMA 
stated that an inter-affiliate exemption is consistent with the 
public interest.
---------------------------------------------------------------------------

    According to AFR, there are serious doubts about whether the inter-
affiliate exemption is in the public interest. AFR stated that any 
hedging and netting benefits gained from corporate groups engaging in 
inter-affiliate swaps must be weighed against the benefits of full 
novation to a central counterparty in the form of a clearinghouse, 
which is a more comprehensive level of risk management. Given the 
experience of the 2008 financial crisis, AFR noted that any risk-
reducing benefit of corporate group risk management practices assumes 
that the corporate group actually implements and adheres to sufficient 
risk management procedures. AFR is concerned about relying on such an 
assumption in light of the fact that there was a large-scale failure of 
proper risk management prior to and during the 2008 financial crisis.
    Better Markets similarly commented that only a very narrow and 
strict inter-affiliate exemption could be in the public interest. 
Better Markets suggested ways in which the Commission should strengthen 
the proposed exemption to satisfy the public interest standard, 
including requiring a 100% majority ownership interest standard, 
requiring that both initial and variation margin be exchanged, and 
banning rehypothecation of posted collateral.\25\
---------------------------------------------------------------------------

    \25\ As discussed further below, both AFR and Better Markets 
contend that all the proposed conditions must be retained and the 
conditions must be strengthened in a number of ways.
---------------------------------------------------------------------------

    After considering the complete record in this matter, the 
Commission has determined that the requirements of section 4(c) of the 
Act have been met with respect to the exemptive relief described above. 
The Commission believes that the exemption, as modified in this 
release, is consistent with the public interest and with the purposes 
of the CEA. The Commission's determination is based, in large part, on 
the transactions that are covered under the exemption. Namely, as most 
commenters noted, inter-affiliate transactions provide an important 
risk management role within corporate groups. In addition, and as 
discussed in the NPRM, the Commission recognizes that swaps entered 
into between corporate affiliates, if properly risk-managed, may be 
beneficial to the entity as a whole. Accordingly, in promulgating this 
rule, the Commission concludes that an exemption subject to certain 
conditions is appropriate for the transactions at issue, promotes 
responsible financial innovation and fair competition, and is 
consistent with the public interest. As the Commission noted in the 
NPRM and as reiterated in AFR's comment, any benefits to the corporate 
entity have to be considered in light of the risks that uncleared swaps 
pose to corporate groups and market participants generally. For this 
reason, the Commission is adopting an inter-affiliate exemption that is 
narrowly tailored and subject to a number of important conditions, 
including that affiliates seeking eligibility for the exemption 
document and manage the risks associated with the swaps.
    Further, the Commission finds that the exemption is only available 
to ``appropriate persons.'' Section 4(c)(3) of the CEA includes within 
the term ``appropriate person'' a number of specified categories of 
persons, including ``such other persons that the Commission determines 
to be appropriate in light of their financial or other qualifications, 
or the applicability of appropriate regulatory protections.'' \26\ 
Given that only eligible contract participants (ECPs) can enter into 
uncleared swaps and that the elements of the ECP definition (as set 
forth in section 1a(18)(A) of the CEA and Commission regulation 1.3(m)) 
generally are more restrictive than the comparable elements of the 
enumerated ``appropriate person'' definition, the Commission finds that 
ECPs are appropriate persons within the scope of section 4(c)(3)(K) for 
purposes of this final release and that in so doing, the class of 
persons eligible to rely on the exemption will be limited to 
``appropriate persons'' within the scope of section 4(c)(3) of the CEA.
---------------------------------------------------------------------------

    \26\ 7 U.S.C. 6(c)(3)(K).
---------------------------------------------------------------------------

    Finally, the Commission finds that this exemption will not have a 
material effect on the ability of the Commission to discharge its 
regulatory responsibilities. This exemption is limited in scope and, as 
described further below, the Commission will have access to information 
regarding the inter-affiliate swaps subject to this exemption because 
they will be reported to an SDR pursuant to the conditions of the 
exemption. In addition to the reporting conditions in the rule, the 
Commission retains its special call, anti-fraud, and anti-evasion 
authorities, which will enable it to adequately discharge its 
regulatory responsibilities under the CEA.
    For the reasons described in this release, the Commission believes 
it is appropriate and consistent with the public interest to adopt such 
an exemption.

[[Page 21755]]

C. Definition of Affiliate Status

    As proposed, Sec.  39.6(g)(1) provides that counterparties to a 
swap may elect the inter-affiliate exemption to the clearing 
requirement if the financial statements of both counterparties are 
reported on a consolidated basis, and either one counterparty directly 
or indirectly holds a majority ownership interest in the other, or a 
third party directly or indirectly holds a majority ownership interest 
in both counterparties. The proposed rule further specified that a 
counterparty or third party directly or indirectly holds a majority 
ownership interest if it directly or indirectly holds 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.
1. Majority Ownership Interest
    Four commenters supported proposed Sec.  39.6(g)(1), which set 
forth the requirements of an affiliate status. CDEU commented that the 
majority-ownership test strikes an appropriate balance between ensuring 
that the rule is not overly broad and providing companies with the 
flexibility to account for differences in corporate structures. EEI 
stated that majority ownership is sufficient to mitigate what EEI 
believes is ``minimal'' risk posed by uncleared inter-affiliate swaps. 
In addition, EEI noted that majority-owned affiliates will have strong 
incentives to internalize one another's risks because the failure of 
one affiliate impacts all affiliates within the corporate group. The 
Working Group generally supported the Commission's definition, but 
stated that inter-affiliate swaps should be unconditionally exempt from 
mandatory clearing when the affiliates are consolidated for accounting 
purposes.\27\ MetLife stated that it would likely limit inter-affiliate 
trading to ``commonly-owned'' affiliates, but agreed with the 
flexibility of including majority-owned affiliates.\28\
---------------------------------------------------------------------------

    \27\ The Working Group also stated that it was unable to 
determine the scope of the proposed rule until the Commission 
provides further guidance on the definition of ``financial entity'' 
under section 2(h)(7) of the CEA. In particular, The Working Group 
asked that the Commission clarify the status of treasury affiliates 
acting on behalf of affiliates able to claim an exception or 
exemption from required clearing. The Working Group further 
requested that the Commission provide guidance regarding what 
constitutes being predominantly engaged in activities that are in 
the business of banking or in activities that are financial in 
nature, as defined in section 4(k) of the Bank Holding Company Act 
of 1956, and clarify that trading physical commodities is not 
financial in nature. In response to The Working Group and other 
comments regarding the applicability of the end-user exception for 
certain inter-affiliate swaps, the Commission notes that it will 
address the use of treasury affiliates under a separate Commission 
action. With regard to the definition of financial entity, the 
Commission provided additional guidance in the end-user exception 
rulemaking, and declined to interpret statutory provisions within 
the jurisdiction of other U.S. authorities. See End-User Exception 
to the Clearing Requirement for Swaps, 77 FR 42560, 42567 (July 19, 
2012) (explaining that ``business of banking'' is a term of art 
found in the National Bank Act and is within the jurisdiction of, 
and therefore subject to interpretation by, the Office of the 
Comptroller of the Currency and section 4(k) of the Bank Holding 
Company Act is within the jurisdiction of, and therefore subject to 
interpretation by, the Board of Governors of the Federal Reserve 
System). Accordingly, further guidance on this issue is beyond the 
scope of this rulemaking, except as provided in note 76 of this 
release.
    \28\ Prudential stated that its affiliates are all wholly-owned 
affiliates and expressed no view on the issue of majority-owned 
affiliates.
---------------------------------------------------------------------------

    Two commenters objected to proposed Sec.  39.6(g)(1) and requested 
the Commission require 100% ownership of affiliates. AFR stated that 
the systemic impact of swaps is based on ownership, not on corporate 
control. AFR also stated that permitting such a low level of joint 
ownership would lead to evasion of the clearing requirement through the 
creation of joint ventures set up to enable swap trading between banks 
without the need to clear the swaps. Similarly, Better Markets agreed 
that only 100% owned affiliates should be eligible for the exemption 
because allowing the exemption for the majority owner permits that 
owner to disregard the views of its minority partners \29\ and creates 
an incentive to evade the clearing requirement by structuring 
subsidiary partnerships. Finally, Better Markets stated that the 
majority-ownership standard would result in corporate groups 
transferring price risk and credit risk to different locations, 
facilitating interconnectedness and potentially giving rise to systemic 
risk during times of market stress.
---------------------------------------------------------------------------

    \29\ Two other commenters also discussed the issue of minority 
investors. ISDA & SIFMA stated that any concerns about the 
protection of minority investors in group entities is ``the province 
of corporate and securities laws.'' EEI noted that ``to the extent 
minority owners have an opinion about electing the exemption, they 
may negotiate with majority-owners as they deem commercially 
appropriate for the right to participate in inter-affiliate clearing 
decisions.''
---------------------------------------------------------------------------

    Having considered these comments, the Commission is adopting 
proposed Sec.  39.6(g)(1) (now Sec.  50.52(a)) with the modifications 
discussed below. The Commission believes that the majority-owned 
standard is not overly broad and provides entities with flexibility to 
account for differences in corporate structure. In particular, 
requiring majority ownership serves to ensure that counterparty credit 
risk posed by inter-affiliate swaps is internalized by the corporate 
group.
    In addition, as the NPRM noted, it is important for the inter-
affiliate clearing exemption to be harmonized with foreign 
jurisdictions that have or are developing comparable clearing regimes 
consistent with the 2009 G-20 Leaders' Statement.\30\ For example, the 
European Parliament and Council of the European Union have adopted the 
European Market Infrastructure Regulation (EMIR).\31\ Subject to the 
relevant provisions, technical standards, and regulations under EMIR, 
certain OTC derivatives transactions between parent and subsidiary 
entities, could be exempt from its general clearing requirement. 
Generally speaking, it appears that the intragroup exemptions under 
EMIR will require majority-ownership rights and consolidated accounting 
and annual reporting.\32\
---------------------------------------------------------------------------

    \30\ At the G-20 meeting in Pittsburgh in 2009, as noted above, 
the G-20 Leaders declared that, ``[a]ll standardized OTC derivative 
contracts should be traded on exchanges or electronic trading 
platforms, where appropriate, and cleared through central 
counterparties by end-2012 at the latest.'' G-20 Leaders' Final 
Statement at Pittsburgh Summit: Framework for Strong, Sustainable 
and Balanced Growth (Sept. 29, 2009).
    \31\ See Regulation (EU) No 648/2012 of the European Parliament 
and of the Council on OTC Derivatives, Central Counterparties and 
Trade Repositories, 2012 O.J. (L 201) (hereinafter ``EMIR'') 
available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF.
    \32\ Id. at Articles 3 and 4.
---------------------------------------------------------------------------

    In response to the concerns of AFR and Better Markets regarding the 
need for the Commission to adopt a stricter requirement of 100% 
ownership, the Commission recognizes the potential for corporate 
entities to structure their affiliates in such a manner as to evade the 
clearing requirement. However, the Commission believes it has carefully 
crafted a narrow exemption based on the condition that the affiliate is 
majority-owned, along with the other conditions imposed under this 
exemption. In terms of the interests of minority shareholders, the 
Commission believes that the views of all shareholders should be taken 
into account when an entity decides whether to clear a swap, but 
ultimately, the decision is a matter for corporate and securities laws.
2. Consolidated Financial Statements
    In addition to the majority-ownership requirement, proposed Sec.  
39.6(g)(1) provided that counterparties to a swap may elect the inter-
affiliate exemption to the clearing requirement if the financial 
statements of both counterparties are reported on a consolidated basis. 
The Commission received several comments on this provision. The FSR 
requested that the

[[Page 21756]]

Commission clarify that alternative accounting standards can be used 
for purposes of meeting the requirement that the financial statements 
of both affiliates be reported on a consolidated basis. In response to 
a question in the NPRM regarding whether the exemption should be 
limited to the ownership threshold based on section 1504 of the 
Internal Revenue Code, MetLife and Prudential both explained that a 
U.S. taxpayer cannot file consolidated U.S. tax returns with its non-
U.S. affiliate. Accordingly, both MetLife and Prudential stated that 
they did not support such a limitation on the exemption.
    In an effort to clarify the consolidated financial reporting 
condition, the Commission is modifying the requirement that financial 
statements be reported on a consolidated basis in two ways. First, the 
Commission is clarifying which entities are subject to the consolidated 
reporting condition. Under revised Sec.  50.52(a)(1)(i), if one of the 
two affiliate counterparties claiming the exemption holds a majority 
interest in the other affiliate counterparty (the ``majority-interest 
holder''), then the financial statements of the majority-interest 
holder must be reported on a consolidated basis and such statements 
must include the financial results of the majority-owned counterparty. 
On the other hand, under revised Sec.  50.52(a)(1)(ii), if a third 
party is the majority-interest holder of both affiliate counterparties 
claiming the exemption (the ``third-party majority-interest holder''), 
then the financial statements of the third-party majority-interest 
holder must be reported on a consolidated basis and such statements 
must include the financial results of both affiliate counterparties to 
the swap. In essence, the rule requires that the financial statements 
of the majority-owner (whether a third party or not) are subject to 
consolidation under accounting standards and must include either the 
other affiliate counterparty's or both majority-owned affiliate 
counterparties' financial results. The Commission is using the term 
``financial results'' to refer to the financial statements, reports, or 
other material of the majority-owned counterparty or counterparties 
that must be consolidated with the majority owner's financial 
statements.
    The second modification to the proposed rule responds to FSR's 
request that the Commission clarify that alternative accounting 
standards are permitted. Accordingly, the consolidated financial 
statements of the majority-interest holder or the third-party majority-
interest holder, as appropriate, may be prepared under either Generally 
Accepted Accounting Principles (GAAP) or International Financial 
Reporting Standards (IFRS). The modification reflects the fact that 
entities claiming the exemption may be subject to different accounting 
standards.
    The Commission is not modifying the rule to limit the exemption to 
an ownership threshold based on section 1504 of the Internal Revenue 
Code.

D. Inter-Affiliate Swap Documentation

    As proposed, Sec.  39.6(g)(2)(ii) provided that eligible affiliate 
counterparties that elect the inter-affiliate exemption must enter into 
swaps with a swap trading relationship document that is in writing and 
includes all the terms governing the relationship between the 
affiliates. These terms include, but are not limited to, payment 
obligations, netting of payments, transfer of rights and obligations, 
governing law, valuation, and dispute resolution. This requirement will 
be satisfied if an eligible affiliate counterparty is an SD or MSP that 
complies with the swap trading relationship documentation requirements 
of Sec.  23.504. Regulation 23.504 includes all the proposed terms 
under proposed Sec.  39.6(g)(2)(ii) plus a number of other specific 
requirements. The NPRM stated that the burden on affiliates would not 
be onerous because all affiliates should be able to use a master 
agreement to document their swaps, however, in the NPRM the Commission 
did not require the use of such a master agreement.
    The Commission received a number of comments both supporting and 
opposing the swap documentation requirement. Better Markets, MetLife, 
and Prudential all supported the proposed documentation requirement. 
Specifically, MetLife and Prudential did not believe that the 
documentation requirement would be any more ``burdensome or costly'' 
for them because they already document all of their swaps. 
Additionally, MetLife and Prudential commented that the proposed 
documentation method is ``preferable'' to any other method and 
represents industry best practice. Better Markets agreed with the 
conditions imposed on the exemption, including the documentation 
requirements, and stated that the conditions should not be 
weakened.\33\
---------------------------------------------------------------------------

    \33\ While it did not address the documentation requirements 
specifically, AFR stated that the proposed conditions on the 
exemption should be fully retained. Similarly, Chris Barnard 
generally expressed support for the proposed rules but did not 
specifically mention the documentation provisions.
---------------------------------------------------------------------------

    Cravath, EEI, CDEU, and DLA Piper opposed the proposed 
documentation requirement. Cravath stated that the costs associated 
with the imposition of documentation requirements outweigh any benefits 
to the financial system, and that the Commission should leave the 
determination as to the appropriate level of documentation to boards of 
directors and management of companies, to determine based on the 
``reasonable exercise of their fiduciary responsibilities.'' DLA Piper 
commented that inter-affiliate swaps are typically documented by a 
simple intercompany agreement, trade ticket or accounting entry rather 
than ISDA Master Agreements, and that the documentation requirements 
would be burdensome.
    CDEU expressed concern that proposed Sec.  39.6(g)(2)(ii)(B) would 
require that full ISDA Master Agreements be used to document inter-
affiliate swaps. CDEU explained that while many market participants use 
master agreements, some end users many not have full master agreements 
because inter-affiliate swaps are purely internal and do not increase 
systemic risk.\34\ CDEU recommended that the proposed rule be revised 
to require that the swap documentation ``include all terms necessary 
for compliance with its centralized risk management program'' and 
eliminate the list of required terms. CDEU also requested that the 
Commission clarify that (1) market participants can continue to use 
documentation required by their risk management programs, and (2) the 
rule does not require market participants to use the ISDA Master 
Agreements.
---------------------------------------------------------------------------

    \34\ CDEU recognized that SDs and MSPs and their counterparties, 
including affiliates, will be subject to the requirements of Sec.  
23.504, but stated that it is not appropriate to apply the same 
requirements to non-registrant affiliates.
---------------------------------------------------------------------------

    EEI recommended that the Commission eliminate the documentation 
requirement because the requirement is duplicative of corporate 
accounting records that affiliates maintain as a matter of prudent 
business practice. According to EEI, current accounting practices will 
address the Commission's tracking and proof-of-claim concerns related 
to inter-affiliate swaps. EEI commented that a documentation 
requirement imposes ``an additional, costly layer of ministerial 
process and documentation that is unnecessary to achieve the 
Commission's stated objectives.'' \35\ EEI

[[Page 21757]]

requested that the Commission allow market participants ``to document 
their inter-affiliate risk transfers pursuant to standard commercial 
accounting and business records practices.''
---------------------------------------------------------------------------

    \35\ EEI commented on the NPRM's consideration of costs and 
benefits and stated that the costs of the proposed documentation 
requirement are unjustified. The NPRM included an estimate that 
there would be a one-time cost of $15,000 to develop appropriate 
documentation for use by an entity's affiliates. EEI objected to 
this estimate because, in its view, the legal costs associated with 
individually negotiating and amending standard agreements between 
individual affiliates would exceed the NPRM's estimates. In 
addition, EEI objected to the NPRM's estimate of 22 affiliated 
counterparties for each corporate group as ``far too low'' for U.S. 
energy companies. However, EEI did not provide specific, 
quantitative information in terms of either the legal costs of 
complying with the proposed documentation requirement or number of 
affiliates for a corporate group subject to this rule.
---------------------------------------------------------------------------

    ISDA & SIFMA stated that the documentation requirements were overly 
prescriptive and would impose unnecessary costs on affiliates. 
Specifically, ISDA & SIFMA identified the valuation and dispute 
resolution requirements as serving little purpose. ISDA & SIFMA 
recommended a more flexible approach that would require adequate 
documentation of ``all transaction terms under applicable law.''
    The Commission considered all of the comments relating to the 
proposed documentation requirement and is retaining the swap 
documentation requirement subject to certain modifications recommended 
by commenters. As discussed in the NPRM, the Commission is concerned 
that without adequate documentation entities will be unable to track 
and manage the risks arising from inter-affiliate swaps. Equally 
important, affiliates must be able to offer sufficient proof of claim 
in the event of insolvency. The Commission is adopting proposed Sec.  
39.6(g)(2)(ii)(A) (now Sec.  50.52(b)(2)(i)), which essentially 
confirms the applicability of Sec.  23.504 to swaps between affiliates 
where one of the affiliates is an SD or MSP. However, with regard to 
swaps between affiliates that are not SDs or MSPs, and in response to 
commenters' requests for a more flexible standard, the Commission is 
adopting ISDA & SIFMA's recommendation that the focus of the 
documentation requirement be on documenting all of an inter-affiliate 
transaction's terms. Accordingly, the Commission is modifying proposed 
Sec.  39.6(g)(2)(ii)(B) (now Sec.  50.52(b)(2)(ii)), to require that 
``the terms of the swap are documented in a swap trading relationship 
document that shall be in writing and shall include all terms governing 
the trading relationship between the eligible affiliate 
counterparties.''
    Under this modification, the Commission is eliminating the non-
exclusive list of terms, which included payment obligations, netting of 
payments, transfer of rights and obligations, governing law, valuation, 
and dispute resolution. The change responds to commenters' requests for 
a more flexible approach that reflects current market best practices. 
While, in most instances, the Commission anticipates that documentation 
between affiliates will include all of the previously enumerated terms, 
the more general rule formulation signals that market participants 
retain the ability to craft appropriate documentation for their 
affiliated entities. This modification also serves to address concerns 
that the intent of the proposed rule was to require formal master 
agreements, such as the ISDA Master Agreement. As explained above, the 
proposed rule was not intended to require affiliates to enter into 
formal master agreements. Rather, the Commission observed that parties 
that already use master agreements to document their inter-affiliate 
swaps would likely meet the requirements of the inter-affiliate 
exemption without additional costs.\36\ This observation was supported 
by commenters such as MetLife and Prudential.
---------------------------------------------------------------------------

    \36\ See Confirmation, Portfolio Reconciliation, Portfolio 
Compression, and Swap Trading Relationship Documentation 
Requirements for Swap Dealers and Major Swap Participants, 77 FR 
55904, 55906 (Sept. 11, 2012) (recognizing that the ISDA Master 
Agreement, and other associated documents in their pre-printed form 
as published by ISDA are capable of compliance with the rules, but 
noting that such agreements are subject to customization by 
counterparties and such customization may or may not comply with 
Commission requirements).
---------------------------------------------------------------------------

    This modification also responds, in part, to CDEU's request that 
the documentation ``include all terms necessary for compliance with its 
centralized risk management program.'' While the Commission is 
modifying the rule to delete the specific references to valuation and 
dispute resolution procedures, ensuring that affiliates entering into 
swaps have sound procedures in place to value their swaps and resolve 
any disputes is critical to risk management. Accordingly, as discussed 
further below, the Commission anticipates that affiliates will include 
rigorous valuation provisions and procedures for elevating and 
resolving disputes in their risk management programs.
    In response to comments from Better Markets and AFR that the 
proposed regulations should be retained and not weakened, the 
Commission does not believe that eliminating the non-exclusive list of 
terms and replacing it with a simple requirement that all terms of the 
swap transaction and the relationship between the affiliates be 
documented will weaken the rule. Rather, eligible affiliates will have 
some discretion, but also have the obligation to ensure that their 
documentation contains an accurate and thorough written record of their 
swaps. The Commission clarifies, however, that book entries would not 
suffice for purposes of complying with the swap documentation condition 
because such entries do not contain sufficient information to 
adequately document the swap or the trading relationship between 
affiliates.
    EEI requested that, if the Commission retains the documentation 
requirement, the Commission clarify that swap confirmations are not 
required because executing confirmations would impose substantial 
costs. In response to this request, the Commission clarifies that for 
swaps between affiliates where one or both of the affiliates is an SD 
or MSP, the confirmation rules under Sec.  23.501 are incorporated into 
Sec.  23.504.\37\ As a result, those affiliates must confirm all the 
terms of their transactions according to the applicable timeframes set 
forth under Sec.  23.501.\38\ By contrast, for swaps between affiliates 
that are not SDs or MSPs, the provisions of Sec.  23.501 do not apply 
and formal confirmation pursuant to Sec.  23.501 is not required. 
However, the Commission notes that the terms of the swap will be 
documented by the affiliates and confirmation of those terms will be 
reported to an SDR under the Commission's reporting rules.\39\
---------------------------------------------------------------------------

    \37\ See 17 CFR 23.504(b)(2); 77 FR 55907-08.
    \38\ See 17 CFR 23.501.
    \39\ See, e.g., 17 CFR 45.3(c)(1)(iii) (requiring the reporting 
counterparty to report all confirmation data for the swap as soon as 
technologically practicable after confirmation, but no later than 30 
minutes after confirmation if confirmation occurs electronically or 
24 business hours after confirmation if confirmation does not occur 
electronically).
---------------------------------------------------------------------------

E. Centralized Risk Management Program

    Proposed Sec.  39.6(g)(2)(iii) requires the swap to be subject to a 
centralized risk management program that is ``reasonably designed to 
monitor and manage the risks associated with the swap.'' If at least 
one of the eligible affiliate counterparties is an SD or MSP, the 
centralized risk management requirement is satisfied by complying with 
the requirements of Sec.  23.600.\40\
---------------------------------------------------------------------------

    \40\ 17 CFR 23.600; Swap Dealer and Major Swap Participant 
Recordkeeping, Reporting, and Duties Rules; Futures Commission 
Merchant and Introducing Broker Conflict of Interest Rules; and 
Chief Compliance Officer Rules for Swap Dealers, Major Swap 
Participants, and Futures Commission Merchants, 77 FR 20128 (Apr. 2, 
2012).

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[[Page 21758]]

    Five commenters generally supported proposed Sec.  39.6(g)(2)(iii). 
AFR supported the proposed risk management program requirement and 
stated that dispensing with or weakening this condition, or any of the 
conditions, would heighten systemic risk and call into question the 
Commission's exemptive authority. Better Markets agreed that requiring 
a centralized risk management program was wholly appropriate and should 
be maintained as a requirement.
    Prudential and MetLife confirmed that both companies currently have 
centralized risk management programs and consider them to be consistent 
with current practice in the industry. Prudential noted that it 
structured its risk management system to allow only one affiliate to 
enter into swaps with third parties, which permits Prudential to impose 
a single credit limit on its market-facing counterparty relationships. 
MetLife's enterprise-wide risk management system provides all 
affiliates trading derivatives with affiliate-specific sets of 
guidelines and limits that are also included in enterprise-wide 
guidance and limits.
    Finally, CDEU expressed support for the centralized risk management 
program requirement, but requested that the Commission clarify that the 
level of risk management for inter-affiliate swaps not be interpreted 
as requiring the same level of risk management that end-users maintain 
for external third-party swaps. CDEU noted that most end users that use 
inter-affiliate swaps currently have robust centralized risk management 
programs in place to monitor all external swap risks and affiliates are 
required to follow group-wide risk polices. CDEU was supportive of the 
proposal so long as the requirement is interpreted reasonably and 
permits entities to ``implement risk policies and procedures 
appropriate to the risks of a corporate group's inter-affiliate 
swaps.''
    Four commenters objected to the proposed requirement, suggested 
alternatives, and/or requested clarification. FSR stated that the 
condition should be eliminated because integrated risk management 
systems ``are generally not established across international 
boundaries'' and are not consistent with general risk practices in 
large, multinational organizations. FSR suggested that the requirement 
be dropped in favor of each entity making ``its own evaluations of the 
risk associated with an inter-affiliate position.''
    Cravath stated that in many cases, for companies outside of the 
financial sector, the proposed rule will require a substantial change 
in the processes and procedures currently maintained by such companies, 
and the cost of complying with the risk management program requirements 
outweigh any benefits to the financial system. Cravath commented that 
rather than subject companies to a risk management rule, ``[c]ompanies 
should have the flexibility to engage in prudent risk management for 
their corporate group in a manner consistent with the overall level of 
risks to their business.''
    EEI suggested that the Commission eliminate the centralized risk 
management program requirement on the grounds that it would be 
duplicative for corporate groups that already have risk management 
programs in place. According to EEI, it is standard industry practice 
for both private and public companies to have a risk management 
program. EEI accordingly does not see a ``need to impose a separate, 
discrete regulatory requirement to document with an SDR or the 
Commission the existence of a centralized risk management program.'' If 
the Commission decides to retain the requirement, EEI requested that 
the Commission require a program be ``reasonably designed to monitor 
and manage the risks associated with the swap'' and provide the 
flexibility to design risk management programs that address the unique 
risks of an entity's business.
    The Working Group requested that the Commission clarify whether 
non-SDs and non-MSPs would be subject to the same enterprise-level risk 
management program as required for SDs and MSPs under Sec.  23.600. If 
the Commission intended to require the same level of risk management, 
The Working Group commented that there are ``a number of commercially 
and legally valid reasons'' why a centralized risk management program 
in accordance with Sec.  23.600 would be inconsistent with current 
industry practice. The Working Group cited cost as a reason companies 
do not provide for centralized risk management on different continents, 
in addition to antitrust and other regulatory reasons. The Working 
Group requested that the Commission clarify that the rule requires only 
that both counterparties be subject to a ``robust risk management 
program.''
    In response to comments, the Commission observes a general 
consensus that market participants have risk management policies and 
procedures in place, at least with regard to affiliates located in the 
same jurisdiction. FSR and The Working Group questioned whether 
entities have centralized risk management programs for affiliates in 
different jurisdictions and whether such cross-border risk management 
systems are prohibitively costly. In response to these comments, the 
Commission points to comments stating that inter-affiliate swaps play a 
critical role in an entity's overall management of risk and provide 
netting benefits among affiliates. Consequently, it stands to reason 
that inter-affiliate swaps between affiliates in different 
jurisdictions are as much a part of an entity's overall risk management 
framework as swaps between affiliates located in the same jurisdiction. 
The Commission does not believe that it would be prudent business 
practice for affiliates to enter into inter-affiliate swaps without 
risk management systems integrated across international boundaries to 
the extent that the entity permits affiliates across jurisdictions to 
enter into swaps with one another.
    In response to comments asking that the Commission clarify the 
level of risk management required for non-SDs and non-MSPs, the 
Commission confirms that the requirements of proposed Sec.  
39.6(g)(2)(iii) (now Sec.  50.52(b)(3)) are intended to be flexible and 
do not require the same level of policies and procedures as required 
under Sec.  23.600 for SDs and MSPs. Under the rule, a company is free 
to structure its centralized risk management program according to its 
unique needs, provided that the program reasonably monitors and manages 
the risks associated with its uncleared inter-affiliate swaps. In all 
likelihood, if a corporate group has a centralized risk management 
program in place that reasonably monitors and manages the risk 
associated with its inter-affiliate swaps as part of current industry 
practice, it is likely that the program would fulfill the requirements 
of proposed Sec.  39.6(g)(2)(iii) (now Sec.  50.52(b)(3)).
    The Commission did not receive comments regarding the requirement 
that SD and MSP affiliates must comply with Sec.  23.600.\41\ The 
Commission is adopting that provision of the rule as proposed.
---------------------------------------------------------------------------

    \41\ 17 CFR 23.600(c)(1)(ii) (``The Risk Management Program 
shall take into account risks posed by affiliates and the Risk 
Management Program shall be integrated into risk management at the 
consolidated entity level.'').
---------------------------------------------------------------------------

    Given that a number of commenters stated that it is common practice 
for market participants, including end users, to have risk management 
programs in place, the Commission is not persuaded by Cravath's comment 
that the rule will require a substantial change in the processes and 
procedures currently maintained by companies to manage risk. 
Accordingly, costs will be

[[Page 21759]]

limited where an entity only needs to make modifications to existing 
risk management programs. Moreover, a corporate group may not have to 
incur any costs if it already has a risk management system that meets 
the requirements of the inter-affiliate exemption in place.

F. Variation Margin

    Proposed Sec.  39.6(g)(2)(iv) required that variation margin be 
collected for swaps between affiliates that are financial entities, in 
compliance with the proposed variation margin requirements in proposed 
Sec.  39.6(g)(3).\42\ The rule further proposed an exception to the 
variation margin requirement for 100% commonly-owned and commonly-
guaranteed affiliates, provided that the common guarantor is under 100% 
common ownership.
---------------------------------------------------------------------------

    \42\ The Commission also requested comments on, among other 
things, whether the Commission should promulgate regulations that 
set forth minimum standards for initial margin for inter-affiliate 
swaps.
---------------------------------------------------------------------------

    Some commenters expressed support for the proposed variation margin 
requirement. Prudential commented that it did not take issue with the 
variation margin requirement, but noted that variation margin may not 
be appropriate or required in every circumstance.\43\ Prudential also 
commented that the Commission should not impose initial margin 
requirements for the inter-affiliate exemption.\44\ Chris Barnard 
agreed that the Commission should require the exchange of variation 
margin for financial entities and noted that the exchange of variation 
margin is consistent with the key principles proposed by the Basel 
Committee on Banking Supervision (BCBS) and the Board of the 
International Organization of Securities Commissions (IOSCO).\45\ 
Better Markets expressed support for the variation margin requirement 
and commented that it should be expanded to non-financial entities.\46\ 
AFR expressed support for the variation margin proposal. Both Better 
Markets and AFR also expressed support for the requirement that 
affiliates post initial margin for inter-affiliate swaps subject to the 
exemption.\47\
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    \43\ Prudential also commented that there is ``no less costly 
risk-management tool'' than variation margin.
    \44\ MetLife also commented that the Commission should not 
impose initial margin requirements for the inter-affiliate 
exemption.
    \45\ See Margin Requirements for Non-Centrally-Cleared 
Derivatives, Consultative Report (July 2012), available at http://www.bis.org/publ/bcbs226.pdf.
    \46\ Better Markets also suggested that the Commission ban the 
rehypothecation of collateral.
    \47\ Better Markets commented that initial margin should be 
required because initial margin is the true ``statistical estimate 
of the potential consequences of a default'' and that variation 
margin is merely the ``daily recalibration'' of the risk estimation 
of initial margin.
---------------------------------------------------------------------------

    Several commenters stated that the proposed variation margin 
requirement for swaps between affiliates that are financial entities is 
not necessary and should not be a condition of the inter-affiliate 
exemption to clearing.\48\ ISDA & SIFMA commented that the benefits of 
variation margin for inter-affiliate swaps are ``tenuous'' because the 
third party to a swap is exposed to the credit risk of the entire group 
not just the specific affiliate with which it enters into a swap. ISDA 
& SIFMA maintain that it is not necessary to protect group entities 
from the credit risk of other group entities because group management 
possesses the tools needed to resolve potential defaults within the 
group. According to ISDA & SIFMA, the Commission can fully achieve its 
regulatory mandate to protect third-party swap counterparties through 
the application of the clearing requirement to those outward-facing 
swaps that are subject to the Commission's regulation, as well as 
regulation of those group entities whose outward-facing swap activities 
are sufficiently large to subject them to SD and MSP registration.\49\
---------------------------------------------------------------------------

    \48\ Cravath commented that variation margin requirements ``tie 
up capital that could otherwise be used for investment purposes to 
create jobs and goods and services for the economy.'' MetLife 
commented that while it is subject to variation margin under state 
insurance law, MetLife believes that the Commission should eliminate 
the variation margin requirement for 100%-owned affiliates and 
should not require ``inter-affiliate guarantees.'' DLA Piper also 
urged the Commission to provide corporate groups with legal 
certainty that no margin requirements will be imposed on any inter-
company swaps.
    \49\ ISDA & SIFMA claimed that the additional liquidity demands 
resulting from variation margin will distort the group's risk 
management choices. ISDA & SIFMA further claimed that while they 
have previously stated that inter-affiliate margin occurs 
``routinely,'' this does not mean that it occurs ``uniformly'' or 
that imposing variation margin would not increase cost.
---------------------------------------------------------------------------

    FSR commented that affiliates should be required to post margin 
only in instances where their primary regulator imposes such a 
requirement for affiliate transactions.\50\ FSR states that requiring 
variation margin for inter-affiliate swaps involving non-bank financial 
entities will limit the ability of companies to efficiently allocate 
risk among affiliates and manage risk centrally.\51\ FSR further 
commented that initial margin should not be required between 
affiliates, and requested that the Commission clarify that the 
exemption does not require the exchange of initial margin between 
affiliates.
---------------------------------------------------------------------------

    \50\ Citing to sections 23A and 23B of the Federal Reserve Act 
and Regulation W as well as public utility, insurance, and 
investment company law, FSR commented that a number of regulated 
entities may be subject to various restrictions on affiliate 
transactions and that for purposes of the inter-affiliate exemption, 
margin requirements should only apply ``to the extent other 
applicable law . . . imposes such restrictions on affiliate 
transactions.'' FSR also points out that subsidiaries of banks are 
``generally not treated as `affiliates' '' within the restrictions 
of sections 23A and 23B of the Federal Reserve Act.
    \51\ FSR further requested that the Commission clarify that to 
the extent that financial entities are required, through credit 
support arrangements with their affiliates, to have minimum transfer 
amounts, thresholds, and other similar arrangements in place, that 
such arrangements would be permitted in connection with inter-
affiliate swaps relying on the inter-affiliate exemption.
---------------------------------------------------------------------------

    CDEU commented that the Commission should not require variation 
margin, or initial margin, with respect to inter-affiliate swaps 
between end-user affiliates. According to CDEU, while margin 
requirements may serve as a risk-management tool for market-facing 
swaps, inter-affiliate swaps do not increase counterparty credit risk 
or contribute to interconnectedness among market participants. CDEU 
stated that a number of specific entities, including banks and 
insurance companies, already post variation margin for inter-affiliate 
swaps, largely because of prudential requirements, and that applying 
variation margin requirement to these entities is unnecessary.\52\ CDEU 
requested that if the Commission retains the variation margin 
requirement, that it limit the exchange of variation margin to SDs and 
MSPs, and that the requirement should not apply to entities that are 
considered ``financial entities.''
---------------------------------------------------------------------------

    \52\ Moreover, CDEU claims that many inter-affiliate swaps 
between end-user corporate groups are not subject to variation 
margin requirements, and that these entities likely will not have 
the liquidity to exchange variation margin, and would likely be 
required to borrow the money from the centralized hedging unit with 
which it is entering the internal swap. Such an arrangement, 
according to CDEU, would transfer the loan back to the centralized 
hedging unit and effectively eliminate any perceived benefit from 
the exchange of variation margin.
---------------------------------------------------------------------------

    With respect to the proposed common guarantor exception to the 
variation margin requirement, ISDA & SIFMA commented that the 
Commission has not provided adequate rationale for requiring a common 
guarantor as a condition for exempting group members from the proposed 
variation margin requirement, nor has the Commission made it clear 
which obligations must be guaranteed. ISDA & SIFMA requested that the 
Commission further clarify the guarantee exception in proposed Sec.  
39.6(g)(2)(iv), including to clarify that it includes ``direct or 
indirect'' ownership, and that swaps between the

[[Page 21760]]

common guarantor and its affiliates are eligible for the exception.\53\
---------------------------------------------------------------------------

    \53\ ISDA requested that the Commission clarify that the 
shareholders of a publicly-owned holding company are the common 
owners and that its 100% owned subsidiaries meet the definition of 
``100% commonly owned,'' and further stated that the Commission 
should address the consequences of a guarantee of a swap being 
considered a swap itself.
---------------------------------------------------------------------------

    CDEU commented that the Commission should not limit the guarantee 
exception to 100% commonly-owned affiliates and should allow the 
exception for majority-owned affiliates. CDEU requested that the 
Commission clarify that only the related market-facing swaps with third 
parties are required to be guaranteed by the common owner or parent. 
CDEU suggested that the Commission clarify that the parent company has 
the option to act as the guarantor of the transactions.
    FSR commented that the variation margin requirement should not 
apply to 100% commonly-owned affiliates even if they do not have a 
common guarantor that is under 100% common ownership. According to FSR, 
the 100% common ownership requirement creates sufficient alignment of 
interests between swap counterparties and places the risk of the swap 
on the ultimate parent entity, and thus, the exchange of variation 
margin would do little to mitigate intercompany risk.
    MetLife and Prudential commented that inter-affiliate swaps should 
not be commonly guaranteed by a 100% wholly-owned affiliate in order to 
be exempt from the variation margin requirement. Specifically, MetLife 
stated that the Commission should not require guarantees or explicit 
credit support as a condition for an exception from the variation 
margin requirement and should rely instead on the direct or indirect 
common ownership requirement. Both MetLife and Prudential stated that 
the corporate group of 100% wholly owned affiliates should be able to 
decide whether internal swaps need to be guaranteed by an affiliate.
    After considering the comments submitted in response to the 
proposed variation margin requirement, the Commission is determining 
not to require variation or initial margin as a condition for electing 
the inter-affiliate exemption. In so doing, the Commission was guided 
by comments expressing concern that a variation margin requirement will 
limit the ability of U.S. companies to efficiently allocate risk among 
affiliates and manage risk centrally. Notwithstanding the Commission's 
determination not to impose variation margin as a condition of the 
inter-affiliate exemption, the Commission is encouraged by comments 
noting that many companies already exchange variation margin, and 
agrees with commenters that collateralizing risk exposure with respect 
to any swaps, including inter-affiliate swaps, is critical, and 
encourages market participants to do so as a matter of sound business 
practice.

G. Treatment of Outward-Facing Swaps and Relief

    Proposed Sec.  39.6(g)(2)(v) provided that eligible affiliate 
counterparties to a swap may elect the inter-affiliate exemption from 
clearing provided that each affiliate counterparty either: (i) Is 
located in the United States; (ii) is located in a jurisdiction with a 
clearing requirement that is comparable and comprehensive to the 
clearing requirement in the United States; (iii) is required to clear 
swaps with non-affiliated parties in compliance with U.S. law; or (iv) 
does not enter into swaps with non-affiliated parties.\54\
---------------------------------------------------------------------------

    \54\ In this release, the requirements of proposed Sec.  
39.6(g)(2)(v), which are now being adopted in new Sec.  50.52(b)(4), 
are referred to as the ``treatment of outward-facing swaps 
condition.''
---------------------------------------------------------------------------

    The Commission received several comments both in support of and in 
opposition to various aspects of the conditions related to the 
treatment of outward-facing swaps in proposed Sec.  39.6(g)(2)(v). The 
Commission has considered each of the comments and has determined to 
adopt the treatment of outward-facing swaps conditions of the inter-
affiliate exemption, with certain modifications described below, 
because such conditions are necessary to prevent evasion of the 
clearing requirement and to help protect the U.S. financial markets. 
The remainder of this Section II.G describes the comments received in 
response to proposed Sec.  39.6(g)(2)(v) (now Sec.  50.52(b)(4)), along 
with the Commission's responses and clarifications with respect to 
those comments.
1. Basis for the Cross-border Conditions
    While recognizing the benefits of exempting certain inter-affiliate 
transactions from the clearing requirement, in the NPRM, the Commission 
described two separate grounds for proposing the treatment of outward-
facing swaps condition to the inter-affiliate exemption. First, the 
Commission explained that an inter-affiliate exemption from required 
clearing could enable entities to evade the clearing requirement 
through trades with affiliates that are located in foreign 
jurisdictions that do not have a comparable and comprehensive clearing 
regime. In addition, the Commission noted in the NPRM that uncleared 
inter-affiliate swaps may pose risk to other market participants, and 
therefore, the financial system if the affiliate enters into swaps with 
third parties that are related on a back-to-back or matched book basis 
with inter-affiliate swaps.
    In support of the proposed treatment of outward-facing swaps 
conditions, AFR stated that inter-affiliate swaps could, without 
appropriate restrictions, bring risk back to the U.S. from foreign 
affiliates. AFR commented that an inter-affiliate swap might be used to 
move parts of the U.S. swaps market outside of U.S. regulatory 
oversight by transferring risk to jurisdictions with little or no 
regulatory oversight, whereby a non-U.S. affiliate of a U.S. entity 
could enter into an outward-facing swap. AFR stated that an inter-
affiliate swap could contribute to financial contagion across different 
groups within a complex financial institution, making it more difficult 
to ``ring-fence'' risks in one part of an organization. AFR further 
commented that laws and regulations of a foreign country might prevent 
U.S. counterparties to swaps from having access to the financial 
resources of an affiliate in the event of a bankruptcy or 
insolvency.\55\ The inability of an affiliate to access resources in 
other jurisdictions, according to AFR, may threaten the ability of U.S. 
creditors to retrieve assets and may put U.S. taxpayers at risk.\56\ 
Better Markets also

[[Page 21761]]

supported the proposed treatment of outward-facing swaps condition.\57\
---------------------------------------------------------------------------

    \55\ AFR suggested that the Commission consult with the U.S. 
banking agencies, such as the FDIC, regarding the potential issues 
relating to bankruptcy of non-U.S. affiliates. As noted above, the 
Commission has consulted with both U.S. and international 
authorities in preparing this adopting release. In response to AFR's 
comments pertaining to the limitations of foreign bankruptcy laws, 
the Commission notes that the specific bankruptcy limitations 
attendant to U.S. counterparties with respect to their non-U.S. 
affiliates are outside the scope of this rulemaking. The Commission 
further notes that the conditions imposed by the rules being adopted 
in this release, in large part, are aimed at ensuring that the 
benefits of central clearing, particularly with respect to 
counterparty and systemic risk mitigation, are maintained with 
respect to inter-affiliate swaps involving non-U.S. affiliates. 
Specifically, the Commission believes that the conditions imposed by 
the rules being adopted in this release will help to mitigate 
potential issues that could arise in uncleared inter-affiliate swaps 
when financial solvency is not an issue for the corporate 
enterprise. Furthermore, these conditions may, to some extent, 
diminish the impact of swaps in transmitting losses across 
affiliates, and in turn, to third-party creditors, following a 
default.
    \56\ AFR also noted restrictions under U.S. banking law with 
respect to the transfer of risk from non-depository to depository 
institutions, and stated that it may be necessary to require ``ring-
fencing'' and separate capitalization of swaps affiliates. The 
Commission believes that these issues are outside of the scope of 
this rulemaking, and as AFR correctly noted, may be an issue that is 
more appropriate for the prudential regulators of such entities to 
consider.
    \57\ Prudential also commented that in relation to its own 
structure, it did not have concerns with the proposed cross-border 
conditions applicable to inter-affiliate swaps involving foreign 
affiliates.
---------------------------------------------------------------------------

    By contrast, ISDA & SIFMA, The Working Group, and CDEU all stated 
that the treatment of outward-facing swaps condition of the proposed 
rule is not necessary or appropriate and that the Commission should 
eliminate it altogether. FSR commented that the inter-affiliate 
exemption should extend to swaps between non-U.S. affiliates, such that 
the swaps should not be subject to mandatory clearing or margin 
requirements, even if the affiliated parties are financial entities.
    Certain commenters stated that the proposed treatment of outward-
facing swaps condition is not necessary to prevent evasion. ISDA & 
SIFMA noted that the Commission's existing anti-evasion authority \58\ 
can address the anti-evasion objectives of the proposed condition, and 
the CDEU made a similar argument with respect to the Commission's new 
anti-evasion authority under section 721(c) of the Dodd-Frank Act. ISDA 
& SIFMA further noted that the Commission should limit application of 
its anti-evasion authority to instances where a foreign affiliate 
engages in a pattern of back-to-back swaps with the U.S. affiliate and 
where neither the affiliates nor the third-party counterparty are 
subject to capital regulation.\59\
---------------------------------------------------------------------------

    \58\ See e.g., Section 2(i)(2) of the CEA (providing authority 
to promulgate rules addressing activities outside of the U.S. to 
prevent evasion of the Dodd-Frank Act); section 2(h)(4) of the CEA 
(requiring the Commission to issue rules to prevent evasion of the 
mandatory clearing requirement); section 721(c) of the Dodd-Frank 
Act (requiring the Commission to promulgate a rule defining certain 
terms to prevent evasion of the Dodd-Frank Act).
    \59\ Entities that are subject to capital regulations include 
SDs, MSPs, and banking entities subject to prudential regulation.
---------------------------------------------------------------------------

    Other commenters opposed the proposed treatment of outward-facing 
swaps condition based on their view that inter-affiliate swaps 
involving non-U.S. affiliates do not pose a risk to the U.S. financial 
markets. CDEU commented that the proposed ``comparable and 
comprehensive'' condition is not necessary or appropriate to reduce 
risk and prevent evasion because, according to CDEU, transactions 
between affiliates do not increase systemic risk, regardless of the 
location of the affiliate.\60\ ISDA & SIFMA stated that the concern 
that foreign inter-affiliate swaps pose risk to the U.S. financial 
system is unfounded because internal swaps have no conclusive effect on 
systemic risk.\61\
---------------------------------------------------------------------------

    \60\ CDEU further stated that inter-affiliate swaps do not 
create systemic risk.
    \61\ Prudential also stated that it does not believe that there 
are any additional risk implications of cross-border inter-affiliate 
swaps for the U.S. market, to the extent that the market-facing 
entity is located in the U.S.
---------------------------------------------------------------------------

    The Commission has considered these comments, and for the reasons 
described below, has determined to retain the treatment of outward-
facing swaps condition to the inter-affiliate exemption, with certain 
modifications and amendments, in order to address comments and provide 
greater clarity.
i. Prevention of Evasion
    As an initial matter, as discussed above, the Commission believes 
that the benefits of inter-affiliate swaps for entities in affiliated 
groups warrant the Commission's use of its exemptive authority under 
section 4(c) of the Act to exclude certain inter-affiliate swaps from 
the clearing requirement. However, the Commission must exercise its 
exemptive authority in view of the Commission's charge under the CEA to 
prevent evasion of the clearing requirement.\62\ The Commission remains 
concerned that absent the treatment of outward-facing swaps condition, 
the inter-affiliate exemption from clearing may create a ready means 
through which some U.S. entities may be able to evade the clearing 
requirement. Accordingly, the Commission believes that the treatment of 
outward-facing swaps condition to the inter-affiliate clearing 
exemption is necessary to address the potential for evasion.
---------------------------------------------------------------------------

    \62\ See sections 2(h)(4) and 2(i)(2) of the CEA.
---------------------------------------------------------------------------

    Section 2(h)(4)(A) of the CEA requires that ``the Commission shall 
prescribe rules * * * as determined by the Commission to be necessary 
to prevent evasions of the clearing requirement under this Act.'' \63\ 
As the Commission explained in the NPRM, and as AFR also described in 
its comments, a broad inter-affiliate exemption from the clearing 
requirement could enable entities to evade the clearing requirement 
potentially through third-party trades with their foreign affiliates 
that are located in jurisdictions that do not have a clearing regime 
that is comparable to, or as comprehensive as, the Commission's 
clearing requirement. For example, rather than execute a swap opposite 
a U.S. counterparty, which would be subject to the clearing 
requirements of section 2(h) of the Act, a U.S. entity could execute an 
uncleared swap with its foreign affiliate or subsidiary, which could 
then execute a swap with a non-affiliated third-party in a jurisdiction 
that is either unregulated or does not have a clearing requirement that 
is comparable to or as comprehensive as the U.S. clearing requirement.
---------------------------------------------------------------------------

    \63\ 7 U.S.C. 2(h)(4).
---------------------------------------------------------------------------

    The Commission disagrees with commenters that suggest that the 
treatment of outward-facing swaps condition is not necessary to deter 
evasion because the Commission can rely on its general anti-evasion 
authority under the CEA or under section 721(c) of the Dodd-Frank Act 
to address the Commission's evasion concerns pertaining to the inter-
affiliate exemption. The Commission notes that section 2(h)(4)(A) of 
the CEA specifically imposes an obligation on the part of the 
Commission to ``prescribe rules'' and ``issue interpretations of 
rules'' that are necessary to prevent evasions of the clearing 
requirement.\64\ Furthermore, from an enforcement perspective, a 
specific regulation provides more transparency to market participants 
with respect to the Commission's enforcement program. While the 
Commission has ample general authority to prevent evasion of the CEA 
and the swaps-related provisions of the Dodd-Frank Act, the Commission 
believes it is appropriate to impose the treatment of outward-facing 
swaps condition to the inter-affiliate exemption to prevent evasion of 
the clearing requirement.
---------------------------------------------------------------------------

    \64\ Under the authority of sections 2(h)(4)(A), 2(h)(7)(F), and 
8a(5) of the CEA, the Commission recently adopted Sec.  50.10 to 
prohibit evasions of the requirements of section 2(h) of the CEA, 
including the end-user exception or any other exception or exemption 
that the Commission may provide by rule, regulation, or order. See 
Clearing Requirement Determination at 74317-19.
---------------------------------------------------------------------------

    In response to ISDA & SIFMA's claim that anti-evasion authority 
should only be applied in limited scenarios where there are back-to-
back trades involving affiliates and non-affiliates who are not subject 
to capital requirements, the Commission declines to pre-judge the 
potential incentives or ways of evading, or complying with, the 
Commission's clearing requirement and the inter-affiliate exemption 
from clearing. To the extent that ISDA & SIFMA suggest that the 
treatment of outward-facing swaps condition should be limited to 
transactions involving back-to-back trades where the affiliates and the 
respective third-party are subject to capital requirements, the 
Commission is not persuaded that the rule should be so narrowly 
tailored to address only the scenario ISDA & SIFMA describe. In 
particular, the Commission notes that back-to-back transactions may not 
serve as the only potential means by which

[[Page 21762]]

affiliates can evade the U.S. clearing mandate, and for that matter, 
transfer risk to one another. Accordingly, the Commission does not 
believe that the treatment of outward-facing swaps condition should be 
limited to the specific circumstances described by ISDA & SIFMA.
ii. Protection of Financial Markets
    In addition to preventing evasion, the Commission believes that the 
treatment of outward-facing swaps condition will help to limit the 
potential transfer of risks to U.S. companies and financial markets 
that may result from third-party swaps between affiliates and non-
affiliated entities domiciled in jurisdictions that do not regulate 
swaps or where the regulation is not comparable to, or as comprehensive 
as, the CEA and Commission regulations. As described in the preceding 
sections of this adopting release, there are numerous benefits 
associated with central clearing of swaps. In particular, clearing 
mitigates counterparty credit risk, provides an organized mechanism for 
collateralizing the risk exposures posed by swaps, and when applied on 
a market-wide scale, clearing reduces systemic risk. The counterparty 
and systemic risk mitigation benefits of central clearing are also 
realized from clearing transactions between affiliates.
    The benefits of clearing notwithstanding, the Commission recognized 
in the NPRM, commenters' assertions that there is less counterparty 
risk associated with inter-affiliate swaps than with swaps between 
third parties to the extent that the affiliated counterparties that are 
members of the same corporate group internalize each other's 
counterparty credit risk.\65\ While the Commission recognizes, 
generally, the benefits of inter-affiliate swaps and the incentives for 
inter-affiliates to fulfill their inter-affiliate swap obligations to 
each other, these swaps are not immune from some of the risks that are 
associated with swaps between non-affiliated parties.
---------------------------------------------------------------------------

    \65\ See NPRM at 50427.
---------------------------------------------------------------------------

    In particular, the Commission is not persuaded that inter-affiliate 
swaps, and swaps between affiliate counterparties outside the U.S. and 
non-affiliated counterparties, pose no risks to the U.S financial 
markets or that central clearing would not mitigate the risks 
associated with such swaps. To the contrary, the counterparty and 
systemic risks associated with inter-affiliate swaps are heightened 
where, for example, the inter-affiliate transaction involves an 
uncleared swap with a foreign affiliate counterparty that is 
subsequently hedged with a third-party uncleared swap. Thus, the 
Commission disagrees with commenters that suggested that inter-
affiliate swaps involving foreign affiliates do not have the potential 
to create systemic risk. As the Commission noted in the NPRM, systemic 
risk implications may be present where the foreign affiliate has large 
inter-affiliate swap positions and enters into related outward-facing 
swaps. If the foreign affiliate defaults on its obligations arising 
from the inter-affiliate swaps, it then increases the likelihood that 
the foreign affiliate could default on the outward-facing swaps, 
potentially jeopardizing the financial integrity of the third-party 
counterparty. Furthermore, to the extent that a foreign affiliate 
enters into both inter-affiliate swaps and related third-party swaps, 
any losses incurred by the foreign affiliate with respect to its inter-
affiliate swaps may flow not only to the unaffiliated third-party 
counterparty, but conceivably, to the broader financial system.\66\
---------------------------------------------------------------------------

    \66\ In the Proposed Cross-Border Interpretive Guidance, the 
Commission specifically discussed the flow of risk to the U.S. by 
entities that facilitate a U.S. person's ability to execute swaps 
outside the Dodd-Frank Act regulatory regime. 77 FR 41228-29, 41234.
---------------------------------------------------------------------------

    Moreover, the Commission notes AFR's comment that inter-affiliate 
swaps can, in some circumstances, contribute to financial contagion 
across different groups within a complex financial institution, making 
it more difficult to contain risks in one part of an organization. As 
evidenced by the events surrounding the 2008 financial crisis, many 
large financial institutions are interconnected and highly inter-
dependent, with affiliated legal entities that are inextricably linked 
to each other.\67\ The interconnected nature of corporate groups, 
therefore, increases the potential that risk in any part of a corporate 
group may spread throughout the organization, jeopardizing the 
financial integrity of not only the U.S affiliate, but depending on the 
scope of a potential default, the broader financial system.
---------------------------------------------------------------------------

    \67\ For a discussion of specific institutional risks leading up 
to the 2008 financial crisis, see Proposed Cross-Border Interpretive 
Guidance at 41215-16.
---------------------------------------------------------------------------

    For the aforementioned reasons, the Commission believes that the 
risk of evasion of U.S. laws and the potential systemic risk associated 
with uncleared inter-affiliate swaps involving foreign affiliates 
necessitates that the inter-affiliate exemption include the treatment 
of outward-facing swaps condition.
    The treatment of outward-facing swaps condition that is being 
adopted as part of the inter-affiliate clearing exemption in this final 
release is aimed at addressing the potential risks associated with an 
eligible foreign affiliate's swaps with non-affiliated counterparties. 
As modified, the final rule requires that, as a condition to the inter-
affiliate exemption, each eligible affiliate counterparty must clear 
all swaps that it enters into with an unaffiliated counterparty to the 
extent that the swap is included in the Commission's clearing 
requirement, i.e., in a class of swaps identified in Sec.  50.4.\68\ In 
order to satisfy this requirement, eligible affiliate counterparties 
must clear their third-party swaps pursuant to the Commission's 
clearing requirement or comply with the requirements for clearing the 
swap under a foreign jurisdiction's clearing mandate that is 
comparable, and comprehensive but not necessarily identical, to the 
clearing requirement of section 2(h) of the Act and part 50 of the 
Commission's regulations, as determined by the Commission. In addition, 
the Commission is modifying the inter-affiliate exemption to allow for 
recognition of clearing exceptions and exemptions under the CEA and an 
exception or exemption under a foreign clearing mandate provided that 
the foreign jurisdiction's clearing mandate is comparable, and 
comprehensive but not necessarily identical, to the clearing 
requirement of section 2(h) of the Act and part 50 and the foreign 
jurisdiction's exception or exemption is comparable to an exception or 
exemption under the CEA or part 50, in each instance as determined by 
the Commission.
---------------------------------------------------------------------------

    \68\ Currently, the scope of the Commission's clearing 
requirement is limited to four classes of interest rate swaps and 
two classes of CDS.
---------------------------------------------------------------------------

    For eligible affiliate counterparties that are not located in the 
U.S. or in a comparable foreign jurisdiction, as determined by the 
Commission, the rule permits such eligible affiliates to clear any 
outward-facing swap that is required to be cleared under Sec.  50.4 
through a registered DCO or a clearing organization that is subject to 
supervision by appropriate government authorities in the home country 
of the clearing organization and has been assessed to be in compliance 
with the Principles for Financial Market Infrastructures (PFMIs).\69\
---------------------------------------------------------------------------

    \69\ See Principles for Financial Market Infrastructures, April 
2012, available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf.
---------------------------------------------------------------------------

    The Commission believes that this modified formulation of the 
treatment of outward-facing swaps condition being adopted as part of 
the final rule will

[[Page 21763]]

more clearly establish the conditions to the exemption and alternative 
methods by which eligible affiliates may satisfy the requirements.
    Moreover, in finalizing the requirement that eligible affiliate 
counterparties clear their swaps with unaffiliated counterparties, the 
Commission considered the approach adopted in EMIR. Articles 3, 4, and 
13 of EMIR generally exempt from clearing OTC derivatives transactions 
between intragroup counterparties, where one counterparty is located in 
the European Union and the other counterparty is located outside the 
European Union, provided that, among other things, the European 
Commission determines that the foreign counterparty is established in a 
country with ``equivalent'' requirements to EMIR.\70\ By requiring that 
a foreign counterparty to an intragroup transaction be located in a 
country with equivalent requirements to EMIR, including clearing, any 
third-party swaps entered into by either the European Union 
counterparty or the non-European Union counterparty would be subject to 
a clearing requirement under EMIR or one that is equivalent to that 
required under EMIR, respectively.
---------------------------------------------------------------------------

    \70\ See EMIR Article 13(1)-(3). The European Union has yet to 
make determinations as to whether third countries have equivalent 
requirements to EMIR. The European Commission (EC) has instructed 
the European Securities and Markets Authority (ESMA) to prepare 
possible implementing acts concerning the equivalence between the 
legal and supervisory frameworks of certain third countries and 
EMIR. Pursuant to the EC's instructions, ESMA must make its 
determination regarding the United States' clearing requirement by 
March 15, 2013. ``Formal Request to ESMA for Technical Advice on 
Possible Implementing Acts Concerning Regulation 648/2012 on OTC 
Derivatives, Central Counterparties and Trade Repositories (EMIR)'' 
available at http://www.esma.europa.eu/system/files/formal_request_for_technical_advice_on_equivalence.pdf.
---------------------------------------------------------------------------

    In addition to the modifications to the treatment of outward-facing 
swaps condition described above, the Commission also is providing a 
transition period with alternative compliance frameworks, in response 
to concerns raised by commenters pertaining to the timing and 
sequencing of the implementation of the inter-affiliate exemption, 
which are discussed below.
2. Time-limited Alternative Compliance Frameworks
    A number of commenters expressed concern with respect to the 
``comparable and comprehensive'' requirement of the proposed rule. 
Several commenters expressed concern with respect to the timing and 
sequencing of the Commission's comparability determination in relation 
to the expected compliance date for the initial clearing requirement 
under section 2(h) of the Act.\71\ These commenters noted that the 
comparability requirement is dependent upon the adoption of clearing 
regimes by other jurisdictions, and that because the U.S. clearing 
requirement is likely to take effect in advance of other jurisdictions 
adopting or finalizing their clearing regimes, non-U.S. affiliates 
effectively will not be able to rely on the inter-affiliate exemption 
from clearing when the Commission's initial clearing requirement takes 
effect. Significantly, ISDA & SIFMA commented that the cross-border 
condition may prove to be unnecessary because it is expected that the 
major financial jurisdictions will implement their own clearing 
regimes. However, ISDA & SIFMA and CDEU noted that questions of timing 
and criteria for comparability render the proposed treatment of 
outward-facing swaps condition problematic, and that unless the 
condition is satisfactorily resolved, the condition could hamper the 
ability of U.S.-based groups to compete in foreign markets. ISDA & 
SIFMA further commented that if the Commission retains the cross-border 
requirements, the Commission should provide an appropriate transition 
period in order to allow foreign jurisdictions to implement their own 
G-20 mandates.
---------------------------------------------------------------------------

    \71\ See Clearing Requirement at 74319-21 (discussing the 
compliance dates for the first clearing requirement determination).
---------------------------------------------------------------------------

    The Working Group commented that because no other jurisdiction has 
a comparable clearing requirement,\72\ the proposed rule would impose 
an obligation on almost all non-U.S. persons to comply with the U.S. 
clearing requirement in the event such entities wanted to engage in a 
non-hedge swap that was subject to mandatory clearing with a U.S. 
person affiliate. The Working Group claimed that this limitation would 
render the exemption unusable and questioned the public policy benefit 
of extending the clearing requirement in such instances. The Working 
Group further commented that the proposed rule represents a broad 
extension of U.S. law by, in effect, imposing the clearing requirement 
under section 2(h)(1)(A) on non-U.S. persons that enter into swaps with 
U.S. person affiliates in order to satisfy the conditions of the inter-
affiliate exemption. AFR supported the comparability condition and 
suggested that the Commission should grant the inter-affiliate 
exemption only with respect to foreign affiliate swaps once foreign 
jurisdictions finalize and implement their own clearing requirements.
---------------------------------------------------------------------------

    \72\ This assertion is no longer accurate. As discussed below, 
Japan has adopted a clearing mandate for certain interest rate swaps 
and CDS.
---------------------------------------------------------------------------

    The Commission recognizes commenters' concerns pertaining to the 
timing and sequencing of the inter-affiliate exemption in light of the 
Commission's clearing requirement, and in view of the ongoing progress 
of other jurisdictions to adopt and implement their respective clearing 
regimes. Accordingly, the Commission has determined to modify the 
proposed rule, as described in this release.
    As an initial matter, and informed in large part by the reports of 
relevant international organizations and ongoing dialogue with 
international regulators, the Commission believes that many 
jurisdictions have made significant progress in implementing their 
clearing regimes. It is the Commission's understanding that the G-20 
Leaders reaffirmed their commitment that all standardized OTC 
derivatives should be cleared through central counterparties by end-
2012.\73\ Importantly, the majority of G-20 members with major 
financial markets have been preparing for mandatory clearing, and 
significant steps towards further implementation have been taken by the 
United States, Japan, Singapore, and the European Union. In Japan, for 
example, the Japanese Financial Services Authority (JFSA) cabinet 
office ordinance regarding central counterparties and trade 
repositories which, among other things, subjects certain transactions 
to mandatory central clearing, became effective on November 1, 2012. 
The JFSA initially requires certain financial institutions to clear 
yen-denominated interest rate swaps that reference Yen-LIBOR, and CDS 
based on the Japanese iTraxx indices at a licensed CCP.
---------------------------------------------------------------------------

    \73\ ``G20 Leaders Declaration Los Cabos Mexico'' (June 18-19, 
2012) at paragraph 39. According to the October 2012 Report of the 
Financial Stability Board (FSB), 10 out of the 19 members of the G-
20 group have either proposed or adopted legislation and/or 
regulations to implement their clearing framework, as of the date of 
that release. FSB, OTC Derivatives Market Reforms: Fourth Progress 
Report on Implementation, Oct. 31, 2012 at 74-77, available at 
https://www.financialstabilityboard.org/publications/r_121031a.pdf.
---------------------------------------------------------------------------

    On November 15, 2012, the Singapore Parliament passed the 
Securities and Futures (Amendment) Bill 2012 to amend the Singapore 
Securities and Futures Act (SFA). This bill puts in place the 
regulatory regime for OTC derivatives in Singapore. This legislation 
institutes mandatory reporting and clearing requirements for financial 
entities and large non-financial entities. The Monetary Authority of

[[Page 21764]]

Singapore is deliberating how to implement these legislative 
requirements and is expected to issue further consultation in 2013.
    In the European Union, EMIR entered into force on August 16, 2012, 
and requires the clearing of all OTC derivatives subject to the 
clearing obligation. Clearing determinations are made at the initiative 
of the national authorities or the European Securities and Markets 
Authority (ESMA). Within six months of ESMA receiving notification by a 
national authority that a central counterparty has been authorized to 
clear a class of OTC derivatives, ESMA must determine whether that the 
class of OTC derivatives should be subject to the clearing obligation. 
At its own initiative, ESMA can also identify classes of OTC 
derivatives that should be subject to the clearing obligation. 
Additional details regarding the specific manner in which clearing 
determinations will be made have been set forth in implementing 
regulations adopted by the European Commission on December 19, 
2012.\74\
---------------------------------------------------------------------------

    \74\ See http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm.
---------------------------------------------------------------------------

    As evidenced by the progress of these jurisdictions, and others 
that host major financial markets across the world in implementing 
their clearing frameworks, the Commission agrees with ISDA & SIFMA that 
the comparability requirement of the inter-affiliate exemption is 
unlikely to pose a significant impediment to the use of the inter-
affiliate exemption by most foreign affiliates because it is expected 
that the major financial jurisdictions will implement their own 
mandatory clearing regimes. Notwithstanding the progress of other 
jurisdictions to implement their clearing regimes, as discussed above, 
the Commission is mindful of commenters' concerns that the compliance 
timeframe for the clearing requirement in the U.S. is likely to precede 
the adoption and/or implementation of the clearing regimes of most 
other jurisdictions.
    Accordingly, the Commission believes that it is important to 
provide for a transition period for foreign regimes to implement their 
clearing mandates to bring swaps into clearing. For certain eligible 
affiliate counterparties located in jurisdictions that have adopted 
swap clearing regimes and are currently in the process of 
implementation, namely Japan, the European Union, and Singapore, the 
Commission is modifying the proposed rule to allow for a transition 
period of one year from the first compliance date of the U.S. clearing 
mandate, until March 11, 2014, for those foreign jurisdictions that are 
working to implement their mandatory clearing regimes.\75\ The 
Commission believes that a transition period of 12 months after 
required clearing began in the U.S. is appropriate given its 
understanding of the progress being made on mandatory clearing in the 
specified foreign jurisdictions. Regulation 50.52(b)(4)(ii)(A) provides 
that during that one-year period, affiliates domiciled in such foreign 
jurisdictions can satisfy the requirements of Sec.  50.52(b)(4)(i) 
through the following: (i) Each eligible affiliate counterparty, or a 
majority-interest holder on behalf of both eligible affiliate 
counterparties, pays and collects full variation margin daily on all 
its swaps with unaffiliated counterparties; or (ii) each eligible 
affiliate counterparty, or a majority-interest holder on behalf of both 
eligible affiliate counterparties, pays and collects full variation 
margin daily on all its swaps with other eligible affiliate 
counterparties.
---------------------------------------------------------------------------

    \75\ While the time-limited alternative compliance framework of 
Sec.  50.52(b)(4)(ii) is limited to jurisdictions that currently 
have the legal authority to adopt mandatory clearing regimes, any 
jurisdiction that later adopts a mandatory clearing regime will be 
eligible for a comparability determination for purposes of this 
rule.
---------------------------------------------------------------------------

    Moreover, the Commission has determined to provide further time-
limited relief for certain eligible affiliated counterparties located 
in the European Union, Japan, or Singapore from complying with the 
requirements of Sec.  50.52(b)(4)(i) (or (b)(4)(ii)(A)) as a condition 
of electing the inter-affiliate exemption. In particular, Sec.  
50.52(b)(4)(ii)(B) provides that if one of the eligible affiliate 
counterparties is located in the European Union, Japan, or Singapore, 
the requirements of paragraph (b)(4)(i) will not apply to such eligible 
affiliate counterparty until March 11, 2014, provided that two 
conditions are met. The first condition provides that the one 
counterparty that directly or indirectly holds a majority ownership 
interest in the other counterparty or the third party that directly or 
indirectly holds a majority ownership interest in both counterparties 
is not a ``financial entity'' as defined in section 2(h)(7)(C)(i) of 
the Act.\76\ The second condition requires that neither eligible 
affiliate counterparty is affiliated with an entity that is an SD or 
MSP, as defined in Sec.  1.3. This condition essentially requires that 
the eligible affiliate counterparties are not part of a corporate group 
with a member affiliate that is an SD or MSP. Accordingly, eligible 
affiliate counterparties that are located in European Union, Japan, or 
Singapore and meet these two conditions, are exempt from the 
requirements of Sec.  50.52(b)(4)(i) until March 11, 2014. The 
Commission believes that providing the time-limited exemption in Sec.  
50.52(b)(4)(ii)(B) to the specific entities described above is 
consistent with comments requesting that the exchange of variation 
margin requirement, to the extent retained, be limited to SDs and MSPs. 
Specifically, ISDA & SIFMA noted in their comments that the scope of 
the Commission's regulatory concern should be limited to SDs and MSPs, 
and that the regulatory regime applicable to SDs already contained 
applicable safeguards, including variation margin requirements. 
Similarly, CDEU commented that any variation margin requirements be 
limited to SDs and MSPs.
---------------------------------------------------------------------------

    \76\ For purposes of meeting the requirements of Sec.  
50.52(b)(4)(ii)(B)(1) until March 11, 2014, the holding company 
(i.e., the ultimate parent of the corporate group) may not be 
considered to be a ``financial entity,'' as defined in section 
2(h)(7)(C)(i) of the CEA, under certain circumstances. The holding 
company must be able to identify all affiliates that meet the 
requirements of Sec.  50.52(a). Of those identified affiliates, a 
predominant number must qualify for the end-user exception under 
Sec.  50.50. If a predominant number of the affiliates meeting the 
requirements of Sec.  50.52(a) qualify for the end-user exception 
under Sec.  50.50, then the holding company may treat the activities 
of all of its affiliates meeting the requirements of Sec.  50.52(a) 
as if the holding company was engaged directly in such activities 
and consider such affiliates' activities on a cumulative basis with 
the holding company's other activities when assessing whether the 
holding company is ``predominantly engaged in activities that are in 
the business of banking, or in activities that are financial in 
nature, as defined in section 4(k) of the Bank Holding Company Act 
of 1956'' under section 2(h)(7)(C)(i)(VIII) of the CEA. In effect, 
the holding company may ``look through'' its investment in 
affiliates to all of the activities of the affiliates meeting the 
requirements of Sec.  50.52(a). Accordingly, the activities of 
affiliates meeting the requirements of Sec.  50.52(a) that are not 
in the business of banking or financial in nature, as defined in 
section 4(k) of the Bank Holding Company Act of 1956, would be 
attributed to the holding company. Conversely, if the affiliates 
meeting the requirements of Sec.  50.52(a) are engaged in activities 
that are in the business of banking or of a financial nature, then 
those activities would be attributed to the holding company for 
purposes of determining whether the holding company is a financial 
entity for purposes of meeting the requirements of Sec.  
50.52(b)(4)(ii)(B)(1).
---------------------------------------------------------------------------

    For eligible affiliate counterparties that are located in 
jurisdictions other than the European Union, Japan or Singapore, the 
Commission also is providing another time-limited alternative 
compliance framework for meeting the requirements of Sec.  
50.52(b)(4)(i). Specifically, Sec.  50.52(b)(4)(iii) provides that if 
an eligible affiliate counterparty located in the United States enters 
into swaps (that are included in a class of swaps identified in Sec.  
50.4), with eligible

[[Page 21765]]

affiliate counterparties located in jurisdictions other than the United 
States, the European Union, Japan, and Singapore, and the aggregate 
notional value of such swaps, which are included in a class of swaps 
identified in Sec.  50.4 does not exceed five percent of the aggregate 
notional value of all swaps, which are included in a class of swaps 
identified in Sec.  50.4, in each instance the notional value as 
measured in U.S. dollar equivalents and calculated for each calendar 
quarter, held by the eligible affiliate counterparty located in the 
United States, then such swaps shall be deemed to satisfy the 
requirements of paragraph (b)(4)(i) until March 11, 2014, provided 
that: (A) Each eligible affiliate counterparty, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, pays and collects full variation margin daily 
on all swaps entered into between the eligible affiliate counterparties 
located in jurisdictions other than the United States, the European 
Union, Japan, and Singapore and an unaffiliated counterparty; or (B) 
each eligible affiliate counterparty, or a third party that directly or 
indirectly holds a majority interest in both eligible affiliate 
counterparties, pays and collects full variation margin daily on all of 
the eligible affiliate counterparties' swaps with the other eligible 
affiliate counterparties.
    The options provided under the two alternative compliance 
frameworks described above are intended to mitigate the risk associated 
with uncleared third-party swaps. The payment and collection of 
variation margin is a vital component of the clearing process. As the 
Commission noted in the NPRM, variation margin is an essential risk-
management tool that serves both as a check on risk-taking that might 
exceed a party's financial capacity and as a limitation on losses when 
there is a failure.\77\ In addition to the risk-management benefits of 
variation margin, certain commenters expressed support for the 
inclusion of variation margin as a condition of the inter-affiliate 
exemption, and thus, the inclusion of variation margin within the 
alternative compliance frameworks is consistent with those comments. 
The Commission further clarifies that eligible affiliate counterparties 
that are eligible to comply with the alternative compliance frameworks 
in Sec.  50.52(b)(4)(ii) or Sec.  50.52(b)(4)(iii) and choose to pay 
and collect variation margin daily on either all of their inter-
affiliate swaps or all of their third party swaps, will have 
flexibility in tailoring their daily variation margin arrangements, 
including with respect to establishing appropriate prices for purposes 
of marking to market and threshold levels at which margin will be 
settled.
---------------------------------------------------------------------------

    \77\ As described in the NPRM, variation margin entails marking 
open positions to their current market value each day and 
transferring funds between the parties to reflect any change in 
value since the previous time the positions were marked. This 
process prevents uncollateralized exposures from accumulating over 
time and thereby reduces the size of any loss resulting from a 
default should one occur. NPRM at 50429.
---------------------------------------------------------------------------

    Notwithstanding the alternative compliance frameworks, the 
Commission encourages all eligible affiliate counterparties to clear 
their outward-facing swaps on a voluntary basis in order to best 
mitigate the risks associated with those swaps. The Commission notes 
that in lieu of complying with the alternative compliance frameworks 
through March 11, 2014, eligible affiliate counterparties also may 
satisfy the outward-facing swap condition by complying with Sec.  
50.52(b)(4)(ii)(E) by clearing their third-party swaps through a 
registered DCO or a clearing organization that is subject to 
supervision by the appropriate government authorities in the home 
country of the clearing organization and has been assessed to be in 
compliance with the PFMIs.
    The Commission believes that the alternative compliance framework 
adopted in this release addresses commenters' concerns pertaining to 
the timing and sequencing of the inter-affiliate exemption and the 
effective date of the Commission's initial clearing determination, and 
incorporates ISDA & SIFMA's recommendation to provide an appropriate 
transition period for foreign jurisdictions to implement their clearing 
regimes.
    In response to The Working Group, the Commission notes that the 
treatment of outward-facing swaps condition is needed to protect U.S. 
financial markets and to prevent evasion of the clearing requirement. 
The modified condition requires that eligible affiliate counterparties, 
whether domiciled in the U.S. or in a foreign jurisdiction, that elect 
the inter-affiliate exemption must clear their outward-facing swaps, if 
such swaps fall within a class identified in Sec.  50.4, or satisfy one 
the provisions in the alternative compliance frameworks, as applicable, 
until March 11, 2014. The alternative compliance frameworks are a 
direct response to concerns raised by The Working Group, and other 
commenters, regarding providing other jurisdictions with sufficient 
time to implement their clearing regimes. The alternative compliance 
framework provides eligible affiliates that elect the inter-affiliate 
exemption with other options, in addition to clearing, for managing the 
risks associated with their outward-facing swaps. In response to 
concerns that foreign-domiciled eligible affiliates would not be able 
to enter into uncleared non-hedge swaps with third parties that are 
foreign-domiciled end users, the Commission notes that it would take 
into consideration any comparable exceptions or exemptions granted 
under a comparable foreign jurisdiction's clearing regime.
    In response to The Working Group's statement that the treatment of 
outward-facing swap condition expands the cross-border application of 
the clearing requirement to cover swaps between U.S. persons and non-
U.S. persons, the Commission observes that U.S. persons are subject to 
the CEA's clearing requirement and part 50 of the Commission's 
regulations. Furthermore, the Commission notes that the final rule 
would permit eligible affiliate counterparties that are not located in 
the U.S. or in a comparable and comprehensive jurisdiction, to elect 
the inter-affiliate exemption provided that they clear any outward-
facing swaps that are required to be cleared under Sec.  50.4, through 
a registered DCO or a clearing organization that is subject to 
supervision by appropriate government authorities in the home country 
of the clearing organization and has been assessed to be in compliance 
with the PFMIs.\78\
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    \78\ The Commission believes that the use of an international 
standard that is substantially similar, though not identical, to the 
requirements under part 39 imposed upon DCOs registered with the 
Commission is appropriate for purposes of the condition. The PFMIs 
were developed with broad participation and comment from entities 
from multiple nations and have been approved by both IOSCO's 
Technical Committee and the CPSS. The Commission further notes that 
eligible affiliate counterparties that are not located in the U.S. 
or in a comparable and comprehensive jurisdiction must comply with 
the requirements of Sec.  50.52(b)(4)(i)(E). However, if such 
entities prefer to clear their swaps pursuant to the clearing 
requirement regime in the U.S. or in a jurisdiction that the 
Commission has determined to have a comparable clearing requirement, 
they also may comply with one of the conditions in Sec.  
50.52(b)(4)(i)(A) or (b)(4)(i)(B).
---------------------------------------------------------------------------

    Although the Commission believes that the alternative frameworks 
described above are necessary in the circumstances described, these 
alternatives are not equivalent to clearing and would not mitigate 
potential losses between swap counterparties in the same manner that 
clearing would. Thus, notwithstanding the alternative compliance 
frameworks, the Commission believes that the requirement that eligible 
affiliates clear

[[Page 21766]]

swaps entered into with non-affiliated counterparties is the most 
appropriate method in which to prevent evasion of the clearing 
requirement and to help protect U.S. financial markets, and encourages 
market participants to do so. As noted above, incorporated within the 
requirement that eligible affiliate counterparties clear their outward-
facing swaps is the option to comply with the requirements of a foreign 
jurisdiction's clearing mandate for the outward-facing swaps, including 
any comparable exception or exemption granted under the foreign 
clearing mandate, provided that such foreign jurisdiction's clearing 
mandate is determined by the Commission to be comparable, and 
comprehensive but not necessarily identical, to the clearing 
requirement established under the CEA, and the exception or exemption 
is determined by the Commission to be comparable to an exception or 
exemption provided under the CEA or part 50.
    In the next section of the release, the Commission describes the 
specific comments raised with respect to the proposed ``comparable and 
comprehensive'' standard and provides a discussion of the its 
consideration of these comments, as well as an explanation of the 
Commission's anticipated process for reviewing and issuing 
comparability determinations in the context of the inter-affiliate 
exemption from clearing.
3. Application of the Comparable and Comprehensive Standard to 
Mandatory Clearing
    Commenters raised questions as to the criteria the Commission would 
consider in rendering a comparability determination. ISDA & SIFMA 
requested that the Commission clarify that ``comparability'' does not 
mean that the host country must have the ``same'' requirement. CDEU 
questioned what specific criteria the Commission would consider in 
making a comparability finding. CDEU recommended that the Commission 
limit the applicability of the comparability requirement to SDs and 
MSPs, and claimed that extending the condition to end-users would 
disproportionately impact end-users that have global operations, 
particularly in emerging markets.\79\ CDEU further suggested that the 
Commission extend the inter-affiliate exemption to non-U.S. affiliates 
that enter into 20 or less third-party swaps per month. The Working 
Group noted that many commercial energy firms have operations in 
foreign jurisdictions that have less commercially robust financial 
markets than those in the U.S., and that the treatment of outward-
facing swaps condition may place significant limitations on the ability 
of commercial enterprises to hedge risk associated with such 
operations, thereby resulting in higher cost of doing business in the 
foreign country or decreasing the business activity of the U.S. company 
in the foreign jurisdiction. The Working Group further commented that 
the proposed rule extends the reach of U.S. law on non-U.S. persons 
``far beyond'' the immediate clearing requirement.\80\
---------------------------------------------------------------------------

    \79\ CDEU claimed that end users would be adversely impacted by 
the increased costs for risk-mitigating transactions between 
affiliates, and noted that the Dodd-Frank Act did not contemplate 
regulation of end-user transactions in the same manner as SD and MSP 
transactions.
    \80\ According to The Working Group, the proposed rule, for 
instance, would require certain non-U.S. persons to enter into an 
agreement with a futures commission merchant (FCM), and to enter 
into a commercial relationship in the U.S. including posting capital 
in U.S. markets that would subject such entities to U.S. bankruptcy 
law.
---------------------------------------------------------------------------

    AFR suggested that the final rule should specifically state that 
the ``comparable and comprehensive'' requirement must apply to each 
``specific type of swap'' being considered for the exemption. AFR 
further stated that the Commission should provide a detailed 
comparability procedure, such as the procedure described in the 
proposed cross-border guidance. MetLife also suggested that rather than 
broadly prohibiting non-U.S. affiliates (that are not located in a 
comparable jurisdiction) from entering into any third-party swaps as a 
condition of the inter-affiliate exemption, the Commission should 
narrow the prohibition in the proposed rule to prohibit non-U.S. 
affiliates (that are not located in a comparable jurisdiction) from 
entering into ``similar swaps of the same product type'' with 
unaffiliated third parties.
    As described above, a number of commenters requested further 
clarification on how the Commission will apply the ``comparable and 
comprehensive'' standard in the context of the mandatory clearing. The 
comparability requirement originally was discussed in the Commission's 
Proposed Cross-Border Interpretive Guidance. Drawing on its experience 
in exempting foreign brokers from certain registrations requirements 
under its rule 30.10 ``comparability'' determinations, the Commission 
proposed the ``comparable and comprehensive'' concept in the Proposed 
Cross-Border Interpretive Guidance \81\ in order to permit certain 
classes of non-U.S. registrants to substitute compliance with the 
requirements of its home jurisdiction's law and regulations, in lieu of 
compliance with the CEA and the Commission's regulations, if the 
Commission finds that the relevant jurisdiction's laws and regulations 
are comparable to the relevant requirements of the CEA and Commission 
regulations.\82\
---------------------------------------------------------------------------

    \81\ Proposed Cross-Border Interpretive Guidance at 41232-35.
    \82\ The Proposed Cross-Border Interpretive Guidance identified 
transaction-level requirements to include mandatory clearing and 
swap processing, margining, segregation, trade execution, swap 
trading documentation, portfolio reconciliation and compression, 
real time public reporting, trade confirmation, and daily trading 
records requirements. The Proposed Cross-Border Interpretive 
Guidance proposed to allow substituted compliance with respect to 
transaction level requirements for swaps between a non-U.S. SD or 
non-U.S. MSP with a non-U.S. person that is guaranteed by a U.S. 
person, as well as swaps with non-U.S. affiliate conduits. See 
Proposed Cross-Border Interpretive Guidance at 41230.
---------------------------------------------------------------------------

    In the Proposed Cross-Border Interpretive Guidance, the Commission, 
in describing its intended approach to making comparability 
determinations, noted that similar to its policy with respect to rule 
30.10, the Commission would retain broad discretion to determine that 
the objectives of any program elements are met, notwithstanding the 
fact that the foreign requirements may not be identical to that of the 
Commission.
i. Comparability of Foreign Clearing Mandate
    In response to comments seeking additional clarity around the 
Commission's comparability determination process, the Commission 
clarifies that it will review the comparability and comprehensiveness 
of a foreign jurisdiction's clearing mandate under Sec.  
50.52(b)(4)(i)(B) by reviewing: (i) The foreign jurisdiction's laws and 
regulations with respect to its mandatory clearing regime (i.e., 
jurisdiction-specific review), and (ii) the foreign jurisdiction's 
clearing determinations with respect to each class of swaps for which 
the Commission has issued a clearing determination under Sec.  50.4 of 
the Commission's regulations (i.e., product-specific review).
    As noted above, and in response to ISDA & SIFMA, the Commission 
reiterates that for purposes of the treatment of outward-facing swaps 
condition of the inter-affiliate exemption, comparability findings with 
respect to a foreign jurisdiction's clearing regime will not require an 
identical regime to the clearing framework established under the Act 
and Commission regulations. Rather, the Commission anticipates that it 
will

[[Page 21767]]

make jurisdiction-specific comparability determinations by comparing 
the regulatory requirements of a foreign jurisdiction's clearing regime 
with the requirements and objectives of the Dodd-Frank Act. Notably, 
the Commission anticipates that the product-specific comparability 
determination will necessarily be made on the basis of whether the 
applicable swap is included in a class of swaps covered under Sec.  
50.4, and if so, whether such swap or class of swaps is covered under 
the foreign jurisdiction's clearing mandate.
ii. Comparability of Exemption or Exception Under Foreign Clearing 
Regime
    With respect to determining whether an exemption or exception under 
a comparable foreign clearing mandate is comparable to an exception or 
exemption under the CEA or part 50, as provided under Sec.  
50.52(b)(4)(i)(D), the Commission anticipates that it would review for 
comparability purposes the foreign jurisdiction's laws and regulations 
with respect to its mandatory clearing regime, as well as the relevant 
exception or exemption. In doing so, the Commission would exercise 
broad discretion to determine whether the requirements and objectives 
of such exemption or exception are consistent with those under the 
Dodd-Frank Act and that such objectives are being met, notwithstanding 
the fact that the exemption or exception from clearing under the 
comparable foreign clearing regime may not be identical to those 
established under the Act or the Commission's regulations. Accordingly, 
the Commission anticipates that comparability determinations with 
respect to a foreign jurisdiction's exemption or exception from 
mandatory clearing could be made at either the entity level, or the 
transaction type, as appropriate.
iii. Responses to Additional Comments
    In response to comments seeking clarification on what will trigger 
a Commission comparability determination, the Commission anticipates 
that it will render jurisdiction-specific and product-specific 
comparability determinations upon the adoption of clearing regimes by 
foreign jurisdictions for classes of swaps covered under Sec.  50.4, 
upon the request of a counterparty that is located in a foreign 
jurisdiction, or upon receipt of a request from another appropriate 
party.
    The Commission further anticipates that once a comparability 
determination is made with respect to the foreign jurisdiction's 
clearing regime, and with regard to a particular class of swaps covered 
under Sec.  50.4, eligible affiliates domiciled in such jurisdiction 
may rely on such determinations for swaps included within the 
applicable class, without further Commission action. To the extent that 
the Commission proposes a change to its regulations governing the 
clearing requirement generally or with respect to any particular 
product class, the Commission will reevaluate whether the proposed 
regulatory change would affect the basis upon which the Commission made 
the comparability determination. To the extent that there are 
discrepancies in the requirements between the foreign jurisdiction and 
the Commission's proposed regulatory change, the Commission anticipates 
that it would issue additional guidance or notifications to market 
participants to determine how affected entities can address any 
discrepancy in requirements.
    The Commission declines to limit the condition that eligible 
affiliates clear their outward-facing swaps to SDs and MSPs, as 
suggested by CDEU. As explained throughout this release, the Commission 
believes that the requirements of Sec.  50.52(b)(4) are necessary to 
prevent evasion of the clearing requirement and to protect U.S. 
financial markets. Moreover, the requirements of section 2(h)(1)(A) 
apply to all market participants not able to elect an exception under 
section 2(h)(7) of the CEA, not just to SDs and MSPs. The Commission 
believes that the modified rule and time-limited alternative compliance 
frameworks adopted in the final rule will provide end users, amongst 
others, with substantial flexibility to comply with the conditions of 
the exemption. Furthermore, the Commission notes that end users also 
may elect the end-user exception from clearing for hedging transactions 
that comply with the requirements of the CEA and Sec.  50.50.
    For the reasons described in this release, the Commission is 
adopting in Sec.  50.52(b) the conditions to the inter-affiliate 
exemption, initially proposed as Sec.  39.6(g)(2)(v), pertaining to 
swaps entered into with unaffiliated counterparties, with the 
modifications described above.

H. Reporting Requirement and Annual Election

    In the NPRM, the Commission explained that general reporting 
requirements under sections 2(a)(13) and 4r of the CEA and part 45 
apply to uncleared inter-affiliate swaps.\83\ In addition, the proposed 
regulations require the reporting counterparty to provide, or cause to 
be provided, to a registered SDR, or if no registered SDR is available, 
to the Commission, certain additional information. Proposed Sec.  
39.6(g)(4)(i) requires the reporting counterparty to confirm that both 
counterparties to the inter-affiliate swap are electing not to clear 
the swap and that both counterparties meet the requirements in proposed 
Sec.  39.6(g)(1)-(2). Proposed Sec.  39.6(g)(4)(ii) requires the 
reporting counterparty to submit information regarding how the 
financial obligations of both counterparties are generally satisfied 
with respect to uncleared swaps. Proposed Sec.  39.6(g)(4)(iii) 
implements section 2(j) of the CEA for purposes of the inter-affiliate 
exemption. Section 2(j) of the CEA applies to an issuer of securities 
registered under section 12 of the Securities Exchange Act of 1934 
(Exchange Act) \84\ or an entity required to file reports under 
Exchange Act section 15(g) (``electing SEC Filers'') that elects an 
exemption from the CEA's clearing requirement under section 2(h)(1)(A) 
of the CEA. Section 2(j) requires that an appropriate committee of the 
electing SEC Filer's board or governing body review and approve its 
decision to enter into swaps subject to an exemption clearing. Proposed 
Sec.  39.6(g)(4)(iii)(A) requires an electing SEC Filer to notify the 
Commission of its SEC Filer status by submitting its SEC Central Index 
Key number. In addition, proposed Sec.  39.6(g)(4)(iii)(B) requires the 
counterparty to report whether an appropriate committee of its board of 
directors (or equivalent governing body) has reviewed and approved the 
decision to enter into the inter-affiliate swaps that are exempt from 
clearing.\85\
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    \83\ See NPRM at 50432.
    \84\ 15 U.S.C. 78l.
    \85\ The proposed requirements under regulations implementing 
section 2(j) mirror the requirements that the Commission finalized 
in its end-user exception rulemaking, End-User Exception to the 
Clearing Requirement for Swaps, 77 FR 42560.
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    Lastly, proposed Sec.  39.16(g)(5) permits a counterparty to 
provide information related to how it generally meets its financial 
obligations and information related to its status as an electing SEC 
Filer on an annual basis in anticipation of electing the inter-
affiliate clearing exemption for one or more swaps. This election is 
effective for inter-affiliate swaps entered into within 365 days 
following the date of such reporting. During the 365-day period, the 
affiliate counterparty would be required to amend the information as 
necessary to

[[Page 21768]]

reflect any material changes to the reported information. Under the 
proposal, confirmation that both counterparties are electing not to 
clear the swap and that they both satisfy the other requirements of the 
exemption would not be subject to an annual filing, but must be done on 
a swap-by-swap basis.
    The Commission received several comments in response to the 
reporting obligations of affiliates. Prudential and MetLife both 
commented that the Commission should clarify that only one counterparty 
is required to report the swap to an SDR. In addition, both Prudential 
and MetLife stated that annual reporting is more efficient than swap-
by-swap reporting.
    EEI stated that the Commission should eliminate the transaction-by-
transaction reporting requirement under proposed Sec.  39.6(g)(4)(i) 
for the election of the exemption and confirmation that the conditions 
have the exemption have been met. Instead, EEI recommended that one of 
the affiliates be permitted to file an annual notice on behalf of both 
affiliates to exempt all of their swaps from clearing for an entire 
year. EEI contended that it will increase costs if both affiliates have 
to communicate that they elect not to clear the swap and meet the 
conditions of the exemption for each swap. EEI also stated that the 
Commission should state that part 45 does not apply to inter-affiliate 
swaps because the Commission will be able to obtain information 
regarding an inter-affiliate transaction based on reporting of a 
corresponding market-facing swap.\86\
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    \86\ EEI cited to a statement in the NPRM's consideration of 
costs and benefits as support for an argument that the Commission 
did not intend for part 45 reporting to apply to inter-affiliate 
swaps. See NPRM at 50433. The statement in the cost-benefit 
consideration of the NPRM merely drew a comparison between the 
reporting requirements under the proposed exemption and the general 
reporting requirements under parts 45 and 46, and those reporting 
requirements applicable to SDs and MSPs under part 23. The statement 
should not be read as calling into question the applicability of 
part 45 to inter-affiliate swaps.
---------------------------------------------------------------------------

    CDEU also objected to reporting any information to an SDR on a 
trade-by-trade basis for inter-affiliate swaps as such reporting would 
be costly and onerous for parties. Instead, CDEU recommended that all 
reporting be done on an annual basis through a board resolution.\87\ 
CDEU also requested that part 45 data be reported on a quarterly basis 
for all inter-affiliate swaps between financial and non-financial end 
users, and that inter-affiliate swaps not be subject to historical swap 
reporting under part 46. Similarly, Cravath asked that the Commission 
``provide meaningful relief from the reporting requirements of Part 45 
and Part 46.''
---------------------------------------------------------------------------

    \87\ Cravath stated that the Commission has determined that part 
43 reporting does not apply to inter-affiliate swaps.
---------------------------------------------------------------------------

    DLA Piper commented that the regulatory reporting requirements are 
unnecessary for inter-affiliate swaps and should be eliminated.\88\ DLA 
Piper claimed that the reporting of both the outward-facing swap and 
the inter-affiliate swap would increase systemic risk by distorting the 
risk to the financial system. DLA Piper also commented that the 
imposition of recordkeeping obligations with respect to inter-affiliate 
swaps would result in significant additional burdens on corporate 
groups. DLA Piper stated that inter-affiliate swaps should be expressly 
exempt from the part 45 and part 46 reporting requirements.
---------------------------------------------------------------------------

    \88\ According to its comment letter, DLA Piper's comments are 
limited to corporate end-users who enter into intercompany hedging 
transactions.
---------------------------------------------------------------------------

    Under sections 2(a)(13) and 4r of the CEA, all swaps must be 
reported to an SDR (or the Commission if there is no available SDR) and 
are subject to comprehensive recordkeeping obligations.\89\ Reporting 
and recordkeeping obligations apply to both historical swaps \90\ and 
those swaps executed after the applicable compliance date listed in 
part 45 of the Commission's regulations.\91\ As indicated in the 
preamble to the final end-user exception \92\ and the NPRM,\93\ parts 
45 and 46 of the Commission's regulations apply to inter-affiliate 
swaps.\94\ Whether an inter-affiliate swap is subject to the part 43 
real-time reporting rules will depend on whether the transaction fits 
within the definition of a ``publically reportable swap transaction.'' 
\95\
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    \89\ See 17 CFR part 45; 17 CFR 45.2 (recordkeeping 
obligations); Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136 (Jan. 13, 2012); 17 CFR part 46; Swap Data Recordkeeping and 
Reporting: Pre-Enactment and Transition Swaps, 77 FR 35200 (June 12, 
2012).
    \90\ As described in the part 46 rules, historical swaps include 
pre-enactment swaps, that is, swaps still in existence after the 
date of enactment of the Dodd-Frank Act, and transition swaps, that 
is, swaps entered into on or after the date of enactment but before 
the compliance date specified in part 45 and other no-action or 
regulatory guidance issued by the Commission or one of the 
Commission's divisions or offices.
    \91\ These reporting obligations may be subject to no-action or 
other regulatory guidance issued by the Commission or any of the 
Commission's divisions or offices. See www.cftc.gov for a complete 
list of the staff no-action letters, Frequently Asked Questions, and 
other regulatory guidance.
    \92\ See End-User Exception to the Clearing Requirement for 
Swaps, 77 FR 42567 (``Congress did not exempt such inter-affiliate 
swaps from the reporting requirements'' and ``inter-affiliate swaps 
must be reported'').
    \93\ NPRM at 50432 (noting that section 4r applies to uncleared 
swaps and that counterparties must comply with proposed rule 
39.6(g)(4) ``[i]n addition to any general reporting requirements 
applicable under other applicable rules'').
    \94\ In addition, under part 45 non-SDs and MSPs must keep 
``full, complete, and systematic records, together with all 
pertinent data and memoranda, with respect to each swap in which 
they are a counterparty.'' 17 CFR 45.2(b). These recordkeeping 
obligations applied to inter-affiliate swaps as early as October 14, 
2010. See Interim Final Rule for Reporting Pre-Enactment Swap 
Transactions, 75 FR 63090 (Oct. 14, 2010). Thus, as of the date of 
this release, swap counterparties already have an obligation to 
maintain swap records that has existed for more than two years.
    \95\ See 17 CFR 43.2 (defining ``publicly reportable swap 
transaction'' as an executed swap that is an arm's length 
transaction between two parties that results in a change in the 
market risk position between the two parties and citing ``internal 
swaps between one-hundred percent owned subsidiaries of the same 
parent entity'' as an example of a swap that does not meet the 
definition); see also Real-Time Public Reporting of Swap Transaction 
Data, 77 FR 1182, 1187 (Jan. 9, 2012) (discussing the real-time 
public reporting of inter-affiliate swaps).
---------------------------------------------------------------------------

    In response to commenters' requests, the Commission is clarifying 
that the reporting obligations under Sec.  39.6(g)(2)(i) (now Sec.  
50.52(c)) can be fulfilled by one of the affiliate counterparties on 
behalf of both counterparties. The selection of which affiliate will be 
considered to be the reporting counterparty should be determined in 
accordance with the provisions of Sec.  45.8 and, for part 43, the 
reporting party under Sec.  43.3(a)(3).
    As noted in the NPRM, the Commission believes that affiliates 
within a corporate group may make independent determinations on whether 
to submit an inter-affiliate swap for clearing. Given the possibility 
that each affiliate may reach different conclusions regarding clearing 
the swap, Sec.  39.6(g)(2)(i) would require that both counterparties 
elect the proposed inter-affiliate clearing exemption. The Commission 
is therefore adopting the electing requirement as proposed.
    With regard to comments recommending that all reporting be done on 
an annual basis rather than a swap-by-swap basis, the Commission 
declines to modify the rule. The Commission believes it is appropriate 
to provide for annual reporting of certain information, including how 
affiliates generally meet their financial obligations and information 
related to its status as an electing SEC Filer.\96\ However, it would 
not be appropriate to allow one annual report to cover both

[[Page 21769]]

affiliate counterparties' election of the exemption from clearing and 
the confirmation that both affiliates meet the conditions of the 
exemption because each affiliate is under an ongoing obligation to 
demonstrate its eligibility to claim the exemption and because 
effective regulatory monitoring requires an indication of the election 
on a swap-by-swap basis.\97\ Accordingly, the election of the exemption 
and the confirmation that the exemption's conditions are met must be 
made for each swap. The Commission does not believe that this reporting 
requirement will impose a significant burden on affiliate 
counterparties because, as discussed above, other detailed information 
for every swap must be reported under sections 2(a)(13) and 4r of the 
CEA and Commission regulations. This approach comports with the 
approach adopted for market participants claiming the end-user 
exception under section 2(h)(7) of the CEA.\98\
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    \96\ The Commission is modifying the proposed reporting 
requirements relating to section 2(j) of the CEA to make them 
consistent with the approach adopted in the end-user exception to 
required clearing. As finalized, under Sec.  50.52(c)(3)(ii), the 
committee of the board of directors (or equivalent body) of the 
eligible affiliate counterparty must have ``reviewed and approved 
the decision to enter into swaps that are exempt from the 
requirements of sections 2(h)(1) and 2(h)(8) of the Act.''
    \97\ If reports to the SDR were made on an annual basis, but 
included swap-by-swap information, regulators would not be able to 
monitor the transmission of risk through the market in a timely 
fashion. Regulators would have a one-year lag before such data could 
be used effectively for such purposes. If reports to the SDR were 
made on an annual basis and did not include swap-by-swap 
information, the regulators would be permanently hindered in their 
ability to monitor the swap markets. As noted above, inter-affiliate 
swaps and outward-facing swaps both transfer risk, but they do so in 
different ways and in differing degrees. Regulators must be able to 
distinguish between inter-affiliate swaps and outward-facing swaps 
in order to monitor markets effectively. If electing entities 
provided an annual statement that they are electing the exemption, 
and do not identify the individual swaps for which the exemption has 
been elected, the data would not allow regulators to distinguish 
between the two groups.
    \98\ See End-User Exception to the Clearing Requirement for 
Swaps, 77 FR 42565-66.
---------------------------------------------------------------------------

    The Commission does not agree with EEI's comment that the 
Commission will be able to obtain information on inter-affiliate swaps 
from the information reported on market-facing swaps, and disagrees 
with DLA Piper's comment that reporting and recordkeeping obligations 
are unnecessary or would increase systemic risk. The reporting and 
recordkeeping requirements promote accountability and transparency, and 
will aid the Commission in monitoring compliance with the inter-
affiliate exemption. Moreover, the Commission does not believe that the 
information relating to inter-affiliate swaps will necessarily be 
identical to market-facing swaps. Also, the Commission does not believe 
that all inter-affiliate swaps will match up to market-facing swaps 
because, as The Working Group commented, entities use inter-affiliate 
trades to transfer physical commodity or futures exposure between 
affiliates for compliance with international tax law, customs, or 
accounting laws.

I. Implementation

    The clearing requirement under section 2(h)(1)(A) of the CEA and 
part 50 of the Commission's regulations shall not apply to a swap 
executed between affiliated counterparties that have the status of 
eligible affiliate counterparties, as defined in Sec.  50.52(a), and 
elect not to clear such swap until the effective date of this 
rulemaking. The effective date of this rulemaking shall be 60 days 
after publication in the Federal Register.

III. Cost-Benefit Considerations

A. Statutory and Regulatory Background

    Section 15(a) of the CEA \99\ requires the Commission to consider 
the costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders. Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors.
---------------------------------------------------------------------------

    \99\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    Prior to the passage of the Dodd-Frank Act, swaps were not required 
to be cleared. In the wake of the financial crisis of 2008, Congress 
adopted the Dodd-Frank Act, which, among other things, amends the CEA 
to impose a clearing requirement for swaps based on determinations by 
the Commission regarding which swaps are required to be cleared through 
a DCO.\100\ This clearing requirement is designed to reduce 
counterparty risk associated with swaps and, in turn, mitigate the 
potential systemic impact of such risk and reduce the risk that swaps 
could cause or exacerbate instability in the financial system.\101\ In 
amending the CEA, however, the Dodd-Frank Act preserved the 
Commission's authority to ``promote responsible economic or financial 
innovation and fair competition'' by exempting any transaction or class 
of transactions, including swaps, from select provisions of the 
CEA.\102\ For reasons explained above,\103\ the Commission proposes to 
exercise its authority under section 4(c)(1) of the CEA to exempt 
inter-affiliate swaps--that is, swaps between majority-owned affiliates 
with financial statements that are reported on a consolidated basis 
under GAAP or IFRS--from the clearing requirement under section 
2(h)(1)(A) of the CEA, subject to certain conditions.
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    \100\ See section 2(h)(1) of the CEA, 7 U.S.C. 2(h)(1).
    \101\ When a bilateral swap is moved into clearing, the 
clearinghouse becomes the counterparty to each of the original 
participants in the swap. This standardizes counterparty risk for 
the original swap participants in that they each bear the same risk 
attributable to facing the clearinghouse as counterparty. In 
addition, clearing mitigates counterparty risk to the extent that 
the clearinghouse is a more creditworthy counterparty relative to 
those that each participant in the trade might have otherwise faced. 
Clearinghouses have demonstrated resilience in the face of past 
market stress. Most recently, they remained financially sound and 
effectively settled positions in the midst of turbulent events in 
2007-2008 that threatened the financial health and stability of many 
other types of entities.
    \102\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1). Section 
4(c)(1) is discussed in greater detail above in Section II.A.
    \103\ See Section II.A above.
---------------------------------------------------------------------------

    In the discussion that follows, the Commission considers the costs 
and benefits of the inter-affiliate exemption to the public and market 
participants generally. The Commission also separately considers the 
costs and benefits of the conditions placed on affiliates that would 
elect the exemption: (1) Majority ownership and financial statements 
that are reported on a consolidated basis under GAAP or IFRS as 
conditions for status as an eligible affiliate counterparty; (2) swap 
trading relationship documentation, which would require affiliates to 
document in writing all terms governing the trading relationship; (3) 
centralized risk management requirement, which would require affiliates 
to subject the swap to centralized risk management; and (4) reporting 
requirements, which would require counterparties to advise an SDR, or 
the Commission if no SDR is available, that both counterparties elect 
the inter-affiliate clearing exemption and to identify the types of 
collateral used to meet financial obligations. In addition to the 
foregoing reporting requirements, counterparties that are issuers of 
securities registered under section 12 of the Securities Exchange Act 
of 1934 or those that are required to file reports under section 15(d) 
of that Act, would be required to identify the SEC central index key 
number and confirm that an appropriate committee of board of directors 
has approved of the affiliates' decision not to clear a swap. The rule 
also would permit affiliates to report certain information on an annual 
basis, rather

[[Page 21770]]

than swap-by-swap. Finally, the Commission considers the costs and 
benefits of the condition regarding the treatment of outward-facing 
swaps.
    In the NPRM, where reasonably feasible, the Commission sought to 
estimate quantifiable dollar costs. In some instances, however, the 
Commission explained that certain costs were not susceptible to 
meaningful quantification, and in those instances, the Commission 
discussed proposed costs and benefits in qualitative terms. As stated 
above, the Commission received a total of 14 comment letters following 
the publication of the NPRM, many of which strongly supported the 
proposed regulations. Some commenters generally addressed the cost-and-
benefit aspect of the current rule; none of them, however, provided any 
quantitative data in response to the Commission's requests for 
comment.\104\
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    \104\ As discussed further below, EEI commented on the NPRM's 
consideration of costs and benefits and stated that the costs of the 
proposed documentation requirement are unjustified. The NPRM 
included an estimate that there would be a one-time cost of $15,000 
to develop appropriate documentation for use by an entity's 
affiliates. EEI objected to this estimate because, in its view, the 
legal costs associated with individually negotiating and amending 
standard agreements between individual affiliates would exceed the 
NPRM's estimates. In addition, EEI objected to the NPRM's estimate 
of 22 affiliated counterparties for each corporate group as ``far 
too low'' for U.S. energy companies. However, EEI did not provide 
specific, quantitative information in terms of either the legal 
costs of complying with the proposed documentation requirement or 
number of affiliates for a corporate group subject to this rule.
---------------------------------------------------------------------------

    In the sections that follow the Commission considers: (1) Costs and 
benefits of the exemption for eligible affiliate counterparties; (2) 
costs and benefits of the exemption for market participants and the 
public; (3) alternatives contemplated by the Commission and the costs 
and benefits relative to the approach adopted herein; (4) the impact of 
exemption in light of the 15(a) factors. The Commission also discusses 
the corresponding comments accordingly.

B. Costs and Benefits of Exemption for Eligible Affiliate 
Counterparties

    Without the final rule exempting swaps between certain affiliated 
counterparties, those entities would have to clear their inter-
affiliate swaps pursuant to section 2(h)(1)(A) of the CEA (unless one 
of the affiliates is able to claim an exception under section 2(h)(7) 
of the CEA and/or Sec.  50.50).\105\ This rule allows eligible 
affiliates to exempt inter-affiliate swaps from clearing, which creates 
both costs and benefits for those entities. Regarding costs, by 
allowing affiliates not to clear certain swaps that would otherwise be 
subject to required clearing, the rule may allow those affiliates to be 
exposed to greater measures of counterparty credit risk with respect to 
one another. On the other hand, the primary benefit of providing this 
exemption for inter-affiliate swaps between eligible affiliate 
counterparties is that each affiliate will not have to incur the costs 
of required clearing. These costs include clearing fees, as well as 
costs associated with margin and capital requirements. The rule also 
facilitates affiliates' use of swaps to hedge various types of risk 
more efficiently.
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    \105\ Under the Sec.  50.50 exception, end users and small 
financial institutions that are hedging or mitigating commercial 
risk may elect not to clear their swaps, subject to certain 
conditions. Because of this exception, as explained in the NPRM, the 
Commission anticipates that the inter-affiliate exemption will be 
elected only when the two counterparties are financial entities that 
do not qualify for the end-user exception. See NPRM at 50426.
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1. Benefits of Clearing Inter-Affiliate Swaps
    The benefits of required clearing have been well-documented by the 
Commission.\106\ As described in the preceding sections of this 
adopting release, there are numerous benefits associated with central 
clearing of swaps. In particular, clearing mitigates counterparty 
credit risk, provides an organized mechanism for collateralizing the 
risk exposures posed by swaps, and when applied to channels where 
systemic risk could be transmitted, clearing reduces systemic risk.
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    \106\ See e.g., Clearing Requirement Determination at 74329.
---------------------------------------------------------------------------

    The counterparty and systemic risk mitigation benefits of central 
clearing also are realized from clearing transactions between 
affiliates. Central clearing would ensure that inter-affiliate swaps 
are fully documented and abide by valuation procedures set by the DCO, 
which would help to ensure that affiliates have current and accurate 
information regarding the value of their positions and would help 
prevent the possibility of valuation disputes.\107\ In addition, when a 
bilateral swap is cleared, the clearinghouse becomes the counterparty 
to each of the original counterparties to the swap. This reduces and 
standardizes the counterparty risk borne by each of the original 
parties to the swap.\108\ Moreover, clearing mitigates the risk of 
financial contagion because the clearinghouse serves as a sort of 
``buffer'' that protects each of the original counterparties from the 
credit risk of the other. This would also be true for inter-affiliate 
swaps. Novating the swap to a clearinghouse so that each affiliate 
faces the clearinghouse would ensure that each affiliate is facing 
minimal counterparty credit risk and would minimize the possibility of 
inter-affiliate swaps becoming a mechanism through which financial 
instability could pass from one affiliate to another.
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    \107\ ISDA & SIFMA stated that valuation and dispute resolution 
procedures would appear to serve little purpose among majority-owned 
affiliates. This comment is discussed above in Section II.D, as well 
as in Section III.C.2. below.
    \108\ A clearinghouse is one of the most credit-worthy 
counterparties available in the market because of the panoply of 
risk management tools it has at its disposal. These tools include 
the contractual right to: (1) Collect initial and variation margin 
associated with outstanding swap positions; (2) mark positions to 
market regularly (usually one or more times per day) and issue 
margin calls whenever the margin in a customer's account has dropped 
below predetermined levels set by the DCO; (3) adjust the amount of 
margin that is required to be held against swap positions in light 
of changing market circumstances, such as increased volatility in 
the underlying; and (4) close out the swap positions of a customer 
that does not meet margin calls within a specified period of time.
     Moreover, in the event that a clearing member defaults on their 
obligations to the DCO, the latter has a number of remedies to 
manage associated risks, including transferring the swap positions 
of the defaulted member, and covering any losses that may have 
accrued with the defaulting member's margin and other collateral on 
deposit. In order to transfer the swap positions of a defaulting 
member and manage the risk of those positions while doing so, the 
DCO has the ability to: (1) Hedge the portfolio of positions of the 
defaulting member to limit future losses; (2) partition the 
portfolio into smaller pieces; (3) auction off the pieces of the 
portfolio, together with their corresponding hedges, to other 
members of the DCO; and (4) allocate any remaining positions to 
members of the DCO. In order to cover the losses associated with 
such a default, the DCO would typically draw from (in order): (1) 
The initial margin posted by the defaulting member; (2) the guaranty 
fund contribution of the defaulting member; (3) the DCO's own 
capital contribution; (4) the guaranty fund contribution of non-
defaulting members; and (5) an assessment on the non-defaulting 
members. These mutualized risk mitigation capabilities are largely 
unique to clearinghouses, and help to ensure that they remain 
solvent and creditworthy swap counterparties even when dealing with 
defaults by their members or other challenging market circumstances.
---------------------------------------------------------------------------

    This rule reduces these benefits by allowing affiliates to exempt 
swaps from required clearing. In the absence of clearing, affiliated 
entities will not be required to collect initial or variation margin, 
or to implement other measures that clearinghouses typically use to 
mitigate their own counterparty credit risk. As a consequence, the 
affiliates may accumulate large outstanding positions with one another 
as the value of their swap positions change value between payment 
dates. If an affiliate with large, out-of-the-money, inter-affiliate 
swap positions defaulted, it could cause financial instability in its 
affiliates, leading to a cascading series of defaults among them. As 
discussed below, the Commission expects that internalization of costs 
and risks among

[[Page 21771]]

affiliated entities, as well as the conditions for electing the 
exemption will mitigate this cost, but will not eliminate it entirely.
2. Reduced Clearing Costs
    As stated above, by exempting qualified affiliates from clearing 
inter-affiliate swaps that would otherwise be subject to the clearing 
requirement, the rule ensures that each affiliate will not incur the 
costs of required clearing for those swaps. These costs include 
clearing fees as well as costs associated with margin and capital 
requirements. Regarding clearing fees, assuming that the affiliated 
counterparties cannot clear on their own behalves or through an 
affiliated clearing member of a DCO, the affiliated counterparties 
would have to arrange to clear their swaps through a futures commission 
merchant (FCM) that is a member of a DCO. Regardless of whether the 
affiliated counterparties clear on their own behalf or contract with an 
FCM, they will incur fees from the DCO.
    For customer clearing, DCOs typically charge FCMs an initial 
transaction fee for each customer swap that is cleared, as well as an 
annual maintenance fee for each of the customers' open positions. For 
example, not including customer-specific and volume discounts, the 
transaction fees for interest rate swaps at CME range from $1 to $24 
per million notional amount and the maintenance fees are $2 per year 
per million notional amount for open positions.\109\ LCH transaction 
fees for interest rate swaps range from $1 to $20 per million notional 
amount, and the maintenance fee ranges from $5 to $20 per swap per 
month, depending on the number of outstanding swap positions that an 
entity has with the DCO.\110\ It is within the FCM's discretion to 
determine whether or how to pass these fees on to their customers.\111\ 
Accordingly, allowing affiliates to elect not to clear swaps that meet 
the requirements of the final rule will result in the affiliates not 
having to pay clearing-related fees, either directly or indirectly, 
with respect to those swaps.
---------------------------------------------------------------------------

    \109\ See CME pricing charts at: http://www.cmegroup.com/trading/cds/files/CDS-Fees.pdf; http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Customer-Fee.pdf; and http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Self-Clearing-Fee.pdf.
    \110\ See LCH pricing for clearing services related to OTC 
interest rate swaps at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.
    \111\ See discussion of clearing fees in the Clearing 
Requirement Determination, 77 FR 74324-25.
---------------------------------------------------------------------------

    Second, permitting an exemption from clearing for swaps between 
affiliates, the final rule will reduce the amount of initial margin 
that such entities are required to post or pay for those swaps. In the 
clearing requirement determination, the Commission estimated that if 
every interest rate swap and CDS that is not currently cleared were 
moved into clearing, the additional initial margin that would need to 
be posted is approximately $19.2 billion for interest rate swaps and 
$53 billion for CDS.\112\ While the estimates provided by the 
Commission in its clearing requirement determination adopting release 
did not include data related to inter-affiliate swaps,\113\ the 
estimates do support a conclusion that the exemption will reduce the 
amount of margin that affiliates would be obligated to allocate to 
initial margin in order to clear inter-affiliate swaps that are subject 
to the clearing requirement. As a consequence, the exemption is likely 
to increase the amount of capital that affiliates may distribute to 
their owners or put to other uses.
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    \112\ See Clearing Requirement Determination at 74326 
(explaining how this estimate was reached and noting that the 
estimate may either over-estimate or under-estimate the amount of 
additional initial margin that would need to be posted).
    \113\ For example, swap data collected by the Bank of 
International Settlements (BIS) does not contain information 
regarding transactions between affiliates (i.e., branches and 
subsidiaries) of the same institution. See, e.g., Statistical 
release: OTC derivatives statistics at end-June 2012, Monetary and 
Economic Department, Bank of International Settlements (Nov. 2012), 
available at http://www.bis.org/publ/otc_hy1211.pdf. The Commission 
relied on BIS data in calculating its additional initial margin 
requirements for required clearing of certain interest rate swaps 
and credit default swaps.
---------------------------------------------------------------------------

    Third, by exempting inter-affiliate swaps from required clearing, 
inter-affiliate swaps would not be subject to variation margin 
requirements under a DCO's rules. Exempting inter-affiliate swaps from 
required clearing's variation margin requirements may help affiliates 
and corporate entities as a whole manage their liquidity needs because 
the entities would not have to routinely collateralize losses at the 
DCO. It is also likely to reduce the operational costs that the 
affiliates would otherwise bear in order to manage margin calls and 
associated variation margin payments.
3. Risk Management Benefits of Inter-Affiliate Swaps
    A number of commenters stated that executing swaps with the market 
through one affiliate enables entities to more efficiently and 
effectively manage corporate risk.\114\ In this arrangement, the one 
affiliate engages in inter-affiliate swaps with other affiliated 
entities in order to hedge the risks of those affiliates. The one, 
central affiliate then engages in market-facing swaps to offset the 
risk that it has taken on. Executing swaps through one affiliate may 
enable corporate entities to concentrate their swap and hedging 
expertise and activity within a single affiliate, which reduces 
personnel costs. It also allows the corporation to net various 
positions before facing the market, thus reducing the number of market 
facing swaps, and the attendant fees.
---------------------------------------------------------------------------

    \114\ See, e.g., letters from The Working Group, EEI, and ISDA & 
SIFMA.
---------------------------------------------------------------------------

    Moreover, these affiliate structures may not only reduce costs, but 
certain types of risk for the corporation as well. By concentrating 
personnel with swap and hedging expertise in one affiliate, and running 
inter-affiliate and market facing swap activities through a single 
entity, corporations may reduce the risk of operational errors. Such 
errors can create considerable risk when engaging in large hedging 
transactions. Moreover, the corporation's operational risk may be 
further mitigated by reducing the total number of market facing swaps 
into which the affiliated entities enter.\115\
    Additionally, as stated above and as noted in the NPRM, affiliates 
that are commonly owned internalize a portion of one another's 
risk.\116\ To the extent that affiliated entities internalize one 
another's risk, those entities have an economic incentive to perform on 
their obligations with respect to one another, thus reducing the 
counterparty risk that they bear as a consequence of their swaps with 
one another. However, the qualification ``to the extent that affiliated 
entities internalize one other's risk'' is significant. Two important 
factors limit the degree to which affiliates internalize one another's 
risk. First, if either of the affiliated entities has a portion of 
ownership that is not held in common, then a corresponding portion of 
the risks transferred to that entity will not be borne by the common 
owners, and thus will not be internalized. In other words, a smaller 
common ownership stake will cause less counterparty risk to be 
internalized, and will lessen the incentive affiliates will have to 
perform on their obligations toward one another. Second, as described 
above, there are circumstances in bankruptcy where affiliates do not 
internalize each other's risks, which may also reduce, or

[[Page 21772]]

eliminate, the affiliates' incentives to perform with respect to their 
obligations they have toward one another.\117\
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    \115\ Commenters also asserted that inter-affiliate swaps are 
used in order to assist in tax management and compliance with 
international laws, stating that the exemption would help to 
preserve those benefits. Commenters did not provide sufficient 
information regarding their operations, tax management strategies, 
and international compliance requirements for the Commission to 
evaluate these stated benefits.
    \116\ See NPRM at 50426 and Section II.A.
    \117\ See Section II.A.
---------------------------------------------------------------------------

    Reduced internalization of risk among affiliates may create 
incentives for certain affiliates to use inter-affiliate swaps to shift 
risk to other affiliates in ways that are not necessarily in the best 
interests of minority stakeholders or counterparties to certain 
affiliates. In order to address this concern, the Commission has 
conditioned election of the exemption on several requirements that are 
intended to mitigate the costs created by reduced internalization of 
risk among affiliates, as well as the foregone benefits of required 
clearing.

C. Costs and Benefits of Exemption's Conditions

    The inter-affiliate exemption from required clearing sets forth 
five conditions that must be satisfied in order to elect the exemption: 
(1) Both affiliates must be majority-owned and their financial 
statements must be reported on a consolidated basis; (2) the swap must 
be documented in a written swap trading relationship document; (3) the 
swap must be subject to a centralized risk management program; (4) 
certain information regarding the swap must be reported to an SDR; and 
(5) both affiliates must meet certain conditions with regard to their 
outward-facing swaps. The Commission believes that entities will have 
to incur costs to satisfy these conditions. Those costs may offset some 
of the benefits that would otherwise result from the exemption. 
However, the exemption is permissive, and therefore the Commission also 
believes that an affiliate will elect the exemption only if these costs 
are less than the costs that an affiliate will incur should it decide 
not to elect the exemption. Moreover, as described below, the 
conditions provide certain benefits to the affiliates' counterparties 
and to the public that the Commission believes are essential in order 
to mitigate counterparty credit risk in situations where affiliates do 
not completely internalize each other's risks. Lastly, the Commission 
believes that in some cases entities are already meeting some or all of 
the requirements for electing the exemption, in which cases the 
affiliates would bear less new costs, or no new costs at all, due to 
the conditions.\118\
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    \118\ See, e.g., letters from MetLife and Prudential (explaining 
that it is current business practice to document inter-affiliate 
swaps); letter from EEI (explaining that inter-affiliate swaps are 
subject to risk management).
---------------------------------------------------------------------------

1. Eligible Affiliate Counterparty Status
    In order to qualify as an eligible affiliate counterparty under the 
terms of the exemption, two factors must be met. First, one affiliate 
must directly or indirectly hold a majority ownership interest in the 
other, or a third party must hold a majority ownership interest in 
both. Second, the financial statements of both affiliates are reported 
on a consolidated basis under Generally Accepted Accounting Principles 
(GAAP) or International Financial Reporting Standards (IFRS).
    The Commission anticipates that in a relatively small number of 
cases entities may alter their ownership structures in order to qualify 
for the inter-affiliate exemption's majority-ownership condition. In 
these cases, entities may bear certain legal costs, and in some cases, 
costs associated with negotiations with other owners in the entity. 
These costs could vary significantly, depending on the complexity of 
the entity's existing ownership structure, including the number of 
owners and the alignment or misalignment of their interests. The 
Commission does not have adequate information to determine which 
entities or how many entities may consider altering their ownership 
structure in order to become eligible for the inter-affiliate 
exemption, but notes again that entities would only do this if they 
anticipate that the benefits of the exemption are greater than the 
costs of meeting the qualifying criteria.
    Four commenters supported proposed majority-ownership requirement. 
CDEU commented that the majority-ownership test strikes an appropriate 
balance between ensuring that the rule is not overly broad and 
providing companies with the flexibility to account for differences in 
corporate structures. EEI noted that majority-owned affiliates will 
have strong incentives to internalize one another's risks because the 
failure of one affiliate impacts all affiliates within the corporate 
group. The Working Group generally supported the Commission's 
definition, but stated that inter-affiliate swaps should be 
unconditionally exempt from mandatory clearing when the affiliates are 
consolidated for accounting purposes. MetLife stated that it would 
likely limit inter-affiliate trading to ``commonly-owned'' affiliates, 
but agreed with the flexibility of including majority-owned affiliates.
    Two commenters objected to the proposal and requested the 
Commission require 100% ownership of affiliates. AFR stated that 
permitting such a low level of joint ownership would lead to evasion of 
the clearing requirement through the creation of joint ventures set up 
to enable swap trading between banks without the need to clear the 
swaps. Similarly, Better Markets agreed that only 100% owned affiliates 
should be eligible for the exemption because allowing the exemption for 
the majority owner permits that owner to disregard the views of its 
minority partners and creates an incentive to evade the clearing 
requirement by structuring subsidiary partnerships. Finally, Better 
Markets stated that the majority-ownership standard will result in 
corporate groups transferring price risk and credit risk to different 
locations facilitating interconnectedness and potentially giving rise 
to systemic risk during times of market stress.
    As discussed above, the degree to which one affiliate's risks are 
internalized by another affiliate depends significantly on the 
percentage of common ownership between them. For example, two 
affiliates that are 100% commonly owned are likely to internalize much 
of one another's risk. This creates a strong incentive for affiliates 
to perform on their obligations to one another. Therefore, if the 
Commission were to increase the common ownership requirement above a 
majority stake, it would likely result in affiliate counterparties 
internalizing more of one another's risk with respect to inter-
affiliate swaps in order to qualify for the exemption. This, in turn, 
would provide additional incentives for affiliates to perform on their 
inter-affiliate swap obligations. However, if the Commission were to 
increase the common ownership percentage requirement, it also would 
reduce the number of affiliates that could qualify for, and benefit 
from, the exemption.
    On the other hand, if the Commission lowered the percentage of 
common ownership that is required to be eligible for the exemption 
(i.e., made it 50% or less), it would increase the number of affiliates 
that are eligible for the exception. This lower standard would allow 
affiliates that internalize less of each other's risks and therefore 
have weaker incentives to perform on their obligations to one another 
to qualify for the exemption. Moreover, the absence of a majority 
common ownership requirement could create opportunities for otherwise 
unrelated entities to form joint ventures and transact swaps with one 
another in order to claim the inter-affiliate exemption from clearing, 
which would undermine the effectiveness of the clearing requirement.
    The Commission considered each of these factors and concluded that 
the majority stake requirement is sufficient to internalize costs and 
incentivize affiliates to perform on their obligations

[[Page 21773]]

to one another. The Commission also believes that the potential for 
evasion is mitigated through the conditions to the final rule, which 
have been carefully crafted in order to narrow the exemption. For 
example, two unrelated entities cannot each hold a majority stake in 
the same affiliate. Consequently, such unrelated entities cannot use an 
inter-affiliate swap as an indirect means of trading without being 
subject to the clearing requirement under section 2(h) of the CEA and 
part 50 of the Commission's regulations.
    As an additional consideration, as noted above, the majority 
requirement also harmonizes with Commission's understanding of the EMIR 
requirements. Harmonizing with EMIR is likely to reduce compliance 
monitoring costs for entities electing the affiliated entity exemption. 
In terms of potential costs in the form of disregarding the interests 
of minority shareholders, the Commission recognizes that a 100% 
ownership requirement would eliminate the risk of minority 
shareholders' interests not being aligned with decisions to elect the 
exemption. However, the Commission is also cognizant that such a 
requirement would reduce the number of affiliates that are able to 
claim the exemption. The Commission believes that the majority-
ownership requirement appropriately considers the risk of the former 
and the benefits of the latter.
    With regard to the consolidation of financial statements, FSR 
requested that the Commission clarify that alternative accounting 
standards can be used for purposes of meeting the requirement that the 
financial statements of both affiliates be reported on a consolidated 
basis. The Commission considered this comment and is adopting the 
alternative suggested by FSR. As modified the rule requires that the 
financial statements of both counterparties be reported on a 
consolidated basis under GAAP or IFRS. This change recognizes the fact 
that some entities claiming the exemption may report their financial 
statements under different accounting standards, and makes it possible 
for those entities to elect the exemption as long as they would be 
required to report their financial statements on a consolidated basis 
under GAAP or IFRS. This likely increases the number of entities that 
may elect the exemption relative to the form of the rule proposed in 
the NPRM while maintaining the protections that were intended with the 
requirement for consolidated financial statements. The Commission also 
modified the rule to clarify which entities are subject to the 
consolidated financial statement requirement.
2. Inter-Affiliate Swap Documentation
    As proposed, the inter-affiliate exemption required that eligible 
affiliate counterparties that elect the inter-affiliate exemption must 
enter into swaps with a swap trading relationship document that is in 
writing and includes all the terms governing the relationship between 
the affiliates. These terms included, but were not limited to, payment 
obligations, netting of payments, transfer of rights and obligations, 
governing law, valuation, and dispute resolution. This requirement 
would be satisfied if an eligible affiliate counterparty is an SD or 
MSP that complies with the swap trading relationship documentation 
requirements of Sec.  23.504.\119\
---------------------------------------------------------------------------

    \119\ For a discussion of the costs and benefits incurred by 
swap dealers and major swap participants that must satisfy 
requirements under Sec.  23.504, see Confirmation, Portfolio 
Reconciliation, Portfolio Compression, and Swap Trading Relationship 
Documentation Requirements for Swap Dealers and Major Swap 
Participants, 77 FR 55904, 55906 (Sept. 11, 2012) (final rule) and 
Swap Trading Relationship Documentation Requirements for Swap 
Dealers and Major Swap Participants, 76 FR 6715, 6724-25 (Feb. 8, 
2011) (proposed rule).
---------------------------------------------------------------------------

    The Commission received a number of comments both supporting and 
opposing the swap documentation requirement. Better Markets, MetLife, 
and Prudential all supported the proposed documentation requirement. 
Specifically, MetLife and Prudential did not believe that the 
documentation requirement would be any more ``burdensome or costly'' 
for them because they already document all of their swaps.
    Cravath, EEI, CDEU, and DLA Piper opposed the proposed 
documentation requirement. Cravath stated that the costs associated 
with the imposition of documentation requirements outweigh any benefits 
to the financial system, and that the Commission should leave the 
determination as to the appropriate level of documentation to boards of 
directors and management of companies, to determine based on the 
``reasonable exercise of their fiduciary responsibilities.'' DLA Piper 
commented that the documentation requirements are burdensome and 
questioned the benefits of imposing documentation requirements on 
transactions between two parties.
    CDEU expressed concern that proposed documentation condition would 
require that full ISDA Master Agreements be used to document inter-
affiliate swaps. CDEU explained that while many market participants use 
master agreements, some end users many not have full master agreements 
because inter-affiliate swaps are purely internal and do not increase 
systemic risk. CDEU recommended that the proposed rule be revised to 
require that the swap documentation ``include all terms necessary for 
compliance with its centralized risk management program'' and eliminate 
the list of required terms. CDEU also requested that the Commission 
clarify that (1) market participants can continue to use documentation 
required by their risk management programs and (2) the rule does not 
require market participants use ISDA Master Agreements.
    EEI recommended that the Commission eliminate the documentation 
requirement because the requirement is duplicative of corporate 
accounting records that affiliates currently maintain. EEI commented 
that a documentation requirement imposes ``an additional, costly layer 
of ministerial process and documentation that is unnecessary to achieve 
the Commission's stated objectives.'' EEI commented on the NPRM's 
consideration of costs and benefits and stated that the costs of the 
proposed documentation requirement are unjustified. The NPRM included 
an estimate that there would be a one-time cost of $15,000 to develop 
appropriate documentation for use by an entity's affiliates. EEI 
objected to this estimate because, in its view, the legal costs 
associated with individually negotiating and amending standard 
agreements between individual affiliates would exceed the NPRM's 
estimates. In addition, EEI objected to the NPRM's estimate of 22 
affiliated counterparties for each corporate group as ``far too low'' 
for U.S. energy companies.\120\ However, EEI did not provide specific, 
quantitative information in terms of either the legal costs of 
complying with the proposed documentation requirement or number of 
affiliates for a corporate group subject to this rule. Accordingly, the 
Commission is unable to verify whether the legal costs or average 
number of affiliates estimates are too low.
---------------------------------------------------------------------------

    \120\ This estimate appeared in the NPRM section regarding the 
Paperwork Reduction Act not in the consideration of costs and 
benefits section.
---------------------------------------------------------------------------

    ISDA & SIFMA stated that the documentation requirements were overly 
prescriptive and would impose unnecessary costs on affiliates. ISDA & 
SIFMA recommended a more flexible approach that would require adequate 
documentation of ``all transaction terms under applicable law.''
    In response to commenters' requests for a more flexible standard, 
the Commission modified the proposal for swaps between affiliates that 
are not

[[Page 21774]]

SDs or MSPs. The Commission adopted ISDA & SIFMA's recommendation that 
the focus of the documentation requirement be on documenting all of an 
inter-affiliate transaction's terms.\121\
---------------------------------------------------------------------------

    \121\ The Commission is modifying the documentation condition to 
require that ``the terms of the swap are documented in a swap 
trading relationship document that shall be in writing and shall 
include all terms governing the trading relationship between the 
affiliates.''
---------------------------------------------------------------------------

    Under this modification, the Commission is eliminating the non-
exclusive list of terms, which included payment obligations, netting of 
payments, transfer of rights and obligations, governing law, valuation, 
and dispute resolution. The change responds to commenters' requests for 
a more flexible approach that reflects current market best practices, 
and signals that market participants retain the ability to craft 
appropriate documentation for their affiliated entities so long as such 
documentation includes the terms of the swap and ``all terms governing 
the trading relationship between the eligible affiliate 
counterparties.'' \122\ This modification also serves to address 
concerns that the intent of the proposed rule was to require formal 
master agreements, such as the ISDA Master Agreement.\123\ The proposed 
rule was not intended to require affiliates to enter into formal master 
agreements. Rather, the Commission observed that parties that already 
use master agreements (of any sort) to document their inter-affiliate 
swaps would likely meet the requirements of the proposed rule without 
additional costs. This observation was supported by commenters such as 
MetLife and Prudential. The Commission believes that these 
modifications to the proposal and clarifications respond to commenters' 
concerns and will serve to reduce documentation costs for those 
electing the inter-affiliate exemption.\124\
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    \122\ See Sec.  50.52(b)(2)(ii).
    \123\ In the NPRM, the Commission estimated that affiliates 
could pay a law firm for up to 30 hours of work at $495 per hour to 
modify an ISDA Master Agreement, resulting in a one-time cost of 
$15,000, and there may be additional costs related to revising 
documentation to address a particular swap. All salaries in these 
calculations are taken from the 2011 SIFMA Report on Management and 
Professional Earnings in the Securities Industry. Annual wages were 
converted to hourly wages assuming 1,800 work hours per year and 
then multiplying by 5.35 to account for bonuses, firm size, employee 
benefits and overhead. The Commission also estimated that affiliates 
would incur costs of less than $1,000 per year related to signing 
swap documents and retaining copies.
    \124\ In response to comments from Better Markets and AFR that 
the proposed regulations should be retained and not weakened, the 
Commission does not believe that eliminating the non-exclusive list 
of terms and replacing it with a simple requirement that all terms 
of the swap transaction and the relationship between the affiliates 
be documented will weaken the rule. Rather, while affiliates will 
have discretion to select the appropriate terms to document their 
swap, they will still have an obligation to ensure that their 
documentation contains an accurate and thorough written record of 
their swaps. In most instances, this will necessarily include all of 
the previously enumerated terms.
---------------------------------------------------------------------------

    Entities that have already established systems for documenting the 
terms of their inter-affiliate swaps and all the terms of the trading 
relationship between eligible affiliates will not bear any costs as a 
consequence of this requirement.\125\ However, as noted in the NPRM, 
the Commission understands that some affiliates may enter into inter-
affiliate swaps with little documentation regarding the terms of the 
swaps.\126\ Such entities may not have systems to document the terms of 
their inter-affiliate swaps or all the terms of the trading 
relationship between eligible affiliates. They will bear some initial 
costs and ongoing costs in order to comply with this requirement. In 
the NPRM, the Commission estimated that the initial costs of up to 
$15,000 to create such the necessary documentation, and less than 
$1,000 per year on an ongoing basis to sign and retain appropriate 
documentation.\127\
---------------------------------------------------------------------------

    \125\ See comments letters from MetLife and Prudential.
    \126\ See NPRM at 50428-50429.
    \127\ See id. at 50434.
---------------------------------------------------------------------------

    In response to EEI's comment regarding duplicative requirements, to 
the extent that the documentation requirement is duplicative of an 
affiliate's existing recordkeeping practices, it will not introduce new 
costs. However, the Commission notes that if existing records do not 
contain the terms of each inter-affiliate swap or all the terms of the 
trading relationship between affiliates, affiliates will be required to 
implement new documentation that creates incremental costs, as noted 
above.
    Regarding benefits, documentation of inter-affiliate swaps is 
essential to effective risk management. In the absence of such 
documentation, affiliates cannot track or value their swaps 
effectively. Documentation also helps ensure that affiliates have proof 
of claim in the event of bankruptcy. As explained earlier, insufficient 
proof of claim could create challenges and uncertainty at bankruptcy 
that could adversely affect affiliates and third party creditors. The 
documentation requirement, to the extent that it requires entities to 
document all the terms that are necessary in order to value inter-
affiliate swaps and to provide legal certainty in the event of 
bankruptcy, will promote effective risk management and resolution of 
claims in the event of insolvency.\128\
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    \128\ As discussed in Section II.D above, the Commission expects 
that, in most instances, documentation between affiliates will 
include all of the previously enumerated terms, several of which are 
essential to effective valuation of swaps and resolution in 
bankruptcy. However, the Commission notes that a more flexible 
approach makes it possible that some entities could document the 
terms of their inter-affiliate swaps and all the terms of their 
trading relationship without covering all of the terms that are 
necessary for effective valuation or resolution in bankruptcy. If 
this occurs, it would reduce the risk management and bankruptcy 
benefits created by the documentation requirement.
---------------------------------------------------------------------------

3. Centralized Risk Management
    Another condition of the inter-affiliate exemption requires that 
the swap be subject to a centralized risk management program that is 
``reasonably designed to monitor and manage the risks associated with 
the swap.'' If at least one of the eligible affiliate counterparties is 
an SD or MSP, the centralized risk management requirement is satisfied 
by complying with the requirements of Sec.  23.600.\129\
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    \129\ For a discussion of the costs and benefits incurred by 
swap dealers and major swap participants that must satisfy 
requirements under Sec.  23.600, see 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, 77 FR 20173-75.
---------------------------------------------------------------------------

    Four commenters objected to the proposed requirement, suggested 
alternatives, and/or requested clarification. FSR stated that the 
condition should be eliminated because integrated risk management 
systems ``are generally not established across international 
boundaries'' and are not consistent with general risk practices in 
large, multinational organizations. FSR suggested that the requirement 
be dropped in favor of each entity making ``its own evaluations of the 
risk associated with an inter-affiliate position.''
    Cravath stated that in many cases, for companies outside of the 
financial sector, the proposed rule will require a substantial change 
in the processes and procedures currently maintained by such companies, 
and the cost of complying with the risk management program requirements 
outweigh any benefits to the financial system. Cravath commented that 
rather than subject companies to a risk management rule, ``[c]ompanies 
should have the flexibility to engage in prudent risk management for 
their corporate group in a manner consistent with the overall level of 
risks to their business.''
    EEI suggested that the Commission eliminate the centralized risk

[[Page 21775]]

management program requirement on the grounds that it would be 
duplicative for corporate groups that already have risk management 
programs in place. According to EEI, it is standard industry practice 
for both private and public companies to have a risk management 
program. EEI accordingly does not see a ``need to impose a separate, 
discrete regulatory requirement to document with an SDR or the 
Commission the existence of a centralized risk management program.'' If 
the Commission decides to retain the requirement, EEI requested that 
the Commission require a program be ``reasonably designed to monitor 
and manage the risks associated with the swap'' and provide the 
flexibility to design risk management programs that address the unique 
risks of an entity's business.
    The Working Group requested that the Commission clarify whether 
non-SDs and non-MSPs would be subject to the same enterprise-level risk 
management program as required for SDs and MSPs under Sec.  23.600. The 
Working Group proposed that the Commission require ``a robust risk 
management program'' rather than ``a centralized risk management 
program.''
    In response to comments asking that the Commission clarify the 
level of risk management required for non-SDs and non-MSPs, the 
Commission confirms that the risk management condition is intended to 
be flexible and does not require the same level of policies and 
procedures as required under Sec.  23.600 for SDs and MSPs. Under the 
rule, a company would be free to structure its centralized risk 
management program according to its unique needs, provided that the 
program reasonably monitors and manages the risks associated with its 
uncleared inter-affiliate swaps. In all likelihood, if a corporate 
group has a centralized risk management program in place that 
reasonably monitors and manages the risk associated with its inter-
affiliate swaps as part of current industry practice, it is likely that 
the program would fulfill the requirements of exemption and therefore 
the exemption would not create new costs in such cases.
    Given that a number of commenters stated that it is common practice 
for market participants, including end users, to have risk management 
programs in place,\130\ expects that the majority of companies with 
eligible affiliates will not have to create centralized risk management 
programs from scratch in order to meet the eligibility requirements for 
the exemption. Those with existing systems may need to make some 
changes in order to centralize them, but the Commission has provided 
significant flexibility to companies in determining the specific 
contours of the centralized risk management system. Given this 
flexibility, and the fact that it is common practice for market 
participants to have risk management programs in place, the Commission 
is not persuaded by Cravath's comment that the rule will require a 
substantial change in the processes and procedures currently maintained 
by companies to manage risk. Accordingly, costs will be limited where 
an entity only needs to make modifications to existing risk management 
programs. Moreover, a corporate group may not have to incur any costs 
if it already has in place a risk management system that meets the 
requirements of the inter-affiliate exemption.
---------------------------------------------------------------------------

    \130\ See, e.g., letters from Prudential, MetLife, and CDEU.
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    The Commission also declined to modify the requirement to state ``a 
robust risk management program'' rather than ``a centralized risk 
management program.'' While change proposed by the Working Group may 
prevent certain entities from having to reorganize their risk 
management program in order to meet the requirements of the inter-
affiliate exemption, it could also significantly reduce the ability of 
the risk management program to mitigate counterparty risk among 
affiliates. In the absence of variation margin, or clearing to mitigate 
counterparty credit risk among affiliates, risk management committees 
must have a clear line of sight into the financial health and 
obligations of each affiliate involved in inter-affiliate swaps.
    In the NPRM, the Commission explained that some affiliates may have 
to create a risk management system to meet the risk management 
condition.\131\ The Commission itemized a number of specific costs, 
including the purchase of equipment and software to adequately evaluate 
and measure inter-affiliate swap risk.\132\ In addition, in the NPRM, 
the Commission estimated that centralized risk management could require 
up to ten full-time staff at an average salary of $150,000 per 
year.\133\ The Commission received no comments in response to its risk 
management condition cost estimates.
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    \131\ As pointed out above, industry commenters underscored the 
fact that many corporate groups that currently use inter-affiliate 
swaps have centralized-risk-management procedures in place.
    \132\ See NPRM at 50434 (estimating such costs to be as high as 
$150,000 for purchasing a computer network at approximately $20,000; 
purchasing personal computers and monitors for 15 staff members at 
approximately $30,000; purchasing software at approximately $20,000; 
purchasing other office equipment, such as printers, at 
approximately $5,000; and installation and unexpected costs that 
could increase up-front costs).
    \133\ This average annual salary is based on 15 senior credit 
risk analysts only. The Commission appreciates that an affiliate 
would likely choose to employ different positions as well, such as 
risk management specialists at $130,000 per year, and computer 
supervisors at $140,000. But for the purposes of this estimate, the 
Commission has assumed salaries at the high end for risk management 
professionals. The Commission also estimated a data subscription for 
price and other market data may have to be purchased at cost of up 
to $100,000 per year.
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    There are benefits that derive from the centralized-risk management 
condition. The Commission expects that centralized risk management 
programs will establish appropriate measurements and procedures to 
monitor the amount of risk that each individual affiliate bears, and to 
monitor the condition of each entity's affiliate counterparties. 
Because a centralized risk management program is more likely to have a 
clear line of sight into the financial condition of all affiliated 
entities, it is better positioned to manage each affiliate's exposure 
to the counterparty risk of other affiliates than a risk management 
program situated inside any single affiliate. As a consequence, 
centralized risk management programs may reduce the likelihood that 
individual affiliates could become insolvent because of their exposure 
to other affiliates, which not only benefits the affiliates, but their 
third party counterparties as well.
4. Reporting to an SDR
    Another condition of electing the inter-affiliate exemption is that 
certain information about the swap and the election of the exemption be 
reported to an SDR. The reporting condition requires affiliates to 
report specific information to an SDR, or to the Commission if no SDR 
is available. Such information includes a notice that both affiliates 
are electing the exemption and that they both meet the other conditions 
of exemption, as well as information regarding how the financial 
obligations of both affiliates are generally satisfied with respect to 
uncleared swaps. The final rule also requires reporting certain 
information if the affiliate is an SEC filer.
    The Commission received several comments in response to the 
reporting obligations of affiliates. Prudential and MetLife both 
commented that the Commission should clarify that only one counterparty 
is required to report the swap to an SDR. EEI stated that the 
Commission should eliminate the transaction-by-transaction reporting

[[Page 21776]]

requirement for the election of the exemption and confirmation that the 
conditions have the exemption have been met. Instead, EEI recommended 
that one of the affiliates be permitted to file an annual notice on 
behalf of both affiliates to exempt all of their swaps from clearing 
for an entire year. EEI contended that it will increase costs if both 
affiliates have to communicate that they elect not to clear the swap 
and meet the conditions of the exemption for each swap.\134\ CDEU also 
objected to reporting any information to an SDR on a trade-by-trade 
basis for inter-affiliate swaps as such reporting would be costly and 
onerous for parties. Instead, CDEU recommended that all reporting be 
done on an annual basis through a board resolution.
---------------------------------------------------------------------------

    \134\ EEI also commented that the Commission should state that 
part 45 does not apply to inter-affiliate swaps because the 
Commission will be able to obtain information regarding an inter-
affiliate transaction based on reporting of a corresponding market-
facing swap. EEI cited to a statement in the NPRM's consideration of 
costs and benefits as support for an argument that the Commission 
did not intend for part 45 reporting to apply to inter-affiliate 
swaps. See NPRM at 50433. As explained above, the statement in the 
cost-benefit consideration of the NPRM merely drew a comparison 
between the reporting requirements under the proposed exemption and 
the general reporting requirements under parts 45 and 46, and those 
reporting requirements applicable to SDs and MSPs under part 23. The 
statement should not be read as calling into question the 
applicability of part 45 to inter-affiliate swaps.
---------------------------------------------------------------------------

    In response to commenters' requests, the Commission clarified that 
the reporting condition can be fulfilled by one of the affiliate 
counterparties on behalf of both counterparties. As noted in the NPRM, 
the Commission believes that affiliates within a corporate group may 
make independent determinations on whether to submit an inter-affiliate 
swap for clearing. Given the possibility that each affiliate may reach 
different conclusions regarding clearing the swap, the final rule 
requires that both counterparties elect the proposed inter-affiliate 
clearing exemption.
    DLA Piper commented that corporate groups do not maintain back-
office systems necessary to keep the level of detail required under 
parts 45 and 46 with respect to their inter-company swaps. DLA Piper 
further commented that many corporate groups will need to develop 
costly systems and procedures, which will increase their hedging costs, 
in order to comply with the reporting rules. The Commission observes 
that the costs of parts 45 and 46 reporting have been addressed in 
prior rulemakings and are beyond the scope of this rule.
    With regard to comments recommending that all reporting be done on 
an annual basis rather than a swap-by-swap basis, the Commission 
declines to modify the rule. The Commission believes it is appropriate 
to provide for annual reporting of certain information, including how 
affiliates generally meet their financial obligations and information 
related to its status as an electing SEC Filer. However, it would not 
be sufficient to allow one annual report to cover both affiliate 
counterparties' election of the exemption from clearing and the 
confirmation that both affiliates meet the conditions of the exemption.
    Eligible affiliates may choose to elect or not elect the exemption 
on a swap-by-swap basis. As noted above, whether a swap is cleared or 
not has a significant impact on its ability to transfer credit risk 
from one entity to another. Regulators must know which swaps are 
cleared and which swaps are not cleared in order to monitor potential 
accumulations and transfers of risk within the financial system. In 
addition, they must know which exemption is being used to exempt 
certain swaps in order to monitor the use of each exemption and its 
possible effect on systemic risk. Consequently, the election of the 
exemption and the confirmation that the exemption's conditions are met 
must be made for each swap.
    The Commission does not believe that this reporting requirement 
will impose a significant burden on affiliate counterparties because, 
as discussed above, other detailed information for every swap must be 
reported under sections 2(a)(13) and 4r of the CEA and Commission 
regulations. This approach comports with the approach adopted for 
market participants claiming the end-user exception under section 
2(h)(7) of the CEA.\135\
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    \135\ See End-User Exception to the Clearing Requirement for 
Swaps, 77 FR 42565-66.
---------------------------------------------------------------------------

    In the NPRM, the Commission estimated specific costs for the 
reporting condition, including entering a notice of election into the 
reporting system.\136\ Cost estimates in the NPRM also included costs 
of identifying how the affiliates expect to meet the financial 
obligations associated with their uncleared swap and providing 
information if either electing affiliate is an SEC Filer.\137\ The 
Commission also estimated costs for entities to modify their reporting 
systems to accommodate the additional data fields required by this 
rule.\138\ The Commission also estimated costs for non-reporting 
affiliates.\139\ Finally, in the NPRM, the Commission explained that 
SDRs would bear costs associated with the reporting conditions insofar 
as SDRs would be required to add or edit reporting data fields to 
accommodate information reported by affiliates electing the inter-
affiliate clearing exemption.\140\ The Commission received no comments 
in response to its cost estimates for the reporting condition.
---------------------------------------------------------------------------

    \136\ The NPRM at 50435, included an estimate that each 
counterparty may spend 15 seconds to two minutes per swap entering a 
notice of election of the exemption into the reporting system. The 
hourly wage for a compliance attorney is $390, resulting in a per 
transaction cost of $1.63-$13.00.
    \137\ See NPRM at 50435. Affiliates may decide to report 
financial obligation information and SEC Filer information on either 
a swap-by-swap or annual basis, and the costs would vary depending 
on the reporting frequency. Regarding the financial obligation 
information, the Commission estimated in the NPRM that it may take 
the reporting counterparty up to 10 minutes to collect and submit 
the information for the first transaction, and one to five minutes 
to collect and submit the information for subsequent transactions 
with that same counterparty. The hourly wage for a compliance 
attorney is $390 resulting in a cost of $65.00 for reporting the 
first inter-affiliate swap, and a cost range of $6.50-$32.50 for 
reporting subsequent inter-affiliate swaps.
    \138\ See id. (estimating that such modifications would create a 
one-time programming expense of approximately one to ten burden 
hours per affiliate, which means a one-time, per entity cost ranging 
from $341 and $3,410).
    \139\ See id. (noting that costs would likely vary substantially 
depending on how frequently the affiliate enters into swaps, whether 
the affiliate undertakes an annual filing, and the due diligence 
that the reporting counterparty chooses to conduct, but estimating 
that a non-reporting affiliate would incur annually between five 
minutes and ten hours of compliance attorney time to communicate 
information to the reporting counterparty, translating to an 
aggregate annual cost for communicating information to the reporting 
counterparty of between $33 to $3,900). See also, id. (noting that 
an annual filing option may be less costly than swap-by-swap 
reporting and estimating that such an option would take an average 
of 30 to 90 minutes, translating to an aggregate annual cost for 
submitting the annual report of between $195 to $585).
    \140\ See generally, Swap Data Recordkeeping and Reporting 
Requirements, 77 FR 2176-2193 (for costs and benefits incurred by 
SDRs). To the extent that no SDR is available to accept this data, 
the costs would fall to the Commission.
---------------------------------------------------------------------------

    The benefits of the reporting condition include enhancing the level 
of transparency associated with inter-affiliate swaps activity, thereby 
affording the Commission new insights into the practices of affiliates 
that engage in inter-affiliate swaps, and helping the Commission and 
other appropriate regulators identify emerging or potential risks. As 
noted above, regulators must know whether swaps are cleared or 
uncleared in order to use swap data to monitor emerging risks. In 
short, the overall benefit of reporting would be a greater body of 
information for the Commission to analyze with the goal of identifying 
and reducing systemic risk.\141\
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    \141\ The Commission received no comments in response to its 
cost estimates for the reporting condition.

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[[Page 21777]]

5. Treatment of Outward-Facing Swaps
    The final condition imposed on the inter-affiliate exemption from 
required clearing relates to the treatment of outward-facing swaps 
entered into by the two eligible affiliate counterparties to the inter-
affiliate swap. As proposed, the condition required that each affiliate 
counterparty either: (i) Is located in the United States; (ii) is 
located in a jurisdiction with a clearing requirement that is 
comparable and comprehensive to the clearing requirement in the United 
States; (iii) is required to clear swaps with non-affiliated parties in 
compliance with U.S. law; or (iv) does not enter into swaps with non-
affiliated parties.
    The Commission received a number of comments in support of and 
opposed to this proposed condition, but did not receive any comments 
quantifying the costs or benefits of the proposed condition. AFR 
supported the proposal and stated that inter-affiliate swaps could, 
without appropriate restrictions, bring risk back to the U.S. from 
foreign affiliates. AFR commented that an inter-affiliate swap might be 
used to move parts of the U.S. swaps market outside of U.S. regulatory 
oversight by transferring risk to jurisdictions with little or no 
regulatory oversight, whereby a non-U.S. affiliate of a U.S. entity 
could enter into an outward-facing swap. AFR stated that an inter-
affiliate swap could contribute to financial contagion across different 
groups within a complex financial institution, making it more difficult 
to ``ring-fence'' risks in one part of an organization. AFR further 
commented that laws and regulations of a foreign country might prevent 
U.S. counterparties to swaps from having access to the financial 
resources of an affiliate in the event of a bankruptcy or insolvency. 
Better Markets also supported the proposed treatment of outward-facing 
swaps condition.
    In opposition to the proposed condition, CDEU commented that the 
proposed ``comparable and comprehensive'' condition is not necessary or 
appropriate to reduce risk and prevent evasion because, according to 
CDEU, transactions between affiliates do not increase systemic risk, 
regardless of the location of the affiliate. ISDA & SIFMA stated that 
the concern that foreign inter-affiliate swaps pose risk to the U.S. 
financial system is unfounded because internal swaps have no conclusive 
effect on systemic risk.\142\
---------------------------------------------------------------------------

    \142\ Other commenters, including The Working Group and FSR also 
opposed the condition regarding treatment of outward-facing swaps. 
See Section II.G above.
---------------------------------------------------------------------------

    The Commission considered each of these comments and decided to 
adopt the treatment of outward-facing swaps condition, with certain 
important modifications, because the Commission believes that the risk 
of evasion of the U.S. clearing requirement and the potential systemic 
risk associated with uncleared inter-affiliate swaps involving foreign 
affiliates and non-affiliated counterparties necessitates that the 
inter-affiliate exemption include such a condition. As modified, the 
final rule requires that each eligible affiliate counterparty must 
clear all swaps that it enters into with third parties to the extent 
that the swap is subject to the Commission's clearing requirement. In 
order to satisfy this requirement, eligible affiliates may clear their 
third-party swaps pursuant to the Commission's clearing requirement or 
comply with the requirements for clearing the swap under a foreign 
jurisdiction's clearing mandate that is comparable to, and as 
comprehensive as, the clearing requirement of section 2(h) of the Act 
and part 50 of the Commission's regulations, as determined by the 
Commission. In addition, the Commission modified the condition to allow 
for recognition of clearing exemptions and exceptions under the CEA and 
an exception or exemption under a comparable foreign jurisdiction's 
clearing mandate that is comparable to an exception or exemption under 
section 2(h)(7) of the CEA or part 50. For entities that are not in a 
jurisdiction with a clearing requirement that is comparable to, and as 
comprehensive as, the clearing mandate in 2(h) of the Act, they may 
comply by clearing swaps with unaffiliated counterparties through a 
registered DCO or clearing organization that is subject to supervision 
by appropriate government authorities in the home country of the 
clearing organization and has been assessed to be in compliance with 
the PFMIs.
    The Commission believes that this modification will provide greater 
clarity and transparency by more clearly establishing the conditions to 
the exemption and alternative methods by which eligible affiliates may 
satisfy the requirements. In addition, the Commission considered the 
approach adopted in EMIR.\143\ To the extent there is consistency with 
the international authorities, including the European Union, the 
likelihood of regulatory arbitrage is reduced. Regulatory arbitrage can 
impose high costs in terms of market efficiency.
---------------------------------------------------------------------------

    \143\ See Section II.G above.
---------------------------------------------------------------------------

    As AFR noted, without appropriate restrictions, inter-affiliate 
swaps could transfer risk back to the United States from foreign 
affiliates. The final rule takes steps to mitigate this risk insofar as 
the intent of the condition on outward-facing swaps is to narrow the 
exemption such that the risk of a cascading series of defaults among 
unrelated entities is reduced.
    For companies whose inter-affiliate swap activities are conducted 
exclusively through entities in the United States and jurisdictions 
with clearing mandates that are comparable to, and as comprehensive as, 
the clearing requirement of section 2(h) of the CEA, all outward-facing 
swaps that fall under a Sec.  50.4 class will be subject to required 
clearing,\144\ which will serve as a buffer to the spread of credit 
risk from one corporation to another through those swaps, thus reducing 
the risk of financial contagion. Affiliates that meet the conditions of 
the inter-affiliate exemption will be able to transfer risk from one 
affiliate to the other without clearing those swaps, but third parties 
that enter into swaps that are required to be cleared with either of 
those affiliates will continue to be protected by clearing requirement.
---------------------------------------------------------------------------

    \144\ In these jurisdictions, outward-facing swaps that are not 
subject to required clearing may be subject to margin requirements, 
which can serve to mitigate counterparty credit risk.
---------------------------------------------------------------------------

    For companies whose inter-affiliate swap activities extend to 
countries without clearing mandates that are comparable to, and as 
comprehensive as, the clearing requirement of section 2(h) of the CEA, 
the requirements of the rule mitigate counterparty risk associated with 
swaps that are required to be cleared under Sec.  50.4 by requiring 
those swaps to be cleared at a DCO or a clearing organization that is 
subject to supervision by appropriate government authorities and that 
is in compliance with the PFMIs. In this manner, swaps that the 
Commission has determined must be cleared cannot be used as a means of 
transferring financial risk among unaffiliated entities where one of 
the counterparties is also claiming an exemption from required clearing 
under this inter-affiliate exemption. However, the Commission observes 
that outward-facing swaps that are not required to be cleared under 
Sec.  50.4 and that are entered into between unrelated entities in a 
jurisdiction without comparable margin requirements, may be a means 
through which financial risk could be passed between unaffiliated 
entities without the protection of required clearing, creating the 
possibility of

[[Page 21778]]

financial contagion.\145\ It is possible that such contagion could then 
be transferred back to the United States or other jurisdictions through 
inter-affiliate swaps, creating potential costs for the public.\146\ 
The Commission notes, however, that this is only a concern to the 
extent that affiliates in such jurisdictions enter into outward-facing 
swaps that are not required to be cleared under Sec.  50.4 in order to 
meet their needs.
---------------------------------------------------------------------------

    \145\ This risk may be mitigated if such swaps were subject to 
bilateral margining.
    \146\ Not only is there the possibility of risk transfer but 
also a potential inability for regulators to monitor the risks that 
are capable of being transferred.
---------------------------------------------------------------------------

    The Commission does not agree with CDEU's assertion that 
transactions between affiliates do not increase systemic risk, 
regardless of the location of the affiliate, or with ISDA & SIFMA's 
comment that the concern that foreign inter-affiliate swaps pose risk 
to the U.S. financial system is unfounded. As noted above, in the 
absence of any restrictions on outward-facing swaps, inter-affiliate 
swaps could be used to transfer risk to jurisdictions without clearing 
requirements or margin requirements for uncleared swaps. Risk could 
then be transferred between unrelated entities without the protection 
of clearing or margin requirements to mitigate the risk of financial 
contagion spreading from one to the other.
    In addition to the modifications to the treatment of outward-facing 
swaps condition described above, the Commission also accepted 
commenter's suggestions and is providing a transition period with two 
alternative compliance frameworks for eligible affiliates domiciled in 
certain foreign jurisdictions that have the legal authority to 
implement mandatory clearing regimes. As noted above, ISDA & SIFMA and 
CDEU stated that questions of timing and criteria for comparability 
render the proposed treatment of outward-facing swaps condition 
problematic, and that unless the condition is satisfactorily resolved, 
the condition could hamper the ability of U.S.-based groups to compete 
in foreign markets. ISDA & SIFMA further commented that if the 
Commission retains the cross-border requirements, the Commission should 
provide an appropriate transition period in order to allow foreign 
jurisdictions to implement their own G-20 mandates. The Commission is 
adopting two alternative compliance frameworks in response to concerns 
raised by commenters pertaining to the timing and sequencing of the 
implementation of the inter-affiliate exemption.
    The Commission is adopting a time-limited alternative compliance 
framework, available until March 11, 2014, for certain eligible 
affiliates transacting swaps with affiliated counterparties located in 
the European Union, Japan, or Singapore. The alternative compliance 
framework will allow affiliated counterparties, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, to pay and collect full variation margin 
daily on all swaps entered into between affiliates or between an 
affiliate and its unaffiliated counterparties, rather than submitting 
such swaps for clearing. In addition, the Commission has determined to 
provide time-limited relief for certain eligible affiliated 
counterparties located in the European Union, Japan, or Singapore from 
complying with the requirements of Sec.  50.52(b)(4)(i) as a condition 
of electing the inter-affiliate exemption. In particular, Sec.  
50.52(b)(4)(ii)(B) provides that if one of the eligible affiliate 
counterparties is located in the European Union, Japan, or Singapore, 
the requirements of paragraph (b)(4)(i) will not apply to such eligible 
affiliate counterparty until March 11, 2014, provided that: (1) The one 
counterparty that directly or indirectly holds a majority ownership 
interest in the other counterparty or the third party that directly or 
indirectly holds a majority ownership interest in both counterparties 
is not a ``financial entity'' as defined in section 2(h)(7)(C)(i) of 
the Act, and (2) neither eligible affiliate counterparty is affiliated 
with an entity that is a swap dealer or major swap participant, as 
defined in Sec.  1.3.
    Another time-limited alternative compliance framework also will be 
available for eligible affiliates transacting swaps with affiliated 
counterparties located outside the European Union, Japan, and 
Singapore, as long as the aggregate notional value of such swaps, which 
are included in a class of swaps identified in Sec.  50.4, does not 
exceed five percent of the aggregate notional value of all swaps, which 
are included in a class of swaps identified in Sec.  50.4, in each 
instance the notional value as measured in U.S. dollar equivalents and 
calculated for each calendar quarter, entered into by the eligible 
affiliate counterparty located in the United States.
    These alternative compliance frameworks will mitigate the 
competitive effects that ISDA & SIFMA and CDEU noted by allowing 
certain entities to collect variation margin rather than clearing such 
swaps until March 11, 2014. The Commission expects that collecting full 
variation margin is likely to be less costly than clearing because the 
latter includes initial margin in addition to variation margin, as well 
as clearing fees. To the extent that the alternative compliance 
approach is less costly, it will reduce the competitive effects that 
foreign affiliates experience during the period of time when comparable 
clearing requirements do not yet exist for competitors operating in 
foreign jurisdictions.
    The time-limited alternative compliance frameworks may, 
nevertheless, have some temporary competitive effects in the market. 
Companies with foreign affiliates that are required to pay and collect 
variation margin daily on all swaps entered into between affiliates or 
between an affiliate and its unaffiliated counterparties will bear some 
costs that competing firms based entirely in foreign jurisdictions may 
not bear because comparable clearing mandates have not yet been 
implemented. In the European Union, Japan, and Singapore, these effects 
are likely to largely disappear once comparable regimes are established 
and companies with entities in those jurisdictions are required to 
clear. In jurisdictions where comparable regimes are never implemented, 
the competitive effects will be longer-standing.
    The Commission, however, believes that such costs are warranted in 
light of the benefits provided by mitigating the likelihood of 
transferring risk back to the United States through inter-affiliate 
swaps that are not cleared or margined. Requiring the payment and 
collection of full variation margin will address the possibility of 
foreign affiliates developing significant counterparty credit risk 
exposures and then passing that risk back to affiliates in the United 
States through non-cleared swaps. Variation margin is one of the tools 
used by clearinghouses to mitigate counterparty credit risk. As an 
independent risk management tool, it reduces counterparty credit risk 
by requiring counterparties to make daily payments reflecting gains or 
losses based on each swap's value. However, it is not a complete 
replacement for the panoply of risk management tools that are used by 
clearinghouses to manage counterparty credit risk. As a consequence, 
this time-limited alternative compliance framework will mitigate 
counterparty credit risk, but not to the extent that clearing would. 
The Commission, however, believes that this measure will enable 
affiliates in the European Union, Japan, or Singapore to take advantage 
of the exemption while comparable clearing regimes are being 
established in those jurisdictions, while

[[Page 21779]]

simultaneously mitigating the risk of financial risk being transferred 
back to the United States through uncleared inter-affiliate swaps. In 
this way it provides benefits to companies with affiliates in these 
jurisdictions, and also to the American public.
    Moreover, the Commission believes that providing additional time-
limited relief for certain affiliates located in the European Union, 
Japan, or Singapore from the requirements of Sec.  50.52(b)(4)(i) to 
clear their outward-facing swaps until March 11, 2014 under Sec.  
50.52(b)(4)(ii)(B) also will mitigate the competitive effects noted 
commenters by allowing such entities to continue to enter into inter-
affiliate swaps without requiring those swaps to be submitted to 
clearing or variation margin, and is likely to be less costly than 
requiring such entities to either clear or exchange variation margin on 
their inter-affiliate or outward-facing swaps.
    Lastly, the Commission received several comments regarding the 
criteria for issuing comparability determinations, and expressing 
concern that unless such issues are satisfactorily resolved, the 
condition could hamper the ability of U.S.-based groups to compete in 
foreign markets. In response, the Commission has provided in this final 
release a significant amount of additional information regarding how 
and when those determinations will be made.
    In the NPRM, the Commission stated that the condition for the 
treatment of outward-facing swaps would not impose additional 
costs.\147\ Commenters stated that the proposed condition would 
increase the costs of inter-affiliate swaps.\148\ In terms of the 
revised rule, there may be some additional costs for entities that must 
clear their outward-facing swaps. Such costs, as discussed above, would 
include the cost of initial and variation margin, contributions to a 
guaranty fund, and clearing fees. However, in light of the comments 
discussed above, the Commission observes that, as modified, and with 
the transition period provided for under the rule, costs have been 
mitigated to the extent possible while preserving the goal of 
preventing evasion.
---------------------------------------------------------------------------

    \147\ See NPRM at 50435.
    \148\ See e.g., letter from CDEU.
---------------------------------------------------------------------------

    In terms of benefits, the Commission stated in the NPRM that the 
corporate group and U.S. financial markets may bear additional risk if 
the foreign affiliate is free to enter into an uncleared swap with a 
third-party that would be subject to clearing were it entered into in 
the United States. The Commission believes that the requirements for 
outward-facing swaps will prevent foreign affiliates from taking on 
significant risk through outward-facing swaps that fall under a Sec.  
50.4 class, which reduces the risk that could then be transferred back 
to the United States through exempt inter-affiliate swaps.

D. Costs and Benefits to Market Participants and the Public

    Many commenters asserted that inter-affiliate swaps do not create 
any additional risk for third parties facing those affiliates.\149\ In 
addition, some commenters state that third parties may benefit from an 
inter-affiliate exemption because it will allow corporate entities to 
hedge their swaps more efficiently.\150\
---------------------------------------------------------------------------

    \149\ See, e.g., letters from EEI, The Working Group, and DLA 
Piper.
    \150\ See, e.g., letters from EEI, The Working Group, and ISDA & 
SIFMA.
---------------------------------------------------------------------------

    The Commission recognizes that these claims may be true to the 
extent that each affiliate, or a common parent, completely internalizes 
the risks facing the other affiliate. Majority ownership facilitates 
such internalization of costs among affiliated entities, and the threat 
of reputational risk is another factor that may cause related entities 
to act in the best interests of affiliate counterparties. However, as 
discussed above, two other factors reduce the degree to which 
affiliated entities may internalize each other's costs. Ownership 
stakes that are less than 100% reduce the percentage of costs that one 
affiliate internalizes from another, and bankruptcy laws providing 
protection for the assets of one affiliate from the creditors of 
another affiliate may create incentives to permit one affiliate to 
fail. These factors reduce the internalization of costs among 
affiliates.
    As a consequence, the counterparty risk that creditors to a given 
entity face may be increased by the inter-affiliate swaps into which 
that the entity enters. This risk may not be ``new'' in the sense that 
it is risk that was previously borne by another affiliate. But from the 
perspective of counterparties to the entity that now bears the risk, it 
is new. It increases the credit risk that the entity they face bears.
    The Commission, however, has established conditions on the inter-
affiliate exemption that are intended to mitigate any increase in 
counterparty risk that third parties might bear as the result of the 
exemption. As described above, the documentation and centralized risk 
management requirements help to ensure that each group of affiliates 
engaging in inter-affiliate swaps has a centralized risk management 
program with adequate information to value and risk manage swap 
positions effectively. Moreover, the reporting requirements will help 
to ensure that regulators have information that is necessary to 
understand the use of inter-affiliate swaps under this exemption.
    In terms of costs, some commenters assert that this exception 
creates risk of contagion and systemic risk that could threaten the 
U.S. financial system.\151\ As explained above, this concern is 
substantiated to the extent that the inter-affiliate exemption prevents 
affiliates from protecting themselves from counterparty risk they bear 
with respect to one another, and to the extent that it prevents third 
parties from protecting themselves from affiliates' counterparty risk. 
The Commission believes that internalization of risk among affiliated 
entities mitigates this concern, and that the application of required 
clearing to swaps between affiliates and third parties further reduces 
the probability of risk cascading through the financial system via 
inter-affiliate swaps.
---------------------------------------------------------------------------

    \151\ See letters from AFR and Better Markets.
---------------------------------------------------------------------------

    AFR stated that the exemption may deprive DCOs of swaps volume and 
liquidity that is necessary for risk management. In effect, the 
exemption will reduce the number of swaps being cleared. All other 
things being equal, this may cause DCOs to increase the margin 
requirements for those swaps to compensate for having less volume, 
which may increase the cost of using cleared swaps. AFR also stated 
that the inter-affiliate exception will enable banks to set up joint 
ventures to trade swaps without clearing them. The Commission believes 
that its conditions with regard to treatment of outward-facing swaps 
address AFR's concerns about evasion of the clearing requirement.

E. Costs and Benefits Compared to Alternatives

    The Commission considered several alternatives to the final 
rulemaking, including: (1) Alternative definitions of eligible 
affiliate counterparty; (2) more prescriptive documentation 
requirements; (3) alternative risk management requirements; (4) 
different requirements for treatment of outward-facing swaps; and (5) 
requiring variation margin for swaps between affiliated financial 
entities. The first four alternatives are discussed at length above. 
The fifth alternative, the imposition of variation margin on swaps 
between affiliates that are financial entities, was considered by the 
Commission and ultimately rejected based on comments.

[[Page 21780]]

    As proposed, the inter-affiliate exemption would have required 
affiliated financial entities to pay and collect variation margin 
associated with their swaps unless the affiliates were 100% commonly 
owned and commonly guaranteed by a 100% commonly owned guarantor. In 
the final rule, the Commission has eliminated the variation margin 
requirement. This change is likely to create significant savings for 
eligible affiliates. Reduced margin requirements will reduce the 
capital costs that entities bear when transacting inter-affiliate 
swaps, and may reduce the capital requirements for financial entities 
under prudential regulation. In addition, it may help entities avoid 
liquidity crunches when their positions move significantly out of the 
money in a short period of time.
    However, eliminating the variation margin requirement also 
significantly reduces the protective value of the eligibility 
requirements that the Commission established in order to reduce the 
likelihood of cascading defaults among affiliated entities, and the 
associated risk to third parties transacting with those entities. 
Without the variation margin requirements, affiliated entities may 
develop large outstanding exposures toward one another, and to the 
degree that affiliated entities do not internalize one another's costs, 
an affiliate that is out of the money will have incentives not to 
perform on its obligations. In addition if the obligations of one 
entity are sufficiently large, its default may jeopardize the health of 
other affiliated entities, which would also increase counterparty risk 
for third parties that have uncleared outstanding positions with those 
entities.

F. Consideration of CEA Section 15(a) Factors

1. Protection of Market Participants and the Public
    In deciding to finalize the inter-affiliate clearing exemption, the 
Commission assessed how to protect affiliated entities, third parties 
in the swaps market, and the public. The Commission has sought to 
ensure that in the absence of a clearing requirement the risks 
presented by uncleared inter-affiliate swaps would be mitigated so that 
significant losses to one affiliate counterparty or a default of one of 
the affiliate counterparties is less likely to create significant 
repercussions for third-parties or the American public. Toward that 
end, the Commission has required that affiliates to execute swap 
trading relationship documentation, maintain a centralized-risk 
management process, and report specific information to an SDR, and meet 
certain requirements related to outward-facing swaps in order to be 
eligible for the exception. As explained in this cost-benefit section, 
these conditions serve multiple objectives that ultimately protect 
market participants and the public.
    For instance, the documentation requirement will reduce 
uncertainties where affiliates incur significant swaps-related losses 
or where there is a defaulting affiliate. Because the documentation 
would be in writing, the Commission expects that there will be less 
contractual ambiguity should disagreements between affiliates arise. 
The condition that an inter-affiliate swap be subject to a centralized 
risk management program reasonably designed to monitor and manage risk 
will also help mitigate the risks associated with inter-affiliate 
swaps. As noted throughout this final rulemaking, inter-affiliate swap 
risk could adversely impact third parties that enter into uncleared 
swaps or other contracts with affiliates engaging in inter-affiliate 
swaps.
    The reporting condition would help the Commission and the 
affiliate's leadership monitor compliance with the inter-affiliate 
clearing exemption. For example, an affiliate that also is an SEC Filer 
must receive a governing board's approval for electing the proposed 
exemption. It cannot act independently. In the Commission's opinion, 
the reporting conditions promote accountability and transparency, 
offering another public safeguard by keeping the Commission and each 
entity's board of directors informed.
    On the other hand, the rule also creates certain costs that will be 
borne by eligible entities, the counterparties to those entities, and 
the public. Regarding costs for eligible entities, the qualification 
requirements will create some new costs for those that do not already 
have recordkeeping and risk management systems that are in compliance 
with the rule. However, as noted above, the Commission believes that 
some entities may already have systems in place that meet most or all 
of the requirements. Moreover, entities will elect the exemption only 
if they project the benefit of doing so is greater than the costs 
associated with the qualifying requirements. Therefore, these costs may 
decrease the value of the exemption, but they will not create new costs 
for entities that choose not to elect the exemption.
2. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    Exempting swaps between majority-owned affiliates within a 
corporate group from the clearing requirement will promote allocational 
efficiency by reducing overall clearing costs for eligible affiliate 
counterparties. The Commission also anticipates that the exemption will 
increase allocational efficiency and the financial integrity of markets 
because it will make it less costly for corporate groups to centralize 
their hedging and market facing swap activities within a single 
affiliate. As explained above, commenters stated that clearing swaps 
through single affiliates enables affiliates and corporate groups to 
more efficiently and effectively manage corporate risk.
    Certain provisions of the proposed rule, such as the requirements 
that inter-affiliate swaps be subject to centralized risk management 
and that certain information be reported, also would discourage abuse 
of the exemption. Together, these conditions promote the financial 
integrity of swap markets and financial markets as a whole.
3. Price Discovery
    Under Commission regulation 43.2, a ``publicly reportable swap 
transaction,'' means, among other things, ``any executed swap that is 
an arm's length transaction between two parties that results in a 
corresponding change in the market risk position between the two 
parties.'' \152\ The Commission does not consider non-arms-length swaps 
as contributing to price discovery in the markets.\153\ Given that 
inter-affiliate swaps as defined in this rulemaking are generally not 
arm's length transactions, the Commission does not anticipate the 
inter-affiliate clearing exemption to have any significant effect on 
price discovery.\154\
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    \152\ 17 CFR 43.2. See also Real-Time Public Reporting of Swap 
Transaction Data, 77 FR 1182 (Jan. 9, 2012).
    \153\ Transactions that fall outside the definition of 
``publicly reportable swap transaction''--that is, transactions that 
are not arms-length--``do not serve the price discovery objective of 
CEA section 2(a)(13)(B).'' Real-Time Public Reporting of Swap 
Transaction Data, 77 FR 1195. See also id. at 1187 (discussing 
``Swaps Between Affiliates and Portfolio Compression Exercises'').
    \154\ The definition of ``publicly reportable swap transaction'' 
identifies two examples of transactions that fall outside the 
definition, including ``internal swaps between one-hundred percent 
owned subsidiaries of the same parent entity.'' 17 CFR 43.2 (adopted 
by Real-Time Public Reporting of Swap Transaction Data, 77 FR 1244). 
The Commission notes that the list of examples is not exhaustive.
---------------------------------------------------------------------------

4. Sound Risk Management Practices
    As a general rule, the Commission believes that clearing swaps is a 
sound

[[Page 21781]]

risk management practice. Exempting certain inter-affiliate swaps from 
the clearing requirement creates additional counterparty exposure for 
affiliates that do not completely internalize each other's risk, and 
for third parties that enter into uncleared swaps or other transactions 
with those affiliated entities. This increased counterparty risk among 
affiliates may increase the likelihood that a default within one 
affiliate could cause significant losses in other affiliated entities. 
If the default causes other affiliated entities to default, then third 
parties that have entered into uncleared swaps or other agreements with 
those entities also could be affected. But, in finalizing the inter-
affiliate clearing exemption, the Commission has assessed the risks of 
inter-affiliate swaps, and believes that the partial internalization of 
costs among affiliated entities, combined with the documentation, risk 
management, reporting, and treatment of outward-facing swaps 
requirements for electing the exception, will mitigate some of the 
risks associated with uncleared inter-affiliate swaps. However, they 
are not a complete substitute for the protections that would be 
provided by required clearing, or by a requirement to use some of the 
same risk management tools that a clearinghouse would use to mitigate 
counterparty credit risk (i.e., initial and variation margin).
    Also, as noted above, without clearing to mitigate transmission of 
risk among affiliates, the risk that any one affiliate takes on, and 
any contagion that may be caused by that risk, may be transferred more 
easily to other affiliates. This makes the risk mitigation requirements 
for outward-facing swaps more important. The Commission's requirements 
for outward-facing swaps mitigate the risk that swaps that the 
Commission has determined are required to be cleared could transfer 
risk that would then be spread among the affiliates, but does not 
eliminate the possibility that swaps that are not required to be 
cleared and are transacted in a regime without mandatory clearing (or 
bilateral margin requirements) for uncleared swaps could result in 
financial risk that impacts its affiliates and counterparties of those 
affiliates.\155\
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    \155\ The Commission notes that even in the absence of required 
clearing or margin requirements for swaps between certain affiliated 
entities, such entities may choose to use initial and variation 
margin to manage risks that could otherwise be transferred from one 
affiliate to another. Similarly, third parties that have entered 
into swaps with affiliates may also include variation margin 
requirements in their swap agreements.
---------------------------------------------------------------------------

    The Commission also believes that SEC Filer reporting is a prudent 
practice. As detailed in this preamble and the rule text, SEC Filers 
are affiliates that meet certain SEC-related qualifications, and their 
governing boards or equivalent bodies are directly responsible to 
shareholders for the financial condition and performance of the 
affiliate. The boards also have access to information that would give 
them a comprehensive picture of the company's financial condition and 
risk management strategies. Therefore, any oversight they provide to 
the affiliate's risk management strategies would likely encourage sound 
risk management practices. In addition, the condition that affiliates 
electing the inter-affiliate clearing exemption must report their 
boards' knowledge of the election is a sound risk management practice.
5. Other Public Interest Considerations
    Aside from those discussed in Section II.A above, the Commission 
has identified no other public interest considerations.

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis respecting the impact.\156\ 
As stated in the NPRM, the clearing requirement determinations and 
rules proposed by the Commission will affect only ECPs because all 
persons that are not ECPs are required to execute their swaps on a 
designated contract market (DCM), and all contracts executed on a DCM 
must be cleared by a DCO, as required by statute and regulation; not by 
operation of any clearing requirement.\157\ Accordingly, the Chairman, 
on behalf of the Commission, certified pursuant to 5 U.S.C. 605(b) that 
the proposed rules would not have a significant economic impact on a 
substantial number of small entities. The Commission then invited 
public comment on this determination. The Commission received no 
comments.
---------------------------------------------------------------------------

    \156\ See 5 U.S.C. 601 et seq.
    \157\ To the extent that this rulemaking affects DCMs, DCOs, or 
FCMs, the Commission has previously determined that DCMs, DCOs, and 
FCMs are not small entities for purposes of the RFA. See, 
respectively and as indicated, 47 FR 18618, 18619 (Apr. 30, 1982) 
(DCMs and FCMs); and 66 FR 45604, 45609 (Aug. 29, 2001) (DCOs).
---------------------------------------------------------------------------

    The Commission has previously determined that ECPs are not small 
entities for purposes of the RFA.\158\ However, in its proposed 
rulemaking to establish a schedule to phase in compliance with certain 
provisions of the Dodd-Frank Act, including the clearing requirement 
under section 2(h)(1)(A) of the CEA, the Commission received a joint 
comment (Electric Associations Letter) from the Edison Electric 
Institute (EEI), the National Rural Electric Cooperative Association 
(NRECA) and the Electric Power Supply Association (EPSA) asserting that 
certain members of NRECA may both be ECPs under the CEA and small 
businesses under the RFA.\159\ These members of NRECA, as the 
Commission understands, have been determined to be small entities by 
the Small Business Administration (SBA) because they are ``primarily 
engaged in the generation, transmission, and/or distribution of 
electric energy for sale and [their] total electric output for the 
preceding fiscal year did not exceed 4 million megawatt hours.'' \160\ 
Although the Electric Associations Letter does not provide details on 
whether or how the NRECA members that have been determined to be small 
entities use the interest rate swaps and CDS that are the subject of 
this rulemaking, the Electric Associations Letter does state that the 
EEI, NRECA, and EPSA members ``engage in swaps to hedge commercial 
risk.'' \161\ Because the NRECA members that have been determined to be 
small entities would be using swaps to hedge commercial risk, the 
Commission expects that they would be able to use the end-user 
exception from the clearing requirement and therefore would not be 
affected to any significant extent by this rulemaking.
---------------------------------------------------------------------------

    \158\ See 66 FR 20740, 20743 (Apr. 25, 2001).
    \159\ See joint letter from EEI, NRECA, and ESPA, dated Nov. 4, 
2011, (Electric Associations Letter), commenting on Swap Transaction 
Compliance and Implementation Schedule: Clearing and Trade Execution 
Requirements under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20, 
2011).
    \160\ Small Business Administration, Table of Small Business 
Size Standards, Nov. 5, 2010.
    \161\ See Electric Associations Letter, at 2. The letter also 
suggests that EEI, NRECA, and EPSA members are not financial 
entities. See id., at note 5, and at 5 (the associations' members 
``are not financial companies'').
---------------------------------------------------------------------------

    Thus, because nearly all of the ECPs that may be subject to the 
proposed clearing requirement are not small entities, and because the 
few ECPs that have been determined by the SBA to be small entities are 
unlikely to be subject to the clearing requirement, the Chairman, on 
behalf of the CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that 
the rules herein will not have a significant economic impact on a 
substantial number of small entities.

[[Page 21782]]

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) \162\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. An 
agency may not conduct or sponsor, and a person is not required to 
respond to, a collection of information unless it has been approved by 
the Office of Management and Budget (OMB) and displays a currently 
valid control number.\163\
---------------------------------------------------------------------------

    \162\ 44 U.S.C. 3501 et seq.
    \163\ Id.
---------------------------------------------------------------------------

    Certain provisions of this final rulemaking impose new information 
collection requirements within the meaning of the PRA, for which the 
Commission must obtain a valid control number. Accordingly, the 
Commission requested, and OMB has assigned control number 3038-0104 for 
the new collection of information. The Commission also has submitted 
this final rule release, the proposed rulemaking, and all required 
supporting documentation to OMB for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The title for this new collection of 
information is ``Rule 50.52 (proposed as rule 39.6(g)) Affiliate 
Transaction Uncleared Swap Notification.'' Responses to this collection 
of information will be mandatory.
    The Commission will protect proprietary information in accordance 
with the Freedom of Information Act and 17 CFR part 145, entitled 
``Commission Records and Information.'' In addition, section 8(a)(1) of 
the CEA strictly prohibits the Commission, unless specifically 
authorized by the Act, from making public ``data and information that 
would separately disclose the business transactions or market positions 
of any person and trade secrets or names of customers.'' \164\ The 
Commission also is required to protect certain information contained in 
a government system of records according to the Privacy Act of 1974, 5 
U.S.C. 552a.
---------------------------------------------------------------------------

    \164\ 7 U.S.C. 12(a)(1).
---------------------------------------------------------------------------

1. Information Provided by Reporting Entities
    The regulations being adopted in this final rule release impose 
certain reporting requirements on eligible affiliates that enter into 
inter-affiliate swaps and elect the inter-affiliate exemption from 
clearing such swaps. As described in the NPRM and in this final 
release, the reporting requirements are designed to address Commission 
concerns regarding inter-affiliate swap risk and to provide the 
Commission with information necessary to regulate the swaps market. In 
particular, regulation 50.52(c) (proposed as Sec.  39.6(g)(4)) will 
require an electing counterparty to provide, or cause to be provided, 
certain information to a registered SDR or, if no registered SDR is 
available to receive the information, to the Commission, in the form 
and manner specified by the Commission. As further described in this 
final rule release, Sec.  50.52(c)(1) requires reporting counterparties 
to notify the Commission each time they elect the inter-affiliate 
clearing exemption for each swap, by reporting certain information to a 
registered SDR, or to the Commission, if no registered SDR is available 
to receive the information. Reporting counterparties also must report 
the information required by Sec.  50.52(c)(2) and (3), and have the 
option to report such information each time that the eligible 
counterparties elect the inter-affiliate exemption for each swap, or on 
an annual basis in anticipation of electing the exemption.
    To determine the total time burden and cost associated with the 
proposed rule for PRA purposes, the Commission estimated the number of 
affiliates that likely would seek to claim the exemption and the 
average number of inter-affiliate swaps for which the affiliates would 
elect to use the proposed exemption. The Commission also estimated the 
time burden required for entities to comply with the reporting 
requirements.
    In estimating the number of affiliates and the average number of 
inter-affiliate swaps that likely would claim the inter-affiliate 
exemption, the Commission used data from the U.S. Bureau of Economic 
Analysis (BEA) to estimate that there are approximately 22 subsidiaries 
per U.S. multinational parent company (MNC), resulting in a total of 
53,195 affiliates that might elect the inter-affiliate exemption.\165\ 
As more fully described in the NPRM, the Commission surveyed five 
corporations to obtain information that allowed it to estimate that 
affiliates enter into an average of 2,230 inter-affiliate swaps 
annually.\166\
---------------------------------------------------------------------------

    \165\ NPRM at 50439-40.
    \166\ Id.
---------------------------------------------------------------------------

    In estimating the time burden associated with complying with the 
reporting requirements of the rules, the Commission stated in the NPRM 
that it expected each reporting counterparty would likely spend between 
15 seconds to two minutes per transaction entering information required 
by Sec.  50.52(c)(1) (proposed Sec.  39.6(g)(4)(i)) into the reporting 
system.\167\ The Commission further estimated that it would take the 
reporting counterparty up to 10 minutes to collect and submit the 
information required under Sec.  50.52(c)(2)-(3) (proposed Sec.  
39.6(g)(4)(ii)-(iii)), for the first transaction and one to five 
minutes to collect and submit the information for subsequent 
transactions with that same counterparty. The Commission estimated that 
together these requirements would cost a reporting counterparty between 
$1.63 and $13.00 to comply with Sec.  50.52(c)(1) (proposed Sec.  
39.6(g)(4)(i)), $65.00 to comply with Sec.  50.52(c)(2)-(3) (proposed 
Sec.  39.6(g)(4)(ii)-(iii)) for the first inter-affiliate swap, and 
between $6.50 and $32.50 to comply with Sec.  50.52(c)(2)-(3) (proposed 
Sec.  39.6(g)(4)(ii)-(iii)) for subsequent inter-affiliate swaps with 
the same counterparty.\168\
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    \167\ The NPRM noted that to comply with proposed Sec.  
39.6(g)(4)(i) (now Sec.  50.52(c)(1)), each reporting counterparty 
would be required to check a box indicating that both counterparties 
to the swap are electing not to clear the swap.
    \168\ NPRM at 50440.
---------------------------------------------------------------------------

    With respect to the annual reporting option described in Sec.  
50.52(d), the Commission stated in the NPRM that it anticipated that at 
least 90% of MNCs would choose to file an annual report in lieu of 
reporting each swap separately. The Commission estimated in the NPRM 
that it would take an average of 30 to 90 minutes to complete and 
submit the filing, resulting in an annual aggregate cost for submitting 
the annual report of approximately $195 to $585.\169\
---------------------------------------------------------------------------

    \169\ NPRM at 50441.
---------------------------------------------------------------------------

    In addition to the specific reporting obligations described in the 
rules, the NPRM also noted that reporting counterparties may need to 
update established reporting systems to comply with the reporting 
requirement, and non-reporting affiliate counterparties may need to 
transmit information to reporting counterparties after entering into a 
swap subject to the rules. In the NPRM, the Commission stated that it 
anticipated that reporting counterparties may have to modify their 
established reporting systems in order to accommodate the additional 
data fields required by Sec.  50.52(c) (proposed Sec.  39.6(g)(4)), and 
estimated that the modifications would create a one-time cost of 
between $341 and $3,410 per entity.\170\ The Commission further stated 
in the NPRM that it anticipated that an affiliate who is not the 
reporting counterparty may need to communicate information to the 
reporting counterparty after executing an inter-affiliate swap, and 
estimated the cost of, among other things, providing

[[Page 21783]]

information to facilitate any due diligence that the reporting 
counterparty may conduct, to be between $33 and $3,900.\171\
---------------------------------------------------------------------------

    \170\ Id.
    \171\ Id.
---------------------------------------------------------------------------

    Using these figures, the Commission estimated that the inter-
affiliate exemption could result in an average total annual burden of 
1,758,369 hours and average total annual costs of $685,309,281, or 
approximately 1.8 minutes and $10.48 per inter-affiliate swap.
2. Information Collection Comments
    The Commission invited public comment on the proposed PRA analysis 
and estimates and on any aspect of the reporting burdens resulting from 
proposed Sec.  39.6(g) (now Sec.  50.52(c)). One commenter submitted 
comments in relation to the Commission's estimate of the number of 
eligible affiliates seeking to claim the exemption. No commenters 
submitted comments to OMB, and OMB itself did not submit any comments 
to the Commission pertaining to the proposed rule.\172\
---------------------------------------------------------------------------

    \172\ See 5 CFR 1320.11(f).
---------------------------------------------------------------------------

    In the context of its comments pertaining to the costs and benefits 
of the reporting requirements of the proposed rule, EEI claimed that 
the Commission's estimation of 22 eligible affiliates per MNC was ``far 
too low'' for many U.S. energy companies. Although EEI commented that 
the Commission's estimate of the number of affiliates per MNC was too 
low in the context of U.S. energy companies, EEI did not provide an 
alternative estimate or point to any other sources of information that 
might provide an alternative source for estimating the average number 
of subsidiaries per MNC.
    The Commission has considered EEI's comment and declines to revise 
its estimate of the number of affiliates of an MNC.\173\ As described 
in the NPRM, the Commission estimated that a total of 53,195 affiliates 
might elect the inter-affiliate clearing exemption. The Commission's 
estimation of the number of affiliates of an MNC was based on the most 
recent data collected by the BEA, which indicated that there are 2,347 
MNCs in the U.S. and 25,424 foreign subsidiaries that are majority 
owned by such MNCs.\174\ To account for the number of majority-owned 
U.S. subsidiaries of MNCs, the Commission doubled the BEA's foreign 
subsidiaries, and determined that there are an estimated 50,848 U.S. 
and foreign subsidiaries, or approximately 22 subsidiaries per MNC.
---------------------------------------------------------------------------

    \173\ The Commission further notes that EEI's comments were made 
exclusively with respect to U.S. energy companies and not the 
broader spectrum of potential MNCs that are included within the 
estimation.
    \174\ See Table I.A 2., ``Selected Data for Foreign Affiliates 
and U.S. Parents in All Industries,'' located at http://www.bea.gov/international/pdf/usdia_2009p/Group%20I%20tables.pdf. The BEA 
defines a U.S. Parent of a MNC as a person that is a resident in the 
United States and owns or controls 10 percent or more of the voting 
securities, or the equivalent, of a foreign business enterprise. A 
Guide to BEA Statistics on U.S. Multinational Companies, available 
at http://www.bea.gov/scb/pdf/internat/usinvest/1995/0395iid.pdf.
---------------------------------------------------------------------------

    The Commission further notes that the estimate of the number of 
affiliates per MNC proposed in the NPRM and adopted in this release for 
purposes of the PRA, is an averaged approximation based on publically 
available information collected by the BEA, and acknowledges that the 
number of affiliates of an MNC may be higher or lower than 22. However, 
there is no basis for concluding that the use of a different source for 
estimating the average number of affiliates per MNC would result in a 
higher number estimate, nor did the Commission receive comments to that 
effect. Accordingly, the Commission believes that its estimation is 
reasonable in light of the information that is publicly available at 
this time, and that its original proposed estimates remain appropriate 
for purposes of the PRA.

List of Subjects in 17 CFR Part 50

    Business and industry, Clearing, Swaps.

    For the reasons stated in the preamble, amend 17 CFR part 50 as 
follows:

PART 50--CLEARING REQUIREMENT AND RELATED RULES

0
1. The authority citation for part 50 continues to read as follows:

    Authority: 7 U.S.C. 2(h) and 7a-1 as amended by Pub. L. 111-203, 
124 Stat. 1376.

0
2. The heading for part 50 is revised to read as set forth above.

0
3. Add Sec.  50.52 to subpart C to read as follows:

Sec.  50.52  Exemption for swaps between affiliates.

    (a) Eligible affiliate counterparty status. Subject to the 
conditions in paragraph (b) of this section:
    (1) Counterparties to a swap may elect not to clear a swap subject 
to the clearing requirement of section 2(h)(1)(A) of the Act and this 
part if:
    (i) One counterparty, directly or indirectly, holds a majority 
ownership interest in the other counterparty, and the counterparty that 
holds the majority interest in the other counterparty reports its 
financial statements on a consolidated basis under Generally Accepted 
Accounting Principles or International Financial Reporting Standards, 
and such consolidated financial statements include the financial 
results of the majority-owned counterparty; or
    (ii) A third party, directly or indirectly, holds a majority 
ownership interest in both counterparties, and the third party reports 
its financial statements on a consolidated basis under Generally 
Accepted Accounting Principles or International Financial Reporting 
Standards, and such consolidated financial statements include the 
financial results of both of the swap counterparties.
    (2) For purposes of this section:
    (i) A counterparty or third party directly or indirectly holds a 
majority ownership interest if it directly or indirectly holds 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; and
    (ii) The term ``eligible affiliate counterparty'' means an entity 
that meets the requirements of this paragraph.
    (b) Additional conditions. Eligible affiliate counterparties to a 
swap may elect the exemption described in paragraph (a) of this section 
if:
    (1) Both counterparties elect not to clear the swap;
    (2)(i) A swap dealer or major swap participant that is an eligible 
affiliate counterparty to the swap satisfies the requirements of Sec.  
23.504 of this chapter; or
    (ii) If neither eligible affiliate counterparty is a swap dealer or 
major swap participant, the terms of the swap are documented in a swap 
trading relationship document that shall be in writing and shall 
include all terms governing the trading relationship between the 
eligible affiliate counterparties;
    (3) The swap is subject to a centralized risk management program 
that is reasonably designed to monitor and manage the risks associated 
with the swap. If at least one of the eligible affiliate counterparties 
is a swap dealer or major swap participant, this centralized risk 
management requirement shall be satisfied by complying with the 
requirements of Sec.  23.600 of this chapter; and
    (4)(i) Each eligible affiliate counterparty that enters into a 
swap, which is included in a class of swaps identified in Sec.  50.4, 
with an unaffiliated counterparty shall:

[[Page 21784]]

    (A) Comply with the requirements for clearing the swap in section 
2(h) of the Act and this part;
    (B) Comply with the requirements for clearing the swap under a 
foreign jurisdiction's clearing mandate that is comparable, and 
comprehensive but not necessarily identical, to the clearing 
requirement of section 2(h) of the Act and this part, as determined by 
the Commission;
    (C) Comply with an exception or exemption under section 2(h)(7) of 
the Act or this part;
    (D) Comply with an exception or exemption under a foreign 
jurisdiction's clearing mandate, provided that:
    (1) The foreign jurisdiction's clearing mandate is comparable, and 
comprehensive but not necessarily identical, to the clearing 
requirement of section 2(h) of the Act and this part, as determined by 
the Commission; and
    (2) The foreign jurisdiction's exception or exemption is comparable 
to an exception or exemption under section 2(h)(7) of the Act or this 
part, as determined by the Commission; or
    (E) Clear such swap through a registered derivatives clearing 
organization or a clearing organization that is subject to supervision 
by appropriate government authorities in the home country of the 
clearing organization and has been assessed to be in compliance with 
the Principles for Financial Market Infrastructures.
    (ii)(A) Except as provided in paragraph (b)(4)(ii)(B) of this 
section, if one of the eligible affiliate counterparties is located in 
the European Union, Japan, or Singapore, the following may satisfy the 
requirements of paragraph (b)(4)(i) of this section until March 11, 
2014:
    (1) Each eligible affiliate counterparty, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, pays and collects full variation margin daily 
on all swaps entered into between the eligible affiliate counterparty 
located in the European Union, Japan, or Singapore and an unaffiliated 
counterparty; or
    (2) Each eligible affiliate counterparty, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, pays and collects full variation margin daily 
on all of the eligible affiliate counterparties' swaps with other 
eligible affiliate counterparties.
    (B) If one of the eligible affiliate counterparties is located in 
the European Union, Japan, or Singapore, the requirements of paragraph 
(b)(4)(i) of this section shall not apply to the eligible affiliate 
counterparty located in the European Union, Japan, or Singapore until 
March 11, 2014, provided that:
    (1) The one counterparty that directly or indirectly holds a 
majority ownership interest in the other counterparty or the third 
party that directly or indirectly holds a majority ownership interest 
in both counterparties is not a ``financial entity'' as defined in 
section 2(h)(7)(C)(i) of the Act; and
    (2) Neither eligible affiliate counterparty is affiliated with an 
entity that is a swap dealer or major swap participant, as defined in 
Sec.  1.3.
    (iii) If an eligible affiliate counterparty located in the United 
States enters into swaps, which are included in a class of swaps 
identified in Sec.  50.4, with eligible affiliate counterparties 
located in jurisdictions other than the United States, the European 
Union, Japan, and Singapore, and the aggregate notional value of such 
swaps, which are included in a class of swaps identified in Sec.  50.4, 
does not exceed five percent of the aggregate notional value of all 
swaps, which are included in a class of swaps identified in Sec.  50.4, 
in each instance the notional value as measured in U.S. dollar 
equivalents and calculated for each calendar quarter, entered into by 
the eligible affiliate counterparty located in the United States, then 
such swaps shall be deemed to satisfy the requirements of paragraph 
(b)(4)(i) of this section until March 11, 2014, provided that:
    (A) Each eligible affiliate counterparty, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, pays and collects full variation margin daily 
on all swaps entered into between the eligible affiliate counterparties 
located in jurisdictions other than the United States, the European 
Union, Japan, and Singapore and an unaffiliated counterparty; or
    (B) Each eligible affiliate counterparty, or a third party that 
directly or indirectly holds a majority interest in both eligible 
affiliate counterparties, pays and collects full variation margin daily 
on all of the eligible affiliate counterparties' swaps with other 
eligible affiliate counterparties.
    (c) Reporting requirements. When the exemption described in 
paragraph (a) of this section is elected, the reporting counterparty, 
as determined in accordance with Sec.  45.8 of this chapter, shall 
provide or cause to be provided the following information to a 
registered swap data repository or, if no registered swap data 
repository is available to receive the information from the reporting 
counterparty, to the Commission, in the form and manner specified by 
the Commission:
    (1) Confirmation that both eligible affiliate counterparties to the 
swap are electing not to clear the swap and that each of the electing 
eligible affiliate counterparties satisfies the requirements in 
paragraph (b) of this section applicable to it;
    (2) For each electing eligible affiliate counterparty, how the 
counterparty generally meets its financial obligations associated with 
entering into non-cleared swaps by identifying one or more of the 
following categories, as applicable:
    (i) A written credit support agreement;
    (ii) Pledged or segregated assets (including posting or receiving 
margin pursuant to a credit support agreement or otherwise);
    (iii) A written guarantee from another party;
    (iv) The electing counterparty's available financial resources; or
    (v) Means other than those described in paragraphs (c)(2)(i), (ii), 
(iii) or (iv) of this section; and
    (3) If an electing eligible affiliate counterparty is an entity 
that is an issuer of securities registered under section 12 of, or is 
required to file reports under section 15(d) of, the Securities 
Exchange Act of 1934:
    (i) The relevant SEC Central Index Key number for that 
counterparty; and
    (ii) Acknowledgment that an appropriate committee of the board of 
directors (or equivalent body) of the eligible affiliate counterparty 
has reviewed and approved the decision to enter into swaps that are 
exempt from the requirements of section 2(h)(1) and 2(h)(8) of the Act.
    (d) Annual reporting. An eligible affiliate counterparty that 
qualifies for the exemption described in paragraph (a) of this section 
may report the information listed in paragraphs (c)(2) and (3) of this 
section annually in anticipation of electing the exemption for one or 
more swaps. Any such reporting by a reporting counterparty under this 
paragraph will be effective for purposes of paragraphs (c)(2) and (3) 
of this section for 365 days following the date of such reporting. 
During the 365-day period, the reporting counterparty shall amend the 
report as necessary to reflect any material changes to the information 
reported. Each reporting counterparty shall have a reasonable basis to 
believe that the eligible affiliate counterparties meet the 
requirements for the exemption under this section.

[[Page 21785]]

    Issued in Washington, DC, on April 1, 2013, by the Commission.
Melissa D. Jurgens,
Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to Clearing Exemption for Swaps Between Certain Affiliated 
Entities--Commission Voting Summary and Statements of Commissioners

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton, 
O'Malia, and Wetjen voted in the affirmative; Commissioner Sommers 
voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the final rule to exempt swaps between certain 
affiliated entities within a corporate group from the clearing 
requirement in the Dodd-Frank Wall Street Reform and Consumer 
Protection Act.
    Since the late 19th century, clearinghouses have lowered risk 
for the public and fostered competition in the futures market. 
Clearing also has democratized the market by fostering access for 
farmers, ranchers, merchants and other participants.
    The Commission approved the first clearing requirement for swaps 
last November, following through on the U.S. commitment at the 2009 
G-20 meeting that standardized swaps be cleared by the end of 2012. 
Following Congress' direction, end-users are not required to bring 
swaps into central clearing.
    A key milestone was reached on March 11 with the requirement 
that swap dealers and the largest hedge funds begin clearing the 
vast majority of interest rate and credit default index swaps. 
Compliance will continue to be phased in throughout this year. Other 
financial entities begin clearing June 10. Accounts managed by third 
party investment managers and ERISA pension plans have until 
September 9.
    The final rule allows for an exemption from clearing for swaps 
between affiliates under the following limitations:
     First, the exemption covers swaps between majority-
owned affiliates whose financial statements are reported on a 
consolidated basis.
     Second, the rule requires documentation of such 
exempted swaps, centralized risk management, and reporting 
requirements for such swaps.
     Third, the exemption requires that each swap entered 
into by the affiliated counterparties with unaffiliated 
counterparties must be cleared. This approach largely aligns with 
the Europeans' approach to an exemption for inter-affiliate 
clearing.
    In order to promote international harmonization regarding 
mandatory clearing, the final rulemaking provides for two time-
limited alternative compliance frameworks for swaps entered into 
with unaffiliated counterparties in jurisdictions outside of the 
United States.
    With regard to affiliated counterparties located in the European 
Union, Japan and Singapore--jurisdictions that have adopted swap 
clearing regimes and are currently in the process of 
implementation--the Commission is phasing compliance with the 
requirement to clear swaps with unaffiliated counterparties until 
March 11, 2014. During the phase-in period affiliated counterparties 
located in these jurisdictions will be able to pay and collect 
variation margin in lieu of clearing. Affiliated counterparties that 
are located in these jurisdictions (that are not affiliated with 
swap dealers or major swap participants) will not have to pay or 
collect such variation margin during the phase-in period, provided 
they are not directly or indirectly majority-owned by a financial 
entity.
    With regard to affiliated counterparties located in other 
foreign jurisdictions, the Commission is phasing compliance with the 
requirement to clear swaps with unaffiliated counterparties until 
March 11, 2014. Until that date, an affiliated counterparty located 
outside the United States, the European Union, Japan and Singapore 
does not have to clear its swaps with unaffiliated counterparties so 
long as the aggregate notional value of such swaps does not exceed 
five percent of the notional value of all swaps entered into by the 
affiliated counterparty located in the United States.
    This phasing in of the inter-affiliate exemption provides a 
transition period for foreign jurisdictions to implement comparable 
and comprehensive clearing regimes.

[FR Doc. 2013-07970 Filed 4-10-13; 8:45 am]
BILLING CODE 6351-01-P
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