Vol. 77 Monday, 

No. 156 August 13, 2012 

Part II 

Commodity Futures Trading Commission 

17 CFR Part 1 

Securities and Exchange Commission 

17 CFR Parts 230, 240 and 241 

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

Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement 

Recordkeeping; Final Rule 

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48208 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1 17 CFR 145.9. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 1 

RIN 3038–AD46 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 230, 240 and 241 

[Release No. 33–9338; 34–67453; File No. 

S7–16–11] 

RIN 3235–AK65 

Further Definition of ‘‘Swap,’’ 

‘‘Security-Based Swap,’’ and 

‘‘Security-Based Swap Agreement’’; 

Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping 

AGENCY: Commodity Futures Trading 

Commission; Securities and Exchange 

Commission. 

ACTION: Joint final rule; interpretations; 

request for comment on an 

interpretation. 

SUMMARY: In accordance with section 

712(a)(8), section 712(d)(1), sections 

712(d)(2)(B) and (C), sections 721(b) and 

(c), and section 761(b) of the DoddFrank Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank Act’’), the 

Commodity Futures Trading 

Commission (‘‘CFTC’’) and the 

Securities and Exchange Commission 

(‘‘SEC’’) (collectively, ‘‘Commissions’’), 

in consultation with the Board of 

Governors of the Federal Reserve 

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

new rules and interpretations under the 

Commodity Exchange Act (‘‘CEA’’) and 

the Securities Exchange Act of 1934 

(‘‘Exchange Act’’) to further define the 

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

and ‘‘security-based swap agreement’’ 

(collectively, ‘‘Product Definitions’’); 

regarding ‘‘mixed swaps;’’ and 

governing books and records with 

respect to ‘‘security-based swap 

agreements.’’ The CFTC requests 

comment on its interpretation 

concerning forwards with embedded 

volumetric optionality, contained in 

Section II.B.2.(b)(ii) of this release. 

DATES: Effective date: October 12, 2012. 

Compliance date: The applicable 

compliance dates are discussed in the 

section of the release titled ‘‘IX. 

Effective Date and Implementation’’. 

Comment date: Comments on the 

interpretation regarding forwards with 

embedded volumetric optionality must 

be received on or before October 12, 

2012. 

ADDRESSES: You may submit comments, 

identified by RIN number 3038–AD46, 

by any of the following methods: 

• CFTC Web Site: via its Comments 

Online process: http:// 

comments.cftc.gov. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: Address to David A. Stawick, 

Secretary of the Commission, 

Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street NW., Washington, DC 

20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

All comments must be submitted in 

English or, if not, accompanied by an 

English translation. Comments will be 

posted as received to http:// 

www.cftc.gov. You should submit only 

information that you wish to make 

available publicly. If you wish the CFTC 

to consider information that is exempt 

from disclosure under the Freedom of 

Information Act, a petition for 

confidential treatment of the exempt 

information may be submitted according 

to the procedures established in § 145.9 

of the CFTC’s Regulations.1

The CFTC reserves the right, but shall 

have no obligation, to review, prescreen, filter, redact, refuse or remove 

any or all of your submission from 

http://www.cftc.gov that it may deem to 

be inappropriate for publication, such as 

obscene language. All submissions that 

have been redacted or removed that 

contain comments on the merits of the 

interpretation will be retained in the 

public comment file and will be 

considered as required under the 

Administrative Procedure Act and other 

applicable laws, and may be accessible 

under the Freedom of Information Act. 

FOR FURTHER INFORMATION CONTACT: 

CFTC: Julian E. Hammar, Assistant 

General Counsel, at 202–418–5118, 

jhammar@cftc.gov, Lee Ann Duffy, 

Assistant General Counsel, at 202–418– 

6763, lduffy@cftc.gov; Mark Fajfar, 

Assistant General Counsel, at 202–418– 

6636, mfajfar@cftc.gov, or David E. 

Aron, Counsel, at 202–418–6621, 

daron@cftc.gov, Office of General 

Counsel, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street NW., Washington, DC 

20581; SEC: Donna M. Chambers, 

Special Counsel, at 202–551–5870, or 

John Guidroz, Attorney-Adviser, at 202– 

551–5870, Division of Trading and 

Markets, or Andrew Schoeffler, Special 

Counsel, at 202–551–3860, Office of 

Capital Markets Trends, Division of 

Corporation Finance, or Wenchi Hu, 

Senior Special Counsel, at 202–551– 

5870, Office of Compliance, Inspections 

and Examinations, Securities and 

Exchange Commission, 100 F Street NE., 

Washington, DC 20549. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Background 

II. Scope of Definitions of Swap and SecurityBased Swap 

A. Introduction 

B. Rules and Interpretations Regarding 

Certain Transactions outside the Scope 

of the Definitions of the Terms ‘‘Swap’’ 

and ‘‘Security-Based Swap’’ 

1. Insurance Products 

(a) Types of Insurance Products 

(b) Providers of Insurance Products 

(c) Grandfather Provision for Existing 

Insurance Transactions 

(d) Alternative Tests 

(e) ‘‘Safe Harbor’’ 

(f) Applicability of Insurance Exclusion to 

Security-Based Swaps 

(g) Guarantees 

2. The Forward Contract Exclusion 

(a) Forward Contracts in Nonfinancial 

Commodities 

(i) Forward Exclusion From the Swap and 

Future Delivery Definitions 

(ii) Nonfinancial Commodities 

(iii) Environmental Commodities 

(iv) Physical Exchange Transactions 

(v) Fuel Delivery Agreements 

(vi) Cleared/Exchange-Traded Forwards 

(b) Commodity Options and Commodity 

Options Embedded in Forward Contracts 

(i) Commodity Options 

(ii) Commodity Options Embedded in 

Forward Contracts 

(iii) Certain Physical Commercial 

Agreements, Contracts or Transactions 

(iv) Effect of Interpretation on Certain 

Agreements, Contracts and Transactions 

(v) Liquidated Damages Provisions 

(c) Security Forwards 

3. Consumer and Commercial Agreements, 

Contracts, and Transactions 

C. Final Rules and Interpretations 

Regarding Certain Transactions Within 

the Scope of the Definitions of the Terms 

‘‘Swap’’ and ‘‘Security-Based Swap’’ 

1. In General 

2. Foreign Exchange Products 

(a) Foreign Exchange Products Subject to 

the Secretary’s Swap Determination: 

Foreign Exchange Forwards and Foreign 

Exchange Swaps 

(b) Foreign Exchange Products Not Subject 

to the Secretary’s Swap Determination 

(i) Foreign Currency Options 

(ii) Non-Deliverable Forward Contracts 

Involving Foreign Exchange 

(iii) Currency Swaps and Cross-Currency 

Swaps 

(c) Interpretation Regarding Foreign 

Exchange Spot Transactions 

(d) Retail Foreign Currency Options 

3. Forward Rate Agreements 

4. Combinations and Permutations of, or 

Options on, Swaps and Security-Based 

Swaps 

5. Contracts for Differences 

D. Certain Interpretive Issues 

1. Agreements, Contracts, or Transactions 

That May Be Called, or Documented 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48209 

2See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

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

is available at http://www.cftc.gov/LawRegulation/ 

OTCDERIVATIVES/index.htm. 

3Pursuant to section 701 of the Dodd-Frank Act, 

Title VII may be cited as the ‘‘Wall Street 

Transparency and Accountability Act of 2010.’’ 

4 In addition, section 719(d)(1)(A) of the DoddFrank Act requires the Commissions to conduct a 

joint study, within 15 months of enactment, to 

determine whether stable value contracts, as 

defined in section 719(d)(2) of the Dodd-Frank Act, 

are encompassed by the swap definition. If the 

Commissions determine that stable value contracts 

are encompassed by the swap definition, section 

719(d)(1)(B) of the Dodd-Frank Act requires the 

Commissions jointly to determine whether an 

exemption for those contracts from the swap 

definition is appropriate and in the public interest. 

Section 719(d)(1)(B) also requires the Commissions 

to issue regulations implementing the 

determinations made under the required study. 

Until the effective date of such regulations, the 

requirements under Title VII do not apply to stable 

value contracts, and stable value contracts in effect 

prior to the effective date of such regulations are not 

considered swaps. See section 719(d) of the DoddFrank Act. The Commissions currently are 

conducting the required joint study and will 

consider whether to propose any implementing 

regulations (including, if appropriate, regulations 

determining that stable value contracts: (i) Are not 

encompassed within the swap definition; or (ii) are 

encompassed within the definition but are exempt 

from the swap definition) at the conclusion of that 

study. 

Using Form Contracts Typically Used 

for, Swaps or Security-Based Swaps 

2. Transactions in Regional Transmission 

Organizations and Independent System 

Operators 

III. The Relationship Between the Swap 

Definition and the Security-Based Swap 

Definition 

A. Introduction 

B. Title VII Instruments Based on Interest 

Rates, Other Monetary Rates, and Yields 

1. Title VII Instruments Based on Interest 

Rates or Other Monetary Rates That Are 

Swaps 

2. Title VII Instruments Based on Yields 

3. Title VII Instruments Based on 

Government Debt Obligations 

C. Total Return Swaps 

D. Security-Based Swaps Based on a Single 

Security or Loan and Single-Name Credit 

Default Swaps 

E. Title VII Instruments Based on Futures 

Contracts 

F. Use of Certain Terms and Conditions in 

Title VII Instruments 

G. The Term ‘‘Narrow-Based Security 

Index’’ in the Security-Based Swap 

Definition 

1. Introduction 

2. Applicability of the Statutory NarrowBased Security Index Definition and Past 

Guidance of the Commissions to Title VII 

Instruments 

3. Narrow-Based Security Index Criteria for 

Index Credit Default Swaps 

(a) In General 

(b) Rules Regarding the Definitions of 

‘‘Issuers of Securities in a Narrow-Based 

Security Index’’ and ‘‘Narrow-Based 

Security Index’’ for Index Credit Default 

Swaps 

(i) Number and Concentration Percentages 

of Reference Entities or Securities 

(ii) Affiliation of Reference Entities and 

Issuers of Securities With Respect to 

Number and Concentration Criteria 

(iii) Public Information Availability 

Regarding Reference Entities and 

Securities 

(iv) Affiliation of Reference Entities and 

Issuers of Securities With Respect to 

Certain Criteria of the Public Information 

Availability Test 

(v) Application of the Public Information 

Availability Requirements to Indexes 

Compiled by a Third-Party Index 

Provider 

(vi) Treatment of Indexes Including 

Reference Entities That Are Issuers of 

Exempted Securities or Including 

Exempted Securities 

4. Security Indexes 

5. Evaluation of Title VII Instruments on 

Security Indexes That Move From BroadBased to Narrow-Based or Narrow-Based 

to Broad-Based 

(a) In General 

(b) Title VII Instruments on Security 

Indexes Traded on Designated Contract 

Markets, Swap Execution Facilities, 

Foreign Boards of Trade, Security-Based 

Swap Execution Facilities, and National 

Securities Exchanges 

H. Method of Settlement of Index CDS 

I. Security-Based Swaps as Securities 

Under the Exchange Act and Securities 

Act 

IV. Mixed Swaps 

A. Scope of the Category of Mixed Swap 

B. Regulation of Mixed Swaps 

1. Introduction 

2. Bilateral Uncleared Mixed Swaps 

Entered Into by Dually-Registered 

Dealers or Major Participants 

3. Regulatory Treatment for Other Mixed 

Swaps 

V. Security-Based Swap Agreements 

A. Introduction 

B. Swaps That Are Security-Based Swap 

Agreements 

C. Books and Records Requirements for 

Security-Based Swap Agreements 

VI. Process for Requesting Interpretations of 

the Characterization of a Title VII 

Instrument 

VII. Anti-Evasion 

A. CFTC Anti-Evasion Rules 

1. CFTC’s Anti-Evasion Authority 

(a) Statutory Basis for the Anti-Evasion 

Rules 

2. Final Rules 

(a) Rule 1.3(xxx)(6) 

(b) Rule 1.6 

(c) Interpretation on the Final Rules 

3. Interpretation Contained in the 

Proposing Release 

(a) Business Purpose Test 

(b) Fraud, Deceit or Unlawful Activity 

B. SEC Position Regarding Anti-Evasion 

Rules 

VIII. Miscellaneous Issues 

A. Distinguishing Futures and Options 

From Swaps 

B. Transactions Entered Into by Foreign 

Central Banks, Foreign Sovereigns, 

International Financial Institutions, and 

Similar Entities 

C. Definition of the Terms ‘‘Swap’’ and 

‘‘Security-Based Swap’’ as Used in the 

Securities Act 

IX. Effective Date and Implementation 

X. Administrative Law Matters—CEA 

Revisions 

A. Paperwork Reduction Act 

B. Regulatory Flexibility Act 

C. Costs and Benefits Considerations 

XI. Administrative Law Matters—Exchange 

Act Revisions 

A. Economic Analysis 

B. Paperwork Reduction Act 

C. Regulatory Flexibility Act Certification 

XII. Statutory Basis and Rule Text 

I. Backbround 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act into law.2

Title VII of the Dodd-Frank Act 3 (‘‘Title 

VII’’) established a comprehensive new 

regulatory framework for swaps and 

security-based swaps. The legislation 

was enacted, among other reasons, to 

reduce risk, increase transparency, and 

promote market integrity within the 

financial system, including by: (i) 

Providing for the registration and 

comprehensive regulation of swap 

dealers, security-based swap dealers, 

major swap participants, and major 

security-based swap participants; (ii) 

imposing clearing and trade execution 

requirements on swaps and securitybased swaps, subject to certain 

exceptions; (iii) creating rigorous 

recordkeeping and real-time reporting 

regimes; and (iv) enhancing the 

rulemaking and enforcement authorities 

of the Commissions with respect to, 

among others, all registered entities and 

intermediaries subject to the 

Commissions’ oversight. 

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

Act provides that the Commissions, in 

consultation with the Board, shall 

jointly further define the terms ‘‘swap,’’ 

‘‘security-based swap,’’ and ‘‘securitybased swap agreement’’ (‘‘SBSA’’).4

Section 712(a)(8) of the Dodd-Frank Act 

provides further that the Commissions 

shall jointly prescribe such regulations 

regarding ‘‘mixed swaps’’ as may be 

necessary to carry out the purposes of 

Title VII. In addition, sections 721(b) 

and 761(b) of the Dodd-Frank Act 

provide that the Commissions may 

adopt rules to further define terms 

included in subtitles A and B, 

respectively, of Title VII, and sections 

721(c) and 761(b) of the Dodd-Frank Act 

provide the Commissions with authority 

to define the terms ‘‘swap’’ and 

‘‘security-based swap,’’ as well as the 

terms ‘‘swap dealer,’’ ‘‘major swap 

participant,’’ ‘‘security-based swap 

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

participant,’’ to include transactions and 

entities that have been structured to 

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48210 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

5 7 U.S.C. 1 et seq. 

6The CFTC has issued final rules regarding SDRs 

and, separately, swap data recordkeeping and 

reporting. See Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR 54538 

(Sep. 1, 2011); Swap Data Recordkeeping and 

Reporting Requirements, 77 FR 2136 (Jan. 13, 2012). 

The SEC has also issued proposed rules regarding 

security-based swap data repositories (‘‘SBSDRs’’), 

including rules specifying data collection and 

maintenance standards for SBSDRs, as well as rules 

regarding security-based swap data recordkeeping 

and reporting. See Security-Based Swap Data 

Repository Registration, Duties, and Core 

Principles, 75 FR 77306 (Dec. 10, 2010); Regulation 

SBSR—Reporting and Dissemination of SecurityBased Swap Information, 75 FR 75208 (Dec. 2, 

2010). 

7The CFTC has issued final rules regarding 

recordkeeping requirements for swap dealers and 

major swap participants. 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 20128 (Apr. 3, 2012). 

8Section 721(a) of the Dodd-Frank Act defines 

the term ‘‘swap’’ by adding section 1a(47) to the 

CEA, 7 U.S.C. 1a(47). This new swap definition also 

is cross-referenced in new section 3(a)(69) of the 

Exchange Act, 15 U.S.C. 78c(a)(69). Citations to 

provisions of the CEA and the Exchange Act, 15 

U.S.C. 78a et seq., in this release refer to the 

numbering of those provisions after the effective 

date of Title VII, except as indicated. 

9Section 761(a) of the Dodd-Frank Act defines 

the term ‘‘security-based swap’’ by adding new 

section 3(a)(68) to the Exchange Act, 15 U.S.C. 

78c(a)(68). This new security-based swap definition 

also is cross-referenced in new CEA section 1a(42), 

7 U.S.C. 1a(42). The Dodd-Frank Act also explicitly 

includes security-based swaps in the definition of 

security under the Exchange Act and the Securities 

Act of 1933 (‘‘Securities Act’’), 15 U.S.C. 77a et seq. 

10Section 721(a) of the Dodd-Frank Act describes 

the category of ‘‘mixed swap’’ by adding new 

section 1a(47)(D) to the CEA, 7 U.S.C. 1a(47)(D). 

Section 761(a) of the Dodd-Frank Act also includes 

the category of ‘‘mixed swap’’ by adding new 

section 3(a)(68)(D) to the Exchange Act, 15 U.S.C. 

78c(68)(D). A mixed swap is defined as a subset of 

security-based swaps that also are based on the 

value of 1 or more interest or other rates, currencies, 

commodities, instruments of indebtedness, indices, 

quantitative measures, other financial or economic 

interest or property of any kind (other than a single 

security or a narrow-based security index), or the 

occurrence, non-occurrence, or the extent of the 

occurrence of an event or contingency associated 

with a potential financial, economic, or commercial 

consequence (other than the occurrence, nonoccurrence, or extent of the occurrence of an event 

relating to a single issuer of a security or the issuers 

of securities in a narrow-based security index, 

provided that such event directly affects the 

financial statements, financial condition, or 

financial obligations of the issuer). 

11Section 761(a) of the Dodd-Frank Act defines 

the term ‘‘security-based swap agreement’’ by 

adding new section 3(a)(78) to the Exchange Act, 15 

U.S.C. 78c(a)(78). The CEA includes the definition 

of ‘‘security-based swap agreement’’ in 

subparagraph (A)(v) of the swap definition in CEA 

section 1a(47), 7 U.S.C. 1a(47). The only difference 

between these definitions is that the definition of 

SBSA in the Exchange Act specifically excludes 

security-based swaps (see section 3(a)(78)(B) of the 

Exchange Act, 15 U.S.C. 78c(a)(78)(B)), whereas the 

definition of SBSA in the CEA does not contain a 

similar exclusion. Instead, under the CEA, the 

exclusion for security-based swaps is placed in the 

general exclusions from the swap definition (see 

CEA section 1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)). 

Although the statutes are slightly different 

structurally, the Commissions interpret them to 

have consistent meaning that the category of 

security-based swap agreements excludes securitybased swaps. 

12See Definitions Contained in Title VII of DoddFrank Wall Street Reform and Consumer Protection 

Act, 75 FR 51429 (Aug. 20, 2010). The ANPR also 

solicited comment regarding the definitions of the 

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

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

swap participant,’’ and ‘‘eligible contract 

participant.’’ These definitions are the subject of a 

separate joint rulemaking by the Commissions. See 

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

‘‘Major Security-Based Swap Participant’’ and 

‘‘Eligible Contract Participant,’’ 77 FR 30596 (May 

23, 2012) (‘‘Entity Definitions Release’’). The 

Commissions also provided the public with the 

ability to present their views more generally on 

implementation of the Dodd-Frank Act through 

their Web sites, dedicated electronic mailboxes, and 

meetings with interested parties. See Public 

Comments on SEC Regulatory Initiatives Under the 

Dodd-Frank Act/Meetings with SEC Officials, 

located at http://www.sec.gov/spotlight/

regreformcomments.shtml; Public Submissions, 

located at http://comments.cftc.gov/Public

Comments/ReleasesWithComments.aspx; External 

Meetings, located at http://www.cftc.gov/Law

Regulation/DoddFrankAct/ExternalMeetings/

index.htm. 

13Copies of all comments received by the SEC on 

the ANPR are available on the SEC’s Internet Web 

site, located at http://www.sec.gov/comments/s7-16- 

10/s71610.shtml. Comments are also available for 

Web site viewing and printing in the SEC’s Public 

Reference Room, 100 F Street NE., Washington, DC 

20549, on official business days between the hours 

of 10 a.m. and 3 p.m. Copies of all comments 

received by the CFTC on the ANPR are available on 

the CFTC’s Internet Web site, located at http://www.

cftc.gov/LawRegulation/DoddFrankAct/OTC_2_

Definitions.html. 

14See supra note 12. 

15See Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap 

Agreement’’; Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping, 76 FR 29818 (May 23, 

2011) (‘‘Proposing Release’’). 

16 Id. 

17 Information about meetings that CFTC staff 

have had with outside organizations regarding the 

implementation of the Dodd-Frank Act is available 

at http://www.cftc.gov/LawRegulation/DoddFrank

Act/ExternalMeetings/index.htm. Information about 

meetings that SEC staff have had with outside 

organizations regarding the product definitions is 

available at http://www.sec.gov/comments/s7-16- 

10/s71610.shtml#meetings. 

evade the requirements of subtitles A 

and B, respectively, of Title VII. 

Section 712(d)(2)(B) of the DoddFrank Act requires the Commissions, in 

consultation with the Board, to jointly 

adopt rules governing books and records 

requirements for SBSAs by persons 

registered as swap data repositories 

(‘‘SDRs’’) under the CEA,5 including 

uniform rules that specify the data 

elements that shall be collected and 

maintained by each SDR.6 Similarly, 

section 712(d)(2)(C) of the Dodd-Frank 

Act requires the Commissions, in 

consultation with the Board, to jointly 

adopt rules governing books and records 

for SBSAs, including daily trading 

records, for swap dealers, major swap 

participants, security-based swap 

dealers, and security-based swap 

participants.7

Under the comprehensive framework 

for regulating swaps and security-based 

swaps established in Title VII, the CFTC 

is given regulatory authority over 

swaps,8 the SEC is given regulatory 

authority over security-based swaps,9

and the Commissions shall jointly 

prescribe such regulations regarding 

mixed swaps as may be necessary to 

carry out the purposes of Title VII.10 In 

addition, the SEC is given antifraud 

authority over, and access to 

information from, certain CFTCregulated entities regarding SBSAs, 

which are a type of swap related to 

securities over which the CFTC is given 

regulatory authority.11

To assist the Commissions in further 

defining the Product Definitions (as well 

as certain other definitions) and in 

prescribing regulations regarding mixed 

swaps as may be necessary to carry out 

the purposes of Title VII, the 

Commissions published an advance 

notice of proposed rulemaking 

(‘‘ANPR’’) in the Federal Register on 

August 20, 2010.12 The comment period 

for the ANPR closed on September 20, 

2010.13 The Commissions received 

comments addressing the Product 

Definitions and/or mixed swaps in 

response to the ANPR, as well as 

comments in response to the 

Commissions’ informal solicitations,14

from a wide range of commenters. 

Taking into account comments received 

on the ANPR, the Commissions 

published a notice of proposed 

rulemaking in the Federal Register on 

May 23, 2011.15 The comment period 

for the Proposing Release closed on July 

22, 2011.16 Together, the Commissions 

received approximately 86 written 

comment letters in response to the 

Proposing Release. 

The Commissions have reviewed and 

considered the comments received, and 

the staffs of the Commissions have met 

with many market participants and 

other interested parties to discuss the 

definitions.17 Moreover, the 

Commissions’ staffs have consulted 

extensively with each other as required 

by sections 712(a)(1) and (2) of the 

Dodd-Frank Act and have consulted 

with staff of the Board as required by 

section 712(d) of the Dodd-Frank Act. 

Based on this review and 

consultation, the Commissions are 

adopting rules and interpretations 

regarding, among other things: (i) The 

regulatory treatment of insurance 

products; (ii) the exclusion of forward 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48211 

18The Commissions refer to these costs and 

benefits as programmatic costs and benefits. 

19The Commissions refer to these costs as 

assessment costs. 

20See sections 712(a)(1) and (a)(2) of the DoddFrank Act. 

21See sections 712(a)(7)(A) and (B) of the DoddFrank Act. 

22See CEA section 1a(47)(A), 7 U.S.C. 1a(47)(A). 

This swap definition is also cross-referenced in new 

section 3(a)(69) of the Exchange Act, 15 U.S.C. 

78c(a)(69). 

23See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B), 

clauses (i)–(x). 

24See CEA sections 1a(47)(C)–(F), 7 U.S.C. 

1a(47)(C)–(F). 

25See CEA section 1a(47)(B)(x), 7 U.S.C. 

1a(47)(B)(x). 

26See section 3(a)(68) of the Exchange Act, 15 

U.S.C. 78c(a)(68). 

based swap definitions; (iii) the 

regulatory treatment of certain 

consumer and commercial contracts; 

(iv) the regulatory treatment of certain 

foreign-exchange related and other 

instruments; (v) swaps and securitybased swaps involving interest rates (or 

other monetary rates) and yields; (vi) 

total return swaps (‘‘TRS’’); (vii) Title 

VII instruments based on futures 

contracts; (viii) the application of the 

definition of ‘‘narrow-based security 

index’’ in distinguishing between 

certain swaps and security-based swaps, 

including credit default swaps (‘‘CDS’’) 

and index CDS; and (ix) the 

specification of certain swaps and 

security-based swaps that are, and are 

not, mixed swaps. In addition, the 

Commissions are adopting rules: (i) To 

clarify that there will not be additional 

books and records requirements 

applicable to SBSAs other than those 

required for swaps; (ii) providing a 

mechanism for requesting the 

Commissions to interpret whether a 

particular type of agreement, contract, 

or transaction (or class of agreements, 

contracts, or transactions) is a swap, 

security-based swap, or both (i.e., a 

mixed swap); and (iii) providing a 

mechanism for evaluating the 

applicability of certain regulatory 

requirements to particular mixed swaps. 

Finally, the CFTC is adopting rules to 

implement the anti-evasion authority 

provided in the Dodd-Frank Act. 

Overall Economic Considerations 

The Commissions are sensitive to the 

costs and benefits of their rules. In 

considering the adoption of the Product 

Definitions, the Commissions have been 

mindful of the costs and benefits 

associated with these rules, which 

provide fundamental building blocks for 

the Title VII regulatory regime. There 

are costs, as well as benefits, arising 

from subjecting certain agreements, 

contracts, or transactions to the 

regulatory regime of Title VII.18

Additionally, there are costs that parties 

will incur to assess whether certain 

agreements, contracts, or transactions 

are indeed subject to the Title VII 

regulatory regime, and, if so, the costs 

to assess whether such Title VII 

instrument is subject to the regulatory 

regime of the SEC or the CFTC.19

Title VII created a jurisdictional 

division between the CFTC and SEC. 

The costs and benefits flowing from an 

agreement, contract, or transaction being 

subject to the regulatory regime of the 

CFTC or the SEC may be impacted by 

similarities and differences in the 

Commissions’ regulatory programs for 

swaps and security-based swaps. Title 

VII calls on the SEC and the CFTC to 

consult and coordinate for the purposes 

of assuring regulatory consistency and 

comparability to the extent possible.20

Title VII also calls on the agencies to 

treat functionally or economically 

similar products or entities in a similar 

manner, but does not require identical 

rules.21 Although the Commissions may 

differ on certain rulemakings, as the 

relevant products, entities and markets 

are different, the Commissions believe 

that, as the CFTC and SEC regulatory 

regimes share a statutory basis in Title 

VII, the costs and benefits of their 

respective regimes should be broadly 

similar and complementary. 

In acknowledging the economic 

consequences of the final rules, the 

Commissions recognize that the Product 

Definitions do not themselves establish 

the scope or nature of those substantive 

requirements or their related costs and 

benefits. In determining the appropriate 

scope of these rules, the Commissions 

consider the types of agreement, 

contract, or transaction that should be 

regulated as a swap, security-based 

swap, or mixed swap under Title VII in 

light of the purposes of the Dodd-Frank 

Act. The Commissions have sought to 

further define the terms ‘‘swap,’’ 

‘‘security-based swap,’’ and ‘‘mixed 

swap’’ to include agreements, contracts, 

and transactions only to the extent that 

capturing these agreements, contracts, 

and transactions is necessary and 

appropriate given the purposes of Title 

VII, and to exclude agreements, 

contracts, and transactions to the extent 

that the regulation of such agreements, 

contracts, and transactions does not 

serve the statutory purposes of Title VII, 

so as not to impose unnecessary 

burdens for agreements, contracts, and 

transactions whose regulation may not 

be necessary or appropriate to further 

the purposes of Title VII. 

II. Scope of Definitions of Swap and 

Security-Based Swap 

A. Introduction 

Title VII of the Dodd-Frank Act 

applies to a wide variety of agreements, 

contracts, and transactions classified as 

swaps or security-based swaps. The 

statute lists these agreements, contracts, 

and transactions in the definition of the 

term ‘‘swap.’’ 22 The statutory definition 

of the term ‘‘swap’’ also has various 

exclusions,23 rules of construction, and 

other provisions for the interpretation of 

the definition.24 One of the exclusions 

to the definition of the term ‘‘swap’’ is 

for security-based swaps.25 The term 

‘‘security-based swap,’’ in turn, is 

defined as an agreement, contract, or 

transaction that is a ‘‘swap’’ (without 

regard to the exclusion from that 

definition for security-based swaps) and 

that also has certain characteristics 

specified in the statute.26 Thus, the 

statutory definition of the term ‘‘swap’’ 

also determines the scope of 

agreements, contracts, and transactions 

that could be security-based swaps. 

The statutory definitions of the terms 

‘‘swap’’ and ‘‘security-based swap’’ are 

detailed and comprehensive, and the 

Commissions believe that extensive 

‘‘further definition’’ of the terms by rule 

is not necessary. Nevertheless, the 

definitions could be read to include 

certain types of agreements, contracts, 

and transactions that previously have 

not been considered swaps or securitybased swaps, and nothing in the 

legislative history of the Dodd-Frank 

Act appears to suggest that Congress 

intended such agreements, contracts, or 

transactions to be regulated as swaps or 

security-based swaps under Title VII. 

The Commissions thus believe that it is 

important to further clarify the 

treatment under the definitions of 

certain types of agreements, contracts, 

and transactions, such as insurance 

products and certain consumer and 

commercial contracts. 

In addition, commenters also raised 

questions regarding, and the 

Commissions believe that it is important 

to clarify: (i) The exclusion for forward 

contracts from the definitions of the 

terms ‘‘swap’’ and ‘‘security-based 

swap;’’ and (ii) the status of certain 

commodity-related products (including 

various foreign exchange products and 

forward rate agreements) under the 

definitions of the terms ‘‘swap’’ and 

‘‘security-based swap.’’ Finally, the 

Commissions are providing 

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48212 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

27 In response to the ANPR, some commenters 

raised concerns regarding the treatment of interaffiliate swaps and security-based swaps. See, e.g., 

Letter from Edward J. Rosen, Cleary Gottlieb Steen 

& Hamilton LLP, Sep. 21, 2010 (‘‘Cleary ANPR 

Letter’’); Letter from Coalition for Derivatives End 

Users, Sep. 20, 2010 (‘‘CDEU ANPR Letter’’); Letter 

from Robert Pickel, Executive Vice President, 

International Swaps and Derivatives Association, 

Inc. (‘‘ISDA’’), Sep. 20, 2010; Letter from Richard 

A. Miller, Vice President and Corporate Counsel, 

Prudential Financial Inc., Sep. 17, 2010; Letter from 

Richard M. Whiting, The Financial Services 

Roundtable, Sep. 20, 2010. A few commenters 

suggested that the Commissions should further 

define the term ‘‘swap’’ or ‘‘security-based swap’’ to 

exclude inter-affiliate transactions. See Cleary 

ANPR Letter and CDEU ANPR Letter. The 

Commissions are considering whether inter-affiliate 

swaps or security-based swaps should be treated 

differently from other swaps or security-based 

swaps in the context of the Commissions’ other 

Title VII rulemakings. 

28CEA section 1a(47)(A)(ii), 7 U.S.C. 1a(47)(A)(ii). 

29See Proposing Release at 29821. The 

Commissions continue to believe that it was not the 

intent of Congress through the swap and securitybased swap definitions to preclude the provision of 

insurance to individual homeowners and small 

businesses that purchase property and casualty 

insurance. See section 2(e) of the CEA, 7 U.S.C. 2(e), 

and section 6(l) of the Exchange Act, 15 U.S.C. 

78f(l) (prohibiting individuals and small businesses 

that do not meet specified financial thresholds or 

other conditions from entering into swaps or 

security-based swaps other than on or subject to the 

rules of regulated futures and securities exchanges). 

Historically, insurance has not been regulated as 

such under the Federal securities laws or under the 

CEA. See infra note 1283. 

30 7 U.S.C. 16(h). Moreover, other provisions of 

the Dodd-Frank Act address the status of insurance 

more directly, and more extensively, than Title VII. 

For example, Title V of the Dodd-Frank Act requires 

the newly established Federal Insurance Office to 

conduct a study and submit a report to Congress, 

within 18 months of enactment of the Dodd-Frank 

Act, on the regulation of insurance, including the 

consideration of Federal insurance regulation. 

Notably, the Federal Insurance Office’s authority 

under Title V extends primarily to monitoring and 

information gathering; its ability to promulgate 

Federal insurance regulation that preempts state 

insurance regulation is significantly restricted. See 

section 502 of the Dodd-Frank Act (codified in 

various sections of 31 U.S.C.). Title V also 

addressed non-admitted insurance and reinsurance. 

Title X of the Dodd-Frank Act also specifically 

excludes the business of insurance from regulation 

by the Bureau of Consumer Financial Protection. 

See section 1027(m) of the Dodd-Frank Act, 12 

U.S.C. 5517(m) (‘‘The [Bureau of Consumer 

Financial Protection] may not define as a financial 

product or service, by regulation or otherwise, 

engaging in the business of insurance.’’); section 

1027(f) of the Dodd-Frank Act, 12 U.S.C. 5517(f) 

(excluding persons regulated by a state insurance 

regulator, except to the extent they are engaged in 

the offering or provision of consumer financial 

products or services or otherwise subject to certain 

consumer laws as set forth in Title X of the DoddFrank Act). 

31 In response to commenters, the Commissions 

are changing the word ‘‘company’’ from the 

proposal to ‘‘person.’’ Each of the CEA, the 

Securities Act, and the Exchange Act contains a 

definition of a ‘‘person.’’ See, e.g., Letter from Carl 

B. Wilkerson, Vice President & Chief Counsel, 

American Council of Life Insurers (‘‘ACLI’’), dated 

July 22, 2011 (‘‘ACLI Letter’’) and Letter from John 

P. Mulhern, Dewey & LeBoeuf LLP (‘‘D&L’’), dated 

July 22, 2011 (‘‘D&L Letter’’). 

interpretations related to the 

definitions.27

B. Rules and Interpretations Regarding 

Certain Transactions Outside the Scope 

of the Definitions of the Terms ‘‘Swap’’ 

and ‘‘Security-Based Swap’’ 

1. Insurance Products 

The statutory definition of the term 

‘‘swap’’ includes, in part, any 

agreement, contract or transaction ‘‘that 

provides for any purchase, sale, 

payment or delivery (other than a 

dividend on an equity security) that is 

dependent on the occurrence, 

nonoccurrence, or the extent of the 

occurrence of an event or contingency 

associated with a potential financial, 

economic, or commercial 

consequence.’’ 28 As stated in the 

Proposing Release, the Commissions do 

not interpret this clause to mean that 

products historically treated as 

insurance products should be included 

within the swap or security-based swap 

definitions.29 The Commissions are 

aware of nothing in Title VII to suggest 

that Congress intended for traditional 

insurance products to be regulated as 

swaps or security-based swaps. 

Moreover, the fact that swaps and 

insurance products are subject to 

different regulatory regimes is reflected 

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

which, in new section 12(h) of the CEA, 

provides that a swap ‘‘shall not be 

considered to be insurance’’ and ‘‘may 

not be regulated as an insurance 

contract under the law of any State.’’ 30

Accordingly, the Commissions believe 

that state or Federally regulated 

insurance products that are provided by 

persons that are subject to state or 

Federal insurance supervision, that 

otherwise could fall within the 

definitions should not be considered 

swaps or security-based swaps so long 

as they satisfy the requirements of the 

Insurance Safe Harbor (as defined 

below). At the same time, however, the 

Commissions are concerned that certain 

agreements, contracts, or transactions 

that are swaps or security-based swaps 

might be characterized as insurance 

products to evade the regulatory regime 

under Title VII of the Dodd-Frank Act. 

Accordingly, the Commissions are 

adopting final rules that (i) clarify that 

certain agreements, contracts, or 

transactions that satisfy the 

requirements of the Insurance Safe 

Harbor will not be considered to be 

swaps or security-based swaps, and (ii) 

provide an Insurance Grandfather 

exclusion from the swap and securitybased swap definitions for any 

agreement, contract, or transaction 

entered into on or before the effective 

date of the Product Definitions, 

provided that, when the parties entered 

into such agreement, contract, or 

transaction, it was provided in 

accordance with the Provider Test (as 

defined below), including a requirement 

that an agreement, contract or 

transaction that is provided in 

accordance with the first prong of the 

Provider Test must be regulated as 

insurance under applicable state law or 

the laws of the United States. 

The final rules contain four subparts: 

The first subpart addresses the 

agreement, contract, or transaction; the 

second subpart addresses the person 31

providing that agreement, contract, or 

transaction; the third subpart includes a 

list of traditional insurance products 

that do not have to meet the 

requirements set out in the first subpart; 

and the fourth subpart contains the 

Insurance Grandfather exclusion (as 

defined below). 

More specifically, with respect to the 

first subpart, the Commissions are 

adopting paragraph (i)(A) of rule 

1.3(xxx)(4) under the CEA and 

paragraph (a)(1) of rule 3a69–1 under 

the Exchange Act (the ‘‘Product Test’’) 

as proposed, with certain modifications 

to respond to commenters’ concerns. As 

adopted, the Product Test provides that 

the terms ‘‘swap’’ and ‘‘security-based 

swap’’ will not include an agreement, 

contract, or transaction that, by its terms 

or by law, as a condition of 

performance: 

• Requires the beneficiary of the 

agreement, contract, or transaction to 

have an insurable interest that is the 

subject of the agreement, contract, or 

transaction and thereby carry the risk of 

loss with respect to that interest 

continuously throughout the duration of 

the agreement, contract, or transaction; 

• Requires that loss to occur and be 

proved, and that any payment or 

indemnification therefor be limited to 

the value of the insurable interest; 

• Is not traded, separately from the 

insured interest, on an organized market 

or over the counter; and 

• With respect to financial guaranty 

insurance only, in the event of payment 

default or insolvency of the obligor, any 

acceleration of payments under the 

policy is at the sole discretion of the 

insurer. 

The Commissions are also adopting 

paragraph (i)(B) of rule 1.3(xxx)(4) 

under the CEA and paragraph (a)(2) of 

rule 3a69–1 under the Exchange Act 

(the ‘‘Provider Test’’) as proposed, with 

certain modifications to respond to 

commenters’ concerns. As adopted, the 

Provider Test requires that an 

agreement, contract, or transaction that 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48213 

32The term ‘‘State’’ is defined in section 3(a)(16) 

of the Exchange Act, 15 U.S.C. 78c(a)(16), to mean 

‘‘any State of the United States, the District of 

Columbia, Puerto Rico, the Virgin Islands, or any 

other possession of the United States.’’ The CFTC 

is incorporating this definition into rule 1.3(xxx)(4) 

for purposes of ensuring consistency between the 

CFTC and SEC rules further defining the terms 

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

33For purposes of this release, the term 

‘‘instrumentality’’ includes publicly supported, 

state operated or quasi-state operated insurance 

programs that may not be subject to state regulatory 

oversight, such as the Illinois Mine Subsidence 

Insurance Fund and the Florida Hurricane 

Catastrophe Fund. 

34For purposes of this release, the Commissions 

anticipate that the parties to an agreement, contract, 

or transaction will evaluate which state law applies 

prior to entering into such agreement, contract, or 

transaction. The Commissions do not anticipate that 

the parties’ analysis of which state law applies will 

change as a result of the adoption of the Insurance 

Safe Harbor. In addition, the Commissions will 

analyze which state law applies (if necessary, in 

consultation with state insurance regulatory 

authorities) if and when such issues arise that the 

Commissions determine to address. The 

Commissions note that courts routinely determine 

what is the ‘‘applicable state law’’ when 

adjudicating disputes involving insurance. 

35For purposes of this release, the term 

‘‘reinsurance’’ means the assumption by an insurer 

of all or part of a risk undertaken originally by 

another insurer. 

36For purposes of this release, the term 

‘‘reinsurer’’ means any person who provides 

reinsurance. 

37For purposes of this release, the term ‘‘cedant’’ 

means the person writing the risk being ceded or 

transferred to a reinsurer. 

38For purposes of this release, the term ‘‘nonadmitted insurance’’ means any property and 

casualty insurance permitted to be placed directly 

or through a surplus lines broker with a nonadmitted insurer eligible to accept such insurance. 

39For purposes of this release, the term ‘‘nonadmitted insurer’’ means, with respect to any State, 

an insurer not licensed to engage in the business of 

insurance in such State, but does not include a risk 

retention group, as that term is defined in section 

2(a)(4) of the Liability Risk Retention Act of 1986, 

15 U.S.C. 3901(a)(4). 

40See infra notes 88, 89, and 90 and 

accompanying text. 

41For example, if a person uses a weather 

derivative or catastrophe swap to assume all or part 

of the risks contained in a portfolio of property and 

casualty insurance policies, that weather derivative 

or catastrophe swap would be a Title VII instrument 

that is subject to regulation under Title VII. 

42As was discussed in the Proposing Release, see 

Proposing Release at 29822 n. 31, certain variable 

life insurance products and annuities are securities 

and therefore are excluded from the swap and 

security-based swap definitions regardless of 

whether they meet the requirements under the final 

rules. See section 1a(47)(B)(v) of the CEA, 7 U.S.C. 

1a(47)(B)(v). These securities would not be swaps 

or security-based swaps whether or not required to 

be registered under the Securities Act. See SEC v. 

United Benefit Life Ins. Co., 387 U.S. 202 (1967) 

(holding that the accumulation provisions of a 

‘‘flexible fund’’ annuity contract were not entitled 

to exemption under section 3(a)(8) of the Securities 

Act, 15 U.S.C. 77c(a)(8), for insurance and 

annuities); SEC v. Variable Annuity Life Ins. Co., 

359 U.S. 65 (1959) (holding that a variable annuity 

was not entitled to exemption under section 3(a)(8) 

of the Securities Act). 

43For the purpose of determining whether an 

agreement, contract or transaction falls within the 

Insurance Safe Harbor, Title VII provides the 

Commissions with flexibility to address the facts 

and circumstances of new products that may be 

marketed or sold as insurance, through joint 

interpretations pursuant to section 712(d)(4) of the 

Dodd-Frank Act. 

satisfies the Product Test must be 

provided: 

• By a person that is subject to 

supervision by the insurance 

commissioner (or similar official or 

agency) of any state 32 or by the United 

States or an agency or instrumentality 33

thereof, and such agreement, contract, 

or transaction is regulated as insurance 

under applicable state law 34 or the laws 

of the United States (the ‘‘first prong’’); 

• (i) Directly or indirectly by the 

United States, any state or any of their 

respective agencies or instrumentalities, 

or (ii) pursuant to a statutorily 

authorized program thereof ((i) and (ii) 

together, the ‘‘second prong’’); or 

• In the case of reinsurance only 35 by 

a person to another person that satisfies 

the Provider Test, provided that: 

(i) Such person is not prohibited by 

applicable state law or the laws of the 

United States from offering such 

agreement, contract, or transaction to 

such person that satisfies the Provider 

Test; 

(ii) The agreement, contract, or 

transaction to be reinsured satisfies the 

Product Test or is one of the 

Enumerated Products (as defined 

below); and 

(iii) Except as otherwise permitted 

under applicable state law, the total 

amount reimbursable by all reinsurers 36

for such agreement, contract, or 

transaction may not exceed the claims 

or losses paid by the cedant 37 ((i), (ii), 

and (iii), collectively, the ‘‘third 

prong’’); or 

• In the case of non-admitted 

insurance 38 by a person who: 

(i) Is located outside of the United 

States and listed on the Quarterly 

Listing of Alien Insurers as maintained 

by the International Insurers 

Department of the National Association 

of Insurance Commissioners; or 

(ii) Meets the eligibility criteria for 

non-admitted insurers 39 under 

applicable state law ((i) and (ii) together, 

the ‘‘fourth prong’’). 

In response to commenters’ requests 

that the Commissions codify the 

proposed interpretation regarding 

certain enumerated types of traditional 

insurance products in the final rules,40

the Commissions are also adopting 

paragraph (i)(C) of rule 1.3(xxx)(4) 

under the CEA and paragraph (a)(3) of 

rule 3a69–1 under the Exchange Act. In 

addition, in response to comments, the 

Commissions are expanding and 

revising the enumerated types of 

traditional insurance products. As 

adopted, the rule provides that the 

terms ‘‘swap’’ and ‘‘security-based 

swap’’ will not include an agreement, 

contract, or transaction that is provided 

in accordance with the Provider Test 

and is any one of the following 

(collectively, ‘‘Enumerated Products’’): 

Surety bonds; fidelity bonds; life 

insurance; health insurance; long-term 

care insurance; title insurance; property 

and casualty insurance; annuities; 

disability insurance; insurance against 

default on individual residential 

mortgages (commonly known as private 

mortgage insurance, as distinguished 

from financial guaranty of mortgage 

pools); and reinsurance (including 

retrocession) of any of the foregoing. 

The Commissions note that the 

inclusion of reinsurance (including 

retrocession) as an Enumerated Product 

is meant to apply to traditional 

reinsurance and retrocession contracts. 

Specifically, traditional reinsurance and 

retrocession contracts that reinsure risks 

ceded under traditional insurance 

products included in the Enumerated 

Product list and provided in accordance 

with the Provider test do not fall within 

the swap or security-based swap 

definitions. An agreement, contract, or 

transaction that is labeled as 

‘‘reinsurance’’ or ‘‘retrocession’’, but is 

executed as a swap or security-based 

swap or otherwise is structured to evade 

Title VII of the Dodd-Frank Act, would 

not satisfy the Insurance Safe Harbor, 

and would be a swap or security-based 

swap.41

In order for an agreement, contract, or 

transaction to qualify under the final 

rules as an insurance product that 

would not be a swap or security-based 

swap: (i) The agreement, contract, or 

transaction must satisfy the criteria in 

the Product Test or be one of the 

Enumerated Products and (ii) the person 

providing the agreement, contract or 

transaction must satisfy one prong of the 

Provider Test.42 The fact that an 

agreement, contract, or transaction 

satisfies the Product Test or is one of the 

Enumerated Products does not exclude 

it from the swap or security-based swap 

definitions if it is not provided by a 

person that satisfies the Provider Test; 

nor does the fact that a product is 

provided by a person that satisfies the 

Provider Test exclude the product from 

the swap or security-based swap 

definitions if the agreement, contract, or 

transaction does not satisfy the criteria 

set forth in the Product Test or is not 

one of the Enumerated Products.43

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48214 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

44See infra notes 178 and 179 and accompanying 

text. 

45The Commissions can engage in rulemakings in 

a variety of ways including an advanced notice of 

proposed rulemaking, a notice of proposed 

rulemaking, or an interim final rule. 

46When determining whether a particular 

product is a swap or security-based swap instead of 

insurance, if such product does not meet the 

requirements set out in the Insurance Safe Harbor, 

the Commissions will consider prior regulation as 

an insurance contract as one factor in their 

respective facts and circumstances analysis. 

47Requiring that a beneficiary of an insurance 

policy have a stake in the interest traditionally has 

been justified on public policy grounds. For 

example, a beneficiary that does not have a property 

right in a building might have an incentive to profit 

from arson. 

48Standard CDS documentation stipulates that 

the incurrence or demonstration of a loss may not 

be made a condition to the payment on the CDS or 

the performance of any obligation pursuant to the 

CDS. See, e.g., ISDA, 2003 ISDA Credit Derivatives 

Definitions, art. 9.1(b)(i) (2003) (‘‘2003 Definitions’’) 

(stating that ‘‘the parties will be obligated to 

perform * * * irrespective of the existence or 

amount of the parties’ credit exposure to a 

Reference Entity, and Buyer need not suffer any loss 

nor provide evidence of any loss as a result of the 

occurrence of a Credit Event’’). 

49See D&L Letter. 

50To the extent an insurance product provides for 

such items as, for example, a rental car for use 

while the car that is the subject of an automobile 

insurance policy is being repaired, the 

Commissions would consider such items as 

constituting part of the value of the insurable 

interest. 

51See, e.g., ‘‘Life Settlements Task Force, Staff 

Report to the United States Securities and Exchange 

Commission’’ (‘‘In an effort to help make the 

bidding process more efficient and to facilitate 

trading of policies after the initial settlement 

occurs, some intermediaries have considered or 

instituted a trading platform for life settlements.’’), 

available at http://www.sec.gov/news/studies/2010/ 

lifesettlements-report.pdf (July 22, 2010). 

52See, e.g., ISDA, 2005 Novation Protocol, 

available at http://www.isda.org/2005novationprot/ 

docs/NovationProtocol.pdf (2005); ISDA, ISDA 

Novation Protocol II, available at http:// 

www.isda.org/isdanovationprotII/docs/NPII.pdf 

(2005); 2003 Definitions, Exhibits E (Novation 

Agreement) and F (Novation Confirmation). 

53See infra notes 74 and 75 and accompanying 

text. 

54See, e.g., Letter from Kim O’Brien, President & 

CEO, National Association for Fixed Annuities 

(‘‘NAFA’’), dated July 21, 2011 (‘‘NAFA Letter’’); 

Letter from Robert Pickel, Executive Vice Chairman, 

ISDA, dated July 22, 2011 (‘‘ISDA Letter’’); ACLI 

Letter; and Letter from Letter from Stephen E. Roth, 

Frederick R. Bellamy and James M. Cain, 

Sutherland Asbill & Brennan LLP on behalf of the 

Committee of Annuity Insurers (‘‘CAI’’), dated July 

22, 2011 (‘‘CAI Letter’’). 

Further, in response to commenters’ 

concerns,44 the Commissions are 

confirming that the Product Test, the 

Provider Test and the Enumerated 

Products represent a non-exclusive safe 

harbor. None of the Product Test, the 

Provider Test, or the Enumerated 

Products (collectively, the ‘‘Insurance 

Safe Harbor’’) implies or presumes that 

an agreement, contract, or transaction 

that does not meet any of their 

respective requirements is a swap or 

security-based swap. Such an 

agreement, contract, or transaction will 

require further analysis of the applicable 

facts and circumstances, including the 

form and substance of such agreement, 

contract, or transaction, to determine 

whether it is insurance, and thus not a 

swap or security-based swap. 

However, future market conditions or 

other developments may prompt the 

Commissions to reconsider whether a 

particular product that satisfies the 

requirements of the Insurance Safe 

Harbor should instead fall within the 

swap or security-based swap definition. 

Because a determination that such a 

product is a swap or security-based 

swap could potentially have an 

unsettling effect on the domestic 

insurance or financial markets, the 

Commissions would only consider 

making a determination that such a 

product is a swap or security-based 

swap through a rulemaking 45 process 

that would provide market participants 

with an opportunity to comment.46

(a) Types of Insurance Products 

Final Rules 

Product Test 

The Commissions are adopting the 

Product Test as proposed, with certain 

modifications to respond to 

commenters’ concerns. The Product 

Test sets forth four criteria for an 

agreement, contract, or transaction to be 

considered insurance. First, the final 

rules require that the beneficiary have 

an ‘‘insurable interest’’ underlying the 

agreement, contract, or transaction and 

thereby carry the risk of loss with 

respect to that interest continuously 

throughout the duration of the 

agreement, contract, or transaction. The 

requirement that the beneficiary be at 

risk of loss (which could be an adverse 

financial, economic, or commercial 

consequence) with respect to the 

interest that is the subject of the 

agreement, contract, or transaction 

continuously throughout the duration of 

the agreement, contract, or transaction 

will ensure that an insurance contract 

beneficiary has a stake in the interest on 

which the agreement, contract, or 

transaction is written.47 Similarly, the 

requirement that the beneficiary have 

the insurable interest continuously 

throughout the duration of the 

agreement, contract, or transaction is 

designed to ensure that payment on the 

insurance product is inextricably 

connected to both the beneficiary and 

the interest on which the insurance 

product is written. In contrast to 

insurance, a credit default swap 

(‘‘CDS’’) (which may be a swap or a 

security-based swap) does not require 

the purchaser of protection to hold any 

underlying obligation issued by the 

reference entity on which the CDS is 

written.48 One commenter identified the 

existence of an insurable interest as a 

material element to the existence of an 

insurance contract.49 Because neither 

swaps nor security-based swaps require 

the presence of an insurable interest at 

all (although an insurable interest may 

sometimes be present coincidentally), 

the Commissions continue to believe 

that whether an insurable interest is 

present continuously throughout the 

duration of the agreement, contract, or 

transaction is a meaningful way to 

distinguish insurance from swaps and 

security-based swaps. 

Second, the requirement that a loss 

occur and be proved similarly ensures 

that the beneficiary has a stake in the 

insurable interest that is the subject of 

the agreement, contract, or transaction. 

If the beneficiary can demonstrate loss, 

that loss would ‘‘trigger’’ performance 

by the insurer on the agreement, 

contract, or transaction such that, by 

making payment, the insurer is 

indemnifying the beneficiary for such 

loss. In addition, limiting any payment 

or indemnification to the value of the 

insurable interest aids in distinguishing 

swaps and security-based swaps (where 

there is no such limit) from insurance.50

Third, the final rules require that the 

insurance product not be traded, 

separately from the insured interest, on 

an organized market or over the counter. 

As the Commissions observed in the 

Proposing Release, with limited 

exceptions,51 insurance products 

traditionally have not been entered into 

on or subject to the rules of an organized 

exchange nor traded in secondary 

market transactions (i.e., they are not 

traded on an organized market or over 

the counter). While swaps and securitybased swaps also generally have not 

been tradable at will in secondary 

market transactions (i.e., on an 

organized market or over the counter) 

without counterparty consent, the 

Commissions understand that all or part 

of swaps and security-based swaps are 

novated or assigned to third parties, 

usually pursuant to industry standard 

terms and documents.52 In response to 

commenter concerns,53 the 

Commissions are clarifying when 

assignments of insurance contracts and 

trading on ‘‘insurances exchanges’’ do 

not constitute trading the contract 

separately from the related insurable 

interest, and thus would not violate the 

Product Test. The Commissions do not 

interpret the assignment of an insurance 

contract as described by commenters 54

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55The assignment of the benefits or proceeds of 

an insurance contract by an owner or beneficiary 

does not violate the trading restriction in the 

Product Test. This interpretation does not extend to 

‘‘stranger originated’’ products. The transfer of 

obligations for policyholder benefits between two 

insurance companies, such as would occur in 

connection with an insurance company merger or 

acquisition, also does not violate the trading 

restriction contained in the Product Test. 

56See Letter from Susan E. Voss, Commissioner 

Iowa Insurance Division & National Association of 

Insurance Commissioners (‘‘NAIC’’) President, and 

Therese M. Vaughan, NAIC Chief Executive Officer, 

dated July 22, 2011 (‘‘NAIC Letter’’). 

57See Patient Protection and Affordable Care Act; 

Establishment of Exchanges and Qualified Health 

Plans, 76 FR 41866 (Jul. 15, 2011) (proposed). 

58Financial guarantee policies are used by 

entities such as municipalities to provide greater 

assurances to potential purchasers of their bonds 

and thus reduce their interest costs. See ‘‘Report by 

the United States Securities and Exchange 

Commission on the Financial Guarantee Market: 

The Use of the Exemption in section 3(a)(2) of the 

Securities Act for Securities Guaranteed by Banks 

and the Use of Insurance Policies to Guarantee Debt 

Securities’’ (Aug. 28, 1987). 

59See, e.g., Letter from Sean W. McCarthy, 

Chairman, Association of Financial Guaranty 

Insurers on the ANPR, dated Sept. 20, 2010 

(explaining the differences between financial 

guaranty policies and CDS); Letter from James M. 

Michener, General Counsel, Assured Guaranty on 

the ANPR, dated Dec. 14, 2010 (noting that the 

Financial Accounting Standards Board has issued 

separate guidance on accounting for financial 

guaranty insurance and CDS); Letter from Ernest C. 

Goodrich, Jr., Managing Director—Legal 

Department, Deutsche Bank AG on the ANPR, dated 

Sept. 20, 2010 (noting that financial guaranty 

policies require the incurrence of loss for payment, 

whereas CDS do not). 

60While a CDS requires payment in full on the 

occurrence of a credit event, the Commissions 

recognize that there are other financial instruments, 

such as corporate guarantees of commercial loans 

and letters of credit supporting payments on loans 

or debt securities, that allow for acceleration of 

payment obligations without such guarantees or 

letters of credit being swaps or security-based 

swaps. 

61See infra note 105 and accompanying text. 

62See supra note 41 and accompany text. 

63See infra notes 93 and 94 and accompanying 

text. 

to be ‘‘trading’’ as that term is used in 

the Product Test.55 Nor do the 

Commissions find that the examples of 

exchanges offered by commenters,56

such as Federal Patient Protection and 

Affordable Care Act ‘‘exchanges,’’ 57 are 

exchanges as that term is used in the 

Product Test, e.g., a national securities 

exchange or designated contract market. 

Mandated insurance exchanges are more 

like marketplaces for the purchase of 

insurance, and there is no trading of 

insurance policies separately from the 

insured interest on these insurance 

exchanges. Thus, the assignment of an 

insurance contract as permitted or 

required by state law, or the purchase or 

assignment of an insurance contract on 

an insurance exchange or otherwise, 

does not constitute trading an 

agreement, contract, or transaction 

separately from the insured interest and 

would not violate the trading restriction 

in the Product Test. For the foregoing 

reasons as clarified, the Commissions 

continue to believe that lack of trading 

separately from the insured interest is a 

feature of insurance that is useful in 

distinguishing insurance from swaps 

and security-based swaps. 

Fourth, the final rules provide that in 

the case of financial guaranty insurance 

policies, also known as bond insurance 

or bond wraps, any acceleration of 

payment under the policy must be at the 

sole discretion of the provider of the 

financial guaranty insurance policy in 

order to satisfy the Product Test.58

Although such products can be 

economically similar to products such 

as CDS, they have certain key 

characteristics that distinguish them 

from swaps and security-based swaps.59

For example, under a financial guaranty 

policy, the insurer typically is required 

to make timely payment of any 

shortfalls in the payment of scheduled 

interest to the holders of the underlying 

guaranteed obligation. Also, for 

particular bonds that are covered by a 

financial guaranty policy, the indenture, 

related documentation, and/or the 

financial guaranty policy will provide 

that a default in payment of principal or 

interest on the underlying bond will not 

result in acceleration of the obligation of 

the insurer to make payment of the full 

amount of principal on the underlying 

guaranteed obligation unless the 

insurer, in its sole discretion, opts to 

make payment of principal prior to the 

final scheduled maturity date of the 

underlying guaranteed obligation. 

Conversely, under a CDS, a protection 

seller frequently is required to make 

payment of the relevant settlement 

amount to the protection buyer upon 

demand by the protection buyer after 

any credit event involving the issuer.60

As noted in the Proposing Release, the 

Commissions do not believe that 

financial guaranty policies, in general, 

should be regulated as swaps or 

security-based swaps. However, because 

of the close economic similarity of 

financial guaranty insurance policies 

guaranteeing payment on debt securities 

to CDS, in addition to the criteria noted 

above with respect to insurance 

generally, the final rules require that, in 

order to satisfy the Product Test, 

financial guaranty policies also must 

satisfy the requirement that they not 

permit the beneficiary of the policy to 

accelerate the payment of any principal 

due on the debt securities. This 

requirement further distinguishes 

financial guaranty policies from CDS 

because, as discussed above, the latter 

generally requires payment of the 

relevant settlement amount on the CDS 

after demand by the protection buyer. 

Finally, in response to comments,61

the Commissions are clarifying that 

reinsurance and retrocession 

transactions fall within the scope of the 

Product Test. The Commissions find 

that these transactions have insurable 

interests, as the Commissions interpret 

such interests in this context, if they 

have issued insurance policies covering 

the risks that they wish to insure (and 

reinsure). Moreover, the Commissions 

find that retrocession transactions are 

encompassed within the Product Test 

and the Provider Test because 

retrocession is reinsurance of 

reinsurance (provided the retrocession 

satisfies the other requirements of both 

tests). In addition, reinsurance 

(including retrocession) of certain types 

of insurance products is included in the 

list of Enumerated Products.62

Requiring all of the criteria in the 

Product Test will help to limit the 

application of the final rules to 

agreements, contracts, and transactions 

that are appropriately regulated as 

insurance, and help to assure that 

agreements, contracts, and transactions 

appropriately subject to the regulatory 

regime under Title VII of the DoddFrank Act are regulated as swaps or 

security-based swaps. As a result, the 

Commissions believe that these 

requirements will help prevent the final 

rules from being used to circumvent the 

applicability of the swap and securitybased swap regulatory regimes under 

Title VII. 

Enumerated Products 

In the Proposing Release, the 

Commissions proposed an 

interpretation that certain enumerated 

types of insurance products would be 

outside the scope of the statutory 

definitions of swap and security-based 

swap under the Dodd-Frank Act if 

provided in accordance with the 

Provider Test and regulated as 

insurance. Based on comments 

received,63 the Commissions are adding 

three products to the list of products as 

proposed (fidelity bonds, disability 

insurance and insurance against default 

on individual residential mortgages), 

adding reinsurance (including 

retrocession) of any of the traditional 

insurance products included in the list, 

deleting a requirement applicable to 

annuities, and codifying the 

Enumerated Products in the final rules. 

The revised list of Enumerated Products 

is: Surety bonds, fidelity bonds, life 

insurance, health insurance, long-term 

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64See supra note 41 and accompanying text. 

65See ACLI Letter; CAI Letter; ISDA Letter 

(objecting to the requirement that the risk of loss be 

held continuously throughout the contact); NAFA 

Letter; NAIC Letter; and Letter from Kenneth F. 

Spence III, Executive Vice President & General 

Counsel, The Travelers Companies, Inc. 

(‘‘Travelers’’), dated Nov. 14, 2011 (‘‘Travelers 

Letter’’). 

66See ACLI Letter; CAI Letter; ISDA Letter; NAIC 

Letter; and Travelers Letter. The Commissions 

understand that some states may define what 

constitutes an insurable interest with reference to 

personal or emotional consequence in addition to 

the financial, economic, or commercial 

consequence mentioned in the statutory swap 

definition. 

67See NAIC Letter and Travelers Letter. However, 

one commenter noted that the Product and Provider 

Tests, as proposed, should be an effective means of 

helping to distinguish between those contracts that 

qualify for exclusion from the definition of swap 

and security-based swap from those contracts that 

will not. See Letter from Michael A. Bell, Senior 

Counsel, Financial Policy, The Property Casualty 

Insurers Association of America, dated July 22, 

2011. 

68See CAI Letter; ISDA Letter; NAFA Letter; and 

NAIC Letter. 

69See Letter from Nicholas D. Latrenta, Executive 

Vice President and General Counsel, Metropolitan 

Life Insurance Companies and its insurance 

affiliates (‘‘MetLife’’), dated July 22, 2011 (‘‘MetLife 

Letter’’). 

70See ACLI Letter; CAI Letter; ISDA Letter; NAFA 

Letter; and Travelers Letter. 

71See ACLI Letter and Travelers Letter. 

72See Travelers Letter. 

73See, e.g., ACLI Letter and CAI Letter. 

74See ACLI Letter; Letter from Chris Barnard 

(‘‘Barnard’’), dated June 28, 2011 (‘‘Barnard Letter’’); 

CAI Letter; NAFA Letter; NAIC Letter; and ISDA 

Letter. 

care insurance, title insurance, property 

and casualty insurance, annuities, 

disability insurance, insurance against 

default on individual residential 

mortgages (commonly known as private 

mortgage insurance, as distinguished 

from financial guaranty of mortgage 

pools), and reinsurance (including 

retrocession) of any of the foregoing.64

The Commissions believe that the 

Enumerated Products, as traditional 

insurance products, are not the types of 

agreements, contracts, or transactions 

that Congress intended to subject to the 

regulatory regime for swaps and 

security-based swaps under the DoddFrank Act. Codifying the Enumerated 

Products in the final rules appropriately 

places traditional insurance products 

outside the scope of the swap and 

security-based swap definition so long 

as such Enumerated Products are 

provided in accordance with the 

Provider Test, including a requirement 

that an Enumerated Product that is 

provided in accordance with the first 

prong of the Provider Test must be 

regulated as insurance under applicable 

state law or the laws of the United 

States. 

Comments 

Insurable Interest 

Six commenters objected to the 

requirement in the Product Test that the 

beneficiary have an insurable interest 

continuously throughout the duration of 

the contract.65 These commenters noted 

that, under state law, an insurable 

interest may not always be required to 

be present continuously throughout the 

duration of the policy. For example, 

commenters noted that life insurance 

may only require an insurable interest at 

the time the policy is executed; 66 and 

some property and casualty or liability 

insurance may only require an insurable 

interest at the time a loss occurs.67

Commenters also noted that annuities 

and health insurance do not require the 

existence of an insurable interest at 

all.68 Another commenter suggested that 

the Commissions modify the Product 

Test to indicate that annuities would 

not need to satisfy the ‘‘insurable 

interest’’ component, or to use 

terminology other than insurable 

interest to make clear that annuities are 

not swaps.69

As discussed above, the Commissions 

are retaining the insurable interest 

requirement of the Product Test. The 

Commissions continue to believe that 

this requirement is a useful tool to 

distinguish insurance from swaps and 

security-based swaps, because swaps 

and security-based swaps do not require 

the presence of an insurable interest (or 

require either counterparty to bear any 

risk of loss) at any time during the term 

of the agreement, contract, or 

transaction. While the Commissions 

acknowledge commenters who argued 

that products such as life insurance, 

property and casualty insurance, and 

annuities may fail the Product Test 

because of the insurable interest 

requirement, the Commissions do not 

interpret any such failure to mean that 

life insurance, property and casualty 

insurance, and annuities are not 

insurance products. To the contrary, as 

discussed above, these products are 

included in the list of Enumerated 

Products that are excluded from the 

swap and security-based swap 

definitions so long as they are provided 

in accordance with the Provider Test. If 

a life insurance, property and casualty 

insurance, or annuity is provided in 

accordance with the Provider Test, such 

product is not a swap or security-based 

swap, whether or not an insurable 

interest is present at all times during the 

term of the contract. 

Indemnification for Loss 

Five commenters objected to the 

requirement in the Product Test that a 

loss occur and be proven, and that any 

payment be limited to the value of the 

insurable interest, because payment 

under many insurance products may not 

be directly based upon actual losses 

incurred.70 Two commenters argued 

that annuities do not provide 

indemnification for loss and that life 

insurance products are not constrained 

by the value of the insurable interest.71

Another argued that many insurance 

policies pay fixed amounts upon the 

occurrence of a loss without a 

requirement that the loss be tied to the 

value of an insurable interest.72

Disability insurance and long-term care 

insurance are other products that 

commenters indicate would not be able 

to satisfy this requirement of the 

Product Test.73

As discussed above, the Commissions 

are retaining the requirement in the 

Product Test that a loss occur and be 

proven and that any payment for such 

loss be limited to the value of the 

insurable interest. The Commissions 

continue to believe that this 

requirement is a useful tool to 

distinguish insurance from swaps and 

security-based swaps, because payments 

under swaps and security-based swaps 

may be required when neither party 

incurs a loss, nor is the amount of 

payment limited by any such loss. 

While the Commissions acknowledge 

commenters who identified various 

products that may fail this part of the 

Product Test, the Commissions do not 

interpret any such failure to mean that 

products such as annuities, disability 

insurance, and long-term care insurance 

are not insurance products. To the 

contrary, as discussed above, these 

products are included in the list of 

Enumerated Products that are excluded 

from the swap and security-based swap 

definitions so long as they are provided 

in accordance with the Provider Test. If 

long-term care insurance, disability 

insurance, or an annuity is provided in 

accordance with the Provider Test, such 

product is not a swap or a securitybased swap, whether or not a loss 

occurs, is proven, or indemnification for 

loss is limited to the value of the 

insurable interest. 

Not Traded Separately 

Six commenters stated that the 

proposed requirement that the 

agreement, contract, or transaction not 

be traded, separately from the insured 

interest, on an organized market or over 

the counter, is not an effective criterion 

in determining whether a product is 

insurance.74 According to commenters, 

this criterion is ineffective and should 

be deleted from the Product Test 

because many conventional insurance 

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75 Id. ACLI stated that many conventional 

insurance products, particularly annuities, can be 

assigned by the owner, and often state insurance 

law requires such assignability as a condition for 

approval of the product for sale under applicable 

insurance law. ACLI also stated that insurance 

policies are frequently assigned among family 

members, to third parties as collateral for loans, and 

in a host of other situations, and does not believe 

that these common kinds of assignment should 

cause an insurance product to be characterized as 

a swap. 

76See Barnard Letter and NAIC Letter. 

77See NAIC Letter. The commenter explained 

that the ‘‘insurance exchanges’’ mandated by the 

Patient Protection and Affordable Care Act would 

be marketplaces for insurance policies. The 

commenter described them as ‘‘cooperatives’’ where 

people could go to buy insurance policies with 

standardized terms/actuaries. The commenter noted 

that the insurable interest would not ‘‘trade’’ 

separately from the insurance policy in these 

cooperatives. 

78See Travelers Letter. 

79See supra notes 54 and 55. 

80See supra notes 56 and 57. 

81See Letter from Bruce E. Stern, Chairman, 

Association of Financial Guaranty Insurers 

(‘‘AFGI’’), dated July 20, 2011 (‘‘AFGI Letter’’); 

ISDA Letter; and Letter from Kimberly M. Welsh, 

Vice President and Assistant General Counsel, 

Reinsurance Association of America (‘‘RAA’’), 

dated July 22, 2011 (‘‘RAA Letter’’). 

82See Letter from Dennis M. Kelleher, President 

& CEO, Better Markets Inc., dated July 22, 2011 

(‘‘Better Markets Letter’’). 

83See ISDA Letter and RAA Letter. 

84 Id. 

85See AFGI Letter. 

86 Id. The commenter argued that these burdens 

would (a) increase instability in the currently fragile 

municipal bond market and (b) decrease the 

availability or attractiveness of bond insurance to 

municipal issuers that would otherwise save money 

by employing bond insurance. The Commissions 

understand that only one member of AFGI is 

currently active in the municipal bond insurance 

market. 

87One commenter noted that ‘‘financial 

guarantors, for some time and in full compliance 

with state insurance laws, have issued insurance 

policies that contemplate acceleration upon events 

unrelated to an issuer default, e.g., upon the 

downgrade of the insurer.’’ See AFGI Letter. In 

response to this comment, the Commissions note 

that the acceleration requirement in the Product 

Test refers only to ‘‘payment default or insolvency 

of the obligor’’ (emphasis added), without 

precluding other triggers. 

88See ACLI Letter; NAIC Letter; RAA Letter; AIA 

Letter; NAFA Letter; and Letter from Mark R. 

Thresher, Executive Vice President, Nationwide, 

dated July 19, 2011 (‘‘Nationwide Letter’’). 

89See Travelers Letter. 

products, such as annuities, are 

assignable (and therefore tradable), 

which may violate the trading 

restriction.75 Two commenters observed 

that the trading of insurance policies 

has already occurred and is expected to 

increase.76 One commenter stated that a 

number of states have ‘‘insurance 

exchanges’’ that sell reinsurance and 

excess or surplus lines, and that the 

Patient Protection and Affordable Care 

Act requires states or the Federal 

government to establish health benefit 

‘‘insurance exchanges’’ through which 

insurers will sell health insurance to 

individuals and small groups.77 One 

commenter recommended that the 

trading restriction apply only to trading 

by the policyholder or beneficiary of an 

insurance policy.78

The Commissions are retaining the 

requirement in the Product Test that the 

agreement, contract, or transaction not 

be traded separately from the insured 

interest, on an organized market or over 

the counter, and as discussed above 

have provided a clarification regarding 

assignments and trading on insurance 

exchanges. The Commissions continue 

to believe that using this criterion is an 

effective way to distinguish insurance 

from swaps and security-based swaps 

because swaps and security-based 

swaps are traded on organized markets 

and over the counter. 

As stated above, the Commissions do 

not interpret the assignment of an 

insurance contract as described by 

commenters to be ‘‘trading’’ as that term 

is used in the Product Test.79 Nor do the 

Commissions find that the examples of 

exchanges offered by commenters, such 

as Federal Patient Protection and 

Affordable Care Act ‘‘exchanges,’’ are 

exchanges as that term is used in the 

Product Test, e.g., a national securities 

exchange or designated contract 

market.80 Mandated insurance 

exchanges are more like marketplaces 

for the purchase of insurance, and there 

is no trading of insurance policies 

separately from the insured interest on 

these insurance exchanges. Thus, the 

assignment of an insurance contract as 

permitted or required by state law, or 

the purchase or assignment of an 

insurance contract on an insurance 

exchange or otherwise, does not 

constitute trading an agreement, 

contract, or transaction separately from 

the insured interest and would not 

violate the trading restriction in the 

Product Test. 

Acceleration 

Three commenters believed that the 

proposed requirement that, in the event 

of payment default or insolvency of the 

obligor, any acceleration of payments 

under a financial guaranty insurance 

policy be at the sole discretion of the 

insurer, is not an effective criterion in 

determining whether financial guaranty 

insurance falls outside the swap and 

security-based swap definitions and 

should be deleted from the Product 

Test.81 However, one commenter 

supported its inclusion, observing that 

the proposed requirement is ‘‘firmly 

based on substantive business 

realities.’’ 82 Two commenters believed 

that the acceleration of payments 

requirement is not useful in 

distinguishing between financial 

guaranty insurance and swaps or 

security-based swaps because it is 

designed to protect financial guaranty 

insurers from insolvency.83 They noted 

that the criterion is a regulatory 

requirement imposed by state insurance 

commissioners that is subject to change, 

and that a state could not change this 

regulatory requirement without 

converting the financial guaranty policy 

into a swap or security-based swap.84

One commenter stated that the 

acceleration of payments criterion has 

been the subject of significant analysis 

and interpretation by state insurance 

regulators, and including the 

requirement in the rules could result in 

conflicting interpretations and 

additional legal uncertainty.85 This 

commenter also stated that this 

uncertainty will impose significant 

burdens on financial guaranty insurers 

that insure municipal bonds.86

The Commissions are retaining the 

requirement that acceleration be at the 

sole option of the provider of the 

financial guaranty insurance policy in 

the Product Test. In response to 

commenter concerns, the Commissions 

are clarifying that they plan to interpret 

the acceleration limitation in 

accordance with applicable state law to 

the extent that it does not contradict the 

Commissions’ rules, interpretations 

and/or guidance regarding what is a 

swap or security-based swap.87 The 

Commissions continue to believe that, 

for purposes of further defining swaps 

and security-based swaps, this criterion 

is useful to distinguish between 

financial guaranty insurance on the one 

hand, and swaps and security-based 

swaps, such as CDS, on the other 

because, as discussed above, the latter 

generally requires payment of the 

relevant settlement amount on the CDS 

after demand by the protection buyer. 

Enumerated Products 

The Commissions proposed an 

interpretation that certain enumerated 

types of insurance products would be 

outside the scope of the statutory 

definitions of swap and security-based 

swap. Several commenters stated that 

the list of enumerated insurance 

products should be codified in order to 

enhance legal certainty.88 In particular, 

one commenter stated that it is 

important for the Commissions to codify 

the interpretation because the 

traditional insurance products included 

in the enumerated list may not satisfy 

the Product Test.89 The commenter also 

expressed concern that insurance 

companies and state insurance 

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90 Id. 

91See D&L Letter. 

92See infra notes 147 and 148 and accompanying 

text. 

93See ACLI Letter; CAI Letter; MetLife Letter; 

Nationwide Letter; and RAA Letter. 

94See ACLI Letter; AIA Letter; CAI Letter; D&L 

Letter; NAIC Letter; Letter from Michael A. Bell, 

Senior Counsel, Financial Policy, RAA Letter; and 

Letter from Robert J. Duke, The Surety & Fidelity 

Association of America (‘‘SFAA’’), dated July 13, 

2011 (‘‘SFAA Letter’’). ACLI, CAI and RAA 

requested the addition of other types of annuity and 

pension plan products, such as group annuity 

contracts, guaranteed investment contracts, funding 

agreements, structured settlements, deposit 

administration contracts, and immediate 

participation guarantee contracts. D&L requested 

the addition of reinsurance of any of the 

enumerated types of traditional insurance products. 

NAIC requested the addition of mortgage guaranty, 

accident, and disability insurance. SFAA request 

the addition of surety and fidelity bonds. 

95See Letter from J. Stephen Zielezienski, Senior 

Vice President & General Counsel, American 

Insurance Association (‘‘AIA’’), dated July 22, 2011 

(‘‘AIA Letter’’). 

96See NAIC Letter. The Commissions note that 

service contracts, although regulated as insurance 

in some states, comprise consumer warranties, 

extended service plans, and buyer protection plans 

of the sort purchased with major appliances, 

electronics, and the like. The Commissions are 

addressing these contracts in their interpretation 

regarding consumer/commercial transactions. See 

infra part II.B.3. 

97SFAA requested that the Commissions issue 

specific guidance that surety and fidelity bonds are 

insurance products rather than swaps, noting that 

all states include surety and fidelity bonds as lines 

of insurance subject to state oversight. Surety bonds 

were already included in the list of enumerated 

insurance products contained in the Proposing 

Release. 

98See supra note 41 and accompanying text. 

99See, e.g., RAA Letter; CAI Letter; Letter from 

Ian K. Shepherd, Managing Director, Alice Corp. 

Pty Ltd (‘‘Alice Corp.’’), dated July 22, 2011. Alice 

Corp. stated that industry loss warrants are a 

contingent instrument with a somewhat illiquid 

secondary market but ‘‘are currently treated as a 

reinsurance product and require an insurable 

interest.’’ Alice Corp. also stated that ‘‘[c]atastrophe 

bonds may reference a specific insured portfolio or 

a set of parameters and may be traded in a 

secondary market and behave like a coupon bond 

if there is no triggering event but have a contingent 

element since some or all of the principal may be 

lost if the referenced event or loss occurs.’’ Id. The 

Commissions note that catastrophe bonds are 

‘‘securities’’ under the Federal securities laws and 

decline to provide an interpretation regarding 

industry loss warrants because it is inappropriate to 

determine whether a complex and novel product is 

a swap or a security-based swap in a general 

definitional rulemaking. 

100See Acceptance of Public Submissions 

Regarding the Study of Stable Value Contracts, 76 

FR 53162 (Aug. 25, 2011). 

101See ACLI Letter and AFGI Letter. Some states 

define concepts such as ‘‘insurable interest’’ in 

statute; in other states definitions have developed 

through common law. The Commissions recognize 

that the terms denoting such concepts may vary 

from state to state; for instance, what one state calls 

an ‘‘insurable interest’’ may be referred to as a 

‘‘material interest’’ in another. See, e.g., New York 

Insurance Law Section 1101 (‘‘material interest’’). 

The Commissions believe, however, that both the 

concepts and their labels are well understood by 

insurance professionals and that any such 

variations would not impede market participants 

from interpreting or applying the final rules. 

Indeed, one commenter acknowledged this and 

applied the concepts, labeled differently, to 

particular products. ‘‘The terms used in the rule’s 

criteria are different from the terms used with 

respect to a surety bond. For example, the bond is 

generally not referred to as a ‘policy.’ In addition, 

the beneficiary of a bond typically is known as the 

‘obligee.’ Further, the bond’s limit is referred to as 

the ‘penal sum.’ Nevertheless, the criteria can be 

applied to surety bonds and fidelity bonds, and 

such application would exclude bonds from the 

statutory definition of swaps.’’ See SFAA Letter. 

regulators would face the possibility 

that the Commissions could revise or 

withdraw the interpretation in the 

future, with or without undergoing a 

formal rulemaking process.90 As noted 

above, in response to commenters’ 

concerns, the Commissions are 

codifying the Enumerated Products in 

the final rules. 

One commenter further argued that 

the enumerated types of insurance 

products included in the list should not 

have to additionally satisfy the 

requirements that the person offering 

such product be a U.S. domiciled 

insurer and that the product be 

regulated in the U.S. as insurance.91 The 

commenter argued that this additional 

requirement would result in the 

Insurance Safe Harbor not applying to 

traditional insurance products offered 

by insurers domiciled outside of the 

U.S. or by insurers that are not 

organized as insurance companies. The 

Commissions are retaining the 

requirement that the Enumerated 

Products be provided in accordance 

with the Provider Test. The 

Commissions also note that, in response 

to commenters’ concerns, the 

Commissions have revised the first 

prong of the Provider Test so that it is 

not limited to insurance companies or to 

entities that are domiciled in the U.S. A 

product that need not satisfy the 

Product Test must be provided in 

accordance with the Provider Test, 

including a requirement that products 

provided in accordance with the first 

prong of the Provider Test must be 

regulated as insurance.92

Five commenters addressed the 

treatment of annuities in the proposed 

interpretive guidance, with all 

recommending that all annuities be 

excluded from the swap and securitybased definitions regardless of their 

status under the tax laws.93 In response 

to the comments, the Commissions are 

eliminating the proposed requirement 

that annuities comply with section 72 of 

the Internal Revenue Code in order to 

qualify as an Enumerated Product. The 

Commissions are persuaded that the 

proposed reference to the Internal 

Revenue Code is unnecessarily limiting 

and does not help to distinguish 

insurance from swaps and securitybased swaps. 

Other commenters suggested adding 

other products to the list of enumerated 

types of insurance products,94 with one 

suggesting that the Commissions’ 

interpretation cover all transactions 

currently reportable as insurance in the 

provider’s regulatory and financial 

reports under a state’s or a foreign 

jurisdiction’s insurance laws.95 One 

commenter noted that the list of 

enumerated types of insurance products 

does not include other state-regulated 

products such as service contracts, that 

may not satisfy the Product Test.96 In 

response to requests to expand the list 

of enumerated products, the 

Commissions are adding fidelity 

bonds,97 disability insurance, and 

insurance against default on individual 

residential mortgages (commonly 

known as private mortgage insurance, as 

distinguished from financial guaranty of 

mortgage pools) to the list of 

Enumerated Products. The Commissions 

agree that these are traditional insurance 

products, and thus their inclusion in the 

list of Enumerated Products is 

appropriate. The Commissions have also 

added reinsurance (including 

retrocession) of any of the traditional 

insurance products to the list of 

Enumerated Products.98 However, the 

Commissions decline at this time to 

expand the list of Enumerated Products 

to include other types of contracts such 

as, guaranteed investment contracts 

(‘‘GICs’’), synthetic GICs, funding 

agreements, structured settlements, 

deposit administration contracts, 

immediate participation guaranty 

contracts, industry loss warrants, and 

catastrophe bonds.99 These products do 

not receive the benefit of state insurance 

guaranty funds; their providers are not 

limited to insurance companies. The 

Commissions received little detail on 

sales of these other products, and do not 

believe it is appropriate to determine 

whether particular complex, novel or 

still evolving products are swaps or 

security-based swaps in the context of a 

general definitional rulemaking. Rather 

these products should be considered in 

a facts and circumstances analysis. With 

respect to GICs, the Commissions have 

published a request for comment 

regarding the study of stable value 

contracts. 100

Reliance on State Law Concepts 

Two commenters noted that the 

Product Test relies on concepts derived 

from state law, such as ‘‘insurable 

interest’’ and ‘‘indemnification for loss,’’ 

which do not have uniform 

definitions.101 This would require the 

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102See ACLI Letter and AFGI Letter. 

103See AFGI Letter. 

104The Commissions may also diverge from 

interpretations or determinations of state law based 

on an analysis of applicable facts and circumstances 

when determining whether a particular product is 

a swap or security-based swap. 

105See ACLI Letter; CAI Letter; D&L Letter; ISDA 

Letter; NAFA Letter; Nationwide Letter; and RAA 

Letter. ACLI noted that the Product Test does not 

include a reference to reinsurance and that the 

‘‘insurable interest’’ requirement under state 

insurance law generally does not apply to 

reinsurance products which, therefore, would not 

satisfy the Product Test. ACLI and CAI state that 

reinsurance in a chain of reinsurance also should 

not be considered a swap or security-based swap. 

In addition to expressly referencing reinsurance and 

retrocession transactions, ACLI believes that the 

Product Test should be expanded to include 

reinsurance and retrocession of insurance risks 

ceded by non-U.S. insurance companies to 

domestic insurance companies. RAA recommended 

adding a new clause to the Product Test to provide 

that ‘‘[a]ny agreement, contract, or transaction 

which reinsures any agreement, contract, or 

transaction meeting the criteria of paragraph 

(xxx)(4)(i)(A)–(C) of this section is also an insurance 

product.’’ 

106See supra note 41 and accompanying text. 107See Proposing Release at 29824. See also id. 

at 29825, Request for Comment 7. 108See ACLI Letter; AIA Letter; AFGI Letter; CAI 

Letter; ISDA Letter; NAFA Letter; NAIC Letter; and 

Nationwide Letter (concurring with ACLI’s 

comments). 

Commenters cited several examples of products 

that would fail a requirement that payment not be 

based on the price, rate, or level of a financial 

instrument, asset, or interest or any commodity. 

ACLI, CAI and NAFA cited registered and 

unregistered variable annuities and variable life 

insurance, and certain fixed annuities and equity 

indexed annuities, stating that these could be 

construed as being based on, or related to, a price, 

rate or level of a financial asset. ACLI also cited 

financial guaranty insurance, and replacement 

value property and casualty insurance, where the 

insurer’s payment obligation may be based on the 

current price of the insured property or adjusted to 

reflect inflation. ACLI and ISDA cited crop 

insurance, because it could call for payment to be 

based in some way on the market price of the 

covered crop on the date of loss. ISDA and RAA 

cited ‘‘dual trigger’’ insurance (such as replacement 

power insurance); property and casualty policies 

purchased by some commodity producers (e.g., oil 

refineries, copper mines) with deductibles that 

increase or decrease based on the price of the 

commodity that the company produces; event 

cancellation insurance that uses commodity indices 

to determine claims; and weather insurance and 

malpractice insurance. NAIC cited guaranteed 

investment contracts, financial guaranty insurance, 

and mortgage guaranty insurance 

109See AIA Letter and AFGI Letter. 

110See Barnard Letter and Better Markets Letter. 

111See Better Markets Letter. 

112See Barnard Letter. 

113See Proposing Release at 29827, Request for 

Comment 17. 

114See AFGI Letter; D&L Letter; and ISDA Letter. 

115See D&L Letter. 

Commissions to analyze state insurance 

law, as well as to determine which state 

law should apply.102 One of these 

commenters also requested that such 

concepts be applied consistently with 

the historical interpretation by the 

applicable state.103

State law differences regarding these 

concepts should not impede the ability 

of market participants from interpreting 

or applying the final rules to 

distinguishing between insurance and 

swaps or security-based swaps, and thus 

the Commissions are retaining these 

concepts in the Product Test. The 

Commissions intend to interpret these 

concepts consistently with the existing 

and developing laws of the relevant 

state(s) governing the agreement, 

contract, or transaction in question. 

However, the Commissions note their 

authority to diverge from state law if the 

Commissions become aware of evasive 

conduct.104

Inclusion of Reinsurance and 

Retrocession Transactions 

Several commenters suggested that 

the Commissions amend the Product 

Test to explicitly address reinsurance 

and retrocession (i.e., reinsurance of 

reinsurance) transactions.105

In response to these comments, the 

Commissions are clarifying that 

reinsurance and retrocession 

transactions may fall within the 

Insurance Safe Harbor, thus, it is 

unnecessary for the Product Test to be 

modified as suggested by these 

commenters. In addition, the 

Commissions have modified the final 

rules to include reinsurance (including 

retrocession) of certain types of 

insurance products in the list of 

Enumerated Products. Reinsurance or 

retrocession of these Enumerated 

Products will fall within the Insurance 

Safe Harbor so long as such reinsurance 

or retrocession is provided in 

accordance with the Provider Test.106

Payment Based on the Price, Rate, or 

Level of a Financial Instrument 

In the Proposing Release, the 

Commissions requested comment on 

whether, in order for an agreement, 

contract, or transaction to be considered 

insurance under the Product Test, the 

Commissions should require that 

payment not be based on the price, rate, 

or level of a financial instrument, asset, 

or interest or any commodity. The 

Commissions also requested comment 

on whether variable annuity contracts 

(where the income is subject to tax 

treatment under section 72 of the 

Internal Revenue Code) and variable life 

insurance should be excepted from such 

a requirement, if adopted.107

Eight commenters stated that it is 

inappropriate to include such a 

requirement in the final rules because a 

number of traditional insurance 

products would not satisfy the 

requirement and suggested that the 

Commissions should instead consider 

whether the agreement, contract, or 

transaction transfers risk and argued 

that such a requirement is not a useful 

marker for distinguishing insurance 

from swaps and security-based 

swaps.108 Several commenters also 

believed that the addition to the Product 

Test of the criterion that payment not be 

based on the price, rate, or level of a 

financial instrument, asset, or interest or 

any commodity would contribute to 

greater legal uncertainty.109

Two commenters agreed that such a 

requirement should be included in the 

final rules.110 One commenter argued 

that any insurance instrument that 

provides for payment based on the 

price, rate, or level of a financial 

instrument, asset, or interest in any 

commodity is in substance a swap or 

security-based, regardless of its label, 

and should be regulated as such.111 One 

of these commenters further 

recommended that the Commissions 

exclude annuity and variable universal 

life insurance from this requirement 

because these products were 

investments with some minimal level of 

life insurance cover or investment 

guarantee rider on top.112

The Commissions are not adopting an 

additional requirement for the Product 

Test that payment not be based on the 

price, rate, or level of a financial 

instrument, asset, or interest or any 

commodity because the Commissions 

find the requirement to be unsuitable for 

distinguishing insurance from swaps 

and security-based swaps. While the 

provision might work for property and 

casualty insurance, as many 

commenters noted, it is not an effective 

distinction for a number of other 

traditional insurance products. 

Accounting Standards 

In the Proposing Release, the 

Commissions requested comment on 

whether the proposed rules relating to 

insurance should include a provision 

related to whether a product is 

recognized at fair value on an ongoing 

basis with changes in fair value 

reflected in earnings under U.S. 

generally accepted accounting 

principles.113

Three commenters argued that the 

proposed rules should not include a 

provision that an insurance product is 

recognized at fair value under generally 

accepted accounting principles.114 One 

commenter argued that the determinants 

of what is an insurance product should 

be the existence of an insurable interest, 

transfer of risk, and indemnification of 

covered loss.115 Another argued that 

factoring accounting standards into the 

analysis of whether a product is a swap 

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48220 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

116See ISDA Letter. 

117See supra note 32, regarding the definition of 

‘‘State’’ contained in the Proposing Release. 

118This requirement in the final rules is 

substantially similar to the requirement included in 

section 3(a)(8) of the Securities Act, 15 U.S.C. 

77c(a)(8). 

119See supra note 34. 

120See Proposing Release at 29824. 

121See infra notes 139, 140, and 141 and 

accompanying text. 

122The Commissions understand that the surplus 

lines brokers who place insurance on behalf of nonadmitted insurers are subject to supervision in the 

states in which they offer non-admitted insurance 

products. 

123See infra notes 145 and 146 and 

accompanying text. 

124See infra notes 147 and 148 and 

accompanying text. 

125See Proposing Release at 29824. 

126See Ex Parte Communication between NAIC 

and CFTC and SEC Staff on October 5, 2011, at 

http://sec.gov/comments/s7-16-11/s71611-61.pdf. 

127The Commissions understand that certain 

types of Federal and State insurance programs, 

including crop insurance, are administered by third 

parties; as a result, the Commissions have added 

‘‘directly or indirectly’’ to the second prong of the 

Provider Test to clarify that it can be satisfied even 

if the agreement, contract, or transaction is not 

provided directly by the federal government or a 

state. See Id. 

128See Proposing Release at 29825. 

129See infra notes 150, 151, 152, and 153 and 

accompanying text. 

or insurance will introduce unnecessary 

complexity in most cases but that the 

examination of accounting standards 

would be useful in cases where the 

classification of a product as insurance 

or swap is unclear.116

After considering these comments, the 

Commissions are not including a 

reference to accounting standards in the 

Product Test. 

(b) Providers of Insurance Products 

Under the first prong of the Provider 

Test, the agreement, contract, or 

transaction must be provided by a 

person that is subject to supervision by 

the insurance commissioner (or similar 

official or agency) of any state117 or by 

the United States.118 In addition, such 

agreement, contract, or transaction also 

must be regulated as insurance under 

applicable state law119 or the laws of the 

United States. 

The Commissions have revised the 

first prong of the Provider Test from the 

proposal. As proposed, the first prong of 

the Provider Test could only be satisfied 

by a company that was organized as an 

insurance company whose primary and 

predominant business activity was the 

writing of insurance or the reinsuring of 

risks underwritten by insurance 

companies.120 The Commissions have 

revised this prong of the Provider Test 

to address commenters’ concerns that 

the proposed rules would exclude 

insurers that were not organized as 

‘‘insurance companies,’’ as well as 

insurers that were domiciled outside of 

the United States.121 As adopted, the 

first prong of the Provider Test can be 

satisfied by any person that is subject to 

state or Federal insurance supervision, 

regardless of that person’s corporate 

structure or domicile. The Commissions 

understand that, with the exception of 

non-admitted insurers,122 foreign 

insurers are subject to supervision in the 

states in which they offer insurance 

products. The treatment of nonadmitted insurers is addressed in the 

fourth prong of the Provider Test. 

The Commissions believe that the 

requirement that the agreement, 

contract, or transaction be provided by 

a person that is subject to state or 

Federal insurance supervision should 

help prevent regulatory gaps that 

otherwise might exist between 

insurance regulation and the regulation 

of swaps and security-based swaps by 

ensuring that products provided by 

persons that are not subject to state or 

Federal insurance supervision are not 

able to be offered by persons that avoid 

regulation under Title VII of the DoddFrank Act as well. 

The first prong of the Provider Test 

also requires that the agreement, 

contract, or transaction being provided 

is ‘‘regulated as insurance’’ under 

applicable state law or the laws of the 

United States. As stated in the 

Proposing Release, the purpose of this 

requirement is that an agreement, 

contract, or transaction that satisfies the 

other conditions of the final rules must 

be subject to regulatory oversight as an 

insurance product. The Commissions 

believe that this condition will help 

prevent products that are not regulated 

as insurance in the states in which they 

are offered, and that are swaps or 

security-based swaps, from being 

characterized as insurance products in 

order to evade the regulatory regime 

under Title VII of the Dodd-Frank Act. 

As noted by commenters,123 the 

Commissions recognize that the 

‘‘regulated as insurance’’ limitation 

means that it is possible that a particular 

product that may not be regulated as 

insurance in a particular state may not 

qualify for the Insurance Safe Harbor.124

As stated in the Proposing Release, 

the Commissions believe that it is 

appropriate to exclude, from regulation 

under Title VII, insurance that is issued 

by the United States or any of its 

agencies or instrumentalities, or 

pursuant to a statutorily authorized 

program thereof, from regulation as 

swaps or security-based swaps.125 Such 

insurance includes, for example, 

Federal insurance of funds held in 

banks, savings associations, and credit 

unions; catastrophic crop insurance; 

flood insurance; Federal insurance of 

certain pension obligations; and 

terrorism risk insurance. At the request 

of commenters,126 the Commissions are 

persuaded that it is also appropriate to 

provide a similar exclusion to insurance 

that is issued by a state or any of its 

agencies or instrumentalities, or 

pursuant to a statutorily authorized 

program thereof. Accordingly, the 

Commissions have revised the second 

prong of the Provider Test to provide 

that products meeting the Product Test 

are excluded from the swap and 

security-based swap definitions if they 

are provided (i) directly or indirectly by 

the Federal government or a state or (ii) 

pursuant to a statutorily authorized 

program of either.127

As stated in the Proposing Release, 

the Commissions believe that where an 

agreement, contract, or transaction 

qualifies for the safe harbor and 

therefore is considered insurance 

excluded from the swap and securitybased swap definitions, the lawful 

reinsurance of that agreement, contract, 

or transaction similarly should be 

excluded.128 Accordingly, the 

Commissions are adopting the third 

prong of the Provider Test as proposed, 

with certain modifications, to provide 

that an agreement, contract, or 

transaction of reinsurance will be 

excluded from the swap and securitybased swap definitions, provided that: 

(i) The person offering such reinsurance 

is not prohibited by applicable state law 

or the laws of the United States from 

offering such reinsurance to a person 

that satisfies the Provider Test; (ii) the 

agreement, contract, or transaction to be 

reinsured meets the requirements under 

the Product Test or is one of the 

Enumerated Products; and (iii) except as 

otherwise permitted under applicable 

state law, the total amount reimbursable 

by all reinsurers for such insurance 

product cannot exceed the claims or 

losses paid by the cedant. 

In response to commenters’ 

concerns,129 the Commissions have 

revised the third prong of the Provider 

Test from that contained in the 

Proposing Release. As adopted, the third 

prong of the Provider Test encompasses 

all reinsurers wherever incorporated or 

organized, and not just those based 

outside of the United States. The 

Commissions also have revised the third 

prong of the Provider Test to clarify that 

the total amount reimbursable by all 

reinsurers may not exceed the claims or 

losses paid by the cedant, unless 

otherwise permitted by applicable state 

law. It is not the Commissions’ intent to 

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130See infra note 146 and accompanying text. 

131For the purposes of this release, the term 

‘‘surplus lines broker’’ means an individual, firm, 

or corporation that is licensed in a state to sell, 

solicit, or negotiate insurance on properties, risks, 

or exposures located or to be performed in a state 

with non-admitted insurers. 

132See supra note 39. With respect to domestic 

reinsurance, state insurance regulators do retain the 

authority to prevent or allow a non-admitted 

company from participating in a state market. Some 

states compile a list of companies that may sell as 

non-admitteds; other states list non-admitted 

companies that may not sell. 

133See Subtitle B of Title V of the Dodd-Frank 

Act. 

134Section 524 of the Nonadmitted and 

Reinsurance Reform Act of 2010 (15 U.S.C. 8204) 

provides that a state cannot prohibit a surplus lines 

broker from placing non-admitted insurance with a 

non-admitted insurer that is listed on the Quarterly 

Listing of Alien Insurers. According to the NAIC the 

non-admitted alien insurers whose names appear in 

the Quarterly Listing of Alien Insurers have filed 

financial statements, copies of auditors’ reports, the 

names of their U.S. attorneys or other 

representatives, and details of U.S. trust accounts 

with the NAIC’s International Insurers Department 

and, based upon those documents and other 

information, appear to fulfill the criteria set forth in 

the International Insurers Department Plan of 

Operation for Listing of Alien Nonadmitted 

Insurers. 

135See ACLI Letter; AIA Letter; CAI Letter; D&L 

Letter; ISDA Letter; NAIC Letter; NAFA Letter; 

Nationwide Letter; RAA Letter; and Travelers 

Letter. 

136See AIA Letter; D&L Letter; and ISDA Letter. 

137 Id. 

138See infra notes 147 and 148 and 

accompanying text. 

139See AIA Letter; D&L Letter; ISDA Letter; RAA 

Letter; NAIC Letter; and Travelers Letter. 

140See AIA Letter; D&L Letter; RAA Letter; and 

Travelers Letter. 

141See RAA Letter and Travelers Letter. 

142See ACLI Letter; CAI Letter; NAFA Letter; 

Nationwide Letter; RAA Letter; and Travelers 

Letter. 

143 Id. 

144 Id. 

impose requirements that conflict with 

state law regarding the calculation of 

amounts reimbursable under 

reinsurance contracts. 

The Commissions have added a fourth 

prong to the Provider Test to address 

commenters’ concerns that the proposed 

Provider Test excluded entities issuing 

insurance products on a non-admitted 

basis through surplus lines brokers.130

Non-admitted insurance is typically 

property and casualty insurance that is 

permitted to be placed through a 

surplus lines broker 131 by an insurer 

that is not licensed to do business in the 

state where the product is offered.132 In 

practice, a provider of non-admitted 

insurance may not satisfy the first prong 

of the Provider Test because it may not 

be subject to state or Federal insurance 

supervision. The Commissions 

understand that non-admitted insurance 

plays a very important role in the 

insurance marketplace. In addition, 

Congress has explicitly recognized nonadmitted insurance products as 

insurance and specified that a state 

cannot prohibit certain types of entities 

from offering non-admitted insurance 

products.133 Because Congress 

recognized that certain persons qualify 

as non-admitted insurers, the 

Commissions find that it is appropriate 

to add the fourth prong to the Provider 

Test. 

A person will qualify under the fourth 

prong of the Provider Test if it satisfies 

any one of the following two 

requirements: 

• It is located outside of the United 

States and listed on the Quarterly 

Listing of Alien Insurers that is 

compiled and maintained by the 

International Insurers Department of the 

National Association of Insurance 

Commissioners;134 or 

• It meets the eligibility criteria for 

non-admitted insurers under applicable 

state law. 

Comments 

General 

The Commissions received ten 

comment letters that addressed the 

Provider Test.135 A few commenters 

recommended that the Commissions 

retract the Provider Test.136 These 

commenters argued that if a product is 

subject to regulation as insurance in the 

United States, the regulated status of the 

insurer is irrelevant.137 The 

Commissions are retaining the Provider 

Test with modifications as discussed 

above. The Commissions believe that 

insurance products should fall outside 

the swap or security-based swap 

definitions only if they are offered by 

persons subject to state or Federal 

insurance supervision or by certain 

reinsurers.138 The Provider Test will 

help to prevent products that are swaps 

or security-based swaps from being 

characterized as insurance in order to 

evade the regulatory regime under Title 

VII of the Dodd-Frank Act. Other 

commenters suggested various 

modifications to the Provider Test and 

those comments are discussed in more 

detail below. 

‘‘Insurance Company’’ Limitation 

Several commenters recommended 

that the Commissions expand the first 

prong of the Provider Test so that it is 

not limited to ‘‘insurance companies,’’ 

but to all insurers because not all 

insurers are organized as ‘‘insurance 

companies,’’139 to accommodate 

insurers and reinsurers that are 

domiciled outside of the United 

States,140 and to cover domestic and 

foreign insurance companies and other 

entities that issue insurance products on 

a non-admitted basis through surplus 

lines brokers.141

The Commissions have revised the 

first prong of the Provider Test to 

remove the ‘‘insurance company’’ 

limitation and to clarify that any person 

that is subject to state or Federal 

insurance supervision will qualify 

under the first prong of the Provider 

Test. As noted above, the Commissions 

also believe that this revision should 

address commenters’ concerns that the 

proposed rules could have excluded 

some foreign insurers since the revised 

test does not require that a person be 

domiciled in the United States; it only 

requires that the person be subject to 

state or Federal insurance supervision. 

Several commenters suggested that 

the proposed Provider Test would 

permit an insurer that is not organized 

as an insurance company to evade state 

insurance oversight by deliberately 

failing the exemption for insurance 

products (that is, by issuing a contract 

that would fail the proposed rules 

because it would not be issued by an 

insurance company).142 These 

commenters were concerned that if a 

product were to be considered a swap 

merely because it was not issued by an 

insurance company, this would render 

the regulation of such products outside 

of the scope of state insurance laws due 

to the Federal preemption of swaps 

regulation.143 Commenters noted that a 

likely consequence of this preemption 

would be that the same product would 

be subject to substantially different 

regulation within a state’s jurisdiction 

based solely on the nature of the issuing 

person.144

The Commissions have revised the 

first prong of Provider Test to address 

commenters’ concerns that providers of 

insurance products could evade state 

insurance regulation by intentionally 

failing the Provider Test, i.e., marketing 

the insurance products as swaps or 

security-based swaps in order to avoid 

state insurance supervision. As adopted, 

any person that provides insurance 

products (and therefore should be 

subject to state or Federal insurance 

supervision) must, in fact, be subject to 

state or Federal insurance supervision 

in order to satisfy the first prong of the 

Provider Test. Persons that are 

organized as insurance companies or 

whose business activity is 

predominantly insurance or 

reinsurance, but who are not in fact 

subject to state or Federal insurance 

supervision, would not satisfy the first 

prong of the Provider Test. 

Finally, as discussed below, the 

Commissions have added a fourth prong 

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145See RAA Letter and Travelers Letter. 

146 Id. These commenters also recommended the 

addition of a new prong to the Provider Test to 

cover domestic or foreign entities that issue 

insurance products on a non-admitted basis through 

surplus lines brokers. See discussion below. The 

Commissions note that the first prong of the 

Provider Test does not apply to reinsurance 

contracts and the third prong of the Provider Test, 

which does apply to reinsurance contracts, does not 

contain the ‘‘regulated as insurance’’ limitation. 

147See SFAA Letter. SFAA stated that all states 

include surety and fidelity bonds as lines of 

insurance subject to state oversight. However, 

Travelers stated that surety bonds may not be 

‘‘specifically’’ regulated as insurance. See Travelers 

Letter. 

148See ACLI Letter. 

149See supra notes 130, 131, and 132 and 

accompanying text. 

150See ACLI Letter; CAI Letter; NAIC Letter; and 

RAA Letter. 

151See RAA Letter. The commenter argued that 

one state’s prohibition on a reinsurance product 

should not affect the ability of the reinsurer to offer 

the product in a state where it is permitted. 

152See RAA Letter and Travelers Letter. Both 

commenters suggested specific edits to the 

proposed rules. 

153See RAA Letter. RAA stated that in an 

insurance receivership reinsurers are required to 

comply with the reinsurance contract and pay all 

amounts due and owing to the estate of the 

insolvent cedant even if the estate of the cedant 

may not necessarily pay the full amount of the 

underlying claims to the applicable policyholders. 154See infra notes 157, 158, 159, and 160 and 

accompanying text. 155See Proposing Release at 29821. 

to the Provider Test to provide relief for 

persons that provide insurance products 

on a non-admitted basis through surplus 

lines brokers. 

‘‘Regulated as Insurance’’ Limitation 

Two commenters recommended that 

the Commissions remove the provision 

in the first prong of the Provider Test 

that states ‘‘and such agreement, 

contract, or transaction is regulated as 

insurance under the laws of such state 

or of the United States.’’145 These 

commenters argued that the provision 

should be deleted because it was 

redundant with the Product Test and 

may exclude certain reinsurers and nonadmitted insurers, as well as products 

that may not be specifically ‘‘regulated 

as insurance’’ in all states.146

The Commissions have retained the 

requirement in the first prong of the 

Provider Test that an insurance product 

must be regulated as insurance, but have 

revised the provision to clarify that an 

insurance product must be regulated as 

insurance under applicable state law or 

the laws of the United States. As 

discussed above, the Commissions 

believe that this condition will help 

prevent products that are not regulated 

as insurance and are swaps or securitybased swaps from being characterized as 

insurance products in order to evade the 

regulatory regime under the Dodd-Frank 

Act. 

The Commissions have received 

conflicting comments regarding whether 

surety bonds are currently offered by 

persons who do not satisfy the Provider 

Test, in particular the ‘‘regulated as 

insurance’’ requirement.147 If a person 

who does not satisfy the Provider Test 

sells a surety bond incidental to other 

business activity and is not subject to 

state or Federal insurance supervision, 

it does not mean that such surety bond 

is a swap or security-based swap. The 

surety bond may not satisfy the 

Insurance Safe Harbor, but it would be 

subject to a facts and circumstances 

analysis. Similarly, one commenter 

indicated that title insurance is not 

always subject to state insurance 

regulation.148 Title insurance sold in a 

state that does not regulate title 

insurance as insurance would be in the 

list of Enumerated Products but would 

not satisfy the Provider Test and, thus 

would not qualify for the Insurance Safe 

Harbor. However, this does not mean 

that title insurance sold in a state that 

does not regulate title insurance as 

insurance is a swap or security-based 

swap. The title insurance may not 

satisfy the Insurance Safe Harbor, but it 

would be subject to a facts and 

circumstances analysis. The 

Commissions anticipate that many 

factors would militate against a 

determination that such a surety bond 

or title insurance that fails the Provider 

Test, because it cannot meet the 

‘‘regulated as insurance’’ requirement, is 

a swap or security-based swap rather 

than insurance. 

The Commissions agree that the 

inclusion of the ‘‘regulated as 

insurance’’ requirement in the first 

prong of the Provider Test will have the 

effect of causing non-admitted 

insurance products to fall within the 

swap and security-based swap 

definitions. In response to commenters’ 

concerns about the ability of nonadmitted insurers to qualify under the 

Provider Test, the Commissions have 

added a fourth prong to the Provider 

Test to address providers of nonadmitted insurance products.149

Providers of Reinsurance 

Several commenters recommended 

that the Commissions expand the third 

prong of the Provider Test to include 

domestic reinsurers.150 One commenter 

requested that the Commissions remove 

the third prong of the Provider Test 

from the final rules because it appears 

to prohibit a reinsurer from offering a 

product in a state where it is permitted 

if any other state prohibits that 

product.151 Two commenters requested 

revisions to the portion of the third 

prong of the Provider Test that 

addresses a cedant’s reimbursable 

losses.152 One commenter argued this 

portion of the third prong of the 

Provider Test may conflict with the 

state-based insurance receivership 

law.153

As noted above, the Commissions 

have revised the third prong of the 

Provider Test to remove the limitation 

that a reinsurance provider has to be 

located outside of the United States, and 

thereby address commenters’ concerns 

that domestic reinsurers would not 

qualify under the reinsurance prong. In 

addition, in response to commenters’ 

concerns, the Commissions have 

clarified the third prong of the Provider 

Test so that it does not prohibit a 

reinsurer from offering a product in a 

state where it is permitted, even if that 

product is prohibited in another state, 

and have revised the portion of the third 

prong of the Provider Test that 

addresses a cedant’s reimbursable losses 

to make it subject to applicable state law 

so that it does not conflict with statebased insurance receivership law. 

(c) Grandfather Provision for Existing 

Insurance Transactions 

In the Proposing Release, the 

Commissions asked whether the 

proposed rules should include a 

provision similar to section 302(c)(1) of 

the Gramm-Leach-Bliley Act that any 

product regulated as insurance before 

the date the Dodd-Frank Act was signed 

into law and provided in accordance 

with the Provider Test would be 

considered insurance and not fall 

within the swap or security-based swap 

definitions. 

In response to comments,154 the 

Commissions are adding a new 

paragraph (ii) to rule 1.3(xxx)(4) under 

the CEA and new paragraph (b) to rule 

3a69–1 under the Exchange Act that 

provides that an agreement, contract, or 

transaction entered into on or before the 

effective date of the Product Definitions 

will be considered insurance and not 

fall within the swap and security-based 

swap definitions, provided that, at such 

time it was entered into, such 

agreement, contract, or transaction was 

provided in accordance with the 

Provider Test (the ‘‘Insurance 

Grandfather’’). 

As stated in the Proposing Release, 

the Commissions are aware of nothing 

in Title VII to suggest that Congress 

intended for traditional insurance 

products to be regulated as swaps or 

security-based swaps.155 The 

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156The Commissions believe that 60 days after 

publication of this release should be sufficient time 

for market participants to enter into pending 

agreements, contracts, or transactions for which the 

Insurance Grandfather may provide relief. 

157See ACLI Letter; AFGI Letter; CAI Letter; and 

D&L Letter. 

158See ACLI Letter and CAI Letter. ACLI and CAI 

argued that products that were regulated as 

insurance prior to the effective date of the DoddFrank Act clearly were not characterized as 

insurance to avoid the Title VII regulatory regime. 

See also AFGI Letter; AFGI argued that all 

insurance contracts issued by state-regulated 

insurance companies should be excluded from the 

swap definition but in the alternative, all insurance 

products regulated as insurance before July 21, 2010 

should be grandfathered. See also D&L Letter. D&L 

stated that prior regulation of insurance products 

before July 21, 2010 could be a consideration, but 

not an absolute determinant for exclusion from the 

swap or security-based swap definitions. 

159See ACLI Letter and CAI Letter. 

160 Id. 

161See ACLI Letter; AGFI Letter; and CAI Letter. 162Section 722(b) of the Dodd-Frank Act 

provides, (B) Regulation of Swaps Under Federal 

and State Law.—Section 12 of the Commodity 

Exchange Act (7 U.S.C. 16) is amended by adding 

at the end the following: ‘‘(h) Regulation of Swaps 

as Insurance Under Federal and State Law.—A 

swap—(1) Shall not be considered to be insurance; 

and (2) may not be regulated as an insurance 

contract under the law of any State.’’ Section 767 

of the Dodd-Frank Act amended section 28(a) of the 

Exchange Act, 15 U.S.C. 78bb(a), to provide, ‘‘A 

security-based swap may not be regulated as an 

insurance contract under any provision of State 

law.’’ 

163See CAI Letter. CAI suggested that for a 

product to be regulated as insurance it means that 

it was provided by an insurance company. See 

supra part II.B.1.b) for a discussion of the need for 

the Provider Test portion of the Insurance Safe 

Harbor. 

Commissions have designed the 

Insurance Safe Harbor to provide greater 

assurance to market participants that 

traditional insurance products that were 

regulated as insurance prior to the 

Dodd-Frank Act will fall outside the 

swap and security-based swap 

definitions. Nevertheless, after 

considering comments received, the 

Commissions believe that it is 

appropriate to adopt the Insurance 

Grandfather in order to assure market 

participants that those agreements, 

contracts, or transactions that meet the 

conditions set out in the Insurance 

Grandfather will not fall within the 

swap or security-based swap 

definitions. 

In order to qualify for the Insurance 

Grandfather an agreement, contract, or 

transaction must meet two 

requirements. First, it must be entered 

into on or before the effective date of the 

Product Definitions. The Commissions 

are linking the Insurance Grandfather to 

the effective date of the Product 

Definitions, rather than the date that the 

Dodd-Frank Act was signed into law, in 

order to avoid unnecessary market 

disruption.156 Second, such agreement, 

contract, or transaction must be 

provided in accordance with the 

Provider Test. In other words, the 

provider must be subject to state or 

Federal insurance supervision or be a 

non-admitted insurer or a reinsurer that 

satisfies the conditions for non-admitted 

insurers and reinsurers that are set out 

in the Provider Test. The Commissions 

note that an agreement, contract or 

transaction that is provided in 

accordance with the first prong of the 

Provider Test must also be regulated as 

insurance under applicable state law or 

the laws of the United States. 

By adopting the Insurance 

Grandfather and the Insurance Safe 

Harbor, the Commissions are excluding 

agreements, contracts, and transactions 

for which the Commissions have found 

no evidence that Congress intended 

them to be regulated as swaps or 

security-based swaps, and are providing 

greater certainty regarding the treatment 

of agreements, contracts, and 

transactions currently regulated as 

insurance. 

Comments 

Four commenters addressed whether 

the final rules should include a 

grandfather provision that would 

exclude certain insurance products from 

the swap or security-based swap 

definitions.157 Two commenters 

suggested that a grandfather provision 

for all products that were regulated as 

insurance before the Dodd-Frank Act 

was signed into law would be 

appropriate, stating that it would reduce 

confusion and uncertainty in applying 

the swap and security-based swap 

definitions to products that are 

traditionally regulated as insurance 

while addressing the Commissions’ 

stated concern that products might be 

structured as insurance products to 

evade Dodd-Frank Act requirements.158

These commenters also stated that it is 

necessary to add an effective date-based 

grandfather provision to the final rule 

providing that any contract or 

transaction subject to state insurance 

regulation and entered into prior to any 

final rules necessary to implement Title 

VII, including the Product Definitions, 

are not swaps or security-based 

swaps.159 These commenters noted that 

a grandfather provision based on 

effective date of all the Title VII rules 

was needed to address product 

development and variation that 

occurred between the date the DoddFrank Act was enacted and the effective 

date of the rules mandated under that 

statute.160

The Commissions believe that the 

combination of the Insurance 

Grandfather along with the Insurance 

Safe Harbor provides market 

participants with increased legal 

certainty with respect to existing 

agreements, contracts, transactions, and 

products. In addition, the fact that the 

Commissions are linking the Insurance 

Grandfather to the effective date of the 

Product Definitions, rather than the date 

that the Dodd-Frank Act was signed into 

law, takes into account product 

development and innovation that may 

have occurred between the date the 

Dodd-Frank Act was signed into law at 

the effective date of the Product 

Definitions. Further, the Commissions 

believe that a grandfather provision that 

would exclude all products regulated as 

insurance before the Dodd-Frank Act 

was signed into law, as recommended 

by some commenters,161 is unnecessary 

because non-grandfathered regulated 

insurance transactions generally should 

fall within the Insurance Safe Harbor. 

The Commissions believe that market 

participants could be incentivized to 

use such a broader grandfather 

provision to create new swap or 

security-based swap products with 

characteristics similar to those of 

existing categories of regulated 

insurance contracts for the purpose of 

evading the Dodd-Frank Act regulatory 

regime. The Commissions also believe 

that a broader grandfather provision 

would be contrary to the explicit 

direction of sections 722(b) and 767 of 

the Dodd-Frank Act which provide that 

swaps and security-based swaps may 

not be regulated as insurance contracts 

by any state.162

One commenter argued that the 

Provider Test should not apply to 

grandfathered contracts. The commenter 

stated that it should be enough that the 

product is regulated as insurance.163 As 

described above, the grandfather 

provision will apply only to agreements, 

contracts, and transactions that are 

entered into prior to the effective date 

of the Product Definitions if they were 

provided in accordance with the 

Provider Test, including a requirement 

that an agreement, contract or 

transaction that is provided in 

accordance with the first prong of the 

Provider Test must be regulated as 

insurance under applicable State law or 

the laws of the United States. As the 

Commissions discussed in the 

Proposing Release, and above in 

describing the Provider Test, the 

Commissions believe the requirement 

that the agreement, contract, or 

transaction be provided in accordance 

with the Provider Test should help 

ensure that persons who are not subject 

to state or Federal insurance supervision 

are not able to avoid the oversight 

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164See ACLI Letter; AIA Letter; AFGI Letter; CAI 

Letter; MetLife Letter; NAFA Letter; NAIC Letter; 

Nationwide Letter; and Travelers Letter. 

165See ACLI Letter; AIA Letter; AFGI Letter; 

MetLife Letter; and Travelers Letter. 

166See section 12(h) of the CEA, 7 U.S.C. 16(h) 

(regarding swaps) and section 28(a)(4) of the 

Exchange Act, 15 U.S.C. 78bb(a)(4) (regarding 

security-based swaps). 

167See section 12(h)(2) of the CEA, 7 U.S.C. 

16(h)(2). 

168Section 3(a)(8) of the Securities Act excludes 

the following from all provisions of the Securities 

Act: Any insurance or endowment policy or 

annuity contract or optional annuity contract, 

issued by a corporation subject to the supervision 

of the insurance commissioner, bank commissioner, 

or any agency or officer performing like functions, 

of any State or Territory of the United States or the 

District of Columbia. 

See infra note 1283 and accompanying text. 

169See ACLI Letter; CAI Letter; NAFA Letter; and 

Nationwide Letter. 

170See NAFA Letter. 

171See ACLI Letter and CAI Letter. 

172See NAIC Letter. 

173See ACLI Letter (Appendix 1). See also CAI 

Letter. CAI stated that it believes that the approach 

and test recommended by ACLI is a fundamentally 

sound method for determining those insurance 

products that are not swaps or security-based swaps 

and that should remain subject to state regulation, 

and is more appropriate than the Commissions’ 

proposals. Nationwide suggested a three-part test to 

differentiate insurance products from swaps and 

security-based swaps similar to the test proposed by 

ACLI. See also Nationwide Letter. 

174See ACLI Letter. 

provided for under Title VII of the 

Dodd-Frank Act. 

(d) Alternative Tests 

A number of commenters proposed 

that the Commissions adopt alternative 

tests to distinguish insurance from 

swaps and security-based swaps.164

After considering each of these 

alternatives, the Commissions are not 

adopting them. 

Several commenters suggested that 

the sole test for determining whether an 

agreement, contract, or transaction is 

insurance should be whether it is 

subject to regulation as insurance by the 

insurance commissioner of the 

applicable state(s).165 The Commissions 

find this alternative to be unworkable 

because it does not provide a sufficient 

means to distinguish agreements, 

contracts and transactions that are 

insurance from those that are swaps or 

security-based swaps. Section 712(d) of 

the Dodd-Frank Act directs the 

Commissions to ‘‘further define’’ the 

terms swap and security-based swap. 

Neither swaps nor security-based swaps 

may be regulated as insurance contracts 

under the laws of any state.166 While 

insurance contracts have long been 

subject to state regulation, swaps and 

security-based swaps were largely 

unregulated. Since the Dodd-Frank Act 

created a new regulatory regime for 

swaps and specifically provides that 

‘‘swaps may not be regulated as an 

insurance contract under the law of any 

state,167 the Commissions believe that it 

is important to have a test that 

distinguishes insurance from swaps and 

security-based swaps without relying 

entirely on the regulatory environment 

prior to the enactment of the DoddFrank Act. The Product Test is an 

important element of the Insurance Safe 

Harbor. 

Several commenters suggested an 

approach in which insurance products 

that qualify for the exclusion contained 

in section 3(a)(8) of the Securities Act168

would be excluded from the swap 

definition.169 One commenter argued 

that ‘‘Section 3(a)(8) has long been 

recognized as the definitive provision as 

to where Congress intends to separate 

securities products that are subject to 

SEC regulation from ‘insurance’ and 

‘annuity’ products that are to be left to 

state insurance regulation’’ and that the 

section 3(a)(8) criteria are well 

understood and have a long history of 

interpretation by the SEC and the 

courts.170 Other commenters suggest 

that because section 3(a)(8) includes 

both a product and a provider 

requirement, if the Commissions 

include it in their final rules, it should 

be a requirement separate from the 

Product Test and the Provider Test, and 

should extend to insurance products 

that are securities.171

While the Commissions agree that the 

section 3(a)(8) criteria have a long 

history of interpretations by the SEC 

and the courts, the Commissions find 

that it is inappropriate to apply the 

section 3(a)(8) criteria in this context. 

Although section 3(a)(8) contains some 

conditions applicable to insurance 

providers that are similar to the prongs 

of the Provider Test, it does not contain 

any conditions that are similar to the 

prongs of the Product Test. Moreover, 

section 3(a)(8) provides an exclusion 

from the Securities Act and the CFTC 

has no jurisdiction under the Federal 

securities laws. Congress directed both 

agencies to further define the terms 

‘‘swap’’ and ‘‘security-based swap.’’ As 

such, the Commissions find that it is 

more appropriate to have a standalone 

rule that incorporates features that 

distinguish insurance products from 

swaps and security-based swaps and 

over which both Commissions will have 

joint interpretative authority. 

One commenter suggested yet another 

approach, recommending that insurance 

be defined as an agreement, contract, or 

transaction that by its terms: 

• Exists for a specified period of time; 

• Where the party (the ‘‘insured’’) to 

the contract promises to make one or 

more payments such as money, goods or 

services; 

• In exchange for another party’s 

promise to provide a benefit of 

pecuniary value for the loss, damage, 

injury, or impairment of an identified 

interest of the insured as a result of the 

occurrence of a specified event or 

contingency outside of the parties’ 

control; and 

• Where such payment is related to a 

loss occurring as a result of a 

contingency or specified event.172

The Commissions do not find this 

alternative preferable to the 

Commissions’ proposal for two reasons. 

First, the requirements of a specified 

term and the promise to make payments 

are present in both insurance products 

and in agreements, contracts, or 

transactions that are swaps or securitybased swaps and therefore do not help 

to distinguish between them. A test 

based solely on these requirements, 

then, could be over-inclusive and 

exclude from the Dodd-Frank Act 

regulatory regime agreements, contracts, 

and transactions that have not 

traditionally been considered insurance. 

Further, the third and fourth 

requirements of this alternative test 

collapse into the Product Test’s 

requirement that the loss must occur 

and be proved, and any payment or 

indemnification therefor must be 

limited to the value of the insurable 

interest. 

One commenter suggested a three-part 

test in lieu of the Product and Provider 

Tests. Under this test, the terms ‘‘swap’’ 

and ‘‘security-based swap’’ would 

exclude any agreement, contract, or 

transaction that: 

• Is issued by a person who is or is 

required to be organized as an insurance 

company and subject to state insurance 

regulation; 

• Is the type of contract issued by 

insurance companies; and 

• Is not of the type that the 

Commissions determine to regulate. 173

This commenter stated that its 

approach does not contain a definition 

of insurance, and believes that is 

preferable to the Commissions’ 

approach, which it believes creates legal 

uncertainty because any attempted 

definition of insurance has the potential 

to be over- or under- inclusive.174 As 

discussed above, the Commissions’ 

rules and interpretations are not 

intended to define insurance. Rather, 

they provide a safe harbor for certain 

types of traditional insurance products 

by reference to factors that may be used 

to distinguish insurance from swaps and 

security-based swaps, and a list of 

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175See AIA Letter. 

176 Id. 

177See supra part II.B.1.c) 

178See ACLI Letter; CAI Letter; NAFA Letter 

(concurring with ACLI and CAI); Nationwide Letter; 

and Travelers Letter. 

179See ACLI Letter. 

180See ACLI Letter; CAI Letter; NAFA Letter 

(concurring with ACLI and CAI); and Nationwide 

Letter (concurring the ACLI and CAI). 

181 Id. The commenters suggested that this 

ambiguity could be resolved by making it clear in 

the final rules that an excluded product is neither 

a swap nor a security-based swap. 

182See Proposing Release at 29827. 

183The discussion in this subsection relates only 

to swaps that are not security-based swaps or mixed 

swaps and has no effect on the laws or regulations 

applicable to security-based swaps or mixed swaps. 

184The Commissions did not express a view 

regarding whether financial guaranty insurance is a 

swap or security-based swap in the Entities Release. 

See Entities Release at 30689, n.1132. 

185Subsequent references to ‘‘guarantees’’ in this 

discussion shall thus be deemed to include 

‘‘financial guaranty insurance policies.’’ 

186For purposes of this release, the CFTC views 

a guarantee of a swap to be a collateral promise by 

a guarantor to answer for the debt or obligation of 

a counterparty obligor under a swap. A guarantee 

of a swap does not include for purposes of this 

release: (i) A ‘‘guarantee agreement’’ as defined in 

CFTC regulation § 1.3(nn), 17 CFR 1.3(nn); (ii) any 

assumption by a clearing member of financial or 

performance responsibility to a derivatives clearing 

organization (‘‘DCO’’) for swaps cleared by a DCO; 

or (iii) any guarantee by a DCO with respect to a 

swap that it clears. 

187E.g., a swap counterparty may specify that a 

guarantee is a Credit Support Document under an 

Continued 

products that do not have to satisfy a 

portion of the safe harbor factors. 

Agreements, contracts, and transactions 

that do not qualify for the Insurance 

Safe Harbor may or may not be 

insurance, depending upon the facts 

and circumstances regarding such 

agreements, contracts and transactions. 

The Commissions find the first two 

requirements of the commenter’s threepart test to be tautologous, and the third 

provides no greater certainty than the 

Commissions’ facts and circumstances 

approach. In addition, the Commissions 

find that this alternative test could 

exclude from the Dodd-Frank Act 

regulatory regime agreements, contracts, 

and transactions that have not 

traditionally been considered insurance. 

Another commenter proposed 

different approaches for existing 

products and new products.175

Specifically, if an existing type of 

agreement, contract or transaction is 

currently reportable as insurance in the 

provider’s regulatory and financial 

reports under a state or foreign 

jurisdiction’s insurance laws, then that 

agreement, contract, or transaction 

would be insurance rather than a swap 

or security-based swap. On the other 

hand, for new products, if this approach 

were inconclusive, this commenter 

recommended that the Commissions use 

the Product Test of the Commissions’ 

rules only.176 As discussed above, rather 

than treating existing products and new 

products differently, the Commissions 

are providing ‘‘grandfather’’ protection 

for agreements, contracts, and 

transactions entered into prior to the 

effective date of the Products 

Definitions.177 Moreover, this 

commenter’s test would eliminate the 

Provider Test for new products, which 

the Commissions believe is important to 

help prevent products that are swaps or 

security-based swaps from being 

characterized as insurance. 

In sum, the Commissions find that 

each of the alternatives proposed by 

commenters could exclude from the 

Dodd-Frank Act regulatory regime 

agreements, contracts, and transactions 

that have not historically been 

considered insurance, and that should, 

in appropriate circumstances, be 

regulated as swaps or security-based 

swaps. Accordingly, the Commissions 

do not find these alternatives to be 

appropriate for delineating the scope of 

the Insurance Safe Harbor from the 

swap and security-based swap 

definitions. 

(e) ‘‘Safe Harbor’’ 

Five commenters recommended that 

the Product Test, the Provider Test, and 

related interpretations should be 

structured as a ‘‘safe harbor’’ so that 

they do not raise any presumption or 

inference that products that do not meet 

the Product Test, Provider Test and 

related interpretations are necessarily 

swaps or security-based swaps.178 One 

commenter suggested that this safe 

harbor approach could be modeled after 

Rule 151 under the Securities Act.179

As discussed above, the Commissions 

do not intend to create a presumption 

that agreements, contracts, or 

transactions that do not fall within the 

Insurance Safe Harbor are necessarily 

swaps or security-based swaps. As 

stated above, the Commissions are 

instead adopting final rules that clarify 

that certain agreements, contracts, or 

transactions meeting the requirements 

of a non-exclusive ‘‘safe harbor’’ 

established by such rules will not be 

considered to be swaps or securitybased swaps. An agreement, contract, or 

transaction that does not fall within the 

Insurance Safe Harbor will require 

further analysis of the applicable facts 

and circumstances to determine 

whether it is insurance, and thus not a 

swap or security-based swap. 

(f) Applicability of Insurance Exclusion 

to Security-Based Swaps 

Four commenters expressed concerns 

that the proposed rules were unclear in 

their application to both swaps and 

security-based swaps.180 These 

commenters argued that the proposed 

rules do not directly exclude insurance 

products from the term ‘‘security-based 

swap’’ because the rules explicitly state 

that ‘‘[t]he term ‘swap’ does not 

include’’ the products that meet the 

Product and Provider Tests, but do not 

make the same statement as to the term 

‘‘security-based swap.’’ 181

The Commissions have revised rule 

1.3(xxx)(4) under the CEA and rule 

3a69–1 under the Exchange Act to 

clarify that the exclusion contained 

therein applies to both swaps and 

security-based swaps. 

(g) Guarantees 

In the Proposing Release, the 

Commissions requested comment on 

whether insurance of an agreement, 

contract, or transaction that falls within 

the swap or security-based swap 

definitions should itself be included in 

the swap or security-based swap 

definition. The Commissions also 

requested comment on whether the 

Commissions should provide guidance 

as to whether swap or security-based 

swap guarantees offered by noninsurance companies should be 

considered swaps or security-based 

swaps.182

Guarantees of Swaps.183

No commenter identified any product 

that insures swaps (that are not securitybased swaps or mixed swaps) other than 

financial guaranty insurance. The CFTC 

finds that insurance of an agreement, 

contract, or transaction that falls within 

the swap definition (and is not a 

security-based swap or mixed swap) is 

functionally or economically similar to 

a guarantee of a swap (that is not a 

security-based swap or mixed swap) 

offered by a non-insurance company.184

Therefore, the CFTC is treating financial 

guaranty insurance of swaps (that are 

not security-based swaps or mixed 

swaps) the same way it is treating all 

other guarantees of swaps (that are not 

security-based swaps or mixed swaps), 

as discussed below.185

The CFTC is persuaded that when a 

swap has the benefit of a guarantee,186

the guarantee is an integral part of that 

swap. The CFTC finds that a guarantee 

of a swap (that is not a security-based 

swap or mixed swap) is a term of that 

swap that affects the price or pricing 

attributes of that swap.187 When a swap 

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ISDA Master Agreement. If the guarantor fails to 

comply with or perform under such guarantee, such 

guarantee expires or terminates, or if such guarantee 

ceases to be in full force and effect, the ‘‘Credit 

Support Default’’ Event of Default under the ISDA 

Master Agreement would generally be triggered, 

potentially bringing down the entire swap trading 

relationship between the parties to the ISDA Master 

Agreement. See generally the standard 1992 ISDA 

Master Agreement and 2002 ISDA Master 

Agreement. However, the CFTC finds the presence 

of a guarantee to be an integral part of a swap and 

that affects the price or pricing attributes of a swap 

whether or not such guarantee is a Credit Support 

Document under an ISDA Master Agreement. 

188This interpretation is consistent with the 

interpretations of the Commissions in the Entity 

Definitions Release. See, e.g., Entity Definitions 

Release at 30689 (‘‘[A]n entity’s swap or securitybased swap positions in general would be attributed 

to a parent, other affiliate or guarantor for purposes 

of major participant analysis to the extent that 

counterparties to those positions would have 

recourse to that other entity in connection with the 

position. Positions would not be attributed in the 

absence of recourse.’’). A swap backed by a partial 

or limited recourse guarantee will include the 

guarantee to the extent of such partial or limited 

recourse; a blanket guarantee that supports both 

swap and non-swap obligations will be treated as 

part of the guaranteed swap only to the extent that 

such guarantee backstops obligations under a swap 

or swaps. 

In the Entity Definitions Release, the 

Commissions stated, ‘‘we do not believe that it is 

necessary to attribute a person’s swap or securitybased swap positions to a parent or other guarantor 

if the person is already subject to capital regulation 

by the CFTC or SEC (i.e., swap dealers, securitybased swap dealers, major swap participants, major 

security-based swap participants, FCMs and brokerdealers) or if the person is a U.S. entity regulated 

as a bank in the United States. Positions of those 

regulated entities already will be subject to capital 

and other requirements, making it unnecessary to 

separately address, via major participant 

regulations, the risks associated with guarantees of 

those positions.’’ Id. In a footnote, the Commissions 

continued, ‘‘As a result of this interpretation, 

holding companies will not be deemed to be major 

swap participants as a result of guarantees to certain 

U.S. entities that are already subject to capital 

regulation.’’ Id. 

As a result of interpreting the term ‘‘swap’’ (that 

is not a security-based swap or mixed swap) to 

include a guarantee of such swap, to the extent that 

a counterparty to a swap position would have 

recourse to the guarantor in connection with the 

position, and based on the reasoning set forth above 

from the Entity Definitions Release in connection 

with major swap participants, the CFTC will not 

deem holding companies to be swap dealers as a 

result of guarantees to certain U.S. entities that are 

already subject to capital regulation. It may, 

however, be appropriate to regulate as a swap 

dealer a parent or other guarantor who guarantees 

swap positions of persons who are not already 

subject to capital regulation by the CFTC (i.e., who 

are not swap dealers, major swap participants or 

FCMs). The CFTC is addressing guarantees 

provided to non-U.S. entities, and guarantees by 

non-U.S. holding companies, in its proposed 

interpretive guidance and policy statement 

regarding the cross-border application of the swaps 

provisions of the CEA, 77 FR 41214 (Jul. 12, 2012). 

189Briefly, in the separate CFTC release the CFTC 

anticipates proposing reporting requirements with 

respect to guarantees of swaps under Parts 43 and 

45 of the CFTC’s regulations and explaining the 

extent to which the duties and obligations of swap 

dealers and major swap participants pertaining to 

guarantees of swaps, as an integral part of swaps, 

are already satisfied to the extent such obligations 

are satisfied with respect to the related guaranteed 

swaps. The CFTC also anticipates addressing in the 

separate CFTC release the effect, if any, of the 

interpretation regarding guarantees of swaps on 

position limits and large trader reporting 

requirements. 

190See AFGI Letter and ISDA Letter. 

191 ISDA Letter. 

192 Id. 

193See Better Markets Letter. 194See Better Markets Letter. 195 ‘‘AIGFP’s obligations were guaranteed by its 

highly rated parent company * * * an arrangement 

that facilitated easy money via much lower interest 

rates from the public markets, but ultimately made 

it difficult to isolate AIGFP from its parent, with 

disastrous consequences.’’ Congressional Oversight 

Panel, The AIG Rescue, Its Impact on Markets, and 

the Government’s Exit Strategy 20 (2010). 196See ISDA Letter. 197See AFGI Letter. 

counterparty typically provides a 

guarantee as credit support for its swap 

obligations, the market will not trade 

with that counterparty at the same price, 

on the same terms, or at all without the 

guarantee. The guarantor’s resources are 

added to the analysis of the swap; if the 

guarantor is financially more capable 

than the swap counterparty, the analysis 

of the swap becomes more dependent 

on the creditworthiness of the 

guarantor. Therefore, the CFTC is 

interpreting the term ‘‘swap’’ (that is not 

a security-based swap or mixed swap) to 

include a guarantee of such swap, to the 

extent that a counterparty to a swap 

position would have recourse to the 

guarantor in connection with the 

position.188 The CFTC anticipates that a 

‘‘full recourse’’ guarantee would have a 

greater effect on the price of a swap than 

a ‘‘limited’’ or ‘‘partial recourse’’ 

guarantee; nevertheless, the CFTC is 

determining that the presence of any 

guarantee with recourse, no matter how 

robust, is price forming and an integral 

part of a guaranteed swap. 

The CFTC’s interpretation of the term 

‘‘swap’’ to include guarantees of swaps 

does not limit or otherwise affect in any 

way the relief provided by the Insurance 

Grandfather. In a separate release, the 

CFTC will address the practical 

implications of interpreting the term 

‘‘swap’’ to include guarantees of swaps 

(the ‘‘separate CFTC release’’).189

Comments 

Three commenters provided 

comments regarding the treatment of 

guarantees. Two commenters 190

opposed treating insurance or 

guarantees of swaps as swaps. 

Suggesting that the products are not 

economically similar, one commented 

that insurance wraps of swaps do not 

‘‘necessarily replicate the economics of 

the underlying swap, and only 

following default could the wrap 

provider end up with the same payment 

obligations as a wrapped defaulting 

swap counterparty.’’ 191 This commenter 

also stated that the non-insurance 

guarantees are not swaps because the 

result of most guarantees is that the 

guarantor is responsible for monetary 

claims against the defaulting party, 

which in this commenter’s view is a 

different obligation than the 

arrangement provided by the underlying 

swap itself.192

One commenter supported treating 

financial guaranty insurance of a swap 

or security-based swap as itself a swap 

or a security-based swap. This 

commenter argued that financial 

guaranty insurance of a swap or 

security-based swap transfers the risk of 

counterparty non-performance to the 

guarantor, making it an embedded and 

essential feature of the insured swap or 

security-based swap. This commenter 

further argued that the value of such 

swap or security-based swap is largely 

determined by the likelihood that the 

proceeds from the financial guaranty 

insurance policy will be available if the 

counterparty does not meet its 

obligations.193 This commenter 

maintained that financial guaranty 

insurance of swaps and security-based 

swaps serves a very similar function to 

credit default swaps in hedging 

counterparty default risk.194

The CFTC is persuaded that when a 

swap (that is not a security-based swap 

or mixed swap) has the benefit of a 

guarantee, the guarantee and related 

guaranteed swap must be analyzed 

together. The events surrounding the 

failure of AIG Financial Products 

(‘‘AIGFP’’) highlight how guarantees can 

cause major risks to flow to the 

guarantor.195 The CFTC finds that the 

regulation of swaps and the risk 

exposures associated with them, which 

is an essential concern of the DoddFrank Act, would be less effective if the 

CFTC did not interpret the term ‘‘swap’’ 

to include a guarantee of a swap. 

Two commenters cautioned against 

unnecessary and duplicative regulation. 

One commented that, because the 

underlying swap, and the parties to it, 

will be regulated and reported to the 

extent required by Title VII, there is no 

need for regulation of non-insurance 

guarantees.196 The other commented 

that an insurance policy on a swap 

would be subject to state regulation; 

without addressing non-insurance 

guarantees, this commenter stated that 

additional Federal regulation would be 

duplicative.197 The CFTC disagrees with 

these arguments. As stated above, the 

CFTC is treating financial guaranty 

insurance of swaps and all other 

guarantees of swaps in a similar manner 

because they are functionally or 

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198See AFGI Letter. Of the members of AFGI, 

only Assured Guaranty (or its affiliates) is currently 

writing financial guaranty insurance policies on 

U.S. municipal obligations. 

199See Regulation SBSR Proposing Release infra 

note 1231. 

200See sections 768(a)(1) and 761(a)(2) of the 

Dodd-Frank Act (amending sections 2(a)(1) of the 

Securities Act, 15 U.S.C. 77b(a)(1), and 3(a)(10) of 

the Exchange Act, 15 U.S.C. 78c(a)(10), 

respectively). 

201See section 2(a)(1) of the Securities Act, 15 

U.S.C. 77b(a)(1). 

202The SEC has previously addressed the 

treatment of financial guaranty insurance under the 

Federal securities laws. See supra note 58. 

203See Proposing Release at 29827. 

204CEA section 1a(47)(B)(ii), 7 U.S.C. 

1a(47)(B)(ii). 

205The discussion in subsections (a) and (b) of 

this section applies solely to the exclusion of 

nonfinancial commodity forwards from the swap 

definition in the CEA. 

206See infra part II.B.2(a)(i)(F). 

207Statutory Interpretation Concerning Forward 

Transactions, 55 FR 39188 (Sep. 25, 1990) (‘‘Brent 

Interpretation’’). 

208Exemption for Certain Contracts Involving 

Energy Products, 58 FR 21286–02 (Apr. 20, 1993) 

(‘‘Energy Exemption’’). 

209CEA section 1a(27), 7 U.S.C. 1a(27). 

210See 156 Cong. Rec. H5248–49 (June 30, 2010) 

(introducing into the record a letter authored by 

Senator Blanche Lincoln, Chairman of the U. S. 

Senate Committee on Agriculture, Nutrition and 

Forestry, and Christopher Dodd, Chairman U. S. 

Senate Committee on Banking, Housing, and Urban 

Affairs, stating that the CFTC is encouraged ‘‘to 

clarify through rulemaking that the exclusion from 

the definition of swap for ‘any sale of a nonfinancial 

commodity or security for deferred shipment or 

delivery, so long as the transaction is intended to 

be physically settled’ is intended to be consistent 

with the forward contract exclusion that is 

currently in the [CEA] and the CFTC’s established 

Continued 

economically similar products. If a 

guarantee of a swap is not treated as an 

integral part of the underlying swap, 

price forming terms of swaps and the 

risk exposures associated with the 

guarantees may remain hidden from 

regulators and may not be regulated 

appropriately. Moreover, treating 

guarantees of swaps as part of the 

underlying swaps ensures that the CFTC 

will be able to take appropriate action 

if, after evaluating information collected 

with respect to the guarantees and the 

underlying swaps, such guarantees of 

swaps are revealed to pose particular 

problems in connection with the swaps 

markets. In the separate CFTC release, 

the CFTC will clarify the limited 

practical effects of the CFTC’s 

interpretation, which should address 

concerns regarding duplicative 

regulation. 

One commenter also argued that 

regulating financial guaranty of swaps 

as swaps would cause monoline 

insurers to withdraw from the market, 

which could adversely affect the U.S. 

and international public finance, 

infrastructure and structured finance 

markets, given that insuring a related 

swap often is integral to the insurance 

of municipal bonds and other 

securities.198 The CFTC finds this 

argument unpersuasive. The CFTC 

understands that the 2008 global 

financial crisis severely affected most 

monolines and only one remains active 

in U.S. municipal markets. Thus, it 

appears that the monolines have, for the 

most part, already exited these markets. 

In addition, as stated above, the CFTC 

will clarify in the separate CFTC release 

the limited practical effects of the 

CFTC’s interpretation, which should 

address these concerns. 

Guarantees of Security-Based Swaps 

The SEC believes that a guarantee of 

an obligation under a security-based 

swap, including financial guaranty 

insurance of a security-based swap, is 

not a separate security-based swap. 

Further, the SEC is not adopting an 

interpretation that a guarantee of a 

security-based swap is part of the 

security-based swap. Instead, the SEC 

will consider requiring, as part of its 

rulemaking relating to the reporting of 

security-based swaps,199 the reporting of 

information about any guarantees and 

the guarantors of obligations under 

security-based swaps in connection 

with the reporting of the security-based 

swap transaction itself. In addition, the 

SEC will consider issues involving 

cross-border guarantees of securitybased swaps in a separate release 

addressing the cross-border application 

of Title VII. The SEC notes that securitybased swaps are included in the 

definition of ‘‘security’’ contained in the 

Securities Act and the Exchange Act.200

Under the Securities Act, a guarantee of 

a security also is a ‘‘security.’’ 201

Therefore, a guarantee of a securitybased swap is a security subject to 

Federal securities law regulation.202

2. The Forward Contract Exclusion 

As the Commissions explained in the 

Proposing Release, the definitions of the 

terms ‘‘swap’’ and ‘‘security-based 

swap’’ do not include forward 

contracts.203 These definitions exclude 

‘‘any sale of a nonfinancial commodity 

or security for deferred shipment or 

delivery, so long as the transaction is 

intended to be physically settled.’’ 204

The Commissions provided an 

interpretation in the Proposing Release 

regarding the applicability of the 

exclusion from the swap and securitybased swap definition for forward 

contracts with respect to nonfinancial 

commodities 205 and securities. The 

Commissions are restating this 

interpretation as set forth in the 

Proposing Release with certain 

modifications in response to 

commenters. 

(a) Forward Contracts in Nonfinancial 

Commodities 

The CFTC provided an interpretation 

in the Proposing Release regarding the 

forward contract exclusion for 

nonfinancial commodities and is 

restating this interpretation with certain 

modifications in response to 

commenters. These clarifications 

include that the CFTC will interpret the 

forward contract exclusion consistent 

with the entire body of CFTC 

precedent.206 The CFTC is also 

clarifying what ‘‘commercial 

participant’’ means under the ‘‘Brent 

Interpretation.’’ 207 In addition, while 

the CFTC is withdrawing its 1993 

‘‘Energy Exemption’’ 208 as proposed, it 

is clarifying that certain alternative 

delivery procedures will not disqualify 

a transaction from the forward contract 

exclusion. In response to comments, the 

CFTC is providing a new interpretation 

regarding book-out documentation, as 

well as additional factors that may be 

considered in its ‘‘facts and 

circumstances’’ analysis of whether a 

particular contract is a forward. 

(i) Forward Exclusion From the Swap 

and Future Delivery Definitions 

(A) Consistent Interpretation 

The wording of the forward contract 

exclusion from the swap definition with 

respect to nonfinancial commodities is 

similar, but not identical, to the forward 

exclusion from the definition of the 

term ‘‘future delivery’’ that applies to 

futures contracts, which excludes ‘‘any 

sale of any cash commodity for deferred 

shipment or delivery.’’ 209

In the Proposing Release, the CFTC 

proposed an interpretation clarifying the 

scope of the exclusion of forward 

contracts for nonfinancial commodities 

from the swap definition and from the 

‘‘future delivery’’ definition in a number 

of respects. After considering the 

comments received, the CFTC is 

restating substantially all of its 

interpretation regarding these forward 

exclusions set forth in the Proposing 

Release, but with several clarifications 

in response to commenters. 

The CFTC is restating from the 

Proposing Release that the forward 

exclusion for nonfinancial commodities 

in the swap definition will be 

interpreted in a manner consistent with 

the CFTC’s historical interpretation of 

the existing forward exclusion with 

respect to futures contracts, consistent 

with the Dodd-Frank Act’s legislative 

history.210 In addition, in response to a 

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policy and orders on this subject, including 

situations where commercial parties agree to ‘bookout’ their physical delivery obligations under a 

forward contract.’’). See also 156 Cong. Rec. H5247 

(June 30, 2010) (colloquy between U. S. House 

Committee on Agriculture Chairman Collin 

Peterson and Representative Leonard Boswell 

during the debate on the Conference Report for the 

Dodd-Frank Act, in which Chairman Peterson 

stated: ‘‘Excluding physical forward contracts, 

including book-outs, is consistent with the CFTC’s 

longstanding view that physical forward contracts 

in which the parties later agree to book-out their 

delivery obligations for commercial convenience 

are excluded from its jurisdiction. Nothing in this 

legislation changes that result with respect to 

commercial forward contracts.’’). 

211See Letter from Craig Donahue, Chief 

Executive Officer, CME Group Inc. (‘‘CME’’), dated 

July 22, 2011 (‘‘CME Letter’’) (requesting this 

clarification). But see below regarding the CFTC’s 

response to CME’s comment concerning the Brent 

Interpretation that it may be inconsistent, in CME’s 

view, with more recent CFTC adjudicatory 

decisions. 

212See, e.g., Brent Interpretation, supra note 207. 

213See Brent Interpretation, supra note 207. The 

CFTC has reiterated this view in more recent 

adjudicative orders. See, e.g., In re Grain Land 

Coop., [2003–2004 Transfer Binder] Comm. Fut. L. 

Rep. (CCH) ¶ 29,636 (CFTC Nov. 25, 2003); In re 

Competitive Strategies for Agric., Ltd., [2003–2004 

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 29,635 

(CFTC Nov. 25, 2003). Courts have expressed this 

view as well. See, e.g., Salomon Forex, Inc. v. 

Tauber, 8 F.3d 966, 971 (4th Cir. 1993) (‘‘[C]ash 

forwards are generally individually negotiated sales 

* * * in which actual delivery of the commodity 

is anticipated, but is deferred for reasons of 

commercial convenience or necessity.’’); CFTC v. 

Int’l Fin. Serv. (N.Y.), 323 F. Supp. 2d 482, 495 

(S.D.N.Y. 2004). See also CFTC v. Co Petro Mktg. 

Grp., Inc., 680 F.2d 573, 579–580 (9th Cir. 1982); 

CFTC v. Noble Metals Int’l, Inc., 67 F.3d 766, 772– 

773 (9th Cir. 1995; CFTC v. Am. Metal Exch. Corp., 

693 F. Supp. 168, 192 (D.N.J. 1988); CFTC v. 

Morgan, Harris & Scott, Ltd., 484 F. Supp. 669, 675 

(S.D.N.Y. 1979) (forward contract exclusion does 

not apply to speculative transactions in which 

delivery obligations can be extinguished under the 

terms of the contract or avoided for reasons other 

than commercial convenience or necessity). 

214The CFTC observed in its decision in In re 

Wright that ‘‘it is well-established that the intent to 

make or take delivery is the critical factor in 

determining whether a contract qualifies as a 

forward.’’ In re Wright, CFTC Docket No. 97–02, 

2010 WL 4388247 at *3 (CFTC Oct. 25, 2010) (citing 

In re Stovall, et al., [1977–1980 Transfer Binder] 

Comm. Fut. L. Rep. (CCH) 20,941 (CFTC Dec. 6, 

1979); Brent Interpretation, supra note 207). In 

Wright, the CFTC noted that ‘‘[i]n distinguishing 

futures from forwards, the [CFTC] and the courts 

have assessed the transaction as a whole with a 

critical eye toward its underlying purpose. Such an 

assessment entails a review of the overall effect of 

the transaction as well as a determination as to 

what the parties intended.’’ Id. at *3 (quoting Policy 

Statement Concerning Swap Transactions, 54 FR 

30694 (Jul. 21, 1989) (‘‘Swap Policy Statement’’) 

(citations and internal quotations omitted)). 

215 In Wright, the CFTC applied its facts and 

circumstances test in an administrative enforcement 

action involving hedge-to-arrive contracts for corn, 

and observed that ‘‘[o]ur views of the 

appropriateness of a multi-factor analysis remain 

unchanged.’’ Wright, note 214, supra, n.13. The 

CFTC let stand the administrative law judge’s 

conclusion that the hedge-to-arrive contracts at 

issue in the case were forward contracts. Id. at **5– 

6. See also Grain Land, supra note 213; Competitive 

Strategies for Agric., supra note 213. 

216See Brent Interpretation, supra note 207. The 

CFTC issued the Brent Interpretation in response to 

a Federal court decision that held that certain 15- 

day Brent system crude oil contracts were illegal 

off-exchange futures contracts. See Transnor 

(Bermuda) Ltd. v. BP N. Am. Petroleum, 738 F. 

Supp. 1472 (S.D.N.Y. 1990). The Brent 

Interpretation provided clarification that the 15-day 

Brent system crude oil contracts were forward 

contracts that were excluded from the CEA 

definition of ‘‘future delivery,’’ and thus were not 

futures contracts. See Brent Interpretation, supra 

note 207. 

217The Brent Interpretation described these 

‘‘book-outs’’ as follows: ‘‘In the course of entering 

into 15-day contracts for delivery of a cargo during 

a particular month, situations often arise in which 

two counterparties have multiple, offsetting 

positions with each other. These situations arise as 

a result of the effectuation of multiple, independent 

commercial transactions. In such circumstances, 

rather than requiring the effectuation of redundant 

deliveries and the assumption of the credit, delivery 

and related risks attendant thereto, the parties may, 

but are not obligated to and may elect not to, 

terminate their contracts and forego such deliveries 

and instead negotiate payment-of-differences 

pursuant to a separate, individually-negotiated 

cancellation agreement referred to as a ‘book-out.’ 

Similarly, situations regularly arise when 

participants find themselves selling and purchasing 

oil more than once in the delivery chain for a 

particular cargo. The participants comprising these 

‘circles’ or ‘loops’ will frequently attempt to 

negotiate separate cancellation agreements among 

themselves for the same reasons and with the same 

effect described above.’’ Brent Interpretation, supra 

note 207, at 39190. 

218 Id. at 39192. 

219 Id. at 39189. 

commenter, the CFTC is clarifying that 

the entire body of CFTC precedent 

regarding forwards should apply to the 

forward exclusions from the swap and 

future delivery definitions.211

The CFTC’s historical interpretation 

has been that forward contracts with 

respect to nonfinancial commodities are 

‘‘commercial merchandising 

transactions.’’ 212 The primary purpose 

of a forward contract is to transfer 

ownership of the commodity and not to 

transfer solely its price risk. As the 

CFTC has noted and reaffirms today: 

The underlying postulate of the [forward] 

exclusion is that the [CEA’s] regulatory 

scheme for futures trading simply should not 

apply to private commercial merchandising 

transactions which create enforceable 

obligations to deliver but in which delivery 

is deferred for reasons of commercial 

convenience or necessity.213

As noted in the Proposing Release, 

because a forward contract is a 

commercial merchandising transaction, 

intent to deliver historically has been an 

element of the CFTC’s analysis of 

whether a particular contract is a 

forward contract.214 In assessing the 

parties’ expectations or intent regarding 

delivery, the CFTC consistently has 

applied a ‘‘facts and circumstances’’ 

test.215 Therefore, the CFTC reads the 

‘‘intended to be physically settled’’ 

language in the swap definition with 

respect to nonfinancial commodities to 

reflect a directive that intent to deliver 

a physical commodity be a part of the 

analysis of whether a given contract is 

a forward contract or a swap, just as it 

is a part of the CFTC’s analysis of 

whether a given contract is a forward 

contract or a futures contract. 

(B) Brent Interpretation 

In this interpretation, the CFTC is 

restating, with certain clarifications in 

response to commenters, its 

interpretation from the Proposing 

Release that the principles underlying 

the CFTC’s ‘‘Brent Interpretation’’ 

regarding book-outs developed in 

connection with the forward exclusion 

from futures apply to the forward 

exclusion from the swap definition as 

well. Book-out transactions meeting the 

requirements specified in the Brent 

Interpretation that are effectuated 

through a subsequent, separately 

negotiated agreement qualify for the safe 

harbor under the forward exclusions. 

As was noted in the Proposing 

Release, the issue of book-outs first 

arose in 1990 in the Brent 

Interpretation 216 because the parties to 

the crude oil contracts in that case could 

individually negotiate cancellation 

agreements, or ‘‘book-outs,’’ with other 

parties.217 In describing these 

transactions, the CFTC stated: 

It is noteworthy that while such [book-out] 

agreements may extinguish a party’s delivery 

obligation, they are separate, individually 

negotiated, new agreements, there is no 

obligation or arrangement to enter into such 

agreements, they are not provided for by the 

terms of the contracts as initially entered 

into, and any party that is in a position in 

a distribution chain that provides for the 

opportunity to book-out with another party 

or parties in the chain is nevertheless entitled 

to require delivery of the commodity to be 

made through it, as required under the 

contracts.218

Thus, in the scenario at issue in the 

Brent Interpretation, the contracts 

created a binding obligation to make or 

take delivery without providing any 

right to offset, cancel, or settle on a 

payment-of-differences basis. The 

‘‘parties enter[ed] into such contracts 

with the recognition that they may be 

required to make or take delivery.’’ 219

On these facts, the Brent 

Interpretation concluded that the 

contracts were forward contracts, not 

futures contracts: 

Under these circumstances, the [CFTC] is 

of the view that transactions of this type 

which are entered into between commercial 

participants in connection with their 

business, which create specific delivery 

obligations that impose substantial economic 

risks of a commercial nature to these 

participants, but which may involve, in 

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220 Id. at 39192. 

221See CME Letter (noting that, although the 

Brent Interpretation applies to ‘‘commercial market 

participants,’’ the proposed guidance in the 

Proposing Release was described as applying to 

‘‘market participants’’ (omitting the word 

‘‘commercial’’) who ‘‘regularly make or take 

delivery of the referenced commodities * * * in the 

ordinary course of business.’’ See also Proposing 

Release at 29829. 

222Brent Interpretation, supra note 207, at 39192. 

223See CME Letter. In connection with its 

comment regarding ‘‘market participants’’ described 

above, see supra note 221, the CME further requests 

confirmation that the CFTC intends to apply the 

Brent Interpretation to market participants who can 

demonstrate that they meet the standard in the 

guidance as proposed, but are not themselves 

commercial actors: 

Because the Commission‘s interpretation does not 

explicitly refer to commercial market participants, 

it would seem to cover financial players as long as 

those entities regularly make or take delivery of the 

underlying commodity in connection with their 

business. Examples of such entities would be hedge 

funds or other investment vehicles that regularly 

make or take delivery of commodities (e.g. gold) in 

conjunction with their line of business—that is, as 

part of their investment strategies. [CME] asks that 

the [CFTC] confirm that the Brent safe harbor would 

be available to these types of market participants 

that technically are not ‘‘commercial’’ actors. 

See CME Letter. 

224Brent Interpretation, supra note 207, at 39191. 

See also dissent of Commissioner Fowler West 

(stating that commercial means ‘‘in the traditional 

sense of those who produce, process, use or * * * 

handle the underlying commodity.’’). Note that 

being a commercial market participant with respect 

to an agreement, contract or transaction in one 

commodity, or grade of a commodity, neither makes 

an entity, nor precludes an entity from being, a 

commercial market participant with respect to an 

agreement, contract or transaction in a different 

grade of the commodity or a different commodity. 

For example, a West Texas Intermediate oil 

producer may or may not also be a commercial with 

respect to Brent. Similarly, that same West Texas 

Intermediate oil producer may or may not have 

commercial corn operations. In determining 

whether an entity is a commercial market 

participant with respect to an agreement, contract 

or transaction in a commodity, the CFTC will 

consider the facts and circumstances, though it is 

not unlikely that an entity that is a commercial 

market participant with respect to one commodity 

may also be a commercial market participant with 

respect to either a different grade of the commodity 

or a closely related commodity. 

225See infra part II.B.2(a)(ii), with respect to the 

CFTC’s interpretation concerning nonfinancial 

commodities. 

226The CFTC reminds market participants that 

this does not mean, as was noted in the Brent 

Interpretation, that these transactions or persons 

who engage in them are wholly outside the reach 

of the CEA for all purposes. See, e.g., CEA section 

8(d), 7 U.S.C. 12(d), which directs the CFTC to 

investigate the marketing conditions of 

commodities and commodity products and 

byproducts, including supply and demand for these 

commodities, cost to the consumer, and handling 

and transportation charges; CEA sections 6(c), 6(d), 

and 9(a)(2), 7 U.S.C. 9, 13b, and 13(a)(2), which 

proscribe any manipulation or attempt to 

manipulate the price of any commodity in interstate 

commerce; and CEA section 6(c) as amended by 

section 753 of the Dodd-Frank Act, which contains 

prohibitions regarding manipulation and false 

reporting with respect to any commodity in 

interstate commerce, including prohibiting any 

person to (i) ‘‘use or employ, or attempt to use or 

employ * * * any manipulative or deceptive 

device or contrivance’’ (section 6(c)(1)); (ii) ‘‘to 

make any false or misleading statement of material 

fact’’ to the CFTC or ‘‘omit to state in any such 

statement any material fact that is necessary to 

make any statement of material fact made not 

misleading in any material respect’’ (section 

6(c)(2)); and (iii) ‘‘manipulate or attempt to 

manipulate the price of any swap, or of any 

commodity in interstate commerce * * * (section 

6(c)(3)). See also Rule 180.1(a) under the CEA, 17 

CFR 180.1(a) (broadly prohibiting in connection 

with a commodity in interstate commerce 

manipulation, false or misleading statements or 

omissions of material fact to the Commission, fraud 

or deceptive practices or courses of business, and 

false reporting). 

227These include pre-transaction netting 

agreements that result in offsetting physical 

delivery obligations, ‘‘bona fide termination rights,’’ 

and certain other methods by which parties may 

settle their delivery obligations. See Energy 

Exemption, supra note 208, at 21293. 

certain circumstances, string or chain 

deliveries of the type described * * * are 

within the scope of the [forward contract] 

exclusion from the [CFTC’s] regulatory 

jurisdiction.220

Although the CFTC did not expressly 

discuss intent to deliver, the Brent 

Interpretation concluded that 

transactions retained their character as 

commercial merchandising transactions, 

notwithstanding the practice of 

terminating commercial parties’ 

delivery obligations through ‘‘bookouts’’ as described. At any point in the 

chain, one of the parties could refuse to 

enter into a new contract to book-out the 

transaction and, instead, insist upon 

delivery pursuant to the parties’ 

obligations under their contract. 

The CFTC also is clarifying that 

commercial market participants that 

regularly make or take delivery of the 

referenced commodity in the ordinary 

course of their business meet the 

commercial participant standard of the 

Brent Interpretation.221 The CFTC notes 

that the Brent Interpretation applies to 

‘‘commercial participants in connection 

with their business.’’ 222 The CFTC 

intends that the interpretation in this 

release be consistent with the Brent 

Interpretation, and accordingly is 

adding ‘‘commercial’’ before ‘‘market 

participants’’ in this final interpretation. 

Such entities qualify for the forward 

exclusion from both the future delivery 

and swap definitions for their forward 

transactions in nonfinancial 

commodities under the Brent 

Interpretation even if they enter into a 

subsequent transaction to ‘‘book out’’ 

the contract rather than make or take 

delivery. Intent to make or take delivery 

can be inferred from the binding 

delivery obligation for the commodity 

referenced in the contract and the fact 

that the parties to the contract do, in 

fact, regularly make or take delivery of 

the referenced commodity in the 

ordinary course of their business. 

Further, in this final interpretation, 

the CFTC clarifies, in response to a 

comment received, that an investment 

vehicle taking delivery of gold as part of 

its investment strategy would not be 

engaging in a commercial activity 

within the meaning of the Brent 

Interpretation.223 By contrast, were the 

investment vehicle, for example, to own 

a gold mine and sell the output of the 

gold mine for forward delivery, or own 

a chain of jewelry stores that produces 

its own jewelry from raw materials and 

purchase a supply of gold from another 

entity’s gold mine in order to provide 

raw materials for its jewelry stores, such 

contracts could qualify as forward 

contracts under the Brent 

Interpretation—provided that such 

contracts otherwise satisfy the terms 

thereof. 

In sum, the CFTC is interpreting the 

term ‘‘commercial’’ in the context of the 

Brent Interpretation in the same way it 

has done since 1990: ‘‘related to the 

business of a producer, processor, 

fabricator, refiner or merchandiser.’’ 224

While a market participant need not be 

solely engaged in ‘‘commercial’’ activity 

to be a ‘‘commercial market participant’’ 

within the meaning of the Brent 

Interpretation under this interpretation, 

the business activity in which it makes 

or takes delivery must be commercial 

activity for it to be a commercial market 

participant. A hedge fund’s investment 

activity is not commercial activity 

within the CFTC’s longstanding view of 

the Brent Interpretation. 

In addition, the CFTC is expanding 

the Brent Interpretation, which applied 

only to oil, to all nonfinancial 

commodities, as proposed.225 As a 

result, book-outs are permissible (where 

the conditions of the Brent 

Interpretation are satisfied) for all 

nonfinancial commodities with respect 

to the exclusions from the definition of 

the term ‘‘swap’’ and the definition of 

the term ‘‘future delivery’’ under the 

CEA.226

(C) Withdrawal of the Energy Exemption 

Because the CFTC has expanded the 

Brent Interpretation to nonfinancial 

commodities in this final interpretation, 

the CFTC also has determined to 

withdraw the Energy Exemption as 

proposed. In response to comments 

received, the CFTC is clarifying that 

certain alternative delivery procedures 

discussed in the Energy Exemption 227

will not disqualify a transaction from 

the Brent Interpretation safe harbor. 

In the Proposing Release, the CFTC 

proposed to withdraw the Energy 

Exemption, which, among other things, 

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48230 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

228See Proposing Release at 29829. The CFTC 

also noted that, to avoid any uncertainty, the DoddFrank Act supersedes the Swap Policy Statement. 

Id. at 29829 n. 74. The CFTC reaffirms that such is 

the case. 

229Compare Energy Exemption, supra note 208, 

at 21293 with Brent Interpretation, supra note 207, 

at 39192. 

230See Energy Exemption, supra note 208, at 

21293. 

231See also infra part II.B.2(b)(v) for a discussion 

of liquidated damages. 

232Energy Exemption, supra note 208, at 21293. 

233 Id. 

234 Id. 

235The CFTC will carefully scrutinize whether 

market participants are legitimately relying on the 

Brent Interpretation safe harbor. For example, if 

non-commercial market participants are 

intermediate purchasers in a delivery chain, then 

the transaction is not actually a commercial 

merchandising transaction, and the parties cannot 

rely on the Brent Interpretation safe harbor. 

236By definition, if two parties exchange (i.e., 

physically deliver) one physical commodity for 

another physical commodity in settlement of the 

parties’ delivery obligations, each seller has 

delivered the commodity that is the subject of its 

delivery obligation under the relevant agreement, 

contract or transaction. Depending on the 

settlement timing, such transactions, which 

resemble barter transactions, would be spot 

transactions or forward transactions. While the 

most common forward transaction involves an 

exchange of a physical commodity for cash, neither 

the Brent Interpretation nor any other CFTC 

authority requires payment for a forward delivery 

to be made in cash. Thus, a physical exchange of 

one quality, grade or type of physical commodity 

for another quality, grade, or type of physical 

commodity does not affect the characterization of 

the transaction as a spot or forward transaction. As 

for the sellers passing title and buyers, instead of 

taking delivery of the commodity, passing title to 

another intermediate purchaser in a chain, this is 

consistent with the description of Brent 

transactions in the Brent Interpretation, provided 

that, as set forth therein, delivery is required and 

‘‘the delivery obligations create substantial 

economic risk of a commercial nature to the parties 

required to make or take delivery * * * includ[ing, 

without limitation,] demurrage, damage, theft or 

deterioration.’’ That description was based on the 

industry delivery structure as it existed prior to the 

Brent Interpretation. To the extent other industries 

are similarly structured for commercial reasons, the 

delivery-by-title-and-related-bill-of-lading-transfer 

delivery method would be able to rely on the Brent 

Interpretation if it otherwise satisfied the terms 

thereof. However, to the extent persons seek to 

establish such a delivery structure for new products 

and markets (e.g., not actually delivering the 

commodity to most of the participants in a chain), 

that could, depending on the applicable facts and 

circumstances, be viewed as outside the Brent 

Interpretation safe harbor or evasion. The CFTC 

expects that the limitation of counterparties eligible 

to rely on the Brent Interpretation to those with a 

commercial purpose for entering into the 

transaction should limit the development of such 

markets to those with commercial reasons for such 

a delivery structure. 

237See Letter from R. Michael Sweeney, Jr., 

Hunton & Williams LLP, on behalf of the Working 

Group of Commercial Energy Firms (‘‘WGCEF’’), 

dated July 22, 2011 (‘‘WGCEF Letter’’). 

238See Proposing Release at 29831, Request for 

Comment 27. 

239Most commenters opposed adding a minimum 

contract size or other conditions to the CFTC’s 

interpretation of the forward exclusion. One 

commenter argued that such an approach would be 

inconsistent with CFTC precedent, citing the fact 

that neither the Brent Interpretation nor subsequent 

CFTC precedent interpreting the forward exclusion 

mention contract size. See CME Letter. Another 

commenter pointed out that Congress did not 

impose such a requirement, and thus believes that 

the CFTC should not do so. See Letter from David 

M. Perlman, Partner, Bracewell & Giuliani LLP, 

Counsel to the Coalition of Physical Energy 

Companies (‘‘COPE’’), dated July 22, 2011 (‘‘COPE 

Letter’’). Similarly, a third commenter argued that 

the only condition Congress placed on the forward 

exclusion is intent to physically settle, and contract 

size is not relevant to such intent. See Letter from 

Natural Gas Supply Association/National Corn 

Growers Association (‘‘NGSA/NCGA’’), dated July 

22, 2011 (‘‘NGSA/NCGA Letter’’). 

Two commenters questioned the reasonableness 

in instituting a minimum contract size below which 

a transaction would become regulated, but 

otherwise would not. See Letter from Craig G. 

Goodman, Esq., President, The National Energy 

Marketers Association (‘‘NEMA’’), dated July 21, 

2011, (‘‘NEMA Letter’’) and Letter from Phillip G. 

Lookadoo on behalf of the International Energy 

expanded the Brent Interpretation to 

energy commodities other than oil, on 

the basis that the exemption was no 

longer necessary in light of the 

extension of the Brent Interpretation to 

nonfinancial commodities.228 The 

Energy Exemption, like the Brent 

Interpretation, requires binding delivery 

obligations at the outset, with no right 

to cash settle or offset transactions.229

Each requires that book-outs be 

undertaken pursuant to a subsequent, 

separately negotiated agreement. 

As discussed above, the CFTC is 

extending the Brent Interpretation to the 

swap definition and applying it to all 

nonfinancial commodities for both the 

swap and future delivery definitions, 

but is withdrawing the Energy 

Exemption. With regard to netting 

agreements that were expressly 

permitted by the Energy Exemption,230

the CFTC clarifies that a physical 

netting agreement (such as, for example, 

the Edison Electric Institute Master 

Power Purchase and Sale Agreement) 

that contains a provision contemplating 

the reduction to a net delivery amount 

of future, unintentionally offsetting 

delivery obligations, is consistent with 

the intent of the book out provision in 

the Brent Interpretation—provided that 

the parties had a bona fide intent, when 

entering into the transactions, to make 

or take delivery (as applicable) of the 

commodity covered by those 

transactions. 

The CFTC also has determined that, 

notwithstanding the withdrawal of the 

Energy Exemption, a failure to deliver as 

a result of the exercise by a party of a 

‘‘bona fide termination right’’ does not 

render an otherwise binding delivery 

obligation as non-binding.231 In the 

Energy Exemption, the CFTC provided 

the following examples of bona fide 

termination rights: force majeure 

provisions and termination rights 

triggered by events of default, such as 

counterparty insolvency, default or 

other inability to perform.232 The CFTC 

confirms that market participants who 

otherwise qualify for the forward 

exclusion may continue to rely on the 

bona fide termination right concept as 

set forth in this interpretation, although, 

as was stated in the Energy Exemption, 

such right must be bona fide and not for 

the purpose of evasion. In this regard, 

the CFTC further clarifies, consistent 

with the Energy Exemption, that a bona 

fide termination right must be triggered 

by something not expected by the 

parties at the time the contract is 

entered into.233

The Energy Exemption also discussed 

a number of methods by which parties 

to energy contracts settle their 

obligations, including: The seller’s 

passage of title and the buyer’s payment 

and acceptance of the underlying 

commodity; taking delivery of the 

commodity in some instances and in 

others instead passing title to another 

intermediate purchaser in a chain; and 

physically exchanging (i.e., delivering) 

one quality, grade or type of physical 

commodity for another quality, grade or 

type of physical commodity.234 The 

CFTC clarifies that these settlement 

methods generally 235 are not 

inconsistent with the Brent 

Interpretation.236

(D) Book-Out Documentation 

The CFTC has taken into 

consideration comments regarding the 

documentation of book-outs.237 Under 

the Brent Interpretation, what is 

relevant is that the book out occur 

through a subsequent, separately 

negotiated agreement. While the CFTC 

is sensitive to existing recordkeeping 

practices for book-outs, in order to 

prevent abuse of the safe harbor, the 

CFTC clarifies that in the event of an 

oral agreement, such agreement must be 

followed in a commercially reasonable 

timeframe by a confirmation in some 

type of written or electronic form. 

(E) Minimum Contract Size and Other 

Contextual Factors 

In the Proposing Release, the CFTC 

requested comment about potentially 

imposing additional conditions (such 

as, for example, a minimum contract 

size) in order for a transaction to qualify 

as a forward contract under the Brent 

Interpretation with respect to the future 

delivery and swap definitions.238 The 

CFTC has determined that a minimum 

contract size should not be required in 

order for a contract to qualify as a 

forward contract under the Brent 

Interpretation.239 However, as suggested 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48231 

Credit Association (‘‘IECA’’), dated July 28, 2011 

(‘‘IECA Letter’’). Two commenters believed that 

such an approach would be contrary to the 

purposes of Dodd-Frank in regulating transactions 

that would affect systemic risk. See NEMA Letter 

and Letter from Dan Gilligan and Michael Trunzo, 

Petroleum Marketers Association of America and 

New England Fuel Institute (‘‘PMAA/NEFI’’), dated 

July 22, 2011 (‘‘PMAA/NEFI Letter’’). One 

commenter urged that the Brent Interpretation be 

applied with minimal restrictive overlay. It believed 

that contract size is a ‘‘contextual factor’’ that may 

be considered in evaluating the existence of intent 

to deliver, but should not be viewed as an 

independent determinant. See ISDA Letter. 

One commenter argued that the forward 

exclusion should be strengthened with additional 

conditions to preclude evasion. Its suggested 

conditions include defining the required regularity 

of delivery (such as a predominance, or ‘‘more often 

than not’’ standard); providing a quantitative test of 

bona fide intent to deliver (such as a demonstrable 

commercial need for the product and justifying 

non-physical settlement based on a change in 

commercial circumstances); and re-evaluating the 

book-outs aspect of the Brent Interpretation. See 

Better Markets Letter. 

240See ISDA Letter. 

241See Letter from Lisa Yoho, Director, 

Regulatory Affairs, BGA, dated July 22, 2011) 

(‘‘BGA Letter’’); COPE Letter; Letter from Michael 

Bardee, General Counsel, Federal Energy Regulatory 

Commission (‘‘FERC’’), dated July 22, 2011 (‘‘FERC 

Staff Letter’’); Letter from Stephanie Bird, Chief 

Financial Officer, Just Energy, dated July 22, 2011 

(‘‘Just Energy Letter’’); Letter from the Electric Trade 

Associations (the Electric Power Supply 

Association, National Rural Electric Cooperative 

Association, Large Public Power Council, Edison 

Electric Institute and American Power Association) 

(‘‘ETA Letter’’), dated July 22, 2011. 

242See ETA Letter (citing the ‘‘Lincoln-Dodd 

Letter’’ printed at 156 Cong. Rec. H5248–249). 243See ETA Letter. The commenter requests that 

the CFTC ‘‘further define the statutory term ‘swap’ 

by defining relevant terms in the Dodd-Frank Act, 

reconciling the wording used in the various 

provisions in the CEA as amended by the DoddFrank Act, and setting forth in the [CFTC’s] rules 

the factors that are determinative in drawing the 

distinction between a ‘swap’ and a ‘nonfinancial 

commodity forward contract.’’’ The commenter 

suggests rule text to codify the CFTC’s 

interpretation regarding the exclusion of 

nonfinancial commodity forward contracts. Id. 

244See FERC Staff Letter. 245See, e.g. Brent Interpretation, supra note 207; 

Energy Exemption, supra note 208; Characteristics 

Distinguishing Cash and Forward Contracts and 

‘‘Trade’’ Options, 50 FR 39656 (Sep. 30, 1985) 

(‘‘1985 CFTC OGC Interpretation’’). 246See supra note 210 and accompanying text. 247See 156 Cong. Rec. H5248–49 (June 30, 2010). 

248This is particularly true given that the CFTC 

intends to interpret the forward exclusion from the 

swap definition consistently with its interpretation 

of the forward exclusion from the term ‘‘future 

delivery,’’ with which market participants have had 

decades of experience. 

249See BGA Letter; COPE Letter; ISDA Letter; 

IECA Letter; Letter from Stuart J. Kaswell, Executive 

Vice President & Managing Director, Managed 

Funds Association (‘‘MFA’’), dated July 22, 2011 

(‘‘MFA Letter’’); NGSA/NCGA Letter; Letter from 

Charles F. Conner, President and CEO, National 

Council of Farmer Cooperatives (‘‘NCFC’’), dated 

July 22, 2011 (‘‘NCFC Letter’’); NEMA Letter; 

PMAA/NEFI Letter; WGCEF Letter. 

250See CME Letter. 

251 Grain Land, supra note 213. 

252Wright, supra note 214. 

by a commenter, the CFTC may consider 

contract size as a contextual factor in 

determining whether a particular 

contract is a forward.240 Moreover, the 

CFTC may consider other contextual 

factors when determining whether a 

contract qualifies as a forward, such as 

a demonstrable commercial need for the 

product, the underlying purpose of the 

contract (e.g. whether the purpose of the 

claimed forward was to sell physical 

commodities, hedge risk, or speculate), 

the regular practices of the commercial 

entity with respect to its general 

commercial business and its forward 

and swap transactions more specifically, 

or whether the absence of physical 

settlement is based on a change in 

commercial circumstances. These 

contextual factors are consistent with 

the CFTC’s historical facts-andcircumstances approach to the forward 

contract exclusion outside of the Brent 

Interpretation safe harbor. 

Comments 

Several commenters believed that the 

CFTC should codify its proposed 

interpretation regarding the Brent 

Interpretation in rule text to provide 

greater legal certainty.241 One 

commenter further commented that the 

Dodd-Frank Act’s legislative history 

expressly directed the CFTC to clarify 

through rulemaking that the 

nonfinancial commodity forward 

contract exclusion from the swap 

definition is intended to be consistent 

with the forward contract exclusion 

from the term ‘‘future delivery.’’242 The 

commenter also stated its view that the 

interpretation as proposed does not 

provide notice to the electricity industry 

as to how to determine whether a 

nonfinancial commodity agreement is a 

swap or a nonfinancial commodity 

forward contract, nor as to which factors 

the CFTC would consider in 

distinguishing between swaps and 

nonfinancial forward contracts.243

Moreover, another commenter suggested 

that the CFTC should include in 

regulatory text a representative, nonexhaustive list of the kinds of contracts 

that are excluded from the swap 

definition.244

The CFTC has determined not to 

codify its interpretation in rule text. The 

CFTC has never codified its prior 

interpretations of the forward contract 

exclusion with respect to the future 

delivery definition as a rule or 

regulation;245 thus, providing an 

interpretation is consistent with the 

manner in which the CFTC has 

interpreted the forward exclusion in the 

past, which in turn is consistent with 

the Dodd-Frank Act legislative 

history.246 Moreover, Congress did not 

direct the CFTC to write rules regarding 

the forward exclusion. The DoddLincoln letter, cited by a commenter in 

support of its argument, ‘‘encourages’’ 

the CFTC to clarify the forward 

exclusion ‘‘through rulemaking’’ in the 

generic sense of that term (i.e., through 

the rulemaking process of notice and 

comment), not specifically through rule 

text.247 Similarly, the CFTC is not 

providing in rule text a representative 

list of contracts in nonfinancial 

commodities that are excluded from the 

swap definition as forwards. 

The CFTC believes that its 

interpretation provides sufficient clarity 

with respect to the forward contract 

exclusion from the swap and future 

delivery definitions.248 The CFTC also 

believes that the interpretation provides 

sufficient notice to the public regarding 

how the forward exclusions from the 

swap and future delivery definitions 

will be interpreted. As noted above, the 

CFTC’s historical approach to the 

forward contract exclusion from the 

future delivery definition developed on 

a case-by-case basis, not by rule. 

Commenters generally supported 

applying the Brent Interpretation to the 

forward exclusion from the swap 

definition and expanding it to all 

nonfinancial commodities for purposes 

of the forward exclusion from both the 

definitions of the terms ‘‘future 

delivery’’ and ‘‘swap.’’ 249 However, in 

addition to the requests for clarification 

to which the CFTC has responded in its 

final interpretation provided above, 

commenters raise other requests for 

clarification. One commenter,250 for 

example, believed that the CFTC’s 

adjudicatory decisions in Grain Land 251

and Wright 252 should be construed to 

have expanded the Brent 

Interpretation’s safe harbor. This 

commenter stated its view that in Grain 

Land, the CFTC recognized that 

cancellation provisions or an option to 

roll the delivery date within flexible 

hedge-to-arrive contracts did not render 

the transactions futures contracts, as 

opposed to forwards. As such, this 

commenter believed this case may be at 

odds with the literal terms of the Brent 

Interpretation regarding book-outs, 

which required that, to be a forward 

contract, any cancellation of delivery 

must be effected through a subsequent, 

separately negotiated agreement. The 

commenter argued that cases 

subsequent to the Brent Interpretation, 

such as Grain Land and Wright, 

recognized the need for flexibility and 

innovation in the commercial 

merchandising transactions that are 

eligible for the forward exclusion. 

Therefore, this commenter requested 

that the CFTC consider the body of 

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48232 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

253See CME Letter. 

254As described above in the interpretation, the 

CFTC has addressed CME’s other comments on the 

forward exclusion, including the interpretation’s 

applicability to commercial market participants and 

CME’s hedge fund example. 

255See COPE Letter Appendix. 

256See IECA Letter. 

257See MFA Letter. 

258Ex Parte Communication between MFA and 

CFTC Staff on September 15, 2011, at http:// 

comments.cftc.gov/PublicComments/ViewExParte.

aspx?id=387&SearchText= . 

259See ISDA Letter. 

260See, e.g., In re Bybee, 945 F.2d 309, 315 (9th 

Cir. 1991). 

261See WGCEF Letter. 

262The Commissions requested comment in the 

Proposing Release on whether they should provide 

guidance regarding the scope of the term 

‘‘nonfinancial commodity’’ and, if so, how and 

where the line should be drawn between financial 

and nonfinancial commodities. See Proposing 

Release at 29832. 

263As noted above, the CEA definition of the term 

‘‘swap’’ excludes ‘‘any sale of a nonfinancial 

commodity or security for deferred shipment or 

delivery, so long as the transaction is intended to 

be physically settled.’’ CEA section 1a(47)(B)(ii), 7 

U.S.C. 1a(47)(B)(ii). Thus, the forward exclusion 

from the swap definition is limited to transactions 

in nonfinancial commodities. To the extent the 

CFTC uses the term ‘‘nonfinancial commodity’’ in 

other contexts in this release, such as in connection 

with the Brent Interpretation (including as it 

applies with respect to the ‘‘future delivery’’ 

definition), the term will have the same meaning as 

discussed in this section in those contexts. 

264The CEA defines an ‘‘exempt commodity’’ as 

‘‘a commodity that is not an excluded commodity 

or an agricultural commodity.’’ CEA section 1a(20), 

7 U.S.C. 1a(20). A security is an excluded 

commodity as discussed below, and therefore is not 

an exempt commodity. 

265The CFTC has defined the term ‘‘agricultural 

commodity’’ in its regulations at Rule 1.3(zz) under 

the CEA, 17 CFR 1.3(zz). See Agricultural 

Commodity Definition, 76 FR 41048 (Jul. 13, 2011). 

266The CEA defines an ‘‘excluded commodity’’ at 

CEA section 1a(19), 7 U.S.C. 1a(19). 

forward contract precedent as a whole 

and extend the Brent Interpretation’s 

safe harbor to situations like those 

presented in Grain Land, 

notwithstanding the absence of a 

subsequent, separately-negotiated 

agreement.253

While, as noted above, the CFTC has 

clarified that the entire body of its 

precedent applies to its interpretation of 

the forward exclusion for nonfinancial 

commodities in the swap definition, the 

CFTC does not believe that there is a 

conflict between the Brent 

Interpretation and the Grain Land or 

Wright cases. In Grain Land, the CFTC 

concluded that the fact that a contract 

includes a termination right, standing 

alone, is not determinative of whether 

the contract is a forward. Rather, as the 

CFTC has always interpreted the 

forward exclusion, it looks to the facts 

and circumstances of the transaction. 

Similarly in Wright, which cited Grain 

Land with approval, the CFTC stated 

that ‘‘[i]n assessing the parties’ 

expectations or intent regarding 

delivery, the Commission applies a 

‘facts and circumstances’ test rather 

than a bright-line test focused on the 

contract’s terms * * * .’’ In contrast, the 

Brent Interpretation is a safe harbor that 

assures commercial parties that bookout their contracts through a 

subsequent, separately negotiated 

agreement that their contracts will not 

fall out of the forward exclusion. The 

CFTC’s conclusion that application of 

its facts-and-circumstances approach 

demonstrated that the particular 

contracts at issue in Grain Land and 

Wright were forwards did not expand 

the scope of the safe harbor afforded by 

the Brent Interpretation.254

Several commenters suggested that 

the Energy Exemption should not be 

withdrawn. One commenter noted that 

the Energy Exemption, along with the 

Brent Interpretation, should inform the 

CFTC’s interpretation of the forward 

exclusion.255 Another commenter 

believed that the Energy Exemption 

appears entirely consistent with the 

Dodd-Frank Act and should be included 

in the rules as a non-exclusive 

exemption to ensure continued 

clarity.256 A third commenter requested 

clarification that revoking the Energy 

Exemption will not harm market 

participants, stating that the Proposing 

Release did not sufficiently explain the 

rationale for withdrawing the Energy 

Exemption or the possible consequences 

for energy market participants. This 

commenter sought confirmation that, 

despite the withdrawal of the Energy 

Exemption, market participants will be 

permitted to rely on the Brent 

Interpretation, as expanded by the 

Energy Exemption, particularly as it 

relates to alternative delivery 

procedures.257 This commenter 

expressed concern that by withdrawing 

the Energy Exemption, the CFTC would 

be revoking the ability of market 

participants to rely on pre-transaction 

netting agreements to offset physical 

delivery obligations as an alternative to 

separately negotiating book-outs after 

entering into the transactions.258 As 

discussed above, the CFTC has 

determined to withdraw the Energy 

Exemption as proposed, but has 

provided certain clarifications to 

address commenters’ concerns. 

One commenter suggested the 

deletion of ‘‘commercial merchandising 

transaction’’ as a descriptive term in the 

interpretation. Although recognizing its 

provenance from the Brent 

Interpretation, this commenter believed 

that the phrase was anachronistic at that 

time, and that it is misleading and 

narrow in the current evolving 

commercial environment.259 Contrary to 

this commenter’s suggestion, the CFTC 

has determined to retain the phrase 

‘‘commercial merchandising 

transaction’’ in its final interpretation 

regarding forward contracts. The CFTC 

characterized forward transactions in 

this manner in the Brent Interpretation, 

as well as in its subsequent 

adjudications. Courts also have 

characterized forwards as commercial 

merchandising transactions or cited the 

CFTC’s characterization with 

approval.260 Accordingly, the CFTC 

believes that ‘‘commercial 

merchandising transaction’’ continues 

to be an accurate descriptive term for 

characterizing forward transactions. 

Another commenter requested that 

the CFTC clarify that a subsequent, 

separately-negotiated agreement to 

effectuate a book-out under the Brent 

Interpretation may be oral or written. 

This commenter noted that the pace at 

which certain energy markets transact 

and the frequency with which book-outs 

may sometimes occur, makes formal 

written documentation of all book-outs 

impracticable.261 The CFTC has 

provided an interpretation above 

regarding the documentation of bookouts in response to this commenter’s 

concerns. 

(ii) Nonfinancial Commodities 

In response to commenters,262 the 

CFTC is providing an interpretation 

regarding the scope of the term 

‘‘nonfinancial commodity’’ in the 

forward exclusion from the swap 

definition.263

The CFTC interprets the term 

‘‘nonfinancial commodity’’ to mean a 

commodity that can be physically 

delivered and that is an exempt 

commodity 264 or an agricultural 

commodity.265 Unlike excluded 

commodities, which generally are 

financial,266 exempt and agricultural 

commodities by their nature generally 

are nonfinancial. The requirement that 

the commodity be able to be physically 

delivered is designed to prevent market 

participants from relying on the forward 

exclusion to enter into swaps based on 

indexes of exempt or agricultural 

commodities outside of the Dodd-Frank 

Act and settling them in cash, which 

would be inconsistent with the 

historical limitation of the forward 

exclusion to commercial merchandising 

transactions. However, to the extent that 

a transaction is intended to be 

physically settled, otherwise meets the 

terms of the forward contract exclusion 

and uses an index merely to determine 

the price to be paid for the nonfinancial 

commodity intended to be delivered, 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48233 

267See supra part II.B.2.a)iii), regarding 

environmental commodities. An emission 

allowance buyer also can consume the allowance by 

retiring it without emitting the permitted amount of 

pollutant. 

268See Letter from Steven J. Mickelsen, Counsel, 

3Degrees Group, Inc., dated July 22, 2011 

(‘‘3Degrees Letter’’); ETA Letter; and Letter from 

Kari S. Larsen, General Counsel, Chief Regulatory 

Officer, Green Exchange LLC, dated July 22, 2011 

(‘‘GreenX Letter’’). Each of these commenters 

proposed its own definition of ‘‘nonfinancial 

commodity.’’ The interpretation above incorporates 

many of their suggestions. 

269See ETA Letter. This is consistent with CFTC 

practice in providing an interpretation rather than 

regulations where warranted. In this context, the 

CFTC is providing an interpretation rather than rule 

text because the CFTC is not limiting the definition 

of ‘‘nonfinancial commodity’’ to exempt and 

agricultural commodities (the latter category 

includes agricultural commodity indexes (see 17 

CFR 1.3(zz)(4))). The definition also requires 

physical deliverability and, with respect to 

intangible commodities, ownership transferability 

and consumability. Whether a commodity has these 

features may require interpretation. In any case, 

courts can rely on agency interpretations. 

270See Proposing Release at 29832, Request for 

Comment 32, asked: Should the forward contract 

exclusion from the swap definition apply to 

environmental commodities such as emissions 

allowances, carbon offsets/credits, or renewable 

energy certificates? If so, please describe these 

commodities, and explain how transactions can be 

physically settled where the commodity lacks a 

physical existence (or lacks a physical existence 

other than on paper)? Would application of the 

forward contract exclusion to such environmental 

commodities permit transactions that should be 

subject to the swap regulatory regime to fall outside 

the Dodd-Frank Act? 

271Because the CFTC has determined, as 

discussed elsewhere in this release, to interpret the 

forward exclusion from the swap definition 

consistently with the forward exclusion from the 

‘‘future delivery’’ definition, the discussion in this 

section applies equally to the forward exclusion 

from future delivery. 

272See also Letter from Gene Grace, Senior 

Counsel, American Wind Energy Association 

(‘‘AWEA’’), dated July 22, 2011 (‘‘AWEA Letter’’) 

(providing a general description of renewable 

energy credits (‘‘RECs’’), emission allowances, and 

offsets, which the commenter collectively termed 

‘‘environmental commodities’’ for purposes of its 

letter). 

273Thus, market participants should apply the 

interpretation to their facts to determine whether 

their specific circumstances support reliance on the 

forward exclusion from the swap definition. 

274Several commenters appear to have confused 

these concepts. The term ‘‘commodity’’ is defined 

in CEA section 1a(9), 7 U.S.C. 1a(9). The forward 

exclusion in CEA section 1a(47)(B)(ii), 7 U.S.C. 

1a(47)(B)(ii), excludes from the swap definition 

‘‘any sale of a nonfinancial commodity or security 

for deferred shipment or delivery, so long as the 

transaction is intended to be physically settled.’’ 

275See supra part II.B.2.a)i)(A). 

276 7 U.S.C. 1a(47)(B)(ii). 

277As commenters also note, each Commission or 

its staff has previously indicated that environmental 

commodities, in the CFTC’s case, and securities, in 

the SEC’s case, can be physically settled. See Letter 

from Kyle Danish, Van Ness Feldman, P.C., on 

behalf of Coalition for Emission Reduction Policy 

(‘‘CERP’’), dated July 18, 2011 (‘‘CERP Letter’’) and 

3Degrees Letter. Also, the recent Carbon Report 

suggested that the forward exclusion could apply to 

agreements, contracts or transactions in 

environmental commodities. See Interagency 

Working Group for the Study on Oversight of 

Carbon Markets (‘‘Interagency Working Group’’), 

Report on the Oversight of Existing and Prospective 

Carbon Markets (January 2011) (‘‘Carbon Report’’). 

The Carbon Report specifically stated that—[n]o set 

of laws currently exist that apply a comprehensive 

regulatory regime—such as that which exists for 

derivatives—specifically to secondary market 

trading of carbon allowances and offsets. Thus, for 

the most part, absent specific action by Congress, 

a secondary market for carbon allowances and 

offsets may operate outside the routine oversight of 

any market regulator. 

278One commenter maintains that a transaction 

in an environmental allowance represents a 

physically-settled transaction because its primary 

purpose is to transfer ownership of the right to emit 

a specified unit of pollution. See Letter from 

Andrew K. Soto, American Gas Association 

(‘‘AGA’’), dated July 22, 2011 (‘‘AGA Letter’’). 

Compare to Proposing Release at 29828 (stating that 

‘‘[t]he primary purpose of the contract is to transfer 

ownership of the commodity’’). 

279Another commenter states that, from a 

practical standpoint, the buyer must take delivery 

to satisfy a compliance obligation, which typically 

requires surrender of allowances and offset credits, 

and likens such transactions to forward sales of 

more tangible commodities, noting they are not 

devices for transferring price risk. See CERP Letter. 

Continued 

the transaction may qualify for the 

forward exclusion from the swap 

definition. 

In addition, the CFTC is providing an 

interpretation that an intangible 

commodity (that is not an excluded 

commodity) which can be physically 

delivered qualifies as a nonfinancial 

commodity if ownership of the 

commodity can be conveyed in some 

manner and the commodity can be 

consumed. One example of an 

intangible nonfinancial commodity that 

qualifies under this interpretation, as 

discussed in greater detail below, is an 

environmental commodity, such as an 

emission allowance, that can be 

physically delivered and consumed 

(e.g., by emitting the amount of 

pollutant specified in the allowance).267

The interpretation provided herein 

recognizes that transactions in 

intangible commodities can, in 

appropriate circumstances, qualify as 

forwards, while setting forth certain 

conditions to assure that the forward 

exclusion may not be abused with 

respect to intangible commodities. 

Comments 

Several commenters believed that the 

CFTC should provide an interpretation 

regarding the meaning of the term 

‘‘nonfinancial commodity’’ to provide 

clarity to market participants on the 

applicability of the forward 

exclusion.268 The CFTC is providing the 

interpretation discussed above to 

address these commenters’ concerns 

but, contrary to one commenter’s 

request, declines to adopt a 

regulation.269

(iii) Environmental Commodities 

The Commissions requested comment 

on whether environmental commodities 

should fall within the forward exclusion 

from the swap definition and, if so, 

subject to what parameters.270 In 

response to commenters, the CFTC is 

providing an interpretation regarding 

the circumstances under which 

agreements, contracts or transactions in 

environmental commodities will satisfy 

the forward exclusion from the swap 

definition.271 The CFTC did not propose 

a definition of the term ‘‘environmental 

commodity’’ in the Proposing Release 

and is not doing so in this release.272

The CFTC believes it is not necessary to 

define the term ‘‘environmental 

commodity’’ because any intangible 

commodity—environmental or 

otherwise—that satisfies the terms of the 

interpretation provided herein is a 

nonfinancial commodity, and thus an 

agreement, contract or transaction in 

such a commodity is eligible for the 

forward exclusion from the swap 

definition.273 The forward exclusion 

from the swap definition does not apply 

to commodities themselves, but to 

certain types of agreements, contracts or 

transactions in a specified type of 

commodity (i.e., a ‘‘nonfinancial’’ 

commodity).274 Environmental 

commodities that meet the 

interpretation regarding nonfinancial 

commodities discussed in subsection 

(ii) above are nonfinancial commodities 

and, therefore, a sale for deferred 

shipment or delivery in such a 

commodity, so long as the transaction is 

intended to be physically settled, may 

qualify for the forward exclusion from 

the swap definition. 

The intangible nature of 

environmental, or other, commodities 

does not disqualify contracts based on 

such commodities from the forward 

exclusion from the swap definition, 

notwithstanding that the core of the 

forward exclusion is intent to deliver 

the underlying commodity.275 As 

commenters noted, securities are 

intangible (with the exception of the 

rare certificated security) and yet they 

are expressly permitted by CEA section 

1a(47)(B)(ii) 276 to be the subject of the 

forward exclusion; this reflects 

recognition by Congress that the forward 

exclusion can apply to intangible 

commodities.277

The CFTC understands that market 

participants often engage in 

environmental commodity transactions 

in order to transfer ownership 278 of the 

environmental commodity (and not 

solely price risk),279 so that the buyer 

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Compare to Proposing Release at 29828 (stating that 

‘‘[t]he primary purpose of the contract is * * * not 

to transfer solely * * * price risk’’). This 

commenter also advises that delivery of RECs and 

offsets is typically deferred for commercial 

convenience, consistent with the Brent 

Interpretation, because ‘‘not all of the purchased 

RECs and offsets are generated at the time of the 

transaction’’ and ‘‘long-term contracts with deferred 

delivery are important for renewable energy 

projects to ensure a consistent revenue stream over 

a long period of time.’’ See CERP Letter. 

280Consumption also can be part of a commercial 

merchandising transaction in the chain of 

commerce. See, e.g., Brent Interpretation, supra 

note 207 (dissent of Commissioner Fowler West) 

(citing the 1985 CFTC OGC Interpretation and cases 

cited therein for the proposition that ‘‘parties to 

forward contracts * * * seek to profit in their 

businesses from producing, processing, distributing, 

storing, or consuming the commodity’’). 

281Similarly, the settlement method for the types 

of environmental commodity transactions described 

by commenters such as RECs, emission allowances, 

and offsets are equivalent to that of physical 

commodities where ownership is transferred by 

delivering a warehouse receipt from the seller to the 

buyer, thereby indicating the presence in the 

warehouse of the contracted for commodity volume. 

See GreenXLetter. See also REMA letter (averring 

that ‘‘[i]n effect, the REC is an intangible contract 

right or interest in that specific quantity of energy; 

thus, it is quite analogous to a warehouse receipt 

that represents title to a physical commodity’’). 

Another similarity between these environmental 

commodity transactions and tangible commodities 

is that it is possible to manipulate the deliverable 

supply of an environmental commodity just as it is 

for a tangible commodity. The CFTC reminds 

market participants of its continuing authority over 

forwards under the CEA’s anti-manipulation 

provisions prohibiting manipulation, making false 

and misleading statements and omissions of 

material fact to the CFTC, fraud and deceptive 

practices, and false reporting. See supra note 226. 

282See Letter from Jennifer Martin, Executive 

Director, Center for Research Solutions (‘‘CRS’’), 

dated July 22, 2011 (‘‘CRS Letter’’). 

283See 3Degrees Letter. 

284See GreenX Letter. 

285One commenter provided a general 

description of renewable energy credits (‘‘RECs’’), 

emission allowances, offsets, (which the commenter 

collectively termed ‘‘environmental commodities’’ 

for purposes of its letter), and related transactions. 

See AWEA Letter. According to the commenter, 

RECs are created by state regulatory bodies in 

conjunction with the production of electricity from 

a qualifying renewable energy facility. The forward 

sale of a REC transfers ownership of the REC from 

the producing entity to another entity that can use 

the REC for compliance with an obligation to sell 

a certain percentage of renewable energy. Many 

times, this forward sale takes place prior to the 

construction of a project to enable developers to 

secure related project financing. See AWEA Letter. 

See also Letter from Mary Anne Mason, 

HoganLovells LLP on behalf of Southern California 

Edison Company, Pacific Gas and Electric Company 

and San Diego Gas and Electric Company 

(‘‘California Utilities’’), dated July 22, 2011 

(‘‘California Utilities Letter’’) (stating that the 

California Utilities transact in allowances, under 

the EPA’s and anticipated California cap-and-trade 

programs, as well as in RECs, in order to comply 

with or participate in various regulatory and 

voluntary programs). 

The CFTC understands that, in the United States, 

emission allowances and offsets are issued by the 

U.S. Environmental Protection Agency (‘‘EPA’’), 

state government entities and private entities. 

Emission allowances and offsets are transferred 

between counterparties, often through forward 

contracts, with the purchasing party obtaining the 

ability to use the allowances or offsets for 

compliance with clean air or greenhouse gas 

regulations. The forward sale of allowances and 

offsets allows market participants to hedge the 

compliance obligations associated with expected 

emissions, or to meet a voluntary emissions 

reduction commitment or make an environmental 

claim. See, e.g., AWEA Letter; Letter from Henry 

Derwent, President and CEO, International 

Emissions Trading Association, dated July 22, 2011 

(defining a carbon offset as a ‘‘credit[] granted by 

a state or regional governmental body or an 

independent standards organization in an amount 

equal to the generation of electricity from a 

qualifying renewable energy facility.’’). 

286See 3Degrees Letter. See also WGCEF Letter 

(advising that ‘‘physical delivery takes place the 

moment that title and ownership in the 

environmental commodity itself is transferred from 

the seller to the buyer[,] whether through the 

execution of a legally binding contract or 

attestation, or submission of records to a centralized 

data base, such as a registry’’); Letter from the Hons. 

Jeffrey A. Merkley, Sherrod Brown and Jeanne 

Shaheen, U.S. Senators, dated January 13, 2012 

(‘‘Senators Letter’’) (relaying that ‘‘[t]he purchase or 

sale of a REC is settled through the transfer of title 

to the REC, either electronically over a tracking 

system or via a paper attestation’’); Letter from 

Harold Buchanan, Chief Executive Officer, CE2 

Carbon Capital, LLC (‘‘CE2’’), dated July 22, 2011 

(‘‘CE2 Letter’’); Letter from Jason M. Rosenstock, ML 

Strategies LLC on behalf of The Business Council 

for Sustainable Energy (‘‘BCSE’’), dated January 24, 

2012 (‘‘BCSE Letter’’); NEMA Letter (stating that 

RECs must be physically settled through a REC 

registry, which ‘‘ensures that there is a physical 

megawatt hour from a green generator behind the 

REC’’). 

287See 3Degrees Letter. See also GreenX Letter 

(stating that environmental commodities share the 

same characteristics as tangible physical 

commodities ‘‘in all key respects,’’ including that 

they are in limited supply). 

288See CRS Letter. CRS explains that retirement 

occurs through a registry or electronic tracking 

system by transfer into a retirement account (or, 

alternatively, an exchange of paperwork) and that, 

once retired, an environmental commodity cannot 

be resold. The CRS also argues that such 

environmental commodity transactions are 

commercial merchandising transactions, and thus 

may be forward contracts, because the primary 

purpose of the transactions is to transfer ownership 

so that the purchaser may comply with an 

applicable environmental program. See also 

3Degrees Letter and AWEA Letter. 

289See Letter from Josh Lieberman, General 

Manager, Renewable Energy Markets Association 

(‘‘REMA’’), dated July 22, 2011 (‘‘REMA Letter’’) 

(distinguishing RECs, which allow the buyer to own 

environmental attributes, from a pure financial 

swap, where only price risk is transferred); See also 

GreenX Letter (likening the settlement of an 

environmental commodity transaction (where 

delivery typically would take place by electronic 

delivery from the registry account of the seller to 

the registry account of the buyer) to that of 

transactions in many tangible physical 

commodities, such as agricultural commodities and 

metals, where settlement is evidenced by an 

can consume the commodity in order to 

comply with the terms of mandatory or 

voluntary environmental programs.280

Those two features—ownership transfer 

and consumption—distinguish such 

environmental commodity transactions 

from other types of intangible 

commodity transactions that cannot be 

delivered, such as temperatures and 

interest rates. The ownership transfer 

and consumption features render such 

environmental commodity transactions 

similar to tangible commodity 

transactions that clearly can be 

delivered, such as wheat and gold.281

For such transactions, in addition to 

the factors discussed above, intent to 

deliver is readily determinable,282

delivery failures generally result from 

frustration of the parties’ intentions,283

and cash-settlement is insufficient 

because delivery of the commodity is 

necessary for compliance purposes.284

For the foregoing reasons, 

environmental commodities can be 

nonfinancial commodities that can be 

delivered through electronic settlement 

or contractual attestation. Therefore, an 

agreement, contract or transaction in an 

environmental commodity may qualify 

for the forward exclusion from the swap 

definition if the transaction is intended 

to be physically settled. 

Comments 

Several commenters responded to the 

Commission’s request for comment 

regarding the applicability of the 

forward exclusion from the swap 

definition for agreements, contracts and 

transactions in environmental 

commodities.285

Most commenters responding to the 

Commissions’ request for comment 

concerning the appropriate treatment of 

agreements, contracts or transactions in 

environmental commodities asserted 

that emission allowances, carbon 

offsets/credits, or RECs should be able 

to qualify for the forward exclusion 

from the swap definition. In support of 

this view, several commenters 

explained that the settlement process for 

environmental commodity transactions 

generally involves ‘‘the transfer of title 

via a tracking system, registry or 

contractual attestation, in exchange for 

a cash payment.’’ 286 One commenter 

stated that this form of settlement 

demonstrates that the lack of physical 

existence of a commodity is not relevant 

to whether a transaction in the 

commodity physically settles for 

purposes of the forward exclusion.287

Another commenter contended that title 

transfer constitutes physical delivery 

because the settlement results in the 

environmental commodity being 

consumed to meet an environmental 

obligation or goal, which occurs through 

‘‘retirement’’ of the environmental 

commodity.288 Other commenters 

compared the settlement of a transaction 

in an environmental commodity 

through an electronic registry system to 

a warehouse receipt that represents title 

to a physical commodity.289

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electronic transfer of a warehouse receipt in the 

records of the warehouse and the underlying 

commodity does not move—it remains in the 

warehouse or vault—but its ownership changes)). 

290See CRS Letter. See also CERP Letter (claiming 

that Congress did not intend for the phrase 

‘‘physically settled’’ in the forward exclusion to be 

limited to tangible commodities because, like 

environmental commodities, securities only exist 

‘‘on paper.’’). See also AWEA Letter. 

291See CRS Letter (‘‘unlike a stock or a bond, 

which can be resold for its cash value, purchasers 

of environmental commodities intend to take 

delivery of RECs or carbon offsets for either 

compliance purposes or in order to make an 

environmental claim regarding their renewable 

energy use or carbon footprint.’’). See also GreenX 

Letter. 

292Such a provision would preclude reliance on 

the forward exclusion. 

293See 3Degrees Letter. 

294See Adaptation of Regulations to Incorporate 

Swaps, 76 FR 33066, June 7, 2011. 

295See California Utilities Letter. 

296See Letter from Michelle Chan, Director, 

Economic Policy Programs, Friends of the Earth, 

dated July 22, 2011. 297While the commenter contended that ‘‘the 

intangible nature of carbon makes it much easier for 

speculators or those simply seeking to hedge carbon 

price risk to take delivery of the carbon itself rather 

than enter into a derivatives transaction,’’ as the 

CFTC states in section VII.A.2.c), infra, deciding to 

enter into a forward transaction rather than a swap 

does not constitute evasion. Thus, if the transaction 

in question is a forward contract, that is the end of 

the analysis, absent the presence of other factors 

that may indicate evasion. See AWEA Letter. 

298See Letter from Katherine Gensler, Director, 

Regulatory Affairs, SEIA, dated August 5, 2011 

(‘‘SEIA Letter’’). 

299See Proposing Release at 29832 n.104. 

300However, in section II.B.3., infra, the 

Commissions provide an interpretation regarding 

the applicability of the swap definition to consumer 

transactions. 

301See Letter from Lauren Newberry, Jeffrey C. 

Fort, Jeremy D. Weinstein, and Christopher B. 

Berendt, Environmental Markets Association, dated 

July 21, 2011. 

302See AGA Letter. 

303 Id. This commenter noted that gas utilities 

often can receive gas at more than one 

interconnection or delivery point on a pipeline. 

304 Id. 

305 Id. 

A few commenters also analogized 

environmental commodities to 

securities, which (with the exception of 

certificated securities) are intangible. 

Some commenters, for example, 

asserted that the language of the forward 

exclusion from the swap definition 

means that non-physical items can be 

physically settled because the 

exclusion, which references securities, 

‘‘implies that securities—which lack a 

strict physical existence—may be 

physically settled.’’ 290

Some commenters assured the 

Commissions that applying the forward 

exclusion to transactions in 

environmental commodities would not 

permit transactions that should be 

subject to the swap regulatory regime to 

fall outside it. One commenter 

submitted that intent to deliver with 

respect to environmental commodities 

will be readily determinable.291 Another 

commenter contended that: 

environmental commodity contracts 

almost universally require delivery and 

that failure to do so is an event of 

default; to the best of its knowledge, it 

is rare for such a contract to include the 

right to unilaterally terminate an 

agreement under a pre-arranged 

contractual provision permitting 

financial settlement; 292 and defaults 

generally are the result of something 

frustrating parties’ intentions.293 Still 

other commenters distinguished 

environmental commodities from other 

intangible commodities, such as the 

nonfinancial commodities (such as 

interest rates and temperatures) that the 

CFTC referred to in its Adaptation 

Notice of Proposed Rulemaking,294

because RECs and emissions allowances 

or offsets can be physically transferred 

from one account to another, whereas 

‘‘it is not possible to move and 

physically transfer an interest rate or a 

temperature reading.’’ 295

As discussed above, the CFTC has 

addressed the foregoing concerns of 

commenters by providing an 

interpretation that agreements, contracts 

and transactions in environmental 

commodities may qualify for the 

forward exclusion from the swap 

definition. 

One commenter stated its view that 

the forward exclusion from the swap 

definition should not be available for 

carbon transactions because they should 

be standardized and conducted on open, 

transparent and regulated exchanges.296

This commenter acknowledged the 

possibility that carbon transactions can 

be physically settled (as the statute 

requires of excluded forward contracts) 

but argued that, in light of the fact that 

there is no cost associated with making 

or taking delivery of carbon, there is no 

cost to store it, and there is no delay in 

delivering it, a forward exclusion for 

carbon transactions may allow financial 

speculators to escape regulation 

otherwise required by the Dodd-Frank 

Act. The CFTC believes that if a 

transaction satisfies the terms of the 

statutory exclusion, the CFTC lacks the 

authority to deprive the transaction of 

the exclusion, absent evasion.297

One commenter stated that ‘‘[i]n the 

solar industry, RECs are often traded by 

an individual consumer as an 

assignment of a right owned by that 

consumer.’’ 298 This commenter also 

advised that many individual 

consumers transact forward contracts 

through solar REC (‘‘SREC’’) aggregators 

at a fixed price. The CFTC notes 299 that 

a transaction entered into by a consumer 

cannot be a forward transaction, and 

accordingly should not be the subject of 

an interpretation of the forward 

exclusion.300

One commenter takes the position 

that, because EPA emission allowances 

are issued in transactions with the EPA, 

only resales of such allowances 

(secondary market transactions) could 

be swaps because the EPA’s initial 

issuance of allowances would be 

excluded from the swap definition 

under CEA section 1a(47)(B)(ix).301 The 

CFTC declines to address the 

commenter’s legal conclusion regarding 

the application of CEA section 

1a(47)(B)(ix), but agrees that an 

emission allowance created by the EPA 

is a nonfinancial commodity and that 

agreements, contracts and transactions 

in such allowances may fall within the 

forward exclusion from the swap 

definition. 

(iv) Physical Exchange Transactions 

The Commissions received a 

comment letter seeking clarification that 

physical exchange transactions are 

forward contracts excluded from the 

swap definition.302 As described by the 

commenter, physical exchange 

transactions involve ‘‘a gas utility 

entering into a transaction with another 

gas utility or other market participant to 

take delivery of natural gas at one 

delivery point in exchange for the same 

quantity of gas to be delivered at an 

alternative delivery point * * * for the 

primary purpose of transferring 

ownership of the physical commodity in 

order to rationalize the delivery of 

physical supplies to where they are 

needed’’ at a price ‘‘generally reflecting 

the difference in value at the delivery 

points.’’ 303 This commenter stated that 

‘‘exchange transactions create binding 

obligations on each party to make and 

take delivery of physical commodities 

[, i]n essence constituting paired 

forward contracts that are intended to go 

to physical delivery.’’ 304 The 

commenter added that, to the extent an 

exchange transaction payment is based 

on an index price, such pricing is not 

severable from the physical 

exchange.305

The CFTC interprets the exchange 

transactions described by the 

commenter, to the extent they are for 

deferred delivery, as examples of 

transactions in nonfinancial 

commodities that are within the forward 

exclusion from the definition of the 

terms ‘‘swap’’ and ‘‘future delivery.’’ 

Based on the information supplied by 

the commenter, they are commercial 

merchandising transactions, the primary 

purpose of which is to transfer 

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306However, if such payment stems from an 

embedded option, the interpretation set forth in the 

embedded option section of this release, see infra 

part II.B.2(b)(v), also would be relevant to 

determining whether an exchange transaction were 

covered by the forward exclusion from the swap 

definition. 

307While the commenter also states that ‘‘[g]as 

utilities contract with interstate pipelines for 

capacity rights to have their gas supplies delivered 

to specific delivery points,’’ its discussion of 

exchange transactions appears unrelated to such 

capacity rights. Therefore, the CFTC’s guidance on 

exchange transactions does not address exchange 

transactions with capacity elements, which, 

depending on their structures, may be covered by 

the guidance set forth in the embedded option 

section of this release or by the CFTC’s recent 

Commodity Options release. See infra note 317. 

Conversely, that parties to an exchange transaction 

separately enter into a capacity transaction with a 

pipeline operator to transport natural gas delivered 

via an exchange transaction is not relevant to 

today’s guidance regarding exchange transactions. 

308This interpretation is limited to the facts and 

circumstances described herein; the CFTC is not 

opining on different facts or circumstances, which 

could change the CFTC’s interpretation. 

309See Proposing Release at 29831–29832, 

Request for Comment 30. 

310See Letter from Peter Krenkel, President and 

CEO, NGX, dated Nov. 4, 2010, resubmitted by 

email to CFTC staff on Sept. 14, 2011 (‘‘NGX 

Letter’’). One other commenter addressed a related 

issue, asserting that the Commissions should clarify 

that cleared forwards between commercial 

participants should be permitted under the forward 

contract exclusion. See Ex Parte Communication 

among Evolution Markets Inc. (‘‘Evolution’’), Ogilvy 

Government Relations (‘‘Ogilvy’’) and CFTC staff on 

May 18, 2011 at http://comments.cftc.gov/Public

Comments/ViewExParte.aspx?id=197&

SearchText=. 

311 Id. 

312As used in this release, the term ‘‘commodity 

option’’ refers to an option that is subject to the 

CEA. 

313See Proposing Release at 29829–30. 

314 17 CFR Parts 32 and 33. 

315See Commodity Options and Agricultural 

Swaps, 76 FR 6095 (Feb. 3, 2011) (proposed). 

316 7 U.S.C. 6c(b). 

ownership of natural gas between two 

parties who intend to physically settle 

such transactions. That exchange 

transactions may involve, in addition to 

gas deliveries at two separate delivery 

points, a cash payment by one party to 

the other reflecting the difference in 

value of the gas at different delivery 

points, or that such payment may be 

based on an index, does not necessarily 

affect the nature of the transactions as 

forward transactions.306 For an 

exchange transaction to fall within the 

forward exclusion, though, the parties to 

the transaction must intend for the 

transaction to be physically settled, and 

the exchange transaction must satisfy all 

applicable interpretations set forth 

herein, including that relating to bookouts.307

(v) Fuel Delivery Agreements 

The CFTC understands that fuel 

delivery agreements can generally be 

described as agreements whereby two or 

more parties agree to divide the cost of 

acquiring fuel for generation facilities 

based on some formula or factors, which 

can include, for example, their 

respective financial contributions to 

developing the source of the fuel (e.g., 

a natural gas field). One example of a 

fuel delivery agreement could involve a 

joint power agency providing to a 

municipal utility a long-term supply of 

natural gas from a natural gas project 

developed by the joint power agency 

and other entities to provide fuel for, 

among others, the joint power agency’s 

and the municipal utility’s natural gasfired electric generating facilities. The 

municipal utility would pay the joint 

power agency through direct capital 

contributions to the entity formed to 

develop the natural gas project for the 

cost of developing it. In addition, the 

municipal utility would pay the joint 

power agency a monthly fee for the 

natural gas supplied from the natural 

gas project. The monthly fee would be 

composed of an operating cost fee 

component, an interstate pipeline 

transportation cost fee component and 

an operating reserve cost fee 

component. The municipal utility’s 

natural gas-fired electric generating 

facility would be used to supply a 

portion of its expected retail electric 

load. 

Such agreements are forward 

transactions if they otherwise meet the 

interpretation set forth in this release 

regarding the forward exclusions (e.g., 

no optionality other than as permitted 

by the interpretation). Monthly or other 

fees that are not in the nature of option 

premiums do not convert the 

transactions from forwards to options. 

Because the transactions as described 

above do not appear to exhibit 

optionality as to delivery, and no other 

aspect of the transactions as described 

above seem to exhibit optionality, the 

fees would not seem to resemble option 

premiums.308

(vi) Cleared/Exchange-Traded Forwards 

In the Proposing Release, the 

Commissions requested comment 

regarding whether forwards executed on 

trading platforms should fall within the 

forward exclusion from the swap 

definition and, if so, subject to what 

parameters.309 One commenter 

requested that the CFTC adopt a nonexclusive safe harbor providing that 

exchange-traded contracts with respect 

to which more than 50 percent of 

contracts, on average on a rolling threemonth basis, go to delivery and where 

100 percent of the counterparties are 

commercial counterparties, are neither 

futures nor swaps (‘‘50/100 Forward 

Safe Harbor’’).310 This commenter 

further requested that the CFTC provide 

an appropriate transition period once 

those thresholds are breached. This 

commenter contended that two 

hallmarks of the exchange-traded 

forward markets, which it characterized 

as ‘‘a relatively new development,’’ are 

that the participants generally are 

commercials and a high percentage of 

contracts go to delivery, 

notwithstanding netting of delivery 

obligations.311 This commenter added 

that, while parties to such contracts 

intend to go to delivery when they enter 

into them, their delivery needs may 

change as time passes. 

The CFTC declines to address this 

request for the 50/100 Forward Safe 

Harbor, which raises policy issues that 

are beyond the scope of this rulemaking. 

Should the CFTC consider the 

implications of the requested 50/100 

Forward Safe Harbor, including possible 

additional conditions for relief, it would 

be appropriate for the CFTC to obtain 

further comment from the public on this 

discrete proposal. For the same reasons, 

the CFTC declines to address at this 

time the comment requesting that the 

CFTC take the view that cleared 

forwards between commercial 

participants fall within the scope of the 

forward contract exclusion. 

(b) Commodity Options and Commodity 

Options Embedded in Forward 

Contracts 

(i) Commodity Options 312

The CFTC noted in the Proposing 

Release 313 that the statutory swap 

definition explicitly provides that 

commodity options are swaps, that it 

had proposed revisions to its existing 

options rules in parts 32 and 33 of its 

regulations 314 with respect to the 

treatment of commodity options under 

the Dodd-Frank Act, and that it had 

requested comment on those proposed 

revisions in that rulemaking 

proceeding.315 Accordingly, the CFTC 

did not propose an additional 

interpretation in the Proposing Release 

with respect to commodity options. 

The CFTC reaffirms that commodity 

options are swaps under the statutory 

swap definition, and is not providing an 

additional interpretation regarding 

commodity options in this release. The 

CFTC recently addressed commodity 

options in the context of a separate final 

rulemaking and interim final 

rulemaking, under its plenary options 

authority in CEA section 4c(b).316 There, 

the CFTC adopted a modified trade 

option exemption, and has invited 

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317See Commodity Options, 77 FR 25320 (Apr. 

27, 2012). 

318See Letter from Brian Knapp, Policy Advisor, 

American Petroleum Institute (‘‘API’’), dated 

January 31, 2012 (‘‘API Letter’’); BGA Letter; COPE 

Letter; ETA Letter; Just Energy Letter; NGSA/NCGA 

Letter; and WGCEF Letter. 

319For example, one commenter asserted that, 

similar to a forward contract on a nonfinancial 

commodity, a commodity option conveys no ability 

for a party to unilaterally require a financial 

settlement. Reasoning that both commodity options 

and forward contracts on nonfinancial commodities 

are intended to settle by physical delivery, this 

commenter contended that they should have the 

same regulatory treatment. See COPE Letter. 

Similarly, another commenter argued that the 

forward exclusion ‘‘plainly covers’’ commodity 

options because they are: (i) Contracts for the sale 

of physical, nonfinancial commodities, (ii) for 

deferred delivery, and (iii) intended to be 

physically settled, given that purchasers have an 

absolute right to physical delivery and sellers have 

an absolute obligation to physically deliver the 

amounts called for by the purchasers if the option 

is exercised. See NGSA/NCGA Letter. A third 

commenter recommended that the CFTC interpret 

the forward exclusion ‘‘broadly’’ to include options 

that, if exercised, become forwards in nonfinancial 

commodities in light of the particular 

circumstances of the electricity industry, where 

electric companies use commodity options to 

efficiently meet the demands of electric customers 

by hedging or mitigating commercial risks due to 

seasonal and geographically unique weather and 

load patterns and fluctuations. See ETA letter. In 

the alternative, a fourth commenter requested that 

the CFTC exercise its plenary options authority 

under CEA section 4c(b), 7 U.S.C. 6c(b), to establish 

a separate regulatory regime for commodity options 

analogous to the trade option exemption under 

former CFTC Rule 32.4. See WGCEF Letter. See 17 

CFR 32.4 (2011). 

320See CEA section 1a(47)(A)(i), 7 U.S.C. 

1a(47)(A)(i) (defining a swap as, among other 

things, ‘‘a put, call * * * or option of any kind 

* * * for the purchase or sale * * * of * * * 

commodities’’) and CEA section 1a(47)(B), 7 U.S.C. 

1a(47)(B) (not excluding commodity options from 

the swap definition). 

321See 1985 CFTC OGC Interpretation, supra note 

245. In this regard, an option cannot be a forward 

under the CFTC’s precedent, because under the 

terms of the contract the optionee has the right, but 

not the obligation, to make or take delivery, while 

under a forward contract, both parties must have 

binding delivery obligations: one to make delivery 

and the other to take delivery. 

322See supra part II.B.2(a)(i)(A). 

323See supra note 317. 

324See Proposing Release at 29830. 

325See 1985 CFTC OGC Interpretation, supra note 

245. 

326Wright, supra note 214. 

327See Proposing Release at 29830. 

328Wright, supra note 214, at n.5. In Wright, the 

CFTC affirmed the Administrative Law Judge’s 

holding that an option embedded in a hedge-toarrive contract did not violate CFTC rules regarding 

the sale of agricultural trade options. The CFTC first 

concluded that the puts at issue operated to adjust 

the forward price and did not render the farmer’s 

overall obligation to make delivery optional. Then, 

turning to the next step of the analysis, the CFTC 

explained that ‘‘the put and [hedge-to-arrive 

contract] operated as a single contract, and in most 

cases were issued simultaneously * * *. We do not 

find that any put was severed from its forward or 

that either of [the put or the hedge-to-arrive 

contract] was traded separately from the other. We 

hold that in these circumstances, no freestanding 

option came into being * * *.’’ Id. at *7. 

329See Proposing Release at 29830. 

330Options in the plural would include, for 

example, a situation in which the embedded 

optionality involves option combinations, such as 

costless collars, that operate on the price term of the 

agreement, contract, or transaction. 

331For example, a forward with an embedded 

option with a formulaic strike price based on an 

index value that may not be known until after 

exercise would be a forward if it meets the rest of 

the 3 components of this interpretation. Triggering 

an option to buy or sell one commodity based on 

the price of a different commodity reaching a 

specified level, such as in a cross-commodity 

transaction, does not constitute an adjustment to 

the forward contract price within the meaning of 

this 3-part interpretation. 

332See Wright, supra note 214, at **6–7. 

333This facts and circumstances approach to 

determining whether a particular embedded option 

Continued 

public comment on the interim final 

rules.317

Comments 

Several commenters in response to 

the Proposing Release argued that 

commodity options should not be 

regulated as swaps.318 In general, these 

commenters believed that commodity 

options should qualify for the forward 

exclusion from the swap definition, 

emphasizing similarities between 

commodity options and forward 

contracts on nonfinancial 

commodities.319

The CFTC is not providing an 

interpretation that commodity options 

qualify as forward contracts in 

nonfinancial commodities. Such an 

approach would be contrary to the plain 

language of the statutory swap 

definition, which explicitly provides 

that commodity options are swaps.320

This approach also would be a 

departure from the CFTC’s and its staff’s 

longstanding interpretation of the 

forward exclusion with respect to the 

term ‘‘future delivery,’’ 321 which the 

CFTC has determined above to apply to 

the forward exclusion from the swap 

definition as well.322 Further, the CFTC 

notes that it has recently issued final 

and interim final rules adopting a 

modified version of the CFTC’s existing 

trade option exemption.323

(ii) Commodity Options Embedded in 

Forward Contracts 

The CFTC is restating the 

interpretation regarding forwards with 

embedded options from the Proposing 

Release, but with certain modifications 

based on comments received. The CFTC 

is providing additional interpretations 

regarding forwards with embedded 

volumetric optionality, optionality in 

the form of evergreen and renewal 

provisions, and optionality with respect 

to delivery points and delivery dates. 

As was noted in the Proposing 

Release, the question of the application 

of the forward exclusion from the swap 

definition with respect to nonfinancial 

commodities, where commodity options 

are embedded in forward contracts 

(including embedded options to cash 

settle such contracts), is similar to that 

arising under the CEA’s existing forward 

contract exclusion from the definition of 

the term ‘‘future delivery.’’ 324 The 

CFTC’s Office of General Counsel 

addressed forward contracts that 

contained embedded options in the 

1985 CFTC OGC Interpretation,325

which recently was adhered to by the 

CFTC in its adjudicatory Order in the 

Wright case.326 While both were issued 

prior to the effective date of the DoddFrank Act, the CFTC believes that, as 

was stated in the Proposing Release, it 

is appropriate to apply this 

interpretation to the treatment of 

forward contracts in nonfinancial 

commodities that contain embedded 

options under the Dodd-Frank Act.327

In Wright, the CFTC stated that it 

traditionally has engaged in a two-step 

analysis of ‘‘embedded options’’ in 

which the first step focuses on whether 

the option operates on the price or the 

delivery term of the forward contract 

and the second step focuses on 

secondary trading.328 As was stated in 

the Proposing Release, these same 

principles can be applied with respect 

to the forward contract exclusion from 

the swap definition for nonfinancial 

commodities in the Dodd-Frank Act, 

too.329 Utilizing these principles, the 

CFTC is providing a final interpretation 

that a forward contract that contains an 

embedded commodity option or 

options 330 will be considered an 

excluded nonfinancial commodity 

forward contract (and not a swap) if the 

embedded option(s): 

1. May be used to adjust the forward 

contract price,331 but do not undermine 

the overall nature of the contract as a 

forward contract; 

2. Do not target the delivery term, so 

that the predominant feature of the 

contract is actual delivery; and 

3. Cannot be severed and marketed 

separately from the overall forward 

contract in which they are embedded.332

In evaluating whether an agreement, 

contract, or transaction qualifies for the 

forward contract exclusions from the 

swap definition for nonfinancial 

commodities, the CFTC will look to the 

specific facts and circumstances of the 

transaction as a whole to evaluate 

whether any embedded optionality 

operates on the price or delivery term of 

the contract, and whether an embedded 

commodity option is marketed or traded 

separately from the underlying 

contract.333 Such an approach will help 

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48238 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

takes a transaction out of the forward contract 

exclusion for nonfinancial commodities is 

consistent with the CFTC’s historical approach to 

determining whether a particular embedded option 

takes a transaction out of the forward contract 

exclusion from the definition of the term ‘‘future 

delivery’’ in the CEA. See id. at *5 (‘‘As we have 

held since Stovall, the nature of a contract involves 

a multi-factor analysis * * *.’’). 

334The CFTC requested comment on, among 

other things: whether there are other factors that 

should be considered in determining how to 

characterize forward contracts with embedded 

options with respect to nonfinancial commodities; 

and whether there are provisions in forward 

contracts with respect to nonfinancial commodities, 

other than delivery and price, containing embedded 

optionality. See Proposing Release at 29832. 

335One commenter characterized ‘‘volumetric 

optionality’’ as the optionality in a contract settling 

by physical delivery and used to meet varying 

customer demand for a commodity.’’ See WGCEF 

Letter. See also BGA Letter (stating that ‘‘it is 

commonplace for energy suppliers to enter into 

commercial transactions with customers (local 

distribution companies, electric utility companies, 

industrial, commercial and residential customers, 

power plants, etc.), which provide volumetric, price 

and delivery-related flexibility and variability’’). 

BGA claims that commercial transactions 

containing embedded volumetric optionality 

‘‘include, but are not limited to, full requirements 

contracts, interruptible load agreements, capacity 

contracts, tolling agreements, energy management 

agreements, natural gas transportation contracts and 

natural gas storage contracts.’’ Id. 

336See, e.g., WGCEF Letter (submitting that 

‘‘‘volumetric optionality’ is [a] separate and distinct 

concept from ‘deliverability optionality’’’); BGA 

Letter; AGA Letter; Letter from Jeffrey Perryman, 

Director, Contracts and Compliance, Atmos Energy 

Holdings, Inc. (‘‘Atmos’’), dated July 22, 2011 

(‘‘Atmos Letter’’); NGSA/NCGA Letter; Letter from 

Paul M. Architzel, Wilmer Hale LLP on behalf of 

ONEOK, Inc. (‘‘ONEOK’’), dated July 22, 2011 

(‘‘ONEOK Letter’’); COPE Letter. 

337When a forward contract includes an 

embedded option that is severable from the forward 

contract, the forward can remain subject to the 

forward contract exclusion, if the parties document 

the severance of the embedded option component 

and the resulting transactions, i.e. a forward and an 

option. Such an option would be subject to the 

CFTC’s regulations applicable to commodity 

options. 

338See discussion in section II.B.2.(a)(i)(B), supra. 

339See, e.g., BGA Letter (advising that 

‘‘[v]ariability associated with an energy customer’s 

physical demand is influenced by factors outside 

the control of * * * energy suppliers (and 

sometimes * * * consumers) * * * including, but 

not limited to, load growth, weather and certain 

operational considerations (e.g., available 

transportation capacity to deliver physical natural 

gas purchased on the spot market)’’). 

340 Volumetric optionality in this category would 

include, for example, a supply contract entered into 

to satisfy a regulatory requirement that a supplier 

procure, or be able to provide upon demand, a 

specified volume of commodity (e.g., electricity). To 

the extent the optionality covers an amount of the 

commodity in excess of the regulatory requirement, 

such optionality would not necessarily be covered 

by this aspect of the guidance, though it may 

nevertheless be covered by the guidance if such 

excess volumetric optionality is based on physical 

factors within the meaning of the guidance. For 

example, the California Utilities explained that the 

California Public Utilities Commission (‘‘CPUC’’) 

requires them to file a supply plan with the CPUC 

demonstrating that they have procured sufficient 

capacity resources (including reserves) needed to 

serve their aggregate system load on a monthly and 

yearly basis. See California Utilities Letter. Each 

utility’s system requirement is 100 percent of its 

peak-hourly forecast load plus a 15–17 percent 

reserve margin. The California Utilities enter into 

resource adequacy agreements to procure electric 

power generating capacity to meet these 

requirements. The ability to call on the additional 

15 to 17% reserve reflected in such an agreement 

is covered by the regulatory requirements part of 

this element. To the extent the California Utilities 

may have a business need to procure additional 

capacity resources beyond the foregoing regulatory 

requirement (e.g., because they wish to maintain a 

slightly larger reserve margin than required due to 

a recent upswing in unscheduled plant outages due 

to aging plants), that may be covered under the 

interpretation if the additional capacity is required 

due to physical factors beyond the control of the 

parties (i.e., the unscheduled outage, in the 

foregoing example). 

341 In other words, the predominant basis for 

failing to exercise the option would be that the 

demand or supply (as applicable) that the 

optionality was intended to satisfy, if needed, never 

materialized, materialized at a level below that for 

which the parties contracted or changed due to 

physical factors or regulatory requirements outside 

the parties’ control. Such failure to exercise, or an 

exercise for a reduced amount of the underlying 

commodity, could, for example, be due to colder 

than expected weather during the summer 

decreasing demand for air conditioning, in turn 

decreasing demand for power to run the air 

conditioning. The Commission does not interpret 

this to mean that absolutely all factors involved in 

the decision to exercise an option must be beyond 

the parties’ control, but rather the decision must be 

predominantly driven by factors affecting supply 

and demand that are beyond a parties control. This 

also means that the forward contract with 

embedded volumetric optionality needs to be a 

commercially appropriate method for securing the 

purchase or sale of the nonfinancial commodity for 

deferred shipment at the time it is entered into. The 

CFTC cautions market participants that, to the 

extent a party relies on the forward exclusion from 

the swap or future delivery definitions, 

notwithstanding that there is volumetric 

optionality, if that volumetric optionality is 

inconsistent with the seventh element of the 

interpretation, the agreement, contract or 

transaction may be an option. 

342See discussion in part II.B.2.(a)(i)(B), supra. 

See also supra note 321. 

assure that commodity options that 

should be regulated as swaps do not 

circumvent the protections established 

in the Dodd-Frank Act through the 

forward contract exclusion for 

nonfinancial commodities instead. 

The CFTC also is providing an 

interpretation, in response to 

commenters,334 with respect to forwards 

with embedded volumetric 

optionality.335 Several commenters 

asserted that agreements, contracts, and 

transactions that contain embedded 

‘‘volumetric options,’’ and that 

otherwise satisfy the terms of the 

forward exclusions, should qualify as 

excluded forwards, notwithstanding 

their embedded optionality.336 The 

CFTC believes that agreements, 

contracts, and transactions with 

embedded volumetric optionality may 

satisfy the forward exclusions from the 

swap and future delivery definitions 

under certain circumstances. 

Accordingly, the CFTC is providing an 

interpretation that an agreement, 

contract, or transaction falls within the 

forward exclusion from the swap and 

future delivery definitions, 

notwithstanding that it contains 

embedded volumetric optionality, 

when: 

1. The embedded optionality does not 

undermine the overall nature of the 

agreement, contract, or transaction as a 

forward contract; 

2. The predominant feature of the 

agreement, contract, or transaction is 

actual delivery; 

3. The embedded optionality cannot 

be severed and marketed separately 

from the overall agreement, contract, or 

transaction in which it is embedded; 337

4. The seller of a nonfinancial 

commodity underlying the agreement, 

contract, or transaction with embedded 

volumetric optionality intends, at the 

time it enters into the agreement, 

contract, or transaction to deliver the 

underlying nonfinancial commodity if 

the optionality is exercised; 

5. The buyer of a nonfinancial 

commodity underlying the agreement, 

contract or transaction with embedded 

volumetric optionality intends, at the 

time it enters into the agreement, 

contract, or transaction, to take delivery 

of the underlying nonfinancial 

commodity if it exercises the embedded 

volumetric optionality; 

6. Both parties are commercial 

parties; 338 and 

7. The exercise or non-exercise of the 

embedded volumetric optionality is 

based primarily on physical factors,339

or regulatory requirements,340 that are 

outside the control of the parties and are 

influencing demand for, or supply of, 

the nonfinancial commodity.341

The first two elements of the 

interpretation for embedded volumetric 

optionality, which mirror the CFTC’s 

historical embedded option 

interpretation discussed above, have 

been modified to reflect that embedded 

volumetric optionality relates to 

delivery rather than price. As noted 

above, the predominant feature of a 

forward contract is a binding, albeit 

deferred, delivery obligation. It is 

essential that any embedded option in a 

forward contract as to volume must not 

undermine a forward contract’s overall 

purpose.342 The CFTC recognizes that 

the nature of commercial operations are 

such that supply and demand 

requirements cannot always be 

accurately predicted and that forward 

contracts that allow for some optionality 

as to the amount of a nonfinancial 

commodity actually delivered offer a 

great deal of value to commercial 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48239 

343 In evaluating whether the predominant feature 

of a transaction is actual delivery, the CFTC will 

look at the contract as a whole. Thus, with respect 

to this contract, the CFTC would consider the intent 

element of the forward exclusions to be satisfied 

because the contract requires the seller to deliver 

a non-nominal volume of a commodity (i.e., 10,000 

bushels of wheat), viewing the contract as a whole. 

As a result, if the other elements of the guidance 

above are satisfied, this contract would be a forward 

contract, even if the party did not exercise the 

option for the additional 5,000 bushels. 

344The fact that the CFTC is expressly including 

the fourth through sixth elements in the embedded 

optionality guidance for volumetric options but not 

elsewhere does not mean that intent to deliver and 

the ability to make or take delivery expressed in 

these elements are not part of the facts and 

circumstances the CFTC will consider in the 

context of determining whether other agreements, 

contracts, and transactions qualify for the forward 

exclusions. Intent to deliver and the ability to make 

or take delivery have long been a part of the CFTC’s 

facts-and-circumstances approach to making that 

determination, and they remain so. The CFTC is 

emphasizing these elements in this guidance 

because the CFTC has not previously expressed the 

view that an agreement, contract, or transaction 

with embedded volumetric optionality which 

affects the delivery term may qualify as a forward 

if these facts and circumstances are present. 

345See, e.g., AGA Letter (advising that ‘‘[i]n 

general, retail demand for natural gas is weather 

driven * * * as a result [of which], a gas utility’s 

peaking supplies must have significant flexibility 

* * * [and g]as utilities * * * use a variety of 

contracts with gas suppliers to physically deal with 

peak periods of demand’’); BGA Letter (citing gas 

supply curtailment due to a pipeline outage and 

power generation curtailment by an Independent 

System Operator for operational reasons as factors 

outside the control of energy suppliers and which 

could impact the amount of a commodity 

delivered). The CFTC understands BGA’s comment 

to address involuntary curtailments, but also 

recognizes that power buyers may agree in advance 

that the relevant Regional Transmission 

Organization or Independent System Operator may, 

in order to maintain system reliability, curtail 

power deliveries to the buyers. While voluntary 

curtailments are within the control of the power 

buyer, the potential system reliability issue is not. 

Therefore, such voluntary curtailments would be 

within the guidance because, if triggered, they 

would be based on a physical factor (e.g., supply 

constraints). 

346See Letter from Keith M. Sappenfield, II, 

Director, US Regulatory Affairs, Encana Marketing 

(USA) Inc. (‘‘Encana’’), dated July 22, 2011 

(‘‘Encana Letter’’). 

347See ONEOK Letter. The CFTC notes that this 

commenter discussed full requirements contracts in 

the context of supply agreements between one of its 

affiliates and retail customers. If such customers are 

non-commercial customers, such contracts are not 

forwards, but nevertheless they may not be swaps 

under the Commissions’ guidance regarding the 

non-exhaustive list of consumer transactions, or 

otherwise if they have characteristics or factors 

described under the consumer transaction 

interpretation, see infra part II.B.3. 

348See, e.g., NY UCC § 2–306(1) (stating that ‘‘[a] 

term which measures the quantity by the output of 

the seller or the requirements of the buyer means 

such actual output or requirements as may occur in 

good faith.* * *’’). This commenter cited Corbin on 

Contracts for the proposition that the mere fact that 

the quantity term of the contract is ‘‘the buyer’s 

needs or requirements’’ does not render the 

requirements contract ‘‘a mere options contract’’ 

because ‘‘the buyer’s promise is not illusory * * * 

[but] is conditional upon the existence of an 

objective need for the commodity.’’ See ONEOK 

Letter (citing Corbin on Contracts § 6.5 at 240–53 

(1995)). 

participants. Where an agreement, 

contract, or transaction requires delivery 

of a non-nominal volume of a 

nonfinancial commodity, even if an 

embedded volumetric option is 

exercised, the CFTC believes that the 

predominant feature of the contract, 

notwithstanding the embedded 

volumetric optionality, is actual 

delivery. This is the case in many 

forward contracts that have an 

embedded option that allows a party to 

buy or sell an additional amount of a 

commodity beyond the fixed amount 

called for in the underlying forward 

contract. For instance, a forward 

contract could call for the delivery of 

10,000 bushels of wheat and include an 

option for an additional 5,000 bushels of 

wheat.343

The third element is substantially the 

same as the third element of the 

interpretation above with respect to 

commodity options embedded in 

forward contracts generally. 

The fourth and fifth elements are 

designed to ensure that both parties 

intend to make or take delivery (as 

applicable), subject to the relevant 

physical factors or regulatory 

requirements, which may lead the 

parties to deliver more or less than 

originally intended. This distinguishes a 

forward contract from a commodity 

option, where only the option seller 

must at all times be prepared to deliver 

during the term of the option. The sixth 

element is intended to ensure that the 

interpretation is not abused by market 

participants not engaged in a 

commercial business involving the 

nonfinancial commodity underlying the 

embedded volumetric optionality.344

The seventh element is based on 

comments stating that parties to 

agreements, contracts, and transactions 

with embedded volumetric optionality 

intend to make or take delivery (as 

applicable) of a commodity, and that it 

is merely the volume of a commodity 

that would be required to be delivered 

if the option is exercised, that varies. It 

is designed to ensure that the 

volumetric optionality is primarily 

driven by physical factors or regulatory 

requirements that influence supply and 

demand and that are outside the parties’ 

control, and that the optionality is a 

commercially reasonable way to address 

uncertainty associated with those 

factors.345 Element seven must be 

interpreted with the other elements set 

forth here. For instance, even if the 

optionality is consistent with element 

seven, such optionality cannot 

undermine the overall nature of the 

contract as a forward contract as 

discussed above. 

As discussed in the interpretation 

regarding forwards with embedded 

optionality discussed above, in 

evaluating whether an agreement, 

contract or transaction with embedded 

volumetric optionality qualifies for the 

forward exclusions, the CFTC will look 

to the relevant facts and circumstances 

of the transaction as a whole to evaluate 

whether the transaction qualifies for the 

forward exclusions from the definitions 

of the terms ‘‘swap’’ and ‘‘future 

delivery.’’ 

The CFTC is providing further 

interpretations to explain how it would 

treat some of the specific contracts 

described in the comment letters. 

According to one commenter, a ‘‘full 

requirements contract’’ can be described 

as a ‘‘contract where the seller agrees to 

provide all requirements for a specific 

customer’s location or delivery 

point.’’ 346 According to another 

commenter, ‘‘[a] full requirements 

contract * * * is a well-established 

concept in contract law’’ and ‘‘[i]n a 

requirements contract, the purchaser 

* * * deals exclusively with one 

supplier.’’ 347 This commenter added 

that, while the amount of commodity 

delivered can vary, it is based on an 

objective need and that the Uniform 

Commercial Code imposes on the buyer 

‘‘an obligation to act in good faith with 

respect to the varying amount that is 

called for delivery.’’ 348 Based upon this 

description, the CFTC believes that a 

going commercial concern with an 

exclusive supply contract has no option 

but to get its supply requirements met 

through that exclusive supplier 

consistent with the terms of the 

contract. Any instance where nominal 

or zero delivery occurred would have to 

be because the commercial requirements 

changed or did not materialize. 

Furthermore, any variability in delivery 

amounts under the contract appears to 

be driven directly by the buyer’s 

commercial requirements and is not 

dependent upon the exercise of any 

commodity option by the contracting 

parties. 

Accordingly, full requirements 

contracts, as described above, appear 

not to contain embedded volumetric 

options. Therefore, a full requirements 

contract may qualify for the forward 

exclusion under the same facts and 

circumstances analysis applicable to all 

other agreements, contracts, and 

transactions that might be forwards. The 

same analysis would apply to an output 

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48240 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

349See Letter from Phillip g. Lookadoo, Esq., Reed 

Smith LLP and Jeremy D. Weinstein, Esq. on behalf 

of IECA dated May 23, 2012 (suggesting that output 

contracts, in addition to full requirements contracts, 

should be within the forward exclusion). An output 

contract has been defined as ‘‘a contract pursuant 

to which the obligor’s duty to supply the promised 

commodity is quantified (and therefore limited) by 

reference to its production thereof.’’ See Boyd v. 

Kmart Corp., 110 F.3d 73 (10th Cir. 1997). 

350See California Utilities Letter. 

351See NEMA Letter. 

352See California Utilities Letter. 

353 Id. 

354See infra part II.B.2.(b)(iii). 

355See AGA Letter. 

356See Atmos Letter. 

357See IECA Letter. 

358The CFTC refers in this and the prior sentence 

to ‘‘additional deliveries’’ because the IECA’s 

example involves an agreement calling for delivery 

of a physical nonfinancial commodity. 

359Using extension or evergreen provisions to 

avoid delivery, however, as was the case with the 

‘‘rolling spot’’ contracts at issue in CFTC v. Zelener, 

373 F.3d 861 (7th Cir. 2004), could constitute 

evasion or violate other provisions of the CEA (e.g., 

CEA section 4(a), 7 U.S.C. 6(a)). This interpretation 

does not limit the CFTC’s other interpretations in 

this release regarding when delivery does not occur 

(e.g., the Brent Interpretation). 

360See NGSA/NCGA Letter (requesting 

clarification of the phrase ‘‘target the delivery 

term.’’). 

361See Proposing Release at 29830, n.81. 

362See COPE Letter. 

363See AGA Letter; API Letter; Atmos Letter; 

ONEOK Letter; NGSA/NCGA Letter; WGCEF Letter. 

364See AGA Letter; Atmos Letter. 

contract satisfying the terms of this 

interpretation.349

With respect to capacity contracts, 

transmission (or transportation) services 

agreements, and tolling agreements, the 

CFTC understands that: (i) Capacity 

contracts are generally products 

designed to ensure that sufficient 

physical generation capacity is available 

to meet the needs of an electrical 

system;350 (ii) transmission (or 

transportation) services agreements are 

generally agreements for the use of 

electricity transmission lines (or gas 

pipelines) that allow a power generator 

to transmit electricity (or gas supplier to 

transport gas) to a specific location;351

and (iii) tolling agreements, as described 

by commenters, provide a purchaser the 

right to the capacity, energy, ancillary 

services and any other product derived 

from a specified generating unit, all 

based upon a delivered fuel price and 

agreed heat rate.352

Such agreements, contracts and 

transactions, may have features that will 

satisfy the ‘‘forwards with embedded 

volumetric optionality’’ interpretation 

discussed above, or, like full 

requirements contracts, may not contain 

embedded volumetric options and may 

satisfy other portions of the forward 

interpretations herein. For example, 

according to one commenter, the 

delivery obligations in some tolling 

agreements are not optional which is 

indicative that the predominant feature 

of such tolling agreements is actual 

delivery.353 It is also possible, based on 

descriptions provided to the CFTC, that 

tolling agreements could fit within the 

interpretation concerning certain 

physical agreements, contracts, or 

transactions,354 or other interpretations 

herein. 

Some commenters focused on 

forwards with embedded volumetric 

optionality in the natural gas industry. 

For example, one commenter stated that 

‘‘peaking supply’’ natural gas contracts 

do not render delivery optional. 

Although the purchaser has the option 

to specify when and if the quantity of 

gas will be delivered on any given day, 

this commenter asserted that there is no 

cash settlement alternative. If the 

purchaser does not exercise the right to 

purchase, then the right is terminated. 

The seller under the transaction must 

deliver the entire quantity of gas that the 

purchaser specifies, or pay liquidated 

damages. Moreover, the option is not 

severable and cannot be marketed 

separately from the supply agreement 

itself.355 Similarly, another commenter 

said that there is no ability to sever an 

embedded option from a natural gas 

forward contract. Moreover, it stated 

that the ability for a gas purchaser to 

specify a quantity of gas for a certain 

day is not to encourage speculative 

activity; rather, it is because the exact 

quantity of gas to be needed on that 

future day is unknown, and many gas 

purchasers have weather-dependent 

needs that cannot accurately be 

predicted in advance.356

Depending on the relevant facts and 

circumstances, these types of 

agreements, contracts, and 

transactions—capacity contracts, 

transmission (or transportation) services 

agreements, tolling agreements, and 

peaking supply contracts—may satisfy 

the elements of the ‘‘forwards with 

embedded volumetric options’’ 

interpretation set forth above, or may 

satisfy other portions of this 

interpretation. If they do, they would 

fall within the forward exclusions from 

the swap and future delivery 

definitions. 

In addition, the CFTC is providing an 

interpretation in response to a comment 

that contracts with evergreen or 

extension terms should be considered 

forwards.357 The CFTC is clarifying that 

an extension term in a commercial 

contract, such as a renewal term in a 

five year power purchase agreement 

(which, due to the renewal, would 

require additional deliveries), is not an 

option on the delivery term within the 

meaning of the CFTC’s interpretation, 

and consequently would not render 

such a contract ineligible for the 

forward exclusions from the definitions 

of the terms ‘‘swap’’ and ‘‘future 

delivery.’’ Similarly, an evergreen 

provision, which automatically renews 

a contract (and, as such, would require 

additional deliveries)358 absent the 

parties affirmatively terminating it, 

would not render such a contract 

ineligible for the forward exclusions 

from the swap or future delivery 

definitions.359 When the Proposing 

Release stated that a forward contract 

containing an embedded option that 

does not ‘‘target the delivery term’’ is an 

excluded forward contract,360 it meant 

that the embedded option does not 

affect the delivery amount.361

Also, in response to a commenter,362

the CFTC clarifies that embedded 

optionality as to delivery points and 

delivery dates will not cause a 

transaction that otherwise qualifies as a 

forward contract to be considered a 

swap. The CFTC emphasizes, however, 

that delivery must occur at some 

delivery point and on some date, or the 

lack of delivery must be due to the 

transaction being booked out or 

otherwise be consistent with the CFTC’s 

interpretation regarding the forward 

exclusions from the swap and future 

delivery definitions. 

Comments 

Commenters generally supported the 

CFTC’s proposed interpretation 

regarding forwards with embedded 

options, but many believed that it 

should be modified or expanded. As 

noted above, several commenters 

believed that forward contracts with 

embedded options that contain 

optionality as to the quantity/volume of 

the nonfinancial commodity to be 

delivered should qualify as forwards, 

and that the CFTC’s proposed 

interpretation (which only mentions 

price optionality) should be modified 

accordingly.363 In this regard, several 

commenters focused on forwards with 

embedded volumetric options in the 

natural gas industry.364 One commenter 

noted that, although the 1985 CFTC 

OGC Interpretation distinguishes 

forward contracts from trade options, it 

is based on a limited number of 

agricultural contract examples, so 

additional guidance is needed, 

particularly in light of the wide range of 

cash market and commercial 

merchandising contracting practices in 

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365See ONEOK Letter. This commenter noted that 

it offers its customers a number of types of contracts 

for delivery of natural gas under which the amount 

called for delivery may vary. In each of these types 

of contracts, this commenter stated that both parties 

intend the contracts to result in delivery of the 

commodity, as needed. The purpose of these 

contracts is to ensure that customers, most of which 

are gas or electric utilities, have an adequate supply 

of natural gas regardless of day-to-day changes in 

demand that may be caused by variation in weather, 

operational considerations, or other factors. They 

are not designed for one-way price protection as 

would be the case with an option. See ONEOK 

Letter. 

366See COPE Letter, Appendix. 

367See WGCEF Letter; 7 U.S.C. 6c(b). 

368 77 FR 25320 (Aug. 27, 2012). Encana believed 

that the guidance on forwards with embedded 

options should include embedded physical delivery 

options because it asserted that many of the 

contracts currently used by participants in the 

wholesale natural gas market contain an option for 

the physical delivery of natural gas. See Encana 

Letter. To the extent that Encana’s comment goes 

beyond volumetric optionality, commodity options 

are discussed supra in section II.B.2(b). 

369See Letter from Roger Cryan, Vice President 

for Milk Marketing and Economics, National Milk 

Producers Federation (‘‘NMPF’’), dated July 22, 

2011 (‘‘NMPF Letter’’). 

370See ETA Letter. Similarly, COPE comments 

that a nonfinancial commodity forward contract 

that, ‘‘by its terms,’’ is intended to settle physically 

should be permitted to contain optionality without 

being transformed into a swap unless such 

optionality negates the physical settlement element 

of the contract. That is, if one party can exercise an 

option to settle the contract financially based upon 

the value change in an underlying cash market, 

then the intent for physical settlement is not 

contained in ‘‘the four corners of the contract’’ and 

may render the contract a swap. See COPE Letter. 

As discussed elsewhere in this release, the CFTC 

historically has eschewed approaches to the 

forward exclusion that rely on the ‘‘four corners of 

the contract,’’ which can provide a roadmap to 

evasion of statutory requirements. 

371Accordingly, this commenter believed that the 

CFTC should provide in its rules that an embedded 

option or embedded optionality will not result in 

a nonfinancial forward being a swap unless: (i) 

Delivery is optional; (ii) financial settlement is 

allowed; and (iii) transfer and trading of the option 

separately from the forward is permitted. See ETA 

Letter. 

372See also NCFC Letter (supporting the CFTC’s 

guidance because it provides legal certainty). 

373See also Commodity Options, 77 FR 25320, 

25324 n. 25 (Apr. 27, 2012) (discussing the CFTC’s 

conclusion that an ‘‘option[] to redeem’’ under the 

USDA Commodity Credit Corporation’s marketing 

loan program constitutes a cotton producer’s 

contractual right to repay its marketing loan and 

‘‘redeem’’ the collateral (cotton) to sell in the open 

market). 

374Separately, it is expected that CFTC staff will 

be issuing no-action relief with respect to the 

conditions of the modified trade option exemption 

(except the enforcement provisions retained in 

§ 32.3(d)) until December 31, 2012. This extension 

will afford the CFTC an opportunity to review and 

evaluate the comments received on both the 

interpretation above regarding embedded 

volumetric optionality, and the modified trade 

option exemption, in order to determine whether 

any changes thereto are appropriate. 

which delivery terms and amounts 

vary.365

In addition, another commenter 

requested more generally that any 

embedded option (for example, price, 

quantity, delivery point, delivery date, 

contract term) that does not permit a 

unilateral election of financial 

settlement based upon the value change 

in an underlying cash market should not 

render the contract a swap.366

As discussed above, the CFTC has 

provided an additional interpretation 

with respect to forwards with embedded 

volumetric options to address 

commenters’ concerns. The CFTC also 

has provided an interpretation above, 

regarding price optionality, optionality 

with respect to delivery points and 

delivery dates specifically in response 

to this commenter, and optionality as to 

certain contract terms (such as 

evergreen and renewal provisions) to 

address particular concerns raised by 

commenters. The CFTC declines to 

adopt a more expansive approach with 

respect to ‘‘any’’ embedded option. 

One commenter requested that an 

option to purchase or sell a physical 

commodity, whether embedded in a 

forward contract or stand alone, should 

either (i) fall within the statutory 

forward exclusion from the swap 

definition, or (ii) alternatively, if 

deemed by the CFTC to be a swap, 

should be exempt from the swap 

definition pursuant to a modified trade 

option exemption pursuant to CEA 

section 4c(b).367 The CFTC has modified 

its proposed interpretation regarding 

forwards with embedded options as 

discussed above; contracts with 

embedded options that are swaps under 

this final interpretation may 

nevertheless qualify for the modified 

trade option exemption recently 

adopted by the CFTC and discussed 

above.368

Another commenter urged the CFTC 

to broadly exempt commercial forward 

contracting from swap regulation by 

generally excluding from the swap 

definition any forward contract with 

embedded optionality between end 

users ‘‘whose primary purpose is 

consistent with that of an ‘end user’, 

and in which any embedded option is 

directly related to ‘end use.’ ’’ 369 The 

CFTC believes that this interpretation is 

vague and overbroad, and declines to 

adopt it. 

Another commenter believed that the 

CFTC’s ‘‘facts and circumstances’’ 

approach to forwards with embedded 

options does not provide the legal 

certainty required by nonfinancial 

entities engaging in commercial 

contracts in the normal course of 

business.370 This commenter further 

argued that many option-like contract 

terms could be determined to ‘‘target the 

delivery term’’ under a facts and 

circumstances analysis.371

The CFTC has long applied a factsand-circumstances approach to the 

forward exclusion, including with 

respect to forwards with embedded 

options, and thus it is an approach with 

which market participants are familiar. 

That approach balances the need for 

legal certainty against the risk of 

providing opportunities for evasion.372

The CFTC’s additional interpretation 

noted above, including clarification 

about the meaning of the phrase ‘‘target 

the delivery term,’’ and forwards with 

embedded volumetric optionality, 

provides enhanced legal certainty in 

response to the commenter’s concerns. 

373

Request for Comment 

The CFTC’s interpretation regarding 

forwards with volumetric options is an 

interpretation of the CFTC and may be 

relied upon by market participants. 

However, the CFTC believes that it 

would benefit from public comment 

about its interpretation, and therefore 

requests public comment on all aspects 

of its interpretation regarding forwards 

with embedded volumetric options,374

and on the following questions: 

1. Are the elements set forth in the 

interpretation to distinguish forwards 

with embedded volumetric optionality 

from commodity options appropriate? 

Why or why not? 

2. Are there additional elements that 

would be appropriate? Please describe 

and provide support for why such 

elements would serve to distinguish 

forwards with embedded volumetric 

optionality from commodity options. 

3. Is the seventh element that, to 

ensure that an agreement, contract, or 

transaction with embedded volumetric 

optionality is a forward and not an 

option, the volumetric optionality is 

based primarily on physical factors, or 

regulatory requirements, that are outside 

the control of the parties and are 

influencing demand for, or supply of, 

the nonfinancial commodity, necessary 

and appropriate? Why or why not? Is 

the statement of this element 

sufficiently clear and unambiguous? If 

not, what adjustments would be 

appropriate? 

4. Are there circumstances where 

volumetric optionality is based on other 

factors? Please describe. Would such 

factors, if made a part of the 

interpretation, serve to distinguish 

forwards with embedded volumetric 

optionality from commodity options? If 

so, how? 

5. Does the interpretation provide 

sufficient guidance as to whether 

agreements, contracts, or transactions 

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48242 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

375See BGA Letter and California Utilities Letter. 

This interpretation also may apply to firm 

transmission agreements pursuant to which 

transmission service may not be interrupted for any 

reason except during an emergency when continued 

delivery of power is not possible. See http:// 

www.interwest.org/wiki/index.php?title=Firm_

transmission_service. 

376See California Utilities Letter. 

377 In this regard, the usage rights offered for sale 

should be limited to the capacity of the specified 

facility. While overselling such capacity would not 

per se be inconsistent with satisfying the terms of 

this interpretation, the CFTC cautions market 

participants that overselling not based on 

reasonable commercial expectations of the use of 

the specified facility could lead the contract to be 

deemed evasion and lead to an agreement, contract 

or transaction being considered a swap, as it would 

undermine the ‘‘right’’ being offered. For example, 

given physical constraints of the power grid and gas 

pipelines, overselling transmission or 

transportation capacity would be per se 

inconsistent with satisfying the terms of this 

interpretation. 

378See BGA Letter and California Utilities Letter. 

379See BGA Letter. 

with embedded volumetric optionality 

permitting a nominal amount, or no 

amount, of a nonfinancial commodity to 

be delivered are forwards or options, 

viewing the agreements, contracts, or 

transactions as a whole, if they satisfy 

the seven elements of the interpretation? 

Why or why not? Does this 

interpretation encourage evasion, or do 

the seven elements sufficiently 

distinguish forwards from agreements, 

contracts, and transactions that may 

evade commodity options regulation? 

6. Is the interpretation sufficiently 

clear with respect to capacity contracts, 

transmission (or transportation) services 

agreements, peaking supply contracts, 

or tolling agreements? Why or why not? 

Do capacity contracts, transmission (or 

transportation) services agreements, 

peaking supply contracts, or tolling 

agreements generally have features that 

satisfy the forwards with volumetric 

options interpretation included in this 

release? If so, which ones? If not, why 

not? Could these types of agreements, 

contracts, and transactions qualify for 

the forward exclusions under other 

parts of the interpretation set forth 

above? Are there material differences in 

the structure, operation, or economic 

effect of these types of agreements, 

contracts, and transactions as compared 

to full requirements contracts that are 

relevant to whether such agreements, 

contracts, and transactions are options 

under the CEA? Please explain. If so, 

what are the material differences? 

7. Do the agreements, contracts, and 

transactions listed in question No. 6 

above have embedded optionality in the 

first instance? Based on descriptions by 

commenters, it appears that they may 

have a binding obligation for delivery, 

but have no set amount specified for 

delivery. Instead, delivery (including 

the possibility of nominal or zero 

delivery) is determined by the terms and 

conditions contained within the 

agreement, contract, or transaction 

(including, for example, the satisfaction 

of a condition precedent to delivery, 

such as a commodity price or 

temperature reaching a level specified 

in the agreement, contract, or 

transaction). That is, the variation in 

delivery is not driven by the exercise of 

embedded optionality by the parties. Do 

the agreements, contracts, and 

transactions listed in question No. 6 

exhibit these kinds of characteristics? If 

so, should the CFTC consider them in 

some manner other than its forward 

interpretation? Why or why not? 

(iii) Certain Physical Commercial 

Agreements, Contracts or Transactions 

The CFTC is providing an 

interpretation in response to comments 

regarding certain physical commercial 

agreements for the supply and 

consumption of energy that provide 

flexibility, such as tolls on power 

plants, transportation agreements on 

natural gas pipelines, and natural gas 

storage agreements.375 Commenters 

recognized that these types of 

agreements, contracts or transactions 

may have option-like features, but 

analogized them to leases and 

concluded that they were forwards 

rather than swaps. One commenter, for 

example, characterized taking power 

produced pursuant to a physical tolling 

agreement—which can involve one 

party thereto providing fuel for a 

generation plant and having the 

exclusive right to take the power 

produced by that plant from the fuel 

provided—thus, in effect, ‘‘renting’’ the 

plant to the extent the plant is used to 

produce power from the fuel provided— 

as more akin to a lease than to an 

option.376

The CFTC will interpret an 

agreement, contract or transaction not to 

be an option if the following three 

elements are satisfied: (1) The subject of 

the agreement, contract or transaction is 

usage of a specified facility or part 

thereof rather than the purchase or sale 

of the commodity that is to be created, 

transported, processed or stored using 

the specified facility; (2) the agreement, 

contract or transaction grants the buyer 

the exclusive use of the specified 

facility or part thereof during its term, 

and provides for an unconditional 

obligation on the part of the seller to 

grant the buyer the exclusive use of the 

specified facility or part thereof; 377 and 

(3) the payment for the use of the 

specified facility or part thereof 

represents a payment for its use rather 

than the option to use it. In such 

agreements, contracts and transactions, 

while there is optionality as to whether 

the person uses the specified facility, 

the person’s right to do so is legally 

established, does not depend upon any 

further exercise of an option and merely 

represents a decision to use that for 

which the lessor already has paid. In 

this context, the CFTC would not 

consider actions such as scheduling 

electricity transmission, gas 

transportation or injection of gas into 

storage to be exercising an option if all 

three elements of the interpretation 

above are satisfied. As with the 

interpretation regarding forwards with 

embedded options generally, discussed 

above, in evaluating whether flexible 

physical commercial agreements that 

meet the 3-part test qualify for the 

forward exclusions, the CFTC will look 

to the specific facts and circumstances 

of the agreement, contract or transaction 

as a whole to evaluate whether the 

agreement, contract or transaction 

qualifies for the forward exclusions 

from the definitions of ‘‘swap’’ and 

‘‘future delivery.’’ 

However, in the alternative, if the 

right to use the specified facility is only 

obtained via the payment of a demand 

charge or reservation fee, and the 

exercise of the right (or use of the 

specified facility or part thereof) entails 

the further payment of actual storage 

fees, usage fees, rents, or other 

analogous service charges not included 

in the demand charge or reservation fee, 

such agreement, contract or transaction 

is a commodity option subject to the 

swap definition. 

Comments 

Two commenters addressed ‘‘leaselike’’ physical agreements, contracts or 

transactions.378 One of these 

commenters asserted that there are 

many physical commercial agreements 

for the supply and consumption of 

energy that effectively provide leases on 

flexible energy assets, such as tolls on 

power plants, transportation agreements 

on natural gas pipelines and natural gas 

storage agreements.379 According to this 

commenter, these assets have the 

capability to be turned on and off to 

meet fluctuating demand due to weather 

and other factors; physical contracts 

around these assets transfer that 

delivery flexibility to the contract 

holder. The commenter believed that 

these types of commercial arrangements 

should not be considered commodity 

options, but rather should be excluded 

forwards. The other commenter 

described tolling agreements as having 

the characteristics of a lease, in that the 

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380See California Utilities Letter. 

381See Request for Comment 35, which stated: 

How would the proposed interpretive guidance set 

forth in this section affect full requirements 

contracts, capacity contracts, reserve sharing 

agreements, tolling agreements, energy management 

agreements, and ancillary services? Do these 

agreements, contracts, or transactions have 

optionality as to delivery? If so, should they—or 

any other agreement, contract, or transaction in a 

nonfinancial commodity that has optionality as to 

delivery—be excluded from the swap definition? If 

so, please provide a detailed analysis of such 

agreements, contracts, or transactions and how they 

can be distinguished from options that are to be 

regulated as swaps pursuant to the Dodd-Frank Act. 

To what extent are any such agreements, contracts, 

or transactions in the electric industry regulated by 

the Federal Energy Regulatory Commission 

(‘‘FERC’’), State regulatory authorities, regional 

transmission organizations (‘‘RTOs’’), independent 

system operators (‘‘ISOs’’) or market monitoring 

units associated with RTOs or ISOs? 

See Proposing Release at 29832. 

382 Id. 

383See Atmos Letter; BGA Letter; California 

Utilities Letter; COPE Letter; ETA Letter; Encana 

Letter; FERC Staff Letter; IECA Letter; NEMA Letter; 

ONEOK Letter; and Letter from Kenneth R. Carretta, 

General Regulatory Counsel—Markets, PSEG 

Services Corp., on behalf of the Public Service 

Electric and Gas Company, PSEG Power LLC, and 

PSEG Energy Resources & Trade LLC (‘‘PSEG 

Companies’’), dated July 22, 2011 (‘‘PSEG Letter’’). 

384See Better Markets Letter. This commenter 

stated that ancillary services are in substance swaps 

based on congestion costs between two 

transmission points, measured by the difference 

between actual prices assigned at those points by 

the grid operator. Capacity contracts are often 

documented using trading agreements for 

transactions in physicals, but this commenter 

believed that they constitute swaps that are used to 

hedge the price risk associated with periodic 

auctions of the contracts to provide reliable 

capacity to the grid operator. This commenter 

asserted that such contracts do not meet the CFTC’s 

appropriate tests to exclude them, which should be 

made explicit in the guidance. This commenter 

stated that basic power contracts often do not meet 

the intent to deliver test because power buyers and 

sellers each schedule delivery to/from the grid, and 

such transactions can be settled based on readily 

available price differentials rather than scheduling 

capacity and load as a pair. At a minimum, this 

commenter believed that guidance should be 

provided to require that, in order to demonstrate 

intent to deliver, secondary delivery-related costs 

(e.g., congestion charges and penalties to which 

those scheduling capacity and load on the grid are 

subject) must be allocated by contract. Id. 

385See supra note 317. 

386 16 U.S.C. 824(f). 

387 7 U.S.C. 6(c)(6). 

388See, e.g., Encana Letter and BGA Letter. 

389See, e.g., The Royal Bank of Scotland Group 

plc, Order Approving Notice To Engage in 

Activities Complementary to a Financial Activity, 

2008 Federal Reserve Bulletin volume 94. 

390 Id. 

391See, e.g., Energy Management Agreement 

between Long Island Lighting Company and Long 

Island Power Authority, available at http:// 

www.lipower.org/pdfs/company/papers/contract/ 

energy.pdf. 

392Similarly, using an EMA would not render 

swaps entered as a result of or pursuant to an EMA 

spot or forward transactions. 

purchasing entity obtains the exclusive 

right to the use of the power plant 

during the term of the agreement.380

This commenter asserted that such 

agreements should not be considered 

commodity options, but rather forwards 

because the obligations are not 

contingent. The CFTC is providing the 

above interpretation that these types of 

agreements, contracts and transactions 

are not commodity options if the above 

conditions are satisfied, but may qualify 

for the forward exclusions under the 

facts and circumstances, in response to 

these commenters’ concerns. 

(iv) Effect of Interpretation on Certain 

Agreements, Contracts and Transactions 

In the Proposing Release,381 the CFTC 

requested comment regarding how its 

proposed interpretation concerning the 

forward contract exclusion would affect 

full requirements contracts, reserve 

sharing agreements, tolling agreements, 

energy management agreements and 

ancillary services. The CFTC asked 

whether such agreements, contracts or 

transactions have optionality as to 

delivery and, if so, whether they, or any 

other agreement, contract or transaction 

in a nonfinancial commodity, should be 

excluded from the swap definition.382

Commenters generally believed that 

such types of agreements, contracts and 

transactions, although they may contain 

delivery optionality, should be 

considered forwards rather than swaps 

or commodity options.383 By contrast, 

one commenter believed that traded 

power markets involve many types of 

contracts that are actually exchanges of 

cash flows based on referenced values 

and that have no relevant characteristics 

of physical delivery.384

With the exception of energy 

management agreements, which are 

discussed below, the interpretations that 

the CFTC has already provided above 

may apply to such types of agreements, 

contracts and transactions. Specifically, 

to the extent that such types of 

agreements, contracts and transactions 

are forwards with embedded volumetric 

options, the CFTC has provided an 

additional interpretation in section 

II.B.2.b(iii) above. To the extent such 

types of agreements, contracts or 

transactions are physical commercial 

agreements, contracts or transactions 

discussed in section II.B.2.b(iii), supra, 

the CFTC has provided an interpretation 

in that section. To the extent such types 

of agreements, contracts and 

transactions are considered commodity 

options, the CFTC has addressed 

commodity options under the separate 

rulemaking establishing a modified 

trade option exemption.385 And to the 

extent that such types of agreements, 

contracts, and transactions, such as 

ancillary services, occur in Regional 

Transmission Organizations or 

Independent System Operators, or 

entered into between entities described 

in section 201(f) of the Federal Power 

Act,386 they may be addressed through 

the public interest waiver process in 

CEA section 4(c)(6).387

With regard to Energy Management 

Agreements (‘‘EMAs’’), in general, 

commenters expressed the view that 

EMAs are forwards, and not swaps, 

although they did not provide analysis 

to support that conclusion.388 They also 

did not provide a working definition of 

EMAs. The CFTC understands that 

EMAs can cover a number of services 

and transactions, which can include 

spot, forward and swap transactions. 

EMAs can include services such as: (i) 

Acting as a financial intermediary by 

substituting one party’s credit and 

liquidity for those of a less credit 

worthy owner of illiquid energy 

producing assets (i.e. the other party to 

the EMA) to facilitate the owner’s 

purchase of fuel and sale of power; 389

(ii) providing market information to 

assist the owner in developing and 

refining a risk-management plan for the 

plant; 390 and (iii) procuring fuel, 

arranging delivery and storage, selling 

excess power not needed to serve load 

for another party.391 The entity carrying 

out these activities may receive a 

portion of the revenue generated from 

such activities as compensation for its 

efforts. Because commenters did not 

provide a working definition of EMAs, 

the CFTC cannot state categorically that 

EMAs are or are not swaps. However, if 

the fuel acquisition, sales of excess 

generation and any other transactions 

executed under the auspices of an EMA 

are not swaps, nothing about the fact 

that the transactions are executed as a 

result of or pursuant to an EMA 

transforms the transactions into swaps. 

For example, if one party hires another 

party to enter into spot or forward 

transactions on its behalf, the fact that 

their relationship is governed by an 

EMA does not render those transactions 

swaps.392 Conversely, were swaps to be 

executed by one party on behalf of 

another party as a result of, or pursuant 

to, an EMA, the parties thereto would 

need to consider their respective roles 

thereunder (e.g. principal versus agent) 

and whether commodity trading 

advisor, introducing broker, futures 

commission merchant, or other 

registration or other elements of the 

Dodd-Frank Act regime were 

implicated. At a minimum, the fact that 

a swap was executed would implicate 

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393This interpretation is limited to the facts and 

circumstances described herein; the CFTC is not 

opining on different facts or circumstances, which 

could change the CFTC’s interpretation. 394With respect to performance guarantees, the 

fact that a failure to deliver a nonfinancial 

commodity triggers a payment under a performance 

guaranty does not excuse the performance, nor 

render delivery optional. Accordingly, such a 

payment trigger would not itself preclude an 

agreement, contract, or transaction from being 

covered by the forward exclusion from the swap or 

future delivery definitions. But see supra part 

II.B.1.g, which provides that the CFTC is 

interpreting the term ‘‘swap’’ (that is not a securitybased swap or mixed swap) to include a guarantee 

of such swap, to the extent that a counterparty to 

a swap position would have recourse to the 

guarantor in connection with the position. 

395See 1985 CFTC OGC Interpretation, supra note 

245 (stating generally that while ‘‘[s]ome contracts 

provide for a liquidated damages of penalty clause 

if the producer fails to deliver, the presence of such 

clauses in a contract does not change the analysis 

of the nature of the contract [if] * * * it is intended 

that delivery of the physical crop occur, absent 

destruction of all or a portion of the crop by forces 

which neither party can control’’). See generally 

Corbin on Contracts § 58.1 (characterizing 

liquidated damages provisions as designed to 

‘‘[d]etermin[e] the amount of damages that are 

recoverable for a breach of contract’’). 

396 In that regard, see 1985 CFTC OGC 

Interpretation, supra note 245 (stating that ‘‘a 

contract provision which permitted a producer to 

avoid delivery for a reason other than for an 

intervening condition not in the control of either 

party could change any conclusion about the nature 

of the contract’’). 

397See ETA Letter. 

398 Id. This commenter cited FERC Order No. 890, 

which recognizes that ‘‘[w]hile any party to any 

contract can choose to fail to perform, that does not 

convey a contractual right to fail to perform’’ and 

that the Edison Electric Institute Master Power 

Purchase and Sale Agreement (‘‘EEI MPPSA’’) 

clearly obligates the supplier to provide power, 

except in cases of force majeure. As the ETA 

explains, ‘‘[t]he EEI MPPSA is a master agreement 

frequently used to document transactions for 

deferred delivery and receipt of nonfinancial 

electric energy, and the terms of the ISDA North 

American Power Annex contain substantially 

identical master agreement provisions * * *.’’ Id. 

399According to this commenter, parties typically 

include liquidated damages provisions in their 

agreements, contracts and transactions to address 

situations in which ‘‘one party or the other may be 

unable, excused or prevented for commercial 

reasons from performing its contractual obligations 

to deliver or receive [the relevant commodity],’’ not 

to serve as ‘‘a financial settlement ‘option’ 

analogous to a financial settlement option in a 

trading instrument.’’ Id. 

400See AGA Letter. 

401 Id. See also Atmos Letter (stating that there is 

no financial incentive for a seller to fail to deliver 

natural gas under contracts used in the natural gas 

industry, as the standard remedy for such a failure 

to deliver is to pay liquidated damages sufficient to 

compensate the purchaser for having to obtain its 

required natural gas). 

402The discussion above regarding the exclusion 

from the swap definition for forward contracts on 

nonfinancial commodities does not apply to the 

exclusion from the swap and security-based swap 

definitions for security forwards or to the 

distinction between security forwards and security 

futures products. 

403See Proposing Release at 29830. 

404See sections 1a(47)(B)(ii), (v), and (vi) of the 

CEA, 7 U.S.C. 1a(47)(B)(ii), (v), and (vi). 

405See section 1a(47)(B)(v) of the CEA, 7 U.S.C. 

1a(47)(B)(v) (excluding from the swap and securitybased swap definitions ‘‘any agreement, contract, or 

transaction providing for the purchase or sale of 1 

or more securities on a fixed basis that is subject 

to [the Securities Act and Exchange Act]’’); and 

section 1a(47)(B)(vi) of the CEA, 7 U.S.C. 

1a(47)(B)(vi) (excluding from the swap and securitybased swap definitions ‘‘any agreement, contract, or 

transaction providing for the purchase or sale of 1 

or more securities on a contingent basis that is 

subject to [the Securities Act and Exchange Act], 

unless the agreement, contract, or transaction 

predicates the purchase or sale on the occurrence 

of a bona fide contingency that might reasonably be 

expected to affect or be affected by the 

creditworthiness of a party other than a party to the 

agreement, contract, or transaction’’). 

406See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 

1a(47)(B)(ii). 

407The Commissions note that calling an 

agreement, contract, or transaction a swap or 

security-based swap does not determine its status. 

See supra part II.D.1. 

reporting and recordkeeping 

requirements.393

(v) Liquidated Damages Provisions 

The Commissions also received 

several comments discussing 

contractual liquidated damages 

provisions. The CFTC is clarifying that 

the presence, in an agreement, contract, 

or transaction involving physical 

settlement of a nonfinancial commodity, 

of a liquidated damages provision 

(which may be referred to by another 

name, such as a ‘‘cover costs’’ or ‘‘cover 

damages’’ provision) does not 

necessarily render such an agreement, 

contract, or transaction ineligible for the 

forward exclusion.394 Such a provision 

in an agreement, contract, or transaction 

is consistent with the use of the forward 

exclusion, provided that the parties 

intend the transaction to be physically 

settled.395 However, liquidated damages 

provisions can be used to mask a lack 

of intent to deliver.396 In light of the 

possibility for evasion of the DoddFrank Act, the CFTC will continue to 

utilize its historical facts-andcircumstances approach in determining 

whether the parties to a particular 

agreement, contract, or transaction with 

a liquidated damage provision have the 

requisite intent to deliver. 

Comments 

One commenter notes that a 

commercial merchandising arrangement 

involving a nonfinancial commodity 

may provide that the remedy for a 

failure to make or take delivery is the 

payment of a market-rate replacement 

price, a payment on a performance 

guaranty, or ‘‘cover damages’’ to 

compensate the non-breaching party for 

the failure of the other party to fulfill its 

contractual obligations.397 Such a 

contractual damages or remedy 

provision, this commenter contended, is 

not analogous to a financial settlement 

option in a trading instrument.398 This 

commenter further asserted that one 

party or the other may be unable to 

perform, or excused or prevented for 

commercial reasons from performing, its 

contractual obligations to make or take 

delivery of a nonfinancial commodity, 

and therefore may be liable to the other 

party for a monetary payment, 

calculated in accordance with the 

contract.399

Another commenter noted that 

physically settled gas contracts, 

including peaking contracts (both for 

daily and monthly supply), bullet day 

contracts and weather contracts, use the 

NAESB Base Contract, which does not 

provide for financial settlement other 

than a liquidated damages provision, 

which would compensate a utility for its 

cost of obtaining alternative supply at 

the prevailing market price if the seller 

fails to deliver.400 This commenter 

stated its view that the seller has no real 

opportunity to arbitrage its obligation to 

deliver based on changes in price, and 

the purchaser has no incentive to fail to 

take delivery of its specified quantities 

of gas, because they are needed for the 

physical operations of its system.401

The CFTC generally agrees with these 

comments regarding liquidated damages 

provisions, and has provided the final 

interpretation described above to 

address them. 

(c) Security Forwards 402

As the Commissions stated in the 

Proposing Release, the Commissions 

believe it is appropriate to address how 

the exclusions from the swap and 

security-based swap definitions apply to 

security forwards and other purchases 

and sales of securities.403 The 

Commissions are restating the 

interpretation set out in the Proposing 

Release without modification. 

The Dodd-Frank Act excludes 

purchases and sales of securities from 

the swap and security-based swap 

definitions in a number of different 

clauses.404 Under these exclusions, 

purchases and sales of securities on a 

fixed or contingent basis 405 and sales of 

securities for deferred shipment or 

delivery that are intended to be 

physically delivered 406 are explicitly 

excluded from the swap and securitybased swap definitions.407 The 

exclusion from the swap and securitybased swap definitions of a sale of a 

security for deferred shipment or 

delivery involves an agreement to 

purchase one or more securities, or 

groups or indexes of securities, at a 

future date at a certain price. 

As with other purchases and sales of 

securities, security forwards are 

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408A purchase or sale of a security occurs at the 

time the parties become contractually bound, not at 

the time of settlement (regardless of whether cash 

or physically settled). See Securities Offering 

Reform, 70 FR 44722 (Aug. 3, 2005). 

409See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 

1a(47)(B)(ii). 

410See sections 1a(47)(B)(v) and (vi) of the CEA, 

7 U.S.C. 1a(47)(B)(v) and (vi). 

411The Commissions provided the interpretation 

in the Proposing Release in response to commenters 

on the ANPR. See Proposing Release at 29830. 

These commenters requested clarification that 

forward sales of MBS guaranteed or sold by Fannie 

Mae, Freddie Mac and Ginnie Mae would not be 

included in the swap and security-based swap 

definitions in order to provide the certainty needed 

to avoid unnecessary disruption of this market. Id. 

412Task Force on Mortgage-Backed Securities 

Disclosure, ‘‘Staff Report: Enhancing Disclosure in 

the Mortgage-Backed Securities Markets,’’ part II.E.2 

(Jan. 2003), which is available at http:// 

www.sec.gov/news/studies/mortgagebacked.htm 

(‘‘MBS Staff Report’’). 

413 Id. 

414 Id. 

415 Id. 

416 Id. The good delivery guidelines, titled 

‘‘Uniform Practices for the Clearance and 

Settlement of Mortgage-Backed Securities and Other 

Related Securities,’’ which govern the mechanics of 

trading and settling MBS, contain specific 

guidelines for trading and settling MBS guaranteed 

or sold by Fannie Mae, Freddie Mac and Ginnie 

Mae in the TBA market. The good delivery 

guidelines outline the basic terms and conditions 

for trading, confirming, delivering and settling 

MBS. The good delivery guidelines set forth the 

basic characteristics that MBS guaranteed or sold by 

Fannie Mae, Freddie Mac and Ginnie Mae must 

have to be able to be delivered to settle an open 

TBA transaction. Id. The Securities Industry and 

Financial Markets Association (‘‘SIFMA’’) is the 

successor to the Bond Market Association and 

publishes the good delivery guidelines, which are 

available at http://www.sifma.org/services/ 

standard-forms-and-documentation/securitizedproducts/. 

417See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 

1a(47)(B)(ii). 

418See sections 1a(47)(B)(v) and (vi) of the CEA, 

7 U.S.C. 1a(47)(B)(v) and (vi). 

419See Letter from Lisa M. Ledbetter, Vice 

President and General Counsel, Legislative & 

Regulatory Affairs, Freddie Mac, Jul. 21, 2011. 

420See Better Markets Letter. 

421 Id. 

422 Id. 

423 Id. 

424See supra note 408. 

excluded from the swap and securitybased swap definitions. The sale of the 

security in this case occurs at the time 

the forward contract is entered into with 

the performance of the contract deferred 

or delayed.408 If such agreement, 

contract, or transaction is intended to be 

physically settled, the Commissions 

believe it would be within the security 

forward exclusion and therefore outside 

the swap and security-based swap 

definitions.409 Moreover, as a purchase 

or sale of a security, the Commissions 

believe it also would be within the 

exclusions for the purchase or sale of 

one or more securities on a fixed basis 

(or, depending on its terms, a contingent 

basis) and, therefore, outside the swap 

and security-based swap definitions.410

In the Proposing Release, the 

Commissions provided the following 

specific interpretation in the context of 

forward sales of mortgage-backed 

securities (‘‘MBS’’) guaranteed or sold 

by the Federal National Mortgage 

Association (‘‘Fannie Mae’’), the Federal 

Home Loan Mortgage Corporation 

(‘‘Freddie Mac’’), and the Government 

National Mortgage Association (‘‘Ginnie 

Mae’’).411 The Commissions are 

restating their interpretation regarding 

such forward sales. 

MBS guaranteed or sold by Fannie 

Mae, Freddie Mac and Ginnie Mae are 

eligible to be sold in the ‘‘To-BeAnnounced’’ (‘‘TBA’’) market, which is 

essentially a forward or delayed 

delivery market.412 The TBA market has 

been described as one that ‘‘allows 

mortgage lenders essentially to sell the 

loans they intend to fund even before 

the loans are closed.’’ 413 In the TBA 

market, the lender enters into a forward 

contract to sell MBS and agrees to 

deliver MBS on the settlement date in 

the future. The specific MBS that will be 

delivered in the future may not yet be 

created at the time the forward contract 

is entered into.414 In a TBA transaction, 

the seller and the buyer agree to five 

terms before entering into the 

transaction: (i) The type of security, 

which will usually be a certain type of 

MBS guaranteed or sold by Fannie Mae, 

Freddie Mac or Ginnie Mae and the type 

of mortgage underlying the MBS; (ii) the 

coupon or interest rate; (iii) the face 

value (the total dollar amount of MBS 

the purchaser wishes to purchase); (iv) 

the price; and (v) the settlement date.415

The purchaser will contract to acquire a 

specified dollar amount of MBS, which 

may be satisfied when the seller delivers 

one or more MBS pools at settlement.416

The Commissions are confirming that 

such forward sales of MBS in the TBA 

market would fall within the exclusion 

for sales of securities on a deferred 

settlement or delivery basis even though 

the precise MBS are not in existence at 

the time the forward MBS sale is 

entered into.417 Moreover, as the 

purchase or sale of a security, the 

Commissions also are confirming that 

such forward sales of MBS in the TBA 

market would fall within the exclusions 

for the purchase or sale of one or more 

securities on a fixed basis (or, 

depending on its terms, a contingent 

basis) and therefore would fall outside 

the swap and security-based swap 

definitions.418

Comments 

The Commissions received two 

comments on the interpretation 

regarding security forwards. One 

commenter recommended that the 

Commissions codify in the text of the 

final rules the interpretation regarding 

forward sales of MBS in the TBA 

market.419 The Commissions are not 

codifying the interpretation because 

codification will create a bright-line test. 

The Commissions note that the analysis 

as to whether any product falls within 

the exclusion for sales of securities on 

a deferred settlement or delivery basis 

requires flexibility, including the 

consideration of applicable facts and 

circumstances. Because the 

interpretation regarding forward sales of 

MBS in the TBA market is based on 

particular facts and circumstances, the 

Commissions do not believe that a 

bright-line test is appropriate. 

Another commenter suggested that 

the Commissions narrow the exclusion 

for contracts for the purchase and sale 

of securities for subsequent delivery as 

applied to security-based swaps because 

parties can use the formal 

characterization of a delivery contract 

for securities to disguise a transaction 

that is substantively a security-based 

swap.420 This commenter was 

concerned because this commenter 

believes that the securities subject to 

such a delivery obligation are often 

easily convertible into cash, which 

facilitates cash settlement without 

actual delivery.421 As such, this 

commenter suggested that the 

Commissions should provide a test for 

determining whether parties have a 

bona fide intent to deliver.422 This 

commenter recommended that such test 

should prohibit cash settlement options 

in contracts for subsequent delivery and 

should not consider a party that 

frequently unwinds physical positions 

with cash settlements using side 

agreements as having the requisite 

intent to deliver.423 The Commissions 

are not providing a test at this time for 

determining whether parties have a 

bona fide intent to deliver because the 

analysis as to whether sales of securities 

for deferred shipment or delivery are 

intended to be physically delivered is a 

facts and circumstances determination 

and a bright-line test will not allow for 

the flexibility needed in such analysis. 

Further, the Commissions note that the 

purchase and sale of a security occurs 

at the time the forward contract is 

entered into.424

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425See Proposing Release at 29832. 

426 Id. 

427 Id. 

428 Id. 

429 Id. If these types of arrangements were subject 

to Title VII, the persons that could enter into or 

engage in them could be restricted because Title VII 

imposes restrictions on entering into swaps and 

security-based swaps with persons who are not 

eligible contract participants (‘‘ECPs’’). See sections 

723(1), 763(e), and 768(b) of the Dodd-Frank Act. 

The Dodd-Frank Act amended the Securities Act 

and the Exchange Act to require that security-based 

swap transactions involving a person that is not an 

ECP must be registered under the Securities Act and 

effected on a national securities exchange, and also 

amended the CEA to require that swap transactions 

involving a person that is not an ECP must be 

entered into on, or subject to the rules of, a board 

of trade designated as a contract market. Id. The 

Commissions note that many consumers and 

commercial and non-profit entities may not be 

ECPs. See section 1a(18) of the CEA, 7 U.S.C. 

1a(18). Further, if these types of arrangements were 

subject to Title VII, they would be subject to the full 

regulatory scheme for swaps and security-based 

swaps created by Title VII. These requirements 

could increase costs for consumers and commercial 

and non-profit entities and potentially disrupt their 

ability to enter into these arrangements. 

430See Proposing Release at 29832–33. 

431See infra note 447 and accompanying text. 

432For example, a mortgage broker may arrange 

a rate lock on behalf of a consumer borrower. 

433The Commissions are not addressing here the 

applicability of any other provisions of the CEA, the 

Federal securities laws or the Commissions’ 

regulations to such agreements, contracts or 

transactions. 

434These agreements, contracts, or transactions 

require the parties respectively to make and take 

delivery of the underlying commodity to each other 

directly; delivery may be deferred for convenience 

or necessity. But see section 2(c)(2)(D) of the CEA, 

7 U.S.C. 2(c)(2)(D), generally prohibiting certain 

leveraged, margined or financed agreements, 

contracts and transactions with non-ECPs when 

actual delivery does not occur within 28 days). The 

Commissions view consumer agreements, contracts, 

and transactions involving periodic or future 

purchases of consumer products and services as 

transactions that are not swaps. This interpretation 

does not extend to consumer agreements, contracts 

or transactions containing embedded optionality or 

embedded derivatives other than those discussed in 

the text associated with this footnote. This analysis 

of consumer contracts is separate from the forward 

contract analysis for commercial merchandising 

transactions discussed in supra part II.B.2. The 

CFTC continues to view the forward contract 

exclusion for nonfinancial commodities as limited 

to commercial merchandising transactions. 

435An example of a consumer loan with a 

variable rate of interest is credit card debt that 

includes a ‘‘teaser’’ rate. The teaser rate is a low, 

adjustable introductory interest rate that is 

temporary. 

436One commenter indicated that such service 

agreements, contracts, or transactions may be 

regulated as insurance in some but not all states. 

However, the Commissions believe that it is 

appropriate to address these agreements, contracts, 

or transactions in the context of their guidance 

regarding consumer and commercial arrangements. 

See NAIC Letter. 

437The Commissions believe that options entered 

into by consumers that result in physical delivery 

of the commodity, if exercised, are not the type of 

agreements, contracts or transactions that Congress 

intended to regulate as swaps or security-based 

swaps. Conversely, options entered into by 

consumers that cash settle based on the difference 

between the market price and the contract price of 

a commodity are not within the scope of this 

interpretation. 

438Examples of these types of transactions 

include consumer transactions that may be 

cancelled pursuant to the Federal Reserve Board’s 

Regulation Z, 12 CFR Part 226 (i.e. certain consumer 

credit transactions that involve a lien on the 

consumer’s principal dwelling), consumer mail/ 

telephone orders that may be cancelled when orders 

have not been filled under 16 CFR Part 435, and 

other consumer transactions that have cancellations 

rights conferred by statute or regulation. 

3. Consumer and Commercial 

Agreements, Contracts, and 

Transactions 

The Commissions noted in the 

Proposing Release that ‘‘[c]onsumers 

enter into various types of agreements, 

contracts, and transactions as part of 

their household and personal lives that 

may have attributes that could be 

viewed as falling within the swap or 

security-based swap definition.425

Similarly, businesses and other entities, 

whether or not for profit, also enter into 

agreements, contracts, and transactions 

as part of their operations relating to, 

among other things, acquisitions or sales 

of property (tangible and intangible), 

provisions of services, employment of 

individuals, and other matters that 

could be viewed as falling within the 

definitions.’’ 426

Commenters on the ANPR pointed out 

a number of areas in which a broad 

reading of the swap and security-based 

swap definitions could cover certain 

consumer and commercial arrangements 

that historically have not been 

considered swaps or security-based 

swaps.427 Examples of such instruments 

cited by those commenters included 

evidences of indebtedness with a 

variable rate of interest; commercial 

contracts containing acceleration, 

escalation, or indexation clauses; 

agreements to acquire personal property 

or real property, or to obtain mortgages; 

employment, lease, and service 

agreements, including those that contain 

contingent payment arrangements; and 

consumer mortgage and utility rate 

caps.428

The Commissions also stated in the 

Proposing Release that they ‘‘do not 

believe that Congress intended to 

include these types of customary 

consumer and commercial agreements, 

contracts, or transactions in the swap or 

security-based swap definition, to limit 

the types of persons that can enter into 

or engage in them, or to otherwise to 

subject these agreements, contracts, or 

transactions to the regulatory scheme for 

swaps and security-based swaps.’’ 429

Accordingly, the Commissions 

proposed an interpretation in the 

Proposing Release to assist consumers 

and commercial and non-profit entities 

in understanding whether certain 

agreements, contracts, or transactions 

that they enter into would be regulated 

as swaps or security-based swaps.430

The Commissions are adopting the 

interpretation set out in the Proposing 

Release with certain modifications in 

response to commenters.431

With respect to consumers, the 

Commissions have determined that the 

types of agreements, contracts, or 

transactions that will not be considered 

swaps or security-based swaps when 

entered into by consumers (natural 

persons) as principals (or by their 

agents)432 primarily for personal, family, 

or household purposes, include:433

• Agreements, contracts, or 

transactions to acquire or lease real or 

personal property, to obtain a mortgage, 

to provide personal services, or to sell 

or assign rights owned by such 

consumer (such as intellectual property 

rights); 

• Agreements, contracts, or 

transactions to purchase products or 

services for personal, family or 

household purposes at a fixed price or 

a capped or collared price, at a future 

date or over a certain time period (such 

as agreements to purchase for personal 

use or consumption nonfinancial energy 

commodities, including agreements to 

purchase home heating fuel or 

agreements involving residential fuel 

storage, in either case, where the 

consumer takes delivery of and uses the 

fuel, and the counterparty is a merchant 

that delivers in the service area where 

the consumer resides);434

• Agreements, contracts, or 

transactions that provide for an interest 

rate cap or lock on a consumer loan or 

mortgage, where the benefit of the rate 

cap or lock is realized only if the loan 

or mortgage is made to the consumer; 

• Consumer loans or mortgages with 

variable rates of interest or embedded 

interest rate options, including such 

loans with provisions for the rates to 

change upon certain events related to 

the consumer, such as a higher rate of 

interest following a default; 435

• Service agreements, contracts, or 

transactions that are consumer product 

warranties, extended service plans, or 

buyer protection plans, such as those 

purchased with major appliances and 

electronics; 436

• Consumer options to acquire, lease, 

or sell real or personal property, such as 

options to lease apartments or purchase 

rugs and paintings, and purchases made 

through consumer layaway plans; 437

• Consumer agreements, contracts, or 

transactions where, by law or 

regulation, the consumer may cancel the 

transaction without legal cause; 438 and 

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439See supra note 96 and accompanying text. See 

also infra notes 436, 454 and 455 and 

accompanying text. 

440The additional example regarding consumer 

options to acquire, lease, or sell real or personal 

property was added in response to a commenter on 

the ANPR. See Letter from White & Case LLP, dated 

September 20, 2010. The Commissions also are 

providing as additional examples consumer 

agreements, contracts, or transactions where, by law 

or regulation, the consumer may cancel the 

transaction without legal cause, and consumer 

guarantees of credit card debt, automobile loans, 

and mortgages of a friend or relative. 

441These business combination transactions 

include, for example, a reclassification, merger, 

consolidation, or transfer of assets as defined under 

the Federal securities laws or any tender offer 

subject to section 13(e) and/or section 14(d) or (e) 

of the Exchange Act, 15 U.S.C. 78m(e) and/or 

78n(d) or (e). These business combination 

agreements, contracts, or transactions can be 

contingent on the continued validity of 

representations and warranties and can contain 

earn-out provisions and contingent value rights. 

442The Commissions believe that such lending 

arrangements included in this category are 

traditional borrower/lender arrangements 

documented using, for example, a loan agreement 

or indenture, as opposed to a synthetic lending 

arrangement documented in the form of, for 

example, a total return swap. The Commissions also 

note that securitization transaction agreements also 

may contain contingent obligations if the 

representations and warranties about the 

underlying assets are not satisfied. 

443While the Commissions have included fixed 

or variable interest rate commercial loans entered 

into by banks, the Commissions understand that the 

CEA does not apply to, and the CFTC may not 

exercise regulatory authority over, identified 

banking products, and that the definitions of the 

terms ‘‘security-based swap’’ and ‘‘security-based 

swap agreement’’ do not include identified banking 

products. See infra note 488, regarding identified 

banking products. However, such loans and 

mortgages provided by certain banks may not 

qualify as identified banking products because 

those banks may not satisfy the definition of ‘‘bank’’ 

for purposes of the ‘‘identified banking products’’ 

definition. See 7 U.S.C. 27(a). 

444See infra notes 456 and 461 and 

accompanying text. 

• Consumer guarantees of credit card 

debt, automobile loans, and mortgages 

of a friend or relative. 

The Commissions have included in the 

interpretation above several additional 

examples of consumer arrangements 

that the Commissions do not consider to 

be swaps or security-based swaps. These 

additional examples have been included 

in response to commenters 439 and the 

Commissions’ determination that such 

additional examples would assist 

consumers in identifying other 

agreements, contracts, or transactions 

that they enter into that would not be 

regulated as swaps or security-based 

swaps.440

The types of commercial agreements, 

contracts, or transactions that involve 

customary business arrangements 

(whether or not involving a for-profit 

entity) and will not be considered swaps 

or security-based swaps under this 

interpretation include: 

• Employment contracts and 

retirement benefit arrangements; 

• Sales, servicing, or distribution 

arrangements; 

• Agreements, contracts, or 

transactions for the purpose of effecting 

a business combination transaction; 441

• The purchase, sale, lease, or transfer 

of real property, intellectual property, 

equipment, or inventory; 

• Warehouse lending arrangements in 

connection with building an inventory 

of assets in anticipation of a 

securitization of such assets (such as in 

a securitization of mortgages, student 

loans, or receivables); 442

• Mortgage or mortgage purchase 

commitments, or sales of installment 

loan agreements or contracts or 

receivables; 

• Fixed or variable interest rate 

commercial loans or mortgages entered 

into by banks 443 and non-banks, 

including the following: 

• Fixed or variable interest rate 

commercial loans or mortgages entered 

into by the Farm Credit System 

institutions and Federal Home Loan 

Banks; 

• Fixed or variable interest rate 

commercial loans or mortgages with 

embedded interest rate locks, caps, or 

floors, provided that such embedded 

interest rate locks, caps, or floors are 

included for the sole purpose of 

providing a lock, cap, or floor on the 

interest rate on such loan or mortgage 

and do not include additional 

provisions that would provide exposure 

to enhanced or inverse performance, or 

other risks unrelated to the interest rate 

risk being addressed; 

• Fixed or variable interest rate 

commercial loans or mortgages with 

embedded interest rate options, 

including such loans or mortgages that 

contain provisions causing the interest 

rate to change upon certain events 

related to the borrower, such as a higher 

rate of interest following a default, 

provided that such embedded interest 

rate options do not include additional 

provisions that would provide exposure 

to enhanced or inverse performance, or 

other risks unrelated to the primary 

reason the embedded interest rate 

option is included; and 

• Commercial agreements, contracts, 

and transactions (including, but not 

limited to, leases, service contracts, and 

employment agreements) containing 

escalation clauses linked to an 

underlying commodity such as an 

interest rate or consumer price index. 

In response to commenters,444 the 

Commissions have included in the 

interpretation above several additional 

examples of commercial arrangements 

that the Commissions do not consider to 

be swaps or security-based swaps. 

The Commissions intend for this 

interpretation to enable consumers to 

engage in transactions relating to their 

households and personal or family 

activities without concern that such 

arrangements would be considered 

swaps or security-based swaps. 

Similarly, with respect to commercial 

business arrangements, this 

interpretation should allow commercial 

and non-profit entities to continue to 

operate their businesses and operations 

without significant disruption and 

provide that the swap and securitybased swap definitions are not read to 

include commercial and non-profit 

operations that historically have not 

been considered to involve swaps or 

security-based swaps. 

The types of agreements, contracts, 

and transactions discussed above are 

not intended to be exhaustive of the 

customary consumer or commercial 

arrangements that should not be 

considered to be swaps or securitybased swaps. There may be other, 

similar types of agreements, contracts, 

and transactions that also should not be 

considered to be swaps or securitybased swaps. In determining whether 

similar types of agreements, contracts, 

and transactions entered into by 

consumers or commercial entities are 

swaps or security-based swaps, the 

Commissions intend to consider the 

characteristics and factors that are 

common to the consumer and 

commercial transactions listed above: 

• They do not contain payment 

obligations, whether or not contingent, 

that are severable from the agreement, 

contract, or transaction; 

• They are not traded on an organized 

market or over-the-counter; and 

• In the case of consumer 

arrangements, they: 

—Involve an asset of which the 

consumer is the owner or beneficiary, 

or that the consumer is purchasing, or 

they involve a service provided, or to 

be provided, by or to the consumer, or 

• In the case of commercial 

arrangements, they are entered into: 

—By commercial or non-profit entities 

as principals (or by their agents) to 

serve an independent commercial, 

business, or non-profit purpose, and 

—Other than for speculative, hedging, 

or investment purposes. 

Two of the key components reflected 

in these characteristics that distinguish 

these agreements, contracts, and 

transactions from swaps and securitybased swaps are that: (i) The payment 

provisions of the agreement, contract, or 

transaction are not severable; and (ii) 

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48248 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

445There also are alternative regulatory regimes 

that have been enacted as part of the Dodd-Frank 

Act specifically to provide enhanced protections to 

consumers relating to various consumer 

transactions. See, e.g., the Consumer Financial 

Protection Act of 2010, Public Law 111–203, tit. X, 

124 Stat. 1376 (Jul. 21, 2010) (establishing the 

Bureau of Consumer Financial Protection to 

regulate a broad category of consumer products and 

amending certain laws under the jurisdiction of the 

Federal Trade Commission); the Mortgage Reform 

and Anti-Predatory Lending Act, Public Law 111– 

203, tit. XIV, 124 Stat. 1376 (Jul. 21, 2010) 

(amending existing laws, and adding new 

provisions, related to certain mortgages). Some of 

these agreements, contracts, or transactions are 

subject to regulation by the Federal Trade 

Commission and other Federal financial regulators 

and state regulators. 

446See infra note 470. 

447See BGA Letter; Letter from The Coalition for 

Derivatives End-Users, Jul. 22, 2011, (‘‘CDEU 

Letter’’); ETA Letter; Letter from Robbie Boone, Vice 

President, Government Affairs, Farm Credit 

Council, Jul. 22, 2011 (‘‘FCC Letter’’); FERC Staff 

Letter; Letter from Warren N. Davis, Of Counsel, 

Sutherland Asbill & Brennan LLP, on behalf of the 

Federal Home Loan Banks, Jul. 22, 2011 (‘‘FHLB 

Letter’’); IECA Letter; ISDA Letter; Just Energy 

Letter; PMAA/NEFI Letter; and SEIA Letter. 

448See ETA Letter; FERC Letter; IECA Letter; and 

Just Energy Letter. 

449See IECA Letter. 

450See Proposing Release at 29832. 

451See ISDA Letter. 

452 Id. 

453See CDEU Letter; FCC Letter; FERC Letter; 

FHLB Letter; ISDA Letter; Just Energy Letter; 

PMAA/NEFI Letter; and SEIA Letter. 

454See Just Energy Letter. 

the agreement, contract, or transaction is 

not traded on an organized market or 

over-the-counter, and therefore such 

agreement, contract, or transaction does 

not involve risk-shifting arrangements 

with financial entities, as would be the 

case for swaps and security-based 

swaps.445 In response to commenters,446

the Commissions clarify that merely 

because an agreement, contract, or 

transaction is assignable does not mean 

that it is ‘‘traded’’ or that the agreement, 

contract, or transaction is a swap or 

security-based swap. An assignment of 

a contractual obligation must be 

analyzed to assure that the result is not 

to sever the payment obligations. 

This interpretation is not intended to 

be the exclusive means for consumers 

and commercial or non-profit entities to 

determine whether their agreements, 

contracts, or transactions fall within the 

swap or security-based swap definition. 

If there is a type of agreement, contract, 

or transaction that is not enumerated 

above, or does not have all the 

characteristics and factors that are listed 

above (including new types of 

agreements, contracts, or transactions 

that may be developed in the future), 

the agreement, contract, or transaction 

will be evaluated based on its particular 

facts and circumstances. Parties to such 

an agreement, contract or transaction 

may also seek an interpretation from the 

Commissions as to whether the 

agreement, contract or transaction is a 

swap or security-based swap. 

Comments 

Eleven commenters provided 

comments on the proposed 

interpretation set forth in the Proposing 

Release regarding consumer and 

commercial arrangements.447 While 

most commenters supported the 

proposed interpretation, these 

commenters suggested certain changes. 

Four commenters recommended that 

the Commissions codify the proposed 

interpretation regarding consumer and 

commercial arrangements.448 The 

Commissions are not codifying the 

interpretation. The interpretation is 

intended to provide guidance to assist 

consumers and commercial and nonprofit entities in evaluating whether 

certain arrangements that they enter into 

will be regulated as swaps or securitybased swaps. The interpretation is 

intended to allow the flexibility 

necessary, including the consideration 

of the applicable facts and 

circumstances by the Commissions, in 

evaluating consumer and commercial 

arrangements to ascertain whether they 

may be swaps or security-based swaps. 

The representative characteristics and 

factors taken together are indicators that 

a consumer or commercial arrangement 

is not a swap or security-based swap 

and the Commissions have provided 

specific examples demonstrating how 

these characteristics and factors apply to 

some common types of consumer and 

commercial arrangements. However, as 

the interpretation is not intended to be 

a bright-line test for determining 

whether a particular consumer or 

commercial arrangement is a swap or 

security-based swap, if the particular 

arrangement does not meet all of the 

identified characteristics and factors, 

the arrangement will be evaluated based 

on its particular facts and 

circumstances. 

One commenter was concerned that 

the interpretation itself implicitly 

suggests that many types of consumer 

and commercial arrangements could be 

swaps, although none of these 

arrangements historically has been 

considered a swap.449 The Commissions 

do not intend to suggest that many types 

of consumer and commercial 

arrangements that historically have not 

been considered swaps are within the 

swap or security-based swap 

definitions. The Commissions provided 

the interpretation in response to 

comments received on the ANPR. 

Commenters on the ANPR identified 

areas in which a broad reading of the 

swap and security-based swap 

definitions could cover certain 

consumer and commercial arrangements 

that historically have not been 

considered swaps or security-based 

swaps.450 The Commissions believe it is 

appropriate to provide the interpretation 

to allow consumers and commercial and 

non-profit entities to engage in such 

transactions without concern that such 

arrangements would be considered 

swaps or security-based swaps. 

One commenter requested that the 

Commissions remove the term 

‘‘customary’’ from the description of 

consumer and commercial arrangements 

in the interpretation.451 The 

Commissions note that the use of the 

term ‘‘customary’’ was not intended to 

limit the interpretation, but rather was 

used to describe certain types of 

arrangements that consumers and 

businesses may normally or generally 

enter into. The Commissions also note 

that the term ‘‘customary’’ is itself not 

a separate representative characteristic 

or factor for purposes of the 

interpretation. 

This commenter also requested that 

specific examples of consumer and 

commercial arrangements that are not 

swaps or security-based swaps include 

‘‘any other similar agreements, 

contracts, or transactions.’’ 452 The 

specific examples are not intended to be 

an exhaustive list and the Commissions 

do not believe that it is necessary to 

include a general catchall provision. 

The interpretation also includes a list of 

representative characteristics and 

factors to be used to analyze other 

consumer and commercial 

arrangements. 

Several commenters suggested 

additional examples of consumer and 

commercial arrangements that the 

Commissions should not consider to be 

swaps or security-based swaps.453 One 

commenter suggested that the 

Commissions should expand the 

example of ‘‘consumer agreements, 

contracts, or transactions to purchase 

products or services at a fixed price or 

a capped or collared price, at a future 

date or over a certain time period (such 

as agreements to purchase home heating 

fuel)’’ to include all nonfinancial energy 

commodities in the parenthetical 

example.454 The Commissions have 

modified the identified consumer 

example to include all nonfinancial 

energy commodities. The parenthetical 

example was not intended to be limited 

to agreements to purchase home heating 

fuel. 

One commenter suggested that the 

Commissions should include as an 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48249 

455See PMAA/NEFI Letter. 456See CDEU Letter; FCC Letter; and FHLB Letter. 457See FCC Letter and FHLB Letter. 458See infra note 488, regarding identified 

banking products. 459See 7 U.S.C. 27(a). See also FCC Letter and 

FHLB Letter. 460See supra note 457. 

461See CDEU Letter; FCC Letter; and FHLB Letter. 

These commenters indicated that such 

arrangements are similar to the arrangements 

included in the list of examples of consumer 

arrangements that the Commissions would not 

consider to be swaps or security-based swaps. 462See section 1a(47)(A)(i) of the CEA, 7 U.S.C. 

1a(47)(A)(i). Similarly, with respect to consumer 

agreements, contracts and transactions providing 

for an interest rate cap or an interest rate lock on 

a consumer loan or mortgage, the Commissions are 

limiting this example to interest rate caps and 

interest rate locks entered into in connection with 

the consumer loan or mortgage and prior to closing 

on the loan or mortgage. For this purpose, both 

because obtaining a consumer loan or mortgage can 

involve a great deal of documentation, which can 

be entered into at different times during the 

process, and because consumers may have some 

flexibility as to their deadline for deciding when to 

include or exclude an interest rate cap or lock in 

their consumer loans or mortgages, the 

Commissions will consider an interest rate cap or 

lock to be entered into in connection with a 

consumer loan or mortgage if it is included in the 

final terms of the loan at closing. 

463See BGA Letter (commercial physical 

transactions in the natural gas and electric power 

markets should also fall under the category of 

exemptions from the swap definition); FERC Letter 

(commercial transactions executed or traded on 

RTOs/ISOs should be included in the 

interpretation); Just Energy Letter (commercial 

arrangements to purchase products or services at a 

fixed price or a capped or collared price, at a future 

date or over a certain time period); and PMAA/NEFI 

Letter (petroleum fuel and gas storage contracts 

between bona fide commercial market participants 

or entities other than financial entities). 

464See supra part II.B.2. The Commissions note 

that they provided the interpretation regarding 

consumer arrangements because the CFTC in the 

past has not interpreted the forward contract 

exclusion for nonfinancial commodities to apply to 

consumer arrangements. See supra note 434. 

465See supra note 317 and accompanying text. 

466See FCC Letter. 

467See ETA Letter and ISDA Letter. 

468 Id. 

additional example residential fuel 

storage contracts.455 The Commissions 

agree that these arrangements should 

not be considered swaps or securitybased swaps, provided that they are 

residential fuel storage contracts where 

the consumer takes delivery of and 

consumes the fuel, and the counterparty 

is a merchant (or agent of a merchant) 

that delivers in the service area where 

the consumer’s residence is located. 

Although the consumer may not 

immediately consume the fuel 

contracted for, because it will ultimately 

consume the fuel for personal, family, or 

household purposes, such a transaction 

is a type of customary consumer 

transaction excluded from the swap and 

security-based swap definitions. 

Three commenters requested 

clarification that commercial loans and 

mortgages would fall within the 

interpretation regardless of whether 

entered into by a bank or non-bank.456

Two of these commenters were 

concerned that the specific example was 

limited to commercial loans and 

mortgages entered into by non-banks 

and did not address commercial loans 

and mortgages entered into by financial 

institutions that are banks but whose 

loans and mortgages do not qualify as 

identified banking products.457 The 

Commissions are revising the example 

to clarify that it includes fixed or 

variable interest rate commercial loans 

or mortgages entered into by both banks 

and non-banks, including such loans 

and mortgages entered into by the Farm 

Credit System institutions and Federal 

Home Loan Banks. The Commissions 

understand that the CEA does not apply 

to, and the CFTC may not exercise 

regulatory authority over, and the 

definitions of the terms ‘‘security-based 

swap’’ and ‘‘security-based swap 

agreement’’ do not include, any fixed or 

variable interest rate commercial loan or 

mortgage entered into by a bank that is 

an identified banking product.458

However, loans and mortgages provided 

by certain banks may not qualify as 

identified banking products because 

those banks do not satisfy the definition 

of ‘‘bank’’ for purposes of the 

‘‘identified banking products’’ 

definition.459 According to 

commenters,460 while this definition of 

‘‘bank’’ includes insured depository 

institutions, certain foreign banks, credit 

unions, institutions regulated by the 

Federal Reserve and trust companies, it 

does not include certain other financial 

institutions that provide commercial 

loans or mortgages, such as governmentsponsored enterprises (including the 

Federal Home Loan Banks) and certain 

cooperatives (including the Farm Credit 

System institutions). 

Three commenters suggested that the 

Commissions should include as 

additional examples commercial rate 

lock agreements and commercial loans 

with interest rate caps, floors, or 

options.461 The Commissions agree that 

these arrangements should not be 

considered swaps or security-based 

swaps, provided that the interest rate 

locks, caps, or floors, or interest rate 

options are embedded in the 

commercial loans or mortgages and not 

entered into separately from the 

commercial loans and mortgages, and 

are including these arrangements as 

examples in the interpretation. 

However, the Commissions are limiting 

the interpretation to embedded interest 

rate locks, caps, or floors, and interest 

rate options because interest rate locks, 

caps, or floors, or interest rate options 

that are entered into separately from the 

commercial loans and mortgages fall 

within the swap definition.462 In order 

to further distinguish these 

arrangements from swaps and securitybased swaps, the interpretation provides 

the following: (i) The embedded interest 

rate lock, cap, or floor must be included 

for the sole purpose of providing a lock, 

cap, or floor on the interest rate on such 

loan or mortgage and may not include 

additional provisions that would 

provide exposure to enhanced or 

inverse performance, or other risks 

unrelated to the interest rate risk being 

addressed, and (ii) the embedded 

interest rate option may not include 

additional provisions that would 

provide exposure to leverage, inverse 

performance, or other risks unrelated to 

the primary reason the embedded 

interest rate option is included in the 

commercial loan or mortgage. 

Four commenters suggested 

additional examples of commercial 

arrangements that relate to nonfinancial 

energy commodities.463 These 

arrangements are more appropriately 

addressed in the context of the forward 

contract exclusion for nonfinancial 

commodities 464 or the trade option 

exemption.465

One commenter supported the 

representative characteristics and 

factors the Commissions set forth to 

distinguish consumer and commercial 

arrangements from swaps and securitybased swaps.466 Two commenters were 

concerned with certain of these 

characteristics and factors because these 

commenters believed that such 

characteristics and factors are common 

in a wide variety of consumer and 

commercial arrangements.467 Both 

commenters suggested that the 

Commissions remove ‘‘for other than 

speculative, hedging or investment 

purposes’’ from the interpretation 

because many of the types of 

transactions listed as examples may be 

undertaken for speculative, hedging or 

investment purposes and because all 

commercial merchandising transactions 

are ‘‘risk-shifting’’ of commercial 

obligations and risks, and ‘‘hedge’’ the 

enterprise’s commercial risks.468 The 

Commissions are not revising the 

interpretation to remove or otherwise 

modify this representative characteristic 

and factor. The Commissions believe 

that commercial arrangements 

undertaken for speculative, hedging or 

investment purposes may be a swap or 

a security-based swap depending on the 

particular facts and circumstances of the 

arrangement. 

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48250 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

469See ISDA Letter. 

470 Id. 

471See ETA Letter. 

472 16 U.S.C. Chapter 12H. 

473Letter from Virginia K. Schaeffer, Attorney, 

Office of General Counsel, Bonneville Power 

Administration, Jul. 22, 2011 (‘‘BPA Letter’’). This 

commenter refers to the implementation of Section 

5(c) of the Northwest Power Act, 16 U.S.C. 839c(c), 

as the ‘‘Residential Exchange Program.’’ See Id. 

474See BPA Letter. This commenter explained 

that, under the REP: ‘‘A Pacific Northwest electric 

utility has a right to * * * sell power to Bonneville 

at the utility’s average system cost (ASC) of 

providing that power * * * Bonneville[] is required 

to purchase that power at the utility’s ASC, and 

then sell an equivalent amount of power back to the 

utility at Bonneville’s rates[,] which are based in 

substantial part on low cost Federal hydro power. 

As required by the Residential Exchange Statute, 

the amount of such power ‘‘exchanged’’ is based on 

the related utility’s residential and small farm 

customer’s power needs (also known as ‘‘loads’’) in 

the Pacific Northwest Region. Under this 

‘‘exchange,’’ no actual power is transferred to or 

from Bonneville. Instead, consistent with 

Congressional intent, the exchange transaction is 

implemented as an accounting device that avoids 

the costs and burdens associated with a physical 

exchange of power and that results in the payment 

of funds by Bonneville to the REP exchanging 

utilities. Reduced to the essentials, the Residential 

Exchange Statute as implemented in * * * REP 

contracts results in Bonneville making cash 

payments for the positive difference between the 

utility’s ASC and Bonneville’s lower rate multiplied 

by the qualifying residential and small farm loads. 

And, as required under the Residential Exchange 

Statute, the entire monetary benefit Bonneville 

provides to the REP exchanging utilities is in turn 

passed through to the residential and small farm 

power consumers of that utility.’’ Id. 475A spread option is ‘‘an option in which the 

payout is based on the difference in performance 

between two assets.’’ Superderivatives, ‘‘Spread 

option in EQ’’ definition, available at http://

www.sdgm.com/Support/Glossary.aspx?letter=S. 

See also S.J. Denga and S.S. Oren, Electricity 

derivatives and risk management, Science Direct at 

945 (2006), available at http://www.ieor.

berkeley.edu/∼oren/pubs/Deng%20and%20Oren86.pdf (defining a spark spread options as ‘‘crosscommodity options paying out the difference 

between the price of electricity sold by generators 

and the price of the fuels used to generate it’’); 

Chicago Mercantile Exchange, Soybean-Corn Price 

Ratio Options Fact Card (describing its soybeancorn price ratio option contract as ‘‘an option on the 

ratio between the price of the referencing Soybean 

futures contract and the price of the referencing 

Corn futures contract * * *’’), available at http://

www.cmegroup.com/trading/agricultural/files/AC440-Soybean-CornRatioOptionsFC.pdf. 

476Even a hedging party assumes the risk that the 

market can move against its hedging position, 

causing the hedge to reduce the profit it otherwise 

would have made on an unhedged position. 477The fact that the Commissions are relying in 

part on this aspect of REP transactions to interpret 

such transactions to be neither swaps nor securitybased swaps does not mean that market participants 

should conclude, in other contexts, that a lack of 

market risk removes an agreement, contract, or 

transaction from the swap and security-based swap 

definitions. The Commissions’ conclusion as to REP 

transactions is based on the unique facts and 

circumstances presented by the commenter. 

478See, e.g., Paul M. Murphy, Northwest Public 

Power Association, Background and Summary of 

the Residential Exchange Program Settlement 

Agreement, March 16, 2011, available at http://

www.nwppa.org/cwt/external/wcpages/wcmedia/

documents/background_and_summary_of_rep_

settlement_agreement.pdf (characterizing the REP 

as ‘‘require[ing] BPA to subsidize the residential 

and small farm consumers of the higher cost 

utilities in the Pacific Northwest’’). 

479See Proposing Release at 29834. 

One of these commenters also 

suggested the Commissions remove ‘‘do 

not contain payment obligations that are 

severable’’ from the interpretation 

because assignment of rights and 

delegation of obligations are common in 

a wide variety of consumer and 

commercial transactions.469 The 

Commissions are not revising the 

interpretation to remove or otherwise 

modify this representative characteristic 

and factor. The Commissions believe 

that the severability of payment 

obligations could be indicative of a 

consumer or commercial arrangement 

that may be a swap or a security-based 

swap depending on the particular facts 

and circumstances of the arrangement 

because the severability of payment 

obligations could be indicative of an 

instrument that is merely an exchange 

of payments, such as is the case with 

swaps and security-based swaps. 

One of these commenters also 

suggested that the Commissions remove 

‘‘not traded on an organized market or 

over the counter’’ from the 

interpretation because many of the types 

of contracts listed as examples are 

assignable and frequently assigned or 

traded.470 The other commenter did not 

suggest removing this factor, but 

requested that the factor be modified to 

provide that the arrangement is not 

traded on a ‘‘registered entity’’ in order 

not to include transactions on organized 

wholesale electricity markets.471 The 

Commissions are not revising the 

interpretation to remove or otherwise 

modify this representative characteristic 

and factor. The Commissions believe 

that the trading of an instrument on an 

organized market or over the counter 

could be indicative of a consumer or 

commercial arrangement that may be a 

swap or a security-based swap 

depending on the particular facts and 

circumstances of the arrangement. 

However, as noted above, the 

Commissions are clarifying that merely 

because an arrangement is assignable 

does not mean that it is ‘‘traded’’ or that 

the arrangement is a swap or securitybased swap. An assignment of a 

contractual obligation must be analyzed 

to assure that the result is not to sever 

the payment obligations. 

Further, as noted above, the 

representative characteristics and 

factors are not intended to be a brightline test for determining whether a 

particular consumer or commercial 

arrangement is a swap or security-based 

swap. These representative 

characteristics and factors taken 

together are indicators that a consumer 

or commercial arrangement is not a 

swap or security-based swap. These 

representative characteristics and 

factors also do not imply or presume 

that a consumer or commercial 

arrangement that does not meet all of 

these characteristics and factors is a 

swap or security-based swap. As noted 

above, if a particular arrangement does 

not meet all of these characteristics and 

factors, the parties will need to evaluate 

the arrangement based on the particular 

facts and circumstances. Moreover, as 

noted above, if there is a type of 

consumer or commercial arrangement 

that does not meet all of these 

characteristics and factors, a party to the 

arrangement can seek an interpretation 

from the Commissions as to whether the 

arrangement is outside the scope of the 

swap and security-based swap 

definitions. 

Residential Exchange Program 

One commenter requested that the 

CFTC further define the term ‘‘swap’’ to 

exclude consumer benefits under the 

Pacific Northwest Electric Power 

Planning and Conservation Act of 1980 

(‘‘Northwest Power Act’’) 472 and 

transactions under the ‘‘Residential 

Exchange Program’’ (‘‘REP’’).473

According to this commenter, the REP 

was established by Congress ‘‘[t]o 

extend the benefits of low cost Federal 

System hydro power to residential and 

small farm electric power consumers 

throughout the Pacific Northwest 

Region.’’ 474 Based on the commenter’s 

description, REP transactions do not 

appear to be among the types of 

transactions historically considered 

swaps or security-based swaps. 

Although the REP transactions 

described by the commenter share some 

features with spread options (e.g., they 

settle in cash based on the difference 

between two price sources),475 in both 

swaps and security-based swaps, each 

party assumes market risk.476 By 

contrast, neither party assumes or 

hedges risk in an REP transaction.477

Instead, the Commissions view an REP 

transaction essentially as a subsidy 

provided to residential and small farm 

utility customers.478 Accordingly, the 

Commissions do not consider the REP 

transactions described by the 

commenter to be swaps or securitybased swaps. 

Loan Participations 

The Commissions provided an 

interpretation in the Proposing Release 

regarding the treatment of loan 

participations.479 The Commissions are 

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480See infra note 504 and accompanying text. 

481See Loan Market Association, ‘‘Guide to 

Syndicated Loans,’’ section 6.2.4 (‘‘A [loan] 

participation * * * is made between the existing 

lender and the participant. This creates new 

contractual rights between the existing lender and 

the participant which mirror existing contractual 

rights between the existing lender and the borrower. 

However this is not an assignment of those existing 

rights and the existing lender remains in a direct 

contractual relationship with the borrower.’’), 

available at http://www.lma.eu.com/uploads/files/

Introductory_Guides/Guide_to_Par_Syndicated

_Loans.pdf. 

482See Letter from R. Bram Smith, Executive 

Director, The Loan Syndications and Trading 

Association, Jan. 25, 2011 (‘‘January LSTA Letter’’); 

Letter from Elliot Ganz, General Counsel, The Loan 

Syndications and Trading Association, Mar. 1, 2011 

(‘‘March LSTA Letter’’); and Letter from Clare 

Dawson, Managing Director, The Loan Market 

Association, Feb. 23, 2011. The Commissions 

understand that neither type of loan participation 

is a ‘‘synthetic’’ transaction. See March LSTA 

Letter. Both types of loan participations are merely 

transfers of cash loan positions and the ratio of 

underlying loan to participation is always one to 

one. Id. 

483The LSTA is The Loan Syndications and 

Trading Association. 

484The LMA is The Loan Market Association. 

485See Letter from Clare Dawson, Managing 

Director, The LMA, Jul. 22, 2011 (‘‘July LMA 

Letter’’). 

486See Id. The participant may exercise an 

‘‘elevation’’ right and request that the grantor use 

commercially reasonable efforts to cause the 

participant to become the legal owner, by 

assignment, of the underlying loan or commitment. 

Id. 

487See sections 1a(47)(B)(v) and (vi) of the CEA, 

7 U.S.C. 1a(47)(b)(v) and (vi), as amended by 

section 721(a)(21) of the Dodd-Frank Act (excluding 

purchases and sales of a security on a fixed or 

contingent basis, respectively from the swap 

definition). 

488See section 403(a) of the Legal Certainty for 

Bank Products Act of 2000, 7 U.S.C. 27a(a), as 

amended by section 725(g)(2) of the Dodd-Frank 

Act (providing that, under certain circumstances, 

the CEA shall not apply to, and the CFTC shall not 

exercise regulatory authority over, identified 

banking products, and the definitions of the terms 

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

agreement’’ shall not include identified banking 

products). 

489See infra note 504 and accompanying text. See 

also infra notes 490, 491, and 492 and 

accompanying text. 

490See July LMA Letter. 

491 Id. 

492 Id. 

493Proposing Release at 29834. 

494See infra note 503 and accompanying text. 

restating the interpretation set out in the 

Proposing Release with certain 

modifications in response to 

commenters.480

Loan participations arise when a 

lender transfers or offers a participation 

in the economic risks and benefits of all 

or a portion of a loan or commitment it 

has entered into with a borrower to 

another party as an alternative or 

precursor to assigning to such person 

the loan or commitment or an interest 

in the loan or commitment.481 The 

Commissions understand that two types 

of loan participations exist in the market 

today,482 LSTA-style participations483

and LMA-style participations.484 LSTAstyle participations transfer a beneficial 

ownership interest in the underlying 

loan or commitment to the 

participant.485 LMA-style participations 

do not transfer a beneficial ownership 

interest in the underlying loan or 

commitment to the participant, but 

rather create a debtor-creditor 

relationship between the grantor and the 

participant under which a future 

beneficial ownership interest is 

conveyed.486

Depending on the facts and 

circumstances, a loan participation may 

be a security under the Federal 

securities laws and, as such, the loan 

participation would be excluded from 

the swap definition as the purchase and 

sale of a security on a fixed or 

contingent basis.487 In addition, 

depending on the facts and 

circumstances, a loan participation may 

be an identified banking product and, as 

such, would be excluded from CFTC 

jurisdiction and from the security-based 

swap and security-based swap 

agreement definitions.488

The Commissions believe it is 

important to provide further guidance as 

to the other circumstances in which 

certain loan participations would not 

fall within the swap and security-based 

swap definitions. Consistent with the 

proposal, the Commissions do not 

interpret the swap and security-based 

swap definitions to include loan 

participations that reflect an ownership 

interest in the underlying loan or 

commitment. The Commissions believe 

that for a loan participation to not be 

considered a swap or security-based 

swap, the loan participation must 

represent a current or future direct or 

indirect ownership interest in the loan 

or commitment that is the subject of the 

loan participation. 

In evaluating whether the loan 

participation represents such an 

ownership interest, the Commissions 

believe the following characteristics 

should be present: 

• The grantor of the loan 

participation is a lender under, or a 

participant or sub-participant in, the 

loan or commitment that is the subject 

of the loan participation. 

• The aggregate participation in the 

loan or commitment that is the subject 

of the loan participation does not 

exceed the principal amount of such 

loan or commitment. Further, the loan 

participation does not grant, in the 

aggregate, to the participant in such loan 

participation a greater interest than the 

grantor holds in the loan or commitment 

that is the subject of the loan 

participation. 

• The entire purchase price for the 

loan participation is paid in full when 

acquired and not financed. The 

Commissions believe a purchase price 

would not be paid in full if the grantor 

of the loan participation extends 

financing to the participant or if such 

participant levers its purchase, 

including by posting collateral to secure 

a future payment obligation. 

• The loan participation provides the 

participant all of the economic benefit 

and risk of the whole or part of the loan 

or commitment that is the subject of the 

loan participation. 

These characteristics, which were 

identified by commenters,489 are 

intended to distinguish loan 

participations from swaps and securitybased swaps based on loans. The first 

characteristic above addresses the 

ownership of the underlying loan or 

commitment. Swaps and security-based 

swaps may be created using a synthetic 

or derivative structure that does not 

require ownership of the underlying 

loan.490 The second characteristic above 

addresses the ratio of the participation 

to the underlying loan or commitment. 

Swaps and security-based swaps based 

on loans may involve synthetic 

exposure to a loan that is a multiple of 

the principal amount.491 The third 

characteristic above addresses leverage 

in the financing of a loan participation. 

Leverage could be indicative of an 

instrument that is merely an exchange 

of payments and not a transfer of the 

ownership of the underlying loan or 

commitment, such as may be the case 

with a swap or security-based swap.492

The fourth characteristic above 

addresses the level of participation in 

the economic benefits and risks of the 

underlying loan or commitment. This 

characteristic is indicative of ownership 

when analyzed with the other 

characteristics and, as noted above, 

swaps and security-based swaps may be 

created using a synthetic or derivative 

structure that does not require 

ownership of the underlying loan. 

The Commissions agree with 

commenters that the loan participation 

does not have to be a ‘‘true 

participation,’’ as the Commissions had 

stated in their interpretation in the 

Proposing Release,493 in order for the 

loan participation to fall outside the 

swap and security-based swap 

definitions.494 The Commissions note 

that the ‘‘true participation’’ analysis is 

used to determine whether a transaction 

has resulted in the underlying assets 

being legally isolated from a transferor’s 

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495 Id. 

496 Id. 

497 Id. 

498See supra note 482. See infra note 501. 

499See infra note 506 and accompanying text. 

500See January LSTA Letter. 

501See FCC Letter; Letter from Richard M. 

Whiting, Executive Director and General Counsel, 

Financial Services Roundtable, Jul. 22, 2011 (‘‘FSR 

Letter’’); July LMA Letter; Letter from R. Bram 

Smith, Executive Director, The LSTA, Jul. 22, 2011 

(‘‘July LSTA Letter’’); MFA Letter; and Letter from 

Kenneth E. Bentsen, Jr., Executive Vice President, 

Public Policy and Advocacy, SIFMA, Jul. 22, 2011 

(‘‘SIFMA Letter’’). 

502See FSR Letter; July LMA Letter; July LSTA 

Letter; MFA Letter; and SIFMA Letter. Commenters 

indicated that both LSTA-style participations and 

LMA-style participations represent a current or 

future direct or indirect ownership interest in the 

related loan or commitment. Id. 

503See July LMA Letter; July LSTA Letter; MFA 

Letter; and SIFMA Letter. These commenters 

indicated that neither LMA-style participations nor 

certain LSTA-style participations are true 

participations. See July LMA Letter; July LSTA 

Letter; and SIFMA Letter. Further, according to the 

July LSTA Letter, ‘‘[l]oan market participants in the 

United States will likely interpret the ‘true 

participation’ requirement as a requirement that 

loan participations must qualify for ‘true sale’ 

treatment in order to avoid classification as a 

‘swap.’ A ‘true sale’ or ‘true participation’ analysis 

is a test aimed at determining whether a transaction 

has resulted in the underlying assets being legally 

isolated from the transferor’s creditors for U.S. 

bankruptcy law purposes. Its underlying purpose is 

to distinguish between a sale and a financing, not 

between a sale and a swap.’’ If this is the case, 

certain LSTA-style participations, which typically 

are offered in the United States, could be 

determined under a ‘‘true sale’’ analysis to be a 

financing and not a true participation. See July 

LSTA Letter. 

504See July LMA Letter; July LSTA Letter; MFA 

Letter; and SIFMA Letter. Commenters 

recommended that the Commissions revise the 

interpretation by providing that the Commissions 

do not interpret the swap and security-based swap 

definitions to include loan participations in which 

(1) the participant is acquiring a current or future 

direct or indirect ownership interest in the related 

loan or commitment, and (2) the agreement 

pursuant to which the participant is acquiring such 

an interest (i) is a participation agreement that is, 

or any similar agreement of a type that has been, 

is presently, or in the future becomes, customarily 

entered into in the primary or secondary loan 

markets, (ii) requires the grantor to represent that 

it is a lender under, or a participant or subparticipant in, the loan or commitment, (iii) 

provides that the participant is entitled to receive 

from the grantor all of the economic benefit of the 

whole or part of a loan or commitment to the extent 

of payments received by the grantor in respect of 

such loan or commitment, and (iv) requires that 

100% of the purchase price calculated with respect 

to the loan or commitment is paid on the settlement 

date. See id. The characteristics identified by these 

commenters are reflected in the Commission’s 

revised interpretation. 

505See July LMA Letter. 

506 Id. 

507See section 1a(47)(B) of the CEA, 7 U.S.C. 

1a(47)(B). 

purposes.495 This analysis is unrelated 

to and does not inform whether a loan 

participation is a swap or security-based 

swap. This analysis also may be subject 

to varying interpretations.496 Further, 

the Commissions understand that this 

analysis could result in certain loan 

participations that reflect an ownership 

interest in the underlying loan or 

commitment being included in the swap 

and security-based swap definitions, 

which the Commissions do not 

intend.497

Rather, as noted above, the 

Commissions believe that the analysis 

as to whether a loan participation is 

outside the swap and security-based 

swap definitions should be based on 

whether the loan participation reflects 

an ownership interest in the underlying 

loan or commitment. The Commissions 

understand that the characteristics 

noted above are indicative, based on 

comments received,498 of whether a 

loan participation represents such an 

ownership interest. Further, in response 

to commenters,499 the Commissions are 

clarifying that the interpretation applies 

to loan participations that are entered 

into both with respect to outstanding 

loans and with respect to a lender’s 

commitments to lend and fund letters of 

credit (e.g., under a revolving credit 

facility). 

The Commissions believe that the 

interpretation will prevent disruption in 

the syndicated loan market for loan 

participations. Loan participations 

facilitate a lender’s diversification of its 

portfolio holdings, provide a key 

component of the efficient settlement 

process, and enhance liquidity in the 

global syndicated loan market.500 The 

interpretation will enable this market to 

continue operating as it did prior to the 

enactment of Title VII. 

Comments 

Commenters supported the 

interpretation that certain loan 

participations should not be included in 

the swap and security-based swaps 

definitions.501 Commenters agreed with 

the proposal that a loan participation 

should represent a current and future 

direct or indirect ownership interest in 

the loan or commitment that is the 

subject of the loan participation.502

However, commenters disagreed with 

the proposal that a loan participation 

should be required to be a ‘‘true 

participation’’ in order for the loan 

participation to fall outside the swap 

and security-based swap definitions 

because LMA-style participations do not 

represent a beneficial ownership in the 

underlying loan or commitment such 

that they would be considered a true 

participation.503 Commenters requested 

that the Commissions remove this factor 

and instead recognize additional 

factors.504 The Commissions agree that 

a loan participation does not have to be 

a true participation in order for the loan 

participation to fall outside the swap 

and security-based swap definitions and 

are revising the interpretation as noted 

above. 

One commenter also indicated that 

loan participations are entered into both 

with respect to outstanding loans and 

with respect to a lender’s commitments 

to lend and fund letters of credit (e.g., 

under a revolving credit facility).505

This commenter requested that the 

Commissions revise the proposed 

interpretation to reflect both 

outstanding loans and a lender’s 

commitments.506 The Commissions 

agree and are revising the interpretation 

to reflect both outstanding loans and 

loan commitments as noted above. 

C. Final Rules and Interpretations 

Regarding Certain Transactions Within 

the Scope of the Definitions of the 

Terms ‘‘Swap’’ and ‘‘Security-Based 

Swap’’ 

1. In General 

In light of provisions in the DoddFrank Act that specifically address 

certain foreign exchange products, the 

Commissions in the Proposing Release 

proposed rules to clarify the status of 

products such as foreign exchange 

forwards, foreign exchange swaps, 

foreign exchange options, nondeliverable forwards involving foreign 

exchange (‘‘NDFs’’), and cross-currency 

swaps. The Commissions also proposed 

a rule to clarify the status of forward 

rate agreements and provided 

interpretations regarding: (i) 

Combinations and permutations of, or 

options on, swaps or security-based 

swaps; and (ii) contracts for differences 

(‘‘CFDs’’). 

The Commissions are adopting the 

rules as proposed without modification 

and are restating the interpretations 

provided in the Proposing Release 

without modification. In addition, the 

Commissions are providing additional 

interpretations regarding foreign 

exchange spot transactions and retail 

foreign currency options. 

As adopted, rule 1.3(xxx)(2) under the 

CEA and rule 3a69–2 under the 

Exchange Act explicitly define the term 

‘‘swap’’ to include certain foreign 

exchange-related products and forward 

rate agreements unless such products 

are excluded by the statutory exclusions 

in subparagraph (B) of the swap 

definition.507 In adopting these rules, 

the Commissions do not mean to suggest 

that the list of agreements, contracts, 

and transactions set forth in rule 

1.3(xxx)(2) under the CEA and rule 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48253 

508See section 1a(47)(E)(i) of the CEA, 7 U.S.C. 

1a(47)(E)(i). The Secretary published in the Federal 

Register a request for comment as to whether an 

exemption from the swap definition for foreign 

exchange swaps, foreign exchange forwards, or 

both, is warranted, and on the application of the 

statutory factors that the Secretary must consider in 

making a determination regarding whether to 

exempt these products. See Determinations of 

Foreign Exchange Swaps and Forwards, 75 FR 

66829 (Oct. 28, 2010). Subsequently, the Secretary 

published in the Federal Register a proposed 

determination to exempt both foreign exchange 

swaps and foreign exchange forwards from the 

definition of the term ‘‘swap’’ in the CEA. See 

Determination of Foreign Exchange Swaps and 

Foreign Exchange Forwards Under the Commodity 

Exchange Act, Notice of Proposed Determination, 

76 FR 25774 (May 5, 2011) (‘‘Notice of Proposed 

Determination’’). The comment period on the 

Secretary’s proposed determination closed on June 

6, 2011. A final determination has not yet been 

issued. 

509See section 1a(24) of the CEA, 7 U.S.C. 1a(24). 

510See section 1a(25) of the CEA, 7 U.S.C. 1a(25). 

511The Secretary’s determination also does not 

affect the CFTC’s jurisdiction over retail foreign 

currency agreements, contracts, or transactions 

pursuant to section 2(c)(2) of the CEA, 7 U.S.C. 

2(c)(2). See section 1a(47)(F)(ii) of the CEA, 7 U.S.C. 

1a(47)(F)(ii). 

512See, e.g., sections 1a(47)(E)(iii) and (iv) of the 

CEA, 7 U.S.C. 1a(47)(E)(iii) and (iv) (reporting and 

business conduct standards, respectively). In 

addition, a determination by the Secretary does not 

exempt any foreign exchange forward or foreign 

exchange swap traded on a designated contract 

market or a swap execution facility, or cleared by 

a derivatives clearing organization, from any 

applicable antifraud or anti-manipulation provision 

under the CEA. See sections 1a(47)(F)(i) and 1b(c) 

of the CEA, 7 U.S.C. 1a(47)(F)(i) and 1b(c). 

513See rules 1.3(xxx)(3)(iii) and (iv) under the 

CEA and rule 3a69–2(c)(3) and (4) under the 

Exchange Act. 

514See rules 1.3(xxx)(2)(i)(C) and (D) under the 

CEA and rules 3a69–2(b)(1)(iii) and (iv) under the 

Exchange Act. The rules further provide that foreign 

exchange forwards and forward exchange swaps are 

not swaps if they fall within one of the exclusions 

set forth in subparagraph (B) of the statutory swap 

definition. See rule 1.3(xxx)(2)(ii) under the CEA 

and rule 3a69–2(b)(2) under the Exchange Act. 

515See rule 1.3(xxx)(3) under the CEA and rule 

3a69–2(c) under the Exchange Act. 

516See rule 1.3(xxx)(3)(ii) under the CEA and rule 

3a69–2(c)(2) under the Exchange Act. The exclusion 

of foreign exchange forwards and foreign exchange 

swaps would become effective upon the Secretary’s 

submission of the determination to exempt to the 

appropriate Congressional Committees. See sections 

1a(47)(E)(ii) and 1b of the CEA, 7 U.S.C. 

1a(46)(E)(ii) and 1b. 

517See CME Letter and SIFMA Letter. 

518See CME Letter. This commenter also believes 

that if the Secretary exempts foreign exchange 

swaps and foreign exchange forwards from the 

swap definition, it would create an ‘‘awkward’’ 

situation both for the CFTC and market 

participants, given that options on such products 

would be swaps but the products into which they 

exercise would not be swaps, and would result in 

a lack of clarity and consistency for market 

participants. Id. 

519See SIFMA Letter. 

520These costs market participants may incur 

relate to the upfront and ongoing costs associated 

with the regulation of Title VII instruments 

generally. See infra parts X and XI, for a discussion 

of these costs. The Commissions also note that the 

final rules will reduce (and may eliminate), the 

costs of determining whether foreign exchange 

swaps and foreign exchange forwards are subject to 

Title VII, as well as the costs associated with 

determining which provisions of the new Title VII 

regulatory regime will apply to these instruments. 

Id. 

521Compare section 712(d)(1) of the CEA 

(Commissions’ joint rulemaking authority to further 

define the term ‘‘swap’’), with section 1a(47)(E) and 

1b of the CEA (Secretary’s authority to determine 

to exempt foreign exchange swaps and foreign 

exchange forwards from the definition of ‘‘swap.’’). 

3a69–2(b) under the Exchange Act is an 

exclusive list. 

2. Foreign Exchange Products 

(a) Foreign Exchange Products Subject 

to the Secretary’s Swap Determination: 

Foreign Exchange Forwards and Foreign 

Exchange Swaps 

The CEA, as amended by the DoddFrank Act, provides that ‘‘foreign 

exchange forwards’’ and ‘‘foreign 

exchange swaps’’ shall be considered 

swaps under the swap definition unless 

the Secretary of the Treasury 

(‘‘Secretary’’) issues a written 

determination that either foreign 

exchange swaps, foreign exchange 

forwards, or both: (i) Should not be 

regulated as swaps; and (ii) are not 

structured to evade the Dodd-Frank Act 

in violation of any rule promulgated by 

the CFTC pursuant to section 721(c) of 

the Dodd-Frank Act.508 A foreign 

exchange forward is defined in the CEA 

as ‘‘a transaction that solely involves the 

exchange of two different currencies on 

a specific future date at a fixed rate 

agreed upon on the inception of the 

contract covering the exchange.’’ 509 A 

foreign exchange swap, in turn, is 

defined as ‘‘a transaction that solely 

involves an exchange of 2 different 

currencies on a specific date at a fixed 

rate that is agreed upon on the inception 

of the contract covering the exchange; 

and a reverse exchange of the 2 

currencies described in subparagraph 

(A) at a later date and at a fixed rate that 

is agreed upon on the inception of the 

contract covering the exchange.’’ 510

Under the Dodd-Frank Act, if foreign 

exchange forwards or foreign exchange 

swaps are no longer considered swaps 

due to a determination by the Secretary, 

nevertheless, certain provisions of the 

CEA added by the Dodd-Frank Act 

would continue to apply to such 

transactions.511 Specifically, those 

transactions still would be subject to 

certain requirements for reporting 

swaps, and swap dealers and major 

swap participants engaging in such 

transactions still would be subject to 

certain business conduct standards.512

The Commissions are adopting the 

rules as proposed to explicitly define by 

rule the term ‘‘swap’’ to include foreign 

exchange forwards and foreign exchange 

swaps (as those terms are defined in the 

CEA),513 in order to include in one rule 

the definitions of those terms and the 

related regulatory authority with respect 

to foreign exchange forwards and 

foreign exchange swaps.514 The final 

rules incorporate the provision of the 

Dodd-Frank Act that foreign exchange 

forwards and foreign exchange swaps 

will no longer be considered swaps if 

the Secretary issues the written 

determination described above to 

exempt such products from the swap 

definition.515 The final rules also reflect 

the continuing applicability of certain 

reporting requirements and business 

conduct standards in the event that the 

Secretary makes such a 

determination.516

Comments 

Two commenters recommended that 

the Commissions defer action on 

defining foreign exchange swaps and 

foreign exchange forwards in their 

regulations until the Secretary has made 

his final determination about whether to 

exempt them.517 One commenter 

believed that finalizing the 

Commissions’ proposal prior to the 

Secretary’s final determination would 

be ‘‘premature.’’ 518 The other 

commenter believed that the industry 

will be ‘‘better positioned’’ to assess the 

need to clarify the scope of the swap 

definition with respect to foreign 

exchange derivatives after the Secretary 

has made his determination.519 The 

Commissions understand that, if the 

final rules are effective before the 

Secretary issues a written 

determination, market participants 

entering into foreign exchange forwards 

and foreign exchange swaps might incur 

costs in order to comply with the 

requirements of the CEA (as amended 

by the Dodd-Frank Act) that could be 

rendered unnecessary if the Secretary 

subsequently were to issue a written 

determination to exempt.520 The 

Commissions, however, believe the final 

rules are necessary because in the event 

the Secretary issues a written 

determination to exempt, certain 

reporting requirements and business 

conduct standards will continue to 

apply to the exempted instruments, and 

the final rules set forth those 

requirements that will continue to 

apply. 

Further, the Commissions do not 

believe that adopting the rules is 

premature, as the Secretary may issue a 

determination at any time, and the 

Secretary’s authority to do so is 

independent of the Commissions’ 

authority to issue these rules to further 

define the term ‘‘swap.’’ 521 The 

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48254 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

522See rule 1.3(xxx)(3)(ii) under the CEA and rule 

3a69–2(c)(2) under the Exchange Act. The statutory 

requirements that remain applicable, 

notwithstanding a written determination by the 

Secretary to exempt, are that foreign exchange 

swaps and foreign exchange forwards shall be 

reported to either a swap data repository, or, if there 

is no swap data repository that would accept such 

swaps or forwards, to the CFTC pursuant to section 

4r of the CEA, 7 U.S.C. 6r, within such time period 

as the CFTC may by rule or regulation prescribe, 

and any party to a foreign exchange swap or 

forward that is a swap dealer or major swap 

participant shall conform to the business conduct 

standards contained in section 4s(h) of the CEA, 7 

U.S.C. 6s(h). Section 1a(47)(E)(iii) and (iv) of the 

CEA, 7 U.S.C. 1a(47)(E)(iii) and (iv). 

523See rule 1.3(xxx)(3)(v) under the CEA and rule 

3a69–2(c)(5) under the Exchange Act. 

524See rule 1.3(xxx)(2)(i) under the CEA and rule 

3a69–2(b)(1) under the Exchange Act. The final 

rules provide, however, that none of these products 

are swaps if they fall within one of the exclusions 

set forth in subparagraph (B) of the statutory swap 

definition. See rule 1.3(xxx)(2)(ii) under the CEA 

and rule 3a69–2(b)(2) under the Exchange Act. 

Also, the rules do not define the term ‘‘swap’’ to 

include currency swaps because they are already 

included in the statutory definition, but the rules 

clarify that currency swaps are not subject to the 

Secretary’s determination. See section 

1a(47)(A)(iii)(VII) of the CEA, 7 U.S.C. 

1a(47)(A)(iii)(VII); rule 1.3(xxx)(3)(v)(A) under the 

CEA; and rule 3a69–2(c)(5)(i) under the Exchange 

Act. 

525This discussion is not intended to address, 

and has no bearing on, the CFTC’s jurisdiction over 

foreign currency options in other contexts. See, e.g., 

CEA sections 2(c)(2)(A)(iii) and 2(c)(2)(B)–(C), 7 

U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)–(C) (offexchange options in foreign currency offered or 

entered into with retail customers). 

526See section 1a(47)(A)(i) of the CEA, 7 U.S.C. 

1a(47)(A)(i). 

527See section 1a(47)(B)(iv) of the CEA, 7 U.S.C. 

1a(47)(B)(iv). 

528A comment regarding the CFTC’s jurisdiction 

over retail foreign currency options is discussed 

below. 

529See rule 1.3(xxx)(2)(ii) under the CEA and rule 

3a69–2(b)(1) under the Exchange Act. The final 

rules treat the terms foreign currency options, 

currency options, foreign exchange options, and 

foreign exchange rate options as synonymous. 

Moreover, for purposes of the final rules, foreign 

currency options include options to enter into or 

terminate, or that otherwise operate on, a foreign 

exchange swap or foreign exchange forward, or on 

the terms thereof. As discussed above, foreign 

exchange options traded on an NSE are securities 

and therefore are excluded from the swap 

definition. See supra note 527 and accompanying 

text. 

530See rule 1.3(xxx)(3)(v) under the CEA and rule 

3a69–2(c)(5) under the Exchange Act. 

531See Proposing Release at 29836. 

532A deliverable forward foreign exchange 

contract is an obligation to buy or sell a specific 

currency on a future settlement date at a fixed price 

set on the trade date. See Laura Lipscomb, Federal 

Reserve Bank of New York, ‘‘An Overview of NonDeliverable Foreign Exchange Forward Markets,’’ 1 

(May 2005) (citation omitted) (‘‘Fed NDF 

Overview’’). 

533See id. at 1–2 (citation omitted). 

534See id. at 2. Being long the emerging market 

currency means that the holder of the NDF contract 

is the ‘‘buyer’’ of the emerging market currency and 

the ‘‘seller’’ of dollars. Conversely, if the emerging 

market currency appreciates relative to the 

previously agreed forward rate, the holder of the 

contract that is short the emerging market currency 

must pay its counterparty the difference between 

the spot market rate and the contracted forward 

price, multiplied by the notional amount. See id. at 

2, n.4. 

535See Proposing Release at 29836. 

Commissions’ final rules are consistent 

with this statutory framework by 

specifically providing that, in the event 

a determination to exempt is issued, 

foreign exchange swaps and foreign 

exchange forwards will not be 

considered swaps, and will be subject 

only to those CEA requirements that are 

specified in the statute.522 As such, the 

final rules accommodate the possibility 

of (rather than the certainty of) an 

exemptive determination made by the 

Secretary. 

Moreover, commenters provided no 

support for the assertion that the 

situation would be awkward for market 

participants because options on foreign 

exchange forwards and foreign exchange 

swaps will be swaps, regardless of 

whether the Secretary determines to 

exempt the underlying transactions 

from the swap definition. The 

Commissions note that Congress drew 

the distinction in the statute between 

foreign currency options and foreign 

exchange forwards and foreign exchange 

swaps. The Commissions conclude that 

adopting these final rules would not 

contribute to a lack of clarity or 

consistency for market participants, 

regardless of any determination the 

Secretary makes. 

(b) Foreign Exchange Products Not 

Subject to the Secretary’s Swap 

Determination 

The Commissions are adopting rules 

as proposed stating that a determination 

by the Secretary that foreign exchange 

forwards or foreign exchange swaps, or 

both, should not be regulated as swaps 

would not affect certain other products 

involving foreign currency, such as 

foreign currency options, NDFs, 

currency swaps and cross-currency 

swaps.523 The rules explicitly define the 

term ‘‘swap’’ to include such products, 

irrespective of whether the Secretary 

makes a determination to exempt 

foreign exchange forwards or foreign 

exchange swaps from the swap 

definition.524

(i) Foreign Currency Options 525

As discussed above, the statutory 

swap definition includes options, and it 

expressly enumerates foreign currency 

options. It encompasses any agreement, 

contract, or transaction that is a put, 

call, cap, floor, collar, or similar option 

of any kind that is for the purchase or 

sale, or based on the value, of 1 or more 

interest or other rates, currencies, 

commodities, securities, instruments of 

indebtedness, indices, quantitative 

measures, or other financial or 

economic interests or property of any 

kind.526 Foreign exchange options 

traded on a national securities exchange 

(‘‘NSE’’), however, are securities under 

the Federal securities laws and not 

swaps or security-based swaps.527

Any determination by the Secretary, 

discussed above, that foreign exchange 

forwards or foreign exchange swaps 

should not be regulated as swaps would 

not impact foreign currency options 

because a foreign currency option is 

neither a foreign exchange swap nor a 

foreign exchange forward, as those 

terms are defined in the CEA. The 

Commissions did not receive any 

comments either on the proposed rule 

further defining the term ‘‘swap’’ to 

include foreign currency options or the 

proposed rule clarifying that foreign 

currency options are not subject to the 

Secretary’s determination to exempt 

foreign exchange swaps and foreign 

exchange forwards.528 Consequently, 

the Commissions are adopting rules to 

explicitly define the term ‘‘swap’’ to 

include foreign currency options (other 

than foreign currency options traded on 

an NSE).529 The rules also state that 

foreign currency options are not foreign 

exchange forwards or foreign exchange 

swaps under the CEA.530

(ii) Non-Deliverable Forward Contracts 

Involving Foreign Exchange 

As explained by the Commissions in 

the Proposing Release,531 an NDF 

generally is similar to a forward foreign 

exchange contract,532 except that at 

maturity the NDF does not require 

physical delivery of currencies; rather, 

the contract typically is settled in a 

reserve currency, such as U.S. dollars. 

One of the currencies involved in the 

transaction, usually an emerging market 

currency, may be subject to capital 

controls or similar restrictions, and is 

therefore said to be 

‘‘nondeliverable.’’ 533 If the spot market 

exchange rate on the settlement date is 

greater (in foreign currency per dollar 

terms) than the previously agreed 

forward exchange rate, the party to the 

contract that is long the nondeliverable 

(e.g. emerging market) currency must 

pay its counterparty the difference 

between the contracted forward price 

and the spot market rate, multiplied by 

the notional amount.534

NDFs are not expressly enumerated in 

the swap definition, but as was stated in 

the Proposing Release,535 they satisfy 

clause (A)(iii) of the swap definition 

because they provide for a future 

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536See section 1a(47)(A)(iii) of the CEA, 7 U.S.C. 

1a(47)(A)(iii) (providing that a swap is an 

agreement, contract, or transaction ‘‘that provides 

on an executory basis for the exchange, on a fixed 

or contingent basis, of 1 or more payments based 

on the value or level of 1 or more interest or other 

rates, currencies, commodities, securities, 

instruments of indebtedness, indices, quantitative 

measures, or other financial or economic interests 

or property of any kind, or any interest therein or 

based on the value thereof, and that transfers, as 

between the parties to the transaction, in whole or 

in part, the financial risk associated with a future 

change in any such value or level without also 

conveying a current or future direct or indirect 

ownership interest in an asset (including any 

enterprise or investment pool) or liability that 

incorporates the financial risk so transferred * * * 

.’’). 

537 In addition, as was noted in the Proposing 

Release, at least some market participants view 

NDFs as swaps today, and thus NDFs also may fall 

within clause (A)(iv) of the swap definition as ‘‘an 

agreement, contract, or transaction that is, or in the 

future becomes, commonly known to the trade as 

a swap.’’ See Proposing Release at 29836. See also 

section 1a(47)(A)(iv) of the CEA, 7 U.S.C. 

1a(47)(A)(iv). Cf. rule 35.1(b)(1)(i) under the CEA, 

17 CFR 35.1(b)(1)(i) (providing that the definition 

of ‘‘swap agreement’’ includes a ‘‘forward foreign 

exchange agreement,’’ without reference to 

convertibility or delivery). 

538 In the Notice of Proposed Determination, the 

Secretary stated that his authority to issue a 

determination ‘‘is limited to foreign exchange 

swaps and forwards and does not extend to other 

foreign exchange derivatives’’ and noted that ‘‘NDFs 

may not be exempted from the CEA’s definition of 

‘‘swap’’ because they do not satisfy the statutory 

definitions of a foreign exchange swap or forward.’’ 

See Notice of Proposed Determination. 

539Likewise, the Commissions have determined 

that a foreign exchange transaction, which initially 

is styled as or intended to be a ‘‘foreign exchange 

forward,’’ and which is modified so that the parties 

settle in a reference currency (rather than settle 

through the exchange of the 2 specified currencies), 

does not conform with the definition of ‘‘foreign 

exchange forward’’ in the CEA. See infra note 626. 

540Currency is an excluded commodity under the 

CEA. See section 1a(19)(i) of the CEA, 7 U.S.C. 

1a(19)(i). In accordance with the interpretation 

regarding nonfinancial commodities, which as 

discussed above, see supra part II.B.2(a), are exempt 

and agricultural commodities that can be physically 

delivered, currency does not qualify as a 

nonfinancial commodity for purposes of the 

forward exclusion from the swap definition. 

541See Proposing Release at 29836. 

542See Fed NDF Overview at 5 (‘‘[E]stimates vary 

but many major market participants estimate as 

much as 60 to 80 percent of NDF volume is 

generated by speculative interest, noting growing 

participation from international hedge funds.’’) and 

4 (‘‘[D]ealers note that much of the volume in 

Chinese yuan NDFs is generated by speculative 

positioning based on expectations for an alteration 

in China’s current, basically fixed exchange rate.’’) 

(italics in original). 

543See id. at 4 (noting that ‘‘[much of the] Korean 

won NDF volume[,] * * * estimated to be the 

largest of any currency, * * * is estimated to 

originate with international investment portfolio 

managers hedging the currency risk associated with 

their onshore investments’’). 

544See CDEU Letter; Letter from The Committee 

on Investment of Employee Benefit Assets, dated 

Jul. 22, 2011 (‘‘CIEBA Letter’’); Letter from Bruce C. 

Bennett, Covington & Burling LLP, dated Jul. 22, 

2011 (‘‘Covington Letter’’); and Letter from Karrie 

McMillan and Cecelia Calaby, the Investment 

Company Institute/American Bar Association 

Securities Association, dated Jul. 22, 2011 (‘‘ICI/ 

ABASA Letter’’). 

545See Covington Letter and ICI/ABASA Letter. 

CLS Bank operates the largest multi-currency cash 

settlement system to eliminate settlement risk in the 

foreign exchange market. 

546See Covington Letter and ICI/ABASA Letter. 

547See Covington Letter. 

548See supra note 520. 

549See ICI/ABASA Letter. 

(executory) payment based on an 

exchange rate, which is an ‘‘interest or 

other rate[ ]’’ within the meaning of 

clause (A)(iii).536 Each party to an NDF 

transfers to its counterparty the risk of 

the exchange rate moving against the 

counterparty, thus satisfying the 

requirement that there be a transfer of 

financial risk associated with a future 

change in rate. This financial risk 

transfer in the context of an NDF is not 

accompanied by a transfer of an 

ownership interest in any asset or 

liability. Thus, an NDF is a swap under 

clause (A)(iii) of the swap definition.537

Moreover, the Commissions have 

determined that NDFs do not meet the 

definitions of ‘‘foreign exchange 

forward’’ or ‘‘foreign exchange swap’’ 

set forth in the CEA.538 NDFs do not 

involve an ‘‘exchange’’ of two different 

currencies (an element of the definition 

of both a foreign exchange forward and 

a foreign exchange swap); instead, they 

are settled by payment in one currency 

(usually U.S. dollars).539

Notwithstanding their ‘‘forward’’ 

label, NDFs also do not fall within the 

forward contract exclusion of the swap 

definition because currency is outside 

the scope of the forward contract 

exclusion for nonfinancial 

commodities.540 Nor have NDFs 

traditionally been considered 

commercial merchandising transactions. 

Rather, as the Commissions observed in 

the Proposing Release,541 NDF markets 

appear to be driven in large part by 

speculation 542 and hedging,543 which 

features are more characteristic of swap 

markets than forward markets. 

Comments 

Commenters who addressed the 

nature of NDFs believed that NDFs 

should not be considered swaps, but 

rather should be categorized as foreign 

exchange forwards. In general, 

commenters maintained that NDFs are 

functionally and economically 

equivalent to foreign exchange forwards, 

and therefore should be treated in the 

same manner for regulatory purposes.544

In support of this view, commenters 

made several arguments, including that 

both NDFs and foreign exchange 

forwards require the same net value to 

be transferred between counterparties; 

the purpose for using them is the 

same—to cover foreign currency 

exchange risk; both are typically short 

term transactions; and both may be 

cleared by CLS Bank.545

In addition, commenters believed that 

not treating NDFs as foreign exchange 

forwards or foreign exchange swaps 

would be contrary to both domestic and 

international market practices. As 

specific examples, commenters noted 

that NDFs typically are traded as part of 

a bank’s or broker’s foreign exchange 

desk; the Federal Reserve Bank of New 

York has described an NDF in a 1998 

publication as an instrument ‘‘similar to 

an outright forward,’’ except that there 

is no physical delivery or transfer of the 

local currency; the Bank for 

International Settlements (‘‘BIS’’) 

categorizes NDFs in its ‘‘outright 

forward’’ category; various European 

regulations do not distinguish between 

the two transaction types; standard 

foreign exchange trading documentation 

includes both net- and physicallysettled foreign exchange transactions in 

general definitions of foreign exchange 

transactions; and special rules under the 

U.S. tax code apply equally to 

physically settled and cash settled 

foreign exchange forwards.546

Commenters also raised potential 

negative consequences to certain U.S. 

market participants if NDFs are not 

considered to be foreign exchange 

forwards. For example, one commenter 

argued that treating NDFs as swaps will 

put U.S. corporations doing business in 

emerging markets at a disadvantage 

relative to U.S. corporations doing 

business solely in developed markets.547

This commenter stated that NDFs are 

widely used by U.S. corporations that 

do business in emerging markets to 

hedge their exposure to the currencies 

of those markets, and that regulating 

NDFs as swaps would significantly 

increase the cost of hedging those 

exposures.548

With respect to the Commissions’ 

legal conclusion that NDFs are not 

foreign exchange forwards, and thus are 

not subject to the Secretary’s 

determination, one commenter stated 

that the Commissions’ reading of the 

definition of the term ‘‘foreign exchange 

forward’’ as not including NDFs is ‘‘too 

restrictive.’’ 549 In this regard, this 

commenter believed that the term 

‘‘exchange’’ should be read to include 

‘‘the economic exchange that occurs in 

net settlement rather than being 

narrowly read as the physical ‘exchange’ 

of two different currencies.’’ 

One commenter, in contrast, agreed 

with the Commissions’ interpretation 

that NDFs are not encompassed within 

the definition of the term ‘‘foreign 

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48256 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

550See CIEBA Letter. 

551 7 U.S.C. 6(c). 

552See ICI/ABASA Letter. 

553See Webster’s New World Dictionary (3d 

College Ed. 1988). 

554See Black’s Law Dictionary. 

555This commenter’s request that the CFTC 

exempt NDFs from the swap definition using its 

exemptive authority under section 4(c) of the CEA, 

7 U.S.C. 6(c), and that the SEC exercise its 

exemptive authority under section 36 of the 

Exchange Act, 78 U.S.C. 78mm, with respect to 

NDFs, is beyond the scope of this rulemaking. 556A swap that exchanges a fixed rate against a 

fixed rate is known as a currency swap. See Federal 

Reserve System, ‘‘Trading and Capital-Markets 

Activities Manual,’’ section 4335.1 (Jan. 2009). 557Cross-currency swaps with a fixed leg based 

on one rate and a floating leg based on another rate, 

where the two rates are denominated in different 

currencies, are generally referred to as crosscurrency coupon swaps, while those with a floating 

leg based on one rate and another floating leg based 

on a different rate are known as cross-currency 

basis swaps. Id. Cross-currency swaps also include 

annuity swaps and amortizing swaps. In crosscurrency annuity swaps, level cash flows in 

different currencies are exchanged with no 

exchange of principal; annuity swaps are priced 

such that the level payment cash flows in each 

currency have the same net present value at the 

inception of the transaction. An amortizing crosscurrency swap is structured with a declining 

principal schedule, usually designed to match that 

of an amortizing asset or liability. Id. 

See also Derivatives ONE, ‘‘Cross Currency Swap 

Valuation’’ (‘‘A cross currency swap is swap of an 

interest rate in one currency for an interest rate 

payment in another currency * * * This could be 

considered an interest rate swap with a currency 

component.’’), available at http:// 

www.derivativesone.com/cross-currency-swapvaluation/; Financial Accounting Standards Board, 

‘‘Examples Illustrating Application of FASB 

Statement No. 138,’’ Accounting for Certain 

Derivative Instruments and Certain Hedging 

Activities, section 2, Example 1, at 3 (‘‘The 

company designates the cross-currency swap as a 

fair value hedge of the changes in the fair value of 

the loan due to both interest and exchange rates.’’), 

available at http://www.fasb.org/derivatives/ 

examples.pdf. 

558BMO Capital Markets, ‘‘Cross Currency 

Swaps,’’ available at http://www.bmocm.com/ 

products/marketrisk/intrderiv/cross/default.aspx. 559See section 1a(47)(A)(iii)(VII) of the CEA, 7 

U.S.C. 1a(47)(A)(iii)(VII). 560Clause (A)(iii) of the swap definition expressly 

refers to a cross-currency rate swap. See section 

1a(47)(A)(iii)(V) of the CEA, 7 U.S.C. 

1a(47)(A)(iii)(V). Although the swap industry 

appears to use the term ‘‘cross-currency swap,’’ 

rather than ‘‘cross-currency rate swap’’ (the term 

used in section 1a(47)(A)(iii)(V) of the CEA), the 

Commissions interpret these terms as synonymous. 561See rule 1.3(xxx)(2)(i)(A) under the CEA and 

rule 3a69–2(b)(1)(i) under the Exchange Act. 562But see supra note 227. 

exchange forward.’’ 550 This commenter 

requested, though, that the CFTC 

exempt NDFs from the swap definition, 

using its exemptive authority under 

section 4(c) of the CEA.551

While commenters raised a number of 

objections to the Commissions’ proposal 

to define NDFs as swaps, these 

objections primarily raise policy 

arguments. No commenter has provided 

a persuasive, alternative interpretation 

of the statute’s plain language in the 

definition of the term ‘‘foreign exchange 

forward’’ to overcome the Commissions’ 

conclusion that, under the CEA, NDFs 

are swaps, not foreign exchange 

forwards. 

One commenter believed that the 

Commissions’ interpretation of 

‘‘exchange of 2 different currencies’’ as 

used in the foreign exchange forward 

definition is too restrictive, and that the 

phrase should be read broadly to mean 

an economic exchange of value in 

addition to physical exchange; the 

Commissions believe that this 

contention is misplaced.552 This 

commenter essentially asks the 

Commissions to interpret the statutory 

language to mean an exchange of foreign 

currencies themselves, as well as an 

exchange based on the value of such 

currencies. However, only the word 

‘‘exchange’’ appears in the relevant 

definitions, reinforcing the conclusion 

that Congress intended the definition of 

‘‘foreign exchange forward’’ to be 

distinct from other types of transactions 

covered by the definition of ‘‘swap’’ in 

the CEA. Moreover, the language of each 

definition emphasizes that these 

transactions may ‘‘solely’’ involve an 

exchange. The ordinary meaning of the 

verb ‘‘exchange’’ is to ‘‘barter’’ 553 or 

‘‘part with, give or transfer for an 

equivalent,’’ 554 i.e., each party is both 

giving to and receiving from the other 

party. This does not occur under an 

NDF, in which only a single party 

makes a payment. 

Elsewhere in the CEA, Congress used 

explicit language that potentially could 

provide support for a broader 

interpretation of the type advocated by 

this commenter, but such language is 

absent from the definition of the term 

‘‘foreign exchange forward.’’ For 

example, section 2(a)(1)(C)(ii) confers 

exclusive jurisdiction on the CFTC over 

‘‘contracts of sale for future delivery of 

a group or index of securities (or any 

interest therein or based upon the value 

thereof) [that meet certain 

requirements]’’. If the phrase ‘‘exchange 

of 2 different currencies’’ had been 

intended to include economic 

exchanges of value, as suggested by this 

commenter, that phrase would have 

included language similar to ‘‘based on 

the value thereof’’ to indicate that other 

mechanisms of transferring value may 

occur in these particular types of 

transactions. Instead, as noted above, 

Congress limited the scope of each of 

these particular transactions by using 

the words ‘‘solely involves the exchange 

of 2 different currencies’’. The 

Commissions conclude that the use of 

the word ‘‘solely’’ provides further 

support for the Commissions’ 

interpretation that exchange means an 

actual interchange of the 2 different 

currencies involved in the 

transaction.555

(iii) Currency Swaps and CrossCurrency Swaps 

A currency swap 556 and a crosscurrency swap 557 each generally can be 

described as a swap in which the fixed 

legs or floating legs based on various 

interest rates are exchanged in different 

currencies. Such swaps can be used to 

reduce borrowing costs, to hedge 

currency exposure, and to create 

synthetic assets 558 and are viewed as an 

important tool, given that they can be 

used to hedge currency and interest rate 

risk in a single transaction. 

Currency swaps and cross-currency 

swaps are not foreign exchange swaps as 

defined in the CEA because, although 

they may involve an exchange of foreign 

currencies, they also require contingent 

or variable payments in different 

currencies. Because the CEA defines a 

foreign exchange swap as a swap that 

‘‘solely’’ involves an initial exchange of 

currencies and a reversal thereof at a 

later date, subject to certain parameters, 

currency swaps and cross-currency 

swaps would not be foreign exchange 

swaps. Similarly, currency swaps and 

cross-currency swaps are not foreign 

exchange forwards because foreign 

exchange forwards ‘‘solely’’ involve an 

initial exchange of currencies, subject to 

certain parameters, while currency 

swaps and cross-currency swaps contain 

additional elements, as discussed above. 

Currency swaps are expressly 

enumerated in the statutory definition 

of the term ‘‘swap.’’ 559 Cross-currency 

swaps, however, are not.560

Accordingly, based on the foregoing 

considerations, the Commissions are 

adopting rules explicitly defining the 

term ‘‘swap’’ to include cross-currency 

swaps.561 The rules also state that 

neither currency swaps nor crosscurrency swaps are foreign exchange 

forwards or foreign exchange swaps as 

those terms are defined in the CEA. The 

Commissions did not receive any 

comments either on the rule further 

defining the term ‘‘swap’’ to include 

cross-currency swaps or the rule 

clarifying that cross-currency swaps and 

currency swaps are not subject to the 

Secretary’s determination to exempt 

foreign exchange swaps and foreign 

exchange forwards. 

(c) Interpretation Regarding Foreign 

Exchange Spot Transactions 

The CEA generally does not confer 

regulatory jurisdiction on the CFTC 

with respect to spot transactions.562 In 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48257 

563Bank for International Settlements, Triennial 

Central Bank Survey, Report on Global Foreign 

Exchange Market Activity in 2010 at 32 (Dec. 2010) 

(defining a foreign exchange spot transaction to 

provide for cash settlement within 2 business days); 

Sam Y. Cross, Federal Reserve Bank of New York, 

‘‘All About * * *. The Foreign Exchange Market in 

the United States’’ at 31–32 (1998). 

564See CFTC Division of Trading and Markets, 

Report on Exchange of Futures for Physicals at 124– 

127 (1987) (noting that foreign currency spot 

transactions settle in 2 days). 

565See CFTC v. Frankwell Bullion, Ltd., 99 F.3d 

299, 300 (9th Cir. 1996) (‘‘Spot transactions in 

foreign currencies call for settlement within two 

days.’’); CFTC v. Int’l Fin. Servs. (NewYork), Inc., 

323 F. Supp. 2d 482, 495 (S.D.N.Y. 2004) (noting 

that spot transactions ordinarily call for settlement 

within two days); Bank Brussels Lambert, S.A. v. 

Intermetals Corp., 779 F.Supp. 741, 742 (S.D.N.Y. 

1991) (same). But the Commissions understand that 

the settlement cycle for spot transactions 

exchanging Canadian dollars for U.S. dollars (or 

vice versa) is T+1. See Cross, supra 563, at 31. 

566 In this regard, while the Commissions will 

look at the relevant facts and circumstances, they 

will not expect that an unintentional settlement 

failure or delay for operational reasons or due to a 

market disruption will undermine the character of 

a bona fide spot foreign exchange transaction as 

such. 

567The interpretation herein with respect to 

Security Conversion Transactions is limited to such 

transactions. 

568 7 U.S.C. 2(c)(2)(C). Similarly, a Securities 

Conversion Transaction is not an option, option on 

a futures contract or futures contract and thus 

would not be subject to CEA section 2(c)(2)(B), 7 

U.S.C. 2(c)(2)(B). Of course, optionality as to 

settlement would render the transaction an option 

and is inconsistent with a ‘‘spot’’ characterization. 569Cf. 12 CFR 220.8(b)(1) under Regulation T (12 

CFR Part 220) (generally permits a customer to 

purchase a security (including a foreign security) in 

a cash account, rather than a margin account, even 

if the customer has no collateral in the account, if 

payment for the security is made within the 

appropriate payment period). Similarly, if a foreign 

exchange buyer in a Securities Conversion 

Transaction posts no margin or collateral on the 

trade date, the CFTC does not consider that 

transaction to be ‘‘margined’’ within the meaning of 

7 U.S.C. 2(c)(2)(C)(i)(I)(bb). 

570See section 2(c)(2)(C)(i)(II) of the CEA, 7 U.S.C. 

2(c)(2)(C) (‘‘[s]ubclause (I) of this clause shall not 

apply to * * * a contract of sale that * * * results 

in delivery within 2 days’’). 

571The CFTC notes, for example, that Congress 

recognized that settlement in various spot markets 

in commodities other than foreign exchange can be 

longer than two days. See CEA section 

2(c)(2)(D)(ii)(III)(aa) (disapplying the DCM-trading 

requirement for certain commodity transactions 

with non-ECPs when the contract ‘‘results in actual 

delivery within 28 days or such other longer period 

as the [CFTC] may determine by rule or regulation 

based on the typical commercial practice in cash or 

spot markets for the commodity involved’’). 

572This interpretation is not intended to address, 

and has no bearing on, the CFTC’s interpretation of 

the term ‘‘actual delivery’’ as set forth in section 

2(c)(2)(D)(ii)(III)(aa), 7 CFR 2(c)(2)(D)(ii)(III)(aa). See 

Retail Commodity Transactions under the 

Commodity Exchange Act, 76 FR 77670, Dec. 14, 

2011. 

573See SIFMA Letter. 

the context of foreign currency, spot 

transactions typically settle within two 

business days after the trade date 

(‘‘T+2’’).563 The accepted market 

practice of a two-day settlement for spot 

foreign currency transactions has been 

recognized by the CFTC564 and the 

courts.565

The Commissions recognize that the 

new foreign exchange forward 

definition in the CEA, which was added 

by the Dodd-Frank Act and which 

applies to an exchange of two different 

currencies ‘‘on a specific future date,’’ 

could be read to apply to any foreign 

exchange transaction that does not settle 

on the same day. Such a reading could 

render most foreign exchange spot 

transactions foreign exchange forwards 

under the CEA; as a result, such 

transactions would be subject to the 

CEA reporting and business conduct 

standards requirements applicable to 

foreign exchange forwards even if the 

Secretary determines to exempt foreign 

exchange forwards from the definition 

of ‘‘swap.’’ The Commissions do not 

believe that Congress intended, solely 

with respect to foreign exchange 

transactions, to extend the reach of the 

CEA to transactions that historically 

have been considered spot transactions. 

At the same time, however, the 

Commissions do not want to enable 

market participants simply to label as 

‘‘spot’’ foreign exchange transactions 

that regularly settle after the relevant 

foreign exchange spot market settlement 

deadline, or with respect to which the 

parties intentionally delay settlement, 

both of which would be properly 

categorized as foreign exchange 

forwards, or CEA section 2(c)(2) 

transactions (discussed separately 

below), in order to avoid applicable 

foreign exchange regulatory 

requirements. 

Accordingly, the Commissions are 

providing an interpretation that a bona 

fide foreign exchange spot transaction, 

i.e., a foreign exchange transaction that 

is settled on the customary timeline of 

the relevant spot market, is not within 

the definition of the term ‘‘swap.’’ In 

general, a foreign exchange transaction 

will be considered a bona fide spot 

transaction if it settles via an actual 

delivery of the relevant currencies 

within two business days. In certain 

circumstances, however, a foreign 

exchange transaction with a longer 

settlement period concluding with the 

actual delivery of the relevant 

currencies may be considered a bona 

fide spot transaction depending on the 

customary timeline of the relevant 

market.566 In particular, as discussed 

below, the Commissions will consider a 

foreign exchange transaction that is 

entered into solely to effect the purchase 

or sale of a foreign security to be a bona 

fide spot transaction where certain 

conditions are met. 

The CFTC will consider the following 

to be a bona fide spot foreign exchange 

transaction: An agreement, contract or 

transaction for the purchase or sale of an 

amount of foreign currency equal to the 

price of a foreign security with respect 

to which (i) the security and related 

foreign currency transactions are 

executed contemporaneously in order to 

effect delivery by the relevant securities 

settlement deadline and (ii) actual 

delivery of the foreign security and 

foreign currency occurs by such 

deadline (such transaction, a ‘‘Securities 

Conversion Transaction’’).567 For 

Securities Conversion Transactions, the 

CFTC will consider the relevant foreign 

exchange spot market settlement 

deadline to be the same as the securities 

settlement deadline. As noted above, 

while the CFTC will look at the relevant 

facts and circumstances, it does not 

expect that an unintentional settlement 

failure or delay for operational reasons 

or due to a market disruption will 

undermine the character of a bona fide 

spot foreign exchange transaction as 

such. 

The CFTC also will interpret a 

Securities Conversion Transaction as 

not leveraged, margined or financed 

within the meaning of section 2(c)(2)(C) 

of the CEA.568 While it is possible to 

view the fact that the buyer of a 

currency in such a transaction does not 

pay for the currency until it is delivered 

as leverage (in that the buyer puts 

nothing down until taking delivery, thus 

achieving 100% leverage) or a financing 

arrangement, the CFTC does not 

interpret it as such for purposes of CEA 

section 2(c)(2)(C).569 Congress 

recognized that settlement of bona fide 

spot foreign exchange transactions 

typically takes two days.570 The fact that 

Congress expressly excluded these types 

of bona fide spot foreign exchange 

transactions does not mean that 

Congress intended to subject Security 

Conversion Transactions to regulation 

under the retail foreign exchange 

regime.571 For the foregoing reasons, the 

CFTC will interpret a Securities 

Conversion Transaction as not 

leveraged, margined or financed within 

the meaning of section 2(c)(2)(C) of the 

CEA.572

Comments 

One commenter requested 

clarification regarding the status of 

foreign exchange spot transactions.573

This commenter recommended that the 

Commissions clarify that foreign 

exchange spot transactions, which this 

commenter defined as ‘‘transactions of 

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574 Id. In this commenter’s view, such 

clarification is necessary to avoid the statutory 

foreign exchange forward definition ‘‘unwittingly 

captur[ing] many typical foreign exchange spot 

transactions * * * settl[ing] within a customary 

settlement cycle,’’ which this commenter stated is 

generally ‘‘T+2’’ in the United States, but can be 

‘‘T+3’’ in some other countries. 

575See Letter from Phoebe A. Papageorgiou, 

Senior Counsel, American Bankers Ass’n and James 

Kemp, Managing Director, Global Foreign Exchange 

Division, dated April 18, 2012 (‘‘ABA/Global FX 

Letter’’). This commenter requested clarification 

that the purchase, sale or exchange of a foreign 

currency by a bank on behalf of a retail customer 

for the sole purpose of effecting a purchase or sale 

of a foreign security or in order to clear or settle 

such purchase or sale, when the settlement period 

for such FX transaction is within the settlement 

cycle for such foreign security, is excluded from the 

retail foreign exchange under the CEA. The CFTC 

has provided the clarification regarding the 

meaning of ‘‘leveraged, margined or financed’’ 

under section 2(c)(2)(C) of the CEA to address this 

commenter’s concern. 

576 7 U.S.C. 2(c)(2)(B). 

577See section 1a(47)(B)(i) of the CEA, 7 U.S.C. 

1a(47)(B)(i). Sections 2(c)(2)(B), (C), and (D) of the 

CEA, 7 U.S.C. 2(c)(2)(B), (C), and (D), govern certain 

types of off-exchange transactions in commodities, 

including foreign currency, in which one of the 

parties to the transaction is not an ECP. 

578ECPs are defined in section 1a(18) of the CEA, 

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

579Section 2(c)(2)(B)(i) of the CEA provides: (i) 

This Act applies to, and the Commission shall have 

jurisdiction over, an agreement, contract, or 

transaction in foreign currency that—(I) is a 

contract of sale of a commodity for future delivery 

(or an option on such a contract) or an option (other 

than an option executed or traded on a national 

securities exchange registered pursuant to section 

6(a) of the Securities Exchange Act of 1934, 15 

U.S.C. 78f(a)); and (II) is offered to, or entered into 

with, a person that is not an eligible contract 

participant, unless the counterparty, or the person 

offering to be the counterparty, of the person is 

[certain regulated counterparties enumerated in the 

statute.] 7 U.S.C. 2(c)(2)(B)(i). Thus, under section 

2(c)(2)(B)(i) of the CEA, the CEA’s exchange-trading 

requirement generally applies with respect to 

futures, options on futures, and options on foreign 

currency. See section 4(a) of the CEA, 7 U.S.C. 6(a) 

(generally requiring futures contracts to be traded 

on or subject to the rules of a DCM); section 4c(b) 

of the CEA, 7 U.S.C. 6c(b) (prohibiting trading 

options subject to the CEA contrary to CFTC rules, 

regulations or orders permitting such trading); Part 

32 of the CFTC’s rules, 17 CFR Part 32 (generally 

prohibiting entering into options subject to the CEA 

(other than options on futures) other than on or 

subject to the rules of a DCM); and CFTC Rule 

33.3(a), 17 CFR 33.3(a) (prohibiting entering into 

options on futures other than on or subject to the 

rules of a DCM). However, if the counterparty to the 

non-ECP is an enumerated regulated entity 

identified in section 2(c)(2)(B)(i)(II) of the CEA, 7 

U.S.C. 2(c)(2)(B)(i)(II), the CEA’s exchange-trading 

requirement does not apply. Accordingly, an 

enumerated regulated entity—including a banking 

institution regulated by the OCC—can, pursuant to 

section 2(c)(2)(B) of the CEA, lawfully enter into a 

future, an option on a future, or an option on 

foreign currency with a non-ECP counterparty on an 

off-exchange basis. 

580See section 1a(47)(B)(i) of the CEA, 7 U.S.C. 

1a(47)(B)(i). 

581See Proposing Release at 29835 n.125. 

582 7 U.S.C. 2(e). 

583The CFTC notes in this regard that repeals by 

implication are strongly disfavored by the courts. 

See, e.g., Village of Barrington, Ill. v. Surface 

Transp. Bd., 636 F.3d 650, 662 (D.C. Cir. 2011) 

(‘‘Repeals by implication, however, are strongly 

disfavored ‘absent a clearly expressed congressional 

intention’ ’’) (quoting Branch v. Smith, 538 U.S. 

254, 273, 123 S.Ct. 1429 (2003)); Agri Processor Co., 

Inc. v. N.L.R.B., 514 F.3d 1, 4 (D.C. Cir. 2008) 

(‘‘[a]mendments by implication, like repeals by 

implication, are not favored’’ and ‘‘will not be 

found unless an intent to repeal [or amend] is ‘clear 

and manifest.’ ’’) (quoting United States v. Welden, 

377 U.S. 95, 102 n. 12, 84 S.Ct. 1082 (1964) and 

Rodriguez v. United States, 480 U.S. 522, 524, 107 

S.Ct. 1391 (1987)). 

584See, e.g., Singer and Singer, Sutherland 

Statutes and Statutory Construction § 47:38 (7th ed. 

2011) (‘‘Words may be supplied in a statute * * * 

where omission is due to inadvertence, mistake, 

accident, or clerical error’’). 

one currency into another that settle 

within a customary settlement cycle,’’ 

are neither foreign exchange forwards 

nor swaps.574 Another commenter 

indicated that the customary settlement 

cycle for purchases of most non-U.S. 

denominated securities is ‘‘T+3’’ (in 

some securities markets, such as South 

Africa, the settlement cycle can take up 

to seven days), and requires the buyer 

to pay for the foreign securities in the 

relevant foreign currency.575 Typically, 

according to this commenter, a brokerdealer or bank custodian acting on 

behalf of the buyer or seller will enter 

into a foreign currency transaction to 

settle on a T+3 basis (or the relevant 

settlement period) as well. Timing the 

foreign exchange transaction to settle at 

the same time as the securities 

transaction benefits the customer by 

reducing his or her exposure to currency 

risk on the securities transaction 

between trade date and settlement date. 

The Commissions have provided the 

interpretation described above regarding 

the interplay between the foreign 

exchange forward definition, the 

meaning of ‘‘leveraged, margined or 

financed’’ under section 2(c)(2)(C) of the 

CEA, and bona fide foreign exchange 

spot transactions to address these 

commenters’ concerns. 

(d) Retail Foreign Currency Options 

The CFTC is providing an 

interpretation regarding the status of 

retail foreign currency options that are 

described in section 2(c)(2)(B) of the 

CEA.576 As noted above, the 

Commissions proposed to include 

foreign currency options generally 

within the definition of the term 

‘‘swap,’’ subject to the statutory 

exclusions in subparagraph (B) of the 

definition. The statutory exclusions 

from the swap definition encompass 

transactions described in sections 

2(c)(2)(C) and (D) of the CEA, but not 

those in section 2(c)(2)(B) of the CEA.577

Section 2(c)(2)(B) of the CEA applies to 

futures, options on futures and options 

on foreign currency (other than foreign 

currency options executed or traded on 

a national securities exchange), and 

permits such transactions to be entered 

into with counterparties who are not 

ECPs 578 on an off-exchange basis by 

certain enumerated regulated entities.579

No issue arises with respect to futures 

or options on futures in foreign currency 

that are covered by section 2(c)(2)(B) of 

the CEA, because they are expressly 

excluded from the statutory swap 

definition.580 Commodity options, 

including options on foreign currency, 

however, are not excluded from the 

swap definition (other than foreign 

currency options executed or traded on 

a national securities exchange). 

The CFTC notes that, in further 

defining the term ‘‘swap’’ to include 

foreign currency options, the Proposing 

Release stated that the proposal was not 

intended to address, and had no bearing 

on, the CFTC’s jurisdiction over foreign 

currency options in other contexts, 

specifically citing section 2(c)(2)(B) of 

the CEA.581 Nonetheless, the CFTC 

acknowledges the ambiguity in the 

statute regarding the status of offexchange foreign currency options with 

non-ECPs that are subject to section 

2(c)(2)(B) of the CEA. While foreign 

currency options are swaps, they also 

are subject to section 2(c)(2)(B) of the 

CEA when entered into off-exchange 

with non-ECPs, and there is no statutory 

exclusion from the swap definition for 

section 2(c)(2)(B) transactions. If foreign 

currency options were deemed to be 

swaps, then, pursuant to section 2(e) of 

the CEA, as added by the Dodd-Frank 

Act,582 they could not be entered into by 

non-ECP counterparties, except on a 

DCM. This would render the provisions 

of section 2(c)(2)(B) of the CEA, 

permitting off-exchange foreign 

currency options with non-ECPs by 

enumerated regulated entities, a nullity. 

The CFTC believes that Congress did 

not intend the swap definition to 

overrule and effectively repeal another 

provision of the CEA in such an oblique 

fashion.583 Nor is there anything in the 

legislative history of the Dodd-Frank 

Act to suggest a congressional intent to 

prohibit only one type of off-exchange 

foreign currency transaction with nonECPs (out of the three types of offexchange foreign currency transactions 

with non-ECPs that are addressed in 

CEA section 2(c)(2)(B)). The omission of 

section 2(c)(2)(B) of the CEA from the 

exclusions set forth in the statutory 

swap definition appears to be a 

scrivener’s error.584 Accordingly, the 

CFTC is applying the exclusion from the 

swap definition to foreign currency 

options described in CEA section 

2(c)(2)(B). 

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585See rules 1.3(xxx)(2)(i)(E) under the CEA and 

rule 3a69–2(b)(1)(v) under the Exchange Act. 

586See generally ‘‘Trading and Capital-Markets 

Activities Manual,’’ supra note 556, section 4315.1 

(‘‘For example, in a six-against-nine-month (6x9) 

FRA, the parties agree to a three-month rate that is 

to be netted in six months’ time against the 

prevailing three-month reference rate, typically 

LIBOR. At settlement (after six months), the present 

value of the net interest rate (the difference between 

the spot and the contracted rate) is multiplied by 

the notional principal amount to determine the 

amount of the cash exchanged between the parties 

* * * . If the spot rate is higher than the contracted 

rate, the seller agrees to pay the buyer the 

differences between the prespecified forward rate 

and the spot rate prevailing at maturity, multiplied 

by a notional principal amount. If the spot rate is 

lower than the forward rate, the buyer pays the 

seller.’’). 

587 It appears that at least some in the trade view 

FRAs as swaps today. See, e.g., The Globecon 

Group, Ltd., ‘‘Derivatives Engineering: A Guide to 

Structuring, Pricing and Marketing Derivatives,’’ 45 

(McGraw-Hill 1995) (‘‘An FRA is simply a oneperiod interest-rate swap.’’); DerivActiv, Glossary of 

Financial Derivatives Terms (‘‘A swap is * * * a 

strip of FRAs.’’), available at http://www.derivactiv.

com/definitions.aspx?search=forward+rate+

agreements. Cf. Don M. Chance, et al., ‘‘Derivatives 

in Portfolio Management,’’ 29 (AIMR 1998) (‘‘[An 

FRA] involves one specific payment and is basically 

a one-date swap (in the sense that a swap is a 

combination of FRAs[,] with some variations).’’). 

Thus, FRAs also may fall within clause (A)(iv) of 

the swap definition, as ‘‘an agreement, contract, or 

transaction that is, or in the future becomes, 

commonly known to the trade as a swap.’’ See 

section 1a(47)(a)(iv) of the CEA, 7 U.S.C. 

1a(47)(a)(iv). 

588See section 1a(47)(A)(iii) of the CEA, 7 U.S.C. 

1a(47)(A)(iii). CFTC regulations have defined FRAs 

as swap agreements. See rule 35.1(b)(1)(i) under the 

CEA, 17 CFR 35.1(b)(1)(i); Exemption for Certain 

Swap Agreements, 58 FR 5587 (Jan. 22, 1993). The 

CFTC recently repealed that rule and amended Part 

35 of its rules in light of the enactment of Title VII 

of the Dodd-Frank Act. See Agricultural Swaps, 76 

FR 49291 (Aug. 10, 2011). 

589See Regulation of Hybrid and Related 

Instruments, 52 FR 47022, 47028 (Dec. 11, 1987) 

(stating ‘‘[FRAs] do not possess all of the 

characteristics of forward contracts heretofore 

delineated by the [CFTC]’’). 

590The Commissions note that Current European 

Union law includes FRAs in the definition of 

‘‘financial instruments.’’ See Markets in Financial 

Instruments Directive (MiFID), ‘‘Directive 2004/39/ 

EC of the European Parliament and of the Council,’’ 

Annex I(C), 4, 5, 10 (Apr. 21, 2004), available at 

http://eur-lex.europa.eu/LexUriServ/LexUri

Serv.do?uri=CONSLEG:2004L0039: 

20070921:EN:PDF. European Commission 

legislation on derivatives, central clearing, and 

trade repositories applies to FRAs that are traded 

over-the-counter and, thus, would subject such 

transactions to mandatory clearing, reporting and 

other regulatory requirements. See Regulation of the 

European Parliament and of the Council on OTC 

derivatives, central counterparties and trade 

repositories, tit. I, art. 2 (1(3b)), 7509/1/12 REV 1 

(Mar. 19, 2012). 

591See section 1a(47)(vi) of the CEA, 7 U.S.C. 

1a(47)(vi). Clause (A)(vi) of the swap definition 

refers specifically to other types of swaps in the 

swap definition. However, because section 3(a)(68) 

of the Exchange Act defines a security-based swap 

as a swap [with some connection to a security], 

clause (A)(vi) of the swap definition is relevant to 

determining whether any combination or 

permutation of, or option on, a security-based swap 

is a security-based swap. 

592See Proposing Release at 29838. 

593Forward swaps are also commonly known as 

forward start swaps, or deferred or delayed start 

swaps. A forward swap can involve two offsetting 

swaps that both start immediately, but one of which 

ends on the deferred start date of the forward swap 

itself. For example, if a counterparty wants to hedge 

its risk for four years, starting one year from today, 

it could enter into a one-year swap and a five-year 

swap, which would partially offset to create a fouryear swap, starting one year forward. A forward 

swap also can involve a contract to enter into a 

swap or security-based swap at a future date or with 

a deferred start date. A forward swap is not a 

nonfinancial commodity forward contract or 

security forward, both of which are excluded from 

the swap definition and discussed elsewhere in this 

release. 

594This category could include categories of 

agreements, contracts or transactions that do not yet 

exist as well as more esoteric swaps that exist but 

that Congress did not refer to by name in the 

statutory swap definition. 

595See Proposing Release at 29838. 

596See Ontario Securities Commission, Staff 

Notice 91–702, ‘‘Offerings of Contracts for 

Difference and Foreign Exchange Contracts to 

Investors in Ontario,’’ at part IV.1 (defining a CFD 

as ‘‘a derivative product that allows an investor to 

obtain economic exposure (for speculative, 

investment or hedging purposes) to an underlying 

asset * * * such as a share, index, market sector, 

currency or commodity, without acquiring 

ownership of the underlying asset’’), available at 

Continued 

3. Forward Rate Agreements 

The Commissions are adopting rules 

as proposed to explicitly define the term 

‘‘swap’’ to include forward rate 

agreements (‘‘FRAs’’).585 The 

Commissions did not receive any 

comments on the proposed rules 

regarding the inclusion of FRAs in the 

swap definition. 

In general, an FRA is an over-thecounter contract for a single cash 

payment, due on the settlement date of 

a trade, based on a spot rate (determined 

pursuant to a method agreed upon by 

the parties) and a pre-specified forward 

rate. The single cash payment is equal 

to the product of the present value 

(discounted from a specified future date 

to the settlement date of the trade) of the 

difference between the forward rate and 

the spot rate on the settlement date 

multiplied by the notional amount. The 

notional amount itself is not 

exchanged.586

An FRA provides for the future 

(executory) payment based on the 

transfer of interest rate risk between the 

parties as opposed to transferring an 

ownership interest in any asset or 

liability.587 Thus, the Commissions 

believe that an FRA satisfies clause 

(A)(iii) of the swap definition.588

Notwithstanding their ‘‘forward’’ 

label, FRAs do not fall within the 

forward contract exclusion from the 

swap definition. FRAs do not involve 

nonfinancial commodities and thus are 

outside the scope of the forward 

contract exclusion. Nor is an FRA a 

commercial merchandising transaction, 

as there is no physical product to be 

delivered in an FRA.589 Accordingly, 

the Commissions believe that the 

forward contract exclusion from the 

swap definition for nonfinancial 

commodities does not apply to FRAs.590

Based on the foregoing 

considerations, the Commissions are 

adopting rules to provide greater clarity 

by explicitly defining the term ‘‘swap’’ 

to include FRAs. As with the foreign 

exchange-related products discussed 

above, the final rules provide that FRAs 

are not swaps if they fall within one of 

the exclusions set forth in subparagraph 

(B) of the swap definition. 

4. Combinations and Permutations of, or 

Options on, Swaps and Security-Based 

Swaps 

Clause (A)(vi) of the swap definition 

provides that ‘‘any combination or 

permutation of, or option on, any 

agreement, contract, or transaction 

described in any of clauses (i) through 

(v)’’ of the definition is a swap.591 The 

Commissions provided an interpretation 

regarding clause (A)(vi) in the Proposing 

Release.592 The Commissions received 

no comments on the interpretation 

provided in the Proposing Release 

regarding combinations and 

permutations of, or options on, swaps 

and security-based swaps and are 

restating their interpretation of clause 

(A)(vi) of the swap definition with one 

technical correction and one 

clarification. 

Clause (A)(vi) means, for example, 

that an option on a swap or securitybased swap (commonly known as a 

‘‘swaption’’) would itself be a swap or 

security-based swap, respectively. The 

Commissions also interpret clause 

(A)(vi) to mean that a ‘‘forward swap’’ 

would itself be a swap or security-based 

swap, respectively.593 By listing 

examples here, the Commissions do not 

intend to limit the broad language of 

clause (A)(vi) of the swap definition, 

which is designed to capture those 

agreements, contracts and transactions 

that are not expressly enumerated in the 

CEA swap definition but that 

nevertheless are swaps.594

5. Contracts for Differences 

As the Proposing Release notes, the 

Commissions have received inquiries 

over the years regarding the treatment of 

CFDs under the CEA and the Federal 

securities laws.595 A CFD generally is an 

agreement to exchange the difference in 

value of an underlying asset between 

the time at which a CFD position is 

established and the time at which it is 

terminated.596 If the value increases, the 

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48260 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

http://www.osc.gov.on.ca/documents/en/SecuritiesCategory9/sn_20091030_91-702_cdf.pdf (Oct. 30, 

2009); Financial Services Authority, Consultation 

Paper 7/20, ‘‘Disclosure of Contracts for 

Difference—Consultation and draft Handbook text,’’ 

at part 2.2 (defining a CFD on a share as ‘‘a 

derivative product that gives the holder an 

economic exposure, which can be long or short, to 

the change in price of a specific share over the life 

of the contract’’), available at http:// 

www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007). 

597See, e.g., Int’l Swaps and Derivatives Ass’n, 

‘‘2002 ISDA Equity Derivatives Definitions,’’ art. 10 

(Dividends) and 11 (Adjustments and Modifications 

Affecting Indices, Shares and Transactions). 

598 In some cases, depending on the facts and 

circumstances, the SEC may determine that a 

particular CFD on an equity security, for example, 

should be characterized as constituting a purchase 

or sale of the underlying equity security and, 

therefore, be subject to the requirements of the 

Federal securities laws applicable to such 

purchases or sales. 

599See Covington Letter and ICI/ABASA Letter. 

600See infra note 606. 

601See Proposing Release at 29839. 

602For example, a company obligated to deliver 

its product to a customer in Los Angeles would 

instead deliver the product in Albany to a different 

company’s customer on behalf of that other 

company. In return, the company with the 

obligation to deliver a product to its customer in 

Albany would deliver the product instead in Los 

Angeles to the customer of the company obligated 

to deliver its product to that customer in Los 

Angeles. 

603See, e.g., Haekel v. Refco, 2000 WL 1460078, 

at *4 (CFTC Sept. 29, 2000) (‘‘[T]he labels that 

parties apply to their transactions are not 

necessarily controlling’’); Reves v. Ernst & Young, 

494 U.S. 56, 61 (1990) (stating that the purpose of 

the securities laws is ‘‘to regulate investments, in 

whatever form they are made and by whatever 

name they are called’’) (emphasis in original). 

604As noted in the Proposing Release, the CFTC 

consistently has found that the form of a transaction 

is not dispositive in determining its nature, citing 

Grain Land, supra note 213, at *16 (CFTC Nov. 25, 

2003) (holding that contract substance is entitled to 

at least as much weight as form); In the Matter of 

First Nat’l Monetary Corp., [1984–1986 Transfer 

Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,698 at 

30,974 (CFTC Aug. 7, 1985) (‘‘When instruments 

have been determined to constitute the functional 

equivalent of futures contracts neither we nor the 

courts have hesitated to look behind whatever selfserving labels the instruments might bear.’’); 

Stovall, supra note 63 (holding that the CFTC ‘‘will 

not hesitate to look behind whatever label the 

parties may give to the instrument’’). As also noted 

in the Proposing Release, the form of a transaction 

is not dispositive in determining whether an 

agreement, contract, or transaction falls within the 

regulatory regime for securities. See SEC v. Merch. 

Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007) 

(‘‘The Supreme Court has repeatedly emphasized 

that economic reality is to govern over form and 

that the definitions of the various types of securities 

should not hinge on exact and literal tests.’’) 

(quoting Williamson v. Tucker, 645 F.2d 404, 418 

(5th Cir. 1981)); Robinson v. Glynn, 349 F.3d 166, 

170 (4th Cir. 2003) (‘‘What matters more than the 

form of an investment scheme is the ‘economic 

reality’ that it represents. * * *’’) (internal citation 

omitted); Caiola v. Citibank, N.A., New York, 295 

F.3d 312, 325 (2d Cir. 2002) (quoting United 

Housing Foundation v. Foreman, 421 U.S. 837, 848 

(1975) (‘‘In searching for the meaning and scope of 

the word ‘security’ * * * the emphasis should be 

on economic reality’’)). See Proposing Release at 

29839 n. 152. 

605The Commissions note, though, that 

documentation is not controlling in evaluating 

whether an agreement, contract or transaction is a 

swap, security-based swap, or neither. 

seller pays the buyer the difference; if 

the value decreases, the buyer pays the 

seller the difference. CFDs can be traded 

on a number of products, including 

treasuries, foreign exchange rates, 

commodities, equities, and stock 

indexes. Equity CFDs closely mimic the 

purchase of actual shares. The buyer of 

an equity CFD receives cash dividends 

and participates in stock splits.597 In the 

case of a long position, a dividend 

adjustment is credited to the client’s 

account. In the case of a short position, 

a dividend adjustment is debited from 

the client’s account. CFDs generally are 

traded over-the-counter (though they 

also are traded on the Australian 

Securities Exchange) in a number of 

countries outside the United States. 

The Commissions provided an 

interpretation in the Proposing Release 

regarding the treatment of CFDs. The 

Commissions are restating the 

interpretation set out in the Proposing 

Release without modification. 

CFDs, unless otherwise excluded, fall 

within the scope of the swap or 

security-based swap definition, as 

applicable.598 Whether a CFD is a swap 

or security-based swap will depend on 

the underlying product of that particular 

CFD transaction. Because CFDs are 

highly variable and a CFD can contain 

a variety of elements that would affect 

its characterization, the Commissions 

believe that market participants will 

need to analyze the features of the 

underlying product of any particular 

CFD in order to determine whether it is 

a swap or a security-based swap. The 

Commissions are not adopting rules or 

additional interpretations at this time 

regarding CFDs. 

Comments 

Two commenters requested that the 

Commissions clarify that nondeliverable forward contracts are not 

CFDs.599 These commenters requested 

that the Commissions determine that 

NDFs involving foreign exchange are 

not swaps. Given that the Commissions 

are defining NDFs as swaps and that 

CFDs involving foreign currency also 

would be swaps, there is no need to 

distinguish NDFs involving foreign 

exchange from CFDs involving foreign 

exchange. 

D. Certain Interpretive Issues 

1. Agreements, Contracts, or 

Transactions That May Be Called, or 

Documented Using Form Contracts 

Typically Used for, Swaps or SecurityBased Swaps 

The Commissions are restating the 

interpretation provided in the Proposing 

Release regarding agreements, contracts, 

or transactions that may be called, or 

documented using form contracts 

typically used for, swaps or securitybased swaps with one modification in 

response to a commenter.600

As was noted in the Proposing 

Release,601 individuals and companies 

may generally use the term ‘‘swap’’ to 

refer to certain of their agreements, 

contracts, or transactions. For example, 

they may use the term ‘‘swap’’ to refer 

to an agreement to exchange real or 

personal property between the parties or 

to refer to an agreement for two 

companies that produce fungible 

products and with delivery obligations 

in different locations to perform each 

other’s delivery obligations instead of 

their own.602 However, the name or 

label that the parties use to refer to a 

particular agreement, contract, or 

transaction is not determinative of 

whether it is a swap or security-based 

swap.603

It is not dispositive that the 

agreement, contract, or transaction is 

documented using an industry standard 

form agreement that is typically used for 

swaps and security-based swaps,604 but 

it may be a relevant factor.605 The key 

question is whether the agreement, 

contract, or transaction falls within the 

statutory definitions of the term ‘‘swap’’ 

or ‘‘security-based swap’’ (as further 

defined and interpreted pursuant to the 

final rules and interpretations herein) 

based on its terms and other 

characteristics. Even if one effect of an 

agreement is to reduce the risk faced by 

the parties (for example, the ‘‘swap’’ of 

physical delivery obligations described 

above may reduce the risk of nondelivery), the agreement would not be a 

swap or security-based swap unless it 

otherwise meets one of those statutory 

definitions, as further defined by the 

Commissions. If the agreement, contract, 

or transaction satisfies the swap or 

security-based swap definitions, the fact 

that the parties refer to it by another 

name would not take it outside the 

Dodd-Frank Act regulatory regime. 

Conversely, if an agreement, contract, or 

transaction is not a swap or securitybased swap, as those terms are defined 

in the CEA and the Exchange Act and 

the rules and regulations thereunder, 

the fact that the parties refer to it, or 

document it, as a swap or security-based 

swap will not subject that agreement, 

contract, or transaction to regulation as 

a swap or a security-based swap. 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48261 

606See IECA Letter. This commenter noted that 

‘‘[e]ven though swaps are commonly documented 

on the ISDA Master Agreements without annexes, 

physical transactions under such agreements with 

power or natural gas annexes are not swaps because 

they are physically settled forward contracts that 

are exempt under 1a47(B)’’). Id. 

607 7 U.S.C. 6(c)(6). 

608The Commissions note that this approach 

should not be taken to suggest any finding by the 

Commissions as to whether or not FTRs or any 

other FERC-regulated instruments or transactions 

are swaps (or futures contracts). 

609See supra part II.B.2(a). 

610See supra note 317. 

611See COPE Letter; ETA Letter; and FERC Staff 

Letter. 

612 Id. 

613See COPE Letter. 

614 Id. 

615See ETA Letter. 

616See FERC Staff Letter. 

617See Better Markets Letter. 

618See NEMA Letter and WGCEF Letter. 

619See COPE Letter. 

620 15 U.S.C. 1011–1015. 

Comments 

The Commissions requested comment 

regarding what agreements, contracts, or 

transactions that are not swaps or 

security-based swaps are documented 

using industry standard form 

agreements that are typically used for 

swaps and security-based swaps, and 

asked for examples thereof and details 

regarding their documentation, 

including why industry standard form 

agreements typically used for swaps and 

security-based swaps are used. One 

commenter stated its view that 

documentation can be a relevant factor 

in determining whether an agreement, 

contract or transaction is a swap or 

security-based swap.606 The 

Commissions are persuaded by the 

commenter and are modifying the 

interpretation to clarify that in 

determining whether an agreement, 

contract or transaction is a swap or 

security-based swap, documentation 

may be a relevant (but not dispositive) 

factor. 

2. Transactions in Regional 

Transmission Organizations and 

Independent System Operators 

The CFTC declines to address the 

status of transactions in Regional 

Transmission Organizations (‘‘RTOs’’) 

and Independent System Operators 

(‘‘ISOs’’), including financial 

transmission rights (‘‘FTRs’’) and 

ancillary services, within this joint 

definitional rulemaking. As was noted 

in the Proposing Release, section 722 of 

the Dodd-Frank Act specifically 

addresses certain instruments and 

transactions regulated by FERC that also 

may be subject to CFTC jurisdiction. 

Section 722(f) added CEA section 

4(c)(6),607 which provides that, if the 

CFTC determines that an exemption for 

FERC-regulated instruments or other 

specified electricity transactions would 

be in accordance with the public 

interest, then the CFTC shall exempt 

such instruments or transactions from 

the requirements of the CEA. Given that 

specific statutory directive, the 

treatment of these FERC-regulated 

instruments and transactions should be 

considered under the standards and 

procedures specified in section 722 of 

the Dodd-Frank Act for a public interest 

waiver, rather than through this joint 

rulemaking to further define the terms 

‘‘swap’’ and ‘‘security-based swap.’’ 608

The CFTC notes that it has been 

engaged in discussions with a number 

of RTOs and ISOs regarding the 

possibility of a petition seeking an 

exemption pursuant to CEA section 

4(c)(6) for certain RTO and ISO 

transactions. The CFTC also notes that 

the status of some RTO and ISO 

transactions may have been addressed 

in the interpretation above regarding 

embedded options and the forward 

exclusion from the swap definition,609

and/or indirectly through the CFTC’s 

recent interim final rulemaking relating 

to trade options.610

Comments 

The CFTC received a number of 

comments discussing transactions in 

RTOs and ISOs.611 These commenters 

argued that the CFTC should further 

define the term ‘‘swap’’ to exclude 

transactions executed or traded on RTOs 

and ISOs.612 One commenter argued 

that the CEA section 4(c)(6) exemptive 

approach will leave regulatory 

ambiguity for market participants, since 

the CFTC might not grant an exemption, 

later revoke an existing exemption, 

grant a partial or conditional exemption, 

or limit an exemption to existing 

products.613 This commenter also noted 

that FERC has complete regulatory 

authority over RTOs and ISOs and their 

transactions, and that Congress expected 

the CFTC and FERC to avoid 

duplicative, unnecessary regulation.614

Another commenter argued that the 

CFTC should exclude RTO and ISO 

transactions in the same manner as 

insurance has been excluded.615 A third 

commenter stated that RTO and ISO 

transactions are commercial 

merchandising transactions and thus 

forwards or, alternatively, that defining 

them as swaps is inconsistent with the 

text, goals, and purpose of the DoddFrank Act.616

By contrast, one commenter asserted 

that FTRs are in substance swaps and 

should be regulated as such.617

Two commenters supported the 

CFTC’s use of its section 722(f) 

authority to exempt FERC-regulated 

transactions and other transactions in 

RTOs or ISOs.618 As discussed above, 

section 722(f) of the Dodd-Frank Act 

added new section 4(c)(6) to the CEA 

specifically addressing how the CFTC 

should approach certain instruments 

and transactions regulated by FERC that 

also may be subject to CFTC 

jurisdiction. The CFTC continues to 

believe, as was stated in the Proposing 

Release, that such an approach is the 

more appropriate means of considering 

issues relating to the instruments and 

transactions specified in CEA section 

4(c)(6). One commenter’s argument that 

the CEA section 4(c)(6) exemptive 

approach will cause regulatory 

ambiguity is not a convincing basis on 

which to forego a process specifically 

designated by Congress for the issue at 

hand.619 The CFTC also believes that 

the ability to tailor exemptive relief, 

after notice and public comment, to the 

complex issues presented by 

transactions on RTOs and ISOs, is 

further reason to favor such an approach 

over the more general directive to 

further define the terms ‘‘swap’’ and 

‘‘security-based swap’’ that is the 

subject of this rulemaking. 

In response to one commenter’s 

contentions that FERC has complete 

regulatory authority over RTOs and 

ISOs and their transactions, and that 

Congress expected the CFTC and FERC 

to avoid duplicative, unnecessary 

regulation, the CFTC notes that 

Congress addressed this issue not by 

excluding RTO and ISO transactions 

from the comprehensive regime for 

swap regulation, but rather by enacting 

the exemptive process in CEA section 

4(c)(6). 

And in response to another 

commenter’s contention that the CFTC 

should exclude RTO and ISO 

transactions in the same manner as 

insurance has been excluded, the CFTC 

notes that Congress provided neither an 

exemptive process equivalent to CEA 

section 4(c)(6) for insurance, nor an 

energy market-equivalent to the 

McCarran-Ferguson Act.620

As noted above, FERC staff opines 

that defining RTO and ISO transactions 

as swaps would be inconsistent with the 

text, goals, and purpose of the DoddFrank Act. The CFTC can consider 

concerns of the sort expressed by FERC 

staff in connection with any petition for 

a CEA section 4(c)(6) exemption that 

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48262 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

621CEA section 4(c)(6) requires the CFTC to 

determine that an exemption pursuant to such 

section ‘‘is consistent with the public interest and 

the purposes of th[e CEA].’’ 7 U.S.C. 6(c)(6). 

622See section 1a(47) of the CEA, 7 U.S.C. 1a(47). 

623See section 3(a)(68) of the Exchange Act, 15 

U.S.C. 78c(a)(68). 

624 In some cases, the Title VII instrument may be 

a mixed swap. Mixed swaps are discussed further 

in section IV below. 

625The determination must be made no later than 

when the parties offer to enter into the Title VII 

instrument because persons are prohibited from 

offering to sell, offering to buy or purchase, or 

selling a security-based swap to any person who is 

not an ECP unless a registration statement is in 

effect as to the security-based swap. See section 5(e) 

of the Securities Act. This analysis also would 

apply with respect to mixed swaps and securitybased swap agreements. With respect to swaps, the 

determination also would need to be made no later 

than the time that provisions of the CEA and the 

regulations thereunder become applicable to a Title 

VII Instrument. For instance, certain duties apply to 

swaps prior to execution. See Daily Trading 

Records under Rule 23.202 under the CEA, 17 CFR 

23.202, and Subpart H of Part 23 of the CFTC’s 

regulations, 17 CFR Part 23, Subpart H (Business 

Conduct Standards for Swap Dealers and Major 

Swap Participants Dealing with Counterparties, 

Including Special Entities). 

626See infra part III.G.5(a), for a discussion 

regarding the evaluation of Title VII Instruments on 

security indexes that move from broad-based to 

narrow-based or narrow-based to broad-based. 

627These secured lending rates are the Eurepo, 

The Depository Trust & Clearing Corporation’s 

General Collateral Finance Repo Index, the 

Repurchase Overnight Index Average Rate and the 

Tokyo Repo Rate. 

628See supra part I, under ‘‘Overall Economic 

Considerations’’. 

629See infra part III.F, regarding the use of certain 

terms and conditions. 

630 Interbank lending rates are measured by 

surveys of the loan rates that banks offer other 

banks, or by other mechanisms. The periods of time 

for such loans may range from overnight to 12 

months or longer. 

The interbank offered rates listed here are 

frequently called either a ‘‘reference rate,’’ the rate 

of ‘‘reference banks,’’ or by a designation that is 

specific to the service that quotes the rate. For some 

of the interbank offered rates listed here, there is a 

similar rate that is stated as an interbank bid rate, 

which is the average rate at which a group of banks 

bid to borrow money from other banks. For 

example, the bid rate similar to LIBOR is called 

LIBID. 

631Today, LIBOR is used as a rate of reference for 

the following currencies: Australian Dollar, 

may be submitted to the CFTC.621

Interested parties on all sides of the 

issue would receive an opportunity to 

comment on the scope and other aspects 

of any proposed exemptive relief at that 

time. 

III. The Relationship Between the Swap 

Definition and the Security-Based Swap 

Definition 

A. Introduction 

Title VII of the Dodd-Frank Act 

defines the term ‘‘swap’’ under the 

CEA,622 and also defines the term 

‘‘security-based swap’’ under the 

Exchange Act.623 Pursuant to the 

regulatory framework established in 

Title VII, the CFTC has regulatory 

authority over swaps and the SEC has 

regulatory authority over security-based 

swaps. The Commissions are further 

defining the terms ‘‘swap’’ and 

‘‘security-based swap’’ to clarify 

whether particular agreements, 

contracts, or transactions are swaps or 

security-based swaps based on 

characteristics including the specific 

terms and conditions of the instrument 

and the nature of, among other things, 

the prices, rates, securities, indexes, or 

commodities upon which the 

instrument is based. 

Because the discussion below is 

focused on whether particular 

agreements, contracts, or transactions 

are swaps or security-based swaps, the 

Commissions use the term ‘‘Title VII 

instrument’’ in this release to refer to 

any agreement, contract, or transaction 

that is included in either the definition 

of the term ‘‘swap’’ or the definition of 

the term ‘‘security-based swap.’’ Thus, 

the term ‘‘Title VII instrument’’ is 

synonymous with ‘‘swap or securitybased swap.’’ 624

The determination of whether a Title 

VII instrument is either a swap or a 

security-based swap should be made 

based on the facts and circumstances 

relating to the Title VII instrument prior 

to execution, but no later than when the 

parties offer to enter into the Title VII 

instrument.625 If the Title VII 

instrument itself is not amended, 

modified, or otherwise adjusted during 

its term by the parties, its 

characterization as a swap or securitybased swap will not change during its 

duration because of any changes that 

may occur to the factors affecting its 

character as a swap or security-based 

swap.626

Classifying a Title VII instrument as a 

swap or security-based swap is 

straightforward for most instruments. 

However, the Commissions provided an 

interpretation in the Proposing Release 

to clarify the classification of swaps and 

security-based swaps in certain areas 

and to provide an interpretation 

regarding the use of certain terms and 

conditions in Title VII instruments. The 

Commissions are restating the 

interpretation set out in the Proposing 

Release with certain modifications to 

the interpretation regarding TRS. 

B. Title VII Instruments Based on 

Interest Rates, Other Monetary Rates, 

and Yields 

Parties frequently use Title VII 

instruments to manage risks related to, 

or to speculate on, changes in interest 

rates, other monetary rates or amounts, 

or the return on various types of assets. 

Broadly speaking, Title VII instruments 

based on interest or other monetary 

rates would be swaps, whereas Title VII 

instruments based on the yield or value 

of a single security, loan, or narrowbased security index would be securitybased swaps. However, market 

participants and financial professionals 

sometimes use the terms ‘‘rate’’ and 

‘‘yield’’ in different ways. The 

Commissions proposed an 

interpretation in the Proposing Release 

regarding whether Title VII instruments 

that are based on interest rates, other 

monetary rates, or yields would be 

swaps or security-based swaps and are 

restating the interpretation, but with a 

modification to the list of examples of 

reference rates to include certain 

secured lending rates under money 

market rates.627 The Commissions find 

that this interpretation is an appropriate 

way to address Title VII instruments 

based on interest rates, other monetary 

rates, or yields and is designed to 

reduce costs associated with 

determining whether such instruments 

are swaps or security-based swaps.628

1. Title VII Instruments Based on 

Interest Rates or Other Monetary Rates 

That Are Swaps 

The Commissions believe that when 

payments exchanged under a Title VII 

instrument are based solely on the 

levels of certain interest rates or other 

monetary rates that are not themselves 

based on one or more securities, the 

instrument would be a swap and not a 

security-based swap.629 Often swaps on 

interest rates or other monetary rates 

require the parties to make payments 

based on the comparison of a specified 

floating rate (such as the London 

Interbank Offered Rate (‘‘LIBOR’’)) to a 

fixed rate of interest agreed upon by the 

parties. A rate swap also may require 

payments based on the differences 

between two floating rates, or it may 

require that the parties make such 

payments when any agreed-upon events 

with respect to interest rates or other 

monetary rates occur (such as when a 

specified interest rate crosses a 

threshold, or when the spread between 

two such rates reaches a certain point). 

The rates referenced for the parties’ 

obligations are varied, and examples of 

such rates include the following: 

Interbank Offered Rates: An average 

of rates charged by a group of banks for 

lending money to each other or other 

banks over various periods of time, and 

other similar interbank rates,630

including, but not limited to, LIBOR 

(regardless of currency); 631 the Euro 

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Canadian Dollar, Danish Krone, Euro, Japanese Yen, 

New Zealand Dollar, Pound Sterling, Swedish 

Krona, Swiss Franc, and U.S. Dollar. 

632Other interbank offered rates include the 

following (with the country or city component of 

the acronym listed in parentheses): AIDIBOR (Abu 

Dhabi); BAIBOR (Buenos Aires); BKIBOR 

(Bangkok); BRAZIBOR (Brazil); BRIBOR/BRIBID 

(Btatislava); BUBOR (Budapest); CHIBOR (China); 

CHILIBOR (Chile); CIBOR (Copenhagen); COLIBOR 

(Columbia); HIBOR (Hong Kong); JIBAR 

(Johannesburg); JIBOR (Jakarta); KAIBOR 

(Kazakhstan); KIBOR (Karachi); KLIBOR (Kuala 

Lumpur); KORIBOR ((South) Korea); MEXIBOR 

(Mexico); MIBOR (Mumbai); MOSIBOR (Moscow); 

NIBOR (Norway); PHIBOR (Philippines); PRIBOR 

(Prague); REIBOR/REIBID (Reykjavik); RIGIBOR/ 

RIGIBID (Riga); SHIBOR (Shanghai); SIBOR 

(Singapore); SOFIBOR (Sofia); STIBOR (Stockholm); 

TAIBOR (Taiwan); TELBOR (Tel Aviv); TRLIBOR 

and TURKIBOR (Turkey); VILIBOR (Vilnius); 

VNIBOR (Vietnam); and WIBOR (Warsaw). 

633A Title VII instrument based solely on the 

level of a constant maturity U.S. Treasury rate 

would be a swap because U.S. Treasuries are 

exempted securities that are excluded from the 

security-based swap definition. Conversely, a Title 

VII instrument based solely on the level of a 

constant maturity rate on a narrow-based index of 

non-exempted securities under the security-based 

swap definition would be a security-based swap. 

634The TED spread is the difference between the 

interest rates on interbank loans and short-term U.S. 

government debt (Treasury bills or ‘‘T-bills’’). The 

latter are exempted securities that are excluded 

from the statutory definition of the term ‘‘securitybased swap.’’ Thus, neither any aspect of U.S. 

Treasuries nor interest rates on interbank loans can 

form the basis of a security-based swap. For this 

reason, a Title VII instrument on a spread between 

interbank loan rates and T-bill rates also would be 

a swap, not a security-based swap. 

635See CME Letter and SIFMA Letter. 636 Id. 637See supra note 633. 638See, e.g., Securities Confirmations, 47 FR 

37920 (Aug. 27, 1982). 

Interbank Offered Rate (‘‘Euribor’’); the 

Canadian Dealer Offered Rate 

(‘‘CDOR’’); and the Tokyo Interbank 

Offered Rate (‘‘TIBOR’’); 632

Money Market Rates: A rate 

established or determined based on 

actual lending or money market 

transactions, including, but not limited 

to, the Federal Funds Effective Rate; the 

Euro Overnight Index Average 

(‘‘EONIA’’ or ‘‘EURONIA’’) (which is the 

weighted average of overnight 

unsecured lending transactions in the 

Euro-area interbank market); the EONIA 

Swap Index; the Eurepo (the rate at 

which, at 11.00 a.m. Brussels time, one 

bank offers, in the euro-zone and 

worldwide, funds in euro to another 

bank if in exchange the former receives 

from the latter the best collateral within 

the most actively-traded European repo 

market); the Australian dollar RBA 30 

Interbank Overnight Cash Rate; the 

Canadian Overnight Repo Rate Average 

(‘‘CORRA’’); The Depository Trust & 

Clearing Corporation’s General 

Collateral Finance (‘‘GCF’’) Repo Index 

(an average of repo rates collateralized 

by U.S. Treasury and certain other 

securities); the Mexican interbank 

equilibrium interest rate (‘‘TIIE’’); the 

NZD Official Cash Rate; the Sterling 

Overnight Interbank Average Rate 

(‘‘SONIA’’) (which is the weighted 

average of unsecured overnight cash 

transactions brokered in London by the 

Wholesale Markets Brokers’ Association 

(‘‘WMBA’’)); the Repurchase Overnight 

Index Average Rate (‘‘RONIA’’) (which 

is the weighted average rate of all 

secured overnight cash transactions 

brokered in London by WMBA); the 

Swiss Average Rate Overnight 

(‘‘SARON’’); the Tokyo Overnight 

Average Rate (‘‘TONAR’’) (which is 

based on uncollateralized overnight 

average call rates for interbank lending); 

and the Tokyo Repo Rate (average repo 

rate of active Japanese repo market 

participants). 

Government Target Rates: A rate 

established or determined based on 

guidance established by a central bank 

including, but not limited to, the 

Federal Reserve discount rate, the Bank 

of England base rate and policy rate, the 

Canada Bank rate, and the Bank of Japan 

policy rate (also known as the Mutan 

rate); 

General Lending Rates: A general rate 

used for lending money, including, but 

not limited to, a prime rate, rate in the 

commercial paper market, or any similar 

rate provided that it is not based on any 

security, loan, or group or index of 

securities; 

Indexes: A rate derived from an index 

of any of the foregoing or following 

rates, averages, or indexes, including 

but not limited to a constant maturity 

rate (U.S. Treasury and certain other 

rates),633 the interest rate swap rates 

published by the Federal Reserve in its 

‘‘H.15 Selected Interest Rates’’ 

publication, the ISDAFIX rates, the 

ICAP Fixings, a constant maturity swap, 

or a rate generated as an average 

(geometric, arithmetic, or otherwise) of 

any of the foregoing, such as overnight 

index swaps (‘‘OIS’’)—provided that 

such rates are not based on a specific 

security, loan, or narrow-based group or 

index of securities; 

Other Monetary Rates: A monetary 

rate including, but not limited to, the 

Consumer Price Index (‘‘CPI’’), the rate 

of change in the money supply, or an 

economic rate such as a payroll index; 

and 

Other: The volatility, variance, rate of 

change of (or the spread, correlation or 

difference between), or index based on 

any of the foregoing rates or averages of 

such rates, such as forward spread 

agreements, references used to calculate 

the variable payments in index 

amortizing swaps (whereby the notional 

principal amount of the agreement is 

amortized according to the movement of 

an underlying rate), or correlation swaps 

and basis swaps, including but not 

limited to, the ‘‘TED spread’’ 634 and the 

spread or correlation between LIBOR 

and an OIS. 

As discussed above, the Commissions 

believe that when payments under a 

Title VII instrument are based solely on 

any of the foregoing, such Title VII 

instrument would be a swap. 

Comments 

Two commenters believed that 

constant maturity swaps always should 

be treated as swaps, rather than mixed 

swaps, because they generally are 

viewed by market participants as rates 

trades instead of trades on securities.635

According to the commenters, the 

‘‘bulk’’ of constant maturity swaps are 

based on exempted securities, but the 

commenters noted that the constant 

maturity leg may be based on a number 

of different rates or yields, including, 

among other things, U.S. Treasury 

yields, Treasury auction rates, yields on 

debt of foreign governments, and debt 

related to indices of mortgage-backed 

securities.636 As discussed above, the 

Commissions are adopting the 

interpretation as proposed. The 

statutory language of the swap and 

security-based swap definitions 

explicitly states that a Title VII 

instrument that is based on a nonexempted security should be a securitybased swap and not a swap.637

2. Title VII Instruments Based on Yields 

The Commissions proposed an 

interpretation in the Proposing Release 

clarifying the status of Title VII 

instruments in which one of the 

underlying references of the instrument 

is a ‘‘yield.’’ The Commissions received 

no comments on the interpretation set 

out in the Proposing Release regarding 

Title VII instruments based on yields 

and are restating the interpretation 

without modification. In cases when a 

‘‘yield’’ is calculated based on the price 

or changes in price of a debt security, 

loan, or narrow-based security index, it 

is another way of expressing the price 

or value of a debt security, loan, or 

narrow-based security index. For 

example, debt securities often are 

quoted and traded on a yield basis 

rather than on a dollar price, where the 

yield relates to a specific date, such as 

the date of maturity of the debt security 

(i.e., yield to maturity) or the date upon 

which the debt security may be 

redeemed or called by the issuer (e.g., 

yield to first whole issue call).638

Except in the case of certain exempted 

securities, when one of the underlying 

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639Section 3(a)(68)(C) of the Exchange Act, 15 

U.S.C. 76c(a)(68)(C). 

640As of January 11, 1983, the date of enactment 

of the Futures Trading Act of 1982, Public Law 97– 

444, 96 Stat. 2294, section 3(a)(12) of the Exchange 

Act, 15 U.S.C. 78c(a)(12), provided that, among 

other securities, ‘‘exempted securities’’ include: (i) 

Securities which are direct obligations of, or 

obligations guaranteed as to principal or interest by, 

the United States; (ii) certain securities issued or 

guaranteed by corporations in which the United 

States has a direct or indirect interest as designated 

by the Secretary of the Treasury; and (iii) certain 

other securities as designated by the SEC in rules 

and regulations. 

641Public Law 97–444, 96 Stat. 2294 (1983). 

642While this guidance focuses on TRS overlying 

securities and loans, TRS also may overlie other 

commodities. Such TRS may be structured 

differently due to the nature of the underlying. 

643See supra part I, under ‘‘Overall Economic 

Considerations.’’ 644See Proposing Release at 29842. 645Where the underlying security is an equity 

security, a TRS is also known as an ‘‘equity swap.’’ 

A bond may also be the underlying security of a 

TRS. 646 If the total return is negative, the seller 

receives this amount from the buyer. TRS can be 

used to synthetically reproduce the payoffs of a 

position. For example, two counterparties may 

enter into a 3-year TRS where the buyer of the TRS 

receives the positive total return on XYZ security, 

if any, and the seller of the TRS receives LIBOR 

plus 30 basis points and the absolute value of the 

negative total return on XYZ security, if any. 

647However, if the underlying reference of the 

TRS is a broad-based security index, it is a swap 

(and an SBSA) and not a security-based swap. In 

addition, a TRS on an exempted security, such as 

a U.S. Treasury, under section 3(a)(12) of the 

Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on 

the date of enactment of the Futures Trading Act 

of 1982 (other than any municipal security as 

defined in section 3(a)(29) of the Exchange Act, 15 

U.S.C. 78c(a)(29), as in effect on the date of 

enactment of the Futures Trading Act of 1982), is 

a swap (and an SBSA), and not a security-based 

swap. Similarly, and as discussed in more detail 

below, an LTRS based on two or more loans that 

are not securities (‘‘non-security loans’’) are swaps, 

and not security-based swaps. 

references of the Title VII instrument is 

the ‘‘yield’’ of a debt security, loan, or 

narrow-based security index in the 

sense where the term ‘‘yield’’ is used as 

a proxy for the price or value of the debt 

security loan, or narrow-based security 

index, the Title VII instrument would be 

a security-based swap. And, as a result, 

in cases where the underlying reference 

is a point on a ‘‘yield curve’’ generated 

from the different ‘‘yields’’ on debt 

securities in a narrow-based security 

index (e.g., a constant maturity yield or 

rate), the Title VII instrument would be 

a security-based swap. However, where 

certain exempted securities, such as 

U.S. Treasury securities, are the only 

underlying reference of a Title VII 

instrument involving securities, the 

Title VII instrument would be a swap. 

Title VII instruments based on 

exempted securities are discussed 

further below. 

The above interpretation would not 

apply in cases where the ‘‘yield’’ 

referenced in a Title VII instrument is 

not based on a debt security, loan, or 

narrow-based security index of debt 

securities but rather is being used to 

reference an interest rate or monetary 

rate as outlined above in subsection one 

of this section. In these cases, this 

‘‘yield’’ reference would be considered 

equivalent to a reference to an interest 

rate or monetary rate and the Title VII 

instrument would be, under the 

interpretation in this section, a swap (or 

mixed swap depending on other 

references in the instrument). 

3. Title VII Instruments Based on 

Government Debt Obligations 

The Commissions provided an 

interpretation in the Proposing Release 

regarding instances in which the 

underlying reference of the Title VII 

instrument is a government debt 

obligation. The Commissions received 

no comments on the interpretation 

provided regarding instances in which 

the underlying reference of the Title VII 

instrument is a government debt 

obligation and are restating such 

interpretation without modification. 

The security-based swap definition 

specifically excludes any agreement, 

contract, or transaction that meets the 

definition of a security-based swap only 

because it ‘‘references, is based upon, or 

settles through the transfer, delivery, or 

receipt of an exempted security under 

[section 3(a)(12) of the Exchange Act], as 

in effect on the date of enactment of the 

Futures Trading Act of 1982 (other than 

any municipal security as defined in 

[section 3(a)(29) of the Exchange Act] 

* * *), unless such agreement, contract, 

or transaction is of the character of, or 

is commonly known in the trade as, a 

put, call, or other option.’’ 639

As a result of this exclusion in the 

security-based swap definition for 

‘‘exempted securities,’’640 if the only 

underlying reference of a Title VII 

instrument involving securities is, for 

example, the price of a U.S. Treasury 

security and the instrument does not 

have any other underlying reference 

involving securities, then the 

instrument would be a swap. Similarly, 

if the Title VII instrument is based on 

the ‘‘yield’’ of a U.S. Treasury security 

and does not have any other underlying 

reference involving securities, then the 

instrument also would be a swap, 

regardless of whether the term ‘‘yield’’ 

is a proxy for the price of the security. 

Foreign government securities, by 

contrast, were not ‘‘exempted 

securities’’ as of the date of enactment 

of the Futures Trading Act of 1982 641

and thus do not explicitly fall within 

this exclusion from the security-based 

swap definition. Therefore, if the 

underlying reference of the Title VII 

instrument is the price, value, or 

‘‘yield’’ (where ‘‘yield’’ is a proxy for 

price or value) of a foreign government 

security, or a point on a yield curve 

derived from a narrow-based security 

index composed of foreign government 

securities, then the instrument is a 

security-based swap. 

C. Total Return Swaps 

The Commissions are restating the 

interpretation regarding TRS set out in 

the Proposing Release with certain 

changes with respect to quanto and 

compo equity TRS and loan TRS based 

on two or more loans, and to reflect that 

TRS can overlie reference items other 

than securities, loans, and indexes of 

securities or loans.642 The Commissions 

find that this interpretation is an 

appropriate way to address TRS and is 

designed to reduce the cost associated 

with determining whether a TRS is a 

swap or a security-based swap.643

As was described in the Proposing 

Release,644 a TRS is a Title VII 

instrument in which one counterparty, 

the seller of the TRS, makes a payment 

that is based on the price appreciation 

and income from an underlying security 

or security index.645 A TRS also can 

overlie a single loan, two or more loans 

and other underliers. The other 

counterparty, the buyer of the TRS, 

makes a financing payment that is often 

based on a variable interest rate, such as 

LIBOR (or other interbank offered rate or 

money market rate, as described above), 

as well as a payment based on the price 

depreciation of the underlying 

reference. The ‘‘total return’’ consists of 

the price appreciation or depreciation, 

plus any interest or income 

payments.646 Accordingly, where a TRS 

is based on a single security or loan, or 

a narrow-based security index, the TRS 

would be a security-based swap.647

In addition, the Commissions are 

providing a final interpretation 

providing that, generally, the use of a 

variable interest rate in the TRS buyer’s 

payment obligations to the seller is 

incidental to the purpose of, and the 

risk that the counterparties assume in, 

entering into the TRS, because such 

payments are a form of financing 

reflecting the seller’s (typically a 

security-based swap dealer) cost of 

financing the position or a related 

hedge, allowing the TRS buyer to 

receive payments based on the price 

appreciation and income of a security or 

security index without purchasing the 

security or security index. As stated in 

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648See infra part IV. 

649See, e.g., Moorad Chowdry, ‘‘Total Return 

Swaps: Credit Derivatives and Synthetic Funding 

Instruments,’’ at 3–4 (noting that the spread to the 

TRS financing rate is a function of: The credit rating 

of the counterparty paying the financing rate; the 

amount, value, and credit quality of the reference 

asset; the dealer’s funding costs; a profit margin; 

and the capital charge associated with the TRS), 

available at http://www.yieldcurve.com/ 

Mktresearch/LearningCurve/TRS.pdf. 

650For example, a security-based swap on an 

equity security priced in U.S. dollars in which 

payments are made in Euros based on the U.S. 

dollar/Euro spot rate at the time the payment is 

made would not be a mixed swap. As the 

Commissions stated in the Proposing Release, under 

these circumstances, the currency is merely 

referenced in connection with the method of 

payment, and the counterparties are not hedging the 

risk of changes in currency exchange rates during 

the term of the security-based swap See Proposing 

Release at 29842, n. 176. 

651See Mixed Swaps, infra part IV. 

652See SIFMA Letter. 

653 Id. 

654Handbook of Corporate Equity Derivatives and 

Equity Capital Markets (‘‘Corporate Equity 

Derivatives Handbook’’), § 1.2.10, at 23, available at 

http://media.wiley.com/product_data/excerpt/05/ 

11199759/1119975905-83.pdf last visited May 4, 

2012. 

655 James M. Mahoney, Correlation Products and 

Risk Management Issues, FRBNY Economic Policy 

Review/October 1995 at 2, available at http:// 

www.ny.frb.org/research/epr/95v01n3/ 

9510maho.pdf last visited May 4, 2012. 

656While applicable in general, this logic, which 

merely expands upon the principle that the 

character of a Title VII instrument as either a swap 

or a security-based swap should follow the 

underlying factors which are incorporated into the 

cash flows of the instrument—a security, yield, 

loan, or other trigger for SEC jurisdiction or as a 

commodity triggering CFTC jurisdiction (or both for 

joint jurisdiction), should not be extrapolated to 

other Title VII instruments, for which other 

principles may override. 

657Although the SIFMA Letter describes quanto 

equity swaps in terms of equity indexes, if the 

underlying reference of a quanto equity swap is a 

single security, the result would be the same. The 

Commissions also note that if a security index 

underlying a quanto equity swap is not narrowbased, the quanto equity swap is a swap. In that 

event, it is not a mixed swap because no element 

of the quanto equity swap is a security-based swap 

and, to be a mixed swap, a Title VII instrument 

must have both swap and security-based swap 

components. 

658See generally Corporate Equity Derivatives 

Handbook, supra note 654, § 1.2.9, at 21–23. 

the Proposing Release, the Commissions 

believe that when such interest rate 

payments act merely as a financing 

component in a TRS, or in any other 

security-based swap, the inclusion of 

such interest rate terms would not cause 

the TRS to be characterized as a mixed 

swap.648 Financing terms may also 

involve adding or subtracting a spread 

to or from the financing rate,649 or 

calculating the financing rate in a 

currency other than that of the 

underlying reference security or security 

index.650

However, where such payments 

incorporate additional elements that 

create additional interest rate or 

currency exposures that are unrelated to 

the financing of the security-based 

swap, or otherwise shift or limit risks 

that are related to the financing of the 

security-based swap, those additional 

elements may cause the security-based 

swap to be a mixed swap. For example, 

where the counterparties embed 

interest-rate optionality (e.g., a cap, 

collar, call, or put) into the terms of a 

security-based swap in a manner 

designed to shift or limit interest rate 

exposure, the inclusion of these terms 

would cause the TRS to be both a swap 

and a security-based swap (i.e., a mixed 

swap). Similarly, if a TRS is also based 

on non-security-based components 

(such as the price of oil, or a currency), 

the TRS would also be a mixed swap.651

The Commissions also are providing 

an additional interpretation regarding a 

quanto equity swap, in response to 

comments raised by one commenter,652

and for illustrative purposes, a similar 

but contrasting product, a compo equity 

swap. A quanto equity swap, which 

‘‘can provide a U.S. investor with 

currency-protected exposure to a nonU.S. equity index by translating the 

percentage equity return in the currency 

of such non-U.S. equity index into U.S. 

dollars,’’ 653 can be described as: 

An equity swap in which [(1)] the 

underlying is denominated in a currency (the 

foreign currency) other than that in which 

the equity swap is denominated (the 

domestic currency) * * * [and (2) t]he final 

value of the underlying is denominated in 

the foreign currency and is converted into the 

domestic currency using the exchange rate 

prevailing at inception[,] result[ing in] the 

investor * * * not [being] exposed to 

currency risk.654

While a quanto equity swap, 

therefore, effectively ‘‘exposes the 

dealer on the foreign leg of the 

correlation product to a variable 

notional principal amount that changes 

whenever the exchange rate or the 

foreign index fluctuates,’’ 655 such 

exposure results from the choice of 

hedges for the quanto equity swap, not 

from the cash flows of the quanto equity 

swap itself.656 Thus, that exposure 

could be viewed as created in the seller 

by the act of entering into the quanto 

equity swap, rather than as a transfer 

between the parties, as is required by 

the third prong of the statutory swap 

definition. Consequently, the dealer’s 

exchange rate exposure could be seen as 

incidental to the securities exposure 

desired by the party initiating the 

quanto equity swap. 

The Commissions view a quanto 

equity swap as a security-based swap, 

and not a mixed swap, where (i) the 

purpose of the quanto equity swap is to 

transfer exposure to the return of a 

security or security index without 

transferring exposure to any currency or 

exchange rate risk; and (ii) any exchange 

rate or currency risk exposure incurred 

by the dealer due to a difference in the 

currency denomination of the quanto 

equity swap and of the underlying 

security or security index is incidental 

to the quanto equity swap and arises 

from the instrument(s) the dealer 

chooses to use to hedge the quanto 

equity swap and is not a direct result of 

any expected payment obligations by 

either party under the quanto equity 

swap.657

By contrast, in a compo equity swap, 

the parties assume exposure to, and the 

total return is calculated based on, both 

the performance of specified foreign 

stocks and the change in the relevant 

exchange rate.658 Because the 

counterparty initiating a transaction can 

choose to avoid currency exposure by 

entering into a quanto equity swap, the 

currency exposure obtained via a compo 

equity swap is not incidental to the 

equity exposure for purposes of 

determining mixed swap status. In fact, 

investors seeking synthetic exposure to 

foreign securities via a TRS may also be 

seeking exposure to the exchange rate 

between the currencies, as evidenced by 

the fact that a number of mutual funds 

exist in both hedged and unhedged 

versions to provide investors exposure 

to the same foreign securities with or 

without the attendant currency 

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659See, e.g., Descriptive Brochure: The Tweedy, 

Browne Global Value Fund II—Currency Unhedged 

at 1, available at http://www.tweedy.com/resources/ 

gvf2/TBGVF-II_verJuly2011.pdf (last visited May 4, 

2012) (comparing the Tweedy, Browne Global 

Value Fund II—Currency Unhedged and the 

Tweedy, Browne Global Value Fund (which hedges 

its currency exposure) and stating that ‘‘[t]he only 

material difference [between the funds] is that the 

Unhedged Global Value Fund generally does not 

hedge currency risk [and] is designed for long-term 

value investors who wish to focus their investment 

exposure on foreign stock markets, and their 

associated non-U.S. currencies’’ and ‘‘[b]y 

establishing the Tweedy, Browne Global Value 

Fund II—Currency Unhedged, we were 

acknowledging that many investors may view 

exposure to foreign currency as another form of 

diversification when investing outside the U.S., 

and/or may have strong opinions regarding the 

future direction of the U.S. dollar.’’). See also the 

PIMCO Foreign Bond Fund (Unhedged) Fact Sheet 

at 1 (stating that ‘‘[t]he fund seeks to capture the 

returns of non-U.S. bonds including potential 

returns due to changes in exchange rates. In a 

declining dollar environment foreign currency 

appreciation may augment the returns generated by 

investments in foreign bonds.’’), available at 

http://investments.pimco.com/Shareholder

Communications/External%20Documents/Foreign

%20Bond%20Fund%20(Unhedged)%20

Institutional.pdf last visited May 4, 2012 and the 

PIMCO Foreign Bond Fund (U.S. Dollar-Hedged) 

INSTL Fact Sheet at 1 (stating that ‘‘[t]he fund seeks 

to capture the returns of non-U.S. bonds but 

generally hedges out most currency exposure in 

order to limit the volatility of returns.’’), available 

at http://investments.pimco.com/Shareholder

Communications/External%20Documents/Foreign

%20Bond%20Fund%20(U.S.%20Dollar-Hedged)

%20Institutional.pdf (last visited May 4, 2012). 

660Such swaps are examples of swaps with 

payments that ‘‘incorporate additional elements 

that create additional * * * currency exposures 

* * * unrelated to the financing of the securitybased swap * * * that may cause the securitybased swap to be a mixed swap.’’ See Proposing 

Release at 29842. 

661See infra note 667 and accompanying text. 

662 Depending on the facts and circumstances 

loans may be notes or evidences of indebtedness 

that are securities. See section 3(a)(10) of the 

Exchange Act. In this section, the Commissions 

address only groups or indexes of loans that are not 

securities. 

663See CEA section 1a(35), 7 U.S.C. 1a(35), and 

section 3(a)(55) of the Exchange Act, 15 U.S.C. 

78c(a)(55). 

664The same would be true with respect to swaps 

(e.g., options, CFDs, NDFs), other than LTRS or loan 

index credit default swaps, on two or more loans 

that are not securities. 

665See July LSTA Letter; Letter from David 

Lucking, Allen & Overy LLP, dated May 26, 2011 

(‘‘Allen & Overy Letter’’); and SIFMA Letter. 

666See SIFMA Letter. 

667See Allen & Overy Letter and July LSTA 

Letter. 

668See SIFMA Letter. 

669 Id. 

670 Id. SIFMA added that such a determination 

could require market participants to determine 

whether a specific interest rate or spread referenced 

in the TRS is sufficiently in line with market rates 

to constitute a financing leg of a transaction under 

the proposed test. SIFMA continues by noting that 

there are a number of examples where a TRS can 

provide for some interest rate or currency exposure 

incidental to the primary purpose of the TRS, 

describing a quanto equity swap as an example. 

671To the extent a market participant is uncertain 

as to the results of such an analysis, it may seek 

informal guidance from the Commissions’ staffs or 

use the process established in this release, see infra 

part VI, for seeking formal guidance from the 

Commissions as to the nature of a Title VII 

instrument as a swap, security-based swap or mixed 

swap. 

672For example, the Commissions would expect 

a dealer perceived by the market to constitute a 

higher counterparty risk to have higher funding 

costs generally, which might affect its TRS 

financing costs. To the extent such a dealer passed 

through its higher TRS financing costs to its TRS 

counterparty, such a pass-through simply would 

reflect the dealer’s specific circumstances, and 

would not transform the TRS from a security-based 

swap into a mixed swap. 

exposure.659 Consequently, a compo 

equity swap is a mixed swap.660

In response to comments,661 the 

Commissions also are providing an 

interpretation with respect to the 

treatment of loan TRS (‘‘LTRS’’) on two 

or more loans. As noted above, the 

second prong of the security-based swap 

definition includes a swap that is based 

on ‘‘a single security or loan, including 

any interest therein or on the value 

thereof.’’ Thus, an LTRS based on a 

single loan, as mentioned above, is a 

security-based swap. The Commissions 

believe, however, that an LTRS based on 

two or more non-security loans are 

swaps, and not security-based swaps.662

An LTRS on a group or index of such 

non-security loans is not covered by the 

first prong of the security-based swap 

definition—swaps based on a narrowbased security index—because the 

definition of the term ‘‘narrow-based 

security index’’ in both the CEA and the 

Exchange Act only applies to securities, 

and not to non-security loans.663 An 

LTRS, moreover, is not covered by the 

third prong of the security-based swap 

definition because it is based on the 

total return of such loans, and not 

events related thereto. Accordingly, an 

LTRS on two or more loans that are nonsecurity loans is a swap and not a 

security-based swap.664

Comments 

The Commissions received three 

comments with respect to the 

interpretation provided on TRS in the 

Proposing Release.665 One of these 

commenters addressed the 

Commissions’ interpretation on 

security-based TRS.666 The other two 

commenters requested that the 

Commissions clarify the treatment of 

LTRS on two or more loans.667

One commenter asserted that the 

terms of a TRS that create interest rate 

or currency exposures incidental to the 

primary purpose of the TRS should not 

cause a transaction that otherwise 

would be deemed to be a security-based 

swap to be characterized as a mixed 

swap.668 This commenter agreed with 

the Commissions that the scope of the 

mixed swap category of Title VII 

instruments is intended to be narrow 

and that, when variable interest rates are 

used for financing purposes incidental 

to counterparties’ purposes, and risks 

assumed, in entering into a TRS, the 

TRS is a security-based swap and not a 

mixed swap.669

This commenter also opined that the 

Commissions’ interpretation that 

‘‘where such payments incorporate 

additional elements that create 

additional interest rate or currency 

exposures * * * unrelated to the 

financing of the [TRS], or otherwise 

shift or limit risks that are related to the 

financing of the [TRS], those additional 

elements may cause the [TRS] to be a 

mixed swap’’ could be seen as requiring 

a quantitative analysis to determine 

whether a reference to interest rates or 

currencies in a TRS is solely for 

financing purposes or creates additional 

exposure that might be construed as 

extending beyond those purposes.670

The Commissions are clarifying that a 

quantitative analysis is not necessarily 

required in order to determine whether 

a TRS is a mixed swap. Any analysis, 

quantitative or qualitative, clearly 

demonstrating the nature of a payment 

(solely financing-related, unrelated to 

financing or a combination of the two) 

can suffice.671

The Commissions also are clarifying 

that market participants are not 

necessarily required to compare their 

financing rates to market financing rates 

in order to determine whether the 

financing leg of a TRS is merely a 

financing leg or is sufficient to render 

the TRS a mixed swap. Because a 

number of factors can influence how a 

particular TRS is structured,672 the 

Commissions cannot provide an 

interpretation applicable to all 

situations. If the financing leg of a TRS 

reflects the dealer’s financing costs on a 

one-to-one basis, the Commissions 

would view such leg as a financing leg. 

Adding a spread would not alter that 

conclusion if the spread is consistent 

with the dealer’s course of dealing 

generally, with respect to a particular 

type of TRS or with respect to a 

particular counterparty. The 

Commissions believe that this would be 

the case even if the spread is ‘‘offmarket,’’ if the deviance from a market 

spread is explained by factors unique to 

the dealer (e.g., the dealer has high 

financing costs), to the TRS (e.g., the 

underlying securities are highly illiquid, 

so financing them is more costly than 

would be reflected in a ‘‘typical’’ market 

spread for other TRS) or to then-current 

market conditions (e.g., a share 

repurchase might make shares harder 

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673The Commissions expect that dealers know 

their financing costs and can readily explain the 

components of the financing leg paid by their TRS 

counterparties. 

674 Id. SIFMA distinguished quanto equity swaps 

from the examples of mixed swaps that the 

Commissions provided in the Proposing Release, 

characterizing them as ‘‘very different.’’ 

675See Allen & Overy Letter and July LSTA 

Letter. 

676See Allen & Overy Letter. Allen & Overy notes 

that a Title VII Instrument that references two 

securities is a security-based swap. It believes that 

treating an LTRS on two or more loans as a swap 

would result in functionally and potentially 

economically similar products being treated in an 

arbitrarily different way, contrary to the spirit of the 

Dodd-Frank Act. 

677The Commissions address the comments 

regarding loan index credit default swaps below. 

See infra note 768 and accompanying text. 678See Proposing Release at 29843. 679See infra note 689 and accompanying text. 680Section 3(a)(68)(A)(ii)(II) of the Exchange Act, 

15 U.S.C. 78c(a)(68)(A)(ii)(II). The first prong of the 

security-based swap definition is discussed below. 

See infra part III.G. 681Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 

15 U.S.C. 78c(a)(68)(A)(ii)(III). 682The Commissions understand that in the 

context of credit derivatives on asset-backed 

securities or MBS, the events include principal 

writedowns, failure to pay principal and interest 

shortfalls. 

683The Commissions understand that some 

single-name CDS now trade with fixed coupon 

payments expressed as a percentage of the notional 

amount of the transaction and payable on a periodic 

basis during the term of the transaction. See Markit, 

‘‘The CDS Big Bang: Understanding the Changes to 

the Global CDS Contract and North American 

Conventions,’’ 3, available at http:// 

www.markit.com/cds/announcements/resource/ 

cds_big_bang.pdf. The Commissions are restating 

their view that the existence of such single-name 

CDS does not change their interpretation. 

684See Proposing Release at 29843. 

685See infra note 689 and accompanying text. 

686See infra note 691. 

687The security-based swap definition further 

defines ‘‘index to include an ‘‘index or group of 

securities.’’ See section 3(a)(68)(E) of the Exchange 

Act, 15 U.S.C. 78c(a)(68)(E). 

for a dealer to procure in order to hedge 

its obligations under a TRS to pay its 

counterparty the capital appreciation of 

a security, resulting in higher financing 

costs due to the decrease in shares 

outstanding, assuming demand for the 

shares does not change). If the spread is 

designed to provide exposure to an 

underlying reference other than 

securities, however, rather than to 

reflect financing costs, such a TRS is a 

mixed swap. 

Market participants are better 

positioned than are the Commissions to 

determine what analysis, and what 

supporting information and materials, 

best establish whether the nature of a 

particular payment reflects financing 

costs alone, or something more. 

Moreover, the Commissions expect that 

a dealer would know if the purpose of 

the payment(s) in question is to cover its 

cost of financing a position or a related 

hedge.673 In such cases, a detailed 

analysis should not be necessary. 

One commenter noted the nature of 

quanto equity swaps as TRS and 

maintained that such a transaction ‘‘is 

equivalent to a financing of a long 

position in the underlying non-U.S. 

equity index[]’’ and that the currency 

protection is incidental to the financing 

element, which is the primary purpose 

of the TRS.674 As discussed above, the 

Commissions have provided a final 

interpretation regarding the appropriate 

classification of Title VII instruments 

that are quanto equity swaps and compo 

equity swaps. 

Two commenters requested that the 

Commissions clarify the status of LTRS 

on two or more loans.675 Both 

commenters stated that while the 

statutory definition of the term 

‘‘security-based swap’’ provides that 

swaps based on a single loan are 

security-based swaps, it does not 

explicitly provide whether swaps on 

indexes of loans are security-based 

swaps.676 They requested clarification 

regarding the treatment of loan based 

swaps, including both LTRS and loan 

index credit default swaps.677

The Commissions have provided the 

final interpretation discussed above 

regarding LTRS based on two or more 

loans that are not securities. The 

Commissions acknowledge that this 

interpretation results in different 

treatment for an LTRS on two nonsecurity loans (a swap), as opposed to a 

Title VII instrument based on two 

securities (a security-based swap). This 

result, however, is dictated by the 

statute. 

D. Security-Based Swaps Based on a 

Single Security or Loan and SingleName Credit Default Swaps 

The Commissions provided an 

interpretation in the Proposing Release 

regarding security-based swaps based on 

a single security or loan and singlename CDS 678 and are restating such 

interpretation with certain 

modifications in response to 

commenters.679 The second prong of the 

statutory security-based swap definition 

includes a swap that is based on ‘‘a 

single security or loan, including any 

interest therein or on the value 

thereof.’’ 680 The Commissions believe 

that under this prong of the securitybased swap definition, a single-name 

CDS that is based on a single reference 

obligation would be a security-based 

swap because it would be based on a 

single security or loan (or any interest 

therein or on the value thereof). 

In addition, the third prong of the 

security-based swap definition includes 

a swap that is based on the occurrence 

of an event relating to a ‘‘single issuer 

of a security,’’ provided that such event 

‘‘directly affects the financial 

statements, financial condition, or 

financial obligations of the issuer.’’ 681

This provision applies generally to 

event-triggered swap contracts. With 

respect to a CDS, such events could 

include, for example, the bankruptcy of 

an issuer, a default on one of an issuer’s 

debt securities, or the default on a nonsecurity loan of an issuer.682

The Commissions believe that if the 

payout on a CDS on a single issuer of 

a security is triggered by the occurrence 

of an event relating to that issuer, the 

CDS is a security-based swap under the 

third prong of the statutory securitybased swap definition.683

In relation to aggregations of 

transactions under a single ISDA Master 

Agreement,684 the Commissions are 

revising the example that was included 

in the Proposing Release referring to 

single-name CDS to clarify that the 

interpretation regarding aggregations of 

transactions is non-exclusive and thus 

not limited to either CDS or singlereference instruments.685

The Commissions believe that each 

transaction under an ISDA Master 

Agreement would need to be analyzed 

to determine whether it is a swap or 

security-based swap. For example, the 

Commissions believe that a number of 

Title VII instruments that are executed 

at the same time and that are 

documented under one ISDA Master 

Agreement, but in which a separate 

confirmation is sent for each 

instrument, should be treated as an 

aggregation of such Title VII 

instruments, each of which must be 

analyzed separately under the swap and 

security-based swap definitions.686 The 

Commissions believe that, as a practical 

and economic matter, each such Title 

VII instrument would be a separate and 

independent transaction. Thus, such an 

aggregation of Title VII instruments 

would not constitute a Title VII 

instrument based on one ‘‘index or 

group’’ 687 under the security-based 

swap definition but instead would 

constitute multiple Title VII 

instruments. The Commissions find that 

this interpretation is an appropriate way 

to address CDS, TRS or other Title VII 

instruments referencing a single security 

or loan or entity that is documented 

under a Master Agreement or Master 

Confirmation and is designed to reduce 

the cost associated with determining 

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688See supra part I, under ‘‘Overall Economic 

Considerations’’. 689See July LSTA Letter. 690 Id. 691See Letter from Richard M. McVey, Chairman 

and Chief Executive Officer, MarketAxess Holdings, 

Inc. (‘‘MarketAxess’’), July 22, 2011 (‘‘MarketAxess 

Letter’’). 692The Commissions believe, based on the July 

LSTA Letter, that the ‘‘Master Confirmation’’ 

structure the commenter described is the same 

general structure as the aggregation of single-name 

CDS the Commissions provided as an example in 

the Proposing Release, but that a ‘‘Master 

Confirmation’’ structure may not be limited to 

single-reference instruments or to CDS and instead 

may be used for a broader range of instruments. See 

July LSTA Letter. The Commissions note that the 

following are examples of ‘‘Master Confirmation’’ 

structure to which the interpretive guidance would 

apply: 2009 Americas Master Equity Derivatives 

Confirmation Agreement, Stand-alone 2007 

Americas Master Variance Swap Confirmation 

Agreement, and 2004 Americas Interdealer Master 

Equity Derivatives Confirmation Agreement and 

March 2004 Canadian Supplement to the Master 

Confirmation. The Commissions believe the broader 

example in this release provides the clarification 

the commenter requested. 

693See Proposing Release at 29843–44. 

694 Id. 

695See infra note 718 and accompanying text. 

696See rule 1.3(bbbb) under the CEA and rule 

3a68–5 under the Exchange Act. 

697A security future is defined in both the CEA 

and the Exchange Act as a futures contract on a 

single security or a narrow-based security index, 

including any interest therein or based on the value 

thereof, except an exempted security under section 

3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), 

as in effect on the date of enactment of the Futures 

Trading Act of 1982 (other than any municipal 

security as defined in section 3(a)(29) of the 

Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on 

the date of enactment of the Futures Trading Act 

of 1982). 

The term security future does not include any 

agreement, contract, or transaction excluded from 

the CEA under sections 2(c), 2(d), 2(f), or 2(g) of the 

CEA, 7 U.S.C. 2(c), 2(d), 2(f), or 2(g), as in effect on 

the date of enactment of the Commodity Futures 

Modernization Act of 2000 (‘‘CFMA’’) or Title IV of 

the CFMA. See section 1a(44) of the CEA, 7 U.S.C. 

1a(44), and section 3(a)(55) of the Exchange Act, 15 

U.S.C. 78c(a)(55). 

698 Depending on the underlying reference of the 

futures contract, though, such swaps could be 

SBSAs. For example, a swap on a future on the S&P 

500 index would be an SBSA. 

699See Proposing Release at 29843. 

700Specifically, rule 3a12–8 under the Exchange 

Act requires as a condition to the exemption that 

the foreign government debt securities not be 

registered under the Securities Act (or be the 

subject of any American depositary receipt 

registered under the Securities Act) and that futures 

contracts on such foreign government debt 

securities ‘‘require delivery outside the United 

States, [and] any of its possessions or territories, 

and are traded on or through a board of trade, as 

defined in [section 2 of the CEA, 7 U.S.C. 2].’’ See 

rules 3a12–8(a)(2) and 3a12–8(b) under the 

Exchange Act, 17 CFR 240.3a12–8(a)(2) and 

240.3a12–8(b). These conditions were ‘‘designed to 

minimize the impact of the exemption on securities 

distribution and trading in the United States. 

* * *’’ See Exemption for Certain Foreign 

Government Securities for Purposes of Futures 

Trading, 49 FR 8595 (Mar. 8, 1984) at 8596–97 

(citing Futures Trading Act of 1982). 

701See rule 3a12–8(a)(1) under the Exchange Act 

(designating the debt securities of the governments 

of the United Kingdom, Canada, Japan, Australia, 

France, New Zealand, Austria, Denmark, Finland, 

the Netherlands, Switzerland, Germany, Ireland, 

Italy, Spain, Mexico, Brazil, Argentina, Venezuela, 

Belgium, and Sweden). 

702The Commissions note, by contrast, that a 

Title VII instrument that is based on the price or 

value of, or settlement into, a futures contract on 

the debt securities of one of the 21 enumerated 

foreign governments and that also has the potential 

to settle directly into such debt securities would be 

a security-based swap and, depending on other 

features of the Title VII instrument, possibly a 

mixed swap. 

703Rule 3a12–8(b) under the Exchange Act 

defines ‘‘qualifying foreign futures contracts’’ as 

‘‘contracts for the purchase or sale of a designated 

foreign government security for future delivery, as 

‘future delivery’ is defined in 7 U.S.C. 2, provided 

such contracts require delivery outside the United 

States, any of its possessions or territories, and are 

traded on or through a board of trade, as defined 

at 7 U.S.C. 2.’’ 17 CFR 240.3a12–8(b). 

704See supra note 700. 

whether such instruments are swaps or 

security-based swaps.688

Comments 

The Commissions received two 

comments regarding the interpretation 

regarding aggregation of Title VII 

instruments under a single ISDA Master 

Agreement. One commenter requested 

that the Commissions clarify that the 

interpretation applies to other types of 

instruments, such as TRS, in addition to 

CDS.689 The commenter also stated that 

the interpretation should be helpful 

with respect to use of a ‘‘Master 

Confirmation’’ structure, which the 

commenter described as use of general 

terms in a ‘‘Master Confirmation’’ that 

apply to a number of instruments with 

separate underlying references but for 

which a separate ‘‘Supplemental 

Confirmation’’ is sent for each separate 

component.690

A second commenter agreed with the 

Commissions’ interpretation that a 

number of single-name CDS that are 

executed at the same time and that are 

documented under one ISDA Master 

Agreement, but in which a separate 

confirmation is sent for each CDS, 

should not be treated as a single index 

CDS and stated that this approach is 

consistent with market practice.691

As discussed above, in response to 

comments the Commissions are 

expanding the example so it is clear that 

it applies beyond just CDS.692

E. Title VII Instruments Based on 

Futures Contracts 

The Commissions proposed an 

interpretation in the Proposing Release 

regarding the treatment, generally, of 

swaps based on futures contracts.693

The Commissions are restating the 

interpretation they provided in the 

Proposing Release without modification. 

The Commissions also discussed in the 

Proposing Release the unique 

circumstance involving certain futures 

contracts on foreign government debt 

securities and requested comment as to 

how Title VII instruments on these 

futures contracts should be treated.694 In 

response to commenters,695 the 

Commissions are adopting a rule 

regarding the treatment of Title VII 

instruments on certain futures contracts 

on foreign government debt 

securities.696

A Title VII instrument that is based on 

a futures contract will either be a swap 

or a security-based swap, or both (i.e., 

a mixed swap), depending on the nature 

of the futures contract, including the 

underlying reference of the futures 

contract. Thus, a Title VII instrument 

where the underlying reference is a 

security future is a security-based 

swap.697 In general, a Title VII 

instrument where the underlying 

reference is a futures contract that is not 

a security future is a swap.698 As the 

Commissions noted in the Proposing 

Release,699 Title VII instruments 

involving certain futures contracts on 

foreign government debt securities 

present a unique circumstance, which is 

discussed below. 

Rule 3a12–8 under the Exchange Act 

exempts certain foreign government 

debt securities, for purposes only of the 

offer, sale, or confirmation of sale of 

futures contracts on such foreign 

government debt securities, from all 

provisions of the Exchange Act which 

by their terms do not apply to an 

‘‘exempted security,’’ subject to certain 

conditions.700 To date, the SEC has 

enumerated within rule 3a12–8 the debt 

securities of 21 foreign governments 

solely for purposes of futures trading 

(‘‘21 enumerated foreign 

governments’’).701

The Commissions recognize that as a 

result of rule 3a12–8, futures contracts 

on the debt securities of the 21 

enumerated foreign governments that 

satisfy the conditions of rule 3a12–8 are 

subject to the CFTC’s exclusive 

jurisdiction and are not considered 

security futures. As a result, applying 

the interpretation above to a Title VII 

instrument that is based on a futures 

contract on the debt securities of these 

21 enumerated foreign governments 

would mean that the Title VII 

instrument would be a swap.702 The 

Commissions note, however, that the 

conditions in rule 3a12–8 were 

established specifically for purposes of 

the offer and sale of ‘‘qualifying foreign 

futures contracts’’ (as defined in rule 

3a12–8) 703 on the debt securities of the 

21 enumerated foreign governments,704

not Title VII instruments based on 

futures contracts on the debt securities 

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705See Proposing Release at 29844. 

706See infra note 718 and accompanying text. 

707See supra note 703. 

708See, e.g., rule 405 under the Securities Act, 17 

CFR 230.405. 

709See supra note 700. 

710 Id. 

711See infra part III.H. 

712See Proposing Release at 29844. 

713See section 2(a)(3) of the Securities Act, 15 

U.S.C. 77b(a)(3), as amended by the Dodd-Frank 

Act. 

714See section 5 of the Securities Act, 15 U.S.C. 

77e, as amended by the Dodd-Frank Act. 

of the 21 enumerated governments. 

Further, the Commissions note that the 

Dodd-Frank Act did not exclude swaps 

on foreign government debt securities 

generally from the definition of the term 

‘‘security-based swap.’’ Accordingly, a 

Title VII instrument that is based 

directly on foreign government debt 

securities, including those of the 21 

enumerated governments, is a securitybased swap or a swap under the same 

analysis as any other Title VII 

instruments based on securities. 

The Commissions indicated in the 

Proposing Release that they would 

evaluate whether Title VII instruments 

based on futures contracts on the debt 

securities of the 21 enumerated foreign 

governments that satisfy the conditions 

of rule 3a12–8 should be characterized 

as swaps, security-based swaps, or 

mixed swaps.705 In response to 

commenters,706 the Commissions are 

adopting rule 1.3(bbbb) under the CEA 

and rule 3a68–5 under the Exchange 

Act, which address the treatment of 

these Title VII instruments. 

The final rules provide that a Title VII 

instrument that is based on or references 

a qualifying foreign futures contract on 

the debt securities of one or more of the 

21 enumerated foreign governments is a 

swap and not a security-based swap, 

provided that the Title VII instrument 

satisfies the following conditions: 

• The futures contract on which the 

Title VII instrument is based or that is 

referenced is a qualifying foreign futures 

contract (as defined in rule 3a12–8) 707

on the debt securities of any one or 

more of the 21 enumerated foreign 

governments that satisfies the 

conditions of rule 3a12–8; 

• The Title VII instrument is traded 

on or through a board of trade (as 

defined in section 1a(6) of the CEA); 

• The debt securities on which the 

qualifying foreign futures contract is 

based or referenced and any security 

used to determine the cash settlement 

amount pursuant to the fourth condition 

below are not covered by an effective 

registration statement under the 

Securities Act or the subject of any 

American depositary receipt covered by 

an effective registration statement under 

the Securities Act; 

• The Title VII instrument may only 

be cash settled; and 

• The Title VII instrument is not 

entered into by the issuer of the 

securities upon which the qualifying 

foreign futures contract is based or 

referenced (including any security used 

to determine the cash payment due on 

settlement of such Title VII instrument), 

an affiliate (as defined in the Securities 

Act and the rules and regulations 

thereunder) 708 of the issuer, or an 

underwriter with respect to such 

securities. 

Under the first condition, the final 

rules provide that the futures contract 

on which the Title VII instrument is 

based or referenced must be a qualifying 

foreign futures contract that satisfies the 

conditions of rule 3a12–8 and may only 

be based on the debt of any one or more 

of the enumerated 21 foreign 

governments. If the conditions of rule 

3a12–8 are not satisfied, then there 

cannot be a qualifying foreign futures 

contract, the futures contract is a 

security future, and a swap on such a 

security future is a security-based swap. 

The second condition of the final 

rules provides that the Title VII 

instrument on the qualifying foreign 

futures contract must itself be traded on 

or through a board of trade because a 

qualifying foreign futures contract on 

the debt securities of one or more of the 

21 enumerated foreign governments 

itself is required to be traded on a board 

of trade. The Commissions believe that 

swaps on such futures contracts should 

be traded subject to rules applicable to 

such futures contracts themselves. 

The third condition of the final rules 

provides that the debt securities on 

which the qualifying foreign futures 

contract is based or referenced and any 

security used to determine the cash 

settlement amount pursuant to the 

fourth condition cannot be registered 

under the Securities Act or be the 

subject of any American depositary 

receipt registered under the Securities 

Act. This condition is intended to 

prevent circumvention of registration 

and disclosure requirements of the 

Securities Act applicable to foreign 

government issuances of their securities. 

This condition is similar to a condition 

included in rule 3a12–8.709

The fourth condition of the final rules 

provides that the Title VII instrument 

must be cash settled. Although, as the 

Commissions recognize, rule 3a12–8 

permits a qualifying foreign futures 

contract to be physically settled so long 

as delivery is outside the United States, 

any of its possessions or territories,710 in 

the context of Title VII instruments, 

only cash settled Title VII instruments 

based on qualifying foreign futures 

contracts on the debt securities of the 21 

enumerated foreign governments will be 

considered swaps. The Commissions 

believe that this condition is 

appropriate in order to provide 

consistent treatment of Title VII 

instruments based on qualifying foreign 

futures contracts on the debt securities 

of the 21 enumerated foreign 

governments with the Commissions’ 

treatment of swaps and security-based 

swaps generally.711

The fifth condition of the final rules 

provides that for a Title VII instrument 

to be a swap under such rules, it cannot 

be entered into by the issuer of the 

securities upon which the qualifying 

foreign futures contract is based or 

referenced (including any security used 

to determine the cash payment due on 

settlement of such Title VII instrument), 

an affiliate of the issuer, or an 

underwriter of the issuer’s securities. 

The Commissions have included this 

condition to address the concerns raised 

by the SEC in the Proposing Release that 

the characterization of a Title VII 

instrument that is based on a futures 

contract on the debt securities of one of 

the 21 enumerated foreign governments 

may affect Federal securities law 

provisions relating to the distribution of 

the securities upon which the Title VII 

instrument is based or referenced.712

The Dodd-Frank Act included 

provisions that would not permit 

issuers, affiliates of issuers, or 

underwriters to use security-based 

swaps to offer or sell the issuers’ 

securities underlying a security-based 

swap without complying with the 

requirements of the Securities Act.713

This provision applies regardless of 

whether the Title VII instrument allows 

the parties to physically settle any such 

security-based swap. In addition, the 

Dodd-Frank Act provided that any offer 

or sale of security-based swaps to nonECPs would have to be registered under 

the Securities Act.714 For example, if a 

Title VII instrument that is based on a 

futures contract on the debt securities of 

one of the 21 enumerated foreign 

governments is characterized as a swap, 

and not a security-based swap, then the 

provisions of the Dodd-Frank Act 

enacted to ensure that there could not 

be offers and sales of securities made 

without compliance with the Securities 

Act, either by issuers, their affiliates, or 

underwriters or to non-ECPs, would not 

apply to such swap transactions. 

Only those Title VII instruments that 

are based on qualifying foreign futures 

contracts on the debt securities of the 21 

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715The Commissions note that the final rules 

provide consistent treatment of qualifying foreign 

futures contracts on the debt securities of the 21 

enumerated foreign governments and Title VII 

instruments based on qualifying foreign futures 

contracts on the debt securities of the 21 

enumerated foreign governments unless the Title 

VII instrument is entered into by the issuer of the 

securities upon which the qualifying foreign futures 

contract is based or referenced (including any 

security used to determine the cash payment due 

on settlement of such Title VII instrument), an 

affiliate of the issuer, or an underwriter with respect 

to such securities. 

716For the quarter that ended December 31, 2011, 

the trading volume reported to the CFTC of 

qualifying foreign futures contracts on the debt 

securities of the 21 enumerated foreign 

governments made available for trading by direct 

access from the U.S. on foreign trading venues 

granted direct access no-action relief by the CFTC 

that exceeded 100,000 contracts per quarter from 

the U.S. were as follows: (i) 7,985,959 contracts for 

3 Year Treasury Bond Futures on the Australian 

Securities Exchange’s ASX Trade24 platform; (ii) 

1,872,592 contracts for 10-Year Government of 

Canada Bond Futures on the Bourse de Montreal; 

(iii) 47,874,911 contracts for Euro Bund Futures on 

Eurex Deutschland (‘‘Eurex’’); (iv) 26,434,713 

contracts for Euro Bobl Futures on Eurex; (v) 

30,489,427 contracts for Euro Schatz Futures on 

Eurex; and (vi) 8,292,222 contracts for Long Gilt 

Futures on the NYSE LIFFE. 

717See supra note 712 and accompanying text. 

718See CME Letter and SIFMA Letter. 

719 Id. Both commenters stated their belief that 

the range of factors considered by the SEC in 

designating the debt securities of the 21 enumerated 

foreign governments as exempted securities 

indicated that there is sufficient disclosure about 

the 21 enumerated foreign governments and their 

securities such that the further disclosure should 

not be necessary. Both commenters also indicated 

that subjecting futures contracts on the debt 

securities of the 21 enumerated foreign 

governments to CFTC regulation, while subjecting 

Title VII instruments based on these futures 

contracts to SEC regulation, would be problematic. 

Id. 

720See Proposing Release at 29845. 

721This interpretation relates solely to the 

determination regarding whether a Title VII 

instrument is a swap or security-based swap. The 

Commissions are not expressing a view regarding 

whether such Title VII instrument would be a 

security-based swap agreement. 

722However, to the extent the fixed term or 

condition is set at a future date or at a future value 

or level of a security, rate, or other commodity 

rather than the value or level of such security, rate, 

or other commodity at the time of execution of the 

Title VII instrument, the discussion above would 

not apply, and the nature of the security, rate, or 

other commodity used in determining the terms or 

conditions would be considered in evaluating 

whether the Title VII instrument is a swap or 

security-based swap. 

enumerated foreign governments and 

that satisfy these five conditions will be 

swaps, not security-based swaps. The 

Commissions note that the final rules 

are intended to provide consistent 

treatment (other than with respect to 

method of settlement) of qualifying 

foreign futures contracts and Title VII 

instruments based on qualifying foreign 

futures contracts on the debt securities 

of the 21 enumerated foreign 

governments.715 The Commissions 

understand that many of the qualifying 

foreign futures contracts on the debt 

securities of the 21 enumerated foreign 

governments trade with substantial 

volume through foreign trading venues 

under the conditions set forth in rule 

3a12–8 716 and permitting swaps on 

such futures contracts subject to similar 

conditions would not raise concerns 

that such swaps could be used to 

circumvent the conditions of rule 3a12– 

8 and the Federal securities laws 

concerns that such conditions are 

intended to protect.717 Further, 

providing consistent treatment for 

qualifying foreign futures contracts on 

the debt securities of the 21 enumerated 

foreign governments and Title VII 

instruments based on futures contracts 

on the debt securities of the 21 

enumerated foreign governments will 

allow trading of these instruments 

through designated contract markets on 

which such futures are listed. 

The Commissions recognize that the 

rules may result in a different 

characterization of a Title VII 

instrument that is based directly on a 

foreign government debt security and 

one that is based on a qualifying foreign 

futures contract on a debt security of 

one of the 21 enumerated foreign 

governments. However, the 

Commissions note that this is the case 

today (i.e., different treatments) with 

respect to other instruments subject to 

CFTC regulation and/or SEC regulation, 

such as futures on broad-based security 

indexes and futures on a single security 

or narrow-based security index. 

Comments 

Commenters did not address the 

interpretation as it applied to Title VII 

instruments based on futures contracts 

generally. Two commenters addressed 

Title VII instruments based on futures 

contracts on debt securities of the 21 

enumerated foreign governments.718

Both commenters requested that the 

Commissions treat these Title VII 

instruments as swaps.719 The 

Commissions agree that these 

instruments should be treated as swaps 

under certain conditions and, therefore, 

are adopting rule 1.3(bbbb) under the 

CEA and rule 3a68–5 under the 

Exchange Act as discussed above to 

treat Title VII instruments based on 

qualifying foreign futures contracts on 

the debt securities of the 21 enumerated 

foreign governments as swaps, provided 

such Title VII instruments satisfy 

certain conditions. 

F. Use of Certain Terms and Conditions 

in Title VII Instruments 

The Commissions provided an 

interpretation in the Proposing Release 

regarding the use of certain fixed terms 

in Title VII instruments and are 

restating that interpretation without 

modification.720 The Commissions are 

aware that market participants’ setting 

of certain fixed terms or conditions of 

Title VII instruments may be informed 

by the value or level of a security, rate, 

or other commodity at the time of the 

execution of the instrument. The 

Commissions believe that, in evaluating 

whether a Title VII instrument with 

such a fixed term or condition is a swap 

or security-based swap, the nature of the 

security, rate, or other commodity that 

informed the setting of such fixed term 

or condition should not itself impact the 

determination of whether the Title VII 

instrument is a swap or a security-based 

swap, provided that the fixed term or 

condition is set at the time of execution 

and the value or level of that fixed term 

or condition may not vary over the life 

of the Title VII instrument.721

For example, a Title VII instrument, 

such as an interest rate swap, in which 

floating payments based on three-month 

LIBOR are exchanged for fixed rate 

payments of five percent would be a 

swap, and not a security-based swap, 

even if the five percent fixed rate was 

informed by, or quoted based on, the 

yield of a security, provided that the 

five percent fixed rate was set at the 

time of execution and may not vary over 

the life of the Title VII instrument.722

Another example would be where a 

private sector or government borrower 

that issues a five-year, amortizing $100 

million debt security with a semiannual coupon of LIBOR plus 250 basis 

points also, at the same time, chooses to 

enter into a five-year interest rate swap 

on $100 million notional in which this 

same borrower, using the same 

amortization schedule as the debt 

security, receives semi-annual payments 

of LIBOR plus 250 basis points in 

exchange for five percent fixed rate 

payments. The fact that the specific 

terms of the interest rate swap (e.g., fiveyear, LIBOR plus 250 basis points, $100 

million notional, fixed amortization 

schedule) were set at the time of 

execution to match related terms of a 

debt security does not cause the interest 

rate swap to become a security-based 

swap. However, if the interest rate swap 

contained additional terms that were in 

fact contingent on a characteristic of the 

debt security that may change in the 

future, such as an adjustment to future 

interest rate swap payments based on 

the future price or yield of the debt 

security, then this Title VII instrument 

would be a security-based swap that 

would be a mixed swap. 

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723See ISDA Letter. 

724See infra part III.G.5(a). 

725See Proposing Release at 29845–58. 

726See Proposing Release at 29845–48. 

727Sections 3(a)(55)(B) and (C) of the Exchange 

Act, 15 U.S.C. 78c(a)(55)(B) and (C), include a 

definition of ‘‘narrow-based security index’’ in the 

same paragraph as the definition of security future. 

See also sections 1a(35)(A) and (B) of the CEA, 7 

U.S.C. 1a(35)(A) and (B). A security future is a 

contract for future delivery on a single security or 

narrow-based security index (including any interest 

therein or based on the value thereof). See section 

3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55), 

and section 1a(44) of the CEA, 7 U.S.C. 1a(44). 

728See section 3(a)(55)(B) of the Exchange Act, 15 

U.S.C. 78c(a)(55)(B). See also sections 1a(35)(A) and 

(B) of the CEA, 7 U.S.C. 1a(35)(A) and (B). 

729The narrow-based security index definition in 

the CEA and Exchange Act also excludes from its 

scope security indexes that satisfy certain specified 

criteria. See sections 3(a)(55)(C)(i)–(vi) of the 

Exchange Act, 15 U.S.C. 78c(a)(55)(C)(i)–(vi), and 

sections 1a(35)(B)(i)–(vi) of the CEA, 7 U.S.C. 

1a(35)(B)(i)–(vi). 

730See Joint Order Excluding Indexes Comprised 

of Certain Index Options From the Definition of 

Narrow-Based Security Index, 69 FR 16900 (Mar. 

31, 2004) (‘‘March 2004 Index Options Joint 

Order’’). 

731See section 1a(35)(B)(vi) of the CEA, 7 U.S.C. 

1a(35)(B)(vi), and section 3(a)(55)(C)(vi) of the 

Exchange Act, 15 U.S.C. 78c(a)(55)(C)(vi). 

732See March 2004 Index Options Joint Order. 

733See Joint Final Rules: Application of the 

Definition of Narrow-Based Security Index to Debt 

Securities Indexes and Security Futures on Debt 

Securities, 71 FR 39434 (Jul. 13, 2006) (‘‘July 2006 

Debt Index Release’’). 

Comments 

One commenter agreed with the 

Commissions’ interpretation generally, 

but believed that the Commissions 

should broaden the interpretation to 

allow a swap to reflect ‘‘resets,’’ or 

changes in the referenced characteristic 

of a security, where those ‘‘resets’’ or 

changes are ‘‘intended to effect a 

purpose other than transmitting the risk 

of changes in the characteristic itself,’’ 

without causing a Title VII instrument 

that is not a security-based swap to 

become a security-based swap.723

The Commissions are not expanding 

the interpretation to allow ‘‘resets’’ of a 

fixed rate derived from a security. The 

interpretation is consistent with the 

statutory swap and security-based swap 

definitions. The Commissions believe 

that a Title VII instrument based on a 

rate that follows a security, and that 

may ‘‘reset’’ or change in the future 

based on changes in that security, is a 

security-based swap. Further, any 

amendment or modification of a 

material term of a Title VII instrument 

would result in a new Title VII 

instrument and a corresponding 

reassessment of the instrument’s status 

as either a swap or a security-based 

swap.724

G. The Term ‘‘Narrow-Based Security 

Index’’ in the Security-Based Swap 

Definition 

1. Introduction 

As noted above, a Title VII instrument 

in which the underlying reference of the 

instrument is a ‘‘narrow-based security 

index’’ is a security-based swap subject 

to regulation by the SEC, whereas a Title 

VII instrument in which the underlying 

reference of the instrument is a security 

index that is not a narrow-based 

security index (i.e., the index is broadbased) is a swap subject to regulation by 

the CFTC. The Commissions proposed 

an interpretation and rules regarding 

usage of the term ‘‘narrow-based 

security index’’ in the security-based 

swap definition, including: 

• The existing criteria for determining 

whether a security index is a narrowbased security index and the 

applicability of past guidance of the 

Commissions regarding those criteria to 

Title VII instruments; 

• New criteria for determining 

whether a CDS where the underlying 

reference is a group or index of entities 

or obligations of entities (typically 

referred to as an ‘‘index CDS’’) is based 

on an index that is a narrow-based 

security index; 

• The meaning of the term ‘‘index’’; 

• Rules governing the tolerance 

period for Title VII instruments on 

security indexes traded on DCMs, SEFs, 

foreign boards of trade (‘‘FBOTs’’), 

security-based SEFs, or NSEs, where the 

security index temporarily moves from 

broad-based to narrow-based or from 

narrow-based to broad-based; and 

• Rules governing the grace period for 

Title VII instruments on security 

indexes traded on DCMs, SEFs, FBOTs, 

security-based SEFs, or NSEs, where the 

security index moves from broad-based 

to narrow-based or from narrow-based 

to broad-based and the move is not 

temporary.725

As discussed below, the Commissions 

are restating the interpretation set forth 

in the Proposing Release with certain 

further clarifications and adopting the 

rules as proposed with certain 

modifications. 

2. Applicability of the Statutory NarrowBased Security Index Definition and 

Past Guidance of the Commissions to 

Title VII Instruments 

The Commissions provided an 

interpretation in the Proposing Release 

regarding the applicability of the 

statutory definition of the term ‘‘narrowbased security index’’ and past guidance 

of the Commissions relating to such 

term to Title VII instruments.726 The 

Commissions are restating the 

interpretation set out in the Proposing 

Release without modification. 

As defined in the CEA and Exchange 

Act,727 an index is a narrow-based 

security index if, among other things, it 

meets any one of the following four 

criteria: 

• It has nine or fewer component 

securities; 

• A component security comprises 

more than 30 percent of the index’s 

weighting; 

• The five highest weighted 

component securities in the aggregate 

comprise more than 60 percent of the 

index’s weighting; or 

• The lowest weighted component 

securities comprising, in the aggregate, 

25 percent of the index’s weighting have 

an aggregate dollar value of average 

daily trading volume of less than 

$50,000,000 (or in the case of an index 

with more than 15 component 

securities, $30,000,000), except that if 

there are two or more securities with 

equal weighting that could be included 

in the calculation of the lowest 

weighted component securities 

comprising, in the aggregate, 25 percent 

of the index’s weighting, such securities 

shall be ranked from lowest to highest 

dollar value of average daily trading 

volume and shall be included in the 

calculation based on their ranking 

starting with the lowest ranked 

security.728

The first three criteria apply to the 

number and concentration of the 

‘‘component securities’’ in the index. 

The fourth criterion applies to the 

average daily trading volume of an 

index’s ‘‘component securities.’’ 729

This statutory narrow-based security 

index definition focuses on indexes 

composed of equity securities and 

certain aspects of the definition, in 

particular the evaluation of average 

daily trading volume, are designed to 

take into account the trading patterns of 

individual stocks.730 However, the 

Commissions, pursuant to authority 

granted in the CEA and the Exchange 

Act,731 previously have extended the 

definition to other categories of indexes 

but modified the definition to take into 

account the characteristics of those 

other categories. Specifically, the 

Commissions have previously provided 

guidance regarding the application of 

the narrow-based security index 

definition to futures contracts on 

volatility indexes 732 and debt security 

indexes.733 Today, then, there exists 

guidance for determining what 

constitutes a narrow-based security 

index. 

Volatility indexes are indexes 

composed of index options. The 

Commissions issued a joint order in 

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734 15 U.S.C. 78f(a). 735See March 2004 Index Options Joint Order. In 

2009, the Commissions issued a joint order that 

provided that, instead of the index options having 

to be listed on an NSE, the index options must be 

listed on an exchange and pricing information for 

the index options, and the underlying index, must 

be computed and disseminated in real time through 

major market data vendors. See Joint Order To 

Exclude Indexes Composed of Certain Index 

Options From the Definition of Narrow-Based 

Security Index, 74 FR 61116 (Nov. 23, 2009) 

(expanding the criteria necessary for exclusion 

under the March 2004 Index Options Joint Order to 

apply to volatility indexes for which pricing 

information for the underlying broad-based security 

index, and the options that compose such index, is 

current, accurate, and publicly available). 

736Under the rules, debt securities include notes, 

bonds, debentures or evidence of indebtedness. See 

rule 41.15(a)(1)(i) under the CEA, 17 CFR 

41.15(a)(1)(i) and rule 3a55–4(a)(1)(i) under the 

Exchange Act, 17 CFR 240.3a55–4(a)(1)(i). See also 

July 2006 Debt Index Release. 

737 15 U.S.C. 78m or 78o(d). 

738 15 U.S.C. 78c(a)(12). 

739See July 2006 Debt Index Rules. The July 2006 

Debt Index Rules also provided that debt securities 

in the index must satisfy certain minimum 

outstanding principal balance criteria, established 

certain exceptions to these criteria and the public 

information availability requirement, and provided 

for the treatment of indexes that include exempted 

securities (other than municipal securities). 

740See sections 3(a)(55)(B) and (C) of the 

Exchange Act, 15 U.S.C. 78c(a)(55)(B) and (C). See 

also sections 1a(35)(A) and (B) of the CEA, 7 U.S.C. 

1a(35)(A) and (B). 

741The statutory definition of the term ‘‘narrowbased security index’’ for equities, and the 

Commissions’ subsequent guidance as to what 

constitutes a narrow-based security index with 

respect to volatility and debt indexes, is applicable 

in the context of distinguishing between futures 

contracts and security futures products. 

742See March 2004 Index Options Joint Order. 

743See July 2006 Debt Index Rules. 

744See infra part III.G.3. 

745 7 U.S.C. 1a(35) and 15 U.S.C. 78c(a)(55). 

746See infra part III.G.3. 

2004 to define when a volatility index 

is not a narrow-based security index. 

Under this joint order, a volatility index 

is not a narrow-based security index if 

the index meets all of the following 

criteria: 

• The index measures the magnitude 

of changes (as calculated in accordance 

with the order) in the level of an 

underlying index that is not a narrowbased security index pursuant to the 

statutory criteria for equity indexes 

discussed above; 

• The index has more than nine 

component securities, all of which are 

options on the underlying index; 

• No component security of the index 

comprises more than 30 percent of the 

index’s weighting; 

• The five highest weighted 

component securities of the index in the 

aggregate do not comprise more than 60 

percent of the index’s weighting; 

• The average daily trading volume of 

the lowest weighted component 

securities in the underlying index (those 

comprising, in the aggregate, 25 percent 

of the underlying index’s weighting) 

have a dollar value of more than 

$50,000,000 (or $30,000,000 in the case 

of an underlying index with 15 or more 

component securities), except if there 

are 2 or more securities with equal 

weighting that could be included in the 

calculation of the lowest weighted 

component securities comprising, in the 

aggregate, 25 percent of the underlying 

index’s weighting, such securities shall 

be ranked from lowest to highest dollar 

value of average daily trading volume 

and shall be included in the calculation 

based on their ranking starting with the 

lowest ranked security; 

• Options on the underlying index 

are listed and traded on an NSE 

registered under section 6(a) of the 

Exchange Act; 734 and 

• The aggregate average daily trading 

volume in options on the underlying 

index is at least 10,000 contracts 

calculated as of the preceding 6 full 

calendar months.735

With regard to debt security indexes, 

the Commissions issued joint rules in 

2006 (‘‘July 2006 Debt Index Rules’’) to 

define when an index of debt 

securities 736 is not a narrow-based 

security index. The first three criteria of 

that definition are similar to the 

statutory definition for equities and the 

order regarding volatility indexes in that 

a debt security index would not be 

narrow-based if: 

• It is comprised of more than nine 

debt securities that are issued by more 

than nine non-affiliated issuers; 

• The securities of any issuer 

included in the index do not comprise 

more than 30 percent of the index’s 

weighting; and 

• The securities of any five nonaffiliated issuers in the index do not 

comprise more than 60 percent of the 

index’s weighting. 

In the July 2006 Debt Index Rules, 

instead of the statutory average daily 

trading volume test, however, the 

Commissions adopted a public 

information availability requirement. 

Under this requirement, assuming the 

aforementioned number and 

concentration criteria were satisfied, a 

debt security index would not be a 

narrow-based security index if the debt 

securities or the issuers of debt 

securities in the index met any one of 

the following criteria: 

• The issuer of the debt security is 

required to file reports pursuant to 

section 13 or section 15(d) of the 

Securities Exchange Act of 1934; 737

• The issuer of the debt security has 

a worldwide market value of its 

outstanding common equity held by 

non-affiliates of $700 million or more; 

• The issuer of the debt security has 

outstanding securities that are notes, 

bonds, debentures, or evidence of 

indebtedness having a total remaining 

principal amount of at least $1 billion; 

• The security is an exempted 

security as defined in section 3(a)(12) of 

the Securities Exchange Act of 1934 738

and the rules promulgated thereunder; 

or 

• The issuer of the security is a 

government of a foreign country or a 

political subdivision of a foreign 

country.739

In the Dodd-Frank Act, Congress 

included the term ‘‘narrow-based 

security index’’ in the security-based 

swap definition, and thus the statutory 

definition of the term ‘‘narrow-based 

security index’’ 740 also applies in 

distinguishing swaps (on security 

indexes that are not narrow-based, also 

known as ‘‘broad-based’’) and securitybased swaps (on narrow-based security 

indexes).741 The Commissions have 

determined that their prior guidance 

with respect to what constitutes a 

narrow-based security index in the 

context of volatility indexes 742 and debt 

security indexes 743 applies in 

determining whether a Title VII 

instrument is a swap or a security-based 

swap, except as the rules the 

Commissions are adopting provide for 

other treatment with respect to index 

CDS as discussed below.744

To make clear that the Commissions 

are applying the prior guidance and 

rules to Title VII instruments, the 

Commissions are adopting rules to 

further define the term ‘‘narrow-based 

security index’’ in the security-based 

swap definition. Under paragraph (1) of 

rule 1.3(yyy) under the CEA and 

paragraph (a) of rule 3a68–3 under the 

Exchange Act, for purposes of the 

security-based swap definition, the term 

‘‘narrow-based security index’’ has the 

same meaning as the statutory definition 

set forth in section 1a(35) of the CEA 

and section 3(a)(55) of the Exchange 

Act,745 and the rules, regulations, and 

orders issued by the Commissions 

relating to such definition. As a result, 

except as the rules the Commissions are 

adopting provide for other treatment 

with respect to index CDS as discussed 

below,746 market participants generally 

may use the Commissions’ past 

guidance in determining whether 

certain Title VII instruments based on a 

security index are swaps or securitybased swaps. 

The Commissions also are providing 

an interpretation and adopting 

additional rules establishing criteria for 

indexes composed of securities, loans, 

or issuers of securities referenced by an 

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747 Id. 

748See infra part III.G.4. 

749See infra part III.G.5. 

750See Proposing Release at 29847–48. 

751See, e.g., Markit, ‘‘Markit CDX’’ (describing the 

Markit CDX indexes and the number of ‘‘names’’ 

included in each index), available at http:// 

www.markit.com/en/products/data/indices/creditand-loan-indices/cdx/cdx.page; Markit, ‘‘Markit 

iTraxx Indices,’’ (stating that the ‘‘Markit iTraxx 

indices are comprised of the most liquid names in 

the European and Asian markets’’) (emphasis 

added), available at http://www.markit.com/en/ 

products/data/indices/credit-and-loan-indices/ 

itraxx/itraxx.page . Examples of indexes based on 

securities include the Markit ABX.HE and CMBX 

indexes. See Markit, ‘‘Markit ABX.HE,’’ (describing 

the Markit ABX.HE index as ‘‘a synthetic tradeable 

index referencing a basket of 20 subprime mortgagebacked securities’’), available at http:// 

www.markit.com/en/products/data/indices/ 

structured-finance-indices/abx/abx.page; and 

Markit, ‘‘Markit CMBX,’’ (describing the Markit 

CMBX index as ‘‘a synthetic tradeable index 

referencing a basket of 25 commercial mortgagebacked securities’’), available at http:// 

www.markit.com/en/products/data/indices/ 

structured-finance-indices/cmbx/cmbx.page. 

752Similarly, an option to enter into a singlename CDS or a CDS referencing a narrow-based 

security index as described above would be a 

security-based swap, while an option to enter into 

a CDS on a broad-based security index or the 

issuers of securities in a broad-based security index 

would be a swap. Index CDS where the underlying 

reference is a broad-based security index would be 

SBSAs. The SEC has enforcement authority with 

respect to swaps that are SBSAs, as discussed 

further in section V., infra. 

753See July 2006 Debt Index Rules. 

754Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 

15 U.S.C. 78c(a)(68)(A)(ii)(III). 

755Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 

15 U.S.C. 78c(a)(68)(A)(ii)(I). 

756Because they apply only with respect to index 

CDS, the definitions of ‘‘issuers of securities in a 

narrow-based security index’’ and ‘‘narrow-based 

security index’’ as adopted do not apply with 

respect to other types of event contracts, whether 

analyzed under the first or third prong. 

757For example, if the reference entities included 

in one index are the same as the issuers of securities 

included in another index, application of the two 

definitions should result in both indexes being 

either broad-based or narrow-based. 

758See Proposing Release at 29848. 

759The discussion throughout this section refers 

to ‘‘reference entities’’ and ‘‘issuers’’ in discussing 

the final rules. The term ‘‘reference entity’’ is 

defined in paragraph (c)(3) of rule 1.3(zzz) under 

the CEA and rule 3a68–1a under the Exchange Act 

and the term ‘‘issuer’’ is defined in paragraph (c)(3) 

of rule 1.3(aaaa) under the CEA and rule 3a68–1b 

under the Exchange Act. The final rules provide 

that the term ‘‘reference entity’’ includes: (i) An 

issuer of securities; (ii) an issuer of securities that 

is an issuing entity of asset-backed securities is a 

reference entity or issuer, as applicable; and (iii) an 

issuer of securities that is a borrower with respect 

to any loan identified in an index of borrowers or 

loans is a reference entity. The final rules provide 

that the term ‘‘issuer’’ includes: (i) An issuer of 

securities; and (ii) an issuer of securities that is an 

issuing entity of asset-backed securities is a 

reference entity or issuer, as applicable. See 

paragraph (c)(3) of rules 1.3(zzz) and 1.3(aaaa) 

under the CEA and rule 3a68–1a and 3a68–1b 

under the Exchange Act. 

index CDS.747 The interpretation and 

rules also address the definition of an 

‘‘index’’ 748 and the treatment of broadbased security indexes that become 

narrow-based and narrow-based indexes 

that become broad-based, including rule 

provisions regarding tolerance and grace 

periods for swaps on security indexes 

that are traded on CFTC-regulated 

trading platforms and security-based 

swaps on security indexes that are 

traded on SEC-regulated trading 

platforms.749 These rules and 

interpretation are discussed below. 

3. Narrow-Based Security Index Criteria 

for Index Credit Default Swaps 

(a) In General 

The Commissions provided an 

interpretation in the Proposing Release 

regarding the narrow-based security 

index criteria for index CDS and are 

restating it without modification.750

While the Commissions understand that 

the underlying reference for most 

cleared CDS is a single entity or an 

index of entities rather than a single 

security or an index of securities, the 

underlying reference for CDS also could 

be a single security or an index of 

securities.751 A CDS where the 

underlying reference is a single entity 

(i.e., a single-name CDS), a single 

obligation of a single entity (e.g., a CDS 

on a specific bond, loan, or asset-backed 

security, or any tranche or series of any 

bond, loan, or asset-backed security), or 

an index CDS where the underlying 

reference is a narrow-based security 

index or the issuers of securities in a 

narrow-based security index is a 

security-based swap. An index CDS 

where the underlying reference is not a 

narrow-based security index or the 

issuers of securities in a narrow-based 

security index (i.e., a broad-based index) 

is a swap.752

The statutory definition of the term 

‘‘narrow-based security index,’’ as 

explained above, was designed with the 

U.S. equity markets in mind.753 Thus, 

the statutory definition is not 

necessarily appropriate for determining 

whether an index underlying an index 

CDS is broad or narrow-based. Nor is 

the guidance that the Commissions have 

previously issued with respect to the 

narrow-based security index definition 

discussed above necessarily 

appropriate, because that guidance was 

designed to address and was uniquely 

tailored to the characteristics of 

volatility indexes and debt security 

indexes in the context of futures. 

Accordingly, the Commissions are 

clarifying that the guidance that the 

Commissions have previously issued 

with respect to the narrow-based 

security index definition discussed 

above does not apply to index CDS. 

Instead, the Commissions are adopting 

rules as discussed below that include 

separate criteria for determining 

whether an index underlying an index 

CDS is a narrow-based security index. 

The Commissions are further defining 

the term ‘‘security-based swap,’’ and the 

use of the term ‘‘narrow-based security 

index’’ within that definition, to modify 

the criteria applied in the context of 

index CDS in assessing whether the 

index is a narrow-based security index. 

The third prong of the security-based 

swap definition includes a Title VII 

instrument based on the occurrence of 

an event relating to the ‘‘issuers of 

securities in a narrow-based security 

index,’’ provided that such event 

directly affects the ‘‘financial 

statements, financial condition, or 

financial obligations of the issuer.’’ 754

The first prong of the security-based 

swap definition includes a Title VII 

instrument that is based on a narrowbased security-index.755 Because the 

third prong of the security-based swap 

definition relates to issuers of securities, 

while the first prong of such definition 

relates to securities, the Commissions 

are further defining both the term 

‘‘narrow-based security index’’ and the 

term ‘‘issuers of securities in a narrowbased security index’’ in the context of 

the security-based swap definition as 

applied to index CDS. The Commissions 

believe it is important to further define 

both terms in order to assure consistent 

analysis of index CDS.756 While the 

wording of the two definitions as 

adopted differs slightly, the 

Commissions expect that they will yield 

the same substantive results in 

distinguishing narrow-based and broadbased index CDS.757

(b) Rules Regarding the Definitions of 

‘‘Issuers of Securities in a Narrow-Based 

Security Index’’ and ‘‘Narrow-Based 

Security Index’’ for Index Credit Default 

Swaps 

The Commissions proposed rules to 

further define the terms ‘‘issuers of 

securities in a narrow-based security 

index’’ and ‘‘narrow-based security 

index’’ in order to provide appropriate 

criteria for determining whether an 

index composed of issuers of securities 

referenced by an index CDS and an 

index composed of securities referenced 

by an index CDS are narrow-based 

security indexes.758 The Commissions 

are adopting rules 1.3(zzz) and 1.3(aaaa) 

under the CEA and rules 3a68–1a and 

3a68–1b under the Exchange Act as 

proposed with certain modifications.759

In formulating the criteria in the final 

rules, and consistent with the guidance 

and rules the Commissions have 

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760See discussion of July 2006 Debt Index Rules. 

761The Commissions note that the language of the 

rules is intended, in general, to be consistent with 

the criteria developed for debt indexes discussed 

above. Certain changes from the criteria developed 

for debt indexes are necessary to address 

differences between futures on debt indexes and 

index CDS. Certain other changes are necessary 

because the rules for debt indexes define under 

what conditions an index is not a narrow-based 

security index, whereas the rules for index CDS 

define what is a narrow-based security index. For 

example, an index is not a narrow-based security 

index under the rule for debt indexes if it is not a 

narrow-based security index under either 

subparagraph (a)(1) or paragraph (a)(2) of the rule. 

See July 2006 Debt Index Rules. Under the rules for 

index CDS, however, an index is a narrow-based 

security index if it meets the requirements of both 

of the counterpart paragraphs in the rules regarding 

index CDS (paragraphs (1)(i) and (1)(ii) of rules 

1.3(zzz) and 1.3(aaaa) under the CEA and paragraph 

(a)(1) and paragraph (a)(2) of rules 3a68–1a and 

3a68–1b under the Exchange Act), even though the 

criteria in the debt index rules and the rules for 

index CDS include generally the same criteria and 

structure. 

762See infra note 768 and accompanying text. 

763 If the loans underlying the index of loans are 

securities, the index CDS would be analyzed in the 

same manner as any other index CDS based on an 

index of securities. 

764An index CDS referencing loans also may be 

based on events relating to the borrower, such as 

bankruptcy, and to defaults on any obligation of the 

borrower. 

765See ISDA Letter and MarketAxess Letter. 

766See MarketAxess Letter. This commenter 

stated that ‘‘The Proposed Rules layout an 

exceedingly complex process for determining 

whether an index CDS is broad-based or narrowbased.’’ Id. 

767See ISDA Letter. 

768See Allen & Overy Letter; July LSTA Letter; 

and SIFMA Letter. 

769See Allen & Overy Letter. 

770 Id. 

771 Id. 

772See July LSTA Letter. This commenter noted 

that prong (III) of the statutory security-based swap 

definition does not clearly reference borrowers of 

loans or indexes of borrowers. However, this 

commenter noted that because most borrowers that 

are named as reference entities in loan CDS 

transactions are corporate entities that issue equity 

interests to one or more shareholders (although they 

may not issue public securities or become subject 

to public reporting requirements), this commenter 

believes that prong (III) can be interpreted to 

include swaps that reference a single borrower or 

borrowers of loans in an index. Id. 

773See SIFMA Letter. 

774The Commissions also are providing guidance 

with respect to TRS based on two or more loans that 

are not securities. See supra part III.C. 

previously issued and adopted 

regarding narrow-based security indexes 

in the context of security futures, the 

Commissions believe that there should 

be public information available about a 

predominant percentage of the reference 

entities included in the index, or, in the 

case of an index CDS on an index of 

securities, about the issuers of the 

securities or the securities underlying 

the index, in order to reduce the 

likelihood that non-narrow-based 

indexes referenced in index CDS or the 

component securities or issuers of 

securities in that index would be readily 

susceptible to manipulation, as well as 

to help prevent the misuse of material 

non-public information through the use 

of CDS based on such indexes. 

To satisfy these objectives, the 

Commissions are adopting rules that are 

based on the criteria developed for debt 

indexes discussed above 760 but that 

tailor these criteria to address index 

CDS.761 These criteria are included 

solely for the purpose of defining the 

terms ‘‘narrow-based security index’’ 

and ‘‘issuers of securities in a narrowbased security index’’ in the first and 

third prongs of the security-based swap 

definition with respect to index CDS 

and will not affect any other 

interpretation or use of the term 

‘‘narrow-based security index’’ or any 

other provision of the Dodd-Frank Act, 

the CEA, or the Exchange Act. 

Further, in response to 

commenters,762 the Commissions are 

clarifying that if an index CDS is based 

on an index of loans that are not 

securities,763 an event relating to a loan 

in the index, such as a default on a loan, 

is an event ‘‘relating to’’ the 

borrower.764 To the extent that the 

borrower is an issuer of securities, the 

index CDS based on such index of loans 

will be analyzed under the third prong 

of the security-based swap definition in 

the same manner as any other index 

CDS. 

Comments 

The Commissions received two 

general comments requesting that the 

proposed rules further defining the 

terms ‘‘issuers of securities in a narrowbased security index’’ and ‘‘narrowbased security index’’ be simplified.765

One commenter believed that the rules 

were exceedingly complicated.766

Another commenter thought that the 

criteria should allow transactions to be 

readily and transparently classifiable as 

a swap or security-based swap.767 The 

commenters did not provide analysis 

supporting their comments or 

recommend language changes. 

The Commissions are adopting the 

rules regarding index CDS essentially as 

proposed with certain modifications to 

address commenters’ concerns. While 

the final rules contain a number of 

elements that are similar or identical to 

elements contained in the statutory 

narrow-based security index definition, 

in order to enable the narrow-based 

security index definition to apply 

appropriately to index CDS, the final 

rules contain some alternative tests to 

those set forth in the statutory 

definition. 

The Commissions also recognize the 

diversity of Title VII instruments. While 

the final rules for index CDS are based 

on the July 2006 Debt Index Rules, the 

substantive differences between the 

final rules in the index CDS and the 

equity or debt security contexts are 

intended to reflect the particular 

characteristics of the CDS marketplace, 

in which, for example, index 

components may be entities (issuers of 

securities) as well as specific equity and 

debt securities. 

The Commissions also received three 

comments requesting clarification 

regarding the applicability of the index 

CDS rules to CDS based on indexes of 

loans.768 One commenter noted that the 

Commissions did not address in the 

Proposing Release the question of 

whether an index composed exclusively 

of loans should be treated as a narrowbased security index.769 This 

commenter noted that because the first 

and third prongs of the statutory 

security-based swap definition do not 

explicitly reference loans, the statutory 

definition does not expressly categorize 

Title VII instruments based on more 

than one loan, or contingent on events 

that occur with respect to more than one 

loan borrower, unless such borrowers 

are also ‘‘issuers of securities.’’ 770 Based 

on this commenter’s view of the 

statutory definition, this commenter 

requested that the Commissions clarify 

the treatment of indexes composed 

exclusively of loans.771 Another 

commenter provided similar comments 

and also requested clarification 

regarding the treatment of CDS based on 

indexes of loans.772 A third commenter 

stated its view that the third prong of 

the statutory security-based swap 

definition implies that Title VII 

instruments on a basket of loans are 

security-based swaps if the lenders 

would satisfy the criteria for issuers of 

a ‘‘narrow-based security index’’ and 

encouraged the Commissions to clarify 

this issue.773 The Commissions agree 

with commenters that an index CDS 

based on an index of loans that are not 

securities is analyzed under the third 

prong of the statutory security-based 

swap definition and, therefore, are 

clarifying the treatment of these Title 

VII instruments above.774

(i) Number and Concentration 

Percentages of Reference Entities or 

Securities 

The Commissions believe that the first 

three criteria of the debt security index 

test (which are based on the statutory 

narrow-based security index definition) 

discussed above (i.e., the number and 

concentration weighting requirements) 

are appropriate to apply to index CDS, 

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775See infra notes 792 and 793 and 

accompanying text. 

776See paragraphs (a)(1)(i)–(iii) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rules 3a68–1a and 

3a68–1b under the Exchange Act. 

777See infra note 804 and accompanying text. 

778See infra notes 795 and 796 and 

accompanying text. 

779 15 U.S.C. 78c(a)(68)(A)(ii)(III). 

780These rules refer to the ‘‘effective notional 

amount’’ allocated to reference entities or securities 

in order to address potential situations in which the 

means of calculating payout across the reference 

entities or securities is not uniform. Thus, if one or 

more payouts is leveraged or enhanced by the 

structure of the transaction (i.e., 2x recovery rate), 

that amount would be the ‘‘effective notional 

amount’’ for purposes of the 30 percent and 60 

percent tests in paragraphs (1)(i)(B) and (1)(i)(C) of 

rules 1.3(zzz) and 1.3(aaaa) and paragraphs (a)(1)(ii) 

and (a)(1)(iii) of rules 3a68–1a and 3a68–1b. 

Similarly, if the aggregate notional amount under a 

CDS is not uniformly allocated to each reference 

entity or security, then the portion of the notional 

amount allocated to each reference entity or 

security (which may be by reference to the product 

of the aggregate notional amount and an applicable 

percentage) would be the ‘‘effective notional 

amount.’’ 

781 15 U.S.C. 78c(a)(68)(A)(ii)(I). 

782See infra part III.G.3(b)(ii), for a discussion of 

the affiliation definition applicable to calculating 

the number and concentration criteria. As noted 

above, the Commissions are modifying the method 

of calculating affiliation for purposes of these 

criteria. 

whether CDS on indexes of securities or 

indexes of issuers of securities.775

Accordingly, the Commissions are 

adopting the first three criteria of rule 

1.3(zzz) under the CEA and rule 3a68– 

1a under the Exchange Act as proposed 

with certain modifications in response 

to commenters’ concerns.776 These rules 

contain the same number and 

concentration criteria as proposed, but 

modify the method of calculating 

affiliation among issuers and reference 

entities in response to commenters.777

Further, in response to commenters,778

the Commissions are providing an 

additional interpretation with respect to 

the application of these criteria to two 

particular types of CDS, commonly 

known as ‘‘nth-to-default CDS’’ and 

‘‘tranched CDS.’’ 

The first three criteria provide that, 

for purposes of determining whether an 

index CDS is a security-based swap 

under section 3(a)(68)(A)(ii)(III) of the 

Exchange Act,779 the term ‘‘issuers of 

securities in a narrow-based security 

index’’ includes issuers of securities 

identified in an index (including an 

index referencing loan borrowers) in 

which: 

• Number: There are nine or fewer 

non-affiliated issuers of securities that 

are reference entities included in the 

index, provided that an issuer of 

securities shall not be deemed a 

reference entity included in the index 

unless (i) a credit event with respect to 

such reference entity would result in a 

payment by the credit protection seller 

to the credit protection buyer under the 

index CDS based on the related notional 

amount allocated to such reference 

entity; or (ii) the fact of such credit 

event or the calculation in accordance 

with clause (i) above of the amount 

owed with respect to such credit event 

is taken into account in determining 

whether to make any future payments 

under the index CDS with respect to any 

future credit events; 

• Single Component Concentration: 

The effective notional amount allocated 

to any reference entity included in the 

index comprises more than 30 percent 

of the index’s weighting; or 

• Largest Five Component 

Concentration: The effective notional 

amount allocated to any five nonaffiliated reference entities included in 

the index comprises more than 60 

percent of the index’s weighting.780

Similarly, the Commissions are 

adopting as proposed the first three 

criteria of rule 1.3(aaaa) under the CEA 

and rule 3a68–1b under the Exchange 

Act. These three criteria provide that, 

for purposes of determining whether an 

index CDS is a security-based swap 

under section 3(a)(68)(A)(ii)(I) of the 

Exchange Act,781 the term ‘‘narrowbased security index’’ includes an index 

in which essentially the same criteria 

apply, substituting securities for issuers. 

Under these criteria, the term ‘‘narrowbased security index’’ would mean an 

index in which: 

• Number: There are nine or fewer 

securities, or securities that are issued 

by nine or fewer non-affiliated issuers, 

included in the index, provided that a 

security shall not be deemed a 

component of the index unless (i) a 

credit event with respect to the issuer of 

such security or a credit event with 

respect to such security would result in 

a payment by the credit protection seller 

to the credit protection buyer under the 

index CDS based on the related notional 

amount allocated to such security, or (ii) 

the fact of such credit event or the 

calculation in accordance with clause (i) 

above of the amount owed with respect 

to such credit event is taken into 

account in determining whether to make 

any future payments under the index 

CDS with respect to any future credit 

events; 

• Single Component Concentration: 

The effective notional amount allocated 

to the securities of any issuer included 

in the index comprises more than 30 

percent of the index’s weighting; or 

• Largest Five Component 

Concentration: The effective notional 

amount allocated to the securities of any 

five non-affiliated issuers included in 

the index comprises more than 60 

percent of the index’s weighting. 

Thus, the applicability of the final 

rules depends on conditions relating to 

the number of non-affiliated reference 

entities or issuers of securities, or 

securities issued by non-affiliated 

issuers, as applicable, included in an 

index and the weighting of notional 

amounts allocated to the reference 

entities or securities included in the 

index, as applicable. These first three 

criteria of the final rules evaluate the 

number and concentration of the 

reference entities or securities included 

in the index, as applicable, and ensure 

that an index with a small number of 

reference entities, issuers, or securities 

or concentrated in only a few reference 

entities, issuers, or securities is narrowbased, and thus where such index is the 

underlying reference of an index CDS, 

the index CDS is a security-based swap. 

Further, as more fully described 

below,782 the final rules provide that a 

reference entity or issuer of securities 

included in an index and any of that 

reference entity’s or issuer’s affiliated 

entities (as defined in the final rules) 

that also are included in the index are 

aggregated for purposes of determining 

whether the number and concentration 

criteria are met. 

Specifically, the final rules provide 

that an index meeting any one of certain 

identified conditions would be a 

narrow-based security index. The first 

condition in paragraph (1)(i)(A) of rule 

1.3(zzz) under the CEA and paragraph 

(a)(1)(i) of rule 3a68–1a under the 

Exchange Act is that there are nine or 

fewer non-affiliated issuers of securities 

that are reference entities in the index. 

An issuer of securities counts toward 

this total only if a credit event with 

respect to such entity would result in a 

payment by the credit protection seller 

to the credit protection buyer under the 

index CDS based on the notional 

amount allocated to such entity, or if the 

fact of such a credit event or the 

calculation of the payment with respect 

to such credit event is taken into 

account when determining whether to 

make any future payments under the 

index CDS with respect to any future 

credit events. 

Similarly, the first condition in 

paragraph (1)(i)(A) of rule 1.3(aaaa) 

under the CEA and paragraph (a)(1)(i) of 

rule 3a68–1b under the Exchange Act 

provides that a security counts toward 

the total number of securities in the 

index only if a credit event with respect 

to such security, or the issuer of such 

security, would result in a payment by 

the credit protection seller to the credit 

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783This requirement is generally consistent with 

the definition of ‘‘narrow-based security index’’ in 

section 1a(35)(A) of the CEA, 7 U.S.C. 1a(35)(A), 

and section 3(a)(55)(B) of the Exchange Act, 15 

U.S.C. 78c(a)(55)(B), and the July 2006 Debt Index 

Rules. 

784 Id. 

785See infra note 795 and accompanying text. 

786An ‘‘nth-to-default CDS’’ is a CDS in which 

the payout is linked to one in a series of defaults 

(such as first-, second- or third-to-default), with the 

contract terminating at that point. See SIFMA 

Letter. 

787See infra note 796 and accompanying text. 

788A ‘‘tranched CDS’’ is a CDS in which the 

counterparties agree to buy and sell credit 

protection on only a portion of the potential losses 

that could occur on an underlying portfolio of 

reference entities. The portion is typically denoted 

as a specified percentage range of aggregate losses 

(e.g., 2 percent to 5 percent, meaning the credit 

protection seller would not make payments until 

aggregate losses exceed 2 percent of the notional of 

the transaction, and would no longer be obligated 

to make payments after aggregate losses reach 5 

percent). See SIFMA Letter. 

789See July 2006 Debt Index Rules. 

790As noted above, the Commissions are 

modifying the method of calculating affiliation for 

purposes of the number and concentration criteria. 

See infra part III.G.3(b)(ii). 

791See ISDA Letter. According to this commenter, 

the ‘‘operational complexity’’ of the number and 

concentration criteria will increase costs and 

compliance risks. Id. 

792See 15 U.S.C. 78c(a)(55)(B) and 7 U.S.C. 

1a(35). 

793See July 2006 Debt Index Rules. 

794See infra part III.G.3(b)(ii). 

795See ISDA Letter and SIFMA Letter. One of 

these commenters noted that such an approach also 

made sense for nth-to-default CDS because they are 

typically based on baskets of less than 10 securities. 

See ISDA Letter. 

796See Markit Letter and SIFMA Letter. One of 

these commenters stated that classifying tranches 

underlying index CDS according to attachment or 

detachment points is not appropriate because it is 

impossible to know for certain at inception of the 

CDS the number of credit events that will 

ultimately affect actual payments, which typically 

depend on the severity of loss associated with each 

credit event. See SIFMA Letter. 

protection buyer under the index CDS 

based on the notional amount allocated 

to such security, or if the fact of such 

a credit event or the calculation of the 

payment with respect to such credit 

event is taken into account when 

determining whether to make any future 

payments under the index CDS with 

respect to any future credit events. 

These provisions are intended to 

ensure that an index concentrated in a 

few reference entities or securities, or a 

few reference entities that are affiliated 

(as defined in the final rules) or a few 

securities issued by issuers that are 

affiliated, are within the narrow-based 

security index definition.783 These 

provisions also are intended to ensure 

that an entity is not counted as a 

reference entity included in the index, 

and a security is not counted as a 

security included in the index, unless a 

credit event with respect to the entity, 

issuer, or security affects payout under 

a CDS on the index.784

Further, as this condition is in the 

alternative (i.e., either there must be a 

credit event resulting in a payment 

under the index CDS or a credit event 

is considered in determining future CDS 

payments), the tests encompass all 

index CDS. For example, and in 

response to a commenter,785 the test 

would cover an nth-to-default CDS,786

in which default with respect to a 

specified component of an index (such 

as the first default or fifth default) 

triggers the CDS payment, even if the 

CDS payment is not made with respect 

to such particular credit event. As 

another example, and in response to 

another commenter,787 the test applies 

to a tranched CDS 788 if the payments 

are made on only a tranche, or portion, 

of the potential aggregate notional 

amount of the CDS (often expressed as 

a percentage range of the total notional 

amount of the CDS) because the CDS 

payment takes into account a credit 

event with respect to an index 

component, even if the credit event 

itself does not result in such a payment. 

The second condition, in paragraphs 

(1)(i)(B) of rules 1.3(zzz) and 1.3(aaaa) 

under the CEA and paragraphs (a)(1)(ii) 

of rules 3a68–1a and 3a68–1b under the 

Exchange Act, is that the effective 

notional amount allocated to any 

reference entity or security of any issuer 

included in the index comprises more 

than 30 percent of the index’s 

weighting. 

The third condition, in paragraphs 

(1)(i)(C) of rules 1.3(zzz) and 1.3(aaaa) 

under the CEA and paragraphs (a)(1)(iii) 

of rules 3a68–1a and 3a68–1b under the 

Exchange Act, is that the effective 

notional amount allocated to any five 

non-affiliated reference entities, or to 

the securities of any five non-affiliated 

issuers, included in the index comprises 

more than 60 percent of the index’s 

weighting. 

Given that Congress determined that 

these concentration percentages are 

appropriate to characterize an index as 

a narrow-based security index, and the 

Commissions have determined they are 

appropriate for debt security indexes in 

the security futures context,789 the 

Commissions believe that these 

concentration percentages are 

appropriate to apply to the notional 

amount allocated to reference entities 

and securities in order to apply similar 

standards to indexes that are the 

underlying references of index CDS. 

Moreover, with respect to both the 

number and concentration criteria, the 

markets have had experience with these 

criteria with respect to futures on equity 

indexes, volatility indexes, and debt 

security indexes.790

Comments 

One commenter expressed its view 

that the Commissions should increase 

the percentage test in the largest five 

component concentration.791 The 

Commissions are adopting the number 

and concentration criteria as proposed. 

The statutory definition of the term 

‘‘security-based swap’’ references the 

definition of the term ‘‘narrow-based 

security index’’ contained in the 

Exchange Act and the CEA,792 which 

includes the same number and 

concentration percentages as the 

Commissions are adopting in this 

release. The Commissions are not 

modifying the statutory definition to 

change the percentages. The statutory 

definition included the concentration 

percentages, which the Commissions 

understand are intended to assure that 

a security index could not be used as a 

surrogate for the underlying securities 

in order to avoid application of the 

Federal securities laws. The 

Commissions also previously 

determined to retain these statutory 

percentages in connection with rules 

relating to debt security indexes in the 

security futures context.793 The 

Commissions believe that these 

percentages are similarly appropriate to 

apply to indexes on which index CDS 

are based. Moreover, with respect to the 

number and concentration criteria, as 

these are in the statutory definition of 

the term ‘‘narrow-based security index’’ 

applicable to security futures, market 

participants have experience in 

analyzing indexes, including equity, 

volatility and debt security indexes, to 

determine compliance with these 

criteria. As discussed below,794 though, 

the Commissions are modifying the 

affiliation definition used in analyzing 

the number and concentration criteria 

for an index. 

Two commenters requested 

clarification regarding nth-to-default 

CDS, stating their view that such CDS 

should be treated as security-based 

swaps to reflect their single-entity 

triggers.795 Two commenters requested 

clarification regarding tranched index 

CDS, including whether the CDS would 

be classified based on the underlying 

index.796 As discussed above, the 

Commissions are providing an 

interpretation on the applicability of the 

first three criteria of the rules to nth-todefault CDS and tranched CDS. As 

noted above, the Commissions believe 

the rules encompass all index CDS, 

regardless of the type or payment 

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797See infra note 804 and accompanying text. 

798See paragraph (c)(4) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

799See paragraph (c)(1) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rules 3a68–1a and 

3a68–1b under the Exchange Act. 

800See paragraph (c)(2) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rules 3a68–1a and 

3a68–1b under the Exchange Act. 

801See Proposing Release at 29849. 

802See infra note 804 and accompanying text. 

The Commissions note that another alternative 

would have been to include a requirement that the 

entities satisfy the 20 percent control threshold and 

also be consolidated with each other in financial 

statements. The Commissions did not include a 

requirement that the entities be consolidated with 

each other in financial statements because they do 

not believe that the scope of the affiliation 

definition should be exposed to the risk of future 

changes in accounting standards. Further, the use 

of a majority ownership control threshold (more 

than 50 percent) is generally consistent with 

consolidation under generally accepted accounting 

principles. See FASB ASC section 810–10–25, 

Consolidation—Overall—Recognition (stating that 

consolidation is appropriate if a reporting entity has 

a controlling financial interest in another entity and 

a specific scope exception does not apply). 

803 In such a case, as noted by commenters, the 

affiliated entities are viewed as part of group for 

which aggregation of these entities is appropriate. 

See infra note 806 and accompanying text. 

804See ISDA Letter (requesting a threshold of at 

least 50 percent); Markit Letter (requesting a 

threshold of at least 50 percent); and SIFMA Letter 

(requesting a threshold of majority ownership, or 51 

percent). One commenter also requested that the 

Commissions clarify the application of the 

affiliation definition. See Markit Letter. The 

Commissions have provided above and in infra part 

III.G.3(b)(ii), several examples illustrating the 

application of the affiliation definition in response 

to this commenter. 

805 Id. 

806See SIFMA Letter. The ISDA Letter provides 

a similar rationale that ‘‘the control threshold was 

too low and potentially disruptive when viewed 

against entities that the swap markets now trade as 

separate entities. In the CDS market, for example, 

entities that share ownership ties of substantially 

more than 20 percent trade quite independently. 

These entities may have completely disparate 

characteristics for the purpose of an index grouping 

of one sort or another.’’ See ISDA Letter. 

807See SIFMA Letter. 

structure, such as whether there is a 

single-entity payment based on credit 

events of other index components or 

whether the payment is based on a 

specific entity. 

(ii) Affiliation of Reference Entities and 

Issuers of Securities With Respect to 

Number and Concentration Criteria 

The Commissions are adopting the 

affiliation definition that applies when 

calculating the number and 

concentration criteria with certain 

modifications from the proposal to 

address commenters’ concerns.797 The 

final rules provide that the terms 

‘‘reference entity included in the index’’ 

and ‘‘issuer of the security included in 

the index’’ include a single reference 

entity or issuer of securities included in 

an index, respectively, or a group of 

affiliated reference entities or issuers 

included in an index, respectively.798

For purposes of the rules, affiliated 

reference entities or issuers of securities 

included in an index or securities 

included in an index issued by affiliated 

issuers will be counted together for 

determining whether the number and 

concentration criteria are met. However, 

with respect to asset-backed securities, 

the final rules provide that each 

reference entity or issuer of securities 

included in an index that is an issuing 

entity of an asset-backed security is 

considered a separate reference entity or 

issuer, as applicable, and will not be 

considered affiliated with other 

reference entities or issuers of securities 

included in the index. 

The final rules provide that a 

reference entity or issuer of securities 

included in an index is affiliated with 

another reference entity or issuer of 

securities included in the index if it 

controls, is controlled by, or is under 

common control with, that other 

reference entity or issuer.799 The final 

rules define control, solely for purposes 

of this affiliation definition, to mean 

ownership of more than 50 percent of a 

reference entity’s or issuer’s equity or 

the ability to direct the voting of more 

than 50 percent of a reference entity’s or 

issuer’s voting equity.800 The affiliation 

definition in the final rules differs from 

the definition included in the proposal, 

which provided for a control threshold 

of 20 percent ownership.801 This change 

is based on the Commissions’ 

consideration of comments received.802

By using a more than 50 percent (i.e., 

majority ownership) test rather than a 

20 percent ownership test for the 

control threshold, there is a greater 

likelihood that there will be an 

alignment of economic interests of the 

affiliated entities that is sufficient to 

aggregate reference entities or issuers of 

securities included in an index for 

purposes of the number and 

concentration criteria.803

As the affiliation definition is applied 

to the number criterion, affiliated 

reference entities or issuers of securities 

included in an index will be viewed as 

a single reference entity or issuer of 

securities to determine whether there 

are nine or fewer non-affiliated 

reference entities included in the index 

or securities that are issued by nine or 

fewer non-affiliated issuers. Similarly, 

as the affiliation definition is applied to 

the concentration criteria, the notional 

amounts allocated to affiliated reference 

entities included in an index or the 

securities issued by a group of affiliated 

issuers of securities included in an 

index must be aggregated to determine 

the level of concentration of the 

components of the index for purposes of 

the 30-percent and 60-percent 

concentration criteria. 

Comments 

Three commenters requested that the 

Commissions revise the affiliation 

definition that applies when calculating 

the number and concentration criteria to 

increase the control threshold from 20 

percent ownership to majority 

ownership.804 These commenters noted 

that majority ownership is consistent 

with current market practice, including 

the definition of affiliate included in the 

2003 ISDA Credit Derivatives 

Definitions.805 One commenter also 

stated its belief that affiliated entities 

should only be aggregated where the 

reference entities’ credit risks are 

substantially similar and credit 

decisions are made by the same group 

of individuals.806 This commenter 

stated its view that 20 percent 

ownership is too low and that majority 

ownership is necessary for credit risk 

and credit decisions to be aligned 

enough as to warrant collapsing two 

issuers into one for purposes of the 

number and concentration criteria.807

As stated above, the Commissions are 

modifying the affiliation definition that 

applies when calculating the number 

and concentration criteria in response to 

commenters to use an affiliation test 

based on majority ownership. Based on 

commenters’ letters, the Commissions 

understand that the current standard 

CDS documentation and the current 

approach used by certain index 

providers for index CDS with respect to 

the inclusion of affiliated entities in the 

same index use majority ownership 

rather than 20 percent ownership to 

determine affiliation. The Commissions 

are persuaded by commenters that, in 

the case of index CDS only it is more 

appropriate to use majority ownership 

because majority-owned entities are 

more likely to have their economic 

interests aligned and be viewed by the 

market as part of a group. The 

Commissions believe that revising the 

affiliation definition in this manner for 

purposes of calculating the number and 

concentration criteria responds to 

commenters’ concerns that the 

percentage control threshold may 

inadvertently include entities that are 

not viewed as part of a group. Thus, as 

revised, the affiliation definition will 

include only those reference entities or 

issuers included in an index that satisfy 

the more than 50 percent (i.e., majority 

ownership) control threshold. The 

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808See supra note 765 and accompanying text. 

809See Proposing Release at 29850. 

810See infra notes 845, 847, 849 and 867 and 

accompanying text. 

811See paragraphs (a)(1)(iv)(A)–(G) of rules 

1.3(zzz) and 1.3(aaaa) under the CEA and rule 

3a68–1a and 3a68–1b under the Exchange Act. 

812 17 CFR 240.12g3–2(b). 

813See July 2006 Debt Index Rules (noting that 

issuers having worldwide equity market 

capitalization of $700 million or more are likely to 

have public information available about them). 

814 15 U.S.C. 78c(a)(77). 

815See July 2006 Debt Index Rules (noting that 

issuers having at least $1 billion in outstanding debt 

are likely to have public information available 

about them). 

816 15 U.S.C. 78c(a)12. 

817 15 U.S.C. 78c(a)(77). 

818See paragraph (b) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

819Most of the thresholds in the public 

information availability test are similar to those the 

Commissions adopted in their joint rules regarding 

the application of the definition of the term 

‘‘narrow-based security index’’ to debt security 

indexes and security futures on debt securities. See 

July 2006 Debt Index Rules. The July 2006 Debt 

Index Rules also included an additional 

requirement regarding the minimum principal 

amount outstanding for each security in the index. 

The Commissions have not included this 

requirement in rule 1.3(zzz) under the CEA and rule 

3a68–1a under the Exchange Act. That requirement 

was intended as a substitute criterion for trading 

volume because the trading volume of debt 

securities with a principal amount outstanding 

above that minimum amount was found to be 

generally larger than debt securities with a 

principal amount outstanding below that minimum 

amount. See July 2006 Debt Index Release. There 

is no similar criterion that would be applicable in 

the context of index CDS. The numerical thresholds 

also are similar to those the SEC adopted in other 

contexts, including in the existing definitions of 

‘‘well-known seasoned issuer’’ and ‘‘large 

accelerated filer.’’ See rule 405 under the Securities 

Act, 17 CFR 230.405, and rule 12b–2 under the 

Exchange Act, 17 CFR 240.12b–2. 

Commissions believe that determining 

affiliation in this manner for purposes of 

calculating the number and 

concentration criteria responds to the 

commenters’ concerns. 

The Commissions also believe that the 

modified affiliation definition addresses 

commenters’ concerns noted above 808

that the rules further defining the terms 

‘‘issuers of securities in a narrow-based 

security index’’ and ‘‘narrow-based 

security index’’ should be simplified. 

The modified affiliation definition 

enables market participants to make an 

affiliation determination for purposes of 

calculating the number and 

concentration criteria by measuring the 

more than 50 percent (i.e., majority 

ownership) control threshold. 

(iii) Public Information Availability 

Regarding Reference Entities and 

Securities 

In addition to the number and 

concentration criteria, the debt security 

index test also includes, as discussed 

above, a public information availability 

test. The public information availability 

test is intended as the substitute for the 

average daily trading volume (‘‘ADTV’’) 

provision in the statutory narrow-based 

security index definition. An ADTV test 

is designed to take into account the 

trading of individual stocks and, 

because Exchange Act registration of the 

security being traded is a listing 

standard for equity securities, the issuer 

of the security being traded must be 

subject to the reporting requirements 

under the Exchange Act. Based on the 

provisions of the statutory ADTV test, 

the Commissions have determined that 

the ADTV test is not useful for purposes 

of determining the status of the index on 

which the index CDS is based because 

index CDS most commonly reference 

entities, which do not ‘‘trade,’’ or debt 

instruments, which commonly are not 

listed, and, therefore, do not have a 

significant trading volume. However, 

the underlying rationale of such 

provision, that there is sufficient trading 

in the securities and therefore public 

information and market following of the 

issuer of the securities, applies to index 

CDS. 

In general, if an index is not narrowbased under the number and 

concentration criteria, it will be narrowbased if one of the reference entities or 

securities included in the index fails to 

meet at least one of the criteria in the 

public information availability test. This 

test was designed to reduce the 

likelihood that broad-based debt 

security indexes or the component 

securities or issuers of securities in that 

index would be readily susceptible to 

manipulation. The fourth condition in 

the index CDS rules sets out a similar 

public information availability test that 

is intended solely for purposes of 

determining whether an index 

underlying a CDS is narrow-based.809

The Commissions are adopting the 

public information availability test 

essentially as proposed with certain 

modifications to address commenters’ 

concerns, including modifications to the 

definition of affiliation for purposes of 

satisfying certain criteria of the public 

information availability test.810

The Commissions are adopting final 

rules under which an index CDS will be 

considered narrow-based (except as 

discussed below) if a reference entity or 

security included in the index does not 

meet any of the following criteria: 811

• The reference entity or the issuer of 

the security included in the index is 

required to file reports pursuant to the 

Exchange Act or the regulations 

thereunder; 

• The reference entity or the issuer of 

the security included in the index is 

eligible to rely on the exemption 

provided in rule 12g3–2(b) under the 

Exchange Act; 812

• The reference entity or the issuer of 

the security included in the index has 

a worldwide market value of its 

outstanding common equity held by 

non-affiliates of $700 million or 

more; 813

• The reference entity or the issuer of 

the security included in the index (other 

than a reference entity or an issuer of 

the security included in the index that 

is an issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Exchange Act 814) has outstanding 

notes, bonds, debentures, loans, or 

evidences of indebtedness (other than 

revolving credit facilities) having a total 

remaining principal amount of at least 

$1 billion; 815

• The reference entity included in the 

index is an issuer of an exempted 

security, or the security included in the 

index is an exempted security, each as 

defined in section 3(a)(12) of the 

Exchange Act 816 and the rules 

promulgated thereunder (except a 

municipal security); 

• The reference entity or the issuer of 

the security included in the index is a 

government of a foreign country or a 

political subdivision of a foreign 

country; or 

• If the reference entity or the issuer 

of the security included in the index is 

an issuing entity of asset-backed 

securities as defined in section 3(a)(77) 

of the Exchange Act,817 such assetbacked security was issued in a 

transaction registered under the 

Securities Act and has publicly 

available distribution reports. 

However, so long as the effective 

notional amounts allocated to reference 

entities or securities included in the 

index that satisfy the public information 

availability test comprise at least 80 

percent of the index’s weighting, failure 

by a reference entity or security 

included in the index to satisfy the 

public information availability test will 

be disregarded if the effective notional 

amounts allocated to that reference 

entity or security comprise less than five 

percent of the index’s weighting.818 In 

this situation, the public information 

availability test for purposes of the 

index would be satisfied. 

The determination as to whether an 

index CDS is narrow-based is 

conditioned on the likelihood that 

information about a predominant 

percentage of the reference entities or 

securities included in the index is 

publicly available.819 For example, a 

reference entity or an issuer of securities 

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820 17 CFR 240.12g3–2(b). 

821 It is important to note that the public 

information availability test is designed solely for 

purposes of distinguishing between index CDS that 

are swaps and index CDS that are security-based 

swaps. The proposed criteria are not intended to 

provide any assurance that there is any particular 

level of information actually available regarding a 

particular reference entity or issuer of securities. 

Meeting one or more of the criteria for the limited 

purpose here—defining the terms ‘‘narrow-based 

security index’’ and ‘‘issuers of securities in a 

narrow-based security index’’ in the first and third 

prongs of the security-based swap definition with 

respect to index CDS—would not substitute for or 

satisfy any other requirement for public disclosure 

of information or public availability of information 

for purposes of the Federal securities laws. 

822See infra note 845 and accompanying text. 

823See July 2006 Debt Index Release. 

824See infra part III.G.3(b)(iv), for a discussion 

regarding the affiliation definition applicable to the 

public information availability test. As noted above, 

the Commissions are modifying the method of 

calculating affiliation for purposes of this test. 825Under this part of the public information 

availability test, all offerings of the asset-backed 

securities will have to be covered by a registration 

statement under the Securities Act, including all 

tranches, so that public information would exist for 

any tranche included in an index. However, as 

noted below, CDS that are offered to ECPs only may 

rely on alternatives to satisfy the public information 

test for asset-backed securities. 

826See infra note 849 and accompanying text. 

827See generally Asset-Backed Securities, 75 FR 

23328 (May 3, 2010). 828See supra note 625 and accompanying text. 

included in the index that is required to 

file reports pursuant to the Exchange 

Act or the regulations thereunder makes 

regular and public disclosure through 

those filings. Moreover, a reference 

entity or an issuer of securities included 

in the index that does not file reports 

with the SEC but that is eligible to rely 

on the exemption in rule 12g3–2(b) 

under the Exchange Act (i.e., foreign 

private issuers) is required to make 

certain types of financial information 

publicly available in English on its Web 

site or through an electronic information 

delivery system generally available to 

the public in its primary trading 

markets.820

The Commissions believe that other 

reference entities or issuers of securities 

included in the index that do not file 

reports with the SEC, but that have 

worldwide equity market capitalization 

of $700 million or more, have at least $1 

billion in outstanding debt obligations 

(other than in the case of issuing entities 

of asset-backed securities), issue 

exempted securities (other than 

municipal securities), or are foreign 

sovereign entities either are required to 

or are otherwise sufficiently likely, 

solely for purposes of the ‘‘narrow-based 

security-index’’ and ‘‘issuers of 

securities in a narrow-based security 

index’’ definitions, to have public 

information available about them.821

In response to commenters,822 the 

Commissions are modifying the 

outstanding debt threshold criterion in 

the public information availability test 

to include any indebtedness, including 

loans, so long as such indebtedness is 

not a revolving credit facility. The 

Commissions believe that expanding the 

definition of indebtedness to include 

loans (other than revolving credit) for 

purposes of the debt threshold 

determination is consistent with the 

view that entities that have significant 

outstanding indebtedness likely will 

have public information available about 

them.823

As more fully described below,824 for 

purposes of satisfying one of these 

issuer eligibility criteria, the final rules 

provide that a reference entity or an 

issuer of securities included in an index 

may rely upon the status of an affiliated 

entity as an Exchange Act reporting 

company or foreign private issuer or 

may aggregate the worldwide equity 

market capitalization or outstanding 

indebtedness of an affiliated entity, 

regardless of whether such affiliated 

entity itself or its securities are included 

in the index. 

In the case of indexes including assetbacked securities, or reference entities 

that are issuing entities of asset-backed 

securities, information about the 

reference entity or issuing entity of the 

asset-backed security will not alone be 

sufficient and, consequently, the rules 

provide that the public information 

availability test will be satisfied only if 

certain information also is available 

about the asset-backed securities. An 

issuing entity (whether or not a 

reference entity) of asset-backed 

securities will meet the public 

information availability test if such 

asset-backed securities were issued in a 

transaction for which the asset-backed 

securities issued (which includes all 

tranches) 825 were registered under the 

Securities Act and distribution reports 

about such asset-backed securities are 

publicly available. In response to 

commenters,826 the Commissions note 

that distribution reports, which 

sometimes are referred to as servicer 

reports, delivered to the trustee or 

security holders, as the case may be, are 

filed with the SEC on Form 10–D. In 

addition, because of the lack of public 

information regarding many assetbacked securities, despite the size of the 

outstanding amount of securities,827 the 

rules do not permit such reference 

entities and issuers to satisfy the public 

information availability test by having at 

least $1 billion in outstanding 

indebtedness. Characterizing an index 

with reference entities or securities for 

which public information is not likely 

to be available as narrow-based, and 

thus index CDS where the underlying 

references or securities are such indexes 

as security-based swaps, should help to 

ensure that the index cannot be used to 

circumvent the Federal securities laws, 

including those relating to Securities 

Act compliance and the antifraud, 

antimanipulation and insider trading 

prohibitions with respect to the index 

components or the securities of the 

reference entities. 

As noted above, if an index is not 

narrow-based under the number and 

concentration criteria, it will be narrowbased if one of the reference entities or 

securities included in the index fails to 

meet at least one of the criteria in the 

public information availability test. 

However, even if one or more of the 

reference entities or securities included 

in the index fail the public information 

availability test, the final rules provide 

that the index will not be considered 

‘‘issuers of securities in a narrow-based 

security index’’ or a ‘‘narrow-based 

security index,’’ so long as the 

applicable reference entity or security 

that fails the test represents less than 

five percent of the index’s weighting, 

and so long as reference entities or 

securities comprising at least 80 percent 

of the index’s weighting satisfy the 

public information availability test. 

An index that includes a very small 

proportion of reference entities or 

securities that do not satisfy the public 

information availability test will be 

treated as a broad-based security index 

if the other elements of the definition, 

including the five percent and 80 

percent thresholds, are satisfied prior to 

execution, but no later than when the 

parties offer to enter into the index 

CDS.828 The five-percent weighting 

threshold is designed to provide that 

reference entities or securities not 

satisfying the public information 

availability test comprise only a very 

small portion of the index, and the 80- 

percent weighting threshold is designed 

to provide that a predominant 

percentage of the reference entities or 

securities in the index satisfy the public 

information availability test. As a result, 

these thresholds provide market 

participants with flexibility in 

constructing an index. The 

Commissions believe that these 

thresholds are appropriate and that 

providing such flexibility is not likely to 

increase the likelihood that an index 

that satisfies these provisions or the 

component securities or issuers of 

securities in that index would be readily 

susceptible to manipulation or that 

there would be misuse of material nonpublic information about the component 

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48280 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

829See paragraph (a)(1)(iv)(H) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

830 17 CFR 230.144A(d)(4). 

831See infra part III.G.3(b)(iv), for a discussion 

regarding the affiliation definition applicable to the 

public information availability test applicable to 

index CDS entered into solely between ECPs. As 

noted above, the Commissions are modifying the 

method of calculating affiliation for purposes of this 

test. 

832See infra note 847 and accompanying text. 

833See SIFMA Letter. This commenter expressed 

its concern that transactions on the same or similar 

indexes may result in differing regulatory treatment 

due to changes in index components as a result of 

component adjustments or as the availability of 

information relating to a component issuer changes 

over time. Id. 

834See Markit Letter. According to this 

commenter, determining whether an index of loans 

or borrowers meets the public information 

availability test would be more difficult and more 

costly than making the same determination for an 

index of securities, which ‘‘are generally subject to 

national or exchange-based reporting and disclosure 

regimes’’ and could create regulatory uncertainty. 

Id. This commenter also expressed its belief that the 

public information availability test would cause 

indexes to switch between a narrow-based and 

broad-based classification, which could result in 

unnecessary cost, confusion, and market disruption. 

Id. 

835See ISDA Letter. This commenter expressed its 

belief that the public information availability test is 

not needed given the largely institutional nature of 

the existing over-the-counter market. Id. See also 

July LSTA Letter. 

836See Markit Letter. This commenter expressed 

its belief that a volume-based classification process 

would be preferable to the public information 

availability test for several reasons. First, the 

statutory definition of ‘‘narrow-based security 

index’’ includes a volume-based factor. Second, a 

volume-based factor could be applied easily and 

transparently because the outstanding notional 

volume of CDS referencing each index constituent 

is captured by the Trade Information Warehouse. 

Third, an index classification based on outstanding 

notional amount as opposed to the public 

information availability test would result in less 

indices migrating from broad- to narrow-based 

classifications, and vice versa. This commenter also 

expressed its belief that a volume-based test would 

ensure that broad-based indices are not readily 

susceptible to manipulation because indexes based 

on constituents with high volumes are likely to 

have significant public information available. Id. 

securities or issuers of securities in that 

index through the use of CDS based on 

such indexes. 

The final rules also provide that, for 

index CDS entered into solely between 

ECPs, there are alternative means to 

satisfy the public information 

availability test. Under the final rules, 

solely for index CDS entered into 

between ECPs, an index will be 

considered narrow-based if a reference 

entity or security included in the index 

does not meet (i) any of the criteria 

enumerated above or (ii) any of the 

following criteria: 829

• The reference entity or the issuer of 

the security included in the index (other 

than a reference entity or issuer 

included in the index that is an issuing 

entity of an asset-backed security) 

makes available to the public or 

otherwise makes available to such ECP 

information about such reference entity 

or issuer pursuant to rule 144A(d)(4) 

under the Securities Act; 830

• Financial information about the 

reference entity or the issuer of the 

security included in the index (other 

than a reference entity or issuer 

included in the index that is an issuing 

entity of an asset-backed security) is 

otherwise publicly available; or 

• In the case of an asset-backed 

security included in the index, or a 

reference entity included in the index 

that is an issuing entity of an assetbacked security, information of the type 

and level included in public 

distribution reports for similar assetbacked securities is publicly available 

about both the reference entity or 

issuing entity and the asset-backed 

security. 

As more fully described below, for 

purposes of satisfying either the rule 

144A information criterion or the 

financial information otherwise publicly 

available criterion, the final rules 

provide that a reference entity or an 

issuer of securities included in an index 

may look to an affiliated entity to 

determine whether it satisfies one of 

these criterion, regardless of whether 

such affiliated entity itself or its 

securities are included in the index.831

In response to commenters,832 the 

Commissions are revising the rule 144A 

information criterion of the public 

information availability test applicable 

to index CDS entered into solely 

between ECPs to clarify that the rule 

144A information must either be made 

publicly available or otherwise made 

available to the ECP. In addition, the 

Commissions are clarifying that 

financial information about the 

reference entity or the issuer of the 

security may otherwise be publicly 

available through an issuer’s Web site, 

through public filings with other 

regulators or exchanges, or through 

other electronic means. This method of 

satisfying the public information 

availability test does not specify the 

precise method by which financial 

information must be available. 

As with other index CDS, with respect 

to index CDS entered into solely with 

ECPs, if the percentage of the effective 

notional amounts allocated to reference 

entities or securities satisfying this 

expanded public information 

availability test comprise at least 80 

percent of the index’s weighting, then a 

reference entity or security included in 

the index that fails to satisfy the 

alternative public information test 

criteria will be disregarded so long as 

the effective notional amount allocated 

to that reference entity or security 

comprises less than five percent of the 

index’s weighting. 

Comments 

The Commissions received a number 

of general and specific comments 

regarding the public information 

availability test. 

A number of commenters believed 

that the public information availability 

test should not be included in the final 

rules for various reasons, including the 

potential disparate treatment between 

products based on indexes due to 

changes in index components,833 the 

impact of the migration of indexes from 

narrow-based to broad-based and viceversa,834 and assertions that the test was 

not needed due to the types of 

participants engaged in swap and 

security-based swap transactions.835

One commenter suggested replacing the 

public information availability test with 

a volume trading test.836

The Commissions are adopting the 

public information availability test as 

proposed with certain modifications 

described above. As discussed above, 

the public information availability test 

is intended as the substitute for the 

ADTV provision in the statutory 

narrow-based security index definition, 

which the Dodd-Frank Act included as 

the method for determining whether 

index CDS are swaps or security-based 

swaps. Based on the reasons discussed 

above, the Commissions have retained 

the public information availability test 

as the underlying rationale of such 

provision, that there is sufficient trading 

in the securities and therefore public 

information and market following of the 

issuer of the securities, applies to index 

CDS. Accordingly, the Commissions 

believe that there should be public 

information available about a 

predominant percentage of the reference 

entities or issuers of securities 

underlying the index in order to prevent 

circumvention of other provisions of the 

Federal securities laws through the use 

of CDS based on such indexes, to reduce 

the likelihood that the index, the 

component securities, or the named 

issuers of securities in the index could 

be readily susceptible to manipulation, 

and to prevent the misuse of material 

non-public information about such an 

index, the component securities, or the 

reference entities. 

The Commissions understand that the 

characterization of an index underlying 

a CDS as broad-based or narrow-based 

may change because of changes to the 

index, such as addition or removal of 

components, or changes regarding the 

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837The index migration issue exists for all 

products in which the ‘‘narrow-based security 

index’’ definition is used. Thus, as is true for 

security futures, the migration issue exists for debt 

security indexes and the statutory definition of the 

term ‘‘narrow-based security index,’’ under which 

an index’s characterization may be affected by a 

change to the index itself or to the components of 

the index. 

838See supra note 625 and accompanying text. 839See infra part III.G.6. 

840See supra note 836 and accompanying text. 

841 In the context of equity securities indexes to 

which the ADTV test applies, there likely is 

information regarding the underlying entities, 

issuers of securities or securities because, as noted 

above, Exchange Act registration of the security 

being traded is a listing standard for equity 

securities and, therefore, the issuer of the security 

being traded must be subject to the reporting 

requirements under the Exchange Act. However, in 

the context of index CDS, there are no comparable 

listing standards that would be applicable to 

provide transparency on the underlying entities, 

issuers of securities or securities. 

842See July LSTA Letter. 

843 Id. 

844As noted above, the Commissions are 

modifying the method of calculating affiliation for 

purposes of certain criteria of the public 

information availability test. See infra part 

III.G.3(b)(iv). 

845See Markit Letter. This commenter suggested 

that the debt threshold should be reduced to $100 

million because debt issuances in some debt 

markets, such as the high yield markets, tend to be 

relatively small. This commenter also suggested 

that the debt threshold should include debt 

guaranteed by the issuer of the securities or 

reference entity because in many cases the issuer 

of the securities or reference entity is merely 

guaranteeing debt of its affiliates and not issuing the 

debt. Finally, this commenter requested 

clarification as to whether the debt threshold 

included loans and leveraged loans. 

specific components of the index, such 

as a decrease in the amount of 

outstanding common equity for a 

component. However, these types of 

changes are contemplated by the 

statutory narrow-based security index 

definition, which the Dodd-Frank Act 

used to establish whether index CDS are 

swaps or security-based swaps.837

Moreover, the Commissions have 

provided that the determination of 

whether a Title VII instrument is a 

swap, security-based swap or mixed 

swap is made prior to execution, but no 

later than when the parties offer to enter 

into the Title VII instrument,838 and 

does not change if a security index 

underlying such instrument 

subsequently migrates from broad to 

narrow (or vice versa) during its life. 

Accordingly, even if the public 

information availability test would 

cause indexes underlying index CDS to 

migrate as suggested by a commenter, 

that will not affect the classification of 

outstanding index CDS entered into 

prior to such migration. However, if an 

amendment or change is made to such 

outstanding index CDS that would 

cause it to be a new purchase or sale of 

such index CDS, that could affect the 

classification of such outstanding index 

CDS. Further, as is true for other 

products using the narrow-based 

security index definition, the 

Commissions also believe that the 

effects of changes to an index 

underlying a CDS traded on an 

organized platform are addressed 

through the tolerance period and grace 

period rules the Commissions are 

adopting, which rules are based on 

tolerance period and grace period rules 

for security futures to which the 

statutory narrow-based security index 

definition applies.839

The Commissions are not adopting a 

volume-based test based on the trading 

of the CDS or the trading of the index, 

either as a replacement for the public 

information availability test or as an 

alternative means of satisfying it, as one 

commenter suggested.840 The 

Commissions believe that using a 

volume-based test based on the trading 

of the CDS or the trading of the index 

would not work in the index CDS 

context because the character of the 

index CDS would have to be determined 

before any trading volume could exist 

and, therefore, the index CDS would fail 

a volume-based test. The Commissions 

also believe that a volume-based test 

based either on the CDS components of 

the index or the index itself would not 

be an appropriate substitute for or an 

alternative to a public information 

availability test with respect to the 

referenced entity, issuer of securities, or 

underlying security because such a 

volume-based test would not provide 

transparency on such underlying 

entities, issuers of securities or 

securities.841

The Commissions believe that the 

public information availability test in 

the index CDS rules allows more 

flexibility with respect to the types of 

components included in indexes 

underlying index CDS. For many 

indexes, such as bespoke indexes, 

trading volume for CDS on individual 

components may not be significant even 

though the index component would 

otherwise have no trouble satisfying one 

of the criteria of the public information 

availability test. The public information 

availability test in the index CDS rules 

also is very similar to the test in the 

rules for debt security indexes, which, 

as noted above, apply in the context of 

Title VII instruments, thus providing a 

consistent set of rules under which 

index compilers and market participants 

can analyze the characterization of CDS. 

One commenter also had concerns 

regarding specific types of indexes and 

specific types of index components, 

including the applicability of the public 

information availability test to indexes 

of loans or borrowers.842 As discussed 

above, however, the Commissions 

believe that index CDS based on indexes 

of loans or borrowers should be 

analyzed under the third prong of the 

statutory security-based swap definition 

in the same manner as any other index 

CDS. Although this commenter noted 

such indexes may include a higher 

proportion of ‘‘private’’ borrowers (those 

borrowers who are not public reporting 

companies or that do not register 

offerings of their securities) and thus 

may themselves not satisfy any of the 

criteria for the public information 

availability test,843 the Commissions 

believe that the information tests of the 

rule as modified will address these 

concerns. The modified rule will add 

loans to the categories of instruments to 

be aggregated for purposes of the 

outstanding indebtedness criterion and, 

as discussed below, will aggregate 

outstanding indebtedness of 

affiliates.844 As a result of these 

modifications, the Commissions believe 

that the indexes the commenter was 

concerned about may be more likely to 

satisfy the public information 

availability test. 

One commenter agreed with 

including an outstanding debt threshold 

as a criterion in the public information 

availability test, but requested that the 

Commissions change this criterion to 

include loans that are not within the 

definition of security, as well as affiliate 

debt guaranteed by the issuer of 

securities or reference entity, and to 

reduce the required outstanding debt 

threshold from $1 billion to $100 

million.845 As discussed above, the 

Commissions are revising the rules to 

expand the types of debt that are 

counted toward the $1 billion debt 

threshold to include any indebtedness, 

including loans, so long as such 

indebtedness is not a revolving credit 

facility. The Commissions have made no 

other changes to the $1 billion debt 

threshold. 

The Commissions believe that the fact 

that an entity has guaranteed the 

obligations of another entity will not 

affect the likelihood that public 

information is available about either the 

borrower on the guaranteed obligation 

or on the guarantor entity. However, the 

Commissions note that they are 

providing an additional interpretation 

on the affiliation definition of the index 

CDS rules, including modifying the 

method of calculating affiliation, that 

should address this commenter’s 

concerns regarding guaranteed affiliate 

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846See infra part III.G.3(b)(iv). 

847See SIFMA Letter. 

848See Markit Letter. 

849 Id. 

850 Id. 

851 Id. 

852 Id. 

853 Distribution reports, which sometimes are 

referred to as servicer reports, delivered to the 

trustee or security holders, as the case may be, are 

filed with the SEC on Form 10–D. 854See infra note 867 and accompanying text. 

855See supra part III.G.3(b)(ii). 

856See paragraph (a)(1)(iv)(A) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

857See paragraph (a)(1)(iv)(B) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

858See paragraph (a)(1)(iv)(C) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

859See paragraph (a)(1)(iv)(D) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

860See paragraph (a)(1)(iv)(H)(1) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

861See paragraph (a)(1)(iv)(H)(2) of rules 1.3(zzz) 

and 1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

862See paragraph (c)(4) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

debt.846 The Commissions also believe 

that the $1 billion debt threshold, which 

is the same amount as the outstanding 

debt threshold in the rules for debt 

security indexes, is set at the 

appropriate level to achieve the 

objective that such entities are likely to 

have public information available about 

them. 

One commenter suggested that the 

proposed rule 144A information 

criterion of the public information 

availability test applicable to index CDS 

entered into solely between ECPs 

should be satisfied if the issuer made 

the rule 144A information available 

upon request to the public or to the ECP 

in question, rather than being required 

to provide the information.847 In 

response to this commenter, the 

Commissions are revising the rule 144A 

information criterion of the public 

information availability test applicable 

to index CDS entered into solely 

between ECPs to clarify that the rule 

144A information must be made 

publicly available or otherwise made 

available to the ECP. 

The Commissions received one 

comment regarding the criteria of the 

public information availability test that 

relate specifically to asset-backed 

securities.848 The commenter was 

concerned that the test for asset-backed 

securities underlying an index may be 

difficult to apply because all assetbacked securities underlying an index 

are not always registered under the 

Securities Act.849 This commenter also 

was concerned that the term 

‘‘distribution reports’’ may not be the 

same as monthly service reports, which 

this commenter indicated are available 

through the deal trustee and/or the SEC 

Web site.850 This commenter also 

believed that it was unclear whether 

these monthly service reports would 

qualify as ‘‘distribution reports’’ for 

purposes of the public information 

availability test and whether 

information regarding Agency MBS 

pools, which are available on Agency 

Web sites, would be sufficient to satisfy 

the public information availability 

test.851 In addition, this commenter 

requested that the Commissions clarify 

that not all tranches of a transaction 

need to be registered under the 

Securities Act to satisfy the publicly 

available distribution report 

requirement.852

The Commissions are adopting as 

proposed the provisions of the public 

information availability test applicable 

to indexes based on asset-backed 

securities. The Commissions note that 

there are two possible ways to satisfy 

the public information availability test 

for index CDS based on asset-backed 

securities or asset-backed issuers. For 

index CDS available to non-ECPs, all 

asset-backed securities in the index or of 

the issuer in the index must have been 

sold in registered offerings under the 

Securities Act and have publicly 

available distribution reports. The 

Commissions are clarifying that 

monthly service reports filed with the 

SEC will satisfy the requirement for 

publicly available distribution 

reports.853 However, for index CDS 

being sold only to ECPs, the public 

information availability test with 

respect to the index components is 

satisfied, regardless of whether the 

asset-backed securities have been sold 

in registered offerings under the 

Securities Act, if information of the type 

and level included in public 

distribution reports for similar assetbacked securities is publicly available 

about both the issuing entity and such 

asset-backed securities. The 

Commissions believe that requiring 

such information about the asset-backed 

securities and the assets in the pools 

underlying such asset-backed securities 

is consistent with existing disclosure 

requirements for asset-backed securities 

and existing practices of ABS issuers. 

(iv) Affiliation of Reference Entities and 

Issuers of Securities With Respect to 

Certain Criteria of the Public 

Information Availability Test 

The Commissions are adopting the 

affiliation definition that applies to 

certain criteria of the public information 

availability test with certain 

modifications from the proposals to 

address commenters’ concerns.854 The 

Commissions are making modifications 

to this affiliation definition that are the 

same as the modifications the 

Commissions are making to the 

affiliation definition that applies when 

calculating the number and 

concentration criteria.855

This affiliation definition applies for 

purposes of determining whether a 

reference entity or issuer of securities 

included in an index satisfies one of the 

following four criteria of the public 

information availability test: (i) The 

reference entity or issuer of the security 

included in the index is required to file 

reports pursuant to the Exchange Act or 

the regulations thereunder; 856 (ii) the 

reference entity or issuer of the security 

included in the index is eligible to rely 

on the exemption provided in rule 

12g3–2(b) under the Exchange Act for 

foreign private issuers; 857 (iii) the 

reference entity or issuer of the security 

included in the index has a worldwide 

market value of its outstanding common 

equity held by non-affiliates of $700 

million or more; 858 and (iv) the 

reference entity or issuer of the security 

included in the index has outstanding 

notes, bonds, debentures, loans, or 

evidences of indebtedness (other than 

revolving credit facilities) having a total 

remaining principal amount of at least 

$1 billion.859 This affiliation definition 

also applies for purposes of determining 

whether a reference entity or issuer of 

securities included in an index satisfies 

one of the following two criteria of the 

alternative public information 

availability test applicable to index CDS 

entered into solely between ECPs: (i) 

The reference entity or issuer of the 

security included in the index makes 

available rule 144A information; 860 and 

(ii) financial information about the 

reference entity or issuer of the security 

included in the index is otherwise 

publicly available.861

The final rules provide that the terms 

‘‘reference entity included in the index’’ 

and ‘‘issuer of the security included in 

the index’’ include a single reference 

entity or issuer of securities included in 

an index, respectively, or a group of 

affiliated entities.862 For purposes of the 

rules, a reference entity or issuer of 

securities included in an index may rely 

upon an affiliated entity to satisfy 

certain criteria of the public information 

availability test. However, with respect 

to asset-backed securities, the final rules 

provide that each reference entity or 

issuer of securities included in an index 

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863See paragraph (c)(1) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

864See paragraph (c)(2) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and rule 3a68–1a and 

3a68–1b under the Exchange Act. 

865See supra part III.G.3(b)(ii). 

866The more than 50 percent (i.e., majority 

ownership) test is generally consistent with 

consolidation under U.S. generally accepted 

accounting principles. See FASB ASC section 810– 

10–25, Consolidation—Overall—Recognition 

(stating that consolidation is appropriate if a 

reporting entity has a controlling financial interest 

in another entity and a specific scope exception 

does not apply). Accordingly, using a more than 50 

percent (i.e., majority ownership) test will make it 

more likely that the reference entity or issuer of 

securities included in the index and the affiliated 

entity will be consolidated with each other in 

financial statements. Consolidated financial 

statements present the financial position and results 

of operations for a parent (controlling entity) and 

one or more subsidiaries (controlled entities) as if 

the individual entities actually were a single 

company or economic entity. 

867See Markit Letter (requesting a threshold of at 

least 50 percent). 

868 Id. 

869 Id. 

870 Id. 

871 Id. This commenter provided Kinder Morgan 

Kansas Inc. (CDS) and Kinder Morgan Inc. (equity) 

as an example of where the reference entity and 

issuer of equity among a corporate group are not the 

same. Id. 

872 Id. 

873See supra note 842 and accompanying text. 

that is an issuing entity of an assetbacked security is considered a separate 

reference entity or issuer, as applicable, 

and will not be considered affiliated 

with any other entities. 

The final rules provide that a 

reference entity or issuer of securities 

included in an index is affiliated with 

another entity if it controls, is controlled 

by, or is under common control with, 

that other entity.863 The final rules 

define control, solely for purposes of 

this affiliation definition, to mean 

ownership of more than 50 percent of a 

reference entity’s or issuer’s equity or 

the ability to direct the voting of more 

than 50 percent of a reference entity’s or 

issuer’s voting equity.864 This revision 

is the same as the modification the 

Commissions are making to the 

affiliation definition that applies when 

calculating the number and 

concentration criteria, which is 

discussed above.865

As the Commissions noted above, this 

change is based on the Commissions’ 

consideration of comments received. By 

using a more than 50 percent (i.e., 

majority ownership) test rather than a 

20 percent ownership test for the 

control threshold, there is a greater 

likelihood that there will be information 

available about the reference entity or 

issuer of securities included in the 

index because the market likely will 

view the affiliated entity and the 

reference entity or issuer of securities 

included in the index as a single 

company or economic entity.866

Accordingly, to the extent information 

regarding the affiliated entity is publicly 

available, there may be information 

regarding the reference entity or issuer 

of securities included in the index that 

also is publicly available. This modified 

control threshold will permit such 

reference entity or issuer of securities to 

rely upon an affiliated entity to satisfy 

one of the criteria of the public 

information availability test. Further, 

unlike the affiliation definition that 

applies when calculating the number 

and concentration criteria, the affiliation 

definition that applies to certain criteria 

of the public information availability 

test does not require that the affiliated 

entity or its securities be included in the 

index. 

As the affiliation definition applies to 

the Exchange Act reporting company 

and foreign private issuer criteria of the 

public information availability test, a 

reference entity or an issuer of securities 

included in an index that itself is not 

required to file reports pursuant to the 

Exchange Act or the regulations 

thereunder or is not eligible to rely on 

the exemption provided in rule 12g3– 

2(b) under the Exchange Act for foreign 

private issuers may rely upon the status 

of an affiliated entity as an Exchange 

Act reporting company or foreign 

private issuer, regardless of whether that 

affiliated entity itself or its securities are 

included in the index, to satisfy one of 

these criteria. For example, a majorityowned subsidiary included in an index 

may rely upon the status of its parent, 

which may or may not be included in 

the index, to satisfy the issuer eligibility 

criteria if the parent is required to file 

reports under the Exchange Act or is a 

foreign private issuer. 

Similarly, as the affiliation definition 

applies to the worldwide equity market 

capitalization and outstanding 

indebtedness criteria of the public 

information availability test, a reference 

entity or an issuer of securities included 

in an index that itself does not have a 

worldwide market value of its 

outstanding common equity held by 

non-affiliates of $700 million or more or 

outstanding notes, bonds, debentures, 

loans, or evidences of indebtedness 

(other than revolving credit facilities) 

having a total remaining principal 

amount of at least $1 billion, may 

aggregate the worldwide equity market 

capitalization or outstanding 

indebtedness of an affiliated entity, 

regardless of whether that affiliated 

entity itself or its securities are included 

in the index, to satisfy one of these 

criteria. For example, a majority-owned 

subsidiary included in an index may 

aggregate the worldwide equity market 

capitalization or outstanding 

indebtedness of its parent and/or other 

affiliated entities, such as other 

majority-owned subsidiaries of the 

parent, to satisfy one of these criteria. 

Finally, as the affiliation definition 

applies to the rule 144A information 

and financial information otherwise 

publicly available criteria of the 

alternative public information 

availability test applicable to index CDS 

entered into solely between ECPs, a 

reference entity or an issuer of securities 

included in an index that itself does not 

make available rule 144A information or 

does not have financial information 

otherwise publicly available may rely 

upon an affiliated entity, regardless of 

whether that affiliated entity itself or its 

securities are included in the index, to 

satisfy one of these criteria. 

Comments 

One commenter requested that the 

Commissions revise the affiliation 

definition that applies for purposes of 

the public information availability test 

to increase the threshold from 20 

percent ownership to majority 

ownership.867 This commenter noted 

that majority ownership is consistent 

with current market practice, including 

the definition of affiliate included in the 

2003 ISDA Credit Derivatives 

Definitions.868 This commenter also 

noted that the current approach with 

respect to the inclusion of affiliated 

entities in the same index uses majority 

ownership rather than 20 percent 

ownership to determine affiliation.869

This commenter also requested that the 

Commissions clarify the application of 

the affiliation definition to the public 

information availability test.870 Further, 

this commenter requested that the 

worldwide equity market capitalization 

criterion should include all affiliated 

entities because the reference entity 

included in the index may not be the 

member of a corporate group that issues 

public equity.871 Finally, this 

commenter was concerned that the 

outstanding indebtedness criterion 

would not include affiliate debt 

guaranteed by the reference entity or 

issuer of securities included in the 

index.872 Further, as noted above,873

another commenter was concerned that 

index CDS may include a higher 

proportion of ‘‘private’’ borrowers (those 

borrowers that are not public reporting 

companies or that do not register 

offerings of their securities) and thus 

may themselves not satisfy each of the 

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874See July LSTA Letter. 

875See Proposing Release at 29851–52. 

876See ISDA Letter and SIFMA Letter. 

877See rules 1.3(zzz)(1)(i) and 1.3(aaaa)(1)(i) 

under the CEA and rules 3a68–1a(a)(2) and 3a68– 

1b(a)(2) under the Exchange Act; and July 2006 

Debt Index Rules. The Commissions did not receive 

any comments on the proposed rules regarding the 

treatment of indexes that include exempted 

securities or reference entities that are issuers of 

exempted securities. 878See section 3(a)(68)(C) of the Exchange Act, 15 

U.S.C. 78c(a)(68)(C) (providing that ‘‘[t]he term 

‘security-based swap’ does not include any 

agreement, contract, or transaction that meets the 

definition of a security-based swap only because 

such agreement, contract, or transaction references, 

is based upon, or settles through the transfer, 

delivery, or receipt of an exempted security under 

paragraph (12) [of the Exchange Act], as in effect on 

the date of enactment of the Futures Trading Act 

of 1982 (other than any municipal security as 

defined in paragraph (29) [of the Exchange Act] as 

in effect on the date of enactment of the Futures 

Trading Act of 1982), unless such agreement, 

contract, or transaction is of the character of, or is 

commonly known in the trade as, a put, call, or 

other option’’). 

criteria for the public information 

availability test.874

The Commissions note the 

commenters’ concerns. The 

Commissions are modifying the method 

of determining affiliation that applies 

for purposes of satisfying certain criteria 

of the public information availability 

test. The final rules provide that a 

reference entity or issuer of securities 

included in an index may rely upon an 

affiliated entity (meeting the more than 

50 percent control threshold) to satisfy 

one of the criterion of the public 

information availability test. This 

modification is similar to the one the 

Commissions are making to the 

affiliation definition that applies for 

purposes of calculating the number and 

concentration criteria. As noted above, 

based on commenters’ letters, the 

Commissions understand that the 

current standard CDS documentation 

and the current approach with respect 

to the inclusion of affiliated entities in 

the same index use majority ownership 

rather than 20 percent ownership to 

determine affiliation. The Commissions 

agree with commenters that in the case 

of index CDS only it is more appropriate 

to use a more than 50 percent (i.e., 

majority ownership) test rather than a 

20 percent ownership test. The 

Commissions believe that because 

reference entities or issuers of securities 

included in an index may rely on an 

affiliated entity to help satisfy the 

public information availability test a 

threshold of majority ownership rather 

than 20 percent ownership will increase 

the likelihood that there is information 

available about the reference entity or 

issuer of securities included in the 

index. The Commissions believe that 

determining affiliation in this manner 

for purposes of the public availability of 

information test responds to the 

commenter’s concerns. 

Further, the Commissions are 

providing several illustrative examples 

of the way in which the affiliation 

definition works in the context of the 

public availability of information 

criteria to address the commenter’s 

concerns regarding the application of 

the affiliation definition in that context. 

The Commissions also note that the 

final rules respond to the commenter’s 

concerns regarding the applicability of 

the affiliation definition to the 

worldwide equity market capitalization 

criterion by providing that the 

worldwide market capitalization of an 

affiliate can be counted in determining 

whether the reference entity or issuer of 

securities included in the index meets 

the worldwide equity market 

capitalization criterion. Moreover, the 

Commissions note that the final rules 

respond to the commenter’s concerns 

regarding affiliate debt by providing that 

indebtedness of an affiliate can be 

counted in determining whether the 

reference entity or issuer of securities 

included in the index meets the 

outstanding indebtedness criterion. 

Finally, the Commissions note that the 

affiliation definition as modified 

responds to the commenter’s concerns 

regarding ‘‘private’’ borrowers because 

the modified affiliation definition will 

allow a reference entity or issuer of 

securities included in an index to 

consider the indebtedness, the 

outstanding equity, and the reporting 

status of an affiliate in determining 

whether the public information 

availability test is satisfied. 

As noted above, the Commissions also 

believe that the modified affiliation 

definition responds to commenters’ 

concerns noted above that the rules 

further defining the terms ‘‘issuers of 

securities in a narrow-based security 

index’’ and ‘‘narrow-based security 

index’’ should be simplified. The 

modified affiliation definition enables 

market participants to make an 

affiliation determination for purposes of 

the public information availability test 

criteria by measuring the more than 50 

percent (i.e., majority ownership) 

control threshold. 

(v) Application of the Public 

Information Availability Requirements 

to Indexes Compiled by a Third-Party 

Index Provider 

The Commissions requested comment 

in the Proposing Release as to whether 

the public information availability test 

should apply to an index compiled by 

an index provider that is not a party to 

an index CDS (‘‘third-party index 

provider’’) that makes publicly available 

general information about the 

construction of the index, index rules, 

identity of components, and 

predetermined adjustments, and which 

index is referenced by an index CDS 

that is offered on or subject to the rules 

of a DCM or SEF, or by direct access in 

the U.S. from an FBOT that is registered 

with the CFTC.875 Two commenters 

stated that the presence of a third-party 

index provider would assure that 

sufficient information is available 

regarding the index CDS itself.876

Neither commenter provided any 

analysis to explain how or whether a 

third-party index provider would be 

able to provide information about the 

underlying securities or issuers of 

securities in the index. The 

Commissions are not revising the rules 

to exclude from the public information 

availability test any index compiled by 

a third-party index provider. 

(vi) Treatment of Indexes Including 

Reference Entities That Are Issuers of 

Exempted Securities or Including 

Exempted Securities 

The Commissions are adopting the 

rules regarding the treatment of indexes 

that include exempted securities or 

reference entities that are issuers of 

exempted securities as proposed 

without modification.877 The 

Commissions believe such treatment is 

consistent with the objective and intent 

of the statutory definition of the term 

‘‘security-based swap,’’ as well as the 

approach taken in the context of 

security futures.878 Accordingly, 

paragraph (1)(ii) of rules 1.3(zzz) and 

1.3(aaaa) under the CEA and paragraph 

(a)(2) of rules 3a68–1a and 3a68–1b 

under the Exchange Act provide that, in 

the case of an index that includes 

exempted securities, or reference 

entities that are issuers of exempted 

securities, in each case as defined as of 

the date of enactment of the Futures 

Trading Act of 1982 (other than 

municipal securities), such securities or 

reference entities are excluded from the 

index when determining whether the 

securities or reference entities in the 

index constitute a ‘‘narrow-based 

security index’’ or ‘‘issuers of securities 

in a narrow-based security index’’ under 

the rules. 

Under paragraph (1)(ii) of rules 

1.3(zzz) and 1.3(aaaa) under the CEA 

and paragraph (a)(2) of rules 3a68–1a 

and 3a68–1b) under the Exchange Act, 

an index composed solely of securities 

that are, or reference entities that are 

issuers of, exempted securities (other 

than municipal securities) will not be a 

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879See section 3(a)(68)(E) of the Exchange Act, 15 

U.S.C. 78c(a)(68)(E). 

880The Commissions noted in the Proposing 

Release that a ‘‘portfolio’’ of securities could be a 

group of securities and therefore an ‘‘index’’ for 

purposes of the Dodd-Frank Act. See Proposing 

Release at 29854. To the extent that changes are 

made to the securities underlying the Title VII 

instrument and each such change is individually 

confirmed, then those substituted securities are not 

part of a security index as defined in the DoddFrank Act, and therefore a Title VII instrument on 

each of those substituted securities is a securitybased swap. 

881Solely for purposes of the discussion in this 

section, the terms ‘‘security index’’ and ‘‘security 

portfolio’’ are intended to include either securities 

or the issuers of securities. 

882See infra note 891 and accompanying text. 

883See supra part I, under ‘‘Overall Economic 

Considerations’’. 

884One example is the S&P 500® Index, an index 

that gauges the large cap U.S. equities market. 

885Alternatively, counterparties may enter into 

Title VII instruments where a third-party 

investment manager selects an initial portfolio of 

securities and has discretionary authority to change 

the composition of the security portfolio in 

accordance with guidelines agreed upon with the 

counterparties. Under the final guidance the 

Commissions are issuing today, such security 

portfolios are treated as narrow-based security 

indexes, and Title VII instruments on those security 

portfolios are security-based swaps. 

886The Commissions understand that a security 

portfolio could be labeled as such or could just be 

an aggregate of individual Title VII instruments 

documented, for example, under a master 

agreement or by amending an annex of securities 

attached to a master trade confirmation. If the 

security portfolio were created by aggregating 

individual Title VII instruments, each Title VII 

instrument must be evaluated in accordance with 

the guidance to determine whether it is a swap or 

a security-based swap. For the avoidance of doubt, 

if the counterparties to a Title VII instrument 

exchanged payments under that Title VII 

instrument based on a security index that was itself 

created by aggregating individual security-based 

swaps, such Title VII instrument would be a 

security-based swap. See supra part III.D. 

887See, e.g., NASDAQ, ‘‘NASDAQ–100 Index’’ 

(‘‘The NASDAQ–100 Index is calculated under a 

modified capitalization-weighted methodology. The 

methodology generally is expected to retain the 

economic attributes of capitalization-weighting 

while providing enhanced diversification. To 

accomplish this, NASDAQ will review the 

composition of the NASDAQ–100 Index on a 

quarterly basis and adjust the weightings of Index 

components using a proprietary algorithm, if certain 

pre-established weight distribution requirements 

are not met.’’), available at http:// 

dynamic.nasdaq.com/dynamic/ 

nasdaq100_activity.stm. 

888 Information regarding security indexes and 

their related methodologies may be widely available 

to the general public or restricted to licensees in the 

case of proprietary or ‘‘private label’’ security 

indexes. Both public and private label security 

indexes frequently are subject to intellectual 

property protection. 

‘‘narrow-based security index’’ or an 

index composed of ‘‘issuers of securities 

in a narrow-based security index.’’ In 

the case of an index where some, but 

not all, of the securities or reference 

entities are exempted securities (other 

than municipal securities) or issuers of 

exempted securities (other than 

municipal securities), the index will be 

a ‘‘narrow-based security index’’ or an 

index composed of ‘‘issuers of securities 

in a narrow-based security index’’ only 

if the index is narrow-based when the 

securities that are, or reference entities 

that are issuers of, exempted securities 

(other than municipal securities) are 

disregarded. The Commissions believe 

this approach should result in 

consistent treatment for indexes 

regardless of whether they include 

securities that are, or issuers of 

securities that are, exempted securities 

(other than municipal securities) while 

helping to ensure that exempted 

securities (other than municipal 

securities) and issuers of exempted 

securities (other than municipal 

securities) are not included in an index 

merely to make the index either broadbased or narrow-based under the rules. 

4. Security Indexes 

The Dodd-Frank Act defines the term 

‘‘index’’ as ‘‘an index or group of 

securities, including any interest therein 

or based on the value thereof.’’ 879 The 

Commissions provided an interpretation 

in the Proposing Release regarding how 

to determine when a portfolio of 

securities is a narrow-based or broadbased security index, and the 

circumstances in which changes to the 

composition of a security index 

(including a portfolio of securities) 880

underlying a Title VII instrument would 

affect the characterization of such Title 

VII instrument.881 The Commissions are 

restating the interpretation set forth in 

the Proposing Release with one 

clarification in response to a 

commenter.882 Specifically, the 

Commissions are clarifying what is 

meant by ‘‘predetermined’’ for purposes 

of whether criteria or a self-executing 

formula for adjusting the security index 

underlying a Title VII instrument 

qualify under the interpretation. The 

Commissions find that this 

interpretation is an appropriate way to 

address how to determine when a 

portfolio of securities is a narrow-based 

or broad-based security index, and the 

circumstances in which changes to the 

composition of a security index 

(including a portfolio of securities) 

underlying a Title VII instrument would 

affect the characterization of such Title 

VII instrument, and is designed to 

reduce costs associated with making 

such a determination.883

A security index in most cases is 

designed to reflect the performance of a 

market or sector by reference to 

representative securities or interests in 

securities. There are several well-known 

security indexes established and 

maintained by recognized index 

providers currently in the market.884

However, instead of using these 

established indexes, market participants 

may enter into a Title VII instrument 

where the underlying reference of the 

Title VII instrument is a portfolio of 

securities selected by the counterparties 

or created by a third-party index 

provider at the behest of one or both 

counterparties. In some cases, the Title 

VII instrument may give one or both of 

the counterparties, either directly or 

indirectly (e.g., through an investment 

adviser or through the third-party index 

provider), discretionary authority to 

change the composition of the security 

portfolio, including, for example, by 

adding or removing securities in the 

security portfolio on an ‘‘at-will’’ basis 

during the term of the Title VII 

instrument.885 Where the 

counterparties, either directly or 

indirectly (e.g., through an investment 

adviser or through the third-party index 

provider), have this discretionary 

authority to change the composition or 

weighting of securities in a security 

portfolio, that security portfolio will be 

treated as a narrow-based security 

index, and therefore a Title VII 

instrument on that security portfolio is 

a security-based swap.886

However, not all changes that occur to 

the composition or weighting of a 

security index underlying a Title VII 

instrument will always result in that 

security index being treated as a narrowbased security index. Many security 

indexes are constructed and maintained 

by an index provider pursuant to a 

published methodology.887 For instance, 

the various Standard & Poor’s security 

indexes are reconstituted and 

rebalanced as needed and on a periodic 

basis pursuant to published index 

criteria.888 Such indexes underlying a 

Title VII instrument would be broadbased or narrow-based depending on the 

composition and weighting of the 

underlying security index. 

In addition, counterparties to a Title 

VII instrument frequently agree to use as 

the underlying reference of a Title VII 

instrument a security index based on 

predetermined criteria where the 

security index composition or weighting 

may change as a result of the occurrence 

of certain events specified in the Title 

VII instrument at execution, such as 

‘‘succession events.’’ Counterparties to a 

Title VII instrument also may use a 

predetermined self-executing formula to 

make other changes to the composition 

or weighting of a security index 

underlying a Title VII instrument. In 

either of these situations, the 

composition of a security index may 

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889See supra note 886, regarding the aggregation 

of separate trades. 

890See infra note 891 and accompanying text. 

891See ISDA Letter. While this commenter agrees 

with the guidance that the predetermined changes 

described in this section should not alter the 

character of an index (or the classification of a Title 

VII instrument based thereon), this commenter 

disagrees that the ability to make discretionary 

changes should cause an otherwise broad-based 

security index to be a narrow-based security index. 

This commenter requested that the Commissions 

classify transactions ‘‘at inception and upon actual 

change in respect of any classification-related 

characteristic, be that change the product of a 

renegotiation or a unilateral exercise of discretion.’’ 

Id. The Commissions note that if material terms of 

a Title VII instrument are amended or modified 

during its life based on an exercise of discretion and 

not through predetermined criteria or a 

predetermined self-executing formula, the 

Commissions view the amended or modified Title 

VII instrument as a new Title VII instrument. See 

infra part III.G.5. 

892 Indeed, the Commissions specifically 

mentioned in this regard, and have included in the 

final guidance above, the various Standard & Poor’s 

security indexes—some of which may be described 

as ‘‘common equity indices’’ as alluded to in ISDA’s 

comment—that are reconstituted and rebalanced as 

needed and on a periodic basis pursuant to 

published index criteria. 

893See supra note 625 and accompanying text. 894For example, if, on its effective date, a Title 

VII instrument tracks the performance of an index 

of 12 securities but is amended during its term to 

track the performance of only 8 of those 12 

securities, the Commissions would view the 

amended or modified Title VII instrument as a new 

Title VII instrument. Because it is a new Title VII 

instrument, any regulatory requirements regarding 

new Title VII instruments apply. Conversely, if, on 

its effective date, a Title VII instrument tracks the 

performance of an index of 12 securities but is 

amended during its term to reflect the replacement 

of a departing ‘‘key person’’ of a hedge fund that 

is a counterparty to the Title VII instrument with 

a new ‘‘key person,’’ the Commissions would not 

view the amended or modified Title VII instrument 

as a new Title VII instrument because the 

amendment or modification is not to a material 

term of the Title VII instrument. 

change pursuant to predetermined 

criteria or predetermined self-executing 

formulas without the Title VII 

instrument counterparties, their agents, 

or third-party index providers having 

any direct or indirect discretionary 

authority to change the security index. 

In general, and by contrast to Title VII 

instruments in which the 

counterparties, either directly or 

indirectly (e.g., through an investment 

adviser or through the third-party index 

provider), have the discretion to change 

the composition or weighting of the 

referenced security index, where there 

is an underlying security index for 

which there are predetermined criteria 

or a predetermined self-executing 

formula for adjusting the security index 

that are not subject to change or 

modification through the life of the Title 

VII instrument and that are set forth in 

the Title VII instrument at execution 

(regardless of who establishes the 

criteria or formula), a Title VII 

instrument on such underlying security 

index is based on a broad-based or 

narrow-based security index, depending 

on the composition and weighting of the 

underlying security index. Subject to 

the interpretation discussed below 

regarding security indexes that may 

shift from being a narrow-based security 

index or broad-based security index 

during the life of an existing Title VII 

instrument, the characterization of a 

Title VII instrument based on a security 

index as either a swap or a securitybased swap will depend on the 

characterization of the security index 

using the above interpretation.889

The Commissions are clarifying in 

response to a commenter that, for 

purposes of this interpretation, criteria 

or a self-executing formula regarding 

composition of a security index 

underlying a Title VII instrument shall 

be considered ‘‘predetermined’’ if it is 

bilaterally agreed upon pre-trade by the 

parties to a transaction.890 In order to 

qualify under this interpretation, 

however, the Commissions reiterate that 

the ‘‘predetermined’’ criteria or selfexecuting formula, as described above, 

must not be subject to change or 

modification through the life of the Title 

VII instrument and must be set forth in 

the Title VII instrument at execution 

(regardless of who establishes the 

criteria or formula). 

Comments 

The Commissions requested comment 

on a number of issues regarding the 

interpretation contained in this section 

as it was proposed, including whether 

the terms ‘‘predetermined criteria’’ and 

‘‘predetermined self-executing formula’’ 

are clear, and whether additional 

interpretations should be provided with 

respect to these terms. The 

Commissions received one comment on 

the interpretation provided in the 

Proposing Release, in which the 

commenter requested clarification that 

criteria affecting the composition of an 

index, when such criteria are agreed 

bilaterally, pre-trade, by the 

counterparties to a bespoke index trade, 

are ‘‘predetermined’’ for purposes of 

determining whether the index is 

treated as narrow-based or broadbased.891

The Commissions are restating the 

interpretation set forth in the Proposing 

Release with one clarification in 

response to the commenter’s concerns. 

As discussed above, the Commissions 

are providing that not all changes that 

occur to the composition or weighting of 

a security index underlying a Title VII 

instrument will result in that security 

index being treated as a narrow-based 

security index. Foremost among these 

examples is a security index that is 

constructed and maintained by an index 

provider pursuant to a published 

methodology.892 Changes to such an 

index pursuant to such a methodology 

are not the type of discretionary changes 

that will render an otherwise broadbased security index a narrow-based 

security index. The Commissions 

believe this clarification addresses the 

commenter’s concerns. 

5. Evaluation of Title VII Instruments on 

Security Indexes That Move from BroadBased to Narrow-Based or Narrow-Based 

to Broad-Based 

(a) In General 

The determination of whether a Title 

VII instrument is a swap, a securitybased swap, or both (i.e., a mixed swap), 

is made prior to execution, but no later 

than when the parties offer to enter into 

the Title VII instrument.893 If the 

security index underlying a Title VII 

instrument migrates from being broadbased to being narrow-based, or vice 

versa, during the life of a Title VII 

instrument, the characterization of that 

Title VII instrument will not change 

from its initial characterization 

regardless of whether the Title VII 

instrument was entered into bilaterally 

or was executed through a trade on or 

subject to the rules of a DCM, SEF, 

FBOT, security-based SEF, or NSE. For 

example, if two counterparties enter 

into a swap based on a broad-based 

security index, and three months into 

the life of the swap the security index 

underlying that Title VII instrument 

migrates from being broad-based to 

being narrow-based, the Title VII 

instrument will remain a swap for the 

duration of its life and will not be 

recharacterized as a security-based 

swap. 

If the material terms of a Title VII 

instrument are amended or modified 

during its life based on an exercise of 

discretion and not through 

predetermined criteria or a 

predetermined self-executing formula, 

the Commissions view the amended or 

modified Title VII instrument as a new 

Title VII instrument.894 As a result, the 

characteristics of the underlying 

security index must be reassessed at the 

time of such an amendment or 

modification to determine whether the 

security index has migrated from broadbased to narrow-based, or vice versa. If 

the security index has migrated, then 

the characterization of the amended or 

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895See infra note 898 and accompanying text. 

896Thus, for example, if a predetermined selfexecuting formula agreed to by the counterparties 

of a Title VII instrument at or prior to the execution 

of the Title VII instrument provided that the 

security index underlying the Title VII instrument 

would decrease from 20 to 5 securities after six 

months, such that the security index would become 

narrow-based as a result of the reduced number of 

securities, then the Title VII instrument is a mixed 

swap at its execution. The characterization of the 

Title VII instrument as a mixed swap will not 

change during the life of the Title VII instrument. 

897As discussed in section III.G.4., supra, to the 

extent a Title VII instrument permits ‘‘at-will’’ 

substitution of an underlying security index, 

however, as opposed to the use of predetermined 

criteria or a predetermined self-executing formula, 

the Title VII instrument is a security-based swap at 

its execution and throughout its life regardless of 

whether the underlying security index was narrowbased at the execution of the Title VII instrument. 898See SIFMA Letter. 

899 Id. 

900 Id. 

901See ISDA Letter. 

902 Id. 

modified Title VII instrument will be 

determined by evaluating the 

underlying security index at the time 

the Title VII instrument is amended or 

modified. Similarly, if a security index 

has migrated from broad-based to 

narrow-based, or vice versa, any new 

Title VII instrument based on that 

security index will be characterized 

pursuant to an evaluation of the 

underlying security index at the 

execution of that new Title VII 

instrument. 

The Commissions provided an 

interpretation in the Proposing Release 

regarding circumstances in which the 

character of a security index on which 

a Title VII instrument is based changes 

according to predetermined criteria or a 

predetermined self-executing formula 

set forth in the Title VII instrument (or 

in a related or other agreement entered 

into by the counterparties or a thirdparty index provider to the Title VII 

instrument) at execution. The 

Commissions are restating this 

interpretation with one clarification in 

response to a commenter.895

Where at the time of execution such 

criteria or such formula would cause the 

underlying broad-based security index 

to become or assume the characteristics 

of a narrow-based security index or vice 

versa during the duration of the 

instrument,896 then the Title VII 

instrument based on such security index 

is a mixed swap during the entire life of 

the Title VII instrument.897 Although at 

certain points during the life of the Title 

VII instrument, the underlying security 

index would be broad-based and at 

other points the underlying security 

index would be narrow-based, 

regulating such a Title VII instrument as 

a mixed swap from the execution of the 

Title VII instrument and throughout its 

life reflects the appropriate 

characterization of a Title VII 

instrument based on a security index 

that migrates pursuant to predetermined 

criteria or a predetermined selfexecuting formula. 

The Commissions are clarifying what 

is meant by whether the pre-determined 

criteria or pre-determined self-executing 

formula ‘‘would cause’’ the underlying 

broad-based security index to become or 

assume the characteristics of a narrowbased security index, or vice versa, as 

noted above in the interpretation. The 

Commissions believe that, unless the 

criteria or formula were intentionally 

designed to change the index from 

narrow to broad, or vice versa, Title VII 

instruments based on indexes that may, 

but will not necessarily, change from 

broad to narrow (or vice versa) under 

such criteria or formula should be 

considered swaps or security-based 

swaps, as appropriate, at execution and 

for the term thereof, and not mixed 

swaps. In such circumstances, it is not 

the case that the criteria or formula 

‘‘would cause’’ the change within the 

meaning of the Commission’s 

interpretation. 

The Commissions believe that this 

interpretation regarding the use of 

predetermined criteria or a 

predetermined self-executing formula 

will prevent potential gaming of the 

Commissions’ interpretation regarding 

security indexes, and prevent potential 

regulatory arbitrage based on the 

migration of a security index from 

broad-based to narrow-based, or vice 

versa. In particular, predetermined 

criteria and predetermined selfexecuting formulas can be constructed 

in ways that take into account the 

characteristics of a narrow-based 

security index and prevent a narrowbased security index from becoming 

broad-based, and vice versa. 

Comments 

The Commissions received two 

comments on the proposed 

interpretation in this section regarding 

the classification of Title VII 

Instruments based on security indexes 

that change from narrow-based to broadbased, or vice versa, under 

predetermined criteria or a 

predetermined self-executing formula, 

as mixed swaps. One commenter 

requested that the Commissions clarify 

that a Title VII instrument based on a 

security index that may, but will not 

necessarily, change from narrow-based 

to broad-based, or vice versa, under 

predetermined criteria or a 

predetermined self-executing formula 

should be characterized at execution as 

a swap or security-based swap, as 

applicable, and not as a mixed swap.898

This commenter believed that the 

Commissions’ interpretation should 

capture as mixed swaps only those Title 

VII instruments on indexes that will 

change with certainty, and not those 

that might change given specific market 

circumstances.899 Moreover, this 

commenter believed that the 

Commissions’ statement that a Title VII 

instrument on a security index governed 

by a pre-determined self-executing 

formula that ‘‘would cause’’ a change 

from broad to narrow, or narrow to 

broad, means that the change in 

character must be a certainty for the 

instrument to be classified as a mixed 

swap.900 The Commissions have 

clarified their interpretation in response 

to this commenter’s concerns as 

discussed above. 

Another commenter disagreed with 

the Commissions’ proposed 

interpretation that transactions on 

indexes under predetermined criteria or 

a predetermined self-executing formula 

that would change from broad to 

narrow, or narrow to broad, should be 

classified as mixed swaps at 

inception.901 This commenter does not 

believe that regulatory arbitrage is such 

a significant concern in this context that 

would justify the challenges to market 

participants if these transactions were 

treated as mixed swaps subject to the 

dual regulatory authority of the 

Commissions.902

The Commissions believe that 

regulatory arbitrage is a sufficient 

concern to justify mixed swap status 

and dual regulatory oversight for Title 

VII instruments where the index would 

change from broad to narrow, or narrow 

to broad, under the pre-determined 

criteria or predetermined self-executing 

formula. Counterparties that are 

concerned about regulatory burdens 

associated with mixed swap status can 

redesign their formula to avoid the 

result, or enter into another swap or 

security-based swap that is structured to 

achieve the same economic result 

without mixed swap status. 

(b) Title VII Instruments on Security 

Indexes Traded on Designated Contract 

Markets, Swap Execution Facilities, 

Foreign Boards of Trade, Security-Based 

Swap Execution Facilities, and National 

Securities Exchanges 

As was recognized in the Proposing 

Release, security indexes underlying 

Title VII instruments that are traded on 

DCMs, SEFs, FBOTs, security-based 

SEFs, or NSEs raise particular issues if 

an underlying security index migrates 

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48288 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

903See Proposing Release at 29856. 

904See paragraphs (2), (3) and (4) of rule 1.3(yyy) 

under the CEA and paragraphs (b), (c) and (d) of 

rule 3a68–3 under the Exchange Act. 

905See Proposing Release at 29857. 

906 If a swap were based on a security index that 

migrated from broad-based to narrow-based, a DCM, 

SEF, or FBOT could no longer offer the Title VII 

instrument because it is now a security-based swap. 

Similarly, if a security-based swap were based on 

a security index that migrated from narrow-based to 

broad-based, a security-based SEF or NSE could no 

longer offer the Title VII instrument because it is 

now a swap. 

907The rules apply only to the particular Title VII 

instrument that is traded on or subject to the rules 

of a DCM, SEF, FBOT, security-based SEF, or NSE. 

As the Commissions noted in the Proposing 

Release, to the extent that a particular Title VII 

instrument is not traded on such a trading platform 

(even if another Title VII instrument of the same 

class or type is traded on such a trading platform), 

the rules do not apply to that particular Title VII 

instrument. See Proposing Release at 29857 n. 259. 

908See Proposing Release at 29857. 

909CEA section 1a(35)(B)(iii), 7 U.S.C. 

1a(35)(B)(iii); section 3(a)(55)(C)(iii) of the Exchange 

Act, 15 U.S.C. 78c(a)(55)(C)(iii). 

910By joint rules, the Commissions have provided 

that ‘‘[w]hen a contract of sale for future delivery 

on a security index is traded on or subject to the 

rules of a foreign board of trade, such index shall 

not be a narrow-based security index if it would not 

be a narrow-based security index if a futures 

contract on such index were traded on a designated 

contract market * * * .’’ See rule 41.13 under the 

CEA, 17 CFR 41.13, and rule 3a55–3 under the 

Exchange Act, 17 CFR 240.3a55–3. Accordingly, the 

statutory tolerance period applicable to futures on 

security indexes traded on DCMs applies to futures 

traded on FBOTs as well. 

911See paragraph (2) of rule 1.3(yyy) under the 

CEA and paragraph (b) of rule 3a68–3 under the 

Exchange Act. 

912See paragraph (3) of rule 1.3(yyy) under the 

CEA and paragraph (c) of rule 3a68–3 under the 

Exchange Act. 

913For purposes of these rules, the term ‘‘narrowbased security index’’ shall also mean ‘‘issuers of 

securities in a narrow-based security index.’’ See 

supra part III.G.3(b), (discussing the rules defining 

‘‘issuers of securities in a narrow-based security 

index’’). 

914This provision is consistent with the 

provisions of the CEA and the Exchange Act 

applicable to futures contracts on security indexes. 

CEA section 1a(35)(B)(iii)(I), 7 U.S.C. 

1a(35)(B)(iii)(I); section 3(a)(55)(C)(iii)(I) of the 

Exchange Act, 15 U.S.C. 78c(a)(55)(C)(iii)(I). 

915This alternative test is the same as the 

alternative test applicable to futures contracts in 

CEA rule 41.12, 17 CFR 41.12, and rule 3a55–2 

under the Exchange Act, 17 CFR 240.3a55–2. 

916These provisions are consistent with the 

parallel provisions in the CEA and Exchange Act 

applicable to futures contracts on security indexes 

traded on DCMs. See CEA section 1a(35)(B)(iii)(II), 

7 U.S.C. 1a(35)(B)(iii)(II), and section 

3(a)(55)(C)(iii)(II) of the Exchange Act, 15 U.S.C. 

78c(a)(55)(C)(iii)(II). 

from broad-based to narrow-based, or 

vice versa.903 The Commissions are 

adopting as proposed their 

interpretation clarifying that the 

characterization of an exchange-traded 

Title VII instrument based on a security 

index at its execution will not change 

through the life of the Title VII 

instrument, regardless of whether the 

underlying security index migrates from 

broad-based to narrow-based, or vice 

versa. Accordingly, a market participant 

who enters into a swap on a broad-based 

security index traded on or subject to 

the rules of a DCM, SEF or FBOT that 

migrates from broad-based to narrowbased may hold that position until the 

swap’s expiration without any change in 

regulatory responsibilities, 

requirements, or obligations; similarly, a 

market participant who enters into a 

security-based swap on a narrow-based 

security index traded on a securitybased SEF or NSE that migrates from 

narrow-based to broad-based may hold 

that position until the security-based 

swap’s expiration without any change in 

regulatory responsibilities, 

requirements, or obligations. 

In addition, the Commissions are 

adopting, as proposed, final rules 

providing for tolerance and grace 

periods for Title VII instruments on 

security indexes that are traded on 

DCMs, SEFs, FBOTs, security-based 

SEFs and NSEs.904 As was noted in the 

Proposing Release,905 in the absence of 

any action by the Commissions, if a 

market participant wants to offset a 

swap or enter into a new swap on a 

DCM, SEF or FBOT where the 

underlying security index has migrated 

from broad-based to narrow-based, or to 

offset a security-based swap or enter 

into a new security-based swap on a 

security-based SEF or NSE where the 

underlying security index has migrated 

from narrow-based to broad-based, the 

participant would be prohibited from 

doing so. That is because swaps may 

trade only on DCMs, SEFs, and FBOTs, 

and security-based swaps may trade 

only on registered NSEs and securitybased SEFs.906 The rules being adopted 

by the Commissions address how to 

treat Title VII instruments traded on 

trading platforms where the underlying 

security index migrates from broadbased to narrow-based or narrow-based 

to broad-based, so that market 

participants will know where such Title 

VII instruments may be traded and can 

avoid potential disruption of their 

ability to offset or enter into new Title 

VII instruments on trading platforms 

when such migration occurs.907

As was noted in the Proposing 

Release,908 Congress and the 

Commissions addressed a similar issue 

in the context of security futures, where 

the security index on which a future is 

based may migrate from broad-based to 

narrow-based or vice versa. Congress 

provided in the definition of the term 

‘‘narrow-based security index’’ in both 

the CEA and the Exchange Act 909 for a 

tolerance period ensuring that, under 

certain conditions, a futures contract on 

a broad-based security index traded on 

a DCM may continue to trade, even 

when the index temporarily assumes 

characteristics that would render it a 

narrow-based security index under the 

statutory definition.910 In general, an 

index is subject to this tolerance period, 

and therefore is not a narrow-based 

security index, if: (i) A futures contract 

on the index traded on a DCM for at 

least 30 days as a futures contract on a 

broad-based security index before the 

index assumed the characteristics of a 

narrow-based security index; and (ii) the 

index does not retain the characteristics 

of a narrow-based security index for 

more than 45 business days over 3 

consecutive calendar months. Pursuant 

to these statutory provisions, if the 

index becomes narrow-based for more 

than 45 business days over 3 

consecutive calendar months, the index 

is excluded from the definition of the 

term ‘‘narrow-based security index’’ for 

the following 3 calendar months as a 

grace period. 

The Commissions believe that a 

similar tolerance period should apply to 

swaps traded on DCMs, SEFs, and 

FBOTs and security-based swaps traded 

on security-based SEFs and NSEs. 

Accordingly, the Commissions are 

adopting the rules, as proposed, 

providing for tolerance periods for 

swaps that are traded on DCMs, SEFs, 

or FBOTs 911 and for security-based 

swaps traded on security-based SEFs 

and NSEs.912

The final rules provide that to be 

subject to the tolerance period, a 

security index underlying a swap 

executed on or subject to the rules of a 

DCM, SEF, or FBOT must not have been 

a narrow-based security index 913 during 

the first 30 days of trading.914 If the 

index becomes narrow-based during the 

first 30 days of trading, the index must 

not have been a narrow-based security 

index during every trading day of the 6 

full calendar months preceding a date 

no earlier than 30 days prior to the 

commencement of trading of a swap on 

such index.915 If either of these 

alternatives is met, the index will not be 

a narrow-based security index if it has 

been a narrow-based security index for 

no more than 45 business days over 3 

consecutive calendar months.916 These 

provisions apply solely for purposes of 

swaps traded on or subject to the rules 

of a DCM, SEF, or FBOT. 

Similarly, the rules provide a 

tolerance period for security-based 

swaps traded on security-based SEFs or 

NSEs. To be subject to the tolerance 

period, a security index underlying a 

security-based swap executed on a 

security-based SEF or NSE must have 

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917These provisions are consistent with the 

parallel provisions in the CEA and the Exchange 

Act applicable to futures contracts on security 

indexes traded on DCMs. See CEA section 

1a(35)(B)(iii), 7 U.S.C. 1a(35)(B)(iii); section 

3(a)(55)(C)(iii) of the Exchange Act, 15 U.S.C. 

78c(a)(55)(C)(iii). 

918See paragraph (4) of rule 1.3(yyy) under the 

CEA and paragraph (d) of rule 3a68–3 under the 

Exchange Act. 

919These provisions are consistent with the 

parallel provisions in the CEA and the Exchange 

Act applicable to futures contracts on security 

indexes traded on DCMs. See CEA section 

1a(35)(D), 7 U.S.C. 1a(35)(D); section 3(a)(55)(E) of 

the Exchange Act, 15 U.S.C. 78c(a)(55)(E). 

920See Proposing Release at 29858. 

921See MarketAxess Letter. 

922 Id. 

923 Id. 

924See July 2006 Debt Index Rules. The 

Commissions are not aware of any disruptions 

caused by the three-month grace period in the 

context of security futures. 

925See supra part I, under ‘‘Overall Economic 

Considerations’’. 

926The Commissions note that section 3(a)(68)(C) 

of the Exchange Act, 15 U.S.C. 78c(a)(68)(C), 

provides that ‘‘[t]he term ‘‘security-based swap’’ 

does not include any agreement, contract, or 

transaction that meets the definition of a securitybased swap only because such agreement, contract, 

or transaction references, is based upon, or settles 

through the transfer, delivery, or receipt of an 

exempted security under paragraph (12) [of the 

Exchange Act], as in effect on the date of enactment 

of the Futures Trading Act of 1982 (other than any 

municipal security as defined in paragraph (29) [of 

the Exchange Act] as in effect on the date of 

enactment of the Futures Trading Act of 1982), 

unless such agreement, contract, or transaction is of 

the character of, or is commonly known in the trade 

as, a put, call, or other option.’’ 

been a narrow-based security index 

during the first 30 days of trading. If the 

index becomes broad-based during the 

first 30 days of trading, paragraph 

(3)(i)(B) of rule 1.3(yyy) under the CEA 

and paragraph (c)(1)(ii) of rule 3a68–3 

under the Exchange Act provide that the 

index must have been a non-narrowbased (i.e., a broad-based) security index 

during every trading day of the 6 full 

calendar months preceding a date no 

earlier than 30 days prior to the 

commencement of trading of a securitybased swap on such index. If either of 

these alternatives is met, the index will 

be a narrow-based security index if it 

has been a security index that is not 

narrow-based for no more than 45 

business days over 3 consecutive 

calendar months.917 These provisions 

apply solely for purposes of securitybased swaps traded on security-based 

SEFs or NSEs. 

In addition, the Commissions are 

adopting rules as proposed that, once 

the tolerance period under the rules has 

ended, there will be a grace period 

during which a Title VII instrument 

based on a security index that has 

migrated from broad-based to narrowbased, or vice versa, will be able to trade 

on the platform on which Title VII 

instruments based on such security 

index were trading before the security 

index migrated and can also, during 

such period, be cleared.918 The final 

rules provide for an additional threemonth grace period applicable to a 

security index that becomes narrowbased for more than 45 business days 

over three consecutive calendar months, 

solely with respect to swaps that are 

traded on or subject to the rules of 

DCMs, SEFs, or FBOTs. During the grace 

period, such an index will not be 

considered a narrow-based security 

index. The rules apply the same grace 

period to a security-based swap on a 

security index that becomes broad-based 

for more than 45 business days over 3 

consecutive calendar months, solely 

with respect to security-based swaps 

that are traded on a security-based SEF 

or NSE. During the grace period, such 

an index will not be considered a broadbased security index.919 As a result, this 

rule provides sufficient time for a Title 

VII instrument based on a migrated 

security index to satisfy listing and 

clearing requirements applicable to 

swaps or security-based swaps, as 

appropriate. 

As was noted in the Proposing 

Release,920 there will be no overlap 

between the tolerance and the grace 

periods under the rules and no ‘‘retriggering’’ of the tolerance period. For 

example, if a security index becomes 

narrow-based for more than 45 business 

days over 3 consecutive calendar 

months, solely with respect to swaps 

that are traded on or subject to the rules 

of DCMs, SEFs, or FBOTs, but as a result 

of the rules is not considered a narrowbased security index during the grace 

period, the tolerance period provisions 

will not apply, even if the securityindex migrated temporarily during the 

grace period. After the grace period has 

ended, a security index will need to 

satisfy anew the requirements under the 

rules regarding the tolerance period in 

order to trigger a new tolerance period. 

The rules will not result in the recharacterization of any outstanding Title 

VII instruments. In addition, the 

tolerance and grace periods as adopted 

will apply only to Title VII instruments 

that are traded on or subject to the rules 

of DCMs, SEFs, FBOTs, security-based 

SEFs, and NSEs. 

Comments 

The Commissions received one 

comment on the proposed rules 

described in this section.921 This 

commenter stated its view that 

extending the ‘‘grace period’’ from three 

months to six months would ease any 

disruption or dislocation associated 

with the delisting process with respect 

to an index that has migrated from 

broad to narrow, or narrow to broad, 

and that has failed the tolerance 

period.922 This commenter also stated 

its view that where an index CDS 

migrates, for entities operating both a 

SEF and a security-based SEF, such 

entities should be permitted to move the 

index from one platform to the other 

simply by providing a notice to the SEC 

and CFTC.923

As discussed above, the Commissions 

are adopting the proposed rules without 

modification. The Commissions note 

that the three-month grace period 

applicable to security futures was 

mandated by Congress in that 

context,924 and the commenter has 

provided no data or evidence for its 

request that the Commissions diverge 

from that grace period and provide for 

a longer grace period with respect to 

swaps and security-based swaps. The 

Commissions believe that the threemonth grace period is similarly 

appropriate to apply in the context of a 

Title VII instrument based on an index 

that has migrated to provide sufficient 

time to execute off-setting positions. 

With respect to the commenter’s other 

suggestion that entities operating both a 

SEF and a security-based SEF should be 

able to move the index from one 

platform to another where an index CDS 

migrates simply by filing a notice with 

the SEC and CFTC, the Commissions do 

not believe that this proposal is within 

the scope of this rulemaking. 

H. Method of Settlement of Index CDS 

The method that the parties have 

chosen or use to settle an index CDS 

following the occurrence of a credit 

event under such index CDS also can 

affect whether such index CDS would 

be a swap, a security-based swap, or 

both (i.e., a mixed swap). The 

Commissions provided an interpretation 

in the Proposing Release regarding the 

method of settlement of index CDS and 

are restating the interpretation without 

modification. The Commissions find 

that this interpretation is an appropriate 

way to address index CDS with different 

settlement methods and is designed to 

reduce the cost associated with 

determining whether such an index CDS 

is a swap or a security-based swap.925

If an index CDS that is not based on 

a narrow-based security index under the 

Commissions’ rules includes a 

mandatory physical settlement 

provision that would require the 

delivery of, and therefore the purchase 

and sale of, a non-exempted security 926

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927The SEC also notes that there must either be 

an effective registration statement covering the 

transaction or an exemption under the Securities 

Act would need to be available for such physical 

delivery of securities and compliance issues under 

the Exchange Act would also need to be considered. 

928The Commissions are aware that the 2003 

Definitions include ‘‘Cash Settlement’’ as a defined 

term and that such ‘‘Settlement Method’’ (also a 

defined term in the 2003 Definitions) works 

differently than auction settlement pursuant to the 

‘‘Big Bang Protocol’’ or ‘‘Auction Supplement’’ 

(each as defined below). The Commissions’ use of 

the term ‘‘cash settlement’’ in this section includes 

‘‘Cash Settlement,’’ as defined in the 2003 

Definitions, and auction settlement, as described in 

the ‘‘Big Bang Protocol’’ or ‘‘Auction Supplement.’’ 

See infra note 929 and accompanying text. 

929See ISDA, ‘‘2009 ISDA Credit Derivatives 

Determinations Committees and Auction Settlement 

CDS Protocol,’’ available at http://www.isda.org/ 

bigbangprot/docs/Big-Bang-Protocol.pdf. 

930The possibility that such index CDS may, in 

fact, be physically settled if an auction is not held 

or if the auction fails would not affect the 

characterization of the index CDS. 

931The Commissions understand that the Big 

Bang Protocol is followed for index CDS involving 

corporate debt obligations but is not followed for 

index CDS based on asset-backed securities, loanonly CDS, and certain other types of CDS contracts. 

To the extent that such other index CDS contain 

auction procedures similar to the auction 

procedures for corporate debt to establish the cash 

price to be paid, the Commissions also would not 

consider such other index CDS that are not based 

on narrow-based security indexes under the 

Commissions’ rules to be mixed swaps. 

932The Commissions understand that other 

conditions may need to be satisfied as well for an 

auction to be held. 

933See supra note 48. 

934The second part of the credit event auction 

process involves offers and sales of securities that 

must be made in compliance with the provisions of 

the Securities Act and the Exchange Act. First, the 

submission of a physical settlement request 

constitutes an offer by the counterparty to either 

buy or sell any one of the deliverable obligations 

in the auction. Second, the submission of the 

irrevocable limit orders by dealers or investors are 

sales or purchases by such persons at the time of 

submission of the irrevocable limit order. Through 

the auction mechanism, where the open interest 

(which represents physical settlement requests) is 

matched with limit orders, buyers and sellers are 

matched. Finally, following the auction and 

determination of the final price, the counterparty 

who has submitted the physical delivery request 

decides which of the deliverable obligations will be 

delivered to satisfy the limit order in exchange for 

the final price. The sale of the securities in the 

auction occurs at the time the limit order is 

submitted, even though the identification of the 

specific deliverable obligation does not occur until 

the auction is completed. 

935See ISDA Letter. 

936With respect to the applicability of the Federal 

securities laws, the Commissions are concerned 

about the use of index CDS to effect distributions 

of securities without compliance with the 

requirements of the Securities Act. The 

Commissions recognize that with respect to 

transactions in security-based swaps by an issuer of 

an underlying security, an affiliate of the issuer, or 

an underwriter the offer and sale of the underlying 

security (in this case the security to be delivered) 

occur at the time that the security-based swap is 

offered and sold, not at the time of settlement. 

Further, the Commissions note the restrictions on 

offers and sales of security-based swaps to nonECPs without compliance with the registration 

requirements of the Securities Act. See section 5(e) 

of the Securities Act, 15 U.S.C. 77e(d). 

or a loan in the event of a credit event, 

such an index CDS is a mixed swap.927

Conversely, if an index CDS that is not 

based on a narrow-based security index 

under the Commissions’ rules includes 

a mandatory cash settlement 928

provision, such index CDS is a swap, 

and not a security-based swap or a 

mixed swap, even if the cash settlement 

were based on the value of a nonexempted security or a loan. 

An index CDS that is not based on a 

narrow-based security index under the 

Commissions’ rules and that provides 

for cash settlement in accordance with 

the 2009 ISDA Credit Derivatives 

Determinations Committees and 

Auction Settlement Supplement to the 

2003 Definitions (the ‘‘Auction 

Supplement’’) or with the 2009 ISDA 

Credit Derivatives Determinations 

Committees and Auction Settlement 

CDS Protocol (‘‘Big Bang Protocol’’) 929

is a swap, and will not be considered a 

security-based swap or a mixed swap 

solely because the determination of the 

cash price to be paid is established 

through a securities or loan auction.930

In 2009, auction settlement, rather than 

physical settlement, became the default 

method of settlement for, among other 

types of CDS, index CDS on corporate 

issuers of securities.931 The amount of 

the cash settlement is determined 

through an auction triggered by the 

occurrence of a credit event.932 The 

Auction Supplement ‘‘hard wired’’ the 

mechanics of credit event auctions into 

the 2003 Definitions.933 The 

Commissions understand that the credit 

event auction process that is part of the 

ISDA terms works as follows. 

Following the occurrence of a credit 

event under a CDS, a determinations 

committee (‘‘DC’’) established by ISDA, 

following a request by any party to a 

credit derivatives transaction that is 

subject to the Big Bang Protocol or 

Auction Supplement, will determine, 

among other matters: (i) Whether and 

when a credit event occurred; (ii) 

whether or not to hold an auction to 

enable market participants to settle 

those of their credit derivatives 

transactions covered by the auction; (iii) 

the list of deliverable obligations of the 

relevant reference entity; and (iv) the 

necessary auction specific terms. The 

credit event auction takes place in two 

parts. In the first part of the auction, 

dealers submit physical settlement 

requests, which are requests to buy or 

sell any of the deliverable obligations 

(based on the dealer’s needs and those 

of its counterparties), and an initial 

market midpoint price is created based 

on dealers’ initial bids and offers. 

Following the establishment of the 

initial market midpoint, the physical 

settlement requests are then calculated 

to determine the amount of open 

interest. 

The aggregate amount of open interest 

is the basis for the second part of the 

auction. In the second part of the 

auction, dealers and investors can 

determine whether to submit limit 

orders and the levels of such limit 

orders. The limit orders, which are 

irrevocable, have a firm price in 

addition to size and whether it is a buy 

or sell order. The auction is conducted 

as a ‘‘dutch’’ auction, in which the open 

buy interests and open sell interests are 

matched.934 The final price of the 

auction is the last limit order used to 

match against the open interest. The 

final price in the auction is the cash 

price used for purposes of calculating 

the settlement payments in respect of 

the orders to buy and sell the 

deliverable obligations and it is also 

used to determine the cash settlement 

payment under the CDS. 

Comments 

One commenter believed that a 

mandatory physical settlement 

provision in an index CDS based on a 

broad-based security index should not 

transform a swap into a mixed swap 

because (i) the SEC would retain 

jurisdiction over a transfer of securities 

as part of such settlement and (ii) 

application of the interpretation would 

be difficult since many instruments 

contemplate physical settlement but 

have a cash settlement option, or vice 

versa.935

As discussed above, the Commissions 

are restating the interpretation regarding 

mandatory physical settlement as 

provided in the Proposing Release. The 

Commissions’ interpretation assures 

that the Federal securities laws apply to 

the offer and sale of the underlying 

securities at the time the index CDS is 

sold.936 The Commissions note the 

commenter’s concerns but believe that 

as a result of the Commissions’ 

understanding of the auction settlement 

process for index CDS, which is the 

primary method by which index CDS 

are settled and which addresses 

circumstances in which securities may 

be tendered in the auction process 

separate from the CDS settlement 

payment, it is not clear that there is in 

fact any significant number of 

circumstances in which such index CDS 

may be optionally physically settled. 

The Commissions note that this 

commenter did not elaborate on the 

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937See section 761(a)(2) of the Dodd-Frank Act 

(inserting the term ‘‘security-based swap’’ into the 

definition of ‘‘security’’ in section 3a(10) of the 

Exchange Act, 15 U.S.C. 78c(a)(10)). 

938See section 768(a)(1) of the Dodd-Frank Act 

(inserting the term ‘‘security-based swap’’ into the 

definition of ‘‘security’’ in section 2(a)(1) of the 

Securities Act, 15 U.S.C. 77b(a)(1)). 

939Sections 761(a)(3) and (4) of the Dodd-Frank 

Act amend sections 3(a)(13) and (14) of the 

Exchange Act, 15 U.S.C. 78c(a)(13) and (14), and 

section 768(a)(3) of the Dodd-Frank Act adds 

section 2(a)(18) to the Securities Act, 15 U.S.C. 

77b(a)(18), to provide that the terms ‘‘purchase’’ 

and ‘‘sale’’ of a security-based swap shall mean the 

‘‘the execution, termination (prior to its scheduled 

maturity date), assignment, exchange, or similar 

transfer or conveyance of, or extinguishing of rights 

or obligations under, a security-based swap, as the 

context may require.’’ 

940Section 3(a)(68)(D) of the Exchange Act, 15 

U.S.C. 78c(a)(68)(D); section 1a(47)(D) of the CEA, 

7 U.S.C. 1a(47)(D). 

941 Id. The exclusion from the definition of the 

term ‘‘swap’’ for security-based swaps does not 

include security-based swaps that are mixed swaps. 

See section 1a(47)(B)(x) of the CEA, 7 U.S.C. 

1a(47)(B)(x). 

942See Proposing Release at 29860. 

943See section 712(a)(8) of the Dodd-Frank Act. 

944Those standard events include inter alia 

bankruptcy, breach of agreement, cross default to 

other indebtedness, and misrepresentations. 

945See section 3(a)(68)(A)(ii)(III) of the Exchange 

Act, 15 U.S.C. 78c(a)(68)(A)(ii)(III). 

946See Better Markets Letter. 

circumstances in which the auction 

process would not apply. 

I. Security-Based Swaps as Securities 

Under the Exchange Act and Securities 

Act 

Pursuant to the Dodd-Frank Act, a 

security-based swap is defined as a 

‘‘security’’ under the Exchange Act937

and Securities Act.938 As a result, 

security-based swaps are subject to the 

Exchange Act and the Securities Act 

and the rules and regulations 

promulgated thereunder.939

The SEC did not provide 

interpretations in the Proposing Release 

on the application of the Exchange Act 

and the Securities Act, and the rules 

and regulations thereunder, to securitybased swaps. However, the SEC 

solicited comment on whether 

additional interpretations may be 

necessary regarding the application of 

certain provisions of the Exchange Act 

and the Securities Act, and the rules 

and regulations promulgated 

thereunder, to security-based swaps. 

The SEC did not receive any comments 

with respect to this issue in the context 

of this rulemaking and is not providing 

any interpretations in this release. 

IV. Mixed Swaps 

A. Scope of the Category of Mixed Swap 

The category of mixed swap is 

described, in both the definition of the 

term ‘‘security-based swap’’ in the 

Exchange Act and the definition of the 

term ‘‘swap’’ in the CEA, as a securitybased swap that is also based on the 

value of 1 or more interest or other rates, 

currencies, commodities, instruments of 

indebtedness, indices, quantitative 

measures, other financial or economic 

interest or property of any kind (other 

than a single security or a narrow-based 

security index), or the occurrence, nonoccurrence, or the extent of the 

occurrence of an event or contingency 

associated with a potential financial, 

economic, or commercial consequence 

(other than an event described in 

subparagraph (A)(ii)(III) [of section 

3(a)(68) of the Exchange Act]).940

A mixed swap, therefore, is both a 

security-based swap and a swap.941 As 

stated in the Proposing Release, the 

Commissions believe that the scope of 

mixed swaps is, and is intended to be, 

narrow.942 Title VII establishes robust 

and largely parallel regulatory regimes 

for both swaps and security-based 

swaps and directs the Commissions to 

jointly prescribe such regulations 

regarding mixed swaps as may be 

necessary to carry out the purposes of 

the Dodd-Frank Act.943 More generally, 

the Commissions believe the category of 

mixed swap was designed so that there 

would be no gaps in the regulation of 

swaps and security-based swaps. 

Therefore, in light of the statutory 

scheme created by the Dodd-Frank Act 

for swaps and security-based swaps, the 

Commissions believe the category of 

mixed swap covers only a small subset 

of Title VII instruments. 

For example, a Title VII instrument in 

which the underlying references are the 

value of an oil corporation stock and the 

price of oil would be a mixed swap. 

Similarly, a Title VII instrument in 

which the underlying reference is a 

portfolio of both securities (assuming 

the portfolio is not an index or, if it is 

an index, that the index is narrowbased) and commodities would be a 

mixed swap. Mixed swaps also would 

include certain Title VII instruments 

called ‘‘best of’’ or ‘‘out performance’’ 

swaps that require a payment based on 

the higher of the performance of a 

security and a commodity (other than a 

security). As discussed elsewhere in this 

release, the Commissions also believe 

that certain Title VII instruments may be 

mixed swaps if they meet specified 

conditions. 

The Commissions also believe that the 

use of certain market standard 

agreements in the documentation of 

Title VII instruments should not in and 

of itself transform a Title VII instrument 

into a mixed swap. For example, many 

instruments are documented by 

incorporating by reference market 

standard agreements. Such agreements 

typically set out the basis of establishing 

a trading relationship with another 

party but are not, taken separately, a 

swap or security-based swap. These 

agreements also include termination 

and default events relating to one or 

both of the counterparties; such 

counterparties may or may not be 

entities that issue securities.944 The 

Commissions believe that the term ‘‘any 

agreement * * * based on * * * the 

occurrence of an event relating to a 

single issuer of a security,’’ as provided 

in the definition of the term ‘‘securitybased swap,’’ was not intended to 

include such termination and default 

events relating to counterparties 

included in standard agreements that 

are incorporated by reference into a 

Title VII instrument.945 Therefore, an 

instrument would not be 

simultaneously a swap and a securitybased swap (and thus not a mixed swap) 

simply by virtue of having incorporated 

by reference a standard agreement, 

including default and termination 

events relating to counterparties to the 

Title VII instrument. 

Comments 

While the Commissions did not 

receive any comments on the 

interpretation regarding the scope of the 

category of mixed swaps, one 

commenter recommended that the 

Commissions require that market 

participants disaggregate mixed swaps 

and enter into separate simultaneous 

transactions so that they cannot employ 

mixed swaps to obscure the underlying 

substance of transactions.946 The 

Commissions are not adopting any rules 

or interpretations to require 

disaggregation of mixed swaps into their 

separate components, as the Dodd-Frank 

Act specifically contemplated that there 

would be mixed swaps comprised of 

both swaps and security-based swaps. 

B. Regulation of Mixed Swaps 

1. Introduction 

The Commissions are adopting as 

proposed paragraph (a) of rule 1.9 under 

the CEA and rule 3a68–4 under the 

Exchange Act to define a ‘‘mixed swap’’ 

in the same manner as the term is 

defined in both the CEA and the 

Exchange Act. The Commissions also 

are adopting as proposed two rules to 

address the regulation of mixed swaps. 

First, paragraph (b) of rule 1.9 under the 

CEA and rule 3a68–4 under the 

Exchange Act will provide a regulatory 

framework with which parties to 

bilateral uncleared mixed swaps (i.e., 

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48292 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

947All references to Title VII instruments in parts 

IV and VI shall include a class of such Title VII 

instruments as well. For example, a ‘‘class’’ of Title 

VII instrument would include instruments that are 

of similar character and provide substantially 

similar rights and privileges. 948As stated in paragraph (c) of proposed rule 1.9 

under the CEA and rule 3a68–4 under the Exchange 

Act, ‘‘parallel provisions’’ means comparable 

provisions of the CEA and the Exchange Act that 

were added or amended by Title VII with respect 

to security-based swaps and swaps, and the rules 

and regulations thereunder. 

949Section 712(a)(7)(A) of the Dodd-Frank Act 

requires the Commissions to treat functionally or 

economically similar entities in a similar manner. 

950Under paragraph (b) of rule 1.9 under the CEA 

and rule 3a68–4 under the Exchange Act, a 

‘‘bilateral uncleared mixed swap’’ will be a mixed 

swap that: (i) Is neither executed on nor subject to 

the rules of a DCM, NSE, SEF, security-based SEF, 

or FBOT; and (ii) will not be submitted to a DCO 

or registered or exempt clearing agency to be 

cleared. To the extent that a mixed swap is subject 

to the mandatory clearing requirement (see section 

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

section 3C(a)(1) of the Exchange Act) (and where a 

counterparty is not eligible to rely on the end-user 

exclusion from the mandatory clearing requirement 

(see section 2(h)(7) of the CEA, 7 U.S.C. 2(h)(7), and 

section 3C(g) of the Exchange Act)), this alternative 

regulatory treatment will not be available. 

951 7 U.S.C. 6s(f) and 12, respectively. 952 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 6s(h)(1)(A), 

6s(h)(4)(A), 9 and 15, 13b, 13a–1, 13a–2, 13, 13c(a), 

13c(b), and 26, respectively. 953 7 U.S.C. 6r. 954 7 U.S.C. 2(a)(13). 955 7 U.S.C. 6s(e). 956 7 U.S.C. 6a. 957 7 U.S.C. 6s(h)(1)(A) and 6s(h)(4)(A). 958 17 CFR 23.410. 

959Business Conduct Standards for Swap Dealers 

and Major Swap Participants With Counterparties, 

77 FR 9734, 9751–9755 (Feb. 17, 2012). The 

Commissions note that, while the introductory text 

of rule 1.9(b)(3)(i)(A) through (F) under the CEA 

and rule 3a68–4(b)(3)(i)(A) through (F) under the 

Exchange Act characterizes the cited CEA sections 

(e.g., ‘‘enforcement,’’ ‘‘capital,’’ etc.), such 

characterization is meant as guidance only. For 

example, final rule 1.9(b)(3)(i)(B) uses the word 

‘‘enforcement’’ to characterize certain of the cited 

CEA sections and the rules and regulations 

promulgated thereunder that prohibit fraud, 

manipulation, or abusive practices. Other cited 

provisions, such as the Whistleblower protections 

under CEA section 23, or the related rules and 

regulations, such as requirements to keep 

counterparty information confidential under rule 

23.410(c) under the CEA, 17 CFR 23.410(c), are 

similarly enforcement provisions in that they 

protect market participants from fraudulent or other 

abusive practices. 

960See supra note 10. 

961Because security-based swaps are also 

securities, compliance with the Federal securities 

mixed swaps that are neither executed 

on or subject to the rules of a DCM, 

NSE, SEF, security-based SEF, or FBOT 

nor cleared through a DCO or clearing 

agency), as to which at least one of the 

parties is dually registered with both 

Commissions, will need to comply. 

Second, paragraph (c) of rule 1.9 under 

the CEA and rule 3a68–4 under the 

Exchange Act establishes a process for 

persons to request that the Commissions 

issue a joint order permitting such 

persons (and any other person or 

persons that subsequently lists, trades, 

or clears that class of mixed swap)947 to 

comply, as to parallel provisions948

only, with specified parallel provisions 

of either the CEA or the Exchange Act, 

and related rules and regulations 

(collectively ‘‘specified parallel 

provisions’’), instead of being required 

to comply with parallel provisions of 

both the CEA and the Exchange Act. 

2. Bilateral Uncleared Mixed Swaps 

Entered Into by Dually-Registered 

Dealers or Major Participants 

Swap dealers and major swap 

participants will be comprehensively 

regulated by the CFTC, and securitybased swap dealers and major securitybased swap participants will be 

comprehensively regulated by the 

SEC.949 The Commissions recognize that 

there may be differences in the 

requirements applicable to swap dealers 

and security-based swap dealers, or 

major swap participants and major 

security-based swap participants, such 

that dually-registered market 

participants may be subject to 

potentially conflicting or duplicative 

regulatory requirements when they 

engage in mixed swap transactions. In 

order to assist market participants in 

addressing such potentially conflicting 

or duplicative requirements, the 

Commissions are adopting, as proposed 

with one modification explained below, 

rules that will permit dually-registered 

swap dealers and security-based swap 

dealers and dually-registered major 

swap participants and major securitybased swap participants to comply with 

an alternative regulatory regime when 

they enter into certain mixed swaps 

under specified circumstances. The 

Commissions received no comments on 

the proposed rules. 

Accordingly, as adopted, paragraph 

(b) of rule 1.9 under the CEA and rule 

3a68–4 under the Exchange Act provide 

that a bilateral uncleared mixed 

swap,950 where at least one party is 

dually-registered with the CFTC as a 

swap dealer or major swap participant 

and with the SEC as a security-based 

swap dealer or major security-based 

swap participant, will be subject to all 

applicable provisions of the Federal 

securities laws (and SEC rules and 

regulations promulgated thereunder). 

The rules as adopted also provide that 

such mixed swaps will be subject to 

only the following provisions of the 

CEA (and CFTC rules and regulations 

promulgated thereunder): 

• Examinations and information 

sharing: CEA sections 4s(f) and 8; 951

• Enforcement: CEA sections 

2(a)(1)(B), 4(b), 4b, 4c, 4s(h)(1)(A), 

4s(h)(4)(A), 6(c), 6(d), 6c, 6d, 9, 13(a), 

13(b) and 23; 952

• Reporting to an SDR: CEA section 

4r; 953

• Real-time reporting: CEA section 

2(a)(13); 954

• Capital: CEA section 4s(e); 955 and 

• Position Limits: CEA section 4a.956

The Commissions are modifying 

proposed rule 1.9(b)(3)(i) under the CEA 

and Rule 3a68–4(b)(3)(i) to include 

additional ‘‘enforcement’’ authority. 

Specifically, as adopted, the rules 

provide that such swaps will be subject 

to the anti-fraud, anti-manipulation, and 

other provisions of the business conduct 

standards in CEA sections 4s(h)(1)(A) 

and 4s(h)(4)(A) and the rules 

promulgated thereunder for mixed 

swaps.957 Rule 23.410 under the 

CEA,958 adopted under CEA section 

4s(h)(1)(A), applies to swap dealers and 

major swap participants and prohibits 

fraud, manipulation, and other abusive 

practices and also imposes requirements 

regarding the confidential treatment of 

counterparty information, which will 

apply to mixed swaps.959

As discussed in the Proposing 

Release, the Commissions believe that 

paragraph (b) of rule 1.9 under the CEA 

and rule 3a68–4 under the Exchange Act 

will address potentially conflicting or 

duplicative regulatory requirements for 

dually-registered dealers and major 

participants that are subject to 

regulation by both the CFTC and the 

SEC, while requiring dual registrants to 

comply with the regulatory 

requirements the Commissions believe 

are necessary to provide sufficient 

regulatory oversight for mixed swap 

transactions entered into by such dual 

registrants. The CFTC also believe that 

paragraph (b) of rule 1.9 under the CEA 

and rule 3a68–4 under the Exchange Act 

will provide clarity to dually-registered 

dealers and major participants, who are 

subject to regulation by both the CFTC 

and the SEC, as to the requirements of 

each Commission that will apply to 

their bilateral uncleared mixed swaps. 

3. Regulatory Treatment for Other 

Mixed Swaps 

Because mixed swaps are both 

security-based swaps and swaps,960

absent a joint rule or order by the 

Commissions permitting an alternative 

regulatory approach, persons who desire 

or intend to list, trade, or clear a mixed 

swap (or class thereof) will be required 

to comply with all the statutory 

provisions in the CEA and the Exchange 

Act (including all the rules and 

regulations thereunder) that were added 

or amended by Title VII with respect to 

swaps or security-based swaps.961 Such 

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laws and rules and regulations thereunder (in 

addition to the provisions of the Dodd-Frank Act 

and the rules and regulations thereunder) will also 

be required. To the extent one of the Commissions 

has exemptive authority with respect to other 

provisions of the CEA or the Federal securities laws 

and the rules and regulations thereunder, persons 

may submit separate exemptive requests or 

rulemaking petitions regarding those provisions to 

the relevant Commission. 

962Other than with respect to the specified 

parallel provisions with which such persons may be 

permitted to comply instead of complying with 

parallel provisions of both the CEA and the 

Exchange Act, any other provision of either the CEA 

or the Federal securities laws that applies to swaps 

or security-based swaps will continue to apply. 

963See section 3(a)(78) of the Exchange Act, 15 

U.S.C. 78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 

1a(47)(A)(v). The Dodd-Frank Act provides that 

certain CFTC registrants, such as DCOs and SEFs, 

will keep records regarding SBSAs open to 

inspection and examination by the SEC upon 

request. See, e.g., sections 725(e) and 733 of the 

Dodd-Frank Act. The Commissions are committed 

to working cooperatively together regarding their 

dual enforcement authority over SBSAs. 

964 15 U.S.C. 78c note. The Dodd-Frank Act 

amended the definition of ‘‘swap agreement’’ in 

section 206A of the GLBA to eliminate the 

requirements that a swap agreement be between 

ECPs, as defined in section 1a(18)(C) of the CEA, 

7 U.S.C. 1a(18)(C), and subject to individual 

negotiation. See section 762(b) of the Dodd-Frank 

Act. Sections 762(c) and (d) of the Dodd-Frank Act 

also made conforming amendments to the Exchange 

Act and the Securities Act to reflect the changes to 

the regulation of ‘‘swap agreements’’ that are either 

‘‘security-based swaps’’ or ‘‘security-based swap 

agreements’’ under the Dodd-Frank Act. 

965See section 3(a)(78) of the Exchange Act, 15 

U.S.C. 78c(a)(78). The CFMA amended the 

Exchange Act and the Securities Act to exclude 

swap agreements from the definitions of security in 

those statutes but subjected ‘‘security-based swap 

agreements,’’ as defined in section 206B of the 

GLBA, 15 U.S.C. 78c note, to the antifraud, antimanipulation, and anti-insider trading provisions of 

the Exchange Act and Securities Act. See CFMA, 

supra note 697, title III. 

The CEA does not contain a stand-alone 

definition of ‘‘security-based swap agreement,’’ but 

includes the definition instead in subparagraph 

(A)(v) of the swap definition in CEA section 1a(47), 

7 U.S.C. 1a(47). The only difference between these 

definitions is that the definition of SBSA in the 

Exchange Act specifically excludes security-based 

Continued 

dual regulation may not be appropriate 

in every instance and may result in 

potentially conflicting or duplicative 

regulatory requirements. However, 

before the Commissions can determine 

the appropriate regulatory treatment for 

mixed swaps (other than the treatment 

discussed above), the Commissions will 

need to understand better the nature of 

the mixed swaps that parties want to 

trade. As a result, the Commissions 

proposed paragraph (c) of rule 1.9 under 

the CEA and rule 3a68–4 under the 

Exchange Act to establish a process 

pursuant to which any person who 

desires or intends to list, trade, or clear 

a mixed swap (or class thereof) that is 

not subject to the provisions of 

paragraph (b) of the rules (i.e., bilateral 

uncleared mixed swaps entered into by 

at least one dual registrant) may request 

the Commissions to publicly issue a 

joint order permitting such person (and 

any other person or persons that 

subsequently lists, trades, or clears that 

class of mixed swap) to comply, as to 

parallel provisions only, with the 

specified parallel provisions, instead of 

being required to comply with parallel 

provisions of both the CEA and the 

Exchange Act.962 The Commissions 

received no comments on the proposed 

rules and are adopting the rules as 

proposed. 

As adopted, paragraph (c) of rule 1.9 

under the CEA and rule 3a68–4 under 

the Exchange Act further provide that a 

person submitting such a request to the 

Commissions must provide the 

Commissions with: 

(i) All material information regarding 

the terms of the specified, or specified 

class of, mixed swap; 

(ii) the economic characteristics and 

purpose of the specified, or specified 

class of, mixed swap; 

(iii) the specified parallel provisions, 

and the reasons the person believes 

such specified parallel provisions 

would be appropriate for the mixed 

swap (or class thereof); 

(iv) an analysis of (1) the nature and 

purposes of the parallel provisions that 

are the subject of the request; (2) the 

comparability of such parallel 

provisions; and (3) the extent of any 

conflicts or differences between such 

parallel provisions; and 

(v) such other information as may be 

requested by either of the Commissions. 

This provision is intended to provide 

the Commissions with sufficient 

information regarding the mixed swap 

(or class thereof) and the proposed 

regulatory approach to make an 

informed determination regarding the 

appropriate regulatory treatment of the 

mixed swap (or class thereof). 

As adopted, paragraph (c) of rule 1.9 

under the CEA and rule 3a68–4 under 

the Exchange Act also will allow a 

person to withdraw a request regarding 

the regulation of a mixed swap at any 

time prior to the issuance of a joint 

order by the Commissions. This 

provision is intended to permit persons 

to withdraw requests that they no longer 

need. This, in turn, will save the 

Commissions time and staff resources. 

As adopted, paragraph (c) of rule 1.9 

under the CEA and rule 3a68–4 under 

the Exchange Act further provide that in 

response to a request pursuant to the 

rules, the Commissions may jointly 

issue an order, after public notice and 

opportunity for comment, permitting 

the requesting person (and any other 

person or persons that subsequently 

lists, trades, or clears that class of mixed 

swap) to comply, as to parallel 

provisions only, with the specified 

parallel provisions (or another subset of 

the parallel provisions that are the 

subject of the request, as the 

Commissions determine is appropriate), 

instead of being required to comply 

with parallel provisions of both the CEA 

and the Exchange Act. In determining 

the contents of such a joint order, the 

Commissions can consider, among other 

things: 

(i) The nature and purposes of the 

parallel provisions that are the subject 

of the request; 

(ii) the comparability of such parallel 

provisions; and 

(iii) the extent of any conflicts or 

differences between such parallel 

provisions. 

Finally, as adopted, paragraph (c) of 

rule 1.9 under the CEA and rule 3a68– 

4 under the Exchange Act require the 

Commissions, if they determine to issue 

a joint order pursuant to these rules, to 

do so within 120 days of receipt of a 

complete request (with such 120-day 

period being tolled during the pendency 

of a request for public comment on the 

proposed interpretation). If the 

Commissions do not issue a joint order 

within the prescribed time period, the 

rules require that each Commission 

publicly provide the reasons for not 

having done so. Paragraph (c) of rule 1.9 

under the CEA and rule 3a68–4 under 

the Exchange Act makes clear that 

nothing in the rules requires either 

Commission to issue a requested joint 

order regarding the regulation of a 

particular mixed swap (or class thereof). 

These provisions are intended to 

provide market participants with a 

prompt review of requests for a joint 

order regarding the regulation of a 

particular mixed swap (or class thereof). 

The rules also will provide transparency 

and accountability by requiring that at 

the end of the review period, the 

Commissions issue the requested order 

or publicly state the reasons for not 

doing so. 

V. Security-Based Swap Agreements 

A. Introduction 

SBSAs are swaps over which the 

CFTC has regulatory and enforcement 

authority but for which the SEC also has 

antifraud and certain other authority.963

The term ‘‘security-based swap 

agreement’’ is defined as a ‘‘swap 

agreement’’ (as defined in section 206A 

of the GLBA 964) of which ‘‘a material 

term is based on the price, yield, value, 

or volatility of any security or any group 

or index of securities, including any 

interest therein’’ but does not include a 

security-based swap.965

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swaps (see section 3(a)(78)(B) of the Exchange Act, 

15 U.S.C. 78c(a)(78)(B)), while the definition of 

SBSA in the CEA does not contain a similar 

exclusion. Instead, the exclusion for security-based 

swaps is placed in the general exclusions from the 

swap definition in the CEA (see CEA section 

1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)). 

966See Proposing Release at 29863. Swaps based 

on indexes that are not narrow-based security 

indexes are not included within the definition of 

the term security-based swap under the Dodd-Frank 

Act. See section 3(a)(68)(A)(ii)(I) of the Exchange 

Act, 15 U.S.C. 78c(a)(68)(A)(ii)(I), and discussion 

supra part III.G. However, such swaps have a 

material term that is ‘‘based on the price, yield, 

value, or volatility of any security or any group or 

index of securities, or any interest therein,’’ and 

therefore such swaps fall within the SBSA 

definition. 

967Swaps on U.S. Treasury securities that do not 

have any other underlying references involving 

securities are expressly excluded from the 

definition of the term ‘‘security-based swap’’ under 

the Dodd-Frank Act. See section 3(a)(68)(C) of the 

Exchange Act, 15 U.S.C. 78c(a)(68)(C) (providing 

that an agreement, contract, or transaction that 

would be a security-based swap solely because it 

references, is based on, or settles through the 

delivery of one or more U.S. Treasury securities (or 

certain other exempted securities) is excluded from 

the security-based swap definition). However, 

swaps on U.S. Treasury securities or on other 

exempted securities covered by subparagraph (C) of 

the security-based swap definition have a material 

term that is ‘‘based on the price, yield, value, or 

volatility of any security or any group or index of 

securities, or any interest therein,’’ and therefore 

fall within the SBSA definition. 

968The Commissions noted that certain 

transactions that were not ‘‘security-based swap 

agreements’’ under the CFMA are nevertheless 

included in the definition of security-based swap 

under the Dodd-Frank Act—including, for example, 

a CDS on a single loan. Accordingly, although such 

transactions were not subject to insider trading 

restrictions under the CFMA, under the Dodd-Frank 

Act they are subject to the Federal securities laws, 

including insider trading restrictions. 

969Specifically, section 712(d)(2)(B) of the DoddFrank Act requires the Commissions, in 

consultation with the Board, to jointly adopt rules 

governing books and records requirements for 

SBSAs by persons registered as SDRs under the 

CEA, including uniform rules that specify the data 

elements that shall be collected and maintained by 

each SDR. Similarly, section 712(d)(2)(C) of the 

Dodd-Frank Act requires the Commissions, in 

consultation with the Board, to jointly adopt rules 

governing books and records for SBSAs, including 

daily trading records, for swap dealers, major swap 

participants, security-based swap dealers, and 

major security-based swap participants. 

970See Swap Data Recordkeeping and Reporting 

Requirements, 75 FR 76573 (Dec. 8, 2010) 

(proposed rules regarding swap data recordkeeping 

and reporting requirements for SDRs, DCOs, DCMs, 

SEFs, swap dealers, major swap participants, and 

swap counterparties who are neither swap dealers 

nor major swap participants); See Reporting, 

Recordkeeping, and Daily Trading Records 

Requirements for Swap Dealers and Major Swap 

Participants, 75 FR 76666 (Dec. 9, 2010) (proposed 

rules regarding reporting and recordkeeping 

requirements and daily trading records 

requirements for swap dealers and major swap 

participants). These rules have been adopted by the 

CFTC. See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136 (Jan. 13, 2012) (final 

rules regarding swap data recordkeeping and 

reporting requirements for SDRs, DCOs, DCMs, 

SEFs, swap dealers, major swap participants, and 

swap counterparties who are neither swap dealers 

or major swap participants); 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 20128 (Apr. 3, 2012) 

(final rules regarding reporting and recordkeeping 

requirements and daily trading records 

requirements for swap dealers and major swap 

participants). 

971See Proposing Release at 29863. 

972Rule 1.7 under the CEA and Rule 3a69–3 

under the Exchange Act provide that the term 

‘‘security-based swap agreement’’ has the meaning 

set forth in CEA section 1a(47)(A)(v), 7 U.S.C. 

1a(47)(A)(v), and section 3(a)(78) of the Exchange 

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

B. Swaps That are Security-Based Swap 

Agreements 

Although the Commissions believe it 

is not possible to provide a bright line 

test to define an SBSA, the 

Commissions believe that it is possible 

to clarify that certain types of swaps 

clearly fall within the definition of 

SBSA. For example, as the Commissions 

noted in the Proposing Release, a swap 

based on an index of securities that is 

not a narrow-based security index (i.e., 

a broad-based security index) would fall 

within the definition of an SBSA under 

the Dodd-Frank Act.966 Similarly, an 

index CDS that is not based on a 

narrow-based security index or on the 

‘‘issuers of securities in a narrow-based 

security index,’’ as defined in rule 

1.3(zzz) under the CEA and rule 3a68– 

1a under the Exchange Act, would be an 

SBSA. In addition, a swap based on a 

U.S. Treasury security or on certain 

other exempted securities other than 

municipal securities would fall within 

the definition of an SBSA under the 

Dodd-Frank Act.967

The Commissions received no 

comments on the examples provided in 

the Proposing Release regarding SBSAs. 

Accordingly, the Commissions are not 

further defining SBSA beyond restating 

the examples above.968

C. Books and Records Requirements for 

Security-Based Swap Agreements 

The Commissions are adopting rule 

1.7 under the CEA and rule 3a68–3 

under the Exchange Act, as proposed, to 

clarify that there will not be additional 

books and records requirements 

regarding SBSAs other than those that 

are required for swaps. The Dodd-Frank 

Act provides that the Commissions shall 

adopt rules regarding the books and 

records required to be kept for 

SBSAs.969 As discussed above, SBSAs 

are swaps over which the CFTC has 

regulatory authority, but for which the 

SEC has antifraud, anti-manipulation, 

and certain other authority. In the 

Proposing Release, the Commissions 

noted that the CFTC had proposed rules 

governing books and records for swaps, 

which would apply to swaps that also 

are SBSAs.970 The Commissions further 

stated their belief that those proposed 

rules would provide sufficient books 

and records regarding SBSAs, and that 

additional books and records 

requirements were not necessary for 

SBSAs.971 The Commissions received 

no comments on the proposed rules. 

Accordingly, rule 1.7 under the CEA 

and rule 3a68–3 under the Exchange Act 

provide that persons registered as SDRs 

under the CEA and the rules and 

regulations thereunder are not required 

to (i) keep and maintain additional 

books and records regarding SBSAs 

other than the books and records 

regarding swaps that SDRs would be 

required to keep and maintain pursuant 

to the CEA and rules and regulations 

thereunder; and (ii) collect and maintain 

additional data regarding SBSAs other 

than the data regarding swaps that SDRs 

are required to collect and maintain 

pursuant to the CEA and rules and 

regulations thereunder. In addition, rule 

1.7 under the CEA and rule 3a68–3 

under the Exchange Act provide that 

persons registered as swap dealers or 

major swap participants under the CEA 

and the rules and regulations 

thereunder, or registered as securitybased swap dealers or major securitybased swap participants under the 

Exchange Act and the rules and 

regulations thereunder, are not required 

to keep and maintain additional books 

and records, including daily trading 

records, regarding SBSAs other than the 

books and records regarding swaps that 

those persons are required to keep and 

maintain pursuant to the CEA and the 

rules and regulations thereunder.972

VI. Process for Requesting 

Interpretations of the Characterization 

of a Title VII Instrument 

The Commissions recognize that there 

may be Title VII instruments (or classes 

of Title VII instruments) that may be 

difficult to categorize definitively as 

swaps or security-based swaps. Further, 

because mixed swaps are both swaps 

and security-based swaps, identifying a 

mixed swap may not always be 

straightforward. 

Section 712(d)(4) of the Dodd-Frank 

Act provides that any interpretation of, 

or guidance by, either the CFTC or SEC 

regarding a provision of Title VII shall 

be effective only if issued jointly by the 

Commissions (after consultation with 

the Board) on issues where Title VII 

requires the CFTC and SEC to issue joint 

regulations to implement the provision. 

The Commissions believe that any 

interpretation or guidance regarding 

whether a Title VII instrument is a 

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973See Proposing Release at 29864–65. 

974The Commissions note that section 718 of the 

Dodd-Frank Act is a separate process from the 

process the Commissions are adopting, and that any 

future interpretation involving the process under 

section 718 would not affect the process being 

adopted here, nor will any future interpretation 

involving the process adopted here affect the 

process under section 718. 

975See paragraph (a) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. 

976See paragraph (b) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. 

977The Commissions also may use this 

information to issue (within the timeframe for 

issuing a joint interpretation) a joint notice of 

proposed rulemaking to further define one or more 

of the terms ‘‘swap,’’ ‘‘security-based swap,’’ or 

‘‘mixed swap.’’ See paragraph (f) of rule 1.8 under 

the CEA and rule 3a68–2 under the Exchange Act, 

which are discussed below. 

978See paragraph (c) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. 

979See paragraph (d) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. 

980See paragraph (e) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. This 120- 

day period is based on the timeframe set forth in 

section 718(a)(3) of the Dodd-Frank Act. 

swap, a security-based swap, or both 

(i.e., a mixed swap), must be issued 

jointly pursuant to this requirement. 

The Commissions proposed rules in 

the Proposing Release to establish a 

process for interested persons to request 

a joint interpretation by the 

Commissions regarding whether a 

particular Title VII instrument (or class 

of Title VII instruments) is a swap, a 

security-based swap, or both (i.e., a 

mixed swap).973 The Commissions are 

adopting the rules as proposed. 

Section 718 of the Dodd-Frank Act 

establishes a process for determining the 

status of ‘‘novel derivative products’’ 

that may have elements of both 

securities and futures contracts. Section 

718 of the Dodd-Frank Act provides a 

useful model for a joint Commission 

review process to appropriately 

categorize Title VII instruments. As a 

result, the final rules include various 

attributes of the process established in 

section 718 of the Dodd-Frank Act. In 

particular, to permit an appropriate 

review period that provides sufficient 

time to ensure Federal regulatory 

interests are satisfied that also does not 

unduly delay the introduction of new 

financial products, the adopted process, 

like the process established in section 

718, includes a deadline for responding 

to a request for a joint interpretation.974

The Commissions are adopting rule 

1.8 under the CEA and rule 3a68–2 

under the Exchange Act that establish a 

process for parties to request a joint 

interpretation regarding the 

characterization of a particular Title VII 

instrument (or class thereof). 

Specifically, the final rules provide that 

any person may submit a request to the 

Commissions to provide a public joint 

interpretation of whether a particular 

Title VII instrument is a swap, a 

security-based swap, or both (i.e., a 

mixed swap).975

The final rules afford market 

participants with the opportunity to 

obtain greater certainty from the 

Commissions regarding the regulatory 

status of particular Title VII instruments 

under the Dodd-Frank Act. This 

provision should decrease the 

possibility that market participants 

inadvertently might fail to meet the 

regulatory requirements applicable to a 

particular Title VII instrument. 

The final rules provide that a person 

requesting an interpretation as to the 

characterization of a Title VII 

instrument as a swap, a security-based 

swap, or both (i.e., a mixed swap), must 

provide the Commissions with the 

person’s determination of the 

characterization of the instrument and 

supporting analysis, along with certain 

other documentation.976 Specifically, 

the person must provide the 

Commissions with the following 

information: 

• All material information regarding 

the terms of the Title VII instrument; 

• A statement of the economic 

characteristics and purpose of the Title 

VII instrument; 

• The requesting person’s 

determination as to whether the Title 

VII instrument should be characterized 

as a swap, a security-based swap, or 

both (i.e., a mixed swap), including the 

basis for such determination; and 

• Such other information as may be 

requested by either Commission. 

This provision should provide the 

Commissions with sufficient 

information regarding the Title VII 

instrument at issue so that the 

Commissions can appropriately evaluate 

whether it is a swap, a security-based 

swap, or both (i.e., a mixed swap).977 By 

requiring that requesting persons 

furnish a determination regarding 

whether they believe the Title VII 

instrument is a swap, a security-based 

swap, or both (i.e., a mixed swap), 

including the basis for such 

determination, this provision also will 

assist the Commissions in more quickly 

identifying and addressing the relevant 

issues involved in arriving at a joint 

interpretation of the characterization of 

the instrument. 

The final rules provide that a person 

may withdraw a request at any time 

prior to the issuance of a joint 

interpretation or joint notice of 

proposed rulemaking by the 

Commissions.978 Notwithstanding any 

such withdrawal, the Commissions may 

provide an interpretation regarding the 

characterization of the Title VII 

instrument that was the subject of a 

withdrawn request. 

This provision will permit parties to 

withdraw requests for which the party 

no longer needs an interpretation. This, 

in turn, should save the Commissions 

time and staff resources. If the 

Commissions believe such an 

interpretation is necessary regardless of 

a particular request for interpretation, 

however, the Commissions may provide 

such a joint interpretation of their own 

accord. 

The final rules provide that if either 

Commission receives a proposal to list, 

trade, or clear an agreement, contract, or 

transaction (or class thereof) that raises 

questions as to the appropriate 

characterization of such agreement, 

contract, or transaction (or class thereof) 

as a swap, security-based swap, or both 

(i.e., a mixed swap), the receiving 

Commission promptly shall notify the 

other.979 This provision of the final 

rules further provides that either 

Commission, or their Chairmen jointly, 

may submit a request for a joint 

interpretation to the Commissions as to 

the characterization of the Title VII 

instrument where no external request 

has been received. 

This provision is intended to ensure 

that Title VII instruments do not fall 

into regulatory gaps and will help the 

Commissions to fulfill their 

responsibility to oversee the regulatory 

regime established by Title VII of the 

Dodd-Frank Act by making sure that 

Title VII instruments are appropriately 

characterized, and thus appropriately 

regulated. An agency, or their Chairmen 

jointly, submitting a request for an 

interpretation as to the characterization 

of a Title VII instrument under this 

paragraph will be required to submit the 

same information as, and could 

withdraw a request in the same manner 

as, a person submitting a request to the 

Commissions. The bases for these 

provisions are set forth above with 

respect to paragraphs (b) and (c) of the 

final rules. 

The final rules require that the 

Commissions, if they determine to issue 

a joint interpretation as to the 

characterization of a Title VII 

instrument, do so within 120 days of 

receipt of the complete external or 

agency submission (unless such 120-day 

period is tolled during the pendency of 

a request for public comment on the 

proposed interpretation).980 If the 

Commissions do not issue a joint 

interpretation within the prescribed 

time period, the final rules require that 

each Commission publicly provide the 

reasons for not having done so within 

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981See section 712(d)(4) of the Dodd-Frank Act. 982See paragraph (f) of rule 1.8 under the CEA 

and rule 3a68–2 under the Exchange Act. 983See Better Markets Letter; CME Letter; and 

SIFMA Letter. 984See Better Markets Letter. 985See CME Letter and SIFMA Letter. These 

commenters suggested that the Commissions should 

be required to issue a joint interpretation for all 

joint interpretive requests that are not withdrawn. 

Id. 

986See CME Letter. This commenter suggested 

that the Commissions should seek expedited 

judicial review to determine the characterization of 

a Title VII instrument if the Commissions cannot 

agree on a joint interpretation. Id. 

987See section 3(a)(78) of the Exchange Act, 15 

U.S.C. 78c(a)(78), and section 1a(47)(A)(v) of the 

CEA, 7 U.S.C. 1a(47)(A)(v). The Dodd-Frank Act 

provides that certain CFTC registrants, such as 

DCOs and SEFs, will keep records regarding 

security-based swap agreements open to inspection 

and examination by the SEC upon request. See, e.g., 

sections 725(e) and 733 of the Dodd-Frank Act. 

988The Commissions note that judicial review 

provisions in section 718 relating to the status of 

novel derivative products only provide that either 

Commission (either the SEC or the CFTC) has the 

right to petition for review of a final order of the 

other Commission with respect to novel derivative 

products that may have elements of both securities 

and futures that affects jurisdictional issues. 

Nothing in section 718 requires that the 

Commissions issue exemptions or interpretations 

pursuant to such section or provides any person 

other than the Commissions the right to petition for 

Court review of a Commission order issued 

pursuant to section 718. 

989See CME Letter and Markit Letter. One of 

these commenters suggested that the Commissions 

should reduce the 120-day review period to 30 days 

because the value of receiving a joint interpretation 

would be negated if a market participant had to 

wait 120 days. This commenter also suggested that 

foreign competitors will gain a competitive 

advantage to U.S. market participants because they 

will not need to wait for a joint interpretation before 

such prescribed time period. This 

provision of the final rules also 

incorporates the mandate of the DoddFrank Act that any joint interpretation 

by the Commissions be issued only after 

consultation with the Board of 

Governors of the Federal Reserve 

System.981 Finally, the rules make clear 

that nothing requires either Commission 

to issue a requested joint interpretation 

regarding the characterization of a 

particular instrument. 

These provisions are intended to 

assure market participants a prompt 

review of submissions requesting a joint 

interpretation of whether a Title VII 

instrument is a swap, a security-based 

swap, or both (i.e., a mixed swap). The 

final rules also provide transparency 

and accountability by requiring that at 

the end of the review period, the 

Commissions issue the requested 

interpretation or publicly state the 

reasons for not doing so. 

The final rules permit the 

Commissions, in lieu of issuing a 

requested interpretation, to issue 

(within the timeframe for issuing a joint 

interpretation) a joint notice of proposed 

rulemaking to further define one or 

more of the terms ‘‘swap,’’ ‘‘securitybased swap,’’ or ‘‘mixed swap.’’ 982

Under the final rules, the 120-day 

period to provide a response will be 

tolled during the pendency of a request 

for public comment on any such 

proposed interpretation. Such a 

rulemaking, as required by Title VII, 

would be required to be done in 

consultation with the Board of 

Governors of the Federal Reserve 

System. This provision is intended to 

provide the Commissions with needed 

flexibility to address issues that may be 

of broader applicability than the 

particular Title VII instrument that is 

the subject of a request for a joint 

interpretation. 

Comments 

Three commenters discussed the 

proposed process for requesting 

interpretations of the characterization of 

a Title VII instrument,983 and while 

supporting such joint interpretive 

process, suggested certain changes, 

including extending it to SBSAs,984

mandating that the Commissions issue a 

response to a request,985 and suggesting 

that the Commissions should seek 

expedited judicial review in the event 

the Commissions do not agree on the 

interpretation.986

The Commissions are adopting the 

final rules as proposed and are not 

including SBSAs in the process. The 

joint interpretive process is intended to 

decrease the possibility that market 

participants inadvertently might fail to 

meet regulatory requirements that are 

applicable to swaps, security-based 

swaps, or mixed swaps and, as such, 

provides a mechanism for market 

participants to request whether an 

instrument will be regulated by the 

CFTC, the SEC, or both. However, the 

Commissions do not believe it is 

appropriate to predetermine whether 

particular swaps also are SBSAs as 

SBSAs are already swaps over which 

the CFTC has regulatory and 

enforcement authority and as to which 

the SEC has antifraud and certain other 

related authorities.987 Predetermining 

whether particular swaps may be SBSAs 

under this process is not needed to 

provide certainty as to the applicable 

regulatory treatment of these 

instruments. 

The Commissions also are retaining in 

the final rules the framework for 

providing or not providing joint 

interpretations. As noted above, section 

718 of the Dodd-Frank Act contains a 

framework for evaluating novel 

derivative products that may have 

elements of both securities and futures 

contracts (other than swaps, securitybased swaps or mixed swaps). The 

Commissions believe that establishing a 

joint interpretive process for swaps, 

security-based swaps and mixed swaps 

that is modeled in part on this statutory 

framework should facilitate providing 

interpretations to market participants in 

a timely manner, if the Commissions 

determine to do so. Establishing a 

process by rule will provide market 

participants with an understandable 

method by which they can request an 

interpretation from the Commissions. 

As the Commissions have the authority, 

but not the obligation, under the DoddFrank Act to further define the terms 

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

‘‘mixed swap,’’ the Commissions are 

retaining the flexibility in the 

interpretive process rules to decide 

whether or not to issue joint 

interpretations. The Commissions 

believe, however, that it is appropriate 

to advise market participants of the 

reasons why such interpretation is not 

being issued and the final rules retain 

the requirement that the Commissions 

publicly explain the reasons for not 

issuing a joint interpretation. 

Further, the Commissions are not 

revising the final rules to provide for 

expedited judicial review. The DoddFrank Act does not contain any 

provision that provides for expedited 

judicial review if the Commissions do 

not issue a joint interpretation with 

respect to a Title VII instrument. 

Although the Commissions note that 

section 718 of the Dodd-Frank Act 

contains a statutorily mandated 

expedited judicial review of one of the 

Commission’s actions (if sought by the 

other Commission) regarding novel 

derivative products that may have 

elements of both securities and futures 

contracts, such statutory provision does 

not apply to Title VII instruments.988

Further, Title VII provides flexibility to 

the Commissions to determine the 

methods by which joint interpretations 

are provided. Title VII does not contain 

any required expedited judicial review 

of Commission actions, and the 

Commissions do not have the authority 

to require expedited judicial review 

under Title VII, with respect to a Title 

VII instrument. Accordingly, the 

Commissions do not believe that 

including such a provision is 

appropriate in the context of providing 

interpretations to market participants 

regarding the definitions of swap, 

security-based swap, or mixed swap. 

Two commenters were concerned 

about the length of the review period 

and believed that the Commissions 

should shorten such time period.989 The 

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trading similar or identical products. See CME 

Letter. The Commissions note that to the extent 

foreign competitors are engaging in swap and 

security-based swap transactions subject to either 

Commission’s jurisdiction, they will be subject to 

the same process for requesting interpretations of 

the characterization of Title VII instruments as U.S. 

market participants. The other commenter 

requested that the Commissions issue a joint 

interpretation for each ‘‘widely-utilized index,’’ at 

the time of the index series’ launch, within a twoweek period rather than the proposed 120-day 

period for novel derivative products under section 

718 of the Dodd-Frank Act. This commenter did not 

recognize that the joint interpretive process would 

be available in this case, and that it may be initiated 

by an index provider. See paragraph (a) of rule 1.8 

under the CEA and rule 3a68–2 under the Exchange 

Act (providing that ‘‘[a]ny person’’ may submit a 

request for a joint interpretation). See Markit Letter. 

990See section 718(a)(3) of the Dodd-Frank Act. 

991See SIFMA Letter. This commenter also 

suggested that while the requesting party, and all 

other market participants, would be bound by the 

joint interpretation when issued, they should not 

face retroactive re-characterization of a transaction 

executed during the review period and prior to the 

issuance of the joint interpretation. Id. 

992One commenter suggested that the 

Commissions should permit the parties seeking a 

joint interpretation to request confidential treatment 

from the Commissions during the course of the 

review period in order to protect proprietary 

information and deal structures. See SIFMA Letter. 

Another commenter suggested that the 

Commissions should make public all requests for 

joint interpretations, any guidance actually 

provided in response to such requests, and any 

decisions not to provide guidance in response to 

such requests (along with an explanation of the 

grounds for any such decision). See Better Markets 

Letter. 

993See 17 CFR 200.81 and 17 CFR 140.98. The 

Commissions note that the joint interpretive process 

is intended to provide, among other things, 

notification to all market participants as to the 

regulatory classification of a particular Title VII 

instrument. In this regard, the Commissions do not 

believe it is appropriate to provide a joint 

interpretation only to the market participants 

requesting the interpretation, while delaying 

publication of the same joint interpretation to 

market participants generally. Therefore, CFTC staff 

will not exercise its discretion under 17 CFR 

140.98(b) to delay publication of a joint 

interpretation. SEC staff does not have discretion 

under 17 CFR 200.81(b) to delay publication of a 

joint interpretation. 

994The CFTC’s publication of any joint 

interpretative request and the joint interpretation 

itself will be subject to the restrictions of section 8 

of the CEA. See 7 U.S.C. 12. Subject to limited 

exceptions, CEA section 8 generally restricts the 

CFTC from publishing ‘‘data and information that 

would separately disclose the business transactions 

or market positions of any person and trade secrets 

or names of customers...’’ Id. The CFTC and its staff 

have a long history of providing interpretive 

guidance with respect to the regulatory status of 

specific proposed transactions in compliance with 

CEA section 8. However, market participants 

making a joint interpretive request should be aware 

that the SEC is not subject to CEA section 8 and, 

therefore, is not subject to the restrictions of CEA 

section 8. The CFTC anticipates that most joint 

interpretive requests will not contain CEA Section 

8 information. However, given that the SEC is not 

subject to the restrictions of CEA section 8, the 

CFTC intends to work with requesting parties to 

assure that joint interpretive requests do not 

include CEA section 8 information. Nevertheless, 

given the foregoing, market participants should not 

submit CEA section 8 information in their joint 

interpretive requests. 

995 7 U.S.C. 1a(47)(E) and 2(i). 

996Proposing Release at 29866. 

997CEA section 1a(47)(E), 7 U.S.C. 1a(47)(E). 

998CEA section 2(i), 7 U.S.C. 2(i). New CEA 

section 2(i), as added by section 722(d) of the DoddFrank Act, also provides that the provisions of Title 

VII relating to swaps shall not apply to activities 

outside the United States unless those activities 

‘‘have a direct and significant connection with 

activities in, or effect on, commerce of the United 

States.’’ 

Commissions are not modifying the 

final rules from those proposed with 

respect to the length of the review 

period. The 120-day review period is 

based on a timeframe established by 

Congress with respect to determining 

the status of novel derivative 

products.990 The Commissions believe 

that this length of the review period also 

is appropriate for other derivative 

products such as swaps, security-based 

swaps, and mixed swaps. Further, the 

Commissions believe the 120-day 

review period is necessary to enable the 

Commissions to obtain the necessary 

information regarding a Title VII 

instrument, thoroughly analyze the 

instrument, and formulate any joint 

interpretation regarding the instrument. 

In a related comment, one commenter 

suggested that the Commissions allow a 

requesting party, while awaiting a joint 

interpretation, to make a good faith 

characterization of a particular Title VII 

instrument and engage in transactions 

based on such characterization.991 The 

Commissions believe that it is essential 

that the characterization of an 

instrument be established prior to any 

party engaging in the transactions so 

that the appropriate regulatory schemes 

apply. The Commissions do not believe 

that allowing market participants to 

make such a determination as to the 

status of a product is either appropriate 

or consistent with the statutory 

provisions providing for the 

Commissions to further define the terms 

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

‘‘mixed swap.’’ Further, allowing market 

participants to determine the status of a 

product could give rise to regulatory 

arbitrage and inconsistent treatment of 

similar products. 

Finally, some commenters expressed 

concern about the public availability of 

information regarding the joint 

interpretive process and asked that the 

parties be able to seek confidential 

treatment of their submissions.992 The 

Commissions note that under existing 

rules of both Commissions, requesting 

parties may seek confidential treatment 

for joint interpretive requests from the 

SEC and the CFTC in accordance with 

the applicable existing rules relating to 

confidential treatment of information.993

The Commissions also note that even if 

confidential treatment has been 

requested, all joint interpretive requests, 

as well all joint interpretations and any 

decisions not to issue a joint 

interpretation (along with the 

explanation of the grounds for such 

decision), will be made publicly 

available at the conclusion of the review 

period.994

VII. Anti-Evasion 

A. CFTC Anti-Evasion Rules 

1. CFTC’s Anti-Evasion Authority 

(a) Statutory Basis for the Anti-Evasion 

Rules 

Pursuant to the authority in sections 

721(c) and 725(g)(2) of the Dodd-Frank 

Act and CEA sections 1a(47)(E) and 

2(i),995 the CFTC is promulgating the 

anti-evasion rules as they were 

proposed and restating the 

accompanying interpretation with 

modifications in response to 

commenters. The CFTC also is 

providing an additional interpretation 

regarding rules 1.3(xxx)(6) and 1.6 

under the CEA. 

Section 721(c) of the Dodd-Frank Act 

requires the CFTC to further define the 

terms ‘‘swap,’’ ‘‘swap dealer,’’ ‘‘major 

swap participant,’’ and ‘‘eligible 

contract participant,’’ in order ‘‘[t]o 

include transactions and entities that 

have been structured to evade’’ subtitle 

A of Title VII (or an amendment made 

by subtitle A of the CEA). Moreover, as 

the CFTC noted in the Proposing 

Release,996 several other provisions of 

Title VII reference the promulgation of 

anti-evasion rules, including: 

• Subparagraph (E) of the definition 

of ‘‘swap’’ provides that foreign 

exchange swaps and foreign exchange 

forwards shall be considered swaps 

unless the Secretary of the Treasury 

makes a written determination that 

either foreign exchange swaps or foreign 

exchange forwards, or both, among 

other things, ‘‘are not structured to 

evade the [Dodd-Frank Act] in violation 

of any rule promulgated by the [CFTC] 

pursuant to section 721(c) of that 

Act;’’ 997

• Section 722(d) of the Dodd-Frank 

Act provides that the provisions of the 

CEA relating to swaps shall not apply to 

activities outside the United States 

unless those activities, among other 

things, ‘‘contravene such rules or 

regulations as the [CFTC] may prescribe 

or promulgate as are necessary or 

appropriate to prevent the evasion of 

any provision of [the CEA] that was 

enacted by the [Title VII];’’ 998 and 

• Section 725(g) of the Dodd-Frank 

Act amends the Legal Certainty for Bank 

Products Act of 2000 to provide that, 

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999The term ‘‘identified banking product’’ is 

defined in section 402 of the Legal Certainty for 

Bank Products Act of 2000, 7 U.S.C. 27. The term 

‘‘appropriate Federal banking agency’’ is defined in 

CEA section 1a(2), 7 U.S.C. 1a(2), and section 

3(a)(72) of the Exchange Act, 15 U.S.C. 78c(a)(72), 

which were added by sections 721(a) and 761(a) of 

the Dodd-Frank Act, respectively. 

1000Section 741(b) of the Dodd-Frank Act amends 

section 6(e) of the CEA, 7 U.S.C. 9a, to provide that 

any DCO, swap dealer, or major swap participant 

‘‘that knowingly or recklessly evades or participates 

in or facilitates an evasion of the requirements of 

section 2(h) [of the CEA] shall be liable for a civil 

monetary penalty in twice the amount otherwise 

available for a violation of section 2(h) [of the 

CEA].’’ This anti-evasion provision is not 

dependent upon the promulgation of a rule under 

section 721(c) of the Dodd Frank Act, and hence the 

proposed rule and interpretive guidance is not 

meant to apply to CEA section 6(e). 

1001See IECA Letter. 

1002 Id.; 7 U.S.C. 2(h)(4)(A) and 9a. 

1003See IECA Letter; 7 U.S.C. 2(i). 

1004CEA section 2(h)(4)(A), 7 U.S.C. 2(h)(4)(A), 

provides: The Commission shall prescribe rules 

under this subsection (and issue interpretations of 

rules prescribed under this subsection) as 

determined by the Commission to be necessary to 

prevent evasions of the mandatory clearing 

requirements under this Act. 

CEA section 6(e), 7 U.S.C. 9a, in relevant part, 

provides: (4) Any designated clearing organization 

that knowingly or recklessly evades or participates 

in or facilitates an evasion of the requirements of 

section 2(h) shall be liable for a civil money penalty 

in twice the amount otherwise available for a 

violation of section 2(h). (5) Any swap dealer or 

major swap participant that knowingly or recklessly 

evades or participates in or facilitates an evasion of 

the requirements of section 2(h) shall be liable for 

a civil money penalty in twice the amount 

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

1005See Barnard Letter and Better Markets Letter. 

1006See CME Letter; ISDA Letter; and SIFMA 

Letter. 

1007See ISDA Letter and SIFMA Letter. 

1008See CME Letter. 

1009Examples described in the guidance are 

illustrative and not exhaustive of the transactions, 

instruments or entities that could be considered 

evasive. In considering whether a transaction, 

instrument or entity is evasive, the CFTC will 

consider the facts and circumstances of each 

situation. 

1010See WGCEF Letter. 

1011 If a transaction is unlawful, the CFTC (or 

another authority) may be able to bring an action 

alleging a violation of the applicable rule, 

regulation, order or law. 

1012See supra part II.D.1. 

although identified banking products 

generally are excluded from the CEA, 

that exclusion shall not apply to an 

identified banking product that is a 

product of a bank that is not under the 

regulatory jurisdiction of an appropriate 

Federal banking agency,999 meets the 

definition of the terms ‘‘swap’’ or 

‘‘security-based swap,’’ and ‘‘has been 

structured as an identified banking 

product for the purpose of evading the 

provisions of the [CEA], the [Securities 

Act], or the [Exchange Act].’’ 1000

Comments 

One commenter asserted the CFTC 

has no statutory basis to promulgate the 

anti-evasion rules, as proposed.1001

Specifically, this commenter stated that 

neither CEA sections 2(h)(4)(A) nor 6(e) 

grant the CFTC authority to prescribe an 

anti-evasion rule and interpretation as 

described in the Proposing Release.1002

Moreover, this commenter argued that 

CEA section 2(i) limits the CFTC to 

prescribing anti-evasion rules related 

only to activities occurring outside of 

the United States.1003 The CFTC finds 

these comments misplaced because CEA 

sections 2(h)(4)(A) and 6(e) provide the 

CFTC with additional authority to 

prescribe anti-evasion rules for specific 

purposes above and beyond the 

authority provided by sections 721(c) 

and 725(g) of the Dodd-Frank Act and 

CEA sections 1a(47)(E) and 2(i), upon 

which the CFTC is relying in this 

rulemaking.1004 In addition, section 2(i) 

of the CEA provides that activities 

conducted outside the United States, 

including entering into agreements, 

contracts and transactions or structuring 

entities, which willfully evade or 

attempt to evade any provision of the 

CEA, shall be subject to the provisions 

of Subtitle A of Title VII of the DoddFrank Act; it does not limit the CFTC’s 

other authorities cited above. 

Accordingly, nothing in CEA sections 

2(h)(4)(A), 2(i) or 6(e) prevent the CFTC 

from prescribing rules 1.3(xxx)(6) and 

1.6. 

Two commenters supported the 

proposal’s ‘‘principles-based’’ approach 

to anti-evasion,1005 while several others 

suggested modifications.1006 Two 

commenters believed that the Proposing 

Release is overly broad and that, if the 

CFTC does finalize anti-evasion rules, 

such rules should be narrower in 

scope.1007 Similarly, one other 

commenter asserted that the CFTC erred 

in the Proposing Release by placing too 

great an emphasis on the flexibility of 

the rules as opposed to providing clarity 

for market participants.1008 The CFTC 

continues to believe a ‘‘principlesbased’’ approach to its anti-evasion 

rules is appropriate. The CFTC is not 

adopting an alternative approach, 

whereby it provides a bright-line test of 

non-evasive conduct, because such an 

approach may provide potential 

wrongdoers with a roadmap for 

structuring evasive transactions. 

Notwithstanding this concern, as 

described below, the CFTC is providing 

an additional interpretation and 

examples of evasion in order to provide 

clarity to market participants.1009

One commenter suggested an 

alternative standard for a finding of 

evasion should be ‘‘whether the 

transaction is lawful or not’’ under the 

CEA, CFTC rules and regulations, 

orders, or other applicable federal, state 

or other laws.1010 The CFTC is not 

adopting this suggested alternative 

standard for evasion because to adopt 

this standard would blur the distinction 

between whether a transaction (or 

entity) is lawful and whether it is 

structured in a way to evade the DoddFrank Act and the CEA. The antievasion rules provided herein are 

concerned with the latter conduct, not 

the former.1011 Thus, the CFTC does not 

believe it is appropriate to limit the 

enforcement of its anti-evasion authority 

to only unlawful transactions. 

2. Final Rules 

(a) Rule 1.3(xxx)(6) 

The CFTC is adopting the Rule 

1.3(xxx)(6) as proposed. As adopted, 

Rule 1.3(xxx)(6)(i) under the CEA 

generally defines as swaps those 

transactions that are willfully structured 

to evade the provisions of Title VII 

governing the regulation of swaps. 

Furthermore, rules 1.3(xxx)(6)(ii) and 

(iii) effectuate CEA section 1a(47)(E)(i) 

and section 725(g) of the Dodd-Frank 

Act, respectively, and will be applied in 

a similar fashion as rule 1.3(xxx)(6)(i). 

Rule 1.3(xxx)(6)(ii) applies to currency 

and interest rate swaps that are willfully 

structured as foreign exchange forwards 

or foreign exchange swaps to evade the 

new regulatory regime for swaps 

enacted in Title VII. Rule 1.3(xxx)(6)(iii) 

applies to transactions of a bank that are 

not under the regulatory jurisdiction of 

an appropriate Federal banking agency 

and where the transaction is willfully 

structured as an identified banking 

product to evade the new regulatory 

regime for swaps enacted in Title VII. 

Rule 1.3(xxx)(6)(iv) provides that in 

determining whether a transaction has 

been willfully structured to evade rules 

1.3(xxx)(6)(i) through (iii), the CFTC 

will not consider the form, label, or 

written documentation dispositive.1012

This approach is intended to prevent 

evasion through clever draftsmanship of 

a form, label, or other written 

documentation. 

Rule 1.3(xxx)(6)(v) further provides 

that transactions, other than 

transactions structured as securities, 

willfully structured to evade (as 

provided in rules 1.3(xxx)(6)(i) through 

(iii)) will be considered in determining 

whether a person is a swap dealer or 

major swap participant. 

Lastly, rule 1.3(xxx)(6)(vi) provides 

that rule 1.3(xxx)(6) will not apply to 

any agreement, contract or transaction 

structured as a security (including a 

security-based swap) under the 

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1013 15 U.S.C. 78c(a)(47). 

1014Proposing Release at 29866. 

1015The CFTC also is adopting the interpretive 

guidance from the Proposing Release, as proposed, 

but with certain clarifications. See infra part 

VII.A.3. 

1016See COPE Letter (requesting clarification that 

transacting in the physical markets (e.g., entering 

into nonfinancial commodity forward contracts), as 

opposed to executing a swap, would not be 

considered evasion). 

1017The CFTC is aware that there are 

circumstances where a forward contract can 

perform the same or a substantially similar 

economic function as a swap through alternative 

delivery procedures. Further, there are 

circumstances where a person who deals in both 

forwards and swaps may make decisions regarding 

financial risk assessment that will involve the 

consideration of regulatory obligations. The CFTC 

will carefully scrutinize the facts and circumstances 

associated with forward contracts. 

1018See MarketAxess Letter (commenting that the 

anti-evasion rules should not apply to transactions 

executed on, or subject to the rules of, a SEF, 

because before a SEF may list a swap, it must selfcertify or voluntarily obtain CFTC approval to list 

the product). 

1019Pursuant to part 40 of the CFTC’s regulations, 

17 CFR Part 40, registered SEFs and DCMs must 

self-certify with the CFTC that any products that 

they list ‘‘[comply] with the [CEA] and regulations 

thereunder’’ and are liable for any false selfcertifications. Therefore, market participants that 

have entered into such transactions will not be 

considered to be engaging in evasion, while a SEF 

or DCM could be found to have falsely self-certified. 

1020See WGCEF Letter (generally expressing 

concern that the penalty for anti-evasion is 

‘‘draconian’’) and IECA Letter (commenting that the 

non-evading party should not become a party to an 

evasive ‘‘swap’’ transaction, and thus subject to the 

regulatory requirements of the Dodd-Frank Act.) . 

1021The analysis of whether a party is ‘‘innocent’’ 

is based on the facts and circumstances of a 

particular transaction as well as a course of dealing 

by each of the parties. 

1022This is not dissimilar to an enforcement 

action for trading illegal off-exchange futures 

contracts in violation of CEA section 4(a), 7 U.S.C. 

6(a). The CFTC regularly seeks restitution for 

victims in enforcement actions where applicable. 

Additionally, victims retain their private rights of 

action for breach of contract and any related 

equitable remedies. 

1023 In considering which provisions of the CEA 

and CFTC regulations are relevant, the CFTC will 

evaluate which CEA provisions and CFTC 

regulations the evasive swap would have had to 

comply with had it not evaded the definition of 

swap (e.g., reporting, recordkeeping, clearing, etc.). 

However, where both parties have willfully 

structured to evade or attempted to evade the 

requirements of the Dodd-Frank Act, the CFTC may 

subject the agreement, contract, instrument, or 

transaction itself to the full regulatory regime and 

the willful evaders to applicable sanctions. 

1024 In other words, the evasive transaction would 

count toward the relevant thresholds (e.g., de 

minimis (with respect to determining swap dealer 

status, if the evasive transaction constituted dealing 

activity) and substantial position (with respect to 

determining major swap participant status)). 

1025See IECA Letter. This same commenter 

suggested that rule 1.3(xxx)(6)(v) should be applied 

only to the authorities regarding evasion provided 

by Congress and refer to the entity structuring the 

evading transaction have been addressed above. 

securities laws as defined in section 

3(a)(47) of the Exchange Act.1013

(b) Rule 1.6 

The CFTC is adopting rule 1.6 as 

proposed. Section 2(i) of the CEA states 

that the provisions of the CEA relating 

to swaps that were enacted by Title VII 

(including any rule prescribed or 

regulation promulgated thereunder) 

shall not apply to activities outside the 

United States unless, among other 

things, those activities ‘‘contravene such 

rules or regulations as the [CFTC] may 

prescribe or promulgate as are necessary 

or appropriate to prevent the evasion of 

any provision of [the CEA] that was 

enacted by [Title VII].’’ 

Pursuant to this authority, rule 1.6(a), 

as adopted, makes it unlawful to 

conduct activities outside the United 

States, including entering into 

transactions and structuring entities, to 

willfully evade or attempt to evade any 

provision of the CEA as enacted under 

Title VII or the rules and regulations 

promulgated thereunder. 

In addition, rule 1.6(b) provides that 

in determining whether a transaction or 

entity has been entered into or 

structured willfully to evade, as 

provided in rule 1.6(a), the CFTC will 

not consider the form, label, or written 

documentation as dispositive. 

Rule 1.6(c) provides that an activity 

conducted outside the United States to 

evade, as described in proposed rule 

1.6(a), shall be subject to the provisions 

of Subtitle A of Title VII of the DoddFrank Act. As the CFTC explained in 

the Proposing Release,1014 such 

provisions are necessary to fully prevent 

those who seek to willfully evade the 

regulatory requirements established by 

Congress in Title VII relating to swaps 

from enjoying any benefits from their 

efforts to evade. 

Lastly, rule 1.6(d) provides that no 

agreement, contract or transaction 

structured as a security (including a 

security-based swap) under the 

securities laws shall be deemed a swap 

pursuant to rule 1.6. 

(c) Interpretation of the Final Rules 

The CFTC is providing an 

interpretation of the final rules in 

response to commenters, addressing (i) 

the applicability of the anti-evasion 

rules to transactions that qualify for the 

forward exclusion, (ii) the applicability 

of the anti-evasion rules to transactions 

executed on a SEF, (iii) the treatment of 

evasive transactions after they are 

discovered, and (iv) documentation 

considerations.1015

With regard to the forward exclusion, 

the CFTC is clarifying, in response to a 

commenter,1016 that entering into 

transactions that qualify for the forward 

exclusion from the swap definition shall 

not be considered evasive. However, in 

circumstances where a transaction does 

not, in fact, qualify for the forward 

exclusion, the transaction may or may 

not be evasive depending on an analysis 

of all relevant facts and 

circumstances.1017

Concerning the applicability of the 

anti-evasion rules to transactions 

executed on a SEF, the CFTC is 

clarifying, in response to comments,1018

that a transaction that has been selfcertified by a SEF (or a DCM), or that 

has received prior approval from the 

CFTC, will not be considered 

evasive.1019

With respect to the treatment of 

evasive transactions after they are 

discovered, the CFTC is clarifying, in 

response to comments,1020 that in 

instances where one party willfully 

structures a transaction to evade but the 

counterparty does not, the transaction, 

which meets the swap definition under 

rule 1.3(xxx)(6), or is subject to the 

provisions of Subtitle A of Title VII 

pursuant to rule 1.6, will be subject to 

all CEA provisions and the regulations 

thereunder (as applied to the party who 

willfully structures a transaction to 

evade). In rare situations where there is 

a true ‘‘innocent party,’’1021 it will likely 

be due to fraud or misrepresentation by 

the evading party and the business 

consequences and remedies will be the 

same as for any such victim.1022 The 

CFTC will impose appropriate sanctions 

only on the willful evader for violations 

of the relevant provisions of the CEA 

and CFTC regulations since the 

individual agreement, contract or 

transaction was (and always should 

have been) subject to them.1023 Further, 

on a prospective basis for future 

transactions or instruments similar to 

those of the particular evasive swap, the 

CFTC will consider these transactions or 

instruments to be swaps within the 

meaning of the Dodd-Frank Act (as 

applied to both the party who willfully 

structures a transaction to evade and the 

‘‘innocent party’’). 

Moreover, evasive transactions will 

count toward determining whether each 

evading party with the requisite intent 

is a swap dealer or major swap 

participant.1024 In response to a 

commenter’s suggestion that, as 

proposed, rule 1.3(xxx)(6)(v) should 

require a pattern of transactions,1025 the 

CFTC is not requiring a pattern of 

evasive transactions as a prerequisite to 

prove evasion, although such a pattern 

may be one factor in analyzing whether 

evasion has occurred under rules 

1.3(xxx)(6) or 1.6. Further, in 

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48300 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1026Thus, for example, if a person, in seeking to 

evade Title VII, structures a product that is a 

privilege on a certificate of deposit, the CFTC’s antievasion rules would not be implicated because CEA 

section 1a(47)(B)(iii), 7 U.S.C. 1a(47)(B)(iii), 

excludes such a product from the swap definition. 

1027Rules 1.3(xxx)(6)(iv) and 1.6(b) provide that 

‘‘in determining whether a transaction has been 

willfully structured to evade, neither the form, 

label, nor written documentation of the transaction 

shall be dispositive.’’ 

1028Proposing Release at 29866. 

1029Cargill v. Hardin, 452 F.2d 1154, 1163 (8th 

Cir. 1971). 

1030See supra part II.D.1. 

1031See CME Letter; COPE Letter; IECA Letter; 

MarketAxess Letter; and WGCEF Letter. 

1032See COPE Letter. 

1033See MarketAxess Letter. 

1034See IECA Letter and WGCEF Letter. 

1035See IECA Letter. 

1036 Id. 

1037See WGCEF Letter. 

1038See CME Letter. 

1039 Id. 

1040 Id. 

1041 Id. 

1042See ISDA Letter. 

determining whether such a transaction 

is a swap, the CFTC will consider 

whether the transaction meets the 

definition of the term ‘‘swap’’ as defined 

by statute and as it is further defined in 

this rulemaking.1026

As an illustration of some of the 

foregoing concepts, if the market for 

foreign exchange forwards on a 

particular currency settles on a T+ 4 

basis, but two counterparties agree to 

expedite the settlement of an foreign 

exchange forward on such currency to 

characterize the transaction falsely as a 

spot transaction in order to avoid 

reporting the transaction, rule 

1.3(xxx)(6)(i) would define the 

transaction as a swap. In this example, 

both parties may be subject to sanctions 

if they both have the requisite intent 

(i.e., willfully evaded). However, had 

the counterparty with the reporting 

obligation in this example convinced 

the other counterparty, by using a false 

rationale unrelated to avoiding 

reporting, to expedite the foreign 

exchange forward settlement in order to 

avoid reporting, then the only party that 

would be at risk for sanctions (i.e., the 

only party with the requisite intent) 

would be the counterparty with the 

reporting obligation who deceived the 

other counterparty. 

With regard to documentation 

considerations, as discussed above, the 

CFTC is adopting rules 1.3(xxx)(6)(iv) 

and 1.6(b), as proposed,1027 but is 

providing the following interpretation. 

As stated in the Proposing Release,1028

the structuring of instruments, 

transactions, or entities to evade the 

requirements of the Dodd-Frank Act 

may be ‘‘limited only by the ingenuity 

of man.’’1029 Therefore, the CFTC will 

look beyond manner in which an 

instrument, transaction, or entity is 

documented to examine its actual 

substance and purpose to prevent any 

evasion through clever draftsmanship— 

an approach consistent with the CFTC’s 

case law in the context of determining 

whether a contract is a futures contract 

and the CFTC’s interpretations in this 

release regarding swaps.1030 The 

documentation of an instrument, 

transaction, or entity (like its form or 

label) is a relevant, but not dispositive, 

factor in determining whether evasion 

has occurred. 

Comments 

The CFTC received a number of 

comments on various aspects of 

proposed rules 1.3(xxx)(6) and 1.6. 

Several commenters requested clarity 

as to what types of transactions might be 

considered evasive under proposed rule 

1.3(xxx)(6) and 1.6.1031 One commenter 

requested that the CFTC clarify that 

transacting in the physical markets (e.g., 

entering into nonfinancial commodity 

forward contracts), as opposed to 

executing a swap, would not be 

considered evasion.1032 As discussed 

above, the CFTC has provided an 

interpretation regarding the 

applicability of the anti-evasion rules to 

transactions that qualify for the forward 

exclusion. Another commenter 

requested that the CFTC clarify that the 

anti-evasion rules would not apply to 

transactions executed on a SEF because, 

before a SEF may list a swap, it must 

self-certify or voluntarily obtain CFTC 

permission to list that product.1033 The 

CFTC has provided an interpretation 

discussed above to address this 

comment. 

Two commenters expressed concern 

regarding the penalty to the 

counterparties to a transaction that is 

deemed to violate the CFTC’s antievasion provisions.1034 Pursuant to the 

final rule, when a transaction violates 

the anti-evasion rules, the CFTC will 

consider the transaction a swap. One of 

these commenters said that the nonevading party should not unilaterally 

become a party to a swap, and thus be 

subject to the regulatory requirements of 

the Dodd-Frank Act.1035 This 

commenter believed the rule should be 

clear that only the ‘‘evading’’ party 

would become a party to a swap, but the 

‘‘non-evading’’ party would not.1036 The 

other comments believed that a 

transaction that is determined to have 

violated the CFTC’s anti-evasion rules 

should be considered a swap only if it 

meets all other aspects of the statutory 

definition of the term ‘‘swap.’’ 1037 The 

CFTC agrees that the anti-evasion rules 

are not meant to ‘‘punish the innocent,’’ 

but rather to appropriately address the 

evading counterparty’s or 

counterparties’ failure to meet the 

requirements of the Dodd-Frank Act. 

Therefore, the CFTC has provided an 

interpretation described above about 

how a transaction, discovered to have 

evaded the CEA or the Dodd-Frank Act 

(and therefore, a swap under rule 

1.3(xxx)(6) or subject to the provisions 

of Subtitle A under rule 1.6) will be 

treated after the evasion is discovered. 

Furthermore, the CFTC agrees that a 

transaction that is determined to have 

violated the CFTC’s anti-evasion rules 

will be considered a swap only if it 

meets the definition of the term ‘‘swap,’’ 

and has provided an interpretation to 

address this comment. In response to 

both comments, the CFTC also has 

provided an example to illustrate the 

concepts in the interpretation. 

The CFTC received one comment 

regarding rules 1.3(xxx)(6)(iv) and 

1.6(b). This commenter believed that a 

difference exists between 

‘‘documentation,’’ which contains 

terms, conditions, etc. of an agreement, 

and the ‘‘form or label.’’ 1038 Thus, 

because a form or label may be 

duplicitously assigned to a transaction, 

this commenter agreed that neither the 

form nor the label should be 

dispositive.1039 However, because 

documentation contains the substance 

of an agreement, this commenter 

believed that documentation should be 

dispositive in determining whether a 

given contract has been entered to 

willfully evade because the substance of 

a contract is derived from its 

documentation.1040 Alternatively, this 

commenter requested that if the CFTC 

does not amend its proposal, the CFTC 

clarify what evidence or subject matter 

would be dispositive of willful 

evasion.1041 The CFTC disagrees with 

these comments and has provided an 

interpretation discussed above that the 

documentation of an instrument, 

transaction, or entity is a relevant, but 

not dispositive, factor. This view not 

only is consistent with CFTC case law, 

and the CFTC’s interpretations herein, 

but reduces the possibility of providing 

a potential roadmap for evasion. 

Two commenters raised issues 

applicable to proposed rule 1.6 alone. 

One commenter believed that proposed 

rule 1.6 should not be adopted until the 

cross-border application of the swap 

provisions of Title VII is addressed.1042

The CFTC disagrees and believes that 

the rule provides sufficient clarity to 

market participants even though the 

CFTC has not yet finalized guidance 

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1043See CME Letter. 

1044See Proposing Release at 29865. 

1045 15 U.S.C. 1604(a) provides, in relevant part, 

that the Federal Reserve Board: shall prescribe 

regulations to carry out the purposes of this 

subchapter * * *. [T]hese regulations may contain 

such classifications, differentiations, or other 

provisions, and may provide for such adjustments 

and exceptions for any class of transactions, as in 

the judgment of the Board are necessary or proper 

to effectuate the purposes of this subchapter, to 

prevent circumvention or evasion thereof, or to 

facilitate compliance therewith. 

In affirming the Board’s promulgation of 

Regulation Z, the Supreme Court noted that antievasion provisions such as section 1604(a) evince 

Congress’s intent to ‘‘stress[] the agency’s power to 

counteract attempts to evade the purposes of a 

statute.’’ Mourning v. Family Publ’ns Serv., Inc., 411 

U.S. 356, 370 (1973) (citing Gemsco v. Walling, 324 

U.S. 244 (1945) (giving great deference to a 

regulation promulgated under similar preventionof-evasion rulemaking authority in the Fair Labor 

Standards Act)). 

1046 31 U.S.C. 5324 (stating, in pertinent part, that 

‘‘[n]o person shall, for the purpose of evading the 

reporting requirements of [the Bank Secrecy Act 

(BSA) or any regulation prescribed thereunder] 

* * * . structure or assist in structuring, or attempt 

to structure or assist in structuring, any transaction 

with one or more domestic financial institutions’’). 

The Federal Deposit Insurance Corporation 

regulations implementing the BSA require banks to 

report transactions that ‘‘the bank knows, suspects, 

or has reason to suspect’’ are ‘‘designed to evade 

any regulations promulgated under the Bank 

Secrecy Act.’’ 12 CFR 353.3 (2010). 

1047The Internal Revenue Code makes it unlawful 

for any person willfully to attempt ‘‘in any manner 

to evade or defeat any tax * * * .’’ 26 U.S.C. 7201. 

While a considerable body of case law has 

developed under the tax evasion provision, the 

statute itself does not define the term, but generally 

prohibits willful attempts to evade tax. 

1048Proposing Release at 29867. 

1049As the CFTC observed in the Proposing 

Release, a similar concept applies with respect to 

tax evasion. See Proposing Release at 29867 n. 324. 

A transaction that is structured to avoid the 

payment of taxes but that lacks a valid business 

purpose may be found to constitute tax evasion. 

See, e.g., Gregory v. Helvering, 293 U.S. 465, 469 

(1935) (favorable tax treatment disallowed because 

transaction lacked any business or corporate 

purpose). Under the ‘‘sham-transaction’’ doctrine, 

‘‘a transaction is not entitled to tax respect if it lacks 

economic effects or substance other than the 

generation of tax benefits, or if the transaction 

serves no business purpose.’’ Winn-Dixie Stores, 

Inc. v. Comm’r, 254 F.3d 1313, 1316 (11th Cir. 

2001) (citing Knetsch v. United States, 364 U.S. 361 

(1960)). ‘‘The doctrine has few bright lines, but ‘it 

is clear that transactions whose sole function is to 

produce tax deductions are substantive shams.’ ’’ Id. 

(quoting United Parcel Serv. of Am., Inc. v. Comm’r, 

254 F.3d 1014, 1018 (11th Cir. 2001)). To be clear, 

though, while the Proposing Release references the 

use of the business purpose test in tax law, the 

CFTC is not using the legitimate business purpose 

consideration in the same manner as the IRS. 

regarding the cross-border application of 

the swap provisions of the Dodd-Frank 

Act. The other commenters believed 

that the proposed rule text and 

interpretation does not fully explain 

how the CFTC would apply proposed 

rule 1.6 in determining whether a swap 

subject to foreign jurisdiction and 

regulated by a foreign regulator is 

evasive.1043 As stated above, an 

agreement, contract, instrument or 

transaction that is found to have been 

willfully structured to evade will be 

subject to CEA provisions and the 

regulations thereunder pursuant to rule 

1.6(c). 

3. Interpretation Contained in the 

Proposing Release 

The CFTC is restating the 

interpretation contained in the 

Proposing Release,1044 but is providing 

additional clarification regarding certain 

types of circumstances that may (or may 

not) constitute an evasion of the 

requirements of Title VII. However, the 

CFTC notes that each activity will be 

evaluated on a case-by-case basis with 

consideration given to all relevant facts 

and circumstances. 

In developing its interpretation, the 

CFTC considered legislative, 

administrative, and judicial precedent 

with respect to the anti-evasion 

provisions in other Federal statutes. For 

example, the CFTC examined the antievasion provisions in the Truth in 

Lending Act,1045 the Bank Secrecy 

Act,1046 and the Internal Revenue 

Code.1047

The CFTC will not consider 

transactions, entities, or instruments 

structured in a manner solely motivated 

by a legitimate business purpose to 

constitute willful evasion (‘‘Business 

Purpose Test’’). Additionally, relying on 

Internal Revenue Service (‘‘IRS’’) 

concepts, when determining whether 

particular conduct is an evasion of the 

Dodd-Frank Act, the CFTC will consider 

the extent to which the conduct 

involves deceit, deception, or other 

unlawful or illegitimate activity. 

(a) Business Purpose Test 

Interpretation 

Consistent with the Proposing 

Release,1048 the CFTC recognizes that 

transactions may be structured, and 

entities may be formed, in particular 

ways for legitimate business purposes, 

without any intention of circumventing 

the requirements of the Dodd-Frank Act 

with respect to swaps. Thus, in 

evaluating whether a person is evading 

or attempting to evade the swap 

requirements with respect to a 

particular instrument, entity, or 

transaction, the CFTC will consider the 

extent to which the person has a 

legitimate business purpose for 

structuring the instrument or entity or 

entering into the transaction in that 

particular manner. Although different 

means of structuring a transaction or 

entity may have differing regulatory 

implications and attendant 

requirements, absent other indicia of 

evasion, the CFTC will not consider 

transactions, entities, or instruments 

structured in a manner solely motivated 

by a legitimate business purpose to 

constitute evasion. However, to the 

extent a purpose in structuring an entity 

or instrument or entering into a 

transaction is to evade the requirements 

of Title VII with respect to swaps, the 

structuring of such instrument, entity, 

or transaction may be found to 

constitute willful evasion.1049

Although some commenters suggest 

that the determination that there is a 

legitimate business purpose, and the use 

of that concept as a relevant fact in the 

determination of the possibility of 

evasion, will not provide appropriate 

clarity, it is a recognized analytical 

method and would be useful in the 

overall analysis of potentially willful 

evasive conduct. 

The CFTC fully expects that a person 

acting for legitimate business purposes 

within its respective industry will 

naturally weigh a multitude of costs and 

benefits associated with different types 

of financial transactions, entities, or 

instruments, including the applicable 

regulatory obligations. In that regard, 

and in response to commenters, the 

CFTC is clarifying that a person’s 

specific consideration of regulatory 

burdens, including the avoidance 

thereof, is not dispositive that the 

person is acting without a legitimate 

business purpose in a particular case. 

The CFTC will view legitimate business 

purpose considerations on a case-bycase basis in conjunction with all other 

relevant facts and circumstances. 

Moreover, the CFTC recognizes that it 

is possible that a person intending to 

willfully evade Dodd-Frank may 

attempt to justify its actions by claiming 

that they are legitimate business 

practices in its industry; therefore, the 

CFTC will retain the flexibility, via an 

analysis of all relevant facts and 

circumstances, to confirm not only the 

legitimacy of the business purpose of 

those actions but whether the actions 

could still be determined to be willfully 

evasive. For example, a person may 

attempt to disguise a product that may 

be a swap by employing accounting 

practices that are not appropriate for 

swaps. Whether or not the method of 

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1050See CME Letter and WGCEF Letter. 

1051See CME Letter. 

1052See ISDA Letter and WGCEF Letter. 

1053See SIFMA Letter. 

1054 Id. 

1055Whereas permissible means of reducing tax 

(or ‘‘tax avoidance,’’ as the IRS refers to the 

practice) is associated with full disclosure and 

explanation of why the tax should be reduced 

under law, tax evasion consists of the willful 

attempt to evade tax liability, and generally 

involves ‘‘deceit, subterfuge, camouflage, 

concealment, or some attempt to color or obscure 

events or to make things seem other than they are.’’ 

The IRS explains: 

Avoidance of taxes is not a criminal offense. Any 

attempt to reduce, avoid, minimize, or alleviate 

taxes by legitimate means is permissible. The 

distinction between avoidance and evasion is fine, 

yet definite. One who avoids tax does not conceal 

or misrepresent. He/she shapes events to reduce or 

eliminate tax liability and, upon the happening of 

the events, makes a complete disclosure. Evasion, 

on the other hand, involves deceit, subterfuge, 

camouflage, concealment, some attempt to color or 

obscure events or to make things seem other than 

they are. For example, the creation of a bona fide 

partnership to reduce the tax liability of a business 

by dividing the income among several individual 

partners is tax avoidance. However, the facts of a 

particular investigation may show that an alleged 

partnership was not, in fact, established and that 

one or more of the alleged partners secretly 

returned his/her share of the profits to the real 

owner of the business, who, in turn, did not report 

this income. This would be an instance of 

attempted evasion. IRS, Internal Revenue Manual, 

part 9.1.3.3.2.1, available at http://www.irs.gov/irm/ 

part9/irm_09-001-003.html#d0e169. 

1056See In re Squadrito, [1990–1992 Transfer 

Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,262 (CFTC 

Mar. 27, 1992) (adopting definition of ‘‘willful’’ in 

McLaughlin v. Richland Shoe Co., 486 U.S. 128 

(1987)). 

1057See CME Letter. 

1058See ISDA Letter and SIFMA Letter. 

1059See ISDA Letter (citing U.S. v. Tarallo, 380 

F.3d 1174, 1187 (9th Cir. 2004), and Merck & Co. 

v. Reynolds, 130 S. Ct. 1784, 1796 (2010)). 

1060See CME Letter; ISDA Letter; and WGCEF 

Letter. 

1061See supra note 1056. 

accounting or employed accounting 

practices are determined to be for 

legitimate business purposes, that alone 

will not be dispositive in determining 

whether it is willfully evasive according 

to either rule 1.3(xxx)(6) or 1.6. 

Because transactions and instruments 

are regularly structured, and entities 

regularly formed, in a particular way for 

various, and often times multiple, 

reasons, it is essential that all relevant 

facts and circumstances be considered. 

Where a transaction, instrument, or 

entity is structured solely for legitimate 

business purposes, it is not willfully 

evasive. By contrast, where a 

consideration of all relevant facts and 

circumstances reveals the presence of a 

purpose that is not a legitimate business 

purpose, evasion may exist. 

Comments 

Two commenters believed the 

proposed business purpose test is 

inappropriate for determining if a 

transaction is structured to evade Title 

VII.1050 One of these commenters stated 

that the CFTC misunderstood how the 

‘‘business purpose’’ test is applied by 

the IRS in the tax evasion context 

resulting in misguided proposed 

interpretive guidance.1051 As stated 

above, the CFTC believes that it is 

appropriate to consider legitimate 

business purposes in determining if a 

transaction is structured to evade Title 

VII. In response to this comment, 

although the interpretation references 

the use of legitimate business purpose 

in tax law, the CFTC is not bound to use 

the legitimate business purpose 

consideration in the same manner as the 

IRS and, accordingly, is not adopting 

the IRS’s interpretation. 

Two commenters urged the CFTC to 

clarify that considering the costs of 

regulation is a legitimate business 

purpose when structuring a transaction. 

Accordingly, they request that the CFTC 

clarify that entering into a transaction to 

avoid costly regulations, even though 

that transaction could otherwise be 

structured as a swap, will not be 

considered per se evasion/evasive.1052

Finally, one commenter took issue with 

the statement that ‘‘absent other indicia 

of evasion, [the CFTC] would not 

consider transactions, entities, or 

instruments in a manner solely 

motivated by a legitimate business 

purpose to constitute evasion.’’ 1053

Because ‘‘transactions, entities, or 

instruments’’ are rarely structured a 

certain way solely for one purpose, this 

commenter believed such a statement 

does not give market participants any 

relief or guidance.1054 The CFTC has 

addressed these comments received on 

the business purpose test through the 

clarifications to its interpretation 

discussed above and reiterates that the 

CFTC will consider all relevant facts 

and circumstances in determining 

whether an action is willfully evasive. 

(b) Fraud, Deceit or Unlawful Activity 

Interpretation 

When determining whether a 

particular activity constitutes willful 

evasion of the CEA or the Dodd-Frank 

Act, the CFTC will consider the extent 

to which the activity involves deceit, 

deception, or other unlawful or 

illegitimate activity. This concept was 

derived from the IRS’s delineation of 

what constitutes tax evasion, as 

elaborated upon by the courts. The IRS 

distinguishes between tax evasion and 

legitimate means for citizens to 

minimize, reduce, avoid or alleviate the 

tax that they pay under the Internal 

Revenue Code.1055 Similarly, persons 

that craft derivatives transactions, 

structure entities, or conduct themselves 

in a deceptive or other illegitimate 

manner in order to avoid regulatory 

requirements should not be permitted to 

enjoy the fruits of their deceptive or 

illegitimate conduct. 

Although it is likely that fraud, deceit, 

or unlawful activity will be present 

where willful evasion has occurred, the 

CFTC does not believe that these factors 

are prerequisites to an evasion finding. 

As stated throughout this release, the 

presence or absence of fraud, deceit, or 

unlawful activity is one fact (or 

circumstance) the CFTC will consider 

when evaluating a person’s activity. 

That said, the anti-evasion rules do 

require willfulness, i.e. ‘‘scienter.’’ In 

response to the commenter who 

requests the CFTC define ‘‘willful 

conduct,’’ the CFTC will interpret 

‘‘willful’’ consistent with how the CFTC 

has in the past, that a person acts 

‘‘willfully’’ when they act either 

intentionally or with reckless 

disregard.1056

Comments 

One commenter, although generally 

supportive of the use of the IRS ‘‘tax 

evasion’’ concept as a guidepost for this 

criterion, requested the CFTC provide 

examples of legitimate versus evasive 

conduct in a manner similar to what is 

contained in the Internal Revenue 

Manual.1057 The CFTC does not believe 

it is appropriate to provide an example 

because such an example may provide 

a guidepost for evasion. 

Two commenters suggested that a 

finding of fraud, deceit, or unlawful 

activity should be a prerequisite to any 

finding of evasion.1058 As noted above, 

the CFTC disagrees that such activity 

should be a prerequisite to a finding of 

evasion, but its presence or absence is 

one relevant fact and circumstance the 

CFTC will consider. Finally, one 

commenter requested further guidance 

defining willful conduct in the context 

of deliberate and knowing 

wrongdoing.1059 As noted above, the 

CFTC has considered the suggestion that 

the CFTC provide guidance on what 

defines ‘‘willful behavior,’’ with some 

commenters submitting that some 

definitional guidance should be offered 

or that the standard should be whether 

or not a transaction is ‘‘lawful.’’ 1060 The 

CFTC agrees with the need for legal 

clarity and believes that the concept of 

willfulness is a well-recognized legal 

concept of which there is substantial 

case law and legal commentary familiar 

to the financial industry.1061

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1062See Barnard Letter and Better Markets Letter. 1063See Barnard Letter. 1064See Effective Date and Implementation infra 

part IX. 1065See CME Letter. 

1066 Id. CME suggested that the CFTC modify the 

futures contract exclusion in CEA Section 

1a(47)(B)(i) so that the modified language would 

read as follows: (B) EXCLUSIONS.—The term 

‘swap’ does not include— (i) any contract for the 

sale of a commodity for future delivery listed for 

trading by a designated contract market (or option 

on such contract) * * * CME believes that such a 

rule would clarify the scope of Section 4(a) of the 

CEA, which makes it illegal to trade a futures 

contract except on or subject to the rules of a DCM. 

CME believed that such a modification would 

clarify the scope of Section 4(a) of the CEA, 7 U.S.C. 

6(a), which makes it unlawful to trade a futures 

contract except on or subject to the rules of a DCM. 

1067See, e.g., Swap Policy Statement, supra note 

214. 

1068 17 CFR Part 40. 

1069CEA section 1a(47)(B)(ix), 7 U.S.C. 

1a(47)(B)(ix). 

1070For this purpose, we consider the 

‘‘international financial institutions’’ to be those 

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

and the institutions defined as ‘‘multilateral 

development banks’’ in the Proposal for the 

Regulation of the European Parliament and of the 

Council on OTC Derivative Transactions, Central 

Counterparties and Trade Repositories, Council of 

the European Union Final Compromise Text, 

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

between the two definitions, but together they 

include the following institutions: the International 

Monetary Fund, International Bank for 

Reconstruction and Development, European Bank 

for Reconstruction and Development, International 

Development Association, International Finance 

Corporation, Multilateral Investment Guarantee 

Agency, African Development Bank, African 

Development Fund, Asian Development Bank, 

Inter-American Development Bank, Bank for 

Economic Cooperation and Development in the 

Middle East and North Africa, Inter-American 

Investment Corporation, Council of Europe 

Development Bank, Nordic Investment Bank, 

Caribbean Development Bank, European Investment 

Bank and European Investment Fund. (The term 

international financial institution includes entities 

referred to as multilateral development banks. The 

International Bank for Reconstruction and 

Development, the International Finance 

Corporation and the Multilateral Investment 

Guarantee Agency are parts of the World Bank 

Group.) The Bank for International Settlements, 

which also submitted a comment, is a bank in 

which the Federal Reserve and foreign central 

banks are members. Another commenter, KfW, is a 

corporation owned by the government of the 

Federal Republic of Germany and the German State 

governments and backed by the ‘‘full faith and 

credit’’ of the Federal Republic of Germany. 

1071But see Dissent of Commissioner Sommers, 

Proposing Release at 29899. 

1072See Letter from Gu ̈nter Pleines and Diego 

Devos, Bank for International Settlements, dated 

July 20, 2011; Letter from Jacques Mirante-Pe ́re ́ and 

Jan De Bel, Council of Europe Development Bank, 

dated July 22, 2011; Letter from Isabelle Laurant, 

European Bank for Reconstruction and 

Development, dated July 22, 2011; Letter from A. 

Querejeta and B. de Mazie`res, European Investment 

Bank, dated July 22, 2011; Letter from J. James 

Spinner and S<ren Elbech, Inter-American 

Development Bank, dated July 22, 2011; Letter from 

Lutze-Christian Funke and Frank Czichowski, KfW, 

dated August 12, 2011; Letter from Heikki Cantell 

and Lars Eibeholm, Nordic Investment Bank, dated 

August 2, 2011; and Letter from Vicenzo La Via, 

World Bank Group, dated July 22, 2011. 

B. SEC Position Regarding Anti-Evasion 

Rules 

Section 761(b)(3) of the Dodd-Frank 

Act grants discretionary authority to the 

SEC to define the terms ‘‘security-based 

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

‘‘major security-based swap 

participant,’’ and ‘‘eligible contract 

participant,’’ with regard to securitybased swaps, ‘‘for the purpose of 

including transactions and entities that 

have been structured to evade’’ subtitle 

B of Title VII (or amendments made by 

subtitle B). 

The SEC did not propose rules under 

section 761(b)(3) regarding anti-evasion 

but requested comment on whether SEC 

rules or interpretive guidance 

addressing anti-evasion with respect to 

security-based swaps, security-based 

swap dealers, major security-based swap 

participants, or ECPs were necessary. 

Two commenters responded to the 

request for comment and recommended 

that the SEC adopt anti-evasion rules 

and interpretive guidance.1062 One 

commenter suggested that the SEC 

model its anti-evasion rules and 

interpretive guidance on the CFTC’s 

anti-evasion rules.1063

The SEC is not adopting anti-evasion 

rules under section 761(b)(3) at this 

time. The SEC notes that since securitybased swaps are ‘‘securities’’ for 

purposes of the Federal securities laws, 

unless the SEC grants a specific 

exemption,1064 all of the SEC’s existing 

regulatory authority will apply to 

security-based swaps. Since existing 

regulations, including antifraud and 

anti-manipulation provisions, will 

apply to security-based swaps, the SEC 

believes that it is unnecessary to adopt 

additional anti-evasion rules for 

security-based swaps under section 

761(b)(3) at this time. 

VIII. Miscellaneous Issues 

A. Distinguishing Futures and Options 

From Swaps 

The Commissions did not propose 

rules or interpretations in the Proposing 

Release regarding distinguishing futures 

from swaps. One commenter requested 

that the CFTC clarify that nothing in the 

release was intended to limit a DCM’s 

ability to list for trading a futures 

contract regardless of whether it could 

be viewed as a swap if traded over-thecounter or on a SEF, since futures and 

swaps are indistinguishable in material 

economic effects.1065 This commenter 

further recommended that the CFTC 

adopt a final rule that further interprets 

the statutory ‘‘swap’’ definition.1066

The CFTC declines to provide the 

requested clarification or adopt a rule. 

Prior distinctions that the CFTC relied 

upon (such as the presence or absence 

of clearing) to distinguish between 

futures and swaps may no longer be 

relevant.1067 As a result, it is difficult to 

distinguish between futures and swaps 

on a blanket basis as the commenter 

suggested. However, a case-by-case 

approach for distinguishing these 

products may lead to more informed 

decision-making by the CFTC. 

Moreover, the CFTC notes that a DCM 

may self-certify its contracts pursuant to 

Part 40 of the CFTC’s rules,1068 subject 

to the CFTC’s oversight authority. If a 

DCM has a view that a particular 

product is a futures contract, it may selfcertify the contract consistent with that 

view. The DCM also has a number of 

other options, including seeking prior 

approval from the CFTC, requesting an 

interpretation, or requesting a 

rulemaking if it is in doubt about 

whether a particular agreement, contract 

or transaction should be classified as a 

futures contract or a swap. 

B. Transactions Entered Into by Foreign 

Central Banks, Foreign Sovereigns, 

International Financial Institutions, and 

Similar Entities 

The swap definition excludes ‘‘any 

agreement, contract, or transaction a 

counterparty of which is a Federal 

Reserve bank, the Federal Government, 

or a Federal agency that is expressly 

backed by the full faith and credit of the 

United States.’’ 1069 Some commenters 

to the ANPR suggested that the 

Commissions should exercise their 

authority to further define the terms 

‘‘swap’’ to similarly exclude 

transactions in which a counterparty is 

a foreign central bank, a foreign 

sovereign, an international financial 

institution (‘‘IFI’’),1070 or similar 

organization. ANPR commenters 

advanced international comity, national 

treatment, limited regulatory resources, 

limits on the Commissions’ respective 

extraterritorial jurisdiction, and 

international harmonization as 

rationales for such an approach. The 

Proposing Release was silent on this 

issue.1071

Comments 

Several commenters asserted that 

swaps transactions to which an IFI is a 

counterparty should be excluded from 

the swap and security-based swap 

definitions.1072 In addition to the 

arguments noted above, commenters 

asserted that certain IFIs have been 

granted certain statutory immunities by 

the United States, and that regulation 

under the Dodd-Frank Act of their 

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1073The commenters’ suggested exclusion from 

the swap definition would also exclude their 

transactions from the security-based swap 

definition, which is based on the definition of 

swap. 

1074See section 2(a)(17) of the Securities Act, 15 

U.S.C. 77b(a)(17). 

1075See sections 3(a)(69) of the Exchange Act, 15 

U.S.C. 78c(a)(69), and 3(a)(68) of the Exchange Act, 

15 U.S.C. 78c(a)(68). The definitions of the terms 

‘‘swap’’ and ‘‘security-based swap’’ in the Exchange 

Act are the same as the definitions of these terms 

in the CEA. See section 1a of the CEA, 7 U.S.C. 1a. 

1076See rule 194 under the Securities Act. 

1077 76 FR 39927 (Jul. 7, 2011) (‘‘Exchange Act 

Exemptive Order’’). The Exchange Act Exemptive 

Order grants temporary relief and provides 

interpretive guidance to make it clear that a 

substantial number of the requirements of the 

Exchange Act do not apply to security-based swaps 

as a result of the revised definition of ‘‘security’’ 

going into effect on July 16, 2011. The Exchange Act 

Exemptive Order also provided temporary relief 

from provisions of the Exchange Act that allow the 

voiding of contracts made in violation of those 

laws. 

1078Rule 240 under the Securities Act, 17 CFR 

230.240, rules 12a–11 and 12h–1(i) under the 

Exchange Act 1934, 17 CFR 240.12a–11 and 

240.12h–1(i), and Rule 4d–12 under the Trust 

Indenture Act of 1939, 17 CFR 260.4d–12 (‘‘SB 

Swaps Interim Final Rules’’). See also 76 FR 40605 

(Jul. 11, 2011). The SB Swaps Interim Final Rules 

provide exemptions under the Securities Act, the 

Exchange Act, and the Trust Indenture Act of 1939 

for those security-based swaps that prior to July 16, 

2011, were security-based swap agreements and are 

defined as ‘‘securities’’ under the Securities Act and 

the Exchange Act as of July 16, 2011, due solely to 

the provisions of the Dodd-Frank Act. The SB 

Swaps Interim Final Rules exempt offers and sales 

of these security-based swaps from all provisions of 

the Securities Act, other than the Section 17(a) antifraud provisions, as well as exempt these securitybased swaps from Exchange Act registration 

requirements and from the provisions of the Trust 

Indenture Act of 1939, provided certain conditions 

are met. 

1079See supra note 12. 

1080The SEC has received a request for certain 

permanent exemptions upon the expiration of the 

exemptions contained in the Exchange Act 

Exemptive Order. See SIFMA SBS Exemptive Relief 

Request (Dec. 5, 2011), which is available at 

http://www.sec.gov/comments/s7-27-11/s72711- 

10.pdf. The SEC also has received comments 

regarding the exemptions under the Securities Act, 

the Exchange Act, and the Trust Indenture Act of 

1939. See Letter from Kenneth E. Bentsen, Jr., 

Executive Vice President, Public Policy and 

Advocacy, SIFMA, and Robert Pickel, Chief 

Executive Officer, ISDA, dated Apr. 20, 2012, which 

is available at http://www.sec.gov/comments/s7-26- 

11/s72611-5.pdf. The SEC is reviewing the request 

for exemptive relief and each related comment and 

will consider any appropriate actions regarding 

such request. 

activities would be inconsistent with 

the grant of these immunities. 

The CFTC declines to provide an 

exclusion from the swap definition 

along the lines suggested by these 

commenters.1073 An exclusion from the 

swap definition for swap transactions 

entered into by foreign sovereigns, 

foreign central banks, IFIs and similar 

entities, would mean that swaps entered 

into by such entities would be 

completely excluded from Dodd-Frank 

regulation. Their counterparties, who 

may be swap dealers or major swap 

participants, or security-based swap 

dealers or major security-based swap 

participants, would have no regulatory 

obligations with respect to such swaps. 

These regulated counterparties could 

develop significant exposures to the 

foreign sovereigns, foreign central 

banks, IFIs and similar entities, without 

the knowledge of the Commissions. 

In addition, swaps entered into by 

foreign sovereigns, foreign central 

banks, IFIs and similar entities 

undeniably are swaps. To be sure, the 

Commissions have adopted rules and 

interpretations to further define the term 

‘‘swap’’ to exclude certain transactions, 

which prior to the enactment of the 

Dodd-Frank Act generally would not 

have been considered swaps. However, 

the CFTC is not using its authority to 

further define the term ‘‘swap’’ to 

effectively exempt transactions that are, 

in fact, swaps. While, as noted above, 

Congress included a counterpartyspecific exclusion for swaps entered 

into by the Federal Reserve Board, the 

Federal government and certain 

government agencies, Congress did not 

provide a similar exemption for foreign 

central banks, foreign sovereigns, IFIs, 

or similar organizations. 

C. Definition of the Terms ‘‘Swap’’ and 

‘‘Security-Based Swap’’ as Used in the 

Securities Act 

The SEC is adopting a technical rule 

that provides that the terms ‘‘swap’’ and 

‘‘security-based swap’’ as used in the 

Securities Act 1074 have the same 

meanings as in the Exchange Act 1075

and the rules and regulations 

thereunder.1076 The SEC is adopting 

such technical rule to assure consistent 

definitions of these terms under the 

Securities Act and the Exchange Act. 

IX. Effective Date and Implementation 

Consistent with sections 754 and 774 

of the Dodd-Frank Act, the final rules 

and interpretations will be effective 

October 12, 2012. The compliance date 

for the final rules and interpretations 

also will be October 12, 2012; with the 

following exceptions: 

• The compliance date for the 

interpretation regarding guarantees of 

swaps will be the effective date of the 

rules proposed in the separate CFTC 

release when such rules are adopted by 

the CFTC. 

• Solely for the purposes of the Order 

Granting Temporary Exemptions under 

the Securities Exchange Act of 1934 in 

Connection with the Pending Revision 

of the Definition of ‘‘Security’’ to 

Encompass Security-Based Swaps 1077

and the Exemptions for Security-Based 

Swaps,1078 the compliance date for the 

final rules further defining the term 

‘‘security-based swap’’ will be February 

11, 2013. 

The CFTC believes that it is 

appropriate to make the compliance 

date for the interpretation regarding 

guarantees of swaps the same as the 

effective date of the rules proposed in 

the separate CFTC release when such 

rules are adopted by the CFTC in order 

to relieve market participants from 

compliance obligations that would arise 

as a result of the interpretation. As 

described in the Exchange Act 

Exemptive Order and as provided in the 

SB Swaps Interim Final Rules, the 

exemptions granted pursuant to the 

Exchange Act Exemptive Order and the 

SB Swaps Interim Final Rules will 

expire upon the compliance date of the 

final rules further defining the terms 

‘‘security-based swap’’ and ‘‘eligible 

contract participant.’’ The final rules 

further defining the term ‘‘eligible 

contract participant,’’ adopted in the 

Entity Definitions Release,1079 were 

published in the Federal Register on 

May 23, 2012. The compliance date and 

the effective date for such final rules is 

the same, July 23, 2012. The SEC 

believes that establishing a compliance 

date for the definition of ‘‘security-based 

swap’’ solely for purposes of the 

Exchange Act Exemptive Order and the 

SB Swaps Interim Final Rules that is 

February 11, 2013 (i.e. 120 days after the 

effective date) is appropriate because 

doing so will leave in place the 

exemptions granted by the Exchange 

Act Exemptive Order and the SB Swaps 

Interim Final Rules for a period of time 

that is sufficient to facilitate 

consideration of that order and rule. 

Specifically, the SEC will consider the 

appropriate treatment of security-based 

swaps under the provisions of the 

Exchange Act not amended by the 

Dodd-Frank Act before expiration of the 

exemptions set forth in the Exchange 

Act Exemptive Order, and will consider 

the appropriate treatment of securitybased swaps for purposes of the 

registration provisions of the Securities 

Act, the registration provisions of the 

Exchange Act, and the indenture 

qualification provisions of the Trust 

Indenture Act of 1939 before the 

expiration of the exemptions set forth in 

the SB Swaps Interim Final Rules.1080

If any provision of these final rules or 

interpretations, or the application 

thereof to any person or circumstance, 

is held to be invalid, such invalidity 

shall not affect other provisions or 

application of such provisions to other 

persons or circumstances that can be 

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1081 44 U.S.C. 3501 et seq. 

1082As discussed below, the ‘‘collection of 

information’’ related to the new ‘‘book out’’ 

confirmation requirement was not included in the 

SEC’s submission and will be the subject of a 

request for a control number by the CFTC to OMB. 

1083 7 U.S.C. 12(a)(1). 

1084 44 U.S.C. 3501–3521. See also 44 U.S.C. 3509 

and 3510. 

given effect without the invalid 

provision or application. 

X. Administrative Law Matters—CEA 

Revisions 

A. Paperwork Reduction Act 

1. Introduction 

The Paperwork Reduction Act of 1995 

(‘‘PRA’’) imposes certain requirements 

on Federal agencies in connection with 

their conducting or sponsoring any 

collection of information as defined by 

the PRA.1081 An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number. Certain 

provisions of this rule will result in new 

collection of information requirements 

within the meaning of the PRA. With 

the exception of the new ‘‘book-out’’ 

confirmation requirement discussed 

below, the CFTC believes that the 

burdens that will be imposed on market 

participants under rules 1.8 and 1.9 

already have been accounted for within 

the SEC’s calculations regarding the 

impact of this collection of information 

under the PRA and the request for a 

control number submitted by the SEC to 

OMB for rule 3a68–2 (‘‘Interpretation of 

Swaps, Security-Based Swaps, and 

Mixed Swaps’’) and rule 3a68–4 

(‘‘Regulation of Mixed Swaps: Process 

for Determining Regulatory Treatment 

for Mixed Swaps’’). In response to this 

submission, OMB issued control 

number 3235–0685. The responses to 

these collections of information will be 

mandatory.1082 The CFTC will protect 

proprietary information according to the 

Freedom of Information Act and 17 CFR 

part 145, headed ‘‘Commission Records 

and Information.’’ In addition, the CFTC 

emphasizes that section 8(a)(1) of the 

CEA 1083 strictly prohibits the 

Commission, unless specifically 

authorized by the CEA, from making 

public ‘‘data and information that 

would separately disclose the business 

transactions or market positions of any 

person and trade secrets or names of 

customers.’’ The CFTC also is required 

to protect certain information contained 

in a government system of records 

pursuant to the Privacy Act of 1974. 

2. Rules 1.8 and 1.9 

As discussed in the proposal, Rules 

1.8 and 1.9 under the CEA will result in 

new ‘‘collection of information’’ 

requirements within the meaning of the 

PRA. Rule 1.8 under the CEA will allow 

persons to submit a request for a joint 

interpretation from the Commissions 

regarding whether an agreement, 

contract or transaction (or a class 

thereof) is a swap, security-based swap, 

or mixed swap. Rule 1.8 provides that 

a person requesting an interpretation as 

to the nature of an agreement, contract, 

or transaction as a swap, security-based 

swap, or mixed swap must provide the 

Commissions with the person’s 

determination of the nature of the 

instrument and supporting analysis, 

along with certain other documentation, 

including a statement of the economic 

purpose for, and a copy of all material 

information regarding the terms of, each 

relevant agreement, contract, or 

transaction (or class thereof). The 

Commissions also may request the 

submitting person to provide additional 

information. In response to the 

submission, the Commissions may issue 

a joint interpretation regarding the 

status of that agreement, contract, or 

transaction (or class of agreements, 

contracts, or transactions) as a swap, 

security-based swap, or mixed swap. 

Rule 1.9 of the CEA enables persons 

to submit requests to the Commissions 

for joint orders providing an alternative 

regulatory treatment for particular 

mixed swaps. Under rule 1.9, a person 

will provide to the Commissions a 

statement of the economic purpose for, 

and a copy of all material information 

regarding, the relevant mixed swap. In 

addition, the person will provide the 

specific alternative provisions that the 

person believes should apply to the 

mixed swap, the reasons the person 

believes it would be appropriate to 

request an alternative regulatory 

treatment, and an analysis of: (i) The 

nature and purposes of the specified 

provisions; (ii) the comparability of the 

specified provisions to other statutory 

provisions of Title VII of the DoddFrank Act and the rules and regulations 

thereunder; and (iii) the extent of any 

conflicting or incompatible 

requirements of the specified provisions 

and other statutory provisions of Title 

VII and the rules and regulations 

thereunder. The Commissions also may 

request the submitting person to provide 

additional information. 

(a) Information Provided by Reporting 

Entities 

The burdens imposed by rules 1.8 and 

1.9 under the CEA are the same as the 

burdens imposed by the SEC’s rules 

3a68–2 and 3a68–4. Therefore, the 

burdens that will be imposed on market 

participants under rules 1.8 and 1.9 

already have been accounted for within 

the SEC’s calculations regarding the 

impact of this collection of information 

under the PRA and the request for a 

control number submitted by the SEC to 

OMB.1084

(b) Information Collection Comments 

In the Proposing Release, the CFTC 

invited public comment on the 

reporting and recordkeeping burdens 

discussed above with regard to rules 1.8 

and 1.9. Pursuant to 44 U.S.C. 

3506(c)(2)(B), the CFTC solicited 

comments in order to: (i) Evaluate 

whether the proposed collections of 

information are necessary for the proper 

performance of the functions of the 

CFTC, including whether the 

information will have practical utility; 

(ii) evaluate the accuracy of the CFTC’s 

estimate of the burden of the proposed 

collections of information; (iii) 

determine whether there are ways to 

enhance the quality, utility, and clarity 

of the information to be collected; and 

(iv) minimize the burden of the 

collections of information on those who 

are to respond, including through the 

use of automated collection techniques 

or other forms of information 

technology. 

No comments were received with 

respect to the reporting and 

recordkeeping burdens discussed in the 

proposing release. In response to the 

request for a control number by the SEC, 

OMB issued control number 3235–0685. 

3. Book-Out Confirmation 

As noted above, the CFTC believes 

that its interpretation which clarifies 

that oral book-out agreements must be 

followed in a commercially reasonable 

timeframe by a confirmation in some 

type of written or electronic form would 

result in a new ‘‘collection of 

information’’ requirement within the 

meaning of the PRA. Therefore, the 

CFTC is submitting the new ‘‘book-out’’ 

information collection to OMB for 

review in accordance with 44 U.S.C. 

3506(c)(2)(A) and 5 CFR 1320.8(d). The 

CFTC will, by separate action, publish 

in the Federal Register a notice on the 

paperwork burden associated with the 

interpretation’s requirement that oral 

book-outs be followed in a 

commercially reasonable timeframe by 

confirmation in some type of written or 

electronic form in accordance with 5 

CFR 1320.8 and 1320.10. If approved, 

this new collection of information will 

be mandatory. 

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48306 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1085 5 U.S.C. 601 et seq. 

1086See 76 FR 29868–89. 

1087See respectively, Policy Statement and 

Establishment of Definitions of ‘‘Small Entities’’ for 

Purposes of the Regulatory Flexibility Act, supra 

note 331, at 18619 (DCMs); A New Regulatory 

Framework for Clearing Organizations, 66 FR 

45604, 45609 (Aug. 29, 2001) (DCOs); Opting Out 

of Segregation, 66 FR 20740, 20743 (Apr. 25, 2001) 

(ECPs). 

1088See respectively, Policy Statement and 

Establishment of Definitions of ‘‘Small Entities’’ for 

Purposes of the Regulatory Flexibility Act, supra 

note 331, at 18619 (DCMs); A New Regulatory 

Framework for Clearing Organizations, 66 FR 

45604, 45609, Aug. 29, 2001 (DCOs). 

1089See Opting Out of Segregation. 66 FR 20740, 

20743, Apr. 25, 2001 (ECPs). 

1090See 76 FR 29868–89. 

1091See respectively, Registration of Swap 

Dealers and Major Swap Participants, 77 FR 2613, 

2620, Jan. 19, 2012 (swap dealers and major swap 

participants); Requirements for Derivatives Clearing 

Organizations, Designated Contract Markets, and 

Swap Execution Facilities Regarding the Mitigation 

of Conflicts of Interest, 75 FR 63732, 63745, Oct. 18, 

2010 (SEFs); Swap Data Repositories, 76 FR 54538, 

54575, Sept. 1, 2011; Registration of Foreign Boards 

of Trade, 76 FR 80674, 80698, Dec. 23, 2011 

(FBOTs). 

1092Energy Exemption, supra note 207. 

1093See supra part II.B.2.(a)(i)(C). 

1094See ETA Letter. In general, ETA states that 

the Small Business Administration (‘‘SBA’’) has 

determined that many of its members are ‘‘small 

entities’’ for purposes of the RFA. Id. (references the 

comment letter filed by the NRECA, APPA and 

LLPC as the ‘‘Not-for-Profit Electric Coalition’’ in 

response to the Commodity Option NOPR’s (76 FR 

6095) assertion that there are no ECPs that are 

‘‘small entities’’ for RFA purposes). 

B. 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.1085 A regulatory flexibility 

analysis or certification typically is 

required for ‘‘any rule for which the 

agency publishes a general notice of 

proposed rulemaking pursuant to’’ the 

notice-and-comment provisions of the 

Administrative Procedure Act, 5 U.S.C. 

553(b). 

With respect to the proposed release, 

while the CFTC provided an RFA 

statement that the proposed rule would 

have a direct effect on numerous 

entities, specifically DCMs, SDRs, SEFs, 

SDs, MSPs, ECPs, FBOTs, DCOs, and 

certain ‘‘appropriate persons’’ who 

relied on the Energy Exemption,1086 the 

Chairman, on behalf of the CFTC, 

certified that the rulemaking would not 

have a significant economic effect on a 

substantial number of small entities. 

Comments on that certification were 

sought. 

In the Proposing Release, the CFTC 

provided that it previously had 

established that certain entities subject 

to the CFTC’s jurisdiction—namely, 

DCMs, DCOs and ECPs—are not small 

entities for purposes of the RFA.1087 As 

the CFTC previously explained, because 

of the central role they play in the 

regulatory scheme concerning futures 

trading, the importance of futures 

trading in the national economy, and 

the financial requirements needed to 

comply with the regulatory 

requirements imposed on them under 

the CEA, DCMs and DCOs have long 

been determined not to be small 

entities.1088 Based on the definition of 

ECP in the Commodity Futures 

Modernization Act of 2000 (‘‘CFMA’’) 

and the legislative history underlying 

that definition, the CFTC determined 

that ECPs were not small entities.1089 In 

light of its past determination, and the 

increased thresholds on ECPs added by 

the Dodd-Frank Act making it more 

difficult for entities to qualify as an ECP, 

the CFTC determined in its proposed 

rulemakings that ECPs are not small 

entities. 

Furthermore, the CFTC provided that 

certain entities that would be subject to 

the proposed rule—namely SDs, MSPs, 

SDRs, SEFs, and FBOTs—are entities for 

which the CFTC had not previously 

made a size determination for RFA 

purposes. The CFTC determined that 

these entities should not be considered 

small entities based on their size and 

characteristics analogous to non-small 

entities that pre-dated the adoption of 

Dodd-Frank,1090 and certified in 

rulemakings that would have an 

economic impact on these entities that 

these entities are not small entities for 

RFA purposes.1091

Finally, the CFTC recognized that, in 

light of the CFTC’s proposed 

withdrawal of the Energy Exemption, 

the proposed rule could have an 

economic impact on certain 

‘‘appropriate persons’’ who relied on the 

Energy Exemption. The Energy 

Exemption listed certain ‘‘appropriate 

persons’’ that could rely on the 

exemption and also required that, to be 

eligible for this exemption, an 

‘‘appropriate person must have 

demonstrable capacity or ability to make 

or take delivery.’’ The Energy 

Exemption stated: ‘‘in light of the 

general nature of the current 

participants in the market, the CFTC 

believes that smaller commercial firms, 

which cannot meet [certain] financial 

criteria, should not be included.’’ 1092

Therefore, the CFTC did not believe that 

the ‘‘appropriate persons’’ eligible for 

the Energy Exemption, and who may be 

affected by its withdrawal, are ‘‘small 

entities’’ for purposes of RFA. Moreover, 

as previously discussed, the CFTC is 

expanding the Brent Interpretation to all 

nonfinancial commodities for both 

swaps and future delivery definitions 

and is clarifying that certain alternative 

delivery procedures discussed in the 

Energy Exemption will not disqualify a 

transaction from the forward contract 

exclusion under the Brent 

Interpretation.1093 Thus, to the extent 

any entities, small or otherwise, relied 

on the Energy Exemption, such entities 

can now rely on the expanded Brent 

Interpretation to qualify for the forward 

contract exclusion. Accordingly, the 

withdrawal of the Energy Exemption 

will not result in a significant economic 

impact on any entities. 

With respect to this rulemaking, 

which includes interpretations, as well 

as general rules of construction and 

definitions that will largely be used in 

other rulemakings, the CFTC received 

one comment respecting its RFA 

certification. The commenter, an 

association that represents producers, 

generators, processors, refiners, 

merchandisers and commercial end 

users of nonfinancial energy 

commodities, including energy and 

natural gas, contended that the CFTC’s 

overall new jurisdiction under the 

Dodd-Frank Act over ‘‘swaps’’ and the 

burdens that the CFTC’s rules place on 

nonfinancial entities, including small 

entities such as its members 1094 that 

execute such swaps, can only be 

determined after the rules and 

interpretations in the product 

definitions rulemaking are finalized. 

Moreover, the commenter asserted that 

its small entity members seek to 

continue their use of nonfinancial 

commodity ‘‘swaps’’ only to hedge the 

commercial risks of their not-for profit 

public service activities. The commenter 

concluded that the CFTC should 

conduct a regulatory flexibility analysis 

for the entire mosaic of its rulemakings 

under the Dodd-Frank Act, taking into 

consideration the products definition 

rulemaking. 

The commenter did not provide 

specific information on how the further 

defining of the terms swap, securitybased swap and security-based swap 

agreement, providing regulations 

regarding mixed swaps, and providing 

regulations governing books and records 

requirements for security-based swap 

agreements would have a significant 

impact on a substantial number of small 

entities. Nonetheless, the CFTC has 

reevaluated this rulemaking in light of 

the commenter’s statements. Upon 

consideration, the CFTC declines to 

consider the economic impacts of the 

entire mosaic of rules under the Doddmstockstill on DSK4VPTVN1PROD with RULES2

Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48307 

1095See Commodity Options, 77 FR 25320, Apr. 

27, 2012. 

1096To the extent the transactions entered into by 

ETA members are traded or executed on Regional 

Transmission Organizations and Independent 

System Operators, or entered into between entities 

described in section 201(f) of the Federal Power 

Act, they may be addressed through the public 

interest waiver process described in CEA section 

4(c)(6). 

1097 7 U.S.C. 19(a). 

1098See 7 U.S.C. 1a(12) (2006). 

1099On October 3, 2008, President Bush signed 

the Emergency Economic Stabilization Act of 2008, 

which was principally designed to allow the U.S. 

Treasury and other government agencies to take 

action to help to restore liquidity and stability to 

the U.S. financial system (e.g., the Trouble Asset 

Relief Program—also known as TARP—under 

which the U.S. Treasury was authorized to 

purchase up to $700 billion of troubled assets that 

weighed down the balance sheets of U.S. financial 

institutions). See Public Law 110–343, 122 Stat. 

3765 (2008). 

1100See 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 xxvii, available at http:// 

www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPOFCIC.pdf. 

1101 Id. at 25 (concluding that ‘‘enactment of 

* * * [the Commodity Futures Modernization Act 

of 2000 (‘‘CFMA’’)] to ban the regulation by both 

the Federal and State governments of over-thecounter (OTC) derivatives was a key turning point 

in the march toward the financial crisis.’’). See also 

id. at 343 (‘‘Lehman, like other large OTC 

derivatives dealers, experienced runs on its 

derivatives operations that played a role in its 

failure. Its massive derivatives positions greatly 

complicated its bankruptcy, and the impact of its 

bankruptcy through interconnections with 

derivatives counterparties and other financial 

institutions contributed significantly to the severity 

and depth of the financial crisis.’’) and id. at 353 

(‘‘AIG’s failure was possible because of the 

sweeping deregulation of [OTC] derivatives, [* * *] 

including capital and margin requirements that 

would have lessened the likelihood of AIG’s failure. 

The OTC derivatives market’s lack of transparency 

and of effective price discovery exacerbated the 

collateral disputes of AIG and Goldman Sachs and 

similar disputes between other derivatives 

counterparties.’’). 

1102The CFTC has provided a table in the 

Appendix that cross-references the costs and 

benefits considerations of the final rules effectuated 

by the Product Definitions in order to provide more 

transparency with respect to this qualitative 

assessment of the programmatic costs. See 

Appendix, ‘‘Rules Effectuated by Product 

Definitions.’’ The CFTC is not providing a 

quantitative estimate of total programmatic costs, 

because it cannot be reliably estimated at this time. 

Many rules have not been finalized, including 

Continued 

Frank Act, since an agency is only 

required to consider the impact of how 

it exercises its discretion to implement 

the statute through a particular rule. In 

all rulemakings, the CFTC performs an 

RFA analysis for that particular rule. 

Moreover, as the commenter 

mentioned, most of the transactions into 

which its members enter are based on 

nonfinancial commodities. The CFTC 

has provided interpretations in this 

release clarifying the forward exclusion 

in nonfinancial commodities from the 

swap definition (and the forward 

exclusion from the definition of ‘‘future 

delivery’’), including forwards with 

embedded volumetric options, and 

separately, has provided for a trade 

option exemption.1095 The CFTC also 

has provided an interpretation that 

certain customary commercial 

transactions are excluded from the swap 

definition.1096

Accordingly, for the reasons stated in 

the proposal and the foregoing 

discussion in response to the comment 

received, the CFTC continues to believe 

that the rulemaking will not have a 

significant impact on a substantial 

number of small entities. Therefore, the 

Chairman, on behalf of the CFTC, 

hereby certifies pursuant to 5 U.S.C. 

605(b) that the rules will not have a 

significant impact on a substantial 

number of small entities. 

C. Costs and Benefits Considerations 

Section 15(a) of the CEA requires the 

CFTC to consider the costs and benefits 

of its actions before promulgating a 

regulation or issuing certain orders 

under the CEA.1097 Section 15(a) further 

specifies that the costs and benefits 

shall be evaluated in light of the 

following five broad areas of market and 

public concern: (1) Protection of market 

participants and the public; (2) 

efficiency, competitiveness, and 

financial integrity of markets; (3) price 

discovery; (4) sound risk management 

practices; and (5) other public interest 

considerations. The CFTC considers the 

costs and benefits resulting from its 

discretionary determinations with 

respect to the Section 15(a) factors. The 

CFTC also considers, qualitatively, costs 

and benefits relative to the status quo, 

that is, the pre-Dodd Frank Act 

regulatory regime, for historical context 

to help inform the reader. 

In the Proposing Release, the CFTC 

assessed the costs and benefits of the 

proposed rules in general, followed by 

assessments of the costs and benefits of 

each of the rules, taking into account the 

considerations described above. The 

CFTC also requested comment on these 

assessments, and a number of comments 

were received. In this Adopting Release, 

the CFTC will again assess the costs and 

benefits of the rules in general followed 

by the individual rules in this 

rulemaking, for each case taking into 

account the above considerations and 

the comments received. These costs and 

benefits, to the extent identified and, 

where possible, quantified have helped 

to inform the decisions of and the 

actions taken by the CFTC that are 

described throughout this release. 

1. Introduction 

Prior to the adoption of Title VII, 

swaps and security-based swaps were 

by and large unregulated. The 

Commodity Futures Modernization Act 

of 2000 (‘‘CFMA’’) excluded financial 

over-the-counter swaps from regulation 

under the CEA, provided that trading 

occurred only among ‘‘eligible contract 

participants.’’ 1098 Swaps based on 

exempt commodities—including energy 

and metals—could be traded among 

ECPs without CFTC regulation, but 

certain CEA provisions against fraud 

and manipulation continued to apply to 

these markets. No statutory exclusions 

were provided for swaps on agricultural 

commodities by the CFMA, although 

they could be traded under certain 

regulatory exemptions provided by the 

CFTC prior to its enactment. Swaps 

based on securities were subject to 

certain SEC enforcement authorities, but 

the SEC was prohibited from 

prophylactic regulation of such swaps. 

In the fall of 2008, an economic crisis 

threatened to freeze U.S. and global 

credit markets. The Federal government 

intervened to buttress the stability of the 

U.S. financial system.1099 The crisis 

revealed the vulnerability of the U.S. 

financial system and economy to widespread systemic risk resulting from, 

among other things, poor risk 

management practices of certain 

financial firms and the lack of 

supervisory oversight for financial 

institutions as a whole.1100 More 

specifically, the crisis demonstrated the 

need for regulation of the over-thecounter derivatives markets.1101

On July 21, 2010, President Obama 

signed the Dodd-Frank Act into law. 

Title VII of the Dodd-Frank Act 

established a comprehensive new 

regulatory framework for swaps and 

security-based swaps. As discussed 

above, the legislation was enacted, 

among other reasons, to reduce risk, 

increase transparency, and promote 

market integrity within the financial 

system, including by: (i) Providing for 

the registration and comprehensive 

regulation of swap dealers, securitybased swap dealers, major swap 

participants, and major security-based 

swap participants; (ii) imposing clearing 

and trade execution requirements on 

swaps and security-based swaps, subject 

to certain exceptions; (iii) creating 

rigorous recordkeeping and real-time 

reporting regimes; and (iv) enhancing 

the rulemaking and enforcement 

authorities of the Commissions with 

respect to, among others, all registered 

entities and intermediaries subject to 

the Commissions’ oversight.1102

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48308 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

capital and margin which may have significant 

costs. Any estimate made of the programmatic costs 

of the Product Definitions would be unreliable and 

therefore may be misleading. 

1103See supra part II.B.2.a). 

1104See supra part II.B.2.a)i)(B). 

1105See supra part II.B.2.a)i)(C). 

Section 721 of the Dodd-Frank Act 

amends the Commodity Exchange Act 

(‘‘CEA’’) by adding definitions of the 

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

and ‘‘security-based swap agreement.’’ 

Section 712(d)(1) provides that the 

CFTC and the SEC, in consultation with 

the Federal Reserve Board, shall jointly 

further define those terms. Section 

712(a)(8) provides further that the 

Commissions shall jointly prescribe 

such regulations regarding ‘‘mixed 

swaps’’ as may be necessary to carry out 

the purposes of Title VII of the DoddFrank Act (‘‘Title VII’’). Section 

712(d)(2) requires the Commissions, in 

consultation with the Federal Reserve 

Board, to jointly adopt rules governing 

books and records requirements for 

security-based swap agreements. 

Under the comprehensive framework 

for regulating swaps and security-based 

swaps established in Title VII, the CFTC 

is given regulatory authority over swaps, 

the SEC is given regulatory authority 

over security-based swaps, and the 

Commissions jointly are to prescribe 

such regulations regarding mixed swaps 

as may be necessary to carry out the 

purposes of Title VII. In addition, the 

SEC is given antifraud authority over, 

and access to information from, certain 

CFTC-regulated entities regarding 

security-based swap agreements, which 

are a type of swap related to securities 

over which the CFTC is given regulatory 

and enforcement authority. 

The statutory definitions of ‘‘swap’’ 

and ‘‘security-based swap’’ in Title VII 

are detailed and comprehensive. The 

Dodd-Frank Act directs the 

Commissions, among other things, to 

‘‘further define’’ these terms; it does not 

direct the Commissions to provide 

definitions for them, which are already 

provided for in the statute. Thus, even 

in the absence of these rules, the DoddFrank Act would require regulating 

products that meet the statutory 

definitions of these terms as swaps and 

security-based swaps. Consequently, a 

large part of the costs and benefits 

resulting from the regulation of swaps 

and security-based swaps derives from 

the Dodd-Frank Act itself and not from 

these rules that further define swaps. 

Several commenters to the ANPR 

issued by the Commissions regarding 

the definitions expressed a concern that 

the product definitions could be read 

broadly to include certain types of 

transactions that previously had never 

been considered swaps or securitybased swaps. In response to those 

comments, the rules and interpretations 

clarify that certain traditional insurance 

products, consumer and commercial 

agreements, and loan participations are 

not swaps or security-based swaps, 

which will increase legal certainty and 

lower the costs of assessing whether a 

product is a swap or security-based 

swap for market participants. In this 

regard, the rules and interpretations are 

intended to reduce unnecessary burdens 

on persons using such agreements, 

contracts, or transactions, the regulation 

of which under Title VII may not be 

necessary or appropriate to further the 

purposes of Title VII. 

In addition, the CFTC is clarifying the 

scope of the forward contract 

exclusion 1103 for nonfinancial 

commodities from the statutory swap 

definition to provide legal certainty for 

market participants as to which 

transactions will qualify for the 

exclusion. In this regard, the CFTC is 

clarifying the circumstances under 

which market participants may rely on 

past CFTC guidance regarding the 

forward exclusion from the definition of 

‘‘future delivery,’’ and in particular the 

Brent Interpretation for booked-out 

transactions,1104 with respect to the 

forward exclusion from the swap 

definition. The CFTC is extending the 

Brent Interpretation to all nonfinancial 

commodities, and is withdrawing the 

Energy Exemption as proposed, 1105

with certain clarifications. The final 

interpretation with clarifications in 

response to comments should enhance 

legal certainty regarding the forward 

exclusions. 

While the statutory definitions of 

swap and security-based swap are 

detailed and comprehensive, the rules 

further clarify whether particular types 

of transactions are swaps or securitybased swaps. For example, foreign 

exchange forwards and swaps are 

defined as swaps, subject to the 

Treasury Secretary’s determination to 

exempt them from the swap definition. 

The statute provides that certain 

provisions of the CEA apply to foreign 

exchange forwards and swaps, even if 

the Treasury Secretary determines to 

exempt them, and the rules reflect this. 

Specifically, these transactions still 

would be subject to certain 

requirements for reporting swaps, and 

swap dealers and major swap 

participants engaging in such 

transactions still would be subject to 

certain business conduct standards. The 

rules also clarify that, because certain 

foreign exchange products do not fall 

within the definitions of foreign 

exchange swap and forward, such 

products are not subject to the Treasury 

Secretary’s determination to exempt. 

Outside of the foreign exchange suite of 

products, the rules and interpretations 

clarify that certain transactions are 

swaps or security-based swaps. These 

products include forward rate 

agreements, certain contracts for 

differences, swaptions and forward 

swaps. The rules and the interpretations 

are intended to increase clarity and legal 

certainty for market participants with 

respect to these products. 

Next this release addresses the 

relationship between swaps and 

security-based swaps and how to 

distinguish them. The Commissions are 

clarifying whether particular 

agreements, contracts or transactions 

that are subject to Title VII of the DoddFrank Act (which are referred to as 

‘‘Title VII Instruments’’ in this release) 

are swaps, security-based swaps or both 

(i.e., mixed swaps). In addition, the 

Commissions are clarifying the use of 

the term ‘‘narrow-based security index’’ 

in the security-based swap definition. In 

general, the CFTC has jurisdiction over 

Title VII instruments on broad-based 

security indexes, while the SEC has 

jurisdiction over Title VII instruments 

on narrow-based security indexes. This 

release clarifies that the existing criteria 

for determining whether a security 

index is narrow-based, and the past 

guidance of the Commissions regarding 

those criteria in the context of security 

futures, apply to Title VII instruments. 

Credit default swaps (‘‘CDS’’) also are 

subject to this same jurisdictional 

division—CDS on broad-based security 

indexes are regulated by the CFTC, 

while CDS on narrow-based security 

indexes (as well as CDS on single name 

securities or loans) generally are 

regulated by the SEC. This release 

provides new criteria tailored to CDS for 

determining whether a CDS is based on 

an index that is a narrow-based security 

index. Also, it explains the term 

‘‘index’’ and adopts a final rule 

governing tolerance and grace periods 

for Title VII instruments on security 

indexes traded on trading platforms. 

These rules and interpretations 

generally are designed to provide clarity 

and enhanced legal certainty regarding 

the appropriate classification of Title VII 

instruments as swaps, security-based 

swaps or mixed swaps, so that market 

participants may ascertain the 

applicable regulatory requirements more 

easily. 

This release anticipates that mixed 

swaps, which are both swaps and 

security-based swaps, will be a narrow 

category, but lists a few examples of 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48309 

1106See Appendix, ‘‘Rules Effectuated by Product 

Definitions.’’ 

1107See Appendix, ‘‘Rules Effectuated by Product 

Definitions.’’ 

mixed swaps and interprets how to 

distinguish one type of TRS that is a 

mixed swap from another that is not. 

This release addresses the regulatory 

treatment of bilateral, uncleared mixed 

swaps where one counterparty is a dual 

registrant with the CFTC and SEC. It 

also establishes a process for requesting 

a joint order from the Commissions to 

determine the appropriate regulatory 

treatment of mixed swaps that do not 

fall into the category of mixed swaps 

where one counterparty is a dual 

registrant. Concerning ‘‘security-based 

swap agreements’’ (or SBSAs), this 

release explains what types of 

transactions are SBSAs and includes 

rules that provide that there will not be 

additional books and records 

requirements regarding SBSAs other 

than those that have been proposed by 

the CFTC for swaps in order to avoid 

duplicative regulation and costs. 

This release also includes rules 

establishing a process for members of 

the public to request a joint 

interpretation from the Commissions 

regarding whether a Title VII instrument 

is a swap, security-based swap or a 

mixed swap. The process includes a 

deadline for a decision, as well as a 

requirement that if the Commissions do 

not issue a joint interpretation within 

the prescribed time period, each 

Commission must publicly provide the 

reasons for not having done so. 

Finally, this release includes antievasion rules and related interpretations 

adopted by the CFTC, which in general 

would apply to agreements, contracts, 

transactions and entities that are 

willfully structured to evade DoddFrank requirements. 

2. Costs and Benefits of the 

Definitions—In General 

The rules and interpretations in this 

Adopting Release: further define the 

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

and ‘‘security-based swap agreement;’’ 

provide for the regulation of ‘‘mixed 

swaps;’’ and address books and records 

requirements for security-based swap 

agreements. In the discussion that 

follows, the CFTC considers the costs 

and benefits resulting from its own 

discretionary determinations with 

respect to the section 15(a) factors. 

There are ‘‘programmatic’’ costs and 

benefits as well as ‘‘assessment’’ costs of 

the Product Definitions. Programmatic 

costs result from subjecting certain 

agreements, contracts, or transactions to 

the regulatory regime of Title VII.1106

Effectiveness of the Products Definitions 

will trigger effectiveness of any statutory 

provision or regulation that depends, in 

whole or in part, on the effectiveness of 

this final rulemaking. By fulfilling the 

statutory mandate, many of the 

programmatic benefits of Title VII and 

the CFTC’s implementing regulations 

are triggered, including risk reduction, 

increasing transparency, and promoting 

market integrity and, by extension, the 

increased possibility of preventing or 

reducing the severity of another global 

financial crisis such as occurred in 

2008. Delimiting the scope of the terms 

‘‘swap,’’ ‘‘security-based swap,’’ 

‘‘security-based swap agreement,’’ and 

‘‘mixed swaps’’ also helps to determine 

the scope of activities and entities that 

will be subject to the various Title VII 

regulatory requirements. Requirements 

for clearing and trade execution, capital 

and margin, business conduct, and 

reporting and recordkeeping, all of 

which have been or will be 

implemented in other CFTC rules, will 

lead to programmatic costs that have 

been or will be addressed in the CFTC’s 

rules to implement those requirements. 

When considering the programmatic 

costs and benefits of the Product 

Definitions, the CFTC recognizes the 

scope of activities and entities affected 

by the further Product Definitions by 

reference to the other final rulemakings 

under Title VII accomplished to date. 

The costs that parties will incur to 

assess whether certain agreements, 

contracts, or transactions are ‘‘swaps,’’ 

‘‘security-based swaps,’’ ‘‘security-based 

swap agreements,’’ or ‘‘mixed swaps’’ 

that are subject to the Title VII 

regulatory regime, and, if so, costs to 

assess whether such Title VII 

instrument is subject to the regulatory 

regime of the SEC or the CFTC are 

referred to herein as assessment costs. 

In general, many commenters have 

suggested that the statutory definitions 

of swap and security-based swap are 

overbroad in that they could be viewed 

to include agreements, contracts, and 

transactions that the market had not 

considered to be swaps or securitybased swaps prior to the enactment of 

the Dodd-Frank Act, are (or could be) 

swaps or security-based swaps. Thus, in 

response to these comments, the CFTC 

has engaged in a qualitative analysis of 

various agreements, contracts, and 

transactions of which the CFTC is aware 

and that commenters have brought to its 

attention. Based on this analysis, the 

CFTC has established rules and 

interpretations to identify agreements, 

contracts, and transactions that are 

swaps or security-based swaps where 

the statutory definition may be 

inadequate or ambiguous. In developing 

the further definitions, the CFTC has 

endeavored to narrow the scope of the 

terms ‘‘swap’’ and ‘‘security-based 

swap’’ without excluding agreements, 

contracts and transactions that the CFTC 

has determined should be regulated as 

swaps and security-based swaps. 

Narrowing the scope of the statutory 

definitions should reduce the overall 

programmatic costs of Title VII because 

fewer agreements, contracts, and 

transactions will be subject to the full 

panoply of Title VII regulation. 

Narrowing the scope of the statutory 

definitions should also increase the net 

programmatic benefits of the CFTC’s 

Title VII regulations because the CFTC 

is targeting in the Product Definitions 

rulemaking agreements, contracts and 

transactions that the CFTC has 

determined, after considering comments 

received and undertaking a qualitative 

analysis, are swaps or security-based 

swaps. The CFTC anticipates that 

applying the full panoply of Title VII 

regulation to only those agreements, 

contracts or transactions that the CFTC 

has determined are swaps or securitybased swaps will be most effective in 

achieving the net benefits of Title VII 

regulation under the Dodd-Frank Act. 

(a) Costs 

The scope of the terms ‘‘swap,’’ 

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

swap agreement,’’ and ‘‘mixed swap’’ is 

an important factor in determining the 

range of activities and entities that will 

be subject to various requirements set 

forth in the Dodd-Frank Act, such as 

trade execution, clearing, reporting, 

registration, business conduct, and 

capital requirements. Complying with 

these requirements, which will be 

implemented in other rules by the 

CFTC, are programmatic costs, which 

also have been or will be addressed in 

the CFTC’s rules to implement those 

requirements.1107

The CFTC believes that the 

rulemaking to further define the terms 

‘‘swap,’’ ‘‘security-based swap,’’ 

‘‘security-based swap agreement,’’ and 

‘‘mixed swap’’ is consistent with how 

market participants understand these 

products. The further definitions 

increase legal certainty and thereby 

reduce assessment costs by clarifying 

that certain products that meet the 

requirements of the applicable rules and 

interpretations, such as traditional 

insurance products, are not swaps. 

(b) Benefits 

Many of the benefits of Title VII and 

the CFTC’s implementing regulations, 

including risk reduction, increasing 

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48310 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1108See ETA Letter. See also IECA Letter II 

(requesting a comprehensive costs benefits analysis 

on all of Title VII). 

1109See WGCEF Letter. 

1110See Proposing Release at 29874. 

1111See FIA Letter; IIB Letter; and ISDA Letter. 

1112See Shell Trading Letter. 

1113See CEB Letter; EIB Letter; and World Bank 

Letter. 

1114See World Bank Letter. 

1115See CME Letter. 

1116 7 U.S.C. 6(a). 

1117See CME Letter. 

transparency, and promoting market 

integrity are programmatic benefits of 

the Products Definitions since they are 

effectuated by Product Definitions. 

These programmatic benefits are 

difficult to quantify and measure. 

Moreover, these benefits can be 

expected to manifest themselves over 

the long run and be distributed over the 

market as a whole. 

The CFTC believes that the final rules 

and interpretations can be consistently 

applied by substantially all market 

participants to determine which 

agreements, contracts, or transactions 

are, and which are not, swaps, securitybased swaps, security-based swap 

agreements, or mixed swaps. The 

benefits of the individual rules and 

interpretations are discussed in their 

respective sections below. 

(c) Comments and Consideration of 

Alternatives 

The CFTC requested comment on the 

costs and benefits of the proposed rules 

and interpretations regarding the 

definitions in general for market 

participants, markets and the public. 

Further, the CFTC requested comment 

as to whether there are any aspects of 

the proposed rules and interpretive 

guidance regarding the definitions that 

are both burdensome to apply and not 

helpful to achieving clarity as to the 

scope of the defined terms, and whether 

there are less burdensome means of 

providing clarity as to the scope of the 

defined terms. 

A commenter 1108 argued that a proper 

cost-benefit analysis can only be 

performed once an integrated and 

complete mosaic of rules is available for 

analysis and doubted that the 

definitions impose no independent 

costs. The CFTC has considered, 

qualitatively, the costs and benefits of 

the entire mosaic of CFTC rules under 

the Dodd-Frank Act in this rulemaking. 

Due to data limitations and other 

uncertainty, the CFTC cannot perform a 

meaningful quantitative analysis, yet. 

The CFTC considers in this rulemaking 

the costs and benefits of how the 

Commissions are exercising their 

discretion in further defining the 

Product Definitions because Congress 

included in the Dodd-Frank Act 

statutory definitions of these terms, over 

which the CFTC has no discretion. 

Moreover, the CFTC has considered the 

independent costs (i.e. costs imposed 

through exercising its discretion) that 

the Products Definitions may impose 

through its determinations as discussed 

below. 

Another commenter 1109 contended 

that the costs and benefits 

considerations in the Proposing Release 

were not based on any empirical data 

and are not consistent with the expected 

costs of compliance anticipated by 

market participants. However, the CFTC 

cannot do a comprehensive empirical 

analysis regarding costs and benefits of 

the Products Definitions before actual 

data is available when the swap 

regulatory regime has been 

implemented in full. Moreover, the 

CFTC did use some empirical estimates 

in its costs and benefits considerations 

in the Proposing Release, namely in 

assessment costs for the process to seek 

an interpretation of whether a product 

is a swap, security-based swap, or 

mixed swap, as well as in the process 

to determine regulatory treatment for 

mixed swaps.1110 Commenters did not 

submit data or other information to 

support an argument that the CFTC’s 

estimates were inaccurate. 

Commenters 1111 expressed concern 

about costs from regulatory uncertainty 

imposed on swaps market participants 

resulting from other Title VII 

rulemakings not yet being final. The 

consideration of thousands of letters 

and the process of due deliberation and 

reasoned decision-making by the CFTC 

has caused delays. Nevertheless, the 

CFTC is working with deliberate speed 

to complete the rulemakings, and 

eventually this particular type of legal 

uncertainty will be eliminated. 

A commenter 1112 requested that interaffiliate swaps be exempt from the swap 

definition, arguing that regulating such 

swaps may increase costs to consumers 

and undermine efficiencies from the use 

of centralized hedging affiliates. The 

CFTC anticipates that it will address 

inter-affiliate swaps in a subsequent 

rulemaking. 

Several commenters 1113 argued that 

foreign central banks, foreign 

sovereigns, international financial 

institutions, such as multilateral 

development banks, and similar 

organizations should be exempt from 

swap regulations, since regulations 

would impose costs on these entities. 

Specifically, a commenter 1114 asserted 

that multilateral development banks 

should not have to register or be subject 

to clearing and margin requirements and 

requested that multilateral development 

banks’ transactions be exempted from 

the definition of a swap. As explained 

above, these transactions are swaps. In 

addition, the proposed exclusion is 

overbroad because it would mean that 

swaps and security-based swaps entered 

into by foreign central banks, foreign 

sovereigns, international financial 

institutions, and similar organizations 

would be completely excluded from 

Dodd-Frank regulation. Their 

counterparties, who may be swap 

dealers and other regulated entities, 

would have no regulatory obligations 

with respect to such swaps, and could 

develop significant exposures without 

the knowledge of the CFTC, other 

regulators and market participants. If 

these transactions were not swaps, then 

no market participant would be 

obligated to report them to a U.S.- 

registered swap data repository or realtime report them. This lack of 

transparency might distort swap pricing 

and impede proper risk management in 

as much as the market may not be aware 

of the risk entailed in these opaque 

transactions and might thwart price 

discovery. 

The Commissions did not propose 

rules or interpretations on how to 

distinguish futures from swaps. A 

commenter requested that the CFTC 

clarify that nothing in the release was 

intended to limit a DCM’s ability to list 

for trading a futures contract regardless 

of whether it could be viewed as a swap 

if traded over-the-counter or on a SEF, 

since futures and swaps are 

‘‘indistinguishable in material economic 

effects.’’ 1115 The commenter further 

recommended that the CFTC adopt a 

final rule that amends the statutory 

definition of the term ‘‘swap’’ by adding 

to the futures contract exclusion in CEA 

Section 1a(47)(B)(i) the following 

language after the word ‘‘delivery’’: 

‘‘Listed for trading by a designated 

contract market.’’ The same commenter 

believed that such a rule would clarify 

the scope of Section 4(a) of the CEA,1116

which makes it illegal to trade a futures 

contract except on or subject to the rules 

of a DCM.1117

Although it is potentially more costly 

to a DCM in terms of providing 

additional analysis to support listing a 

futures contract on its exchange, the 

CFTC is not adopting the distinction the 

commenter advocates. Prior distinctions 

that the CFTC relied upon (such as the 

presence or absence of clearing) to 

distinguish between futures and swaps 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48311 

1118See, e.g., Swap Policy Statement, supra 

note 214. 

1119 17 CFR Part 40. 

may no longer be relevant.1118 As a 

result, it is difficult to distinguish 

between futures and swaps on a blanket 

basis as the commenter suggested. 

However, a case-by-case approach for 

distinguishing these products may lead 

to more informed decision-making by 

the CFTC. 

The CFTC notes that a DCM may selfcertify its contracts pursuant to Part 40 

of the CFTC’s rules,1119 subject to the 

CFTC’s oversight authority. If a DCM 

has a view that a particular product is 

a futures contract, it may self-certify the 

contract consistent with that view. The 

DCM also has a number of other 

options, including seeking prior 

approval from the CFTC, requesting an 

interpretation, or requesting a 

rulemaking if it is in doubt about 

whether a particular agreement, contract 

or transaction should be classified as a 

futures contract or a swap. 

3. Costs and Benefits of Rules and 

Interpretations Regarding Insurance 

Rule 1.3(xxx)(4)(i) under the CEA 

clarifies that agreements, contracts or 

transactions that satisfy its provisions 

will not be swaps or security-based 

swaps. Specifically, the term ‘‘swap’’ 

and ‘‘security-based swap’’ does not 

include an agreement, contract, or 

transaction under rule 1.3(xxx)(4)(i)(A) 

that, by its terms or by law, as a 

condition of performance on the 

agreement, contract, or transaction: (i) 

Requires the beneficiary of the 

agreement, contract, or transaction to 

have an insurable interest that is the 

subject of the agreement, contract, or 

transaction and thereby carry the risk of 

loss with respect to that interest 

continuously throughout the duration of 

the agreement, contract, or transaction; 

(ii) requires that loss to occur and be 

proved, and that any payment or 

indemnification therefor be limited to 

the value of the insurable interest; (iii) 

is not traded, separately from the 

insured interest, on an organized market 

or over-the-counter; and (iv) with 

respect to financial guaranty insurance 

only, in the event of payment default or 

insolvency of the obligor, any 

acceleration of payments under the 

policy is at the sole discretion of the 

insurer (the ‘‘Product Test’’). 

Rule 1.3(xxx)(4)(i)(B) under the CEA 

provides that for an agreement, contract, 

or transaction that meets the Product 

Test to be excluded from the swap and 

security-based swap definitions as 

insurance, it must be provided: (i) By a 

person that is subject to supervision by 

the insurance commissioner (or similar 

official or agency) of any State or by the 

United States or an agency or 

instrumentality thereof, and such 

agreement, contract, or transaction is 

regulated as insurance applicable State 

law or the laws of the United States (the 

‘‘first prong’’); (ii) directly or indirectly 

by the United States, any State, or any 

of their respective agencies or 

instrumentalities, or pursuant to a 

statutorily authorized program thereof 

(the ‘‘second prong’’); (iii) in the case of 

reinsurance only, by a person to another 

person that satisfies the Provider Test, 

provided that: such person is not 

prohibited by applicable State law or 

the laws of the United States from 

offering such agreement, contract, or 

transaction to such person that satisfies 

the Provider Test; the agreement, 

contract, or transaction to be reinsured 

satisfies the Product Test or is one of the 

Enumerated Products; and except as 

otherwise permitted under applicable 

State law, the total amount reimbursable 

by all reinsurers for such agreement, 

contract, or transaction may not exceed 

the claims or losses paid by the cedant; 

or (iv) in the case of non-admitted 

insurance by a person who: is located 

outside of the United States and listed 

on the Quarterly Listing of Alien 

Insurers as maintained by the 

International Insurers Department of the 

National Association of Insurance 

Commissioners; or meets the eligibility 

criteria for non-admitted insurers under 

applicable State law (the ‘‘Provider 

Test’’). 

In response to commenters’ requests 

that the Commissions codify the 

proposed interpretation regarding 

certain enumerated types of insurance 

products in the final rules, the 

interpretation is being codified in 

paragraph (i)(C) of rule 1.3(xxx)(4) 

under the CEA. In addition, in response 

to comments, the Commissions are 

expanding and revising the list of 

traditional insurance products. As 

adopted, the rule provides that the 

terms ‘‘swap’’ and ‘‘security-based 

swap’’ will not include an agreement, 

contract, or transaction that is provided 

in accordance with the conditions set 

forth in the Provider Test and is one of 

the following types of products 

(collectively, ‘‘Enumerated Products’’): 

surety bonds; fidelity bonds; life 

insurance; health insurance; long-term 

care insurance; title insurance; property 

and casualty insurance; annuities; 

disability insurance; insurance against 

default on individual residential 

mortgages (commonly known as private 

mortgage insurance, as distinguished 

from financial guaranty of mortgage 

pools); and reinsurance (including 

retrocession) of any of the foregoing. 

Based on comments received, the 

Commissions are adding three products 

to the list of products as proposed, 

adding reinsurance (including 

retrocession) of any of the traditional 

insurance products included in the list, 

and deleting a requirement applicable to 

annuities that they must be subject to 

tax treatment under section 72 of the 

Internal Revenue Code. 

The Commissions are also clarifying 

that the Product Test, the Provider Test 

and the Enumerated Products in the 

rules are a non-exclusive safe harbor 

(the ‘‘Insurance Safe Harbor’’), such that 

if a product fails the Insurance Safe 

Harbor, that does not necessarily mean 

that the product is a swap or securitybased swap—further analysis may be 

required in order to make that 

determination. 

Rule 1.3(xxx)(4)(ii) provides a 

‘‘grandfather’’ for insurance transactions 

(as opposed to insurance products), 

pursuant to which transactions that are 

entered into on or before the effective 

date of the Product Definitions will not 

fall within the definition of swap or 

security-based swap, provided that, at 

such time that it was entered into, the 

transaction was provided in accordance 

with the Provider Test. 

The CFTC is interpreting the term 

‘‘swap’’ (that is not a security-based 

swap or mixed swap) to include a 

guarantee of such swap, to the extent 

that a counterparty to a swap position 

would have recourse to the guarantor in 

connection with the position. The CFTC 

is persuaded that when a swap has the 

benefit of a guarantee, the guarantee is 

an integral part of that swap. The CFTC 

finds that a guarantee of a swap (that is 

not a security-based swap or mixed 

swap) is a term of that swap that affects 

the price or pricing attributes of that 

swap. When a swap counterparty 

typically provides a guarantee as credit 

support for its swap obligations, the 

market will not trade with that 

counterparty at the same price, on the 

same terms, or at all without the 

guarantee. The guarantor’s resources are 

added to the analysis of the swap; if the 

guarantor is financially more capable 

than the swap counterparty, the analysis 

of the swap becomes more dependent 

on the creditworthiness of the 

guarantor. The CFTC anticipates that a 

‘‘full recourse’’ guarantee would have a 

greater effect on the price of a swap than 

a ‘‘limited’’ or ‘‘partial recourse’’ 

guarantee; nevertheless, the CFTC is 

determining that the presence of any 

guarantee with recourse, no matter how 

robust, is price forming and an integral 

part of a guaranteed swap. The CFTC’s 

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48312 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1120 Improperly characterizing swaps as insurance 

may theoretically cause market participants that are 

not licensed insurance companies to become 

licensed insurance companies, if applicable, thus 

imposing costs of complying with state insurance 

regulation. 1121The CFTC anticipates that traditional 

insurance products will either be easy to identify 

from the list of Enumerated Products or will 

unambiguously satisfy the Products Test. 

1122The CFTC believes that $27,000 represents a 

reasonable estimate of the upper end of the range 

of the costs to undertake the legal analysis of the 

status of an agreement, contract, or transaction as 

a swap or security-based swap. The average cost 

incurred by market participants in connection with 

assessing whether an agreement, contract, or 

transaction is a swap or security-based swap is 

based upon the estimated amount of time that staff 

believes will be required for both in-house counsel 

and outside counsel to apply the definition. Staff 

estimates that some agreements, contracts, or 

transactions will clearly satisfy the Insurance Safe 

Harbor, Insurance Grandfather and an in-house 

attorney, without the assistance of outside counsel, 

will be able to make a determination in less than 

one hour. Based upon data from SIFMA’s 

Management & Professional Earnings in the 

Securities Industry 2011 (modified by SEC staff to 

account for an 1800-hour-work-year and multiplied 

by 5.35 to account for bonuses, firm size, employee 

benefits and overhead), staff estimates that the 

average national hourly rate for an in-house counsel 

is $378. If an agreement, contract, or transaction is 

more complex, the CFTC estimates the analysis will 

require approximately 30 hours of in-house counsel 

time and 40 hours of outside counsel time. The 

CFTC estimates the costs for outside legal services 

to be $400 per hour. This is based on an estimated 

$400 per hour cost for outside legal services. This 

is the same estimate used by the SEC for these 

services in the release involving Exemptions for 

Security-Based Swaps Issued By Certain Clearing 

Agencies, Release No. 33–9308 (Mar. 30, 2012), 77 

FR 20536 (Apr. 5, 2012). Accordingly, on the high 

end of the range the CFTC estimates the cost to be 

$27,340 ($11,340 (based on 30 hours of in-house 

counsel time ✖ $378) + $16,000 (based on 40 hours 

of outside counsel ✖ $400). The estimate is rounded 

to two significant digits to avoid the impression of 

false precision of the estimate. 

1123Because a guarantee is a common and wellunderstood product, that has been used in 

commerce since long before the existence of swaps 

markets, the CFTC anticipates that whether a 

guarantee is present or not will be obvious. 

1124As a result of interpreting the term ‘‘swap’’ 

(that is not a security-based swap or mixed swap) 

to include a guarantee of such swap, to the extent 

that a counterparty to a swap position would have 

recourse to the guarantor in connection with the 

position, and based on the reasoning set forth in the 

Entity Definitions Release in connection with major 

swap participants, the CFTC will not deem holding 

companies to be swap dealers as a result of 

guarantees to certain U.S. entities that are already 

subject to capital regulation. This interpretation 

mitigates the programmatic costs imposed on 

potential swap dealers by not attributing to a 

guarantor swap positions of a guaranteed entity that 

is already subject to capital regulation. 

1125An individual is considered an ECP if the 

individual ‘‘has amounts invested on a 

discretionary basis, the aggregate of which is in 

excess of—(i) $10,000,000; or (ii) $5,000,000 and 

who enters into the agreement, contract, or 

transaction in order to manage the risk associated 

with an asset owned or liability incurred, or 

reasonable likely to be owned or incurred, by the 

individual.’’ Section 1a(18)(A)(xi) of the CEA, 7 

U.S.C. 1a(18)(A)(xi). 

interpretation of the term ‘‘swap’’ to 

include guarantees of swap does not 

limit or otherwise affect in any way the 

relief provided by the Insurance 

Grandfather. In a separate release, the 

CFTC will address the practical 

implications of interpreting the term 

‘‘swap’’ to include guarantees of swaps 

(the ‘‘separate CFTC release’’). 

(a) Costs 

A market participant will need to 

ascertain whether an agreement, 

contract, or transaction satisfies the 

criteria set forth in rule 1.3(xxx)(4). This 

analysis will have to be performed prior 

to entering into the agreement, contract, 

or transaction to ensure that the relief 

provided by the Insurance Safe Harbor 

is available. The CFTC expects that 

potential costs associated with any 

possible uncertainty cited by 

commenters as to whether an 

agreement, contract, or transaction that 

the participants consider to be 

insurance could instead be regulated as 

a swap would be greater without the 

Insurance Safe Harbor than the cost of 

the analysis under the final rule herein. 

Although the Insurance Safe Harbor is 

designed to mitigate costs associated 

with legal uncertainty and 

misclassification of products, to the 

extent that it inadvertently fails to 

exclude certain types of insurance 

products from the definitions, these 

failures could lead to costs for market 

participants entering into agreements, 

contracts, or transactions. Some 

insurance products might inadvertently 

be subjection to regulation as swaps. To 

the extent that the Insurance Safe 

Harbor leads to the inadvertent 

misclassification of some swaps as 

insurance, costs for market participants 

entering into agreements, contracts, or 

transactions that are inadvertently 

regulated as insurance products, and not 

as swaps, may increase.1120 Similarly, 

insurance products inadvertently 

mischaracterized as swaps could impose 

additional costs on market participants, 

who could be required to meet certain 

regulatory requirements applicable to 

swaps. 

Assessment costs should be minimal 

or non-existent for traditional insurance 

products,1121 but for a new and novel 

insurance product that is more complex, 

the costs of analysis may be greater. 

Nevertheless, it is anticipated that such 

cases will be infrequent. Moreover, it 

may be difficult to assess whether 

products that do not fall within the 

Insurance Safe Harbor are swaps or 

security-based swaps rather than 

insurance. Market participants may 

need to request an interpretation from 

the Commissions regarding such 

products, or obtain an opinion of 

counsel, which will involve certain 

costs.1122 However, the CFTC expects 

such cases will arise less frequently in 

light of the increased clarity provided 

by the rule. An alternative to a safe 

harbor approach under the rule—that 

failure to meet the rule and 

interpretation would automatically 

mean that the product is a swap and not 

insurance—would likely impose greater 

costs on market participants and result 

in more frequent misclassification of 

products. 

The CFTC is interpreting the term 

‘‘swap’’ (that is not a security-based 

swap or mixed swap) to include a 

guarantee of such swap, to the extent 

that a counterparty to a swap position 

would have recourse to the guarantor in 

connection with the position. The CFTC 

anticipates minimal or no assessment 

costs from the interpretation with 

respect to guarantees of swaps.1123 The 

CFTC does, however, anticipate that 

there will be some programmatic costs 

associated with the requirements that it 

will propose for guarantees of swaps in 

the separate CFTC release.1124 The 

CFTC will carefully consider those costs 

in that rulemaking. 

(b) Benefits 

Subjecting traditional insurance 

products to Title VII could, absent 

exception, prevent individuals who are 

not ECPs from obtaining insurance to 

protect their properties or families 

against accidental hazards or risks,1125

or require insurance sold to individuals 

who are not ECPs to be traded on 

exchanges and be cleared. The 

Commissions have found no evidence 

that Congress intended them to be 

regulated as swaps or security-based 

swaps. In light of the above 

considerations, the Commissions have 

determined to provide the Insurance 

Safe Harbor and Insurance Grandfather 

in the final rules in order to assure 

market participants that those 

agreements, contracts, or transactions 

that meet their conditions will not fall 

within the swap or security-based swap 

definitions. Limiting the number of 

unexpected product classification 

outcomes for market participants 

provides the benefit of predictability 

when entering into their transactions 

The business of insurance is already 

subject to established pre-Dodd-Frank 

Act regulatory regimes. Requirements 

that may work well for swaps and 

security-based swaps may not be 

appropriate for traditional insurance 

products. To the extent that the final 

rules distinguish insurance from swaps 

and security-based swaps, the CFTC 

should be able to tailor rules for specific 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48313 

1126See AFGI Letter; AIA Letter; and ISDA Letter. 

1127See ISDA Letter. 

1128See AFGI Letter. 

1129See ACLI Letter; NAIC Letter; and RAA 

Letter. 

1130See MetLife Letter. 

1131See supra note 162 

1132See supra note 163. 

1133See supra note 164. 

products that are swaps or securitybased swaps to achieve Title VII 

regulatory objectives. In adopting the 

Insurance Safe Harbor, the CFTC has 

sought to achieve those net benefits that 

may be obtained from not supplanting 

existing insurance regulation that are 

consistent with the regulatory objectives 

of Title VII. 

Without the Insurance Safe Harbor, 

market participants might be more 

uncertain about whether an agreement, 

contract, or transaction is an insurance 

product rather than a swap. Rule 

1.3(xxx)(4) is intended to reduce the 

potential uncertainty of what constitutes 

a swap by setting forth clear and 

objective criteria for distinguishing an 

agreement, contract, or transaction that 

is insurance from a swap. Providing 

such an objective rule and explanation 

mitigates the potential additional costs 

of petitioning the Commissions, or 

obtaining an opinion of counsel, about 

whether an agreement, contract, or 

transaction is insurance or a swap. 

The objective criteria provided by the 

rule also will aid sound risk 

management practices because it will be 

easier for market participants to decide 

whether a particular agreement, 

contract, or transaction is insurance or 

a swap. 

Further, the CFTC anticipates that the 

interpretation of the term ‘‘swap’’ to 

include guarantees of swaps and the 

separate CFTC release will provide 

programmatic benefits by enabling the 

CFTC and market participants to receive 

more price-forming data about swaps, 

which may help improve price 

discovery for swaps. The CFTC will 

carefully consider these and other 

benefits in the separate CFTC release. 

(c) Comments and Consideration of 

Alternatives 

The CFTC requested comment on the 

costs and benefits of proposed rule 

1.3(xxx)(4) and interpretive guidance to 

distinguish between insurance products 

and swaps for market participants, 

markets, and the public. Several 

commenters 1126 argued that any 

additional requirement beyond the 

requirement of the rules that a product 

is a regulated insurance product creates 

legal uncertainty and imposes costs. 

Specifically, a commenter 1127 asserted 

that it is a burden to introduce 

conditions that are neither universal nor 

fundamental, such as showing a 

continuing risk of loss for some 

insurance contracts. Another 

commenter 1128 argued that legal 

uncertainty may result in conflicting 

interpretations, which can be a 

significant burden for financial guaranty 

transactions that typically require the 

delivery of a legal opinion. 

The Commissions have expanded the 

list of insurance products excluded from 

the swap definition to cover certain 

traditional insurance products that 

commenters have brought to their 

attention and that the Commissions 

have determined are not swaps. The 

Commissions are also clarifying that the 

Insurance Safe Harbor does not imply or 

presume that an agreement, contract or 

transaction that does not meet its 

requirements is a swap or security-based 

swap, but will require further analysis 

of the applicable facts and 

circumstances, including the form and 

substance of the agreement, contract, or 

transaction, to determine whether it is 

insurance, and thus not a swap or 

security-based swap. With regard to 

financial guaranty in particular, the 

acceleration of payment criterion is 

designed to reflect market practice and 

aid appropriate product classification. 

The Commissions are stating that they 

intend to interpret concepts upon which 

the Product Test relies that are derived 

from state law consistently with the 

existing and developing laws of the 

relevant state(s) governing the 

agreement, contract, or transaction in 

question. However, the Commissions 

note their authority to diverge from state 

law if the Commissions become aware 

of evasive conduct. While the CFTC 

cannot anticipate under what 

circumstances or how often the 

Commissions might diverge from state 

law, the CFTC believes that there will be 

more consistent than inconsistent 

interpretations. Accordingly, the rules 

do not present the increased burden or 

legal uncertainty that these commenters 

suggested. 

Several commenters also requested 

that the Commissions codify the 

proposed interpretive guidance 

regarding enumerated insurance 

products in rule text on the basis that 

codification would enhance legal 

certainty, and thereby reduce costs.1129

The Commissions have decided to 

include a list of products in rule text in 

response to these commenters concerns. 

A commenter proposed that the sole 

test for determining whether an 

agreement, contract or transaction is 

insurance should be whether it is 

subject to regulation as insurance by the 

insurance commissioner of the 

applicable state(s).1130 While the 

commenter’s test is potentially easier 

and thus may be less costly to apply 

than the Commissions’ test, it would be 

inadequate because, as explained in 

section II.B.1.(d) above, it would 

essentially delete the product prong of 

the insurance safe harbor, and thus 

begging the question of how to 

distinguish insurance from swaps and 

security-based swaps and allowing state 

insurance regulators to supplant the 

Commissions’ role in further defining, 

or determining what is, a swap. Further, 

market participants might misconstrue 

the commenter’s test in close cases to 

mean that any activity permitted by the 

insurance commissioner of the relevant 

state(s) may not be regulated as swaps 

or security-based swaps. However, 

insurance companies are in many 

circumstances permitted by state 

insurance regulators to enter into swaps 

or security-based swaps, illustrating that 

the fact that while an insurance 

company may enter into an agreement, 

contract or transaction, it does not 

necessarily mean that such agreement, 

contract or transaction is insurance. 

Further, the domain of insurance 

regulation may change and then this 

commenter’s test would induce an 

evolving boundary between state and 

CFTC regulation. 

Several commenters suggested an 

approach in which insurance products 

that qualify for the exclusion contained 

in section 3(a)(8) of the Securities Act of 

1933 would be excluded from the swap 

definition.1131 One commenter argued 

that ‘‘Section 3(a)(8) has long been 

recognized as the definitive provision as 

to where Congress intends to separate 

securities products that are subject to 

SEC regulation from ‘insurance’ and 

‘annuity’ products that are to be left to 

state insurance regulation’’ and that the 

section 3(a)(8) criteria are well 

understood and have a long history of 

interpretation by the SEC and the 

courts.1132 Other commenters suggest 

that because section 3(a)(8) includes 

both a product and a provider 

requirement, if the Commissions 

include it in their final rules, it should 

be a requirement separate from the 

Product Test and the Provider Test, and 

should extend to insurance products 

that are securities.1133

While the Commissions agree that the 

section 3(a)(8) criteria have a long 

history of interpretations by the SEC 

and the courts, the Commissions find 

that it is inappropriate to apply the 

section 3(a)(8) criteria in this context. 

Although section 3(a)(8) contains some 

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1134See NAIC Letter. 

1135See also CAI Letter and Nationwide Letter. 

1136See ACLI ANPR Letter. 

1137See ACLI Letter. 

1138See AIA Letter. 

1139See AFGI Letter, ISDA Letter. 

1140 ISDA Letter. 

1141 Id. 

conditions applicable to insurance 

providers that are similar to the prongs 

of the Provider Test, it does not contain 

any conditions that are similar to the 

prongs of the Product Test. Moreover, 

section 3(a)(8) provides an exclusion 

from the Securities Act and the CFTC 

has no jurisdiction under the Federal 

securities laws. Congress directed both 

agencies to further define the terms 

‘‘swap’’ and ‘‘security-based swap.’’ As 

such, the Commissions find that it is 

more appropriate to have a standalone 

rule that incorporates features that 

distinguish insurance products from 

swaps and security-based swaps and 

over which both Commissions will have 

joint interpretative authority. 

Another commenter proposed the 

following test for an agreement, 

contract, or transaction to be insurance: 

[It] [e]xists for a specified period of time; 

Where the one party to the contract 

promises to make one or more payments such 

as money, goods or services; 

In exchange for another party’s promise to 

provide a benefit of pecuniary value for the 

loss, damage, injury, or impairment of an 

identified interest of the insured as a result 

of the occurrence of a specified event or 

contingency outside of the parties’ control; 

and 

Where such payment is related to a loss 

occurring as a result of a contingency or 

specified event.1134

This test may not represent a less 

costly alternative to the Commissions’ 

test in light of its complexity, and in any 

event would not distinguish swaps and 

security-based swaps from insurance 

more effectively than the Commissions’ 

test for two reasons. The requirements 

of a specified term and the payment of 

premiums are present in both insurance 

products and in agreements, contracts, 

or transactions that are swaps or 

security-based swaps, and therefore 

such requirements do not help to 

distinguish between them. A test based 

solely on these requirements, then, 

would be over-inclusive and exclude 

from the Dodd-Frank regulatory regime 

agreements, contacts, and transactions 

that have not traditionally been 

considered insurance. Also, the third 

and fourth requirements of the 

commenter’s test collapse into the 

Product Prong’s requirement that the 

loss must occur and be proved, and any 

payment or indemnification therefor 

must be limited to the value of the 

insurable interest. 

Another commenter offered a 3-part 

test1135 in lieu of the Commissions’ test: 

(1) The insurance contract must be 

issued by an insurance company and 

subject to state insurance regulation; 

(2) The insurance contract must be the 

type of contract issued by insurance 

companies; and 

(3) The insurance contract must not 

be of a type that the CFTC and SEC 

determine to regulate.1136

The commenter stated that its 

approach does not contain a definition 

of insurance, and for that reason 

believes that is preferable to the 

Commissions’ approach, which it 

believes creates legal uncertainty 

because any attempted definition of 

insurance has the potential to be overor under-inclusive.1137

While the commenter’s test may 

appear simpler on its face, the CFTC 

does not believe that it represents a less 

costly alternative. The first two 

requirements of the commenter’s test do 

not help to distinguish swaps from 

insurance; the third provides no greater 

certainty than the Commissions’ facts 

and circumstances approach. Moreover, 

as discussed in section II.B.1(d) above, 

the Commissions’ rules and related 

interpretations are not intended to 

define insurance. Rather, they provide a 

safe harbor for certain types of 

traditional insurance products by 

reference to factors that may be used to 

distinguish insurance from swaps and 

security-based swaps. Agreements, 

contracts, and transactions that do not 

qualify for the Insurance Safe Harbor 

may or may not be swaps, depending 

upon the facts and circumstances. Thus, 

the Commissions’ test neither creates 

legal uncertainty as suggested by the 

commenter, nor the costs associated 

with such uncertainty. 

Another commenter proposed 

different approaches for existing 

products and new products. According 

to the commenter, if an existing type of 

agreement, contract or transaction is 

currently reportable as insurance in the 

provider’s regulatory and financial 

reports under a state or foreign 

jurisdiction’s insurance laws, then that 

agreement, contract or transaction 

would be insurance rather than a swap 

or security-based swap. On the other 

hand, for new products, if this approach 

is inconclusive, the commenter 

recommended that the Commissions use 

the product prong of the Commissions’ 

test only.1138

The commenter’s proposal may 

represent a less costly alternative than 

the Commissions’ test. However, rather 

than treating existing products and new 

products differently, the Commissions 

as discussed above are providing 

‘‘grandfather’’ protection for agreements, 

contracts, and transactions entered into 

on or before the effective date of the 

Products Definitions. Moreover, the 

commenter’s test would eliminate the 

provider test for new products, which 

the Commissions believe is important to 

help prevent products that are swaps or 

security-based swaps from being 

characterized as insurance. 

In sum, the CFTC finds that, while 

some of the alternatives proposed by 

commenters may appear less costly to 

apply than the Commissions’ test, in all 

cases they would sweep out of the 

Dodd-Frank Act regulatory regime for 

swaps agreements, contracts, and 

transactions that have not historically 

been considered insurance, and that 

should, in appropriate circumstances, 

be regulated as swaps or security-based 

swaps. Accordingly, the CFTC does not 

find these alternative tests proposed by 

commenters to be better tools than the 

Insurance Safe Harbor for limiting the 

scope of the statutory definitions of 

swap and security-based swap. 

Excluding agreements, contracts, and 

transactions that are, in fact, swaps from 

the further definition of the term 

‘‘swap’’ is inconsistent with the CFTC’s 

regulatory objectives and could increase 

risk to the U.S. financial system. 

Three commenters provided 

comments regarding the treatment of 

guarantees of swaps. Two 

commenters 1139 opposed treating 

insurance or guarantees of swaps as 

swaps. Suggesting that the products are 

not economically similar, one 

commenter argued that insurance wraps 

of swaps do not ‘‘necessarily replicate 

the economics of the underlying swap, 

and only following default could the 

wrap provider end up with the same 

payment obligations as a wrapped 

defaulting swap counterparty.’’ 1140 This 

commenter also stated that the noninsurance guarantees are not swaps 

because the result of most guarantees is 

that the guarantor is responsible for 

monetary claims against the defaulting 

party, which in this commenter’s view 

is a different obligation than the 

arrangement provided by the underlying 

swap itself.1141

One commenter supported treating 

financial guaranty insurance of a swap 

or security-based swap as itself a swap 

or a security-based swap. This 

commenter argued that financial 

guaranty insurance of a swap or 

security-based swap transfers the risk of 

counterparty non-performance to the 

guarantor, making it an embedded and 

essential feature of the insured swap or 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48315 

1142See Better Markets Letter. 1143See Better Markets Letter. 1144 ‘‘AIGFP’s obligations were guaranteed by its 

highly rated parent company * * * an arrangement 

that facilitated easy money via much lower interest 

rates from the public markets, but ultimately made 

it difficult to isolate AIGFP from its parent, with 

disastrous consequences.’’ Congressional Oversight 

Panel, The AIG Rescue, Its Impact on Markets, and 

the Government’s Exit Strategy 20 (2010). 1145See ISDA Letter. 1146See AFGI Letter. 

1147See AFGI Letter. Of the members of AFGI, 

only Assured Guaranty (or its affiliates) is currently 

writing financial guaranty insurance policies on 

U.S. municipal obligations. 

1148See EEI Letter (‘‘Without legal certainty as to 

the regulatory treatment of their forward contracts, 

EEI’s members and other end users who rely on the 

forward contract exclusion likely will face higher 

transaction costs due to greater uncertainty. These 

increased transaction costs may include: (i) More 

volatile or higher commodity prices; and (ii) 

increased credit costs, in each case caused by 

changes in market liquidity as end users change the 

way they transact in the commodity markets. A 

single regulatory approach that uses the same 

criteria to confirm that a forward contract is 

Continued 

security-based swap. This commenter 

further argued that the value of such 

swap or security-based swap is largely 

determined by the likelihood that the 

proceeds from the financial guaranty 

insurance policy will be available if the 

counterparty does not meet its 

obligations.1142 This commenter 

maintained that financial guaranty 

insurance of swaps and security-based 

swaps serves a similar function to credit 

default swaps in hedging counterparty 

default risk.1143

While the CFTC is not further 

defining guarantees of swaps to be 

swaps, the CFTC is persuaded that 

when a swap (that is not a securitybased swap or mixed swap) has the 

benefit of a guarantee, the guarantee and 

related guaranteed swap should be 

analyzed together. The events 

surrounding the failure of AIG Financial 

Products (‘‘AIGFP’’) highlight how 

guarantees can cause major risks to flow 

to the guarantor.1144 The CFTC finds 

that the regulation of swaps and the risk 

exposures associated with them, which 

is an essential concern of the DoddFrank Act, would be less effective if the 

CFTC did not interpret the term ‘‘swap’’ 

to include a guarantee of a swap. 

Two commenters cautioned against 

unnecessary and duplicative regulation. 

One commented that, because the 

underlying swap, and the parties to it, 

will be regulated and reported to the 

extent required by Title VII, there is no 

need for regulation of non-insurance 

guarantees.1145 The other commented 

that an insurance policy on a swap 

would be subject to state regulation; 

without addressing non-insurance 

guarantees, this commenter stated that 

additional Federal regulation would be 

duplicative.1146 The CFTC disagrees 

with these arguments. As stated above, 

the CFTC is treating financial guaranty 

insurance of swaps and all other 

guarantees of swaps in a similar manner 

because they are functionally or 

economically similar products. If a 

guarantee of a swap is not treated as an 

integral part of the underlying swap, 

price forming terms of swaps and the 

risk exposures associated with the 

guarantees may remain hidden from 

regulators and may not be regulated 

appropriately. Moreover, treating 

guarantees of swaps as part of the 

underlying swaps ensures that the CFTC 

will be able to take appropriate action 

if, after evaluating information collected 

with respect to the guarantees and the 

underlying swaps, such guarantees of 

swaps are revealed to pose particular 

problems in connection with the swaps 

markets. The separate CFTC release 

clarifies the limited practical effects of 

the CFTC’s interpretation, which should 

address industry concerns regarding 

duplicative regulation. 

One commenter also argued that 

regulating financial guaranty of swaps 

as swaps would cause monoline 

insurers to withdraw from the market, 

which could adversely affect the U.S. 

and international public finance, 

infrastructure and structured finance 

markets, given that insuring a related 

swap often is integral to the insurance 

of municipal bonds and other 

securities.1147 The CFTC finds this 

argument unpersuasive. The CFTC 

understands that the 2008 global 

financial crisis severely affected most 

monolines and only one remains active 

in U.S. municipal markets. Thus, it 

appears that the monolines have, for the 

most part, already exited these markets. 

In addition, as stated above, the separate 

CFTC release clarifies the limited 

practical effects of the CFTC’s 

interpretation, which should address 

industry concerns. 

4. Costs and Benefits of the 

Withdrawing the Energy Exemption and 

Interpretation Regarding the Forward 

Contract Exclusion From the Swap 

Definition 

The CFTC is clarifying that the 

forward contract exclusion from the 

swap definition for nonfinancial 

commodities should be read 

consistently with the forward contract 

exclusion from the CEA definition of the 

term ‘‘future delivery.’’ In that regard, 

the CFTC is retaining the Brent 

Interpretation and extending it to apply 

to all nonfinancial commodities, and 

withdrawing the Energy Exemption, 

which had extended the Brent 

Interpretation regarding the forward 

contract exclusion from the term ‘‘future 

delivery’’ to energy commodities other 

than oil, as it is no longer necessary. 

Although the CFTC is withdrawing the 

Energy Exemption, the CFTC is 

providing that certain alternative 

delivery procedures, such as physical 

netting agreements, that are mentioned 

in the Energy Exemption, are consistent 

with the intent of the book out provision 

in the Brent Interpretation—provided 

that the parties had a bona fide intent, 

when entering into the transactions, to 

make or take (as applicable) delivery of 

the commodity covered by those 

transactions. The CFTC also is 

providing an interpretation regarding 

documentation of orally booked-out 

transactions. 

In addition, the CFTC is clarifying 

that its prior guidance regarding 

commodity options embedded in 

forward contracts should be applied as 

well to the treatment of forward 

contracts in nonfinancial commodities 

that contain embedded options under 

the Dodd-Frank Act. The final 

interpretation also explains the CFTC’s 

position with regard to forwards with 

embedded volumetric optionality, 

including an explanation of how it 

would treat some of the specific 

contracts described by commenters, 

such as full requirements contracts. It 

also explains the CFTC’s view with 

respect to certain contractual 

provisions, such as liquidated damages 

and renewable/evergreen provisions 

that do not disqualify the transactions in 

which they are contained from the 

forward exclusions. The CFTC has also 

provided an interpretation regarding 

nonfinancial commodities, including 

environmental commodities, and 

interpretations concerning physical 

exchange transactions, fuel delivery 

agreements, certain physical 

commercial agreements, and energy 

management agreements. 

(a) Costs 

The CFTC’s statement that it will 

construe the forward contract exclusion 

consistently with respect to the 

definitions of the terms ‘‘swap’’ and 

‘‘future delivery,’’ as discussed herein, 

will not impose any new material costs 

on market participants. It also will 

establish a uniform interpretation of the 

forward contract exclusion from the 

definitions of both statutory terms, 

which will avoid the significant costs 

that some commenters state would 

result if the forward contract exclusion 

were construed differently in these two 

contexts.1148 In addition, the CFTC’s 

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48316 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

excluded from the Commission’s jurisdiction over 

swaps and futures will reduce this uncertainty and 

the associated costs to end users.’’ (footnote 

omitted)). 

1149The CFTC believes that $20,000 represents a 

reasonable estimate of the upper end of the range 

of the costs to undertake the legal analysis of the 

status of an agreement, contract, or transaction as 

a forward contract that qualifies for the forward 

exclusions. The average cost incurred by market 

participants in connection with assessing whether 

an agreement, contract, or transaction is a forward 

contract is based upon the estimated amount of 

time that staff believes will be required for both inhouse counsel and outside counsel to apply the 

definition. The staff estimates that costs associated 

with determining whether an agreement, contract, 

or transaction is a forward contract will range up 

to $20,000 after rounding to two significant digits. 

Staff estimates that some agreements, contracts, or 

transactions will clearly fall within the Brent safe 

harbor, and an internal attorney, without the 

assistance of outside counsel, will be able to make 

a determination in less than one hour. Based upon 

data from SIFMA’s Management & Professional 

Earnings in the Securities Industry 2011 (modified 

by CFTC staff to account for an 1800-hour-workyear and multiplied by 5.35 to account for bonuses, 

firm size, employee benefits and overhead), staff 

estimates that the average national hourly rate for 

an internal attorney is $378. If an agreement, 

contract, or transaction is more complex, the CFTC 

estimates the analysis will require approximately 20 

hours of in-house counsel time and 30 hours of 

outside counsel time. The CFTC estimates the costs 

for outside legal services to be $400 per hour. 

Accordingly, on the high end of the range the CFTC 

estimates the cost to be $19,560 ($7,560 (based on 

20 hours of in-house counsel time × $378) + $12,000 

(based on 30 hours of outside counsel × $400) 

which is then rounded to two significant digits to 

$20,000. 

1150 If contracts are being used for speculative 

purposes they are probably swaps and should be 

subject regulation under Title VII. 

1151See BGA Letter; COPE Letter; ETA Letter; 

FERC Staff Letter; and Just Energy Letter. 

clarification regarding the continued 

viability of the alternative delivery 

procedures in the Energy Exemption 

should reduce costs to the industry by 

conferring legal certainty that their 

transactions may continue to have these 

procedures without losing their 

eligibility for the forward exclusions. 

As noted in section II.B.2.(a)(ii) above, 

the CFTC has explained its position 

regarding nonfinancial commodities. 

This should help the industry to 

determine whether their transactions are 

eligible for the forward exclusions, and 

consequently reduce costs to the 

industry for transactions involving nonfinancial commodities such as 

renewable energy credits that may be 

eligible for the forward exclusions. The 

final interpretation regarding forwards 

with embedded volumetric optionality 

should reduce costs to the industry, 

because these transactions may qualify 

for the forward exclusions from the 

swap and ‘‘future delivery’’ definitions. 

The explanation of how the CFTC will 

view specific contracts mentioned by 

commenters under this interpretation 

should enhance legal certainty and 

thereby reduce costs. 

The clarification that certain 

contractual provisions do not disqualify 

transactions from the forward exclusion 

also should reduce costs to the industry 

by providing increased legal certainty 

that these provisions will not render 

their transactions subject to Dodd-Frank 

Act regulation. Similar cost reductions 

should be achieved through enhanced 

legal certainty provided by the CFTC’s 

interpretations of physical exchange 

transactions, fuel delivery agreements, 

and certain physical commercial 

agreements, all of which may qualify for 

the forward exclusions under these 

interpretations. The interpretation 

regarding energy management 

agreements, which provides that the fact 

that a particular transaction is done 

under the auspices of such agreements 

does not alter the nature of that 

transaction, should likewise enhance 

legal certainty and reduce costs. While 

the CFTC’s interpretation regarding 

documentation of oral book-outs—that 

an oral book-out be followed by a 

confirmation in a commercially 

reasonable time in written or electronic 

form—may impose costs for industries 

that do not document their orally 

booked out transactions, the CFTC 

believes that this requirement is 

consistent with prudent business 

practices and is necessary to prevent 

abuse of the Brent safe harbor. 

Market participants will need to 

assess whether products are forward 

contracts that qualify for the forward 

exclusions from the swap and future 

delivery definitions, and may need to 

request an interpretation regarding such 

products, or obtain an opinion of 

counsel, which will involve certain 

costs. 1149

(b) Benefits 

The CFTC’s interpretations regarding 

the forward exclusions should provide 

market participants with greater legal 

certainty regarding whether their 

transactions qualify for the forward 

exclusion from the swap definition, 

which should facilitate commercial 

merchandising activity. For example, 

the interpretation regarding forwards 

with embedded volumetric options 

should facilitate commercial 

merchandising activity of the electricity, 

natural gas, and other industries that 

employ these contracts where delivery 

quantities are flexible, while the 

conditions in the interpretations should 

help to assure that these contracts are 

bona fide forwards. 

In addition, the interpretation should 

result in the appropriate classification of 

transactions as commercial 

merchandising transactions (and thus 

forward contracts) that are not subject to 

Title VII regulation. This will enhance 

market participants’ efficient use of the 

swaps markets and, as described above, 

reduce costs on industry. Documenting 

oral book-outs should promote good 

business practices and aid the CFTC in 

preventing evasion through abuse of the 

forward exclusion. Finally, the CFTC’s 

interpretation regarding commercial 

market participants should ensure that 

the forward exclusions may only be 

used for commercial merchandising 

activity and not for speculative 

purposes. 1150

The CFTC’s position regarding 

nonfinancial commodities should help 

the industry to determine whether their 

transactions are eligible for the forward 

exclusions, which should facilitate 

commercial merchandising activity for 

transactions involving non-financial 

commodities such as renewable energy 

credits that may be eligible for the 

forward exclusions. 

(c) Comments and Consideration of 

Alternatives 

The CFTC requested comment in the 

Proposing Release on the costs and 

benefits of the proposed interpretive 

guidance regarding the forward contract 

exclusion and the withdrawal of the 

Energy Exemption for market 

participants, markets and the public. 

Several commenters requested that 

the CFTC codify its proposed guidance 

regarding the forward contract exclusion 

in rule text to provide greater legal 

certainty, which they argued may 

mitigate costs.1151 However, upon 

consideration, the CFTC is not codifying 

its interpretation in rule text. As 

discussed in section II.B.2.(a)(i), above, 

the CFTC has never codified its prior 

interpretations of the forward contract 

exclusion with respect to the future 

delivery definition as a rule or 

regulation. Publishing an interpretation 

in this release is consistent with the 

manner in which the CFTC has 

interpreted the forward exclusion in the 

past. The additional research costs 

associated with an interpretation as 

opposed to codification in the Code of 

Federal Regulations will be small, 

because the CFTC has placed this 

interpretation, and all other product 

interpretations, in this adopting release 

for the convenience of practitioners. 

Moreover, courts may rely upon agency 

interpretations; thus, the CFTC believes 

that codification would not mitigate 

costs much. 

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1152See Just Energy Letter; NEMA Letter; NGSA/ 

NCGA Letter; ONEOK Letter; and WGCEF Letter. 

1153 7 U.S.C. 6c(b). 

1154See 3Degrees Letter; AWEA Letter; CERP 

Letter; EMA Letter; GreenX Letter; PMAA/NEFI 

Letter; REMA Letter; and WGCEF Letter. 

1155See California Utilities Letter. 

1156See COPE Letter, Appendix. 

1157See WGCEF Letter; 7 U.S.C. 6c(b). 

1158See Commodity Options, 77 FR 25320, April 

27, 2012. 17 CFR 32.3. Encana Marketing (USA) Inc. 

(‘‘Encana’’) believes that the guidance on forwards 

with embedded options should include embedded 

physical delivery options because it asserts that 

many of the contracts currently used by participants 

in the wholesale natural gas market contain an 

option for the physical delivery of natural gas. See 

Encana Letter. To the extent that Encana’s comment 

goes beyond volumetric optionality, commodity 

options are discussed above in section II.B.2.(b)(i). 

1159See NMPF Letter. 

1160See ETA Letter at 19 n. 47. Similarly, COPE 

comments that a nonfinancial commodity forward 

contract that, ‘‘by its terms,’’ is intended to settle 

physically should be permitted to contain 

optionality without being transformed into a swap 

unless such optionality negates the physical 

settlement element of the contract. That is, if one 

party can exercise an option to settle the contract 

financially based upon the value change in an 

underlying cash market, then the intent for physical 

settlement is not contained in ‘‘the four corners of 

the contract’’ and may render the contract a swap. 

COPE Letter. While COPE’s approach may impose 

less costs on market participants (as more 

transactions likely would qualify for the forward 

exclusion, as discussed in section II.B.2.(b)(ii), 

above, the CFTC has eschewed approaches to the 

forward exclusion that rely on the ‘‘four corners of 

the contract,’’ which can provide a roadmap to 

evasion of statutory requirements. 

Some commenters1152 argued that 

physical options should be considered 

forward contracts excluded from the 

definition of a swap, because increased 

regulation would cause harm to 

physical commodity markets without 

providing significant benefits. The 

statutory definition of ‘‘swap’’ provides 

that options—including physical 

options—are swaps. Accordingly, the 

CFTC may not exclude such options 

from the swap definition. Further, 

treating physical options as forward 

contracts would be inconsistent with 

longstanding CFTC precedent. 

Nonetheless, the CFTC has provided 

relief using its plenary authority under 

CEA Section 4c(b)1153 over commodity 

options through the trade option 

exemption. While certain capacity 

contracts on RTOs and ISOs and certain 

contracts entered into by section 201(f) 

entities may be considered options and 

therefore would be swaps, regulation of 

these contracts may be addressed 

through the public interest waiver 

process in CEA section 4(c)(6). 

Several commenters1154 argued that 

renewable energy credits should not be 

swaps; rather, renewable energy credits 

should be considered nonfinancial 

commodities eligible for the forward 

exclusion from the swap definition. 

They asserted that swap regulations 

would raise transaction costs making it 

more difficult and expensive to support 

renewable energy. The CFTC is 

clarifying that renewable energy credits 

are nonfinancial commodities and that 

transactions therein are eligible for the 

forward exclusion if they satisfy the 

terms thereof. So if these transactions 

meet the forward exclusion, they will 

bear no increased costs. 

A commenter1155 requested that 

tolling contracts be considered forwards 

and not swaps, seeking to avoid 

unnecessary cost of regulatory 

uncertainty and unintended conflict 

between the CFTC and other regulators. 

The CFTC has not provided blanket 

interpretations regarding particular 

products in the rulemaking, but has 

provided an interpretation regarding the 

forward contract exclusions provided 

above in section II.B.2. To the extent a 

commenter still is uncertain about the 

treatment of a specific type of 

transaction, the commenter may request 

an interpretation from the CFTC. 

Another commenter argued more 

generally that any embedded option (for 

example, price, quantity, delivery point, 

delivery date, contract term) that does 

not permit a unilateral election of 

financial settlement based upon the 

value change in an underlying cash 

market should not render the contract a 

swap.1156 While the commenter’s 

approach with respect to ‘‘any’’ 

embedded option may result in lower 

costs for market participants because 

more contracts likely would be 

excluded as forwards from the swap 

definition and thus not be subject to 

regulation under the Dodd-Frank Act, 

such an expansive approach may 

inappropriately classify contracts as 

forwards. The CFTC is providing an 

interpretation with respect to forwards 

with embedded volumetric options to 

address commenters’ concerns. The 

CFTC is also explaining its position 

above regarding price optionality, 

optionality with respect to delivery 

points and delivery dates specifically in 

response to the commenter’s letter, and 

optionality as to certain contract terms 

(such as evergreen and renewal 

provisions) to address particular 

concerns raised by commenters. 

Another commenter suggested that an 

option to purchase or sell a physical 

commodity, whether embedded in a 

forward contract or stand alone, should 

either (i) fall within the statutory 

forward exclusion from the swap 

definition, or (ii) alternatively, if 

deemed by the CFTC to be a swap, 

should be exempt from the swap 

definition pursuant to a modified trade 

option exemption pursuant to CEA 

Section 4c(b).1157 Although this 

proposal may on its face appear to be 

simpler than the CFTC’s, it is 

substantively similar to the one the 

CFTC is adopting. The CFTC has 

modified the proposed interpretive 

guidance regarding forwards with 

embedded options as discussed in 

section II.B.2.(b)(ii) above; contracts 

with embedded options that are swaps 

under the final interpretation may 

nevertheless qualify for the modified 

trade option exemption recently 

adopted by the CFTC.1158 The CFTC is 

not adopting an approach that forwards 

with any type of embedded option 

should fall within the statutory forward 

exclusion from the swap definition. 

Such an approach would be overbroad 

because it would exclude contracts that 

are not appropriately classified as 

forwards. The commenter also requested 

that trade option exemptions be granted 

for physical commodities. The costs and 

benefits of the trade option exemption 

are addressed in that rulemaking. 

Another commenter urged the CFTC 

to broadly exempt commercial forward 

contracting from swap regulation by 

generally excluding from the swap 

definition any forward contract with 

embedded optionality between end 

users ‘‘whose primary purpose is 

consistent with that of an ‘end user’, 

and in which any embedded option is 

directly related to ‘end use.’ ’’1159

While this alternative may appear to 

be less costly than the CFTC’s 

interpretation, its vagueness may create 

significant legal uncertainty about the 

scope of the forward exclusion, which 

may increase costs on market 

participants. Even if this approach does 

represent a lower cost alternative, 

however, it is overbroad and likely 

would result in the inappropriate 

classification of transactions as forward 

contracts, and thus would not achieve 

the CFTC’s objective of appropriately 

classifying transactions that should 

qualify for the forward exclusions. 

Another commenter believed that the 

CFTC’s ‘‘facts and circumstances’’ 

approach to forwards with embedded 

options does not provide the legal 

certainty required by nonfinancial 

entities engaging in commercial 

contracts in the normal course of 

business.1160 The commenter further 

argued that many option-like contract 

terms could be determined to ‘‘target the 

delivery term’’ under a facts and 

circumstances analysis. Accordingly, 

the commenter believed that the CFTC 

should provide in its rules that an 

embedded option or embedded 

optionality will not result in a 

nonfinancial forward being a swap 

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1161See ETA Letter. 

1162See also NCFC Letter (supporting the CFTC’s 

guidance because it provides legal certainty). 

1163See also Commodity Options, 77 FR 25320, 

25324 n. 25, April 27, 2012 (discussing the CFTC’s 

conclusion that an ‘‘option[] to redeem’’ under the 

USDA Commodity Credit Corporation’s marketing 

loan program constitutes a cotton producer’s 

contractual right to repay its marketing loan and 

‘‘redeem’’ the collateral (cotton) to sell in the open 

market). 

1164See IECA II Letter. 

1165See Commodity Options, 77 FR 25320, April 

27, 2012. 

unless: (1) Delivery is optional; (2) 

financial settlement is allowed; and (3) 

transfer and trading of the option 

separately from the forward is 

permitted.1161

The CFTC has long applied a facts 

and circumstances approach to the 

forward exclusion, including with 

respect to forwards with embedded 

options, an approach with which market 

participants are familiar. That approach 

balances the need for legal certainty 

against protecting market participants, 

market integrity and the risk of 

providing opportunities for evasion.1162

By contrast, the commenter’s bright-line 

approach may be simpler to apply, but 

could undermine market integrity and 

creates greater evasion opportunities. 

Moreover, the CFTC’s additional 

interpretation noted above, including 

clarification about the meaning of the 

phrase ‘‘target the delivery term,’’ and 

forwards with embedded volumetric 

optionality, provides enhanced legal 

certainty in response to the commenter’s 

concerns, which should mitigate the 

costs of the CFTC’s approach to market 

participants.1163

Another commenter 1164 stated its 

view that the full costs of applying the 

Dodd-Frank regulatory apparatus to 

physical energy transactions, or of 

energy companies being forced to 

abandon full-requirements bilateral 

contracting will significantly increase 

the costs to be paid by U.S. consumers. 

The CFTC is sensitive to these concerns. 

The CFTC is providing relief for fullrequirements contracts so long as they 

satisfy the conditions set forth in the 

interpretation. 

The CFTC is also providing relief for 

other types of physical energy contracts 

that may qualify for the forward 

exclusions. Separately, the CFTC has 

provided relief for trade options in 

another rulemaking.1165

5. Loan Participations 

In the Proposing Release, the 

Commissions proposed guidance that 

they do not interpret the swap and 

security-based swap definitions to 

include loan participations in which: (i) 

The purchaser is acquiring a current or 

future direct or indirect ownership 

interest in the related loan; and (ii) the 

loan participations are ‘‘true 

participations’’ (the participant acquires 

a beneficial ownership interest in the 

underlying loans). One commenter 

expressed concern with the second 

prong of the proposed guidance. 

Specifically, the commenter said that 

the ‘‘true participation’’ requirement 

may result in the improper classification 

of loan participations as swaps, because 

LMA-style loan participations may not 

qualify. Moreover, because of legal 

uncertainty associated with the ‘‘true 

participation’’ terminology derived from 

U.S. bankruptcy law, LSTA-style loan 

participations may be subject to 

improper classification as well. The 

commenter proposed an alternative test 

described in section II.B.3., above. 

The Commissions largely are adopting 

the recommendation from the 

commenter regarding the Commissions’ 

proposed guidance concerning loan 

participations as not swaps or securitybased swaps, with certain 

modifications. This reduces costs for 

market participants because the 

Commissions’ test for loan 

participations from the proposal 

included a ‘‘true participation’’ 

requirement that commenters suggested 

is subject to legal uncertainty. Benefits 

of the rule include enhanced legal 

certainty that loan participations that 

meet the requirements of the 

interpretation are not swaps, which 

should facilitate loan participation 

market activity. 

6. Interpretation Regarding Commercial/ 

Consumer Transactions 

The Commissions are stating that 

certain customary consumer and 

commercial transactions that have not 

previously been considered swaps or 

security-based swaps do not fall within 

the statutory definitions of those terms. 

Specifically with regard to consumer 

transactions, the Commissions are 

adopting as proposed the interpretation 

that certain transactions entered into by 

consumers (natural persons) as 

principals or their agents primarily for 

personal, family or household purposes 

would not be considered swaps or 

security-based swaps. The Commissions 

have added to the list of consumer 

transactions certain residential fuel 

storage contracts; service contracts; 

consumer options to buy, sell or lease 

real or personal property; and certain 

consumer guarantees of loans (credit 

cards, automobile, and mortgage). The 

Commissions have also clarified that 

consumer transactions used to purchase 

nonfinancial energy commodities are 

not swaps or security-based swaps. With 

respect to commercial transactions, the 

Commissions are adopting as proposed 

the interpretation that certain 

commercial transactions involving 

customary business arrangements 

(whether or not involving a for-profit 

entity) would not be considered swaps 

or security-based swaps. The 

Commissions also are clarifying that 

commercial loans by the Federal Home 

Loan Banks and Farm Credit Institutions 

are not swaps. Finally, the Commissions 

are explaining the factors characteristic 

of consumer and commercial 

transactions that the Commissions will 

consider in determining whether other 

consumer and commercial transactions 

that are not specifically listed in the 

interpretation should be considered 

swaps or security-based swaps. 

(a) Costs 

The CFTC believes that the forgoing 

interpretation should mitigate costs 

because it increases legal certainty that 

specific customary consumer and 

commercial transactions are not swaps 

or security-based swaps subject to 

Dodd-Frank regulation. As a result of 

this interpretation, consumers and 

industry participants will not have to 

seek legal advice regarding whether 

these transactions are swaps or securitybased swaps. The interpretation 

regarding commercial loans made by the 

Federal Home Loan Banks and Farm 

Credit Institutions also reduces costs by 

not subjecting these transactions to 

additional Dodd-Frank Act regulation. 

To the extent a customary consumer or 

commercial transaction is not included 

in the interpretation, consumers and 

market participants may incur costs in 

seeking an interpretation from the 

Commissions regarding the status of 

their transactions or an opinion of 

counsel. However, the CFTC has 

emphasized that the lists are not 

exclusive, and has provided the factors 

it will consider for determining whether 

other consumer and commercial 

transactions that are not specifically 

listed in the interpretation should be 

considered swaps or security-based 

swaps, which should assist consumers 

and market participants in deciding 

whether to seek an interpretation and 

thus mitigate these costs. 

(b) Benefits 

The foregoing interpretation provides 

increased legal certainty benefits for 

market participants and should ensure 

that customary consumer and 

commercial transactions, which have 

never been considered swaps or 

security-based swaps, will not be 

subject to Dodd-Frank Act regulation, 

and may facilitate consumer and 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48319 

1166See ETA Letter; ICEA Letter; and Just Energy 

Letter. 

1167The additional research costs associated with 

an interpretation as opposed to codification in the 

Code of Federal Regulations will be small, because 

the CFTC has placed this interpretation, and all 

other products interpretations, in this adopting 

release for the convenience of practitioners. 

1168See IECA Letter. 

1169See FCC Letter. 

1170The BPA refers to the implementation of 

Section 5(c) of the Northwest Power Act, 16 U.S.C. 

839c(c), as the ‘‘Residential Exchange Program.’’ 

1171 Id. at 3. 

1172 16 U.S.C. Chapter 12H. 

1173See Bonneville Letter. 

1174 7 U.S.C. 6r. 

1175 7 U.S.C. 6s. 

1176As discussed in section II.C.2.(c) above, in 

general, a foreign exchange transaction will be 

considered a bona fide spot transaction if it settles 

via an actual delivery of the relevant currencies 

within two business days. However a foreign 

exchange transaction with a longer settlement 

Continued 

commercial activity. As discussed 

above, the interpretation regarding the 

factors that the Commissions will 

consider in determining whether 

transactions that are not listed in the 

interpretation are swaps or securitybased swaps should assist market 

participants in determining whether to 

seek an interpretation regarding such 

transactions. Therefore, this 

interpretation helps to mitigate costs of 

legal uncertainty. 

(c) Comments and Consideration of 

Alternatives 

Several commenters believed that the 

proposed interpretive guidance 

regarding consumer/commercial 

transactions does not provide sufficient 

legal certainty and request that the 

Commissions codify such guidance in 

regulations in order to provide greater 

legal certainty, which may mitigate 

costs.1166 The Commissions decline to 

codify the interpretation into rule text. 

The interpretation is intended to 

provide guidance to assist consumers 

and commercial and non-profit entities 

in evaluating whether certain 

arrangements that they enter into will be 

regulated as swaps or security-based 

swaps. The interpretation is intended to 

allow the flexibility necessary, 

including the consideration of the 

applicable facts and circumstances by 

the Commissions, in evaluating 

consumer and commercial arrangements 

to ascertain whether they may be swaps 

or security-based swaps. The 

representative characteristics and 

factors taken together are indicators that 

a consumer or commercial arrangement 

is not a swap or security-based swap, 

and the Commissions have provided 

specific examples demonstrating how 

these characteristics and factors apply to 

some common types of consumer and 

commercial arrangements. However, as 

the interpretation is not intended to be 

a bright-line test for determining 

whether a particular consumer or 

commercial arrangement is a swap or 

security-based swap, if the particular 

arrangement does not meet all of the 

identified characteristics and factors, 

the arrangement will be evaluated based 

on its particular facts and 

circumstances. Also, the courts may rely 

on the interpretation and as such, the 

CFTC does not believe that the adoption 

of rule text as opposed to an 

interpretation will mitigate costs 

associated with perceived legal 

uncertainty.1167

A commenter 1168 asserted that 

Federal courts will have to hear more 

disputes, because proposed CFTC 

jurisdiction would pre-empt significant 

aspects of state and Federal law 

concerning the purchase and sale of 

goods and services. This rulemaking 

includes safe-harbors from the 

definition of a swap for customary 

consumer and commercial transactions. 

The Commissions have expanded the 

list of consumer transactions that are 

excluded from the swap definition. 

While it may be possible that Federal 

courts will nevertheless hear more 

disputes, that would be a result of the 

statutory swap definition and not from 

the interpretation being adopted by the 

Commissions (which should reduce the 

number of such disputes). 

Another commenter 1169 agreed with 

the general factors proposed for 

identifying agreements, contracts, or 

transactions that are not swaps, but 

requested additional clarity with respect 

to particular transactions. Specifically, 

the commenter requested that 

commercial loans and financing 

facilities with embedded interest rate 

options should not be considered 

swaps. To clarify, interest rate options 

are swaps. As discussed in section 

II.B.3. above, plain vanilla interest rate 

options embedded in a loan, such as 

rate locks, rate caps and rate collars, are 

not swaps. If a product is more complex, 

it may be appropriate for the CFTC to 

consider it in response to a specific 

request for interpretation. 

7. Residential Exchange Program 

(‘‘REP’’) 

The REP 1170 was established by 

Congress ‘‘[t]o extend the benefits of low 

cost Federal System hydro power to 

residential and small farm electric 

power consumers throughout the Pacific 

Northwest Region.’’ 1171 A commenter 

requests that the CFTC further define 

the term ‘‘swap’’ to exclude consumer 

benefits under the Pacific Northwest 

Electric Power Planning and 

Conservation Act of 1980 (‘‘Northwest 

Power Act’’) 1172 and transactions under 

the REP 1173 to allow a subsidy to 

continue to be received by residential 

and small farm utilities. 

The Commissions do not consider the 

REP transactions described by the 

commenter to be swaps or securitybased swaps. Consequently, this 

rulemaking clarifies that Dodd-Frank 

regulatory costs will not be imposed on 

REPs and allows the subsidy to continue 

to be provided to residential and small 

farm utilities. 

8. Costs and Benefits of Rule Regarding 

Foreign Exchange Products and Forward 

Rate Agreements 

CFTC rule 1.3(xxx)(2) under the CEA 

explicitly defines the term ‘‘swap’’ to 

include an agreement, contract, or 

transaction that is a cross-currency 

swap, currency option, foreign currency 

option, foreign exchange option, foreign 

exchange rate option, foreign exchange 

forward, foreign exchange swap, 

forward rate agreement, and nondeliverable forward involving foreign 

exchange, unless such agreement, 

contract, or transaction is otherwise 

excluded by section 1a(47)(B) of the 

CEA. Rule 1.3(xxx)(3) provides that: (i) 

A foreign exchange forward or a foreign 

exchange swap shall not be considered 

a swap if the Secretary of the Treasury 

makes the determination described in 

CEA section 1a(47)(E)(i); and (ii) 

notwithstanding any such 

determination, certain provisions of the 

CEA will apply to such a foreign 

exchange forward or foreign exchange 

swap (specifically, the reporting 

requirements in section 4r of the 

CEA 1174 and regulations thereunder 

and, in the case of a swap dealer or 

major swap participant that is a party to 

a foreign exchange swap or foreign 

exchange forward, the business conduct 

standards in section 4s of the CEA 1175

and regulations thereunder). Rule 

1.3(xxx)(3) further clarifies that a 

currency swap, cross-currency swap, 

currency option, foreign currency 

option, foreign exchange option, foreign 

exchange rate option, or non-deliverable 

forward involving foreign exchange is 

not a foreign exchange forward or 

foreign exchange swap subject to a 

determination by the Secretary of the 

Treasury as described in the preamble. 

The Commissions are also clarifying 

that a bona fide foreign exchange spot 

transaction, i.e., a foreign exchange 

transaction that is settled on the 

customary timeline 1176 of the relevant 

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48320 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

period concluding with the actual delivery of the 

relevant currencies may be considered a bona fide 

spot transaction depending on the customary 

timeline of the relevant market. In particular, a 

foreign exchange transaction that is entered into 

solely to effect the purchase or sale of a foreign 

security is a bona fide spot transaction where 

certain conditions are met. 

1177CEA section 1a(24), 7 U.S.C. 1a(24)(definition 

of a ‘‘foreign exchange forward’’); CEA section 

1a(25), 7 U.S.C. 1a(25)(definition of a ‘‘foreign 

exchange swap’’). 

1178See CEIBA Letter; Covington Letter; ISDA 

Letter; and MFA Letter. 

spot market, is not within the definition 

of the term ‘‘swap.’’ In addition, the 

interpretation clarifies that retail foreign 

currency options described in CEA 

Section 2(c)(2)(B) are not swaps. This 

clarification allows market participants 

to engage in these transactions with 

non-ECP customers who would 

otherwise have to engage in onexchange transactions. 

(a) Costs 

In complying with rule 1.3(xxx)(2), a 

market participant will need to ascertain 

whether an agreement, contract, or 

transaction is a swap under the 

definition. This analysis will have to be 

performed upon entering into the 

agreement, contract, or transaction. 

However, any costs associated with this 

analysis are expected to be less than the 

costs of doing the same analysis absent 

the rule, particularly given potential 

confusion in the event of a 

determination by the Secretary of the 

Treasury that foreign exchange forwards 

and/or foreign exchange swaps not be 

considered swaps. To the extent that 

rule 1.3(xxx)(2) improperly includes 

certain types of agreements, contracts, 

and transactions in the swap definition, 

and therefore the imposition of 

additional requirements and obligations, 

these requirements and obligations 

could lead to costs for market 

participants entering into such 

agreements, contracts, or transactions. 

However, the CFTC has carefully 

considered each of the agreements, 

contracts and transactions described 

above that it is further defining as swaps 

under rule 1.3(xxx)(2) and believe that 

they are appropriately classified as 

such, subject to the statutory exclusions. 

(b) Benefits 

Because the statutory definition of the 

term ‘‘swap’’ includes a process by 

which the Secretary of the Treasury may 

determine that certain agreements, 

contracts, and transactions that meet the 

statutory definition of a ‘‘foreign 

exchange forward’’ or ‘‘foreign exchange 

swap,’’ respectively,1177 shall not be 

considered swaps, the CFTC is 

concerned that application of the 

definition, without further clarification, 

may cause uncertainty about whether, if 

the Secretary of the Treasury makes 

such a determination, certain 

agreements, contracts, or transactions 

would be swaps. Rule 1.3(xxx)(3) 

increases legal certainty that a currency 

swap, cross-currency swap, currency 

option, foreign currency option, foreign 

exchange option, foreign exchange rate 

option, or non-deliverable forward 

involving foreign exchange, is a swap 

(unless it is otherwise excluded by the 

statutory definition of the term ‘‘swap’’). 

The rule also increases legal certainty 

that reporting requirements, and 

business conduct requirements for swap 

dealers and major swap participants, are 

applicable to foreign exchange forwards 

and foreign exchange swaps even if the 

Secretary of the Treasury determines 

that they should not be considered 

swaps, and is consistent with the 

statute. The CFTC also is concerned that 

confusion could be generated by the 

‘‘forward’’ label of non-deliverable 

forwards involving foreign exchange, 

and forward rate agreements. Rule 

1.3(xxx)(2) increases legal certainty that 

these types of agreements, contracts, 

and transactions are swaps. 

Providing such a rule to market 

participants to determine whether 

certain types of agreements, contracts, 

or transactions are swaps alleviates 

additional costs to persons of inquiring 

with the Commissions, or obtaining an 

opinion of counsel, about whether such 

agreements, contracts, or transactions 

are swaps. In addition, such a rule 

regarding the requirements that apply to 

foreign exchange forwards and foreign 

exchange swaps that are subject to a 

determination by the Secretary of the 

Treasury similarly alleviates additional 

costs to persons of inquiring with the 

Commissions, or obtaining an opinion 

of counsel, to determine the 

requirements that are applicable to such 

foreign exchange forwards and foreign 

exchange swaps. As with the other rules 

comprising the Product Definitions, 

enhanced legal certainty will help 

market participants to engage in sound 

risk management practices, which will 

benefit both market participants and the 

public. 

The interpretation concerning bona 

fide foreign exchange spot transactions 

should result in the appropriate 

classification of such transactions as not 

subject to Dodd-Frank Act regulation. 

The interpretation regarding retail 

foreign currency options subject to CEA 

Section 2(c)(2)(B) as not swaps provides 

clarity and reduces costs for market 

participants, who could not offer the 

product to non-ECP customers offexchange in accordance with the 

provisions of CEA Section 2(c)(2)(B). 

In addition, including certain FX 

transactions, forward rate agreements 

and certain other transactions in the 

swap definition protects the public by 

explicitly subjecting these transactions 

to Dodd-Frank regulation. 

(c) Comments and Consideration of 

Alternatives 

The CFTC requested comment as to 

the costs and benefits of proposed rules 

1.3(xxx)(2) and (3). As discussed in the 

preamble, some commenters 1178 argued 

that non-deliverable foreign exchange 

forward transactions should be 

regulated as foreign exchange forwards, 

because regulating them as swaps would 

increase the cost of hedging foreign 

currency exposures in emerging 

markets. 

Non-deliverable forward transactions 

do not satisfy the statutory definition of 

foreign exchange forwards, as explained 

in section II.C.2.(b)(ii), supra. They do 

satisfy the swap definition, however. 

Accordingly, the CFTC lacks discretion 

not to define them as swaps. 

9. Costs and Benefits of Rule Regarding 

Title VII Instruments on Futures on 

Foreign Sovereign Debt Under Exchange 

Act Rule 3a12–8 

Rule 1.3(bbbb) provides that a Title 

VII instrument that is based on or 

references a qualifying foreign futures 

contract on the debt securities of one or 

more of the 21 enumerated foreign 

governments is a swap and not a 

security-based swap if the Title VII 

instrument satisfies the following 

conditions: 

• The futures contract on which the 

Title VII instrument is based or that is 

referenced must be a qualifying foreign 

futures contract (as defined in rule 

3a12–8) on the debt securities of any 

one or more of the 21 enumerated 

foreign governments that satisfies the 

conditions of rule 3a12–8; 

• The Title VII instrument is traded 

on or through a board of trade (as 

defined in section 1a(6) of the CEA); 

• The debt securities on which the 

qualifying foreign futures contract is 

based or referenced and any security 

used to determine the cash settlement 

amount pursuant to the fourth condition 

below are not registered under the 

Securities Act or the subject of any 

American depositary receipt registered 

under the Securities Act; 

• The Title VII instrument may only 

be cash settled; and 

• The Title VII instrument is not 

entered into by the issuer of the 

securities upon which the qualifying 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48321 

1179See, e.g., rule 405 under the Securities Act, 

17 CFR 230.405. 

1180The Commissions note that the final rules 

provide consistent treatment of qualifying foreign 

futures contracts on the debt securities of the 21 

enumerated foreign governments and Title VII 

instruments based on qualifying foreign futures 

contracts on the debt securities of the 21 

enumerated foreign governments unless the Title 

VII instrument is entered into by the issuer of the 

securities upon which the qualifying foreign futures 

contract is based or referenced (including any 

security used to determine the cash payment due 

on settlement of such Title VII instrument), an 

affiliate of the issuer, or an underwriter with respect 

to such securities. 

1181See supra note 716 and accompanying text. 

1182See supra note 712 and accompanying text. 

1183For example, index CDS and single name 

CDS have typically been traded on the same trading 

desk, and customers have typically held their 

positions in a single account. The CFTC notes that 

the jurisdictional divide will impact among other 

things portfolio margining. 

foreign futures contract is based or 

referenced (including any security used 

to determine the cash payment due on 

settlement of such Title VII instrument), 

an affiliate (as defined in the Securities 

Act and the rules and regulations 

thereunder) 1179 of the issuer, or an 

underwriter with respect to such 

securities. 

Only those Title VII instruments that 

are based on qualifying foreign futures 

contracts on the debt securities of the 21 

enumerated foreign governments and 

that satisfy these five conditions will be 

swaps. The final rules are intended to 

provide consistent treatment (other than 

with respect to method of settlement) of 

qualifying foreign futures contracts and 

Title VII instruments based on 

qualifying foreign futures contracts on 

the debt securities of the 21 enumerated 

foreign governments.1180 The 

Commissions understand that many of 

the qualifying foreign futures contracts 

on the debt securities of the 21 

enumerated foreign governments trade 

with substantial volume through foreign 

trading venues under the conditions set 

forth in rule 3a12–8 1181 and permitting 

swaps on such futures contracts subject 

to similar conditions would not raise 

concerns that such swaps could be used 

to circumvent the conditions of rule 

3a12–8 and the Federal securities laws 

concerns that such conditions are 

intended to protect.1182 Further, 

providing consistent treatment for 

qualifying foreign futures contracts on 

the debt securities of the 21 enumerated 

foreign governments and Title VII 

instruments based on futures contracts 

on the debt securities of the 21 

enumerated foreign governments will 

allow trading of these instruments 

through DCMs on which such futures 

are listed. There may also be crossmargining benefits when different 

contracts are margined at the same 

derivatives clearing organization, such 

as may be the case if a swap on a futures 

contract and a corresponding futures 

contract trade on the same DCM. This 

cross-margining would enhance sound 

risk management practices. 

The CFTC believes that the 

assessment cost associated with 

determining whether a swap on certain 

futures contracts on foreign government 

securities constitute a swap or securitybased swap under rule 1.3(bbbb) should 

be minimal. Currently, qualifying 

foreign futures contracts on debt 

securities of the 21 enumerated foreign 

governments are traded on exchanges or 

boards of trade. Market participants may 

look at the exchange or board of trade 

listing to determine what they are. 

Therefore, the assessment, in 

accordance with the rule, would 

primarily focus on whether such swap 

itself is traded on or through a board of 

trade; whether the swap is cash-settled; 

whether the futures is traded on a board 

of trade; whether any security used to 

determine the cash settlement amount 

are not registered under the Securities 

Act or the subject of any American 

depositary receipt registered under the 

Securities Act; and whether the swap is 

entered into by the foreign government 

issuing the debt securities upon which 

the qualifying futures contract is based 

or referenced, an affiliate of such foreign 

government or an underwriter of such 

foreign government securities. All of 

these determinations may be readily and 

quickly ascertained by the parties 

entering into the agreement, contract, or 

transaction. Therefore, the assessment 

costs associated with rule 1.3(bbbb) 

should be nominal because parties 

should be able to make assessments in 

less than an hour. 

10. Costs and Benefits of Rules and 

Interpretations Regarding Title VII 

Instruments Where the Underlying 

Reference Is a Security Index 

Historically, the market for index CDS 

did not divide along jurisdictional 

divisions between the CFTC and 

SEC; 1183 however, the Dodd-Frank Act 

created a jurisdictional divide between 

swaps and security-based swaps. Under 

the jurisdictional division, the CFTC has 

jurisdiction over Title VII instruments 

based on non-narrow-based security 

indexes while the SEC has jurisdiction 

over Title VII instruments based on 

narrow-based security indexes. The SEC 

also has jurisdiction over Title VII 

instruments based on a single security 

or loan, and certain events related to an 

issuer of securities or issuers of 

securities in a narrow-based security 

index. 

Rule 1.3(yyy)(1) under the CEA 

provides that, for purposes of the 

security-based swap definition, the term 

‘‘narrow-based security index’’ would 

have the same meaning as the statutory 

definition set forth in CEA section 

1a(35), and the rules, regulations, and 

orders issued by the Commissions 

relating to such definition. As a result, 

except where the new rules the 

Commissions are adopting provide for 

other treatment, market participants 

generally will be able to use the 

Commissions’ past guidance in 

determining whether certain Title VII 

instruments based on a security index 

are swaps or security-based swaps. 

The Commissions are promulgating 

additional rules and providing 

interpretations regarding Title VII 

instruments based on a security index. 

The interpretations and additional rules 

set forth new narrow-based security 

index criteria with respect to indexes 

composed of securities, loans, or issuers 

of securities referenced by an index 

CDS. The interpretations and rules also 

address the definition of an ‘‘index’’ and 

the treatment of broad-based security 

indexes that become narrow-based and 

narrow-based indexes that become 

broad-based, including rule provisions 

regarding tolerance and grace periods 

for swaps on security indexes that are 

traded on CFTC-regulated and SECregulated trading platforms. 

(a) Costs 

In complying with the rules and 

interpretations, a market participant 

will need to ascertain whether a Title 

VII instrument is a swap or a securitybased swap according to the criteria set 

forth in the definitions of the terms 

‘‘issuers of securities in a narrow-based 

security index’’ and ‘‘narrow-based 

security index’’ as used in the securitybased swap definition. This analysis 

will have to be performed prior to the 

execution of, but no later than an offer 

to enter into, a Title VII instrument, and 

when the material terms of a Title VII 

instrument are amended or modified, to 

ensure compliance with rules 1.3(yyy), 

1.3(zzz) or 1.3(aaaa). 

However, any such costs are expected 

to be less than the costs of doing the 

same analysis absent the rules, which 

the CFTC believes would be more 

difficult and lead to greater uncertainty. 

In particular, rule 1.3(yyy) allows 

market participants to reduce the costs 

of determining whether a Title VII 

instrument based on a security index, 

other than an index CDS, is a swap or 

security-based swap by clarifying that 

they will be able to use the 

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1184Additionally, the number of components in 

an index may impact the assessment costs based on 

having to determine whether the indexes 

components satisfy the various tests within the rule. 

1185The average cost incurred by market 

participants in connection with assessing whether 

an agreement, contract, or transaction is a swap or 

security-based swap is based upon the estimated 

amount of time that staff believes will be required 

for both in-house counsel and outside counsel to 

apply the definition. The staff estimates that costs 

associated with determining whether an agreement, 

contract, or transaction is a swap or security-based 

swap will range up to $20,000 after rounding to two 

significant digits. Staff estimates that some index 

CDS will be standard and an internal attorney, 

without the assistance of outside counsel will be 

able to make a determination in less than one hour. 

Based upon data from SIFMA’s Management & 

Professional Earnings in the Securities Industry 

2011 (modified by CFTC staff to account for an 

1800-hour-work-year and multiplied by 5.35 to 

account for bonuses, firm size, employee benefits 

and overhead), staff estimates that the average 

national hourly rate for an internal attorney is $378. 

If an agreement, contract, or transaction is more 

complex, the CFTC estimates the analysis will 

require approximately 20 hours of in-house counsel 

time and 30 hours of outside counsel time. The 

CFTC estimates the costs for outside legal services 

to be $400 per hour. Accordingly, on the high end 

of the range the CFTC estimates the cost to be 

$19,560 ($7,560 (based on 20 hours of in-house 

counsel time × $378) + $12,000 (based on 30 hours 

of outside counsel x $400) which is then rounded 

to two significant digits to $20,000. 

Commissions’ past guidance regarding 

narrow-based security index in making 

that determination. In the context of 

index CDS, the Commissions’ past 

guidance regarding narrow-based 

security indexes does not establish 

criteria on whether index CDS is a swap 

or a security-based swap. Accordingly, 

without further explanation, it would 

not be clear on which side of the CFTC/ 

SEC jurisdictional divide index CDS 

would fall. CFTC rules 1.3(zzz) and 

1.3(aaaa) allow market participants to 

reduce the costs of determining whether 

an index CDS is a swap or a securitybased swap by providing a test with 

objective criteria that is similar to a test 

with which they already are familiar in 

the security futures context, yet tailored 

to index CDS in particular. 

Additionally, absent rule 1.3(yyy), 

which applies the tolerance period 

rules, if a security index underlying a 

Title VII instrument traded on a trading 

platform migrated from being broadbased to being narrow-based, market 

participants may suffer disruption of 

their ability to offset or enter into new 

Title VII instruments, and incur 

additional costs as a result. 

DCMs and SEFs will incur costs in 

assessing whether an index underlying 

a Title VII instrument is broad-based, in 

monitoring the index for migration from 

broad to narrow-based. There will also 

be other costs resulting from the 

migration such as delisting costs. Such 

migration costs are mitigated by the 

tolerance period of 45 business days 

over three calendar months which 

should reduce the incidence of 

migration. Similarly, the three-month 

grace period following an indexes 

failure of the tolerance period should 

mitigate delisting and other costs. There 

will be a range of assessment costs 

depending on how customized the 

index underlying an index CDS is.1184

In determining whether a Title VII 

instrument is a swap or a security-based 

swap, market participants will need to 

apply the criteria found in CFTC rules 

1.3(yyy), 1.3(zzz) and 1.3(aaaa). Market 

participants may conduct such analysis 

in-house or employ outside third-party 

service providers to conduct such 

analysis. The costs associated with 

obtaining such outside professional 

services would vary depending on the 

relevant facts and circumstances, 

particularly the composition of the 

index. The CFTC believes, however, that 

$20,000 represents a reasonable estimate 

of the upper end of the range of the 

costs of obtaining the services of outside 

professional in undertaking the 

analysis.1185 The CFTC believes that 

some index CDS based on an 

established index would not need the 

assistance of outside counsel, and a 

determination can be made in less than 

one hour. If an agreement, contract, or 

transaction is more complex, the CFTC 

estimates the analysis will require up to 

approximately 20 hours of in-house 

counsel time and 30 hours of outside 

counsel time. 

(b) Benefits 

Rules 1.3(zzz) and 1.3(aaaa) clarify the 

treatment of an index CDS as either a 

swap or a security-based swap by setting 

forth objective criteria for meeting the 

definition of the terms ‘‘issuers of 

securities in a narrow-based security 

index’’ and ‘‘narrow-based security 

index,’’ respectively. These objective 

rules alleviate additional costs to 

persons trading index CDS of inquiring 

with the Commissions, or obtaining an 

opinion of counsel, to make complex 

determinations regarding whether an 

index is broad- or narrow-based, and 

whether an index CDS based on such an 

underlying index is a swap or securitybased swap. 

Also, rules 1.3(zzz) and 1.3(aaaa) 

should reduce the potential for market 

participants to use an index CDS to 

evade regulations, because they set 

objective requirements relating to the 

concentration of the notional amount 

allocated to each reference entity or 

security included in the index, as well 

as the eligibility conditions for reference 

entities and securities. Finally, these 

rules benefit the public by requiring that 

the providers of index CDS make 

publicly available sufficient information 

regarding the reference entities in an 

index underlying the index CDS. By 

requiring that such information be made 

publicly available, rules 1.3(zzz) and 

1.3(aaaa) seek to assure the transparency 

of the index components that will be 

beneficial to market participants who 

trade such instruments and to the 

public. 

Separately, rule 1.3(yyy) addresses 

exchange-traded swaps based on 

security indexes where the underlying 

index migrates from broad-based to 

narrow-based. The rule includes 

provisions that many market 

participants are familiar with from 

security futures trading. The CFTC 

believes that by using a familiar 

regulatory scheme, market participants 

will be able to more readily understand 

the rule as compared to a wholly new 

regulatory scheme. Also, the use of a 

‘‘tolerance period’’ for swaps on security 

indexes that migrate from broad-based 

to narrow-based also creates greater 

clarity by establishing a 45-day 

timeframe (and subsequent grace 

period) on which market participants 

may rely. This tolerance period results 

in cost savings when compared to the 

alternative scenario where no tolerance 

period is provided and a migration of an 

index from broad-based to narrow-based 

would result in potential impediments 

to the ability of market participants to 

offset their swap positions. 

Finally, the Commissions are stating 

that the determination of whether a 

Title VII instrument is a swap, a 

security-based swap, or both (i.e., a 

mixed swap), is made prior to the 

execution of, but no later than an offer 

to enter into, the Title VII instrument. If 

the security index underlying a Title VII 

instrument migrates from being broadbased to being narrow-based, or vice 

versa, during the life of a Title VII 

instrument, the characterization of that 

Title VII instrument would not change 

from its initial characterization 

regardless of whether the Title VII 

instrument was entered into bilaterally 

or was executed through a trade on or 

subject to the rules of a DCM, SEF, 

FBOT, security-based SEF, or NSE. 

Absent this interpretation, market 

participants potentially would need to 

expend additional resources to 

continually monitor their swaps to see 

if the indexes on which they are based 

have migrated from broad-based to 

narrow-based. Since the rule provides 

that the initial determination prevails 

regardless of whether the underlying 

index migrates from broad-based to 

narrow-based, market participants do 

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1186See ISDA Letter. 

1187See LSTA Letter. 

1188See MarketAxess Letter. 

1189See Markit Letter. 1190See MarketAxess Letter. 1191See July 2006 Debt Index Rules. The 

Commissions are not aware of any disruptions 

caused by the three-month grace period in the 

context of security futures. 

1192See section III.G.3.(b). 

1193See ISDA Letter; Markit Letter; and SIFMA 

Letter. 

not need to expend these monitoring 

costs. 

(c) Comments and Consideration of 

Alternatives 

A commenter asserted that the 

regulatory complexity for index CDS is 

not worth the high compliance 

costs.1186 The statute provides that the 

CFTC has jurisdiction over swaps on 

broad-based security indices, and the 

SEC has jurisdiction over swaps on 

narrow-based security indices, single 

securities or loans, and certain events 

related to the issuers of securities. The 

Commissions need to establish criteria 

for index CDS, because their past 

guidance regarding narrow-based 

security indices does not address them. 

Without further explanation, it would 

not be clear on which side of the CFTC/ 

SEC jurisdictional division certain 

products would fall. The number and 

concentration limits are derived from 

criteria that Congress has imposed in 

the security futures context. The public 

information availability test does not 

require that index constituents satisfy 

all of its requirements; rather, the 

constituents may satisfy any one of 

them for the index to be broad-based, 

and there is a de minimis level for 

noncompliance. 

Another commenter 1187 stated that 

the proposed interpretation needs to be 

clearer on loan-based swap transactions 

and that it is costly to determine 

whether a particular set of loans or 

borrowers meets the Commissions’ 

public information availability 

requirement. The Commissions are 

clarifying that a TRS on two or more 

loans is not subject to the broad-based/ 

narrow-based jurisdictional divide, but 

is a swap under the CFTC’s jurisdiction. 

With respect to loan index CDS, the 

Commissions believe that the index CDS 

rules, including the public information 

availability requirement, should apply 

to indexes of loans underlying index 

CDS. However, the Commissions are 

amending the proposed rules to include 

loans within the categories of 

instruments to be aggregated for the 

total principal amount of debt 

outstanding threshold of the public 

information availability requirement, 

and will aggregate outstanding debt of 

affiliates for purposes of the test, which 

the CFTC believes should address the 

commenter’s concerns. 

A commenter 1188 pointed out that 

there may be costs to relist index-based 

CDS when the index stops being, or 

becomes, broad-based. Another 

commenter 1189 believed that the public 

information availability test will cause 

indices to switch between narrow-based 

and broad-based classification, which 

could result in unnecessary cost, 

confusion, and market disruption. 

The statutory framework requires 

delisting and relisting. These costs are 

mitigated by the tolerance period for 

migration, which may help to prevent 

frequent migration of indices from 

broad-based to narrow-based or vice 

versa. Moreover, it is the case for both 

on and off-exchange Title VII 

instruments that the Commissions are 

stating that the determination of 

whether a Title VII instrument on a 

security index is a swap or securitybased swap is made prior to execution, 

but no later than the offer to enter into 

the instrument, and remains the same 

throughout the life of the instrument. 

Accordingly, even if the public 

information availability test would 

cause indexes underlying index CDS to 

migrate as suggested by a commenter, 

that will not affect the classification of 

outstanding index CDS entered into 

prior to such migration. However, if an 

amendment or change is made to such 

outstanding index CDS that would 

cause it to be a new purchase or sale of 

such index CDS, that could affect the 

classification of such outstanding index 

CDS. 

A commenter asserted that extending 

the ‘‘grace period’’ from three months to 

six months would ease any disruption 

or dislocation associated with the 

delisting process with respect to an 

index that has migrated from broad to 

narrow, or narrow to broad, and that has 

failed the tolerance period.1190 The 

commenter further suggested that where 

an index CDS migrates, for entities 

operating both a SEF and a securitybased SEF, such entities should be 

permitted to move the index from one 

platform to the other simply by 

providing a notice to the SEC and CFTC. 

The Commissions are adopting the 

proposed rules without modification. As 

discussed in Section III.G.5(b) above, 

the Commissions note that the threemonth grace period applicable to 

security futures was mandated by 

Congress in that context,1191 and the 

commenter has provided no data or 

evidence for its request that the 

Commissions diverge from that grace 

period and provide for a longer grace 

period with respect to swaps and 

security-based swaps. The Commissions 

believe that the three-month grace 

period is similarly appropriate to apply 

in the context of an index that has 

migrated to provide sufficient time to 

execute off-setting positions. With 

respect to the commenter’s other 

suggestion that entities operating both a 

SEF and a security-based SEF should be 

able to move the index from one 

platform to another where an index CDS 

migrates simply by filing a notice with 

the SEC and CFTC, the Commissions do 

not believe that this proposal is within 

the scope of this rulemaking. 

Many commenters offered alternatives 

to the various tests in proposed rules 

1.3(zzz) and 1.3(aaaa).1192 As discussed 

more fully above in Section III.G.3.(b), 

the Commissions have incorporated 

many of the suggested alternatives into 

the final rules and interpretations and 

rejected, after careful consideration, 

other suggested alternatives. For 

example, three commenters requested 

that the Commissions revise the 

affiliation definition that applies when 

calculating the number and 

concentration criteria to require a 

majority control affiliation threshold, 

rather than the 20 percent threshold in 

the proposed rules.1193 As discussed in 

section III.G.3.(b) above, the 

Commissions are modifying the 

affiliation definition that applies when 

calculating the number and 

concentration criteria in response to 

commenters to use an affiliation test 

based on majority ownership. Based on 

commenters’ letters, the Commissions 

understand that the current standard 

CDS documentation and the current 

approach used by certain index 

providers for index CDS with respect to 

the inclusion of affiliated entities in the 

same index use majority ownership 

rather than 20 percent ownership to 

determine affiliation. The Commissions 

are persuaded by commenters that in 

the case of index CDS only it is more 

appropriate to use majority ownership 

because majority-owned entities are 

more likely to have their economic 

interests aligned and be viewed by the 

market as part of a group. The 

Commissions believe that revising the 

affiliation definition in this manner for 

purposes of calculating the number and 

concentration criteria responds to 

commenters’ concerns that the 

percentage control threshold may 

inadvertently include entities that are 

not viewed as part of a group. Thus, as 

revised, the affiliation definition will 

include only those reference entities or 

issuers included in an index that satisfy 

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48324 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1194See SIFMA Letter. 

1195See Markit Letter. 

1196 Id. 

1197See supra part III.G.3(b)(iii); See Securities 

Offering Reform, Release No. 33–8591 (Jul. 19, 

2005), 70 FR 44722 (Aug. 3, 2005) (discussing 

economic analysis involved in determining the $1 

billion threshold for non-convertible securities in 

the context of well-known seasoned issuers). 

1198See ISDA Letter and SIFMA Letter. 

1199See Anon. Letter. 

1200This estimate is based on information 

indicating that the average costs associated with 

preparing and submitting a no-action request to the 

SEC staff in connection with the identification of 

whether certain products are securities, which the 

CFTC believes is a process similar to the process 

under rule 1.8. The staff estimates that costs 

associated with such a request will cost 

approximately $20,000. The CFTC estimates the 

analysis will require approximately 20 hours of inhouse counsel time and 30 hours of outside counsel 

time. Based upon data from SIFMA’s Management 

& Professional Earnings in the Securities Industry 

2011 (modified by CFTC staff to account for an 

1800-hour-work-year and multiplied by 5.35 to 

account for bonuses, firm size, employee benefits 

and overhead), staff estimates that the average 

national hourly rate for an internal attorney is $378. 

The CFTC estimates the costs for outside legal 

services to be $400 per hour. Accordingly, the CFTC 

estimates the cost to be $20,000 ($7,560 (based on 

20 hours of in-house counsel time × $378) + $12,000 

(based on 30 hours of outside counsel × $400) 

rounded to two significant digits to $20,000 to 

submit a joint request for interpretation. 

1201This estimate is based on information 

indicating that the average costs associated with 

preparing and submitting a no-action request to the 

SEC staff in connection with the identification of 

whether certain products are securities, which the 

CFTC believes is a process similar to the process 

under rule 3a68–4(c). The staff estimates that costs 

associated with such a request will cost 

approximately $31,000. The CFTC estimates the 

analysis will require approximately 30 hours of inhouse counsel time and 50 hours of outside counsel 

time. Based upon data from SIFMA’s Management 

& Professional Earnings in the Securities Industry 

2011 (modified by CFTC staff to account for an 

1800-hour-work-year and multiplied by 5.35 to 

account for bonuses, firm size, employee benefits 

and overhead), staff estimates that the average 

national hourly rate for an internal attorney is $378. 

The CFTC estimates the costs for outside legal 

services to be $400 per hour. Accordingly, the CFTC 

estimates the cost to be $31,000 ($11,340 (based on 

30 hours of in-house counsel time × $378) + $20,000 

(based on 50 hours of outside counsel × $400) 

rounded to two significant digits to submit a joint 

request for interpretation. 

the more than 50 percent (i.e., majority 

ownership) control threshold. 

Due to the high compliance costs 

resulting from the public information 

availability test in particular, a 

commenter 1194 argued that the 

Commissions should abandon that test. 

The final rules retain the public 

information availability test, which does 

not present significant compliance costs 

because it does not require that 

constituents satisfy all of the 

requirements and permits a de minimis 

level of noncompliance. 

One commenter offered an alternative 

to the public information availability 

test based on the volume of trading.1195

After careful consideration and as 

described more fully above in section 

II.G.3.(b), above, the Commissions are 

not adopting a volume based test either 

as a replacement or alternative for the 

public information availability test. A 

volume based test would not be readily 

ascertainable with respect to certain 

underlying components which are not 

exchange traded or do not satisfy listing 

standards. The public information 

availability test allows for more 

flexibility with respect to the 

components included in indexes 

underlying index CDS than a volumebased test. Individual components in an 

index CDS may not satisfy a volumebased test but could otherwise satisfy 

one of the criteria of the public 

information availability test. The public 

information availability test is similar to 

the test in the rules for debt security 

indexes, which, as noted above, apply 

in the context of Title VII Instruments. 

The public information availability test, 

accordingly, provides a consistent set of 

rules under which index compilers and 

market participants can analyze the 

characterization of index CDS. 

In the public information availability 

test, one commenter proposed moving 

the outstanding debt threshold from $1 

billion to $100 million.1196 As stated 

above, the CFTC believes that the $1 

billion debt threshold, which is the 

same amount as the outstanding debt 

threshold in the rules for debt security 

indexes, is set at the appropriate level 

to achieve the objective that such 

entities are likely to have public 

information available about them.1197

However, the adopted rules expand on 

the types of debt that are counted 

toward the $1 billion debt threshold to 

include any indebtedness, including 

loans, so long as such indebtedness in 

not a revolving credit facility. 

In response to a request for comment 

by the Commissions, two commenters 

believed that the presence of a thirdparty index provider would assure that 

sufficient information is available 

regarding the index CDS itself, but 

neither commenter provided an analysis 

to explain how or whether a third-party 

index provider would be able to provide 

information about the underlying 

securities or issuers of securities in the 

index.1198 Accordingly, the 

Commissions are not adopting this 

alternative. 

A commenter 1199 argued that legal 

uncertainty would present a burden to 

market participants absent the 

Commissions clarifying the status of 

swaps on shares of exchange traded 

funds that reference broad-based 

security indices. However, market 

participants can request a clarification 

through the interpretation process 

established herein by the Commissions. 

II. Costs and Benefits of Processes To 

Determine Whether a Title VII 

Instrument is a Swap, Security-Based 

Swap, or Mixed Swap, and To 

Determine Regulatory Treatment for 

Mixed Swaps 

(a) Costs 

Rule 1.8 under the CEA allows 

persons to submit a request for a joint 

interpretation from the Commissions 

regarding whether an agreement, 

contract or transaction (or a class of 

agreements, contracts, or transactions) is 

a swap, security-based swap, or mixed 

swap. The CFTC estimates the cost of 

submitting a request for a joint 

interpretation pursuant to rule 1.8 

would be a cost of about $7,700 for 

internal company or individual time 

and associated costs of $12,000 for the 

services of outside professionals.1200

Once such a joint interpretation is 

made, however, other market 

participants that seek to transact in the 

same agreement, contract, or transaction 

(or class thereof) would have regulatory 

clarity about whether it is a swap, 

security-based swap, or mixed swap, so 

the CFTC expects the aggregate costs of 

submitting joint interpretations to 

decrease over time as joint 

interpretations are issued and the 

number of new requests decrease as a 

result. 

Separately, CFTC rule 1.9 under the 

CEA allows persons to submit a request 

for a joint order from the Commissions 

regarding an alternative regulatory 

treatment for particular mixed swaps. 

This process applies except with respect 

to bilateral, uncleared mixed swaps 

where one of the parties to the mixed 

swap is dually registered with the CFTC 

as a swap dealer or major swap 

participant and with the SEC as a 

security-based swap dealer or major 

security-based swap participant. With 

respect to bilateral uncleared mixed 

swaps where one of the parties is a dual 

registrant, the rule provides that such 

mixed swaps would be subject to the 

regulatory scheme set forth in rule 1.9 

in order to provide clarity as to the 

regulatory treatment of such mixed 

swaps. 

The CFTC estimates that the cost of 

submitting a request for a joint order 

seeking an alternative regulatory 

treatment for a particular mixed swap 

would be approximately $31,000.1201

Absent such a process, though, market 

participants that desire or intend to 

enter into such a mixed swap (or class 

thereof) would be required pursuant to 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48325 

1202See Better Markets Letter. 

1203 Id. 

Title VII of the Dodd-Frank Act to 

comply with all regulatory requirements 

applicable to both swaps and securitybased swaps. The CFTC believes that 

the cost of such dual regulation would 

likely be at least as great, if not greater, 

than the costs of the process set forth in 

rule 1.9 to request an alternative 

regulatory treatment for such the mixed 

swap. The rule regarding bilateral 

uncleared mixed swaps where at least 

one party is a dual registrant does not 

entail any additional costs, and may 

reduce costs for dual registrants that 

enter into such mixed swaps by 

eliminating potentially duplicative or 

inconsistent regulation. 

(b) Benefits 

The CFTC believes that the rules that 

enable market participants to submit 

requests for joint interpretations 

regarding the nature of various 

agreements, contracts, or transactions, 

and requests for joint orders regarding 

the regulatory treatment of mixed swaps 

will help to create a more level playing 

field (since the joint interpretations and 

joint orders will be available to all 

market participants) regarding which 

agreements, contracts, or transactions 

constitute swaps, security-based swaps, 

or mixed swaps, and the regulatory 

treatment applicable to particular mixed 

swaps. The joint interpretations and 

joint orders will be available to all 

market participants. The availability of 

such joint interpretations and joint 

orders regarding the scope of the 

definitions and the regulatory treatment 

of mixed swaps will reduce transaction 

costs and thereby promote the use of 

Title VII instruments for risk 

management and other purposes. 

The product interpretation process 

established by the Commissions has a 

120-day deadline. This deadline will 

facilitate new products coming to 

market relatively quickly. Further, the 

process holds the Commissions 

accountable because they will have to 

state why they are not providing an 

interpretation when they decline to do 

so. 

(c) Comments and Consideration of 

Alternatives 

A commenter 1202 recommended that 

the Commissions require that market 

participants disaggregate mixed swaps 

and enter into separate simultaneous 

transactions so that they cannot employ 

mixed swaps to obscure the underlying 

substance of transactions.1203 The 

Commissions are not adopting any rules 

or interpretations to require 

disaggregation of mixed swaps into their 

separate components, as the Dodd-Frank 

Act specifically contemplated that there 

would be mixed swaps comprised of 

both swaps and security-based swaps. 

Moreover, the CFTC believes that 

requiring market participants to 

disaggregate their agreements, contracts, 

or transactions into swaps and securitybased swaps may limit the freedom of 

contract or discourage innovation of 

financial products and potentially 

increase transaction costs for swap 

market participants. 

12. Costs and Benefits of SBSA Books 

and Records, and Data, Requirements 

CFTC rule 1.7 under the CEA would 

clarify that there would not be books 

and records or data requirements 

regarding SBSAs other than those that 

would exist for swaps. The rule 

alleviates any additional books and 

records or information costs to persons 

who are required to keep and maintain 

books and records regarding, or collect 

and maintain data regarding, SBSAs 

because the rule does not require such 

persons to keep or maintain any books 

and records, or collect and maintain any 

data, regarding SBSAs that differs from 

the books, records, and data required 

regarding swaps. 

Specifically, rule 1.7 would require 

persons registered as SDRs to: i) keep 

and maintain books and records 

regarding SBSAs only to the extent that 

SDRs are required to keep and maintain 

books and records regarding swaps; and 

ii) collect and maintain data regarding 

SBSAs only to the extent that SDRs are 

required to collect and maintain data 

regarding swaps. In addition, rule 1.7 

would require persons registered as 

swap dealers or major swap participants 

to keep and maintain books and records, 

including daily trading records, 

regarding SBSAs only to the extent that 

those persons would be required to keep 

and maintain books and records 

regarding swaps. 

Because rule 1.7 imposes no 

requirements with respect to SBSAs 

other than those that exist for swaps, 

rule 1.7 would impose no costs other 

than those that are required with respect 

to swaps in the absence of rule 1.7. Rule 

1.7 provides clarity by establishing 

uniform requirements regarding books 

and records, and data collection, 

requirements for swaps and for SBSAs. 

No comments were received with 

respect to Rule 1.7. 

13. Costs and Benefits of the AntiEvasion Rules and Interpretation 

The CFTC is exercising the antievasion rulemaking authority granted to 

it by the Dodd-Frank Act. Generally, 

CFTC rule 1.3(xxx)(6) under the CEA 

defines as a swap any agreement, 

contract, or transaction that is willfully 

structured to evade the provisions of 

Title VII governing the regulation of 

swaps. Further, CFTC rule 1.6 under the 

CEA would prohibit activities 

conducted outside the United States, 

including entering into agreements, 

contracts, and transactions and 

structuring entities, to willfully evade or 

attempt to evade any provision of the 

CEA as enacted by Title VII or the rules 

and regulations promulgated 

thereunder. 

As opposed to providing a bright-line 

test, rule 1.3(xxx)(6) would apply to 

agreements, contracts, and transactions 

that are willfully structured to evade 

and rule 1.6 would apply to entering 

into agreements, contracts, or 

transactions to evade (or as an attempt 

to evade) and structuring entities to 

evade (or as an attempt to evade) 

subtitle A of Title VII governing the 

regulation of swaps. Although this test 

does not provide a bright line, it helps 

ensure that would-be evaders cannot 

willfully structure their transactions or 

entities for the purpose of evading the 

requirements of subtitle A of Title VII. 

The CFTC also is explaining some 

circumstances that may constitute an 

evasion of the requirements of subtitle 

A of Title VII, while at the same time 

preserving the CFTC’s ability to 

determine, on a case-by-case basis, with 

consideration given to all the facts and 

circumstances, that other types of 

transactions or actions constitute an 

evasion of the requirements of the 

statute or the regulations promulgated 

thereunder. 

(a) Costs 

Market participants may incur costs 

when deciding whether a particular 

transaction or entity could be construed 

as being willfully structured to evade 

subtitle A of Title VII of the Dodd-Frank 

Act; however, the rules and related 

interpretations explain what constitutes 

evasive conduct, which should serve to 

mitigate such costs. 

(b) Benefits 

Absent the proposed anti-evasion 

rules and related interpretations, price 

discovery might be impaired because 

markets would not be informed about 

those transactions, since through 

evasion such transactions would not 

comply with Dodd-Frank Act regulatory 

requirements. Additionally, certain risks 

could increase in a manner that the 

CFTC would not be able to measure 

accurately. The anti-evasion rules and 

related interpretations will bring the 

appropriate scope of transactions and 

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1204See CME Letter. 

1205See ISDA Letter. 

1206See COPE Letter. 

1207See SIFMA Letter. 

1208See IECA Letter II. 

1209See WGCEF Letter. 

1210 If a transaction is unlawful, the CFTC (or 

another authority) may be able to bring an action 

alleging a violation of the applicable rule, 

regulation, order or law. 

entities within the regulatory framework 

established by the Dodd-Frank Act, 

which will better allow the CFTC to 

assure transparency and protect the U.S. 

financial system from certain risks that 

could go undetected through evasive 

conduct. 

(c) Comments and Consideration of 

Alternatives 

A commenter 1204 asserted that a 

market participant should be able to 

enter into a transaction or structure an 

instrument or entity to avoid higher 

regulatory burdens and attendant costs 

as long as the transaction or entity has 

an overriding business purpose. 

Another commenter 1205 noted that the 

CFTC recognized in the Proposing 

Release that choosing to do a securitybased swap over a swap to lessen a 

regulatory burden does not constitute 

evasion in itself, but expressed the view 

that this should not be limited to a 

choice between structuring a transaction 

as a swap and security. In this 

commenter’s view, parties must be able 

to legitimately consider all relevant 

factors, including the cost and burden of 

regulation, in making their structuring 

choices. Another commenter 1206

requested that the CFTC make clear that 

movements away from swaps towards 

physical trades that reduce regulatory 

burdens will not be considered evasion 

under the final rule. A different 

commenter 1207 argued that the antievasion proposal is overly broad and 

unnecessarily limits the ability of 

market participants to choose between 

legitimate structuring alternatives. 

Finally, another commenter 1208 believes 

that the proposed rules will create an 

‘‘impossible burden’’ on the innocent 

(non-evading) party. 

Activity conducted solely for a 

legitimate business purpose, absent 

other indicia of evasion, does not 

constitute evasion as described in the 

CFTC’s interpretation. The CFTC has 

clarified that consideration of regulatory 

burdens, including evidence of 

regulatory avoidance, is not dispositive 

of whether there has been evasion or 

not, but should be considered along 

with all other relevant facts and 

circumstances. For example, activities 

structured as securities instead of swaps 

and transactions that meet the forward 

exclusion are not evasion per se. The 

CFTC has clarified that it will impose 

appropriate sanctions on the willful 

evader for violation of the CEA and 

CFTC regulations and not on nonevading parties. 

A commenter suggests that an 

alternative standard for a finding of 

evasion should be ‘‘whether the 

transaction is lawful or not’’ under the 

CEA, CFTC rules and regulations, 

orders, or other applicable federal, state 

or other laws.1209 While the 

commenter’s alternative standard for 

evasion may impose lower costs on 

market participants because it is a 

bright-line test, the CFTC is not 

adopting it. The commenter’s alternative 

standard would blur the distinction 

between whether a transaction (or 

entity) is lawful and whether it is 

structured in a way to evade DoddFrank and the CEA. The anti-evasion 

rules provided herein are concerned 

with the latter conduct, not the 

former.1210 Thus, the CFTC does not 

believe it is appropriate to limit the 

enforcement of its anti-evasion authority 

to only unlawful transactions. 

CEA Section 15(a) Summary: 

(1) Protection of Market Participants and 

the Public 

Including certain foreign exchange 

transactions, forward rate agreements 

and certain other transactions in the 

swap definition protects the public by 

subjecting these transactions to DoddFrank regulation. Similarly, the antievasion rules protect market 

participants against evasive conduct 

that would take away the protection 

afforded to them under Dodd-Frank 

regulation. 

(2) Efficiency, Competitiveness, and the 

Financial Integrity of Markets 

The CFTC believes that the final rules 

and interpretations can be consistently 

applied by substantially all market 

participants to determine which 

agreements, contracts, or transactions 

are, and which are not, swaps, securitybased swaps, security-based swap 

agreements, or mixed swaps. This may 

improve resource allocation efficiency 

as market participant may not have to 

incur the cost of petitioning the 

Commissions or obtaining an opinion of 

counsel to determine the status of 

agreements, contracts or transactions as 

frequently as would be necessary 

without the rules or interpretations. 

Moreover, the Commissions’ 

statement that the determination of 

whether a Title VII instrument is a 

swap, a security-based swap, or both 

(i.e., a mixed swap), is made prior to the 

execution of, but no later than an offer 

to enter into, the Title VII instrument, 

and remains the same throughout the 

instrument’s life (absent amendment of 

the instrument), improves resource 

allocation efficiency because, without 

this interpretation, market participants 

potentially would need to expend 

additional resources to continually 

monitor their swaps to see if the indexes 

on which they are based have migrated 

from broad-based to narrow-based. The 

tolerance and grace periods for index 

CDS traded on CFTC and SEC-regulated 

trading platforms should lower the 

frequency of index migration and 

attendant costs, also improving resource 

allocation efficiency. 

(3) Price Discovery 

Not exempting swaps from foreign 

central banks, foreign sovereigns, 

international financial institutions, such 

as multilateral development banks, and 

similar organizations helps improve 

transparency and price discovery 

through disclosure that might otherwise 

not occur. Market participants will be 

informed about the prices of these 

transactions. Furthermore, they will be 

better informed about the risks that 

these transactions entail. 

The CFTC’s interpretation of the term 

‘‘swap’’ to include guarantees of swaps 

that are not security-based swaps or 

mixed swaps and the separate CFTC 

release will enable the CFTC and market 

participants to receive more priceforming data about such swaps, which 

help improve price discovery for swaps. 

Without anti-evasion rules, price 

discovery might be impaired, since 

market participants would otherwise 

not be informed about relevant but 

evasive swap transactions. 

(4) Sound Risk Management Practices 

Properly classifying transactions as 

swaps or not swaps may lead to sound 

risk management practices, because the 

added clarity provided by the rules and 

interpretations herein will enable 

market participants to consider whether 

a particular agreement, contract, or 

transaction is a swap, prior to entering 

into such agreement, contract or 

transaction. 

The business of insurance is already 

subject to established pre-Dodd-Frank 

Act regulatory regimes. Requirements 

that may work well for swaps and 

security-based swaps may not be 

appropriate for traditional insurance 

products. To the extent that the final 

rules distinguish insurance from swaps 

and security-based swaps, the CFTC 

believes that the Commissions should 

be able to tailor rules for specific 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48327 

1211 15 U.S.C. 78c(f). 

products that are swaps or securitybased swaps to achieve Title VII 

regulatory objectives. In adopting the 

Insurance Safe Harbor, the CFTC 

believes that the Commissions seek to 

achieve those net benefits that may be 

obtained from not supplanting existing 

insurance regulation. 

Documenting oral book-outs should 

promote good business practices and aid 

the CFTC in preventing evasion through 

abuse of the forward exclusion. 

Title VII instruments on qualifying 

foreign futures contracts on debt 

securities of one of the 21 enumerated 

foreign governments is a swap and not 

a security-based swap if the Title VII 

instrument satisfies certain conditions. 

The classification may provide crossmargining benefits when swap contracts 

and the futures contract are margined at 

the same derivatives clearing 

organization, and thus, may enhance 

sound risk management practices. 

Other Public Interest Considerations 

Documenting oral book-outs should 

promote good business practices and aid 

the CFTC in preventing evasion through 

abuse of the forward exclusion. 

The product interpretation process 

established by the Commissions has a 

120-day deadline. This deadline will 

facilitate new products coming to 

market relatively quickly. Further, the 

process holds the Commissions 

accountable, because they will have to 

state why they are not providing an 

interpretation when they decline to do 

so. 

The rule for books and records 

requirements for SBSAs does not 

impose new recordkeeping 

requirements on SBSAs, but relies on 

existing recordkeeping requirements for 

swaps, which avoids unnecessary 

regulation. 

APPENDIX—RULES EFFECTUATED BY THE PRODUCT DEFINITIONS

Agricultural Swaps ...................................... Makes no distinction between agricultural swaps and other 

swaps.

76 FR 49291, 49297, Aug. 10, 

2011 

Commodity Options .................................... Exempts subject to conditions certain options on physical commodities where parties are commercials or ECPs. The option 

results in physical delivery of the underlying.

77 FR 25320, 25331, Apr. 27, 

2012 

CPO/CTA compliance obligations .............. Rescinds the exemption from CPO registration; rescinds relief 

from the certification requirement for annual reports provided 

to operators of certain pools offered only to qualified eligible 

persons (QEPs; modifies the criteria for claiming relief); and 

require the annual filing of notices claiming exemptive relief 

under several sections of the Commission’s regulations. Finally, the adopted amendments include new risk disclosure 

requirements for CPOs and CTAs.

77 FR 11252, 11275, Feb. 24, 

2012 

Business Conduct Standards for SDs and 

MSPs With Counterparties.

Applies to SDs and (except where indicated) MSPs and prohibits certain abusive practices, requires disclosures of material information to counterparties and requires SDs/MSPs to 

undertake certain due diligence relating to their dealings with 

counterparties. Certain rules do not apply to transactions initiated on a swap execution facility (SEF) or designated contract market (DCM) when the SD/MSP does not know the 

identity of the counterparty prior to execution.

77 FR 9734, 9805, Feb. 17, 2012 

SD and MSP Recordkeeping, Reporting, 

and Duties Rules; FCMs and IBs Conflicts of Interest Rules; and Chief Compliance Officer Rules for SDs, MSPs, 

and FCMs.

Establishes reporting, recordkeeping, and daily trading records 

requirements for SDs and MSPs; establishes and governs 

the duties of SDs and MSPs; establishes conflicts of interest 

requirements for SDs, MSPs, FCMs, and IBs; establishes the 

designation, qualifications, and duties of the chief compliance 

officers (CCOs) of FCMs, SDs, and MSPs and describes the 

required contents of the annual report detailing a registrant’s 

compliance policies and activities, to be prepared by the 

chief compliance officer and furnished to the CFTC.

77 FR 20128, 20166, Apr. 3, 

2012 

Position Limits for Futures and Swaps ...... Establishes limits on speculative positions in 28 selected physical commodity futures and swaps.76 FR 71626, 71662, Nov. 18, 

2011 

Real-Time Public Reporting of Swap 

Transaction Data.

Establishes regulations concerning the real-time public reporting of swap transactions and pricing data.77 FR 1182, 1232, Jan. 9, 2012 

Swap Data Recordkeeping and Reporting 

Requirements.

Establishes swap data recordkeeping and reporting requirements for registered entities and counterparties.77 FR 2136, 2176, Jan. 13, 2012 

Swap Data Repositories: Registration 

Standards, Duties and Core Principles.

Establishes regulations concerning the registration and regulation of swap data repositories.76 FR 54538, 54572, Sept. 1, 

2011 

Registration of SDs and MSPs .................. Establishes the process for the registration of SDs and MSPs .. 77 FR 2613, 2623, Jan. 19, 2012 

XI. Administrative Law Matters— 

Exchange Act Revisions 

A. Economic Analysis 

1. Overview 

The SEC is sensitive to the costs and 

benefits of its rules. In adopting the final 

rules in this release, the SEC has been 

mindful of the costs and benefits 

associated with these rules which 

provide fundamental building blocks for 

the Title VII regulatory regime 

established by Congress. In addition, 

section 3(f) of the Exchange Act requires 

the SEC, whenever it engages in 

rulemaking and is required to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, to consider, in addition to the 

protection of investors, whether the 

action will promote competition, 

efficiency, and capital formation.1211

Moreover, section 23(a)(2) of the 

Exchange Act requires the SEC, when 

adopting rules under the Exchange Act, 

to consider the impact such rules would 

have on competition. Section 23(a)(2) 

also prohibits the SEC from adopting 

any rule that would impose a burden on 

competition not necessary or 

appropriate in furtherance of the 

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1212 15 U.S.C. 78w(a)(2). 

1213See Proposing Release at 29885. 

1214See section 712(d)(1) of the Dodd-Frank Act. 

1215See supra part II.B.1. 

1216See supra part II.B.1.c). 

1217See supra part II.C.2. 

1218See section 3(a)(68)(A)(ii)(III) of the Exchange 

Act, 15 U.S.C. 78c(a)(68)(A)(ii)(III). 

1219See supra part III.G. 

1220See supra part III.G.5. 

1221See supra part III.E. 

1222See supra part IV. 

1223See supra part VI. 

1224See supra part V. 

1225The CFMA added section 206A to the GLBA, 

15 U.S.C. 78c note, to define the term ‘‘swap 

agreement’’ to mean any agreement, contract, or 

transaction between ECPs, the material terms of 

which (other than price and quantity) are subject to 

individual negotiation, that fall within certain 

categories of transactions. Additionally, the CFMA 

added section 206B to the GLBA, 15 U.S.C. 78c 

note, which defined a ‘‘security-based swap 

agreement’’ to mean a swap agreement (as defined 

in section 206A of the GLBA) on which a material 

term is based on the price, yield, value, or volatility 

of any security or any group or index of securities, 

or any interest therein. Furthermore, the CFMA 

added section 206C to the GLBA, 15 U.S.C. 78c 

note, which defined a ‘‘non-security-based swap 

agreement’’ to mean any swap agreement (as 

defined in section 206A of the GLBA) that is not 

a security-based swap agreement (as defined in 

section 206B of the GLBA). Title VII amended the 

definition of the term ‘‘swap agreement’’ (discussed 

in footnote 1284) and repealed the definition of the 

terms ‘‘security-based swap agreement’’ and ‘‘nonsecurity-based agreement.’’ See sections 762(a) and 

(b) of the Dodd-Frank Act. However, Title VII also 

added a new definition of the term ‘‘security-based 

swap agreement’’ in section 3(a)(78) of the 

Exchange Act, 15 U.S.C. 78c(a)(78), that is generally 

consistent with the repealed definition, except that 

the new definition excludes security-based swaps. 

Accordingly, Title VII provides jurisdiction to the 

CFTC for security-based swap agreements, such as 

Title VII Instruments based on broad-based 

securities indexes, and also retains the SEC’s 

jurisdiction over such instruments in instances of 

fraud, manipulation, or insider trading. 

1226The CFMA excluded from the definition of 

the term ‘‘security’’ the term ‘‘security-based swap 

agreement’’ as well as the term ‘‘non-security based 

swap agreement’’ (as those terms are defined in 

section 206B and 206C (respectively) of the GLBA, 

15 U.S.C. 78c note). See sections 2A(a) and (b)(1) 

of the Securities Act, 15 U.S.C. 77b–1(a) and (b)(1), 

and sections 3A(a) and (b)(1) of the Exchange Act, 

15 U.S.C. 78c–1(a) and (b)(1). Furthermore, the 

CFMA explicitly prohibited the SEC from 

registering, or requiring, recommending, or 

suggesting the registration under the Securities Act 

and the Exchange Act of any security-based swap 

agreement (as defined in section 206B of the GLBA). 

See section 2A(b)(2) of the Securities Act, 15 U.S.C. 

77b–1(b)(2), and section 3A(b)(2) of the Exchange 

Act, 15 U.S.C. 78c–1(b)(2). The CFMA also made 

explicit that the SEC is prohibited from either (1) 

promulgating, interpreting, or enforcing rules or (2) 

issuing orders of general applicability under the 

Securities Act or Exchange Act in a manner that 

imposes or specifies reporting or recordkeeping 

requirements, procedures, or standards as 

prophylactic measures against fraud, manipulation, 

or insider trading with respect to any security-based 

swap agreement (as defined in section 206B of the 

GLBA). However, the CFMA did provide the SEC 

with limited enforcement authority under section 

10(b) of the Exchange Act, 15 U.S.C. 78j(b), and the 

rules promulgated thereunder that prohibit fraud, 

manipulation, or insider trading (but not rules 

imposing or specifying reporting or record-keeping 

requirements, procedures, or standards as 

prophylactic measures against fraud, manipulation, 

or insider trading). Furthermore, the CFMA applies 

judicial precedents under sections 9, 10(b), 15, 16, 

20, and 21A of the Exchange Act, 15 U.S.C. 78i, 

78j(b), 78o, 78p, 78t, and 78u–1, as well as section 

17(a) of the Securities Act, 15 U.S.C. 77q(a), to 

security-based swap agreements (as defined in 

section 206B of the GLBA) to the same extent as 

they apply to securities. 

purposes of the Exchange Act.1212 The 

SEC requested comment on all aspects 

of the costs and benefits of the proposed 

rules in the Proposing Release,1213 and 

any effect these rules may have on 

competition, efficiency, and capital 

formation. 

These final rules implement the 

mandate of Title VII that the CFTC and 

the SEC, in consultation with the 

Federal Reserve Board, jointly further 

define the terms ‘‘swap,’’ ‘‘securitybased swap,’’ and ‘‘security-based swap 

agreement.’’ 1214 The rules adopted in 

this release may be divided into three 

categories: 

First, the Commissions are adopting 

rules that will assist market participants 

in determining whether particular 

agreements, contracts, and transactions 

fall within or outside the swap and 

security-based swap definitions (i.e., 

identifying products subject to Title 

VII). The final rules provide: (1) An 

Insurance Safe Harbor for those 

agreements, contracts, and transactions 

that the Commissions believe Congress 

does not intend to be Title VII 

instruments; 1215 (2) a ‘‘grandfather’’ for 

those insurance agreements, contracts, 

or transactions (as opposed to insurance 

product categories) entered into on or 

before the effective date of the Product 

Definitions provided that, when the 

parties entered into such agreement, 

contract, or transaction, it was provided 

in accordance with the Provider 

Test; 1216 and (3) further definition of 

the term ‘‘swap’’ to specifically list 

certain enumerated products and not 

include certain foreign exchange 

forwards and foreign exchange 

swaps.1217

Second, the Commissions are 

adopting rules that will assist market 

participants in determining whether a 

particular Title VII instrument is a swap 

subject to CFTC regulation, a securitybased swap subject to SEC regulation, or 

a mixed swap subject to regulation by 

the CFTC and the SEC (i.e., mapping the 

jurisdictional divide between the CFTC 

and the SEC). Specifically, Title VII 

instruments that are CDS referencing a 

security index or a group or index of 

issuers of securities or obligations of 

issuers of securities may be swaps 

subject to CFTC regulation or securitybased swaps subject to SEC regulation, 

depending on whether such Title VII 

instruments are based on events relating 

to ‘‘issuers of securities in a narrowbased security index’’ or events relating 

to securities in a ‘‘narrow-based security 

index’’.1218 The final rules further 

define the terms ‘‘issuers of securities in 

a narrow-based security index’’ and 

‘‘narrow-based security index’’ for 

purposes of this analysis.1219 Further, 

the Commissions are adopting rules that 

provide tolerance and grace periods for 

Title VII instruments based on a security 

index that are traded on certain trading 

platforms where the security index may 

temporarily move from being within the 

‘‘narrow-based security index’’ 

definition to being outside (e.g.,. moving 

from narrow-based to broad-based, or 

vice versa.) 1220 Additionally, the 

Commissions are providing clarification 

that a Title VII instrument based on a 

qualifying foreign futures contract on 

the debt securities of one or more of the 

21 enumerated foreign governments is a 

swap and not a security-based swap, if 

certain conditions are met.1221

Third, the Commissions are adopting 

rules that provide: (1) A regulatory 

framework for certain mixed swaps and 

a process for market participants to 

request that the Commissions issue a 

joint order determining the appropriate 

regulatory treatment of certain other 

mixed swaps 1222 and (2) a process for 

market participants to request a joint 

interpretation from the Commissions 

regarding whether a particular Title VII 

instrument is a swap, security-based 

swap, or mixed swap.1223 The final 

rules also provide that market 

participants have no additional books 

and records requirements for SBSAs 

other than those for swaps.1224

In considering the economic 

consequences of the final rules, the SEC 

acknowledges the regulatory regime that 

was in place prior to the enactment of 

Title VII. Prior to the enactment of Title 

VII, swaps and security-based swaps 

were by-and-large unregulated. The 

Commodity Futures Modernization Act 

of 2000 (‘‘CFMA’’) created a regulatory 

regime that prohibited the SEC from 

regulating security-based swap 

agreements,1225 though it provided the 

SEC with limited enforcement authority 

over such instruments with respect to 

fraud, manipulation, and insider 

trading.1226 Title VII created an entirely 

new regulatory regime to regulate 

swaps, security-based swap agreements 

and security-based swaps. 

2. Economic Analysis Considerations 

The rules adopted in this release 

implicate different types of potential 

costs and benefits. First, there are costs, 

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1227The SEC expects that the benefits resulting 

from further defining the terms ‘‘swap,’’ ‘‘securitybased swap,’’ and ‘‘mixed swap’’ will likely accrue 

primarily at the programmatic level. To the extent 

appropriate, given the purposes of Title VII, the 

Commissions have sought to mitigate the costs 

persons will incur in connection with determining 

whether the instrument is a swap, security-based 

swap, or mixed swap. 

1228See Order Pursuant to Sections 15F(b)(6) and 

36 of the Securities Exchange Act of 1934 Granting 

Temporary Exemptions and Other Temporary 

Relief, Together With Information on Compliance 

Dates for New Provisions of the Securities Exchange 

Act of 1934 Applicable to Security-Based Swaps, 

and Request for Comment, Release No. 34–64678 

(June 15, 2011), 76 FR 36287 (June 22, 2011); 

Exchange Act Exemptive Order; and SB Swaps 

Interim Final Rules. 

1229See supra part XI.A.1. 

1230See section 15F of the Exchange Act, 15 

U.S.C. 78o–10. 

1231See section 3(a)(75) of the Exchange Act, 15 

U.S.C. 78c(a)(75) (defining the term ‘‘security-based 

swap data repository’’); section 13(m) of the 

Exchange Act, 15 U.S.C. 78m(m) (regarding public 

availability of security-based swap data); section 

13(n) of the Exchange Act, 15 U.S.C. 78m(n) 

(regarding requirements related to SB SDRs); and 

section 13A of the Exchange Act, 15 U.S.C. 78m– 

1 (regarding reporting and recordkeeping 

requirements for certain security-based swaps). See 

also Security-Based Swap Data Repository 

Registration, Duties, and Core Principles, Release 

No. 34–63347 (Nov. 19, 2010), 75 FR 77306 (Dec. 

10, 2010); corrected at 75 FR 79320 (Dec. 20, 2010) 

and 76 FR 2287 (Jan. 13, 2011) (‘‘SDR Proposing 

Release’’); and Regulation SBSR—Reporting and 

Dissemination of Security-Based Swap Information, 

Release No. 34–63346 (Nov. 19, 2010), 75 FR 75208 

(Dec. 2, 2010) (‘‘Regulation SBSR Proposing 

Release’’). In each proposing release the SEC invited 

comment with respects to the costs and benefits of 

each of the proposed rules. The costs associated 

with these and other substantive rules, along with 

any comments received by the SEC addressing the 

costs of the proposed rules, are being addressed in 

more detail in connection with the applicable 

rulemakings. 

1232See section 3C(a)(1) of the Exchange Act, 15 

U.S.C. 78c–3(a)(1). See also Process for Submissions 

for Review of Security-Based Swaps for Mandatory 

Clearing and Notice Filing Requirements for 

Clearing Agencies; Technical Amendments to Rule 

19b–4 and Form 19b–4 Applicable to All SelfContinued 

as well as benefits, arising from 

subjecting certain agreements, contracts, 

or transactions to the regulatory regime 

of Title VII. The SEC refers to these 

costs and benefits as ‘‘programmatic’’ 

costs and benefits. Additionally, there 

are costs that parties will incur to assess 

whether certain agreements, contracts, 

or transactions are indeed subject to the 

Title VII regulatory regime, and, if so, 

costs to assess whether such Title VII 

instrument is subject to the regulatory 

regime of the SEC or the CFTC. The SEC 

refers to these costs as ‘‘assessment’’ 

costs.1227

The programmatic costs and benefits 

and the assessment costs raise distinct 

analytic issues. First, the SEC recognizes 

that the Product Definitions, while 

integral to the regulatory requirements 

that will be imposed on the swap and 

security-based swap markets pursuant 

to Title VII, do not themselves establish 

the scope or nature of those substantive 

requirements or their related costs and 

benefits. The SEC anticipates that the 

rules implementing the substantive 

requirements under Title VII will be 

subject to their own economic analysis, 

but final rules have not yet been 

adopted that would subject agreements, 

contracts, or transactions, or entities 

that act as intermediaries (such as 

security-based swap dealers (‘‘SBS 

dealers’’) or major security-based swap 

participants (‘‘MSBSPs’’)) or provide 

market infrastructures (such as clearing 

agencies, trade repositories and trade 

execution facilities), to such substantive 

requirements. The costs and benefits 

described below are therefore those that 

may arise in connection with: (1) 

Determining whether certain 

agreements, contracts, or transactions 

are Title VII instruments (i.e., the 

assessment costs) and (2) subjecting 

those agreements, contracts, or 

transactions that are Title VII 

instruments, determined based on the 

statutory definitional lines that the 

Commissions are further defining, to a 

complete and fully effective 

complement of Title VII statutory and 

regulatory requirements. In addition, the 

discussion below addresses the costs 

and benefits arising from security-based 

swaps being within the definition of 

security under the Securities Act and 

the Exchange Act. Once a Title VII 

Instrument is determined to be a 

security-based swap, the security-based 

swap will be a security subject to the 

full panoply of the Federal securities 

laws. Such treatment will give rise to 

costs and benefits, including those that 

apply to securities generally. Securitybased swaps may be subject to 

additional costs to the extent that there 

are overlapping regulatory requirements 

arising from the Title VII regulatory 

requirements and those Federal 

securities laws requirements that apply 

to securities generally. The SEC has 

already taken action to address some of 

such overlapping or inconsistent 

requirements 1228 and will continue to 

evaluate other needed actions, if any, to 

minimize any such overlapping 

regulatory implications. 

Second, in determining the 

appropriate scope of these rules, the 

SEC considers the types of agreements, 

contracts, or transactions that should be 

regulated as swaps, security-based 

swaps, or mixed swaps under Title VII 

in light of the purposes of the DoddFrank Act, the overall regulatory 

framework, the historical treatment of 

the instruments and other regulatory 

frameworks, and the data currently 

available to the SEC. The SEC has 

sought to further define the terms 

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

‘‘mixed swap’’ to address the status of 

agreements, contracts, and transactions 

that are appropriate to regulate as 

swaps, security-based swaps and mixed 

swaps within the purposes of Title VII 

and not to include those agreements, 

contracts, and transactions that 

historically have not been considered to 

be swaps or security-based swaps 

thereby not imposing unnecessary or 

inappropriate Title VII costs and 

burdens on parties engaging in 

agreements, contracts, and transactions. 

In addition, the SEC recognizes that 

these rules may have effects on 

competition, efficiency, and capital 

formation as a result of certain 

agreements, contracts, and transactions 

being determined to fall under or 

outside the Title VII regulatory regime, 

or as a result of the jurisdictional divide 

between the SEC and CFTC as mandated 

by the statute. 

In the sections below, the SEC begins 

by recognizing that the Title VII 

regulatory regime has programmatic 

benefits and costs, as well as assessment 

costs. These costs and benefits have 

informed the decisions and the actions 

taken that are described throughout the 

release. Accordingly, the analysis below 

includes references to the discussions of 

the decisions and actions taken by the 

Commissions set forth above in other 

parts of this release. Finally the SEC 

discusses the effects of these rules on 

competition, efficiency, and capital 

formation. 

3. Programmatic Benefits and Costs 

By enacting Title VII, Congress 

created a regulatory regime for swaps 

and security-based swaps that 

previously did not exist.1229 Title VII 

amendments to the Exchange Act 

impose, among other requirements, the 

following: (1) Registration and 

comprehensive oversight of SBS dealers 

and MSBSPs; 1230 (2) reporting of 

security-based swaps to a registered 

security-based swap data repository 

(‘‘SB SDR’’), or to the SEC (if the 

security-based swap is uncleared and no 

SB SDR will accept the security-based 

swap for reporting), and dissemination 

of the security-based swap market data 

to the public; 1231 (3) clearing of 

security-based swaps at a registered 

clearing agency (or a clearing agency 

that is exempt from registration) if the 

SEC makes a determination that such 

security-based swaps are required to be 

cleared, unless an exception from the 

mandatory clearing requirement 

applies; 1232 and (4) if a security-based 

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48330 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

Regulatory Organizations, 75 FR 82490 (Dec. 30, 

2010) (‘‘Clearing Procedures Proposing Release’’). In 

the Clearing Procedures Proposing Release the SEC 

invited comment with respects to the costs and 

benefits of each of the proposed rules. The costs 

associated with these and other substantive rules, 

along with any comments received by the SEC 

addressing the costs of the proposed rules, are being 

addressed in more detail in connection with the 

applicable rulemakings. 

1233See section 3D of the Exchange Act, 15 U.S.C. 

78c–4. 

1234See section 3D(e) of the Exchange Act, 15 

U.S.C. 78c–4(e). 

1235See sections 3C(g) and (h) of the Exchange 

Act, 15 U.S.C. 78c–3(g) and (h). See also section 

3(a)(77) of the Exchange Act, 15 U.S.C. 78c(77) 

(defining the term ‘‘security-based swap execution 

facility’’). See also Registration and Regulation of 

Security-Based Swap Execution Facilities, Release 

No. 34–63825 (Feb. 2, 2011), 76 FR 10948 (Feb. 28, 

2011) (‘‘SB SEF Proposing Release’’). In the SB SEF 

Proposing Release each proposing release the SEC 

invited comment with respects to the costs and 

benefits of each of the proposed rules. The costs 

associated with these and other substantive rules, 

along with any comments received by the SEC 

addressing the costs of the proposed rules, are being 

addressed in more detail in connection with the 

applicable rulemakings. 

1236See sections 761(a)(2) and 768(a)(1) of the 

Dodd-Frank Act (amending sections 3(a)(10) of the 

Exchange Act, 15 U.S.C. 78c(a)(10), and 2(a)(1) of 

the Securities Act, 15 U.S.C. 77b(a)(1), 

respectively). The Dodd-Frank Act also amended 

the Securities Act to provide that any offer or sale 

of a security-based swap by or on behalf of the 

issuer of the securities upon which such securitybased swap is based or is referenced, an affiliate of 

the issuer, or an underwriter, shall constitute a 

contract for sale of, sale of, offer for sale, or offer 

to sell such securities. See section 768(a) of the 

Dodd-Frank Act (amending section 2(a)(3) of the 

Securities Act, 15 U.S.C. 77b(a)(3)). 

1237 15 U.S.C. 77e. 

1238See section 6(l) of the Exchange Act, 15 

U.S.C. 78f(l). 

1239For example, dealers and major participants 

will be subject to business conduct requirements of 

section 15F of the Exchange Act, and thus will be 

required, among other things, to determine that 

their counterparty meets certain eligibility 

standards before entering into security-based swaps 

with them and to disclose information about 

material risks and characteristics, material 

incentives, conflicts of interest, the daily mark, and 

clearing rights. See Business Conduct Standards for 

Security-Based Swaps Dealer and Major SecurityBased Swap Participants, Release No. 34–64766 

(June 29, 2011), 76 FR 42396, 42406, 42410 (July 

18, 2011) (‘‘Business Conduct Standards Proposing 

Release’’). Also, for example, in connection with 

registration requirements the SEC expects securitybased swap dealers and major security-based swap 

participants to incur costs in connection with 

completing and filing forms, providing related 

certifications, addressing additional requirements 

in connection with associated persons, as well as 

certain additional costs. See Registration of 

Security-Based Swap Dealers and Major SecurityBased Swap Participants, Release No. 34–65543 

(Oct. 12, 2011), 76 FR 65784, 65813–18 (Oct. 24, 

2011) (‘‘SB Swap Participant Registration Proposing 

Release’’). In each proposing release the SEC invited 

comment with respects to the costs and benefits of 

each of the proposed rules. The costs associated 

with these and other substantive rules, along with 

any comments received by the SEC addressing the 

costs of the proposed rules, are being addressed in 

more detail in connection with the applicable 

rulemakings. 

1240See section 15F(b)(5) of the Exchange Act, 15 

U.S.C. 78o–10(b)(5). 

1241See section 3D(a) of the Exchange Act, 15 

U.S.C. 78c–4. 

1242See section 13(n)(1) of the Exchange Act, 15 

U.S.C. 78m(n)(1). 

1243See section 17A(g) of the Exchange Act, 15 

U.S.C. 78q–1(g). 

1244The SEC has proposed rules related to the 

registration requirements for each of these new 

registrants. See SB Swap Participant Registration 

Proposing Release; SB SEF Proposing Release; SDR 

Proposing Release; and Clearing Agency Standards 

for Operation and Governance, Release No. 34– 

64017 (Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) 

(‘‘Clearing Agency Standards Proposing Release’’). 

In each proposing release the SEC invited comment 

with respects to the costs and benefits of each of 

the proposed rules. The costs associated with these 

and other substantive rules, along with any 

comments received by the SEC addressing the costs 

of the proposed rules, are being addressed in more 

detail in connection with the applicable 

rulemakings. 

1245See sections 3D(d), 13(n)(5) and (7), and 

15F(h) and (j) of the Exchange Act, 15 U.S.C. 78c– 

4(d), 78m(n)(5) and (7), and 78o–10(h) and (j). 

1246See sections 3D(d)(2), (3), (4), (6), and (8) of 

the Exchange Act, 15 U.S.C. 78c–4(d)(2), (3), (4), (6), 

and (8). See also SB SEF Proposing Release. In the 

SB SEF Proposing Release the SEC invited comment 

with respects to the costs and benefits of each of 

the proposed rules. The costs associated with these 

and other substantive rules, along with any 

comments received by the SEC addressing the costs 

of the proposed rules, are being addressed in more 

detail in connection with the applicable 

rulemakings. 

1247See section 13(n)(5) of the Exchange Act, 15 

U.S.C. 78m(n)(5). See also SDR Proposing Release. 

In the SDR Proposing Release the SEC invited 

comment with respects to the costs and benefits of 

each of the proposed rules. The costs associated 

with these and other substantive rules, along with 

any comments received by the SEC addressing the 

costs of the proposed rules, are being addressed in 

swap is subject to the clearing 

requirement, execution of the securitybased swap transaction on an exchange, 

on a security-based swap execution 

facility (‘‘SB SEF’’) registered under the 

Exchange Act,1233 or on an SB SEF that 

has been exempted from registration by 

the SEC under the Exchange Act,1234

unless no SB SEF or exchange makes 

such security-based swap available for 

trading.1235 In addition, Title VII 

amends the Securities Act and the 

Exchange Act to include security-based 

swaps in the definition of ‘‘security’’ for 

the purposes of those statutes.1236 As a 

result, security-based swaps are subject 

to the full panoply of the Federal 

securities laws. Title VII also added 

specific provisions to the Securities Act 

and Exchange Act affecting how 

security-based swaps may be sold. For 

example, Title VII amended section 5 of 

the Securities Act to require that a 

registration statement meeting the 

requirements of the Securities Act be in 

effect before there can be an offer to sell, 

offer to buy, purchase or sale of a 

security-based swap from or to any 

person who is not an ECP.1237 In 

addition, Title VII added section 6(l) to 

the Exchange Act to require that any 

security-based swap transaction with or 

for a person that is not an ECP must be 

effected on a national securities 

exchange.1238

The creation of regulatory regimes for 

agreements, contracts, or transactions 

that are defined as a swap or securitybased swap will result in an array of 

programmatic benefits. However, if an 

agreement, contract or transaction falls 

within the swap or security-based swap 

definition, the parties to the agreement, 

contract, or transaction also may incur 

a number of upfront and ongoing costs 

associated with the regulation of Title 

VII instruments and transactions. These 

programmatic benefits and costs, 

discussed in more detail below, relate to 

Title VII registration; business conduct 

standards, compliance, operation and 

governance; clearing, trade execution, 

and reporting and processing; investor 

protection provisions of Title VII and 

the application of the Federal securities 

laws.1239

(a) Title VII Registration of Entities 

Involved in Security-Based Swaps 

As a result of Title VII imposing a 

new regulatory regime on security-based 

swaps, in addition to making such 

security-based swaps securities under 

the Securities Act and the Exchange 

Act, Title VII will require the 

registration of entirely new types of 

registrants with the SEC, including SBS 

dealers and MSBSPs,1240 SB SEFs,1241

SB SDRs,1242 and clearing agencies 

registered to clear security-based 

swaps.1243 The SEC expects that 

registrants will incur costs in gathering 

information, accurately completing 

forms and filing these forms with the 

SEC.1244 Registration will provide the 

SEC with information regarding 

registrants which will enable the SEC to 

oversee the SEC’s security-based swap 

registrants. 

(b) Business Conduct Standards, 

Compliance, Operation, and Governance 

Title VII imposes requirements on 

registrants that did not exist prior to the 

adoption of Title VII, including core 

principles, duties and/or standards that 

are related to the type of registrant and 

its function.1245 For example, Title VII 

includes core principles for SB SEFs, 

many of which require SB SEFs to 

establish and enforce rules specific to 

the trading of security-based swaps.1246

Similarly, Title VII assigns duties (in 

addition to core principles) that are 

specific to the nature of SB SDRs, e.g. 

the acceptance and maintenance of data 

related to security-based swaps.1247 The 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48331 

more detail in connection with the applicable 

rulemakings. 

1248The SEC has proposed rules regarding 

business conduct standards for security-based swap 

dealers and major security-based swap participants. 

See Business Conduct Standards Proposing Release. 

In the Business Conduct Standards Proposing 

Release the SEC invited comment regarding the 

costs and benefits associated with the proposed 

rules. The costs associated with these and other 

substantive rules, along with any comments 

received by the SEC addressing the costs of the 

proposed rules, are being addressed in more detail 

in connection with the applicable rulemakings. 

1249See section 15F(h)(3)(B) of the Exchange Act, 

15 U.S.C. 78o–10(h)(3)(B). 

1250See section 15F(h)(3)(C) of the Exchange Act, 

15 U.S.C. 78o–10(h)(3)(C). 

1251Title VII amends the Exchange Act to define 

a special entity as: (1) A Federal agency; (2) a State, 

State agency, city, county, municipality, or other 

political subdivision of a State; (3) any employee 

benefit planned, as defined in section 3 of the 

Employee Retirement Income Security Act of 1974; 

or (4) any governmental plan, as denied in section 

3 of the Employee Retirement Income Security Act 

of 1974; or any endowment, including an 

endowment that is an organization in section 

501(c)(3) of the Internal Revenue Code of 1986. See 

section 15F(h)(2)(C) of the Exchange Act, 15 U.S.C. 

78o–10(h)(2)(C). 

1252See sections 15F(h)(2), (h)(4), and (h)(5) of the 

Exchange Act, 15 U.S.C. 78o–10(h)(2), (h)(4), and 

(h)(5). 

1253See section 15F(h)(4)(B) and (C) of the 

Exchange Act, 15 U.S.C. 78o–10(h)(4)(B) and (C). 

1254See section 15F(j)(5) of the Exchange Act, 15 

U.S.C. 78o–10(j)(5). 

1255See section 15F(j)(2) of the Exchange Act, 15 

U.S.C. 78o–10(j)(2). 

1256See section 15F(e) of the Exchange Act, 15 

U.S.C. 78o–10(e). 

1257See Entity Definitions Release at 30723, supra 

note 12. 

1258See 15 U.S.C. 78c–5. 

1259 Id. 

1260 Id. 

1261See 15 U.S.C. 78c–3. See also Clearing 

Procedures Proposing Release; Clearing Agency 

Standards Proposing Release; End-User Exception 

of Mandatory Clearing of Security-Based Swaps, 

Release No. 34–63556 (Dec. 15, 2010), 75 FR 79992 

(Dec. 21, 2010) (‘‘End-User Exception Proposing 

Release’’); and Ownership Limitations and 

Governance Requirements for Security-Based Swap 

Clearing Agencies, Security-Based Swap Execution 

Facilities, and National Securities Exchanges with 

Respect to Security-Based Swaps under Regulation 

MC, Release No. 34–63107, (Oct. 14, 2010), 75 FR 

65882 (Oct. 26, 2010) (‘‘Proposed Regulation MC’’). 

In each proposing release the SEC invited comment 

with respects to the costs and benefits of each of 

the proposed rules. The SEC has received 

comments on the cost and benefits of these 

proposed rules. The costs associated with these and 

other substantive rules are being addressed in more 

detail in connection with the applicable 

rulemakings. 

1262See U.S. Gov’t Accountability Office, 

Systemic Risk: Regulatory Oversight and Recent 

Initiatives to Address Risk Posed by Credit Default 

Swaps, GAO–09–397T, at 13 (Mar. 5, 2009). 

1263 15 U.S.C. 78c–3. Such clearing agencies also 

are required to register. See section 17A(g) of the 

Exchange Act, 15 U.S.C. 78q–1(g). 

1264See sections 3C(h) and 13(m) of the Exchange 

Act, 15 U.S.C. and 13m(m). See also Regulation 

SBSR Proposing Release; and SDR Proposing 

Release. 

1265See SDR Proposing Release; and SB SEF 

Proposing Release. In each proposing release the 

SEC invited comment with respects to the costs and 

benefits of each of the proposed rules. The costs 

associated with these and other substantive rules, 

along with any comments received by the SEC 

addressing the costs of the proposed rules, are being 

addressed in more detail in connection with the 

applicable rulemakings. 

1266See section 15F(i) of the Exchange Act, 15 

U.S.C. 78o–10(i). See also Trade Acknowledgment 

and Verification on Security-Based Swap 

Transactions, Release No. 34–63727 (Jan. 14, 2011), 

76 FR 3859 (Jan. 21, 2011) (‘‘Trade Documentation 

Proposing Release’’). In the Trade Documentation 

Proposing Release the SEC invited comment with 

respects to the costs and benefits of each of the 

proposed rules. The costs associated with these and 

other substantive rules, along with any comments 

received by the SEC addressing the costs of the 

proposed rules, are being addressed in more detail 

in connection with the applicable rulemakings. 

provisions of Title VII related to SB 

SEFs and SB SDRs are designed to 

provide transparency in the securitybased swap market. 

Title VII also imposes a number of 

requirements on registered SBS dealers 

and MSBSPs, such as external business 

conduct requirements.1248 Specifically, 

section 15F(h)(3)(B) of the Exchange Act 

establishes certain disclosure 

requirements for SBS dealers and 

MSBSPs,1249 and section 15F(h)(3)(C) of 

the Act requires that communications 

by these entities meet certain standards 

of fairness and balance.1250 The level of 

protection becomes higher for special 

entities 1251 to whom dealers offer 

security-based swaps.1252 For example, 

an SBS dealer that acts as an advisor to 

a special entity has a duty to act in the 

best interest of the special entity and is 

required to make reasonable efforts to 

obtain such information as is necessary 

for the SBS dealer to make a reasonable 

determination that any security-based 

swap recommended by the SBS dealer 

is in the best interests of the special 

entity.1253 In addition, section 15F(j)(5) 

of the Exchange Act imposes 

requirements intended to address 

potential conflicts of interest that may 

arise in transactions between a SBS 

dealer or MSBSP and its 

counterparty.1254 Title VII also imposes 

upon SBS dealers and MSBSPs 

requirements to implement risk 

management policies and procedures 

that are designed to prevent them from 

taking on excessive risk and to enable 

them to better deal with market 

fluctuations that might otherwise 

endanger their financial health.1255

Section 15F(e) of the Exchange Act as 

added by section 764(a) of the Dodd 

Frank Act, imposes capital and margin 

requirements on dealers and major 

participants,1256 which are designed to 

reduce the financial risks of these 

institutions and contribute to the 

stability of the security-based swap 

market in particular and the U.S. 

financial system more generally.1257

With respect to a security-based swap 

submitted for clearing, counterparties 

will be required to post initial margin 

and maintenance margin to secure its 

obligations under the trade. 

Section 3E of the Exchange Act, 

among other things, requires registered 

brokers, dealers and SBS dealers that 

collect initial and variation margin from 

counterparties to cleared security-based 

swap transactions to maintain that 

collateral in segregated accounts.1258

With respect to uncleared swaps, 

section 3E gives a counterparty to a SBS 

dealer or MSBSP that collects collateral 

the right to request segregation of initial 

margins and maintenance of such initial 

margins in accordance with rules 

promulgated by the SEC.1259 These 

protections provide market participants 

who enter into transactions with these 

entities confidence that their collateral 

accounts will remain separate from the 

SBS dealer or MSBSP’s assets in the 

event of bankruptcy.1260

(c) Clearing, Trade Execution, Reporting 

and Processing 

Section 763 of the Dodd-Frank Act 

adds section 3C to the Exchange Act, 

which deals with clearing for securitybased swaps.1261 Prior to the enactment 

of Title VII, swaps which traded on a 

bilateral basis were subject to 

counterparty credit risk, which may not 

have been fully mitigated by the posting 

of collateral.1262 Section 3C of the 

Exchange Act requires that securitybased swaps, with some exceptions, be 

cleared through a central counterparty 

(‘‘CCP’’) registered with the SEC.1263

Clearing a security-based swap places a 

CCP between the parties to a trade and 

reduces the counterparty risk. 

Title VII also requires the execution of 

clearable security-based swaps on 

exchanges or SB SEFs if such securitybased swaps are available to trade and 

the reporting of trades to an SB SDR and 

dissemination of trading data to the 

public.1264 Title VII also imposes 

requirements relating to the operations 

of the SB SEFs and SDRs.1265 Section 

15F(i) of the Exchange Act establishes 

regulatory standards for certain 

[registered security-based swap entities] 

related to the confirmation, processing, 

netting, documentation, and valuation 

of security-based swaps, which should 

enhance the efficiency of the trade 

execution and processing of securitybased swaps.1266

Furthermore, sections 15F(f), (g), and 

(j)(3) of the Exchange Act impose certain 

reporting, recordkeeping, and regulatory 

disclosure requirements on SBS dealers 

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1267See section 15F(f) of the Exchange Act, 15 

U.S.C. 78o–10(f) (reporting and recordkeeping 

requirements); section 15F(g) of the Exchange Act, 

15 U.S.C. 78o–10(g) (daily trading records 

requirements); section 15F(j)(3) of the Exchange 

Act, 15 U.S.C. 78o–10(j)(3) (requirements related to 

the disclosure of information to regulators). See also 

Regulation SBSR Proposing Release. In the 

Regulation SBSR Proposing Release the SEC invited 

comment with respects to the costs and benefits of 

each of the rules proposed in the release. The costs 

associated with these and other substantive rules, 

along with any comments received by the SEC 

addressing the costs of the proposed rules, are being 

addressed in more detail in connection with the 

applicable rulemakings. 

1268See section 13(m)(1)(F) of the Exchange Act, 

15 U.S.C. 13m(m)(1)(F). See also Regulation SBSR 

Proposing Release. In the Regulation SBSR 

Proposing Release the SEC invited comment with 

respects to the costs and benefits of each of the 

proposed rules. The costs associated with these and 

other substantive rules, along with any comments 

received by the SEC addressing the costs of the 

proposed rules, are being addressed in more detail 

in connection with the applicable rulemakings. 

1269 15 U.S.C. 78c note. 

1270See supra part XI.A.1, notes 1225 and 1226. 

1271See supra part XI.A.1, notes 1225 and 1226 

and part I. See also Prohibition Against Fraud, 

Manipulation, and Deception in Connection with 

Security-Based Swaps, Release No. 34–63236 (Nov. 

3, 2010), 75 FR 68560 (Nov. 8, 2010) (‘‘SB Swap 

Antifraud Proposing Release’’). In the SB Swap 

Antifraud Proposing Release the SEC invited 

comment with respects to the costs and benefits of 

each of the proposed rules. The costs associated 

with these and other substantive rules, along with 

any comments received by the SEC addressing the 

costs of the proposed rules, are being addressed in 

more detail in connection with the applicable 

rulemakings. 

1272See section 2(a)(1) of the Securities Act and 

section 3(a)(10) of the Exchange Act, 15 U.S.C. 

77b(a)(1) and 15 U.S.C. 78c(a)(10). 

1273See, e.g., Order Granting Temporary 

Exemptions under the Securities Exchange Act of 

1934 in Connection with the Pending Revision of 

the Definition of ‘‘Security’’ to Encompass SecurityBased Swaps, and Request for Comment, 76 FR 

39927 (July 7, 2011) (discussing the effect of the 

amendment to the definition of the term ‘‘security’’ 

to include security-based swaps under the 

Exchange Act and granting certain temporary relief 

and providing interpretive guidance). 

1274See section 768(b) of the Dodd Frank Act 

(adding section 5(e) of the Securities Act, 15 U.S.C. 

77e(d)). 

1275See section 6(l) of the Exchange Act, 15 

U.S.C. 78f(l). 

1276See section 768(a) of the Dodd-Frank Act 

(amending section 2(a)(3) of the Securities Act, 15 

U.S.C. 77b(a)(3)). 

1277For offers and sales to non-ECPs, the statute 

requires registration of the security-based swap 

transaction. 

1278One commenter suggested that the best 

measure of the benefits of the Dodd-Frank Act is the 

cost of the 2008 financial crisis. This commenter 

provided, as an example, an estimate from the Bank 

of England that the cost of the 2008 financial crisis 

in terms of lost output was between $60 trillion and 

$200 trillion. See Letter from Dennis Kelleher, 

Better Markets to the CFTC, June 3, 2011, regarding 

the reopening and extension of comment periods 

for rulemaking implementing the Dodd-Frank Wall 

Street Reform and Consumer Protection Act. The 

SEC recognizes that this estimate addresses the 

aggregate cost of the financial crisis. It is also 

recognized that others have expressed concern 

regarding the potential cost of the requirements of 

Dodd-Frank. See, e.g., letters from SIFMA, the 

American Bankers Association, the Financial 

Services Roundtable and the Clearing House 

Association, dated February 13, 2012 (commenting 

on Prohibitions and Restrictions on Proprietary 

Trading and Certain Interests in, and Relationships 

With, Hedge Funds and Private Equity Funds, 76 FR 

68846 (Nov. 7, 2011)) and The Financial Services 

Roundtable, dated October 17, 2011 (commenting 

on Further Definition of ‘‘Swap Dealer,’’ ‘‘SecurityBased Swap Dealer,’’ ‘‘Major Swap Participant,’’ 

‘‘Major Security-Based Swap Participant’’ and 

‘‘Eligible Contract Participant,’’ 75 FR 80174 (Dec. 

21, 2010)). 

and MSBSPs.1267 Specifically, Title VII 

imposes on parties to a security-based 

swap the responsibility to ‘‘report 

security-based swap transaction 

information to the appropriate 

registered entity in a timely manner as 

may be prescribed by the [SEC].’’ 1268

Title VII’s reporting, recordkeeping, and 

disclosure requirements should enhance 

the volume and quality of information 

available in the market and facilitate 

effective oversight by the SEC. 

(d) Investor Protection Provisions of 

Title VII and the Application of the 

Federal Securities Laws 

Prior to the enactment of Title VII, the 

SEC had the ability to bring actions 

based on fraud, manipulation or insider 

trading relating to security-based swap 

agreements (as defined in section 206B 

of the GLBA 1269) but did not have any 

other regulatory authority over swaps, 

security-based swaps or market 

participants involved in security-based 

swap transactions.1270 Title VII provides 

the SEC with antifraud enforcement 

authority over SBSAs under Title VII 

and gives the SEC the authority to 

regulate security-based swap 

transactions and the security-based 

swaps market, including the authority to 

prevent or deter fraud, manipulation or 

deceptive conduct and take other 

actions.1271

By including security-based swaps in 

the definition of security under the 

Securities Act and the Exchange Act 

and repealing the restrictions on 

regulating security-based swap 

agreements as securities, Title VII 

extended the investor protections under 

the Federal securities laws to securitybased swaps. In particular, Title VII 

amends the Exchange Act and the 

Securities Act to include security-based 

swaps within the definition of the term 

‘‘security.’’ 1272 Accordingly, securitybased swaps are securities and benefit 

from the investor protections provided 

by the Federal securities laws.1273 In 

addition to the antifraud and antimanipulation provisions, these 

protections include the registration, 

disclosure and civil liability provisions 

of the Securities Act and the disclosure 

provisions of the Exchange Act. Title VII 

specifically provides protections to nonECPs by adding section 5(e) to the 

Securities Act, which requires that a 

registration statement must be in effect 

before a person can offer to sell, offer to 

purchase from, or otherwise enter into 

security-based swaps with nonECPs.1274 Any security-based swap with 

or for a person that is not an ECP must 

be effected on a national securities 

exchange.1275 Furthermore, Title VII 

ensures that a security-based swap 

cannot be used to avoid registration or 

investor protection under the Securities 

Act by providing that if a security-based 

swap is entered into by an issuer’s 

affiliate or underwriter, the offer and 

sale of the underlying security must 

comply with the Securities Act.1276

The programmatic benefits related to 

investor protection under the Federal 

securities laws have corresponding costs 

including costs associated with 

compliance with the registration and 

disclosure regime of the Securities Act 

if an exemption from such registration 

provisions is not available.1277

The above programmatic benefits and 

costs that will flow from regulation of 

the security-based swap market 

mandated by Title VII will be 

significant, although very difficult to 

quantify and measure.1278 Moreover, the 

benefits can be expected to manifest 

themselves over the long run and be 

distributed over the market as a whole. 

The programmatic costs and benefits 

associated with substantive rules 

applicable to security-based swaps 

under Title VII are being addressed in 

more detail in connection with the 

applicable rulemakings implementing 

Title VII. There are programmatic costs 

that may arise from the application of 

other provisions of the Federal 

securities laws to security-based swaps, 

security-based swap transactions and 

market participants involved in such 

security-based swap transactions, 

including costs arising from potential 

overlapping regulatory requirements. 

The SEC already has taken interim 

actions to mitigate such overlapping and 

potentially conflicting regulatory 

requirements and will be carefully 

evaluating any future actions that may 

be necessary and appropriate to address 

such overlapping or conflicting 

requirements. 

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1279See supra part II.B.1. 

1280 Id. 

1281 Id. 

1282 Id. 

1283See generally section 3(a)(8) of the Securities 

Act, 15 U.S.C. 77c(a)(8), and section 12(g) of the 

Exchange Act, 15 U.S.C. 78l(g). The SEC has 

previously stated its view that Congress intended 

any insurance contract falling within section 3(a)(8) 

to be excluded from all provisions of the Securities 

Act notwithstanding the language of the Securities 

Act indicating that section 3(a)(8) is an exemption 

from the registration but not the antifraud 

provisions. See Definition of ‘‘Annuity Contract or 

Optional Annuity Contract’’, 49 FR 46750, 46753 

(Nov. 28, 1984). See also Tcherepnin v. Knight, 389 

U.S. 332, 342 n.30 (1967) (Congress specifically 

stated that ‘‘insurance policies are not to be 

regarded as securities subject to the provisions of 

the [Securities] act,’’ (quoting H.R. Rep. 85, 73rd 

Cong., 1st Sess. 15 (1933)). See also supra note 42. 

1284Section 206A of the GLBA, 15 U.S.C. 78c note 

defined the term ‘‘swap agreement’’ and the CFMA 

had two requirements in addition to the definition 

of ‘‘swap’’ itself: (1) The transaction is between 

ECPs (as defined prior to enactment of the DoddFrank Act); and (2) the material terms of the swap 

agreement (other than price and quantity) are 

subject to individual negotiation. Section 762 of the 

Dodd-Frank Act removed these requirements from 

the definition of swap agreement. See supra part 

XI.A.1, notes 1225 and 1226. The definition of swap 

in Title VII of the Dodd-Frank Act is not 

conditioned on the existence of either of the two 

requirements, although swap or security-based 

swap transactions with non-ECPs are subject to 

additional restrictions under the Federal securities 

laws and the Commodity Exchange Act. See CEA 

section 1a(47), 7 U.S.C. 1a(47). Insurance policies 

are typically not subject to individual negotiation. 

Additionally, the average insurance purchaser may 

not qualify as an ECP. See CEA section 

1a(18)(A)(xi), 7 U.S.C. 1a(18)(A)(xi). 1285An individual is considered an ECP if the 

individual ‘‘has amounts invested on a 

discretionary basis, the aggregate of which is in 

excess of—(i) $10,000,000; or (ii) $5,000,000 and 

who enters into the agreement, contract, or 

transaction in order to manage the risk associated 

with an asset owned or liability incurred, or 

reasonable likely to be owned or incurred, by the 

individual.’’ CEA section 1a(18)(A)(xi), 7 U.S.C. 

1a(18)(A)(xi). 

1286See section 5(e) of the Securities Act, 15 

U.S.C. 77e(d). 

1287See CEA section 2(e), 7 U.S.C. 2(e), and 

section 6(l) of the Exchange Act, 15 U.S.C. 78f(l). 

1288See Registration of Swap Dealers and Major 

Swap Participants, 77 FR 2613, corrected at 77 FR 

3590 (regarding swap dealers and major swap 

participants); SB Swap Participant Proposing 

Release, supra note 1239, (regarding SBS dealers 

and MSBSPs). 

4. Costs and Benefits Associated With 

Specific Rules 

(a) Insurance Safe Harbor and 

Grandfather for Insurance Products 

(Rules 3a69–1 Under the Exchange Act) 

(i) Programmatic Benefits and Costs 

The Commissions are adopting rules 

that establish an Insurance Safe Harbor 

and an Insurance Grandfather for certain 

agreements, contracts, and transactions 

that meet the conditions and tests set 

forth in rule 3a69–1 under the Exchange 

Act.1279 The agreements, contracts, and 

transactions that satisfy the Insurance 

Safe Harbor or Insurance Grandfather 

under the Exchange Act will fall outside 

the statutory swap and security-based 

swap definitions.1280 The SEC believes 

that the conditions and tests set forth in 

the Insurance Safe Harbor represent the 

characteristics of many types of 

traditional insurance products.1281 As 

stated above, the Commissions are not 

aware of anything in the legislative 

history or Title VII itself to suggest that 

Congress intended for traditional 

insurance products to be regulated as 

swaps or security-based swaps.1282

Typically, insurance has not been 

regulated under the Federal securities 

laws; although variable life insurance 

and annuities are securities and are 

regulated under the Federal securities 

laws.1283 Although a broad reading of 

the swap definition could encompass 

traditional insurance, the SEC does not 

believe that such a reading is consistent 

with Congressional intent.1284 To 

include products that meet the 

Insurance Safe Harbor or Insurance 

Grandfather in the swap or securitybased swap definition would subject 

traditional insurance products to the 

Title VII regime which the SEC does not 

believe is intended by Congress. 

Imposing programmatic costs on the 

insurance industry, such as those 

associated with compliance with the 

registration, compliance, and operation 

and governance requirements as 

described above, in addition to the 

Securities Act and Exchange Act 

requirements applicable to securitybased swap transactions involving nonECPs, would increase the business costs 

of insurance providers, which costs 

could be passed on to the consumers 

who need such insurance. In addition, 

because of the above costs as well as the 

Securities Act and Exchange Act 

restrictions applicable to offers and 

sales of security-based swaps to nonECPs, including products that meet the 

Insurance Safe Harbor in the swap or 

security-based swap definition could 

potentially affect the ability of insurance 

providers to continue to offer insurance 

products and disrupt contracts that 

satisfy the Insurance Grandfather that 

are used every day in the American 

economy. For example, if Title VII 

applied to traditional insurance 

products, people who purchased 

insurance to protect their property or 

families against accidental hazards or 

risks would need to be qualified as 

ECPs 1285 or the offer and sale of the 

insurance products that were securitybased swaps would need to be 

registered with the SEC1286 and traded 

on an exchange; 1287 and for swaps that 

are under the CFTC jurisdiction would 

only be able to be sold on or subject to 

the rules of a board of trade. In addition, 

insurance providers that offer insurance 

products exceeding the de minimis 

threshold (as adopted in the Entities 

Release) applicable to swap dealers and 

security-based swap dealers would be 

required to register as swap dealers or 

SBS dealers 1288 and be subject to the 

substantive requirements that result 

from such registration. 

The rules adopted in this release 

provide continuity in the regulatory 

treatment of agreements, contracts, and 

transactions that are insurance and fall 

outside the swap and security-based 

swap definitions. Market participants 

will be able to continue to rely on their 

existing understanding of insurance 

laws and regulations to engage in 

business activities relating to the 

insurance agreements, contracts, and 

transactions that satisfy the Insurance 

Safe Harbor or Insurance Grandfather. 

(ii) Assessment Costs 

Market participants will need to 

assess whether a particular agreement, 

contract, or transaction satisfies the 

Insurance Safe Harbor or Insurance 

Grandfather, prior to execution, but no 

later than when the parties offer to enter 

into the agreement, contract, or 

transaction. If such agreement, contract, 

or transaction satisfies rules 3a69–1 

under the Exchange Act, it would fall 

outside the swap and security-based 

swap definitions. If such agreement, 

contract, or transaction does not satisfy 

the Insurance Safe Harbor or Insurance 

Grandfather, it would need to be 

analyzed based upon its own facts and 

circumstances in order to determine 

whether it falls within or outside the 

swap or security-based swap definition. 

For agreements, contracts, or 

transactions entered into subsequent to 

the effective date of such rule, this 

analysis will have to be performed prior 

to execution but no later than when the 

parties offer to enter into the agreement, 

contract, or transaction to customers to 

ensure compliance with Title VII. 

Incurring these assessment costs with 

respect to these agreements, contracts, 

or transactions would not have been 

required in most cases prior to Title VII 

for two primary reasons. First, as 

security-based swaps were not regulated 

prior to Title VII, there was no need to 

determine whether an agreement, 

contract or transaction fell within or 

outside the definition of security-based 

swap agreement in the CFMA. Second, 

the need for parties to assess individual 

types of insurance for purposes of 

determining whether the Federal 

securities laws apply would be limited 

because, as previously stated, typically, 

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1289See supra note 1283. 

1290See supra part II.B.1. 

1291See supra part II.B.1.c). 

1292The average cost incurred by market 

participants in connection with assessing whether 

an agreement, contract, or transaction is a swap or 

security-based swap is based on the estimated 

amount of time that staff believes will be required 

for both in-house counsel and outside counsel to 

apply rule 3a69–1. Staff estimates that some 

agreements, contracts, or transactions will clearly 

satisfy the Insurance Safe Harbor, Insurance 

Grandfather and an in-house attorney, without the 

assistance of outside counsel, will be able to make 

a determination in one hour. Based upon data from 

SIFMA’s Management & Professional Earnings in 

the Securities Industry 2011 (modified by SEC staff 

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

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits and overhead), staff estimates 

that the average national hourly rate for an in-house 

counsel is $378. If an agreement, contract, or 

transaction is more complex, the SEC estimates the 

analysis will require approximately 30 hours of inhouse counsel time and 40 hours of outside counsel 

time. The SEC estimates the costs for outside legal 

services to be $400 per hour. This is based on an 

estimated $400 per hour cost for outside legal 

services. This is the same estimate used by the SEC 

for these services in the release involving 

Exemptions for Security-Based Swaps Issued By 

Certain Clearing Agencies, Release No. 33–9308 

(Mar. 30, 2012), 77 FR 20536 (Apr. 5, 2012). 

Accordingly, on the high end of the range the SEC 

estimates the cost to be $27,340 ($11,340 (based on 

30 hours of in-house counsel time x $378) + 

$16,000 (based on 40 hours of outside counsel x 

$400). This estimate is rounded by two significant 

digits to avoid the impression of false precision of 

the estimate. 

1293See supra part XI.A.4(a)(ii). 

1294See supra part II.B.1.d), for a discussion of 

each of the proposed alternatives. 

1295See ACLI Letter; AFGI Letter; AIA Letter; 

MetLife Letter and Travelers Letter. 

1296 15 U.S.C. 77c(a)(8). 

1297See ACLI Letter at 7; AFGI Letter at 3; CAI 

Letter at 21–25 and Nationwide Letter at 4. 

1298See ACLI Letter; AIA Letter; Nationwide 

Letter and NAIC Letter. 

1299See supra part II.B.1. 

1300See supra part II.B.1.d). 

1301For a more detailed discussion of the 

comments, including those that suggested 

alternatives, and the Commissions’ response, see 

supra part II.B.1.d). 

insurance has not been regulated under 

the Federal securities laws, although 

variable life insurance and annuities are 

securities and are regulated under the 

Federal securities laws.1289

The SEC believes that rule 3a69–1 

under the Exchange Act reduces the 

assessment costs that would otherwise 

exist without these rules. Without rule 

3a69–1 under the Exchange Act, market 

participants would still need to assess 

whether or not the agreement, contract, 

or transaction they are offering falls 

within the swap or security-based swap 

definition. More time and effort would 

likely be spent on the assessment 

because of lack of any safe harbor or 

grandfather to rely on. Without rule 

3a69–1 under the Exchange Act, market 

participants may feel the need to request 

joint interpretations from the 

Commissions before they invest 

resources in insurance business, even 

with respect to agreements, contracts, or 

transactions that would otherwise meet 

the Insurance Safe Harbor or Insurance 

Grandfather. 

The SEC recognizes that the 

assessment costs associated with rule 

3a69–1 under the Exchange Act may 

include costs related to obtaining legal 

advice on whether an agreement, 

contract, or transaction meets the 

requirements of the Insurance Safe 

Harbor or Insurance Grandfather. The 

SEC has sought to minimize the costs of 

this analysis by adopting an approach 

that incorporates the characteristics of 

traditional insurance into the 

straightforward Product Test and 

Provider Test, as described in the 

discussions of relevant rules above. 

The SEC believes there will be 

minimal assessment costs for parties to 

determine whether an agreement, 

contract, or transaction is among those 

specifically enumerated in rule 3a69–1 

under the Exchange Act 1290 or that falls 

within the Insurance Grandfather.1291

With respect to rule 3a69–1 under the 

Exchange Act, the SEC believes that at 

least some market participants are likely 

to seek legal counsel for interpretation 

of various aspects of the rule, 

particularly when structuring new or 

novel insurance products. The costs 

associated with obtaining such legal 

counsel would vary depending on the 

relevant facts and circumstances, 

including the complexity of the 

agreement, contract, or transaction and 

whether an interpretation from the 

Commissions is requested. The SEC 

believes that the range of costs to 

undertake the legal analysis required to 

determine whether the Insurance Safe 

Harbor or Insurance Grandfather applies 

to an agreement, contract, or transaction 

will range from $378 to $27,000, with 

$27,000 representing a reasonable 

estimate of the upper end of the range 

of the costs.1292

(iii) Alternatives 

The SEC could have determined to 

not further define the terms ‘‘swap’’ and 

‘‘security-based swap’’ to address the 

status of traditional insurance products. 

If the Commissions did not further 

define the terms ‘‘swap’’ and ‘‘securitybased swap’’ to address the status of 

traditional insurance products by 

adopting the Insurance Safe Harbor or 

the Insurance Grandfather certain 

insurance providers would have treated 

their insurance products as swaps or 

security-based swap, thereby incurring 

programmatic costs that would 

otherwise be avoidable. Other insurance 

providers could misinterpret the 

application of the definition of swap to 

certain agreements, contracts, or 

transactions to determine that they fall 

outside such definition of swap or 

security-based swap, in which case the 

amount of Title VII programmatic 

benefits and costs with respect to such 

products may potentially decrease. As 

stated above, without rule 3a69–1 under 

the Exchange Act, there also would be 

higher assessment costs to determine 

whether an agreement, contract, or 

transaction falls within or outside the 

swap or security-based swap 

definition.1293

The Commissions received several 

comments in support of alternatives to 

rule 3a69–1 under the Exchange Act as 

proposed.1294 The alternatives suggested 

by commenters include: 

• A test based on whether the 

agreement, contract, or transaction is 

subject to regulation as insurance by the 

insurance commissioner of the 

applicable state(s).1295

• A test based on the application of 

section 3(a)(8) of the Securities Act 1296

to the agreement, contract, or 

transaction.1297

• Various alternative tests that add (or 

exclude) requirements to the Product 

Test and the Provider Test.1298

The Commissions have considered 

each of these alternatives proposed by 

commenters and are adopting the final 

rule as discussed above.1299 The 

Commissions are not adopting the 

specific alternative tests as proposed by 

commenters. In considering each of 

these alternatives, the SEC has taken 

into account the costs and benefits 

associated with each alternative. 

In the SEC’s view, as discussed 

above,1300 because these alternative 

tests do not adequately distinguish 

traditional insurance products from 

Title VII instruments, they could result 

in an over-inclusive Insurance Safe 

Harbor or Insurance Grandfather and 

fail to include in the Title VII regulatory 

regime agreements, contracts, and 

transactions that Congress intended to 

be regulated as swaps or security-based 

swaps.1301 Therefore, the programmatic 

benefits of the Title VII regime would 

not be fully realized if any of the 

alternatives were adopted. 

(b) Narrow-Based Security Index Rules 

(Rules 3a68–1a, 3a68–1b, and 3a68–3(a) 

Under the Exchange Act) 

(i) Programmatic Costs and Benefits 

As previously stated, Title VII created 

a jurisdictional division between the 

CFTC and the SEC. The CFTC has 

jurisdiction over swaps, whereas the 

SEC has jurisdiction over security-based 

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1302See section 3(a)(68)(A)(II) of the Exchange 

Act, 15 U.S.C. 78c(a)(68)(A)(II). 

1303See section 3(a)(68)(A)(I) and (III) of the 

Exchange Act, 15 U.S.C. 78c(a)(68)(A)(I) and (III). 

1304See supra part III.G.3.b). 

1305See supra part XI.A.3. 

1306See section 712(a)(1) and (a)(2) of the DoddFrank Act. 

1307See section 712(a)(7)(A) and (B) of the DoddFrank Act. 

1308See generally supra part III.G. 

1309The average cost incurred by market 

participants in connection with assessing whether 

an agreement, contract, or transaction is a swap or 

security-based swap is based on the estimated 

amount of time that staff believes will be required 

for both in-house counsel and outside counsel to 

apply the definition. Staff estimates that the average 

national hourly rate for an in-house counsel is $378 

based on data from SIFMA’s Management & 

Continued 

swaps. In most instances it is clear 

based on a plain reading of the statute 

whether a Title VII instrument is a swap 

or security-based swap (e.g., a CDS 

referencing a single security or issuer is 

a security-based swap).1302 In other 

instances, such as index CDS, whether 

a Title VII instrument is a swap or 

security-based swap depends on 

whether such instrument is based on a 

‘‘narrow-based security index’’ or events 

relating to ‘‘issuers of securities in a 

narrow-based security index’’.1303 The 

Commissions are adopting rules 3a68– 

1a and 3a68–1b under the Exchange Act 

to further define the terms ‘‘issuers of 

securities in a narrow-based security 

index’’ and ‘‘narrow-based security 

index’’ for purposes of analyzing 

CDS.1304 Additionally, the Commissions 

are adopting rule 3a68–3(a) under the 

Exchange Act to define narrow-based 

security index, except as otherwise 

provided in rules 3a68–1a and 3a68–1b, 

consistent with the statutory definition 

set forth in section 3(a)(55) of the 

Exchange Act and the rules, regulations 

and orders of the SEC thereunder. 

As discussed above, there are 

programmatic costs and benefits that 

flow from being a Title VII 

instrument.1305 The overall 

programmatic costs and benefits flowing 

from an agreement, contract, or 

transaction being a swap or a securitybased swap may be impacted by the 

similarities and differences in the 

Commissions’ regulatory programs for 

swaps and security-based swaps. 

Generally, the Title VII regulatory 

regimes of the CFTC and SEC are 

expected to be broadly similar and 

complementary. Title VII requires the 

SEC and the CFTC to consult and 

coordinate for the purposes of assuring 

regulatory consistency and 

comparability with respect to rules 

adopted and orders issued pursuant to 

Title VII to the extent possible.1306 Title 

VII provides that the Commissions 

should treat functionally or 

economically similar products or 

entities in a similar manner in such 

rules or orders, but does not require 

identical rules.1307 The Commissions 

may, therefore, diverge substantively on 

certain rulemakings. In certain areas, the 

SEC believes it may be appropriate for 

Title VII’s application to security-based 

swaps to be different from its 

application to the swaps that will be 

regulated by the CFTC, as the relevant 

products, entities and market 

themselves are different, or because the 

relevant statutory provisions are 

different. The SEC believes, however, 

that the programmatic costs and benefits 

(which will be discussed in subsequent 

releases adopting substantive rules) that 

will flow from the application of rules 

under either jurisdiction as a result of 

applying rules 3a68–1a, 3a68–1b, and 

3a68–3(a) under the Exchange Act are 

expected to be broadly similar and 

complementary. 

In addition, since Title VII 

specifically provides that security-based 

swaps are securities and grants the SEC 

the exclusive authority to regulate 

security-based swaps (other than as to 

mixed swaps for which the SEC shares 

jurisdiction with the CFTC), in adopting 

rules 3a68–1a, 3a68–1b, and 3a68–3(a) 

under the Exchange Act to further 

define the terms ‘‘narrow-based security 

index,’’ and ‘‘issuers of securities in a 

narrow-based security index’’, the SEC 

is mindful of the programmatic costs 

and benefits specifically associated with 

security-based swaps falling under the 

Federal securities laws regime and being 

regulated by the SEC. These 

programmatic benefits include, for 

example, the applicability of the 

Securities Act registration, disclosure, 

and civil liability scheme, as well as the 

SEC’s authority to take action to protect 

investors and prevent fraud and market 

manipulation. These benefits could in 

some cases have corresponding costs 

associated with the application of the 

Securities Act related to registration, 

disclosure and civil liability scheme and 

the registration, disclosure and liability 

provisions of the Exchange Act. For 

example, if an issuer of an underlying 

security enters into a security-based 

swap it will have to comply with the 

Securities Act registration requirements 

both for the security-based swap and the 

underlying security unless an 

exemption from registration is available. 

As another example, if market 

participants wish to sell security-based 

swaps to non-ECPs they will have to 

comply with the registration 

requirements of the Securities Act. Any 

person that would be required to 

comply with the registration 

requirements of the Securities Act with 

respect to security-based swaps will 

incur the costs of such registration, 

including legal and accounting costs. 

Additionally, such person will become 

subject to the periodic reporting 

requirements of the Exchange Act, 

unless already subject to such 

requirements, and incur the costs 

associated with such Exchange Act 

periodic reporting. 

(ii) Assessment Costs 

Market participants will need to 

ascertain whether an agreement, 

contract or transaction based on an 

index is a swap or a security-based 

swap, prior to execution, but no later 

than when the parties offer to enter into 

it, according to the criteria set forth in 

the definitions of the terms ‘‘narrowbased security index’’ and ‘‘issuers of 

securities in a narrow-based security 

index.’’ The SEC expects that this 

assessment will be made each time an 

index is considered to be used or 

created for purposes of transactions 

based on such index, and each time the 

material terms of the index on which 

the agreement, contract, or transaction is 

based are amended or modified.1308

These assessment costs with respect to 

agreements, contracts, or transactions 

based on indexes did not arise prior to 

the enactment of Title VII. The SEC 

believes that such assessment costs may 

vary depending on the composition of 

the index that may underlie agreement, 

contract, or transaction. For example, 

the number of components in an index 

may impact the assessment costs 

because of the need to determine 

whether the index’s components satisfy 

the various tests within the rule. 

However, once such assessment is 

performed and the narrow-based or 

broad-based characteristics have been 

established with respect to an index, 

unless the characteristic of such index 

changes, any market participants 

engaging in agreements, contracts, or 

transactions referencing such index 

would not need to incur any material 

assessment costs, other than to confirm 

that the index has not changed in a way 

that would change its classification from 

narrow-based to broad-based or vice 

versa. 

Although the assessment cost 

associated with rules 3a68–1a, 3a68–1b, 

and 3a68–3(a) under the Exchange Act 

may vary, the SEC estimates that costs 

associated with undertaking the 

determination of whether an agreement, 

contract or transaction based on an 

index is a swap or security-based swap 

will range from $378 to $20,000.1309 The 

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48336 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

Professional Earnings in the Securities Industry 

2011 (modified by SEC staff to account for an 1800- 

hour-work-year and multiplied by 5.35 to account 

for bonuses, firm size, employee benefits and 

overhead). The SEC estimates the costs for outside 

legal services to be $400 per hour. This is the same 

estimate used by the SEC for these services in the 

release involving Exemptions for Security-Based 

Swaps Issued By Certain Clearing Agencies, Release 

No. 33–9308 (Mar. 30, 2012), 77 FR 20536 (Apr. 5, 

2012). Accordingly, on the high end of the range the 

SEC estimates the cost to be $19,560 ($7,560 (based 

on 20 hours of in-house counsel time x $378) + 

$12,000 (based on 30 hours of outside counsel x 

$400). This estimate is rounded by two significant 

digits to avoid the impression of false precision of 

the estimate. 

1310For example, the legal costs associated with 

the analysis of whether an index or basket CDS is 

a swap or security-based swap will include, among 

other things, analysis of the weighting of each index 

or basket component, the aggregate weighting of any 

five non-affiliated reference entities included in the 

index or basket, whether a predominant percentage 

(by weighting) of the issuers included in the index 

or basket satisfy the public information availability 

test and whether any issuer included in the index 

or basket with 5% or more weighting satisfies the 

public information availability test. 

1311See supra part XI.4.(b)(i). 

1312See supra part III.G.3. 

1313 Id. 

1314See LSTA Letter (with respect to loans), 

Markit Letter, ISDA Letter and SIFMA Letter. 

1315See supra part III.G.3.b(iii). 

1316 Id. 

1317 Id. 

1318 Id. 

1319So long as the effective notional amounts 

allocated to reference entities or securities included 

in the index that satisfy the public information 

availability test comprise at least 80 percent of the 

index’s weighting, failure by a reference entity or 

security included in the index to satisfy the public 

information availability test would be disregarded 

if the effective notional amounts allocated to that 

reference entity or security comprise less than 5 

percent of the index’s weighting. See paragraph (b) 

of rules 1.3(zzz) and 1.3(aaaa) under the CEA and 

rule 3a68–1a and 3a68–1b under the Exchange Act. 

SEC believes that some agreements, 

contracts, or transactions based on an 

established index would not need the 

assistance of outside counsel, and a 

determination can be made in one hour. 

If an agreement, contract, or transaction 

is more complex, the SEC estimates the 

analysis will require approximately 20 

hours of in-house counsel time and 30 

hours of outside counsel time. 

Accordingly, if an agreement, contract 

or transaction is based on a newly 

structured customized index or basket 

to suit a particular investment or 

hedging need, the SEC estimates that the 

assessment may be at or close to the 

upper end of the estimated range, as 

part of the structuring of such 

customized index or basket.1310

(iii) Alternatives 

The Commissions received many 

comments on proposed rules 3a68–1a 

and 3a68–1b and have incorporated 

many of the suggested alternatives into 

the final rules and rejected, after careful 

consideration, other suggested 

alternatives, as fully discussed in 

section III.G.3.b. The policy choices 

made with respect to accepting or 

rejecting the alternatives suggested by 

the commenters have been informed by 

the cost and benefit considerations. In 

particular, as stated above, the SEC is 

mindful of the programmatic costs and 

benefits specifically associated with 

security-based swaps falling under the 

Federal securities laws regime.1311

One alternative to rules 3a68–1a and 

3a68–1b is for the Commissions to not 

further define the terms ‘‘issuers of 

securities in a narrow-based security 

index’’ or ‘‘narrow-based security 

index.’’ The SEC believes the 

assessment cost associated with 

determining whether an index CDS is a 

swap or security-based swap would be 

greater in the absence of rules 3a68–1a 

and 3a68–1b. Without these rules, 

market participants would still need to 

analyze index components and it would 

be difficult to apply the statutory 

language of ‘‘issuer of securities in a 

narrow-based security index’’ in section 

3(a)(68)(A)(ii)(III) of the Exchange Act to 

index CDS, given that the existing 

statutory definition of ‘‘narrow-based 

security index’’ and the past guidance 

are focused on equity security indexes, 

volatility indexes and debt security 

indexes, none of which are specifically 

tailored for index CDS.1312 Absent rules 

3a68–1a and 3a68–1b, it is very likely 

that market participants would need to 

request interpretations from the 

Commissions. Rules 3a68–1a and 3a68– 

1b provide tailored and objective 

criteria, similar to the criteria used in 

the context of futures contracts on 

volatility indexes and debt security 

indexes, to assist market participants in 

determining whether an index CDS is 

based on issuers of securities in a 

narrow-based security index.1313 These 

rules will allow market participants to 

make determinations without requesting 

interpretations from the Commissions 

and, therefore, should reduce the 

assessment costs. 

Commenters expressed concern 

associated with the public information 

availability test and suggested that the 

public information availability test not 

be incorporated into the final rule for 

various reasons.1314 As discussed 

above 1315, the Commissions are 

adopting the public information 

availability test with some 

modifications. 

The SEC believes there are many 

programmatic benefits associated with 

the public information availability test. 

As noted above, the public information 

availability test is intended as the 

substitute test for the ADTV provision 

in the statutory narrow-based security 

index definition.1316 The ADTV test is 

designed to take into account the 

trading of equity securities and, because 

the listing standards for equity 

securities require that the security be 

registered under the Exchange Act, the 

issuer of the equity security will be 

subject to the periodic reporting 

requirements of the Exchange Act. Due 

to the specific provisions of the 

statutory ADTV test, the Commissions 

have determined that the ADTV test is 

not a useful test for purposes of 

determining whether an index of 

reference entities or debt securities is a 

‘‘narrow-based security index’’ because 

the components of the index are either 

reference entities, which do not ‘‘trade,’’ 

or debt instruments, which commonly 

are not listed, and, therefore, do not 

have a significant trading volume.1317

Applying the ADTV test in the existing 

statutory narrow-based security index 

definition would not serve any 

purposes. However, the basis for such 

provision, that there is sufficient trading 

in the securities, public information 

about, and therefore market following 

of, the issuer of the securities, applies to 

index CDS. As a substitute for such 

ADTV test, the SEC believes that there 

should be public information available 

about a predominant percentage of the 

reference entities included in the index, 

or, in the case of an index CDS on an 

index of securities, about the issuers of 

the securities or the securities 

underlying the index. The SEC believes 

that this should reduce the likelihood 

that non-narrow-based indexes 

referenced in index CDS, or the 

component securities, or the named 

issuers of securities in that index would 

be used as a surrogate for the reference 

entities securities without complying 

with the Federal securities laws. In 

particular, the SEC believes that the 

public information availability test 

should reduce the likelihood that the 

index CDS could be used to circumvent 

the registration provisions of the 

Securities Act and provisions of the 

Exchange Act through the use of CDS 

based on such indexes, manipulate the 

reference entities securities or the 

securities in the index and reduce the 

potential for misuse of material nonpublic information through the use of 

CDS based on such indexes.1318 If a CDS 

is based on an index that does not 

satisfy the public information 

availability test,1319 such index CDS 

will be a security-based swap and thus 

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1320See id. 

1321See LSTA Letter (with respect to loans); and 

SIFMA Letter 

1322See July LSTA Letter. See also supra part 

III.G.3(b)(iii). 

1323See supra part III.G.3.b)iii). 

1324See Markit Letter. 

1325See supra part III.G.3.b)iii). 

1326 Id. 

1327See ISDA Letter; and SIFMA Letter. Neither 

commenter provided any analysis to explain how 

or whether a third-party index provider would be 

able to provide information about the underlying 

securities or issuers of securities in the index. 

1328See supra part III.G.3.b)iii). 

1329 Id. 

1330 Id. 

1331 Id. 

subject to the Federal securities laws 

and the SEC’s oversight.1320

Some commenters indicated that the 

determinations of public availability of 

information would be costly but did not 

quantify such costs or explain the 

difficulty in making an assessment of 

whether information was publicly 

available.1321 The SEC recognizes that 

there will be assessment costs 

associated with application of the 

public information availability test. The 

SEC notes that the public information 

availability test applies only for 

purposes of determining whether an 

index is a ‘‘narrow-based security 

index.’’ The SEC would expect that 

market participants would look to the 

index provider to make the assessment 

or, if the index or basket is customized 

by the market participant that the 

creator of the index would take into 

account the public information 

availability of the index components in 

creating the custom index or basket. As 

a result, while the SEC recognizes that 

there will be costs in evaluating whether 

the index components satisfy the tests, 

including the public information 

availability test, the SEC believes that 

the index provider (or the creator of the 

custom index or basket) would already 

be evaluating the index components to 

determine whether the provider’s index 

criteria were satisfied and, as part of 

such evaluation, would be able to 

ascertain whether the public 

information availability test is satisfied. 

One commenter raised a specific 

concern about the assessment cost 

relating to applying the public 

information availability test to indexes 

of loans or borrowers and stated that 

unlike index of securities, which are 

generally subject to national or 

exchange-based reporting and 

disclosure regimes, a higher proportion 

of the components of an index of loans 

or borrowers may not be registered 

securities or reporting companies under 

the Exchange Act and therefore, this 

commenter stated that it would be more 

difficult or costly to determine whether 

an index of loans or borrowers meets the 

public information availability test.1322

The SEC has modified the public 

information availability test to expand 

the categories of instrument to be 

aggregated for purposes of the 

outstanding indebtedness criterion and 

to change the method of calculating 

affiliation for purposes of the public 

information availability test. The SEC 

believes that these modifications will 

mitigate the assessment costs that the 

commenter is concerned about.1323

The SEC believes that the overall 

assessment costs of including a public 

information availability test are justified 

in light of its benefits of preventing the 

index CDS from being used as a 

surrogate for the underlying securities 

or securities of the referenced issuer of 

securities. This should, in turn, prevent 

circumvention of the application of the 

Securities Act to index CDS 

transactions, and prevent fraud, 

manipulation and misuse of material 

non-public information. 

One commenter suggested replacing 

the public information availability test 

with a volume trading test.1324 The 

Commissions are not adopting a 

volume-trading test based on the CDS 

components of the index or on the index 

itself, either as a replacement for the 

public information availability test or as 

an alternative means of satisfying it. A 

volume trading test based on CDS is not 

practicable to use to determine the 

character of such index CDS because the 

character of the index CDS would have 

to be determined prior to any 

transaction in the Title VII Instrument. 

Given that there would be no trading 

volume at the time such determination 

is made, the index CDS would fail a 

volume-trading test in all cases 1325 and 

the assessment costs incurred in 

connection with such test would not 

serve any purpose. There also would be 

assessment costs in determining how 

many transactions in the CDS index or 

each CDS component of the index 

existed, and it is not apparent that any 

such trade information is either publicly 

available or verifiable at this time. In 

addition, the SEC also believes that a 

volume test based either on the CDS 

components of the index or the CDS 

index itself would not be an appropriate 

substitute for or an alternative to a 

public information availability test with 

respect to the referenced entity, issuer of 

securities, or underlying security 

because such a volume-based test would 

not provide transparency on such 

underlying entities, issuers of securities 

or securities.1326 The volume of 

transactions in a particular CDS or the 

CDS index does not relate to whether 

there is public information about the 

reference entity or reference security 

underlying the CDS or CDS index. 

Therefore, a volume-trading test would 

not achieve the programmatic benefits 

described above with respect to the 

public information availability test. 

Similarly, the Commissions also 

rejected commenters’ suggestion that the 

presence of a third-party index provider 

would assure that sufficient information 

is available regarding the index CDS 

itself without the need for a public 

information availability test.1327 As 

stated above, the public information 

availability test is intended to assure the 

availability of information about the 

components of the index, the 

underlying securities and issuers of the 

securities.1328 The existence of a thirdparty index provider does not imply any 

greater likelihood that such public 

information is available.1329 Although 

the existence of a third-party index 

provider as a substitute for the public 

information availability test would 

reduce assessment costs of the market 

participants using such an index (other 

than the index provider who must 

evaluate compliance with index 

criteria), the SEC does not believe that 

the existence of the third party index 

provider is a substitute for the public 

information availability test. The SEC 

believes that the information a thirdparty index provider makes available 

about the construction of an index, 

index rules, components, and 

predetermined adjustments provides 

information only about the index and is 

not a substitute for the public 

availability of information about the 

issuers of the securities or the securities 

in the index.1330 In addition, the SEC 

does not believe that the existence of a 

third-party index provider indicates any 

likelihood that such public information 

is available about the components of the 

index, which the SEC believes is 

important to reduce the potential for 

manipulation of the component 

securities of an index, or the named 

issuers of securities in an index, the 

misuse of non-public information about 

such an index, the component securities 

or the reference entities and 

circumvention of other provisions of the 

Federal securities laws through the use 

of CDS based on such an index.1331

Further, the SEC notes that a third-party 

index provider may create customized 

indexes at the behest of market 

participants, including as part of its 

regular business and be paid by such 

market participants for its index 

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1332 Id. See also Proposing Release at 29852. 

1333 Id. 

1334See supra part III.E. 

1335See supra note 717 and accompanying text. 

1336 Id. 1337 Id. 

1338See supra part III.G.5. 

1339 Id. 

customization and creation services.1332

Accordingly, the SEC does not believe 

that a third party index test is an 

appropriate alternative for the public 

information availability test and the 

costs to market participants is justified 

by the programmatic benefits such test 

provides.1333

As more fully discussed above in 

section III.G.3.b.iii, in considering other 

alternatives, including whether to revise 

or maintain the public information 

availability test, the SEC has 

consistently considered the 

programmatic benefits described above 

and the importance of assuring that 

there is information available with 

respect to the issuers of securities 

constituting a predominant percentage 

of an index on which a CDS is based if 

such index is not going to be considered 

a ‘‘narrow-based security index.’’ 

(c) Swaps on Certain Futures Contracts 

on Foreign Sovereign Debt (Rule 3a68– 

5 Under the Exchange Act) 

(i) Programmatic Benefits and Costs 

Rule 3a68–5 provides that a Title VII 

instrument that is based on qualifying 

foreign futures contracts on debt 

securities of one of the 21 enumerated 

foreign governments is a swap and not 

a security-based swap if the Title VII 

instrument satisfies certain 

conditions.1334 This rule is intended to 

prevent such Title VII instruments from 

being used to circumvent both the 

conditions of rule 3a12–8 and the 

Federal securities laws protections 

underlying such conditions.1335 The 

conditions provided in rule 3a68–5 are 

intended to address these concerns. As 

discussed above, certain of the 

qualifying foreign futures contracts on 

the debt securities of one of the 21 

enumerated foreign governments that 

satisfy the conditions of rule 3a12–8 

trade with significant volume through 

foreign trading venues.1336 Treating 

Title VII Instruments on such qualifying 

foreign futures contracts, subject to the 

conditions provided in rule 3a68–5, as 

swaps and not security-based swaps 

would not raise the concerns that such 

swaps could be used to circumvent rule 

3a12–8, the Federal securities laws 

concerns that such conditions are 

intended to protect, or allow 

circumvention of the provisions of the 

Securities Act applicable to securitybased swaps (including those applicable 

to security-based swaps entered into by 

issuer of securities underlie such 

security-based swaps, their affiliates, or 

underwriters of their securities).1337

There are certain programmatic costs 

associated with the rule that market 

participants will need to be cognizant 

of. For example, although rule 3a12–8 

allows qualifying foreign futures to be 

physically settled outside the United 

States, the conditions of rule 3a68–5 

require that the swap be cash settled in 

order to be a swap and not a securitybased swap. This has the potential cost 

of not permitting settlement on the same 

terms as the qualifying foreign future. 

However, the SEC believes that, as with 

other Title VII Instruments, if the Title 

VII Instrument can be physically settled 

with securities, it will be a securitybased swap. The other condition in rule 

3a68–5 that may impact the 

characterization of the Title VII 

Instrument is that the Title VII 

Instrument cannot be entered into by 

the foreign government, its affiliates, or 

an underwriter of its securities. This 

condition is intended to preserve the 

programmatic benefit of the application 

of the Securities Act to transactions in 

Title VII Instruments entered into by 

issuers of securities, their affiliates and 

underwriters. Moreover, the final rule 

provides consistent treatment of 

qualifying foreign futures contracts on 

the debt securities of the 21 enumerated 

foreign governments and Title VII 

instruments based on such futures 

contracts on the debt securities of the 21 

enumerated foreign governments, which 

will allow instruments to trade through 

designated contract markets. 

(ii) Assessment Costs 

The SEC believes that the assessment 

cost associated with determining 

whether a swap on certain futures 

contracts on foreign government 

securities constitute a swap or securitybased swap under rule 3a68–5 should 

be minimal. Currently, qualifying 

foreign futures contracts on debt 

securities of the 21 enumerated foreign 

governments are traded on exchanges or 

boards of trade. Market participants may 

look at the exchange or board of trade 

listing to determine what they are. 

Therefore, the assessment, in 

accordance with the rule, would 

primarily focus on whether such swap 

itself is traded on or through a board of 

trade; whether the swap is cash-settled; 

whether the futures is traded on a board 

of trade; whether any security used to 

determine the cash settlement amount 

are not registered under the Securities 

Act or the subject of any American 

depositary receipt registered under the 

Securities Act; and whether the swap is 

entered into by the foreign government 

issuing the debt securities upon which 

the qualifying futures contract is based 

or referenced, an affiliate of such foreign 

government or an underwriter of such 

foreign government securities. All of 

these determinations may be readily 

ascertained by the parties entering into 

the agreement, contract, or transaction. 

Therefore, the assessment costs 

associated with rule 3a68–5 under the 

Exchange Act should be nominal 

because parties should be able to make 

assessments under rule 3a68–5 in less 

than an hour. 

(d) Tolerance and Grace Period for 

Swaps and Security-Based Swaps 

Traded on Regulated Trading Platforms 

(Rule 3a68–3 Under the Exchange Act) 

(i) Programmatic Benefits and Costs 

In addition to defining narrow-based 

security index consistent with the 

statutory definition set forth in section 

3(a)(55) of the Exchange Act and the 

rules, regulations and orders of the SEC 

thereunder, Rule 3a68–3 under the 

Exchange Act establishes a tolerance 

and grace period for swaps and securitybased swaps to address the treatment of 

indexes that migrate from broad-based 

to narrow-based or narrow-based to 

broad-based, so that market participants 

will know which regulatory jurisdiction 

will apply to such Title VII 

instruments.1338

There are programmatic costs and 

benefits associated with tolerance and 

grace periods. Because swaps may only 

trade on designated contract markets 

(‘‘DCM’’), swap execution facilities 

(‘‘SEF’’), and foreign boards of trade 

(‘‘FBOT’’), and security-based swaps 

may trade only on registered national 

securities exchanges (‘‘NSE’’) and SB 

SEFs, a tolerance and grace period 

creates the benefit of permitting the 

index provider to substitute certain 

index components in order to maintain 

the characteristic of such index being 

narrow-based or broad-based and allow 

market participants to continue to enter 

into the Title VII instrument on which 

such index is based.1339 The associated 

programmatic costs are primarily related 

to the monitoring of index migrations 

performed by various trading platforms. 

Such monitoring costs would be part of 

the operation costs that a trading 

platform would incur in connection 

with implementing Title VII regardless 

of whether rule 3a68–3 under the 

Exchange Act is adopted. Absent rule 

3a68–3 under the Exchange Act, trading 

platforms still need to have the 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48339 

1340See MarketAxess Letter. See also supra part 

III.G.5.b). 

1341See section 3(a)(55)(C)(iii)(II) of the Exchange 

Act, 15 U.S.C. 77c(a)(55)(C)(iii)(II). 

1342See supra part X.4(b)(i). 

1343 Id. 

1344As stated in the Proposing Release at 29878, 

n. 354, this estimate is based on information 

indicating that the average costs associated with 

preparing and submitting a no action request to the 

SEC staff, which the SEC believes is a process 

similar to the process under rule 3a68–2 under the 

Exchange Act. The staff estimates that costs 

associated with a request pursuant to rule 3a68–2 

will cost approximately $19,560. The SEC estimates 

the analysis will require approximately 20 hours of 

in-house counsel time and 30 hours of outside 

counsel time. Based upon data from SIFMA’s 

Management & Professional Earnings in the 

Securities Industry 2011 (modified by SEC staff to 

account for an 1800-hour-work-year and multiplied 

by 5.35 to account for bonuses, firm size, employee 

benefits, and overhead), staff estimates that the 

average national hourly rate for an in-house 

attorney is $378. The SEC estimates the costs for 

outside legal services to be $400 per hour. This is 

the same estimate used by the SEC for these 

services in the release involving Exemptions for 

Security-Based Swaps Issued By Certain Clearing 

Agencies, Release No. 33–9308 (Mar. 30, 2012), 77 

FR 20536 (Apr. 5, 2012). Accordingly, the SEC 

estimates the cost to be $19,560 ($7,560 (based on 

20 hours of in-house counsel time × $378) + $12,000 

(based on 30 hours of outside counsel × $400)) to 

submit a joint request for interpretation. This 

estimate is rounded by two significant digits to 

avoid the impression of false precision of the 

estimate. 

1345 15 U.S.C. 78c(a)(69). 

1346 7 U.S.C. 1a(47)(B). 

1347 7 U.S.C. 1a(47)(E)(i). 

1348 7 U.S.C. 6r. 

technology necessary to monitor and 

conduct surveillance for index 

migration, as well as create internal 

policies and procedures relating to such 

migration. On the other hand, without a 

tolerance and grace period, if a market 

participant wishes to offset a securitybased swap to hedge its index CDS 

position on an SEC-regulated trading 

platform where the underlying security 

index has migrated from narrow-based 

to broad-based, the participant would be 

prohibited from doing so because a Title 

VII instrument based on the index 

would be a swap, and is ineligible for 

trading on an NSE or SB SEF. 

(ii) Assessment Costs 

Rule 3a68–3 under the Exchange Act 

provides a tolerance and grace period 

and does not require any determination 

to be made beyond the programmatic 

cost to monitor for migration as 

described above. The SEC believes that 

the assessment costs associated with 

rule 3a68–3 under the Exchange Act 

should be nominal on the parties 

entering into an agreement, contract, or 

transaction. 

(iii) Alternatives 

One commenter stated its view that 

extending the ‘‘grace period’’ from three 

months to six months would ease any 

disruption or dislocation associated 

with the delisting process with respect 

to an index that has migrated from 

broad-based to narrow-based, or narrowbased to broad-based, and such 

migration is not reversed during the 

tolerance period.1340 The commenter 

did not provide any data, evidence, or 

other justification for its request. The 

Commissions are adopting the threemonth grace period as proposed, which 

was the time frame used by Congress in 

the context of migration of indexes 

underlying security futures to address 

the same issue caused by index 

migration.1341 The SEC believes that the 

three-month grace period gives parties 

to a swap or security-based swap on an 

index that has migrated sufficient time 

to execute offsetting positions and 

believes that it is appropriate to 

maintain the three-month period that is 

the applicable grace period for security 

futures. 

(e) Request for Interpretation Process 

(Rule 3a68–2 Under the Exchange Act) 

(i) Programmatic Benefits and Costs 

Rule 3a68–2 under the Exchange Act 

allows persons to submit a request for 

a joint interpretation from the 

Commissions regarding whether an 

agreement, contract or transaction (or a 

class of agreements, contracts, or 

transactions) is a swap, security-based 

swap, or mixed swap. As stated 

above,1342 if an agreement, contract, or 

transaction is a swap or a security-based 

swap the overall programmatic costs 

and benefits that may arise from the 

Commissions’ regulatory programs are 

expected to be broadly similar and 

complementary.1343 However, in 

implementing Title VII the 

Commissions may diverge on rules and 

requirements stemming from the Title 

VII regulatory regime. Accordingly, a 

party to an agreement, contract, or 

transaction will need to know the 

appropriate classification, e.g. whether 

it is a swap or security-based swap, in 

order to know which regulatory regime 

and corresponding requirements is 

applicable. The Dodd-Frank Act 

requires that, with respect to the 

definitions of swaps, security-based 

swaps, and mixed swaps, the 

Commissions must jointly interpret 

such definitions. This rule, by providing 

a mechanism for the Commissions to 

provide such joint interpretations, 

allows parties to understand the timing 

and process for seeing such joint 

interpretation. Regardless of this rule, 

the programmatic costs and benefits that 

flow from being a swap or securitybased swap remain the same for parties 

requesting a joint interpretation. But, 

the rule allows for parties to the 

agreement, contract, or transaction to 

request through a joint interpretation 

from the Commissions, what regulatory 

regime would apply or whether the 

agreement, contract, or transaction is 

within the definition of swap or 

security-based swap. 

(ii) Assessment Costs 

The SEC estimates the costs of 

submitting a request for a joint 

interpretation pursuant to rule 3a68–2 

under the Exchange Act would be 

approximately $20,000.1344 The use of 

inside counsel in lieu of outside counsel 

would reduce this estimate. Once such 

a joint interpretation is made, however, 

other market participants that seek to 

transact in the same agreement, 

contract, or transaction (or class thereof) 

would be able to rely on such 

interpretation in determining whether 

their agreement, contract, or transaction 

is a swap, security-based swap, or 

mixed swap. Accordingly, assessment 

costs may be affected by the number of 

parties seeing an interpretation or 

whether prior interpretations with 

respect to the same or similar 

agreements, contracts, or transactions 

have been sought. 

(f) Definition of Swap (Rule 3a69–2 

Under the Exchange Act) 

(i) Programmatic Benefits and Costs 

Rule 3a69–2(a) under the Exchange 

Act states that the term swap has the 

meaning set forth in section 3(a)(69) of 

the Exchange Act.1345 Rule 3a69–2(b) 

under the Exchange Act explicitly 

defines the term ‘‘swap’’ to include an 

agreement, contract, or transaction that 

is a cross-currency swap, currency 

option, foreign currency option, foreign 

exchange option, foreign exchange rate 

option, foreign exchange forward, 

foreign exchange swap, forward rate 

agreement, or non-deliverable forward 

involving foreign exchange, unless such 

agreement, contract, or transaction is 

otherwise excluded by section 1a(47)(B) 

of the CEA.1346 Rule 3a69–2(c) under 

the Exchange Act provides that: (1) A 

foreign exchange forward or a foreign 

exchange swap shall not be considered 

a swap if the Secretary of the Treasury 

makes the determination described in 

section 1a(47)(E)(i) of the CEA; 1347 and 

(2) notwithstanding any such 

determination, certain provisions of the 

CEA will apply to such a foreign 

exchange forward or foreign exchange 

swap (specifically, the reporting 

requirements in section 4r of the 

CEA 1348 and regulations thereunder 

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48340 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1349 7 U.S.C. 6s. 

1350 7 U.S.C. 1a(47)(B). 

1351For purposes of paragraph (c) of rule 3a68– 

4 under the Exchange Act, ‘‘parallel provisions’’ 

means comparable provisions of the CEA and the 

Exchange Act that were added or amended by Title 

VII with respect to security-based swaps and swaps, 

and the rules and regulations thereunder. 

1352As discussed in the Proposing Release at 

29878, note 356, this estimate is based on 

information indicating that the average costs 

associated with preparing and submitting a noaction request to the SEC staff, which the SEC 

believes is a process similar to the process under 

rule 3a68–4(c). The staff estimates that costs 

associated with such a request will cost 

approximately $31,340. The SEC estimates the 

analysis will require approximately 30 hours of inhouse counsel time and 50 hours of outside counsel 

time. Based upon data from SIFMA’s Management 

& Professional Earnings in the Securities Industry 

2011 (modified by SEC staff to account for an 1800- 

hour-work-year and multiplied by 5.35 to account 

for bonuses, firm size, employee benefits, and 

overhead), staff estimates that the average national 

hourly rate for an in-house attorney is $378. The 

SEC estimates the costs for outside legal services to 

be $400 per hour. This is the same estimate used 

by the SEC for these services in the release 

involving Exemptions for Security-Based Swaps 

Issued By Certain Clearing Agencies, Release No. 

33–9308 (Mar. 30, 2012), 77 FR 20536 (Apr. 5, 

and, in the case of a swap dealer or 

major swap participant that is a party to 

a foreign exchange swap or foreign 

exchange forward, the business conduct 

standards in section 4s of the CEA 1349

and regulations thereunder). Rule 3a69– 

2(c) under the Exchange Act further 

clarifies that a currency swap, crosscurrency swap, currency option, foreign 

currency option, foreign exchange 

option, foreign exchange rate option, or 

non-deliverable forward involving 

foreign exchange is not a foreign 

exchange forward or foreign exchange 

swap subject to a determination by the 

Secretary of the Treasury as described in 

the preamble. 

Rule 3a69–2 is parallel to rule 

1.3(xxx)(2) under the CEA. In order to 

determine whether an agreement, 

contract, or transaction is a ‘‘swap’’ or 

‘‘security-based swap’’, it is necessary 

for the Commissions to adopt parallel 

rules that will apply to a Title VII 

instrument. Therefore, rule 3a69–2 is 

included under the Exchange Act. The 

definition of swap is the starting point 

for determining the status of a Title VII 

Instrument as a swap, security-based 

swap, or mixed swap. To the extent that 

the specific agreements, contracts, and 

transactions listed in section 1a(47)(B) 

of the CEA are swaps, the programmatic 

costs and benefits that flow from such 

agreements, contracts or transactions 

being a Title VII instrument under rule 

3a69–2 will be determined by the 

substantive rules adopted by the CFTC 

mandated by Title VII. If any such 

agreements, contracts, or transactions 

are security-based swaps, the 

programmatic costs and benefits will be 

the same as with other security-based 

swaps. 

(ii) Assessment Costs 

Since this rule lists some of the types 

of agreements, contracts or transactions 

already listed in section 1a(47)(B) of the 

CEA 1350 and the determination made by 

the Secretary of the Treasury, the SEC 

does not believe there would be 

assessment costs in addition to those 

incurred by market participants in 

determining whether an agreement, 

contract or transaction falls within the 

definition of swap. 

(g) Mixed Swaps (Rule 3a68–4 Under 

the Exchange Act) 

(i) Programmatic Benefits and Costs 

Rule 3a68–4(a) under the Exchange 

Act defines a ‘‘mixed swap’’ in the same 

manner as the term is defined in both 

the CEA and Exchange Act. 

Furthermore, rule 3a68–4(b) under the 

Exchange Act establishes the regulatory 

framework for mixed swaps with which 

parties to bilateral uncleared mixed 

swaps (i.e., mixed swaps that are neither 

executed on or subject to the rules of a 

DCM, NSE, SEF, SB SEF, or FBOT nor 

cleared through a DCO or clearing 

agency), as to which at least one of the 

parties is dually registered with both the 

CFTC and the SEC, will need to comply. 

The SEC believes that paragraph (b) of 

rule 3a68–4 under the Exchange Act 

will augment the programmatic benefits 

of the Title VII regulatory regime. The 

rule addresses potentially duplicative 

regulatory requirements for duallyregistered dealers and major 

participants that are subject to 

regulation by both the CFTC and the 

SEC, while requiring dual registrants to 

comply with the regulatory 

requirements the Commissions believe 

are necessary to provide sufficient 

regulatory oversight for mixed swaps 

transactions entered into by such dual 

registrants. It eliminates potentially 

duplicative regulation and reduces the 

programmatic costs associated with 

regulatory implementation and 

compliance in the context of mixed 

swaps by providing that a bilateral 

uncleared mixed swap would be subject 

to all applicable provisions of the 

Federal securities laws (and the SEC 

rules and regulations promulgated 

thereunder) but would be subject only 

to certain CEA provisions (and the 

CFTC rules and regulations promulgated 

thereunder). 

Rule 3a68–4(c) under the Exchange 

Act establishes a process for persons to 

request that the Commissions issue a 

joint order, with respect to parallel 

provisions 1351 applicable to mixed 

swaps, to permit such persons (and any 

other person or persons that 

subsequently lists, trades, or clears that 

class of mixed swap) to comply with the 

parallel provisions of either the CEA or 

the Exchange Act and related rules and 

regulations (collectively ‘‘specified 

parallel provisions’’), instead of being 

required to comply with parallel 

provisions in both the CEA and the 

Exchange Act. This process applies 

except with respect to bilateral, 

uncleared mixed swaps where one of 

the parties to the mixed swap is dually 

registered with the CFTC as a swap 

dealer or major swap participant and 

with the SEC as a security-based swap 

dealer or major security-based swap 

participant, for which the regulatory 

framework is established under rule 

3a68–4(c). The SEC has recognized the 

programmatic benefits associated with 

rule 3a68–4(c) and believes that in the 

mixed swap area, the process 

established by rule 3a68–4(c) would 

eliminate potentially duplicative 

regulatory requirements and reduce the 

compliance costs associated with mixed 

swaps. 

(ii) Assessment Costs 

With respect to rule 3a68–4(b) under 

the Exchange Act, one cost is that 

parties to a mixed swap would need to 

determine whether they satisfy the 

conditions set forth in such rule in order 

to ascertain the regulatory treatment of 

the mixed swap. Such assessment 

includes determining whether the 

mixed swap is neither executed on nor 

subject to the rules of a DCM, NSE, SEF, 

SB SEF, or FBOT, whether the mixed 

swap will not be submitted for clearing, 

and whether one party to the mixed 

swap is a dually registered dealer or 

major participant. The SEC believes that 

the above determinations would be 

based on readily ascertainable facts and 

the assessment costs associated with 

such determinations should be minimal. 

With respect to rule 3a68–4(c) under 

the Exchange Act, parties to mixed 

swaps have the option to decide 

whether to submit a request for issuing 

a joint order, weighing the benefits 

realized from the joint order against the 

cost of submitting such request. If 

parties to mixed swaps decide to submit 

a request, the SEC estimates the total 

costs of preparing and submitting a 

party’s request to the Commissions 

pursuant to rule 3a68–4(c) under the 

Exchange Act will be $31,000 per 

request for mixed swaps for which a 

request for a joint interpretation 

pursuant to rule 3a68–4(c) was not 

previously made.1352 The use of inside 

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2012). Accordingly, the SEC estimates the cost to 

be $31,340 ($11,340 (based on 30 hours of in-house 

counsel time × $378) + $20,000 (based on 50 hours 

of outside counsel × $400)) to submit a joint request 

for interpretation. This estimate is rounded by two 

significant digits to avoid the impression of false 

precision of the estimate. 

1353See Better Markets Letter. 

1354 Id. 

1355See supra part V. 

1356 7 U.S.C. 24a and 6s. Pursuant to sections 

21(b)(2) and 4s(f)(1)(B)(ii) of the CEA, the CFTC has 

adopted rules with respect to data collection and 

maintenance by SDR and books and records 

requirements for swap dealers and major swap 

participants. 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 20128 (April 3, 2012); and Swap 

Data Recordkeeping and Reporting Requirements, 

77 FR 2136 (January 13, 2012). 

1357See Proposing Release at 29863. See also 

supra part V. 

1358 15 U.S.C. 78c(f). 

1359 15 U.S.C. 78w(a)(2). 

1360The SEC is also acting pursuant to its 

rulemaking authority provided by sections 3 and 

23(a) of the Exchange Act. 

1361See Proposing Release at 29885–87. 

1362 Id. at 29887. 

counsel in lieu of outside counsel 

would reduce this estimate. Absent such 

a process, though, market participants 

that desire or intend to offer or enter 

into such a mixed swap (or class 

thereof) would not have the option to 

request for the Commissions’ joint 

interpretation and absent a joint 

interpretation, they would be required 

pursuant to Title VII to comply with all 

regulatory requirements applicable to 

both swaps and security-based swaps. 

(iii) Alternatives 

One commenter recommended that 

the Commissions require that market 

participants disaggregate mixed swaps 

and enter into separate simultaneous 

transactions so that they cannot employ 

mixed swaps to obscure the underlying 

substance of transactions.1353 This 

commenter stated that ‘‘the regulatory 

complexity of dealing with a mixed 

swap far outweighs the legitimate 

benefits to counterparties from 

documenting the transactions as mixed 

swaps.’’ 1354 This commenter asserted 

that some benefits of requiring 

disaggregation include more useful 

price reporting; increased transparency; 

regulatory reporting and monitoring that 

will align with the transaction database 

of the counterparties; and the thwarting 

of illegitimate motivations, such as 

obfuscation of prices and fees. 

Regardless of the benefits of 

disaggregation raised by the commenter, 

Title VII specifically contemplates that 

there would be mixed swaps comprised 

of both swaps and security-based swaps. 

The SEC believes that requiring parties 

to disaggregate mixed swaps into 

separate components is not consistent 

with congressional intent and may 

result in certain programmatic costs, 

such as limiting the types of derivatives 

products and transactions market 

participants may offer and enter into 

and increasing transaction costs (such as 

documentation costs) by disaggregating 

a mixed swap into multiple separate 

transactions. 

(h) Books and Records Requirement for 

SBSAs (Rule 3a69–3 Under the 

Exchange Act) 

(i) Programmatic Benefits and Costs 

Rule 3a69–3 under the Exchange Act 

provides that there are no additional 

books and records, or data, requirements 

regarding SBSAs beyond those required 

for swaps. The SEC recognized the 

following programmatic benefits and 

costs in adopting this rule. 

As discussed above, SBSAs are swaps 

over which the CFTC has primary 

regulatory authority, but for which the 

SEC has antifraud, anti-manipulation, 

and certain other authority.1355 There 

will be programmatic benefits and costs 

as a result of the SDRs, swap dealers, 

and major swap participants 

implementing and complying with the 

books and records requirements 

provided in sections 21 and 4s of the 

CEA.1356 The programmatic benefits and 

costs will flow from the substantive 

rules adopted by the CFTC regarding 

record keeping requirements for swaps. 

SBSAs are swaps and will be subject to 

these books and records requirements. 

The SEC believes that the rules 

proposed by the CFTC would provide 

sufficient books and records regarding 

SBSAs,1357 and that additional books 

and records requirements for SBSAs 

may be duplicative and would not 

produce corresponding benefits 

warranting such additional costs. Rule 

3a69–3 under the Exchange Act avoids 

any additional programmatic costs, 

especially the additional compliance 

and operation costs that would be 

incurred by SDRs, swap dealers, and 

major swap participants in the area of 

data maintenance and recordkeeping, 

beyond those which have already been 

prescribed by the CFTC’s rules. 

(ii) Assessment Costs 

The SEC does not believe that any 

assessment costs associated with rule 

3a69–3 under the Exchange Act would 

be material. 

5. Effects on Competition, Efficiency, 

and Capital Formation 

Section 3(f) of the Exchange Act 

requires the SEC, whenever it engages in 

rulemaking and is required to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, to consider, in addition to the 

protection of investors, whether the 

action would promote efficiency, 

competition, and capital formation.1358

In addition, section 23(a)(2) of the 

Exchange Act 1359 requires the SEC, 

when adopting rules under the 

Exchange Act, to consider the impact 

such rules would have on competition. 

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

also prohibits the SEC from adopting 

any rule that would impose a burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. 

The Commissions are further defining 

‘‘swap’’ and ‘‘security-based swap’’ 

pursuant to section 712(d)(1) of the 

Dodd-Frank Act.1360 In the Proposing 

Release, the SEC stated that the SEC 

preliminarily believed that the proposed 

Exchange Act rules would not impose 

significant burden on competition, that 

they would create efficient processes, 

and that they would not have adverse 

effects on capital formation.1361 In the 

Proposing Release, the SEC requested 

comment on each of these issues,1362

and no commenters responded to 

specifically address these issues. 

The SEC recognizes that the most 

significant impact of the swap and 

security-based swap definitions will 

derive from these definitions serving as 

the foundation for implementing the 

Title VII regulatory regime, particularly 

given the significant impacts that Title 

VII will have on the security-based swap 

market. In adopting these definitional 

rules, the SEC has sought to fairly reflect 

the statutory definitions and their 

underlying intent to implement the 

regulatory framework Congress intended 

to impose on the derivatives markets by 

enacting Title VII. 

The scope of the definitions will 

affect the ultimate regulatory effects on 

competition, efficiency, and capital 

formation that will accompany the full 

implementation of Title VII. The SEC 

anticipates analyzing these effects in the 

adopting releases for the particular 

regulations. Below is a general 

discussion of the impacts on 

competition, efficiency, and capital 

formation as a result of the rules being 

adopted in this release. 

The final rules being adopted relate 

primarily to further defining the terms 

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

‘‘mixed swap’’ to determine (i) the 

instruments that will be subject to the 

Title VII regulatory regime and (ii) the 

jurisdictional line between Title VII 

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1363See Entity Definitions Release, at 30740. 

1364 Id. 

1365 Id. 

1366 Id. 

1367 Id. 

1368 Id. 

1369See Business Conduct Standards Proposing 

Release, 76 FR 42396–42459, at 42452. See also 

supra part XI.A.3. 

1370See Entity Definitions Release, at 30740. 

1371 Id. at 30723–30724. 

1372See Entity Definitions Release, at 30742. 

1373See Business Conduct Standards Proposing 

Release, at 42452; SDR Proposing Release, at 77365. 

1374See supra part XI.A.3. 

instruments regulated by the SEC and 

those regulated by the CFTC. There also 

are procedural rules regarding 

interpretive requests and joint orders 

from the Commissions, and 

recordkeeping relating to SBSAs. The 

SEC believes that these procedural rules 

are related to the status of a product and 

the regulatory treatment of a mixed 

swaps, and therefore, the effects of these 

rules on competition, efficiency, and 

capital formation are subsumed in the 

overall impact of the rules defining the 

perimeter of the Title VII regulatory 

regime, and those of the rules relating to 

the jurisdictional line between the SEC 

and CFTC. 

(a) The Status of Products 

The status of products as inside the 

Title VII regulatory perimeter (i.e., 

swaps and security-based swaps) or 

outside the regulatory perimeter will 

have impacts on market participants. 

These rules will impact the status of 

certain market participants currently 

acting as intermediaries in the securitybased swap market, subjecting them to 

regulatory oversight and registration. As 

the SEC has noted, the market among 

intermediaries for security-based swaps 

is highly concentrated. The 

concentration in large part appears to 

reflect the fact that larger entities 

possess competitive advantages in 

engaging in over-the-counter securitybased swap dealing activities, 

particularly with respect to having 

sufficient financial resources to provide 

potential counterparties with adequate 

assurances of financial performance.1363

At the same time, as noted by 

commenters to the Entities Definition 

Release, some entities engage in smaller 

volumes of security-based swap dealing 

activity.1364 Some small and mid-size 

banks, for example, routinely provide 

such services involving relatively small 

notional amounts to their customers.1365

Although these relatively small dealers 

in general may not compete directly 

with the largest dealers (because they 

service a different segment of the 

market), they may be expected to play 

a role in helping certain types of 

customers (such as customers with a 

relatively small need for security-based 

swaps) enter into security-based swaps, 

thus promoting the availability of these 

products.1366 This availability may 

assist market participants (as end users), 

as discussed below, in engaging 

security-based swap activities that may 

be related to their businesses or 

financing needs. 

As the SEC has noted before, persons 

who fall within the definitions of 

‘‘security-based swap dealer’’ and 

‘‘major security-based swap participant’’ 

will incur a range of programmatic costs 

by virtue of their status as a registered 

dealer or major participant and certain 

assessment costs regarding their 

security-based swap activities. To the 

extent the costs associated with these 

statutorily mandated requirements are 

relatively fixed or large enough, they 

may negatively affect competition 

within the security-based swap 

market.1367 This may, for example, lead 

smaller dealers or entities for whom 

dealing is not a core business to keep 

their security-based swap dealing 

activity below the volume threshold 

required to be registered with the SEC 

or exit the market if the profit from the 

security-based swap dealing activity 

cannot justify the cost incurred to 

comply with the Title VII requirements; 

both scenarios could cause customers to 

have less access to the market or to 

incur higher costs in accessing the 

market. Such costs might also deter the 

entry of new firms into the market. If 

sufficiently high, these costs of 

compliance may increase concentration 

among dealers.1368

Certain aspects of the regulation of 

products defined as security-based 

swaps may enhance competition in the 

market for security-based swaps. For 

example, the proposed business conduct 

standards, if adopted as proposed, 

including those for disclosure of 

material risks and for fair and balanced 

communications, may reduce 

information asymmetries between 

security-based swap dealers, major 

security based swap participants, and 

their counterparties. The reduction of 

information asymmetries should 

promote price efficiency, promote more 

informed decision-making, and reduce 

the incidence of fraudulent or 

misleading representations.1369

In addition, as the SEC noted in the 

Entity Definitions Release, the current 

security-based swap market is subject to 

the potential for risk spillovers and 

systemic risk, which can occur when 

the financial sector as a whole (or 

certain key segments) is exposed to a 

significant amount of concentrated 

financial risk, either through direct 

counterparty relationships or the 

deterioration of asset values, and such 

exposure gives rise to the systemic 

chain effect of one firm’s financial 

distress or losses leading to financial 

distress or losses of the entire financial 

sector as a whole.1370 With respect to 

transactions involving security-based 

swaps, security-based swap dealers and 

major security-based swap participants 

will be regulated and, as noted in the 

Entity Definitions Release, such 

regulation and requirements are 

expected to increase market 

participants’ confidence in the dealers’ 

and major participants’ ability to 

perform their obligations.1371

The effect of the definitions on 

efficiency and capital formation is 

linked to their effect on competition. 

Markets that are competitive, with fair 

and transparent pricing and equal 

access to security-based swaps, may be 

expected to promote the efficient 

allocation of capital. Similarly, 

definitions that promote, or do not 

unduly restrict, competition can be 

accompanied by regulatory benefits that 

minimize the risk of market failure and 

thus promote efficiency and capital 

formation within the market.1372

As discussed above, certain Title VII 

requirements and rules relating to 

intermediaries, such as internal and 

external business conduct standards, if 

adopted as proposed, are expected to 

reduce information asymmetries and 

promote price efficiency. These 

business conduct standards, if adopted 

as proposed, would also help regulators 

perform their functions in an effective 

manner. The resulting increase in 

market integrity could affect capital 

formation in U.S. capital markets 

positively.1373

Other entities also will be affected by 

the scope of the security-based swap 

definition, including clearing agencies 

that currently, and in the future will, 

clear security-based swaps, the securitybased swap data repositories that collect 

security-based swap data, and the SB 

SEFs and exchanges that are transaction 

venues for security-based swaps, 

subjecting these entities to regulation 

and oversight by the SEC.1374 For 

example, The SEC has noted that the 

intent of the proposed rules concerning 

standards for clearing agency operations 

and governance standards of clearing 

agencies is to promote the prompt and 

accurate clearance and settlement of 

securities transactions, including 

security-based swap transactions, by 

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1375See Clearing Agency Standards Proposing 

Release, at 14535. 

1376 Id. 

1377See SB SEF Proposing Release, at 11049. 

1378 Id. 

1379 Id. at 11049–50. 

1380 Id. at 11049. 

1381 Id. 

1382 Id. at 11050. 

1383 Id. 

1384See SDR Proposing Release, at 77365. 

1385 Id. 

1386See section 2(a)(1) of the Securities Act and 

section 3(a)(10) of the Exchange Act, 15 U.S.C. 

77b(a)(1) and 15 U.S.C. 78c(a)(10). 

1387See supra part XI.A.3. 

1388See section 3(a)(14) of the Securities Act and 

Rule 238 under the Securities Act. 

1389See Entity Definitions Release, at 30742. 

1390 Id. 

requiring certain minimum standards at 

clearing agencies.1375 The SEC stated 

that it preliminarily believes that these 

requirements would ensure resilient and 

cost-effective clearing agency operations 

as well as promote transparent and 

effective clearing agency governance 

that would consequently support 

confidence among market participants 

in clearing agencies’ ability to serve as 

efficient mechanisms for clearance and 

settlement and to facilitate capital 

formation.1376

Similarly, the SEC has previously 

stated that the core principles, duties, 

and requirements imposed by Title VII 

and the proposed rules on SB SEFs will 

foster innovation in the security-based 

swap market by allowing entities that 

seek to become SB SEFs to structure 

diverse platforms for the trading of 

security-based swaps,1377 increase pretrade price transparency, and establish 

fair, objective, and not unreasonably 

discriminatory standards for granting 

impartial access to trading on the SB 

SEFs,1378 thereby furthering higher 

efficiency, promoting competition, and 

encouraging capital formation.1379 The 

SEC also noted that any resulting 

increase in market integrity proceeding 

from the rules intended to support the 

statutorily-mandated regulatory 

obligations of SB SEFs would likely 

increase market participants’ confidence 

in the soundness and fairness of the 

security-based swap market.1380 Such 

increased confidence likely would 

stimulate financial investment in SB 

swaps by corporate entities and others 

that may find that more transparent 

venues for the trading of SB swaps 

would allow them to purchase SB swaps 

to offset business risks and to meet 

hedging objectives.1381 Further, to the 

extent that market participants utilize 

SB swaps to better manage portfolio 

risks with respect to positions in 

underlying securities, the extent that 

they are willing to participate in the SB 

swap market may impact their 

willingness to participate in the 

underlying asset’s market.1382

Therefore, the Commission stated its 

preliminary belief that the proposed 

rules would help encourage capital 

formation.1383

Furthermore, in the proposing release 

regarding SDRs, 1384 the SEC noted that, 

by allowing multiple SDRs to provide 

data collection, maintenance, and 

recordkeeping services, the rules are 

intended to promote competition among 

SDRs. The SEC also stated that the 

proposed rules promote data collection, 

maintenance, and recordkeeping 

according to existing best practices that 

are used in similar capital market 

institutions and are likely to positively 

affect transparency in credit markets 

and would help capital formation in the 

broader capital markets whose 

participants rely on security-based swap 

markets to meet their hedging 

objectives.1385

Other parties to security-based swap 

transactions may be affected by the 

definitions as well. Title VII amends the 

Exchange Act and the Securities Act to 

include security-based swap within the 

definition of the term ‘‘security.’’ 1386

End-users will have the benefit and 

protection of the existing Federal 

securities laws, including the Exchange 

Act and Securities Act provisions added 

by Title VII. As a result of the 

amendment to the Securities Act 

regarding security-based swap 

transactions entered into by issuers of 

the securities underlying the securitybased swap, and their affiliates and 

underwriters,1387 such issuers, affiliates, 

and underwriters cannot use securitybased swaps without also complying 

with the Securities Act provisions with 

respect to the underlying securities. 

Furthermore, Title VII provides 

protections to non-ECPs by adding 

provisions to both the Securities Act 

and the Exchange Act that require 

security-based swap transactions with 

such non-ECPs to be covered by an 

effective registration statement under 

the Securities Act and traded on a 

national securities exchange, and for 

brokers and dealers engaging in 

transactions with non-ECPs to be 

registered as such under section 15 of 

the Exchange Act. To the extent 

counterparties, including issuers of the 

underlying securities, or their affiliates 

or underwriters, determine to engage in 

such transactions, other counterparties 

may have a greater willingness to engage 

in such transactions because of the 

protections afforded by the Securities 

Act registration, disclosure, and civil 

liability scheme. An increased interest 

by end-users may create effects on 

competition. 

While other securities-related 

derivatives have the same limitations on 

issuers, affiliates, and underwriters 

using the derivative to avoid the 

Securities Act application to the 

underlying securities at the time the 

transaction is entered into, these other 

derivatives, such as security options and 

security futures, do not contain the 

same limitation on transactions with 

non-ECPs. Although security options 

and security futures must be traded on 

a national securities exchange as one 

condition to avail themselves of an 

exemption from registration under the 

Securities Act,1388 other exemptions 

from registration under the Securities 

Act may be available for transactions in 

security options sold to non-ECPs that 

are not available to security-based swap 

transactions with non-ECPs. 

There also may be effects on 

efficiency and capital formation by 

facilitating end-users’ use of securitybased swaps for investment or hedging 

of risks relating to investments or 

business operations, thereby affecting 

liquidity and costs in connection with 

the issuance of equity and debt 

securities. The further definitions may 

promote capital formation by facilitating 

these hedging and investment activities. 

For example, in the context of CDS, as 

credit risk is correlated, lenders who 

made loans and investors in debt 

securities may find it desirable to hedge 

credit risks on their loan or securities 

portfolios by purchasing protection 

through single-name or index CDS.1389

Although basis risk may exist in this 

type of trade, it should be effective at 

reducing counterparty exposure.1390

(b) Jurisdictional Divide Impacts 

There may be competitive impacts 

that arise due to the jurisdictional 

divide between the CFTC and the SEC 

that Congress imposed in Title VII. 

While the competitive impacts of the 

substantive rules will be addressed as 

part of each substantive rulemaking, the 

SEC acknowledges that such 

competitive effects may exist as a 

consequence of the statutory 

jurisdictional divide. These competitive 

impacts may arise due to capital and 

margin treatment, for example, which 

may affect demand for security-based 

swaps as compared to other types of 

security instruments. In addition, to the 

extent there are differences in regulatory 

treatment between security-based swaps 

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1391See section 3E(a) of the Exchange Act, 15 

U.S.C. 78c–5(a). 

1392See section 3E(b)(1) of the Exchange Act, 15 

U.S.C. 78c–5(b)(1). 

1393See section 4d(f)(1) of the CEA, 7 U.S.C. 

6d(f)(1). 

1394See section 4d(f)(2)(A) of the CEA, 7 U.S.C. 

6d(f)(2)(A). 

1395See, e.g., letter to the SEC from ICE Clear 

Credit LLC, dated November 7, 2011 (‘‘ICE Clear 

Credit Letter’’), available at http://www.sec.gov/ 

rules/petitions/2011/petn4-641.pdf (requesting 

exemptive relief from the application of section 

15(c)(3) of the Exchange Act and Rule 15c3–3 

thereunder to allow ICE Clear Credit, and its 

members that are dually-registered broker-dealers 

and futures commission merchants, to, among other 

things: (1) Hold customer assets used to margin, 

secure, or guarantee customer positions consisting 

of cleared credit default swaps that include swaps 

and security-based swaps in a commingled 

customer omnibus account subject to section 4d(f) 

of the CEA; and (2) calculate margin for this 

commingled customer account on a portfolio 

margin basis); see also section 4d(F)(1) of the CEA 

(making it unlawful for any person to, among other 

things, accept money and securities from a swaps 

customer for a cleared swap unless such person has 

registered with the CFTC as a futures commission 

merchant). 

1396See ICE Clear Credit Letter at 6, 13–14. See 

also Statement of General Policy on the Sequencing 

of the Compliance Dates for Final Rules Applicable 

to Security-Based Swaps Adopted Pursuant to the 

Securities Exchange Act of 1934 and the DoddFrank Wall Street Reform and Consumer Protection 

Act, 77 FR 35625 n.138 (June 14, 2012). 

1397See the discussion of assessment costs of 

various rules and interpretations, supra part XI.A.4. 

1398See supra parts XI.A.3and XI.A.4. 

1399 44 U.S.C. 3501 et seq. 1400 44 U.S.C. 3507(d) and 5 CFR 1320.11. 

and other securities-based or securitiesrelated instruments, there will be 

competition across the markets affecting 

all market participants. 

As one example of the possible 

competitive effects of the jurisdictional 

divide, section 3E(a) of the Exchange 

Act provides that only a registered 

broker, dealer, or security-based swap 

dealer may accept margin from 

customers to secure cleared securitybased swap transactions,1391 and that 

the broker, dealer, or security-based 

swap dealer shall treat and deal with all 

margin received from a customer as 

belonging to the customer.1392

Similarly, section 4d(f) of the 

Commodity Exchange Act requires that 

only a registered futures commission 

merchant may accept margin from 

customers to secure cleared swap 

transactions 1393 and that the futures 

commissions merchant shall treat and 

deal with margin received from a 

customer as belonging to the 

customer.1394 The SEC understands that 

many members of clearing agencies are 

dually-registered broker-dealers and 

futures commission merchants and that 

much of the clearing of security-based 

swaps may occur through such duallyregistered entities.1395 Because 

collateral for swaps and security-based 

swaps are required under applicable 

statutory requirements to be maintained 

in two separate accounts under the CEA 

and Exchange Act, respectively, the 

derivatives portfolio of a customer will 

be separated into a swap portfolio and 

a security-based swap portfolio, with 

two separate margin accounts and 

without the benefits of netting swaps 

against security-based swaps for 

purposes of calculating margin 

requirements. Absent the adoption of a 

margin and segregation approach that 

would permit a customer to hold both 

swaps and security-based swaps in a 

single customer account, a customer 

who clears swaps and security-based 

swaps through a clearing member who 

is dually-registered as a futures 

commission merchant with the CFTC 

and a broker-dealer with the SEC may 

have to deliver collateral to the clearing 

member with respect to the customer’s 

cleared swap portfolio and also deliver 

collateral as margin to the clearing 

member with respect to its securitybased swap portfolio even if the 

positions in the swap portfolio offset the 

risk arising from the positions in the 

security-based swap portfolio. This will 

impact customers’ liquidity, as opposed 

to holding swap and security-based 

swap positions in one single 

account,1396 and increase customers’ 

transaction costs. Such an increase will 

affect customers’ ability to use securitybased swaps and may drive them to seek 

less expensive alternatives. Decrease in 

demand for security-based swaps may 

increase dealer competition in the 

security-based swap market for the 

remaining business, or result in dealers 

exiting the market. 

In addition, there may be competitive 

impacts on security-based swap dealers, 

major security-based swap participants, 

clearing agencies, security-based swap 

data repositories and security-based 

swap execution facilities (or national 

securities exchanges) if they provide 

services for both security-based swaps 

and swaps, as their businesses will be 

divided based on the jurisdictional line 

between swaps and security-based 

swaps. For registered entities whose 

derivatives activities involve products 

that reference indexes or baskets, they 

will incur assessment costs 1397 and, to 

the extent that SEC and CFTC 

regulations diverge, they will incur 

additional regulatory compliance 

costs 1398 to implement two sets of 

regulations that would not otherwise be 

incurred if the jurisdictional divide did 

not exist. The SEC recognizes that these 

costs may affect existing market 

participants’ considerations whether to 

continue to operate their business, and 

new entrants’ desire to enter into new 

business, across two separate regulatory 

regimes and if they determine that the 

incremental costs of operating the 

derivatives business under two separate 

regulatory regimes would outweigh 

potential revenues, they may exit 

certain products to limit the application 

of regulatory requirements to solely 

those of the CFTC or the SEC. This 

could result in a redistribution of the 

swaps or security-based swaps dealing 

activity in the derivatives market and 

lead to further concentration of securitybased swap dealing activity. 

The SEC understands that Congress 

intended to create two parallel 

regulatory regimes for the derivatives 

market that complement each other. 

Each regulatory regime will have the 

benefit of the regulatory expertise of the 

respective agency. The rules further 

defining swap, security-based swap, and 

mixed swap do not by themselves create 

negative competitive impacts other than 

those which potentially could be 

imposed if the Commissions’ 

substantive requirements differ 

substantially. 

Finally, the rules being adopted may 

have effects on efficiency and capital 

formation. For example, the rules 

defining the terms ‘‘issuers of securities 

in a narrow-based security index’’ and 

‘‘narrow-based security index’’ for 

purposes of the jurisdictional divide are 

intended to, among other things, 

minimize the likelihood that an index 

on which a CDS is based that is outside 

of the SEC’s jurisdiction can be used as 

a surrogate or substitute for the 

underlying security, or with respect to 

securities of the referenced issuer, or to 

manipulate the market for such 

securities. Such provisions will provide 

greater protection to the reference 

issuers or the issuers of the securities in 

the index that the index CDS cannot be 

used in a manner that will adversely 

affect such issuers and their ability to 

raise capital. 

In conclusion, the SEC believes the 

rules and interpretations adopted here 

would not have overall adverse effects 

on efficiency, competition, or capital 

formation. 

B. Paperwork Reduction Act 

1. Background 

Rules 3a68–2 and 3a68–4(c) under the 

Exchange Act contain new ‘‘collection 

of information’’ requirements within the 

meaning of the Paperwork Reduction 

Act of 1995.1399 The SEC has submitted 

them to the Office of Management and 

Budget (‘‘OMB’’) for review in 

accordance with the PRA.1400 The titles 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48345 

1401See Proposing Release at 29877, 29879. 

1402See discussion of rules 3a68–2 and 3a68–4(c) 

supra parts VI and IV.B.3. 

1403See supra part I. 1404See infra part XI.B.3. 

for the collections of information are: (1) 

Interpretation of Swaps, Security-Based 

Swaps, and Mixed Swaps and (2) 

Regulation of Mixed Swaps: Process for 

determining regulatory treatment for 

mixed swaps (OMB Control No. 3235– 

0685). An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a currently valid OMB 

control number. 

The rules containing these two 

collections of information are being 

adopted pursuant to the Exchange Act. 

The rules establish a process through 

which a person can submit a request to 

the Commissions that the Commissions 

provide a joint interpretation of whether 

an agreement, contract, or transaction 

(or class thereof) is a swap, securitybased swap, or both (i.e., a mixed swap). 

The rules also establish a process with 

respect to mixed swaps through which 

a person can submit a request to the 

Commissions that the Commissions 

issue a joint order permitting the 

requesting person (and any other person 

or persons that subsequently lists, 

trades, or clears that class of mixed 

swap) to comply, as to parallel 

provisions only, with specified parallel 

provisions, instead of being required to 

comply with parallel provisions of both 

the CEA and the Exchange Act. The 

hours and costs associated with 

preparing and sending these requests 

will constitute reporting and cost 

burdens imposed by each collection of 

information. 

In the Proposing Release, the SEC 

requested comment on the collection of 

information requirements.1401 As 

discussed in connection with rules 

3a68–2 and 3a68–4(c) under the 

Exchange Act, under the Exchange Act 

the final rules require the same 

information to be collected as 

proposed.1402 As noted above, the 

Commissions received approximately 86 

comment letters on the Proposing 

Release.1403 The SEC did not receive 

any comments that directly address its 

Paperwork Reduction Act analysis or its 

burden estimates. However, the SEC did 

receive comments regarding 

confidentiality of information submitted 

as a result of the collection of 

information requirements. These 

comments do not directly address the 

SEC’s Paperwork Reduction Act 

analysis, but they do implicate those 

aspects of the analysis regarding 

confidentiality. These comments are 

discussed below.1404

2. Summary of Collection of Information 

Under Rules 3a68–2 and 3a68–4(c) 

Under the Exchange Act 

First, the SEC is adopting new rule 

3a68–2 under the Exchange Act, which 

will allow persons to submit a request 

for a joint interpretation from the 

Commissions regarding whether an 

agreement, contract, or transaction (or a 

class thereof) is a swap, security-based 

swap, or both (i.e., a mixed swap). 

Under rule 3a68–2 under the Exchange 

Act, a person will provide to the 

Commissions all material information 

regarding the terms of, and a statement 

of the economic characteristics and 

purpose of, each relevant agreement, 

contract, or transaction (or class 

thereof), along with that person’s 

determination as to whether each such 

agreement, contract, or transaction (or 

class thereof) should be characterized as 

a swap, security-based swap, or both 

(i.e., a mixed swap), including the basis 

for such a determination. The 

Commissions also may request the 

submitting person to provide additional 

information. 

The Commissions may issue in 

response a joint interpretation or joint 

notice of proposed rulemaking regarding 

the status of that agreement, contract, or 

transaction (or class thereof) as a swap, 

security-based swap, or both (i.e., a 

mixed swap). Any joint interpretation, 

like any joint notice of proposed 

rulemaking, will be public and may 

discuss the material information 

regarding the terms of the relevant 

agreement, contract, or transaction (or 

class thereof), as well as any other 

information the Commissions deem 

material to the interpretation. 

Requesting persons also will be 

permitted to withdraw a request made 

pursuant to rule 3a68–2 under the 

Exchange Act at any time before the 

Commissions have issued a joint 

interpretation or joint notice of 

proposed rulemaking in response to the 

request. 

Persons will submit requests pursuant 

to rule 3a68–2 under the Exchange Act 

on a voluntary basis. However, if a 

person submits a request, all of the 

information required under the rule, 

including any additional information 

requested by the Commissions, must be 

submitted to the Commissions, except to 

the extent a person withdraws the 

request pursuant to the rule. 

Second, the SEC is adopting rule 

3a68–4(c) under the Exchange Act, 

which will allow persons to submit 

requests to the Commissions for joint 

orders regarding the regulation of a 

particular mixed swap (or class thereof). 

Under rule 3a68–4(c) under the 

Exchange Act, a person will provide to 

the Commissions all material 

information regarding the terms of, and 

the economic characteristics and 

purpose of, the specified (or specified 

class of) mixed swap. In addition, a 

person will provide the specified 

parallel provisions, the reasons the 

person believes such specified parallel 

provisions are appropriate for the mixed 

swap (or class thereof), and an analysis 

of: (1) The nature and purposes of the 

parallel provisions that are the subject 

of the request; (2) the comparability of 

such parallel provisions; and (3) the 

extent of any conflicts or differences 

between such parallel provisions. The 

Commissions also may request the 

submitting person to provide additional 

information. 

The Commissions may issue in 

response a joint order, after public 

notice and opportunity for comment, 

permitting the requesting person (and 

any other person or persons that 

subsequently lists, trades, or clears that 

class of mixed swap) to comply, as to 

parallel provisions only, with the 

specified parallel provisions (or another 

subset of the parallel provisions that are 

the subject of the request, as the 

Commissions determine is appropriate), 

instead of being required to comply 

with parallel provisions of both the CEA 

and the Exchange Act. Any joint order 

will be public and may discuss the 

material information regarding the terms 

of the relevant agreement, contract, or 

transaction (or class thereof), as well as 

any other information the Commissions 

deem material to the interpretation. 

Requesting persons also will be 

permitted to withdraw a request made 

pursuant to rule 3a68–4(c) under the 

Exchange Act at any time before the 

Commissions have issued a joint order 

in response to the request. 

Persons will submit requests pursuant 

to rule 3a68–4(c) under the Exchange 

Act on a voluntary basis. However, if a 

person submits a request, all of the 

information required under the rule, 

including any additional information 

requested by the Commissions, must be 

submitted to the Commissions, except to 

the extent a person withdraws the 

request pursuant to the rule. 

3. Reasons for and Use of Information 

The SEC will use the information 

collected pursuant to rule 3a68–2 under 

the Exchange Act to evaluate 

agreements, contracts, or transactions 

(or classes thereof) in order to provide 

joint interpretations or joint notices of 

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48346 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

1405See supra part VI. 1406See 17 CFR 200.81 and 17 CFR 140.98. See 

also supra part VI. 1407See supra part VI. 1408See Proposing Release at 29876. 

1409This total number includes an estimated 250 

swap dealers, 50 major swap participants, 50 

security-based swap dealers, 10 major securitybased swap participants, 35 SEFs, 20 security-based 

SEFs, 12 DCOs, 17 DCMs, 15 SDRs, 10 SBSDRs, and 

6 clearing agencies, as set forth by the CFTC and 

SEC, respectively, in their other Dodd-Frank Act 

rulemaking proposals. See Entity Definitions 

Release, supra note 12 (regarding security-based 

swap dealers and major security-based swap 

participants); Registration of Swap Dealers and 

Major Swap Participants, supra note 1288 

(regarding swap dealers and major security-based 

swap participants); SDR Proposing Release, supra 

note 1231 (regarding SBSDRs); Swap Data 

Repositories, supra note 6 (regarding SDRs); Core 

Principles and Other Requirements for Swap 

Execution Facilities, 76 FR 1214, Jan. 7, 2011 

(regarding SEFs); Registration and Regulation of 

Security-Based Swap Execution Facilities, 76 FR 

10948, Feb. 28, 2011 (regarding security-based 

SEFs); Derivatives Clearing Organization General 

Provisions and Core Principles, 76 FR 69334 (Nov. 

8, 2011); Core Principles and Other Requirements 

for Designated Contract Markets, 75 FR 80572, Dec. 

22, 2010 (regarding DCMs); Clearing Agency 

Standards for Operation and Governance, 76 FR 

14472, Mar. 16, 2011 (regarding clearing agencies). 

1410 Id. 

1411See supra note 12 and accompanying text. 

1412See infra note 1414 and accompanying text. 

1413See infra note 1415 and accompanying text. 

1414The SEC believes that there will be 

approximately 50 requests in the first year. See 

discussion infra part XI.B.5. The SEC recognizes 

that one person might submit more than one request 

but for purposes of the PRA is considering the 

submitter of each such request as a separate person. 

1415The SEC believes it is reasonable to estimate 

that it will receive 20 requests in the first year and, 

as with rule 3a68–2 under the Exchange Act, it will 

count the submitter of each request as a separate 

person. See id. 

proposed rulemaking with the CFTC 

regarding whether these agreements, 

contracts, or transactions (or classes 

thereof) are swaps, security-based 

swaps, or both (i.e., mixed swaps) as 

defined in the Dodd-Frank Act. The SEC 

will use the information collected 

pursuant to rule 3a68–4(c) under the 

Exchange Act to evaluate a specified, or 

a specified class of, mixed swap in order 

to provide joint orders or joint notices 

of proposed rulemaking with the CFTC 

regarding the regulation of that 

particular mixed swap or class of mixed 

swap. The information provided to the 

SEC pursuant to rules 3a68–2 and 3a68– 

4(c) under the Exchange Act also will 

allow the SEC to monitor the 

development of new OTC derivatives 

products in the marketplace and 

determine whether additional 

rulemaking or interpretive guidance is 

necessary or appropriate. 

As discussed above, some 

commenters expressed concern about 

the public availability of information 

regarding the joint interpretive process 

and asked that the parties be able to 

seek confidential treatment of their 

submissions.1405 As stated above, under 

existing rules of both Commissions, 

requesting parties may seek confidential 

treatment for joint interpretive requests 

from the SEC and the CFTC in 

accordance with the applicable existing 

rules relating to confidential treatment 

of information.1406 Also as stated above, 

even if confidential treatment has been 

requested, all joint interpretive requests, 

as well all joint interpretations and any 

decisions not to issue a joint 

interpretation (along with the 

explanation of the grounds for such 

decision), will be made publicly 

available at the conclusion of the review 

period.1407

4. Respondents 

As discussed in the Proposing 

Release, the SEC believes that the 

relevant categories of persons that will 

submit requests under rule 3a68–2 

under the Exchange Act will be swap 

dealers, security-based swap dealers, 

major swap participants, and major 

security-based swap participants; SEFs, 

security-based SEFs and DCMs trading 

swaps; and SDRs, SBSDRs, DCOs 

clearing swaps, and clearing agencies 

clearing security-based swaps.1408 The 

SEC estimates that the total number of 

such persons will be 475.1409 Similarly, 

the SEC believes that the relevant 

categories of persons that will submit a 

request under rule 3a68–4(c) under the 

Exchange Act will be SEFs, securitybased SEFs, and DCMs trading swaps 

and estimates that the total number of 

such persons will be 72.1410

However, based on the SEC’s 

experience and information received 

from commenters to the ANPR 1411 and 

during meetings with the public to 

discuss the Product Definitions 

generally, and taking into consideration 

the certainty provided by the rules and 

interpretive guidance in this release, the 

SEC believes that the number of 

requests for a joint interpretation to the 

Commissions pursuant to rule 3a68–2 

under the Exchange Act will be 

small.1412 With respect to proposed rule 

3a68–4(c) under the Exchange Act, the 

SEC also estimates the number of 

requests for joint orders will be 

small.1413 Pursuant to the Commissions’ 

rules and interpretive guidance, a 

number of persons that engage in 

agreements, contracts, or transactions 

that are swaps, security-based swaps, or 

both (i.e., a mixed swap) will be certain 

that their agreements, contracts, or 

transactions are, indeed, swaps, 

security-based swaps, or both, (i.e., 

mixed swaps) and will not request an 

interpretation pursuant to rule 3a68–2 

under the Exchange Act. Also, as the 

Commissions provide joint 

interpretations regarding whether 

agreements, contracts, or transactions 

(or classes thereof) are or are not swaps, 

security-based swaps, or both (i.e., 

mixed swaps), the SEC expects that the 

number of requests for interpretation 

will decrease over time. The SEC 

believes that the rules and interpretive 

guidance regarding swaps, securitybased swaps, and mixed swaps the 

Commissions are adopting, as well as 

the additional guidance issued pursuant 

to joint interpretations and orders under 

rules 3a68–2 and 3a68–4(c) under the 

Exchange Act, will result in a narrow 

pool of potential respondents, 

approximately 50,1414 to the collection 

of information requirements of proposed 

rule 3a68–2 under the Exchange Act. 

Although the SEC does not have precise 

figures for the number of requests that 

persons will submit after the first year, 

the SEC believes it is reasonable to 

estimate that there likely will be fewer 

than 10 requests on average in each 

ensuing year. 

Similarly, because the SEC believes 

that both the category of mixed swap 

transactions and the number of market 

participants that engage in mixed swap 

transactions are small, the SEC believes 

that the pool of potential persons 

requesting a joint order regarding the 

regulation of a specified, or specified 

class of, mixed swap pursuant to 

proposed rule 3a68–4(c) under the 

Exchange Act will be small. In addition, 

depending on the characteristics of a 

mixed swap (or class thereof), a person 

may choose not to submit a request 

pursuant to rule 3a68–4(c) under the 

Exchange Act. The SEC also notes that 

any joint order issued by the 

Commissions will apply to any person 

that subsequently lists, trades, or clears 

that specified, or specified class of, 

mixed swap, so that requests for joint 

orders could diminish over time. Also, 

persons may submit requests for an 

interpretation under rule 3a68–4(c) 

under the Exchange Act that do not 

result in an interpretation that the 

agreement, contract, or transaction (or 

class thereof) is a mixed swap.1415 Also, 

those requests submitted pursuant to 

rule 3a68–2 under the Exchange Act 

that result in an interpretation that the 

agreement, contract, or transaction (or 

class thereof) is not a mixed swap will 

reduce the pool of possible persons 

submitting a request regarding the 

regulation of particular mixed swaps (or 

class thereof) pursuant to rule 3a68–4(c) 

under the Exchange Act. 

Furthermore, although certain 

requests made pursuant to rule 3a68– 

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1416See discussion supra part VI. 

1417See discussion supra part XI.A.4.e(ii). This 

estimate is based on information indicating that the 

average burden associated with preparing and 

submitting a no-action request to the SEC staff in 

connection with the identification of whether 

certain products are securities, which the SEC 

believes is a process similar to the process under 

rule 3a68–2 under the Exchange Act, is 

approximately 20 hours and associated costs of 

$12,000. Assuming these costs correspond to legal 

fees, which the SEC estimates at an hourly cost of 

$400, the SEC estimates that this cost is equivalent 

to approximately 30 hours ($12,000/$400). The 

estimated internal or company time burden for rule 

3a68–2 under the Exchange Act has not changed 

from that included in the Proposing Release, but the 

estimated burden of the cost for outside 

professionals for rule 3a68–2 under the Exchange 

Act has been revised from that included in the 

Proposing Release to reflect updated data regarding 

hourly costs for the services of outside 

professionals. The estimate of the dollar burden for 

rule 3a68–2 under the Exchange Act in the 

Proposing Release was based on data from SIFMA’s 

‘‘Management & Professional Earnings in the 

Securities Industry 2009.’’ See Proposing Release at 

29876, note 345. The hourly rate used to estimate 

the PRA burdens is discussed above. See supra note 

1344. 

1418See Proposing Release at 29876, 29877–78. 

1419See id. 

1420See discussion supra part XI.B.4. 

1421See discussion supra part IV.B.3. 

1422See supra note 1415 and accompanying text. 

1423See supra note 1352. 

1424This estimate is based on information 

indicating that the average burden associated with 

preparing and submitting a no-action request to the 

SEC staff in connection with the regulatory 

treatment of certain securities products, which the 

SEC believes is a process similar to the process 

under rule 3a68–4(c) under the Exchange Act, is 

approximately 30 hours and associated costs of 

$20,000. Assuming these costs correspond to legal 

fees, which the SEC estimates at an hourly cost of 

$400 as discussed above, the SEC estimates that this 

cost is equivalent to approximately 50 hours 

($20,000/$400). As with rule 3a68–2 under the 

Exchange Act, the estimated internal or company 

time burdens for rule 3a68–4(c) under the Exchange 

Act have not changed from those included in the 

Proposing Release, but the estimated burdens of the 

cost for outside professionals for rule 3a68–4(c) 

under the Exchange Act have been revised from 

those included in the Proposing Release to reflect 

updated data regarding hourly costs for the services 

of outside professionals. 

4(c) under the Exchange Act may be 

made without a previous request for a 

joint interpretation pursuant to rule 

3a68–2 under the Exchange Act, the 

SEC believes that most requests under 

rule 3a68–2 under the Exchange Act 

that result in the interpretation that an 

agreement, contract, or transaction (or 

class thereof) is a mixed swap will 

result in a subsequent request for 

alternative regulatory treatment 

pursuant to rule 3a68–4(c) under the 

Exchange Act. The SEC believes that 90 

percent, or 18 of the estimated 20 

requests pursuant to rule 3a68–4(c) 

under the Exchange Act in the first year 

would be such ‘‘follow-on’’ requests. 

In addition, not only the requesting 

party, but also any other person that 

subsequently lists, trades, or clears that 

mixed swap, will be subject to, and 

must comply with, the joint order 

regarding the regulation of the specified, 

or specified class of, mixed swap, as 

issued by the Commissions. Therefore, 

the SEC believes that the number of 

requests for a joint order regarding the 

regulation of mixed swaps, particularly 

involving specified classes of mixed 

swaps, will decrease over time. As 

discussed above, the SEC believes that 

as the Commissions provide joint orders 

regarding alternative regulatory 

treatment, the number of requests 

received will decrease over time. The 

SEC believes it is reasonable to estimate 

that there likely will be five requests on 

average in each ensuing year. 

5. Paperwork Reduction Act Burden 

Estimates 

Rules 3a68–2 and 3a68–4(c) under the 

Exchange Act require submission of 

certain information to the Commissions 

to the extent persons elect to request an 

interpretation and/or alternative 

regulatory treatment. Rules 3a68–2 and 

3a68–4(c) under the Exchange Act each 

require certain information that a 

requesting party must include in its 

request to the Commissions in order to 

receive a joint interpretation or order, as 

applicable. 

(a) Rule 3a68–2 Under the Exchange Act 

Rule 3a68–2 will apply only to 

requests made by persons that desire an 

interpretation from the Commissions. 

For each agreement, contract, or 

transaction (or class thereof) for which 

a person requests the Commissions’ 

joint interpretation under rule 3a68–2 

under the Exchange Act, the requesting 

person will be required to provide 

certain information, as discussed 

above.1416

As discussed above, the SEC believes 

it is reasonable to estimate that 50 

requests will be received in the first 

year. For purposes of the PRA, the SEC 

estimates the total paperwork burden 

associated with preparing and 

submitting a person’s request to the 

Commissions pursuant to rule 3a68–2 

under the Exchange Act will be 20 

hours per request and associated costs 

of $12,000 for outside professionals, 

which the SEC believes will consist of 

services provided by attorneys.1417

These total costs include all collection 

burdens associated with the rule, 

including burdens related to the initial 

determination requirements. 

Assuming 50 requests in the first year, 

the SEC estimates that this will result in 

an aggregate burden for the first year of 

1000 hours of company time (50 

requests × 20 hours/request) and 

$600,000 for the services of outside 

professionals (e.g., attorneys) (50 

requests × 30 hours/request × $400). The 

estimated internal or company time 

burden for rule 3a68–2 under the 

Exchange Act has not changed from that 

included in the Proposing Release.1418

However, the estimated burden of the 

cost for outside professionals for rule 

3a68–2 under the Exchange Act has 

been revised from that included in the 

Proposing Release to reflect updated 

data regarding the hourly cost for an 

attorney.1419

As discussed above, the SEC believes 

that there will be 10 requests on average 

in each ensuing year, which results in 

an aggregate burden in each ensuing 

year of 200 hours of company time (10 

requests × 20 hours/request) and 

$120,000 for the services of outside 

professionals (e.g., attorneys) (10 

requests × 30 hours/request × $400).1420

(b) Rule 3a68–4(c) Under the Exchange 

Act 

Rule 3a68–4(c) under the Exchange 

Act will require any party requesting a 

joint order regarding the regulation of a 

specified, or specified class of, mixed 

swap under the rule to include certain 

information about the agreement, 

contract, or transaction (or class thereof) 

that is a mixed swap, including the 

specified parallel provisions that the 

person believes should apply to the 

mixed swap (or class thereof), the 

reasons the person believes the 

specified parallel provisions will be 

appropriate for the mixed swap.1421

As discussed above, the SEC believes 

the number of requests that persons will 

submit pursuant to rule 3a68–4(c) under 

the Exchange Act is quite small given 

the limited types of agreements, 

contracts, and transactions (or classes 

thereof) the Commissions believe will 

constitute mixed swaps and that it will 

receive 20 requests in the first year.1422

For purposes of the PRA, the SEC 

estimates the total paperwork burden 

associated with preparing and 

submitting a party’s request to the 

Commissions pursuant to rule 3a68–4(c) 

under the Exchange Act will be 30 

hours and associated costs of $20,000 

for the services of outside professionals, 

which the SEC believes will consist of 

services provided by attorneys,1423 per 

request for mixed swaps for which a 

request for a joint interpretation 

pursuant to rule 3a68–4(c) under the 

Exchange Act was not previously 

made.1424 These total costs include all 

collection burdens associated with the 

rule, including burdens related to the 

initial determination requirements. 

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1425See supra note 1415 and accompanying text. 

1426This estimate takes into account that certain 

information regarding the mixed swap (or class 

thereof), namely the material terms and the 

economic purpose, will have already been gathered 

and prepared as part of the request submitted 

pursuant to proposed rule 3a68–2 under the 

Exchange Act. The SEC estimates that these items 

constitute approximately 10 hours fewer and a 

reduction in associated costs of $6,000. Assuming 

these costs correspond to legal fees, which the SEC 

estimates at an hourly cost of $400, the SEC 

estimates that this cost is equivalent to 

approximately 15 hours ($6,000/$400). As noted 

above, these amounts are revised from those 

included in the Proposing Release to reflect 

updated data regarding the hourly costs for the 

services of outside professionals. 

1427See Proposing Release at 29876, 29878–79. 

1428See id. 

1429 5 U.S.C. 601 et seq. 

1430 5 U.S.C. 603(a). 

1431 5 U.S.C. 551 et seq. 

1432Although section 601(b) of the RFA defines 

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

Commissions to formulate their own definitions. 

The SEC has adopted definitions for the term small 

entity for the purposes of SEC rulemaking in 

accordance with the RFA. Those definitions, as 

relevant to this proposed rulemaking, are set forth 

in Rule 0–10, 17 CFR 240.0–10. See Statement of 

Management on Internal Accounting Control, 47 FR 

5215, Feb. 4, 1982. 

1433See 5 U.S.C. 605(b). 

1434See 17 CFR 240.0–10(a). 

1435See 17 CFR 240.17a–5(d). 

1436See 17 CFR 240.0–10(c). 

1437See 13 CFR 121.201 (Subsector 522). 

1438See id. at Subsector 522. 

1439See id. at Subsector 523. 

1440See id. at Subsector 524. 

Assuming 20 requests in the first year, 

the SEC estimates that this will result in 

an aggregate burden for the first year of 

600 hours of company time (20 requests 

× 30 hours/request) and $400,000 for the 

services of outside professionals (20 

requests × 50 hours/request × $400).1425

As discussed above, the SEC believes 

that most requests under rule 3a68–2 

under the Exchange Act that result in 

the interpretation that an agreement, 

contract, or transaction (or class thereof) 

is a mixed swap will result in a 

subsequent request for alternative 

regulatory treatment pursuant to rule 

3a68–4(c) under the Exchange Act. 

Also as discussed above, the SEC 

believes that 90 percent, or 18 of the 

estimated 20 requests pursuant to rule 

3a68–4(c) under the Exchange Act in the 

first year, as discussed above will be 

‘‘follow-on’’ requests. For mixed swaps 

for which a request for a joint 

interpretation pursuant to rule 3a68–2 

under the Exchange Act was previously 

made, the SEC estimates the total 

paperwork burden under the PRA 

associated with preparing and 

submitting a party’s request to the 

Commissions pursuant to rule 3a68–4(c) 

under the Exchange Act will be 10 

hours fewer and $6,000 less per request 

than for mixed swaps for which a 

request for a joint interpretation 

pursuant to rule 3a68–2 under the 

Exchange Act was not previously made 

because certain, although not all, of the 

information required to be submitted 

and necessary to prepare pursuant to 

rule 3a68–4(c) under the Exchange Act 

will have been required to be submitted 

and necessary to prepare pursuant to 

rule 3a68–2 under the Exchange Act.1426

The SEC estimates that this will result 

in an aggregate burden for such ‘‘followon’’ requests in the first year of 360 

hours of company time (18 requests × 20 

hours/request) and $252,000 for the 

services of outside professionals (18 

requests × 35 hours/request × $400) and 

an aggregate burden for all requests in 

the first year of 420 hours of company 

time (2 requests × 30 hours/request and 

18 requests × 20 hours/request) and 

$292,000 for the services of outside 

professionals (2 requests × 50 hours/ 

request × $400 and 18 requests × 35 

hours/request × $400). 

The estimated internal or company 

time burden for rule 3a68–4(c) under 

the Exchange Act has not changed from 

that included in the Proposing 

Release.1427 However, the estimated 

burden of the cost for outside 

professionals for rule 3a68–4(c) has 

been revised from that included in the 

Proposing Release to reflect updated 

data regarding the hourly cost for an 

attorney.1428

As discussed above, the SEC believes 

that there will be five requests on 

average in each ensuing year. Assuming 

five requests in each ensuing year, the 

SEC estimates that this will result in an 

aggregate burden in each ensuing year of 

150 hours of company time (5 requests 

× 30 hours/request) and $100,000 for the 

services of outside professionals (5 

requests × 50 hours/request × $400). As 

discussed above, however, assuming 

that approximately 90 percent, or 4 of 

the estimated 5 requests pursuant to 

rule 3a68–4(c) under the Exchange Act 

in each ensuing year are ‘‘follow-on’’ 

requests to requests for joint 

interpretation from the Commissions 

under rule 3a68–4(c) under the 

Exchange Act, the SEC estimates that 

this will result in an aggregate burden 

for such ‘‘follow-on’’ requests in each 

ensuing year of 80 hours of company 

time (4 requests × 20 hours/request) and 

$56,000 for the services of outside 

professionals (4 requests × 35 hours/ 

request × $400) and an aggregate burden 

for all requests in each ensuing year of 

110 hours of company time (1 request × 

30 hours/request and 4 requests × 20 

hours/request) and $76,000 for the 

services of outside professionals (1 

request × 50 hours/request × $40] and 4 

requests × 35 hours/request × $400). 

C. Regulatory Flexibility Act 

Certification 

The Regulatory Flexibility Act 

(‘‘RFA’’) 1429 requires Federal agencies, 

in promulgating rules, to consider the 

impact of those rules on small entities. 

Section 603(a) 1430 of the Administrative 

Procedure Act,1431 as amended by the 

RFA, generally requires the SEC to 

undertake a regulatory flexibility 

analysis of all proposed rules, or 

proposed rule amendments, to 

determine the impact of such 

rulemaking on ‘‘small entities.’’ 1432

Section 605(b) of the RFA provides that 

this requirement shall not apply to any 

proposed rule or proposed rule 

amendment, which if adopted, would 

not have a significant economic impact 

on a substantial number of small 

entities.1433

For purposes of SEC rulemaking in 

connection with the RFA, a small entity 

includes: (1) When used with reference 

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

an investment company, an ‘‘issuer’’ or 

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

recent fiscal year, had total assets of $5 

million or less 1434 and (2) a brokerdealer with total capital (net worth plus 

subordinated liabilities) of less than 

$500,000 on the date in the prior fiscal 

year as of which its audited financial 

statements were prepared pursuant to 

rule 17a–5(d) under the Exchange 

Act,1435 or, if not required to file such 

statements, a broker-dealer with total 

capital (net worth plus subordinated 

liabilities) of less than $500,000 on the 

last day of the preceding fiscal year (or 

in the time that it has been in business, 

if shorter); and is not affiliated with any 

person (other than a natural person) that 

is not a small entity.1436 Under the 

standards adopted by the Small 

Business Administration, small entities 

in the finance and insurance industry 

include the following: (1) For entities 

engaged in credit intermediation and 

related activities, entities with $175 

million or less in assets; 1437 (2) for 

entities engaged in non-depository 

credit intermediation and certain other 

activities, entities with $7 million or 

less in annual receipts; 1438 (3) for 

entities engaged in financial 

investments and related activities, 

entities with $7 million or less in 

annual receipts; 1439 (4) for insurance 

carriers and entities engaged in related 

activities, entities with $7 million or 

less in annual receipts; 1440 and (5) for 

funds, trusts, and other financial 

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1441See id. at Subsector 525. 

1442See Proposing Release at 29887. 

1443See 17 CFR 240.0–10(a). 

1444See Proposing Release at 29887. 

1445See Proposing Release at 29887–88. 

1446See Proposing Release at 29888. 

1447See Letter from the National Rural Electric 

Cooperative Association, the American Public 

Power Association, the Large Public Power Council, 

the Edison Electric Institute, and the Electric Power 

Supply Association (July 22, 2011). 

1448See id. 

vehicles, entities with $7 million or less 

in annual receipts.1441

The Proposing Release stated that, 

based on the SEC’s existing information 

about the swap markets, the SEC 

believed that the swap markets, while 

broad in scope, are largely dominated by 

entities such as those that would qualify 

as swap dealers, security-based swap 

dealers, major swap participants, and 

major security-based swap participants 

(collectively, ‘‘swap market dealers and 

major participants’’) and that the SEC 

believed that such entities exceed the 

thresholds defining ‘‘small entities’’ set 

out above.1442

The Proposing Release also stated 

that, although it is possible that other 

persons may engage in swap and 

security-based swap transactions, the 

SEC did not believe that any of these 

entities would be ‘‘small entities’’ as 

defined in rule 0–10 under the 

Exchange Act 1443 and that feedback 

from industry participants about the 

swap markets indicates that only 

persons or entities with assets 

significantly in excess of $5 million (or 

with annual receipts significantly in 

excess of $7 million) participate in the 

swap markets.1444

The Proposing Release further stated 

that, to the extent that a small number 

of transactions did have a counterparty 

that was defined as a ‘‘small entity’’ 

under SEC rule 0–10, the SEC believed 

it is unlikely that the proposed rules 

and interpretive guidance would have a 

significant economic impact on that 

entity because the proposed rules and 

interpretive guidance simply would 

address whether certain products fall 

within the swap definition, address 

whether certain products are swaps, 

security-based swaps, SBSAs, or mixed 

swaps, provide a process for requesting 

interpretations of whether agreements, 

contracts, and transactions are swaps, 

security-based swaps, and mixed swaps, 

provide a process for requesting 

alternative regulatory treatment for 

mixed swaps, and specify that the books 

and records for SBSAs are those that are 

applicable to all entities.1445

As a result, the SEC certified that the 

proposed rules and interpretive 

guidance would not have a significant 

economic impact on a substantial 

number of small entities for purposes of 

the RFA, and requested written 

comments regarding this 

certification.1446

In response to the Proposing Release, 

one commenter, representing a number 

of market participants, submitted a 

comment to the CFTC related to the 

RFA.1447 The commenter did not 

address the letter to the SEC or provide 

comments regarding the SEC’s RFA 

analysis.1448

The SEC continues to believe that the 

types of entities that would participate 

in the swap markets—which generally 

would be swap market dealers and 

major participants—would not be 

‘‘small entities’’ for purposes of the 

RFA. The final rules and interpretive 

guidance do not themselves impose any 

compliance obligations. Instead they 

describe the categories of agreements, 

contracts, and transactions that are 

outside the scope of the Product 

Definitions and delineate the 

jurisdictional divide between the SEC’s 

and the CFTC’s regulatory regime. 

Accordingly, the SEC certifies that the 

final rules and interpretive guidance 

would not have a significant economic 

impact on a substantial number of small 

entities for purposes of the RFA. 

XII. Statutory Basis and Rule Text 

List of Subjects 

17 CFR Part 1 

Definitions, General swap provisions. 

17 CFR Parts 230 and 240 

Reporting and recordkeeping 

requirements, Securities. 

17 CFR Part 241 

Securities. 

Commodity Futures Trading 

Commission 

Pursuant to the Commodity Exchange 

Act, 7 U.S.C. 1 et seq., as amended by 

Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, 

Public Law 111–203, 124 Stat. 1376 

(2010) (‘‘Dodd-Frank Act’’), and sections 

712(a)(8), 712(d), 721(a), 721(b), 721(c), 

722(d), and 725(g) of the Dodd-Frank 

Act, the CFTC is adopting rules 1.3(xxx) 

through 1.3(bbbb) and 1.6 through 1.9 

under the Commodity Exchange Act. 

Text of Final Rules 

For the reasons stated in the 

preamble, the CFTC is amending Title 

17, Chapter I, of the Code of Federal 

Regulations, as follows: 

PART 1—GENERAL REGULATIONS 

UNDER THE COMMODITY EXCHANGE 

ACT 

■ 1. The authority citation for part 1 is 

revised to read as follows: 

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

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

6r, 7, 7a, 7b, 8, 9, 10, 12, 12a, 12c, 13a, 13a– 

1, 16, 16a, 21, 23, and 24. 

■ 2. Amend § 1.3 by: 

■ a. Adding and reserving paragraphs 

(nnn) through (www); and 

■ b. Adding paragraphs (xxx), (yyy), 

(zzz), (aaaa) and (bbbb). 

The additions read as follows: 

§ 1.3 Definitions. 

* * * * * 

(nnn)–(www) [Reserved] 

(xxx) Swap. (1) In general. The term 

swap has the meaning set forth in 

section 1a(47) of the Commodity 

Exchange Act. 

(2) Inclusion of particular products. 

(i) The term swap includes, without 

limiting the meaning set forth in section 

1a(47) of the Commodity Exchange Act, 

the following agreements, contracts, and 

transactions: 

(A) A cross-currency swap; 

(B) A currency option, foreign 

currency option, foreign exchange 

option and foreign exchange rate option; 

(C) A foreign exchange forward; 

(D) A foreign exchange swap; 

(E) A forward rate agreement; and 

(F) A non-deliverable forward 

involving foreign exchange. 

(ii) The term swap does not include 

an agreement, contract, or transaction 

described in paragraph (xxx)(2)(i) of this 

section that is otherwise excluded by 

section 1a(47)(B) of the Commodity 

Exchange Act. 

(3) Foreign exchange forwards and 

foreign exchange swaps. 

Notwithstanding paragraph (xxx)(2) of 

this section: 

(i) A foreign exchange forward or a 

foreign exchange swap shall not be 

considered a swap if the Secretary of the 

Treasury makes a determination 

described in section 1a(47)(E)(i) of the 

Commodity Exchange Act. 

(ii) Notwithstanding paragraph 

(xxx)(3)(i) of this section: 

(A) The reporting requirements set 

forth in section 4r of the Commodity 

Exchange Act and regulations 

promulgated thereunder shall apply to a 

foreign exchange forward or foreign 

exchange swap; and 

(B) The business conduct standards 

set forth in section 4s(h) of the 

Commodity Exchange Act and 

regulations promulgated thereunder 

shall apply to a swap dealer or major 

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swap participant that is a party to a 

foreign exchange forward or foreign 

exchange swap. 

(iii) For purposes of section 1a(47)(E) 

of the Commodity Exchange Act and 

this paragraph (xxx), the term foreign 

exchange forward has the meaning set 

forth in section 1a(24) of the Commodity 

Exchange Act. 

(iv) For purposes of section 1a(47)(E) 

of the Commodity Exchange Act and 

this paragraph (xxx), the term foreign 

exchange swap has the meaning set 

forth in section 1a(25) of the Commodity 

Exchange Act. 

(v) For purposes of sections 1a(24) 

and 1a(25) of the Commodity Exchange 

Act and this paragraph (xxx), the 

following transactions are not foreign 

exchange forwards or foreign exchange 

swaps: 

(A) A currency swap or a crosscurrency swap; 

(B) A currency option, foreign 

currency option, foreign exchange 

option, or foreign exchange rate option; 

and 

(C) A non-deliverable forward 

involving foreign exchange. 

(4) Insurance. (i) This paragraph is a 

non-exclusive safe harbor. The terms 

swap as used in section 1a(47) of the 

Commodity Exchange Act and securitybased swap as used in section 1a(42) of 

the Commodity Exchange Act do not 

include an agreement, contract, or 

transaction that: 

(A) By its terms or by law, as a 

condition of performance on the 

agreement, contract, or transaction: 

(1) Requires the beneficiary of the 

agreement, contract, or transaction to 

have an insurable interest that is the 

subject of the agreement, contract, or 

transaction and thereby carry the risk of 

loss with respect to that interest 

continuously throughout the duration of 

the agreement, contract, or transaction; 

(2) Requires that loss to occur and to 

be proved, and that any payment or 

indemnification therefor be limited to 

the value of the insurable interest; 

(3) Is not traded, separately from the 

insured interest, on an organized market 

or over-the-counter; and 

(4) With respect to financial guaranty 

insurance only, in the event of payment 

default or insolvency of the obligor, any 

acceleration of payments under the 

policy is at the sole discretion of the 

insurer; and 

(B) Is provided: 

(1)(i) By a person that is subject to 

supervision by the insurance 

commissioner (or similar official or 

agency) of any State or by the United 

States or an agency or instrumentality 

thereof; and 

(ii) Such agreement, contract, or 

transaction is regulated as insurance 

under applicable State law or the laws 

of the United States; 

(2)(i) Directly or indirectly by the 

United States, any State or any of their 

respective agencies or instrumentalities; 

or 

(ii) Pursuant to a statutorily 

authorized program thereof; or 

(3) In the case of reinsurance only, by 

a person to another person that satisfies 

the conditions set forth in paragraph 

(xxx)(4)(i)(B) of this section, provided 

that: 

(i) Such person is not prohibited by 

applicable State law or the laws of the 

United States from offering such 

agreement, contract, or transaction to 

such person that satisfies the conditions 

set forth in paragraph (xxx)(4)(i)(B) of 

this section; 

(ii) The agreement, contract, or 

transaction to be reinsured satisfies the 

conditions set forth in paragraph 

(xxx)(4)(i)(A) or paragraph (xxx)(4)(i)(C) 

of this section; and 

(iii) Except as otherwise permitted 

under applicable State law, the total 

amount reimbursable by all reinsurers 

for such agreement, contract, or 

transaction may not exceed the claims 

or losses paid by the person writing the 

risk being ceded or transferred by such 

person; or 

(4) In the case of non-admitted 

insurance, by a person who: 

(i) Is located outside of the United 

States and listed on the Quarterly 

Listing of Alien Insurers as maintained 

by the International Insurers 

Department of the National Association 

of Insurance Commissioners; or 

(ii) Meets the eligibility criteria for 

non-admitted insurers under applicable 

State law; or 

(C) Is provided in accordance with the 

conditions set forth in paragraph 

(xxx)(4)(i)(B) of this section and is one 

of the following types of products: 

(1) Surety bond; 

(2) Fidelity bond; 

(3) Life insurance; 

(4) Health insurance; 

(5) Long term care insurance; 

(6) Title insurance; 

(7) Property and casualty insurance; 

(8) Annuity; 

(9) Disability insurance; 

(10) Insurance against default on 

individual residential mortgages; and 

(11) Reinsurance of any of the 

foregoing products identified in 

paragraphs (xxx)(4)(i)(C)(1) through (10) 

of this section; or 

(ii) The terms swap as used in section 

1a(47) of the Commodity Exchange Act 

and security-based swap as used in 

section 1a(42) of the Commodity 

Exchange Act do not include an 

agreement, contract, or transaction that 

was entered into on or before the 

effective date of paragraph (xxx)(4) of 

this section, and that, at such time that 

it was entered into, was provided in 

accordance with the conditions set forth 

in paragraph (xxx)(4)(i)(B) of this 

section. 

(5) State. For purposes of paragraph 

(xxx)(4) of this section, the term State 

means any state of the United States, the 

District of Columbia, Puerto Rico, the 

U.S. Virgin Islands, or any other 

possession of the United States. 

(6) Anti-Evasion: 

(i) An agreement, contract, or 

transaction that is willfully structured to 

evade any provision of Subtitle A of the 

Wall Street Transparency and 

Accountability Act of 2010, including 

any amendments made to the 

Commodity Exchange Act thereby 

(Subtitle A), shall be deemed a swap for 

purposes of Subtitle A and the rules, 

regulations, and orders of the 

Commission promulgated thereunder. 

(ii) An interest rate swap or currency 

swap, including but not limited to a 

transaction identified in paragraph 

(xxx)(3)(v) of this section, that is 

willfully structured as a foreign 

exchange forward or foreign exchange 

swap to evade any provision of Subtitle 

A shall be deemed a swap for purposes 

of Subtitle A and the rules, regulations, 

and orders of the Commission 

promulgated thereunder. 

(iii) An agreement, contract, or 

transaction of a bank that is not under 

the regulatory jurisdiction of an 

appropriate Federal banking agency (as 

defined in section 1a(2) of the 

Commodity Exchange Act), where the 

agreement, contract, or transaction is 

willfully structured as an identified 

banking product (as defined in section 

402 of the Legal Certainty for Bank 

Products Act of 2000) to evade the 

provisions of the Commodity Exchange 

Act, shall be deemed a swap for 

purposes of the Commodity Exchange 

Act and the rules, regulations, and 

orders of the Commission promulgated 

thereunder. 

(iv) The form, label, and written 

documentation of an agreement, 

contract, or transaction shall not be 

dispositive in determining whether the 

agreement, contract, or transaction has 

been willfully structured to evade as 

provided in paragraphs (xxx)(6)(i) 

through (xxx)(6)(iii) of this section. 

(v) An agreement, contract, or 

transaction that has been willfully 

structured to evade as provided in 

paragraphs (xxx)(6)(i) through 

(xxx)(6)(iii) of this section shall be 

considered in determining whether a 

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person that so willfully structured to 

evade is a swap dealer or major swap 

participant. 

(vi) Notwithstanding the foregoing, no 

agreement, contract, or transaction 

structured as a security (including a 

security-based swap) under the 

securities laws (as defined in section 

3(a)(47) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(47))) shall be 

deemed a swap pursuant to this 

paragraph (xxx)(6) or shall be 

considered for purposes of paragraph 

(xxx)(6)(v) of this section. 

(yyy) Narrow-based security index as 

used in the definition of ‘‘security-based 

swap.’’ 

(1) In general. Except as otherwise 

provided in paragraphs (zzz) and (aaaa) 

of this section, for purposes of section 

1a(42) of the Commodity Exchange Act, 

the term narrow-based security index 

has the meaning set forth in section 

1a(35) of the Commodity Exchange Act, 

and the rules, regulations and orders of 

the Commission thereunder. 

(2) Tolerance period for swaps traded 

on designated contract markets, swap 

execution facilities, and foreign boards 

of trade. Notwithstanding paragraph 

(yyy)(1) of this section, solely for 

purposes of swaps traded on or subject 

to the rules of a designated contract 

market, swap execution facility, or 

foreign board of trade, a security index 

underlying such swaps shall not be 

considered a narrow-based security 

index if: 

(i)(A) A swap on the index is traded 

on or subject to the rules of a designated 

contract market, swap execution facility, 

or foreign board of trade for at least 30 

days as a swap on an index that was not 

a narrow-based security index; or 

(B) Such index was not a narrowbased security index during every 

trading day of the six full calendar 

months preceding a date no earlier than 

30 days prior to the commencement of 

trading of a swap on such index on a 

market described in paragraph 

(yyy)(2)(i)(A) of this section; and 

(ii) The index has been a narrowbased security index for no more than 

45 business days over three consecutive 

calendar months. 

(3) Tolerance period for securitybased swaps traded on national 

securities exchanges or security-based 

swap execution facilities. 

Notwithstanding paragraph (yyy)(1) of 

this section, solely for purposes of 

security-based swaps traded on a 

national securities exchange or securitybased swap execution facility, a security 

index underlying such security-based 

swaps shall be considered a narrowbased security index if: 

(i)(A) A security-based swap on the 

index is traded on a national securities 

exchange or security-based swap 

execution facility for at least 30 days as 

a security-based swap on a narrowbased security index; or 

(B) Such index was a narrow-based 

security index during every trading day 

of the six full calendar months 

preceding a date no earlier than 30 days 

prior to the commencement of trading of 

a security-based swap on such index on 

a market described in paragraph 

(yyy)(3)(i)(A) of this section; and 

(ii) The index has been a security 

index that is not a narrow-based 

security index for no more than 45 

business days over three consecutive 

calendar months. 

(4) Grace period. 

(i) Solely with respect to a swap that 

is traded on or subject to the rules of a 

designated contract market, swap 

execution facility, or foreign board of 

trade, an index that becomes a narrowbased security index under paragraph 

(yyy)(2) of this section solely because it 

was a narrow-based security index for 

more than 45 business days over three 

consecutive calendar months shall not 

be a narrow-based security index for the 

following three calendar months. 

(ii) Solely with respect to a securitybased swap that is traded on a national 

securities exchange or security-based 

swap execution facility, an index that 

becomes a security index that is not a 

narrow-based security index under 

paragraph (yyy)(3) of this section solely 

because it was not a narrow-based 

security index for more than 45 business 

days over three consecutive calendar 

months shall be a narrow-based security 

index for the following three calendar 

months. 

(zzz) Meaning of ‘‘issuers of securities 

in a narrow-based security index’’ as 

used in the definition of ‘‘security-based 

swap’’ as applied to index credit default 

swaps. 

(1) Notwithstanding paragraph 

(yyy)(1) of this section, and solely for 

purposes of determining whether a 

credit default swap is a security-based 

swap under the definition of ‘‘securitybased swap’’ in section 

3(a)(68)(A)(ii)(III) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(68)(A)(ii)(III), as incorporated in 

section 1a(42) of the Commodity 

Exchange Act, the term issuers of 

securities in a narrow-based security 

index means issuers of securities 

included in an index (including an 

index referencing loan borrowers or 

loans of such borrowers) in which: 

(i)(A) There are nine or fewer nonaffiliated issuers of securities that are 

reference entities included in the index, 

provided that an issuer of securities 

shall not be deemed a reference entity 

included in the index for purposes of 

this section unless: 

(1) A credit event with respect to such 

reference entity would result in a 

payment by the credit protection seller 

to the credit protection buyer under the 

credit default swap based on the related 

notional amount allocated to such 

reference entity; or 

(2) The fact of such credit event or the 

calculation in accordance with 

paragraph (zzz)(1)(i)(A)(1) of this section 

of the amount owed with respect to 

such credit event is taken into account 

in determining whether to make any 

future payments under the credit default 

swap with respect to any future credit 

events; 

(B) The effective notional amount 

allocated to any reference entity 

included in the index comprises more 

than 30 percent of the index’s 

weighting; 

(C) The effective notional amount 

allocated to any five non-affiliated 

reference entities included in the index 

comprises more than 60 percent of the 

index’s weighting; or 

(D) Except as provided in paragraph 

(zzz)(2) of this section, for each 

reference entity included in the index, 

none of the criteria in paragraphs 

(zzz)(1)(i)(D)(1) through (8) of this 

section is satisfied: 

(1) The reference entity included in 

the index is required to file reports 

pursuant to section 13 or section 15(d) 

of the Securities Exchange Act of 1934 

(15 U.S.C. 78m or 78o(d)); 

(2) The reference entity included in 

the index is eligible to rely on the 

exemption provided in rule 12g3–2(b) 

under the Securities Exchange Act of 

1934 (17 CFR 240.12g3–2(b)); 

(3) The reference entity included in 

the index has a worldwide market value 

of its outstanding common equity held 

by non-affiliates of $700 million or 

more; 

(4) The reference entity included in 

the index (other than a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)) has outstanding notes, 

bonds, debentures, loans, or evidences 

of indebtedness (other than revolving 

credit facilities) having a total remaining 

principal amount of at least $1 billion; 

(5) The reference entity included in 

the index is the issuer of an exempted 

security as defined in section 3(a)(12) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(12)) (other than any 

municipal security as defined in section 

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48352 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

3(a)(29) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(29))); 

(6) The reference entity included in 

the index is a government of a foreign 

country or a political subdivision of a 

foreign country; 

(7) If the reference entity included in 

the index is an issuing entity of an assetbacked security as defined in section 

3(a)(77) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(77)), such 

asset-backed security was issued in a 

transaction registered under the 

Securities Act of 1933 (15 U.S.C. 77a et 

seq.) and has publicly available 

distribution reports; and 

(8) For a credit default swap entered 

into solely between eligible contract 

participants as defined in section 1a(18) 

of the Commodity Exchange Act: 

(i) The reference entity included in 

the index (other than a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77))) makes available to 

the public or otherwise makes available 

to such eligible contract participant 

information about the reference entity 

included in the index pursuant to rule 

144A(d)(4) under the Securities Act of 

1933 (17 CFR 230.144A(d)(4)); 

(ii) Financial information about the 

reference entity included in the index 

(other than a reference entity included 

in the index that is an issuing entity of 

an asset-backed security as defined in 

section 3(a)(77) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(77))) is otherwise publicly 

available; or 

(iii) In the case of a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)), information of the 

type and level included in publicly 

available distribution reports for similar 

asset-backed securities is publicly 

available about both the reference entity 

included in the index and such assetbacked security; and 

(ii)(A) The index is not composed 

solely of reference entities that are 

issuers of exempted securities as 

defined in section 3(a)(12) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(12)), as in effect on the 

date of enactment of the Futures 

Trading Act of 1982 (other than any 

municipal security as defined in section 

3(a)(29) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(29))), as in 

effect on the date of enactment of the 

Futures Trading Act of 1982; and 

(B) Without taking into account any 

portion of the index composed of 

reference entities that are issuers of 

exempted securities as defined in 

section 3(a)(12) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(29))), the remaining 

portion of the index would be within 

the term ‘‘issuer of securities in a 

narrow-based security index’’ under 

paragraph (zzz)(1)(i) of this section. 

(2) Paragraph (zzz)(1)(i)(D) of this 

section will not apply with respect to a 

reference entity included in the index if: 

(i) The effective notional amounts 

allocated to such reference entity 

comprise less than five percent of the 

index’s weighting; and 

(ii) The effective notional amounts 

allocated to reference entities included 

in the index that satisfy paragraph 

(zzz)(1)(i)(D) of this section comprise at 

least 80 percent of the index’s 

weighting. 

(3) For purposes of this paragraph 

(zzz): 

(i) A reference entity included in the 

index is affiliated with another 

reference entity included in the index 

(for purposes of paragraph (zzz)(3)(iv) of 

this section) or another entity (for 

purposes of paragraph (zzz)(3)(v) of this 

section) if it controls, is controlled by, 

or is under common control with, that 

other reference entity included in the 

index or other entity, as applicable; 

provided that each reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)) will not be considered 

affiliated with any other reference entity 

included in the index or any other 

entity that is an issuing entity of an 

asset-backed security. 

(ii) Control for purposes of this 

section means ownership of more than 

50 percent of the equity of a reference 

entity included in the index (for 

purposes of paragraph (zzz)(3)(iv) of this 

section) or another entity (for purposes 

of paragraph (zzz)(3)(v) of this section), 

or the ability to direct the voting of more 

than 50 percent of the voting equity of 

a reference entity included in the index 

(for purposes of paragraph (zzz)(3)(iv) of 

this section) or another entity (for 

purposes of paragraph (zzz)(3)(v) of this 

section). 

(iii) In identifying a reference entity 

included in the index for purposes of 

this section, the term reference entity 

includes: 

(A) An issuer of securities; 

(B) An issuer of securities that is an 

issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)); and 

(C) An issuer of securities that is a 

borrower with respect to any loan 

identified in an index of borrowers or 

loans. 

(iv) For purposes of calculating the 

thresholds in paragraphs (zzz)(1)(i)(A) 

through (1)(i)(C) of this section, the term 

reference entity included in the index 

includes a single reference entity 

included in the index or a group of 

affiliated reference entities included in 

the index as determined in accordance 

with paragraph (zzz)(3)(i) of this section 

(with each reference entity included in 

the index that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77)) being considered a separate 

reference entity included in the index). 

(v) For purposes of determining 

whether one of the criterion in either 

paragraphs (zzz)(1)(i)(D)(1) through 

(zzz)(1)(i)(D)(4) of this section or 

paragraphs (zzz)(1)(iv)(D)(8)(i) and 

(a)(1)(iv)(D)(8)(ii) of this section is met, 

the term reference entity included in the 

index includes a single reference entity 

included in the index or a group of 

affiliated entities as determined in 

accordance with paragraph (zzz)(3)(i) of 

this section (with each issuing entity of 

an asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77)) being considered a separate 

entity). 

(aaaa) Meaning of ‘‘narrow-based 

security index’’ as used in the definition 

of ‘‘security-based swap’’ as applied to 

index credit default swaps. 

(1) Notwithstanding paragraph 

(yyy)(1) of this section, and solely for 

purposes of determining whether a 

credit default swap is a security-based 

swap under the definition of ‘‘securitybased swap’’ in section 3(a)(68)(A)(ii)(I) 

of the Securities Exchange Act of 1934 

(15 U.S.C. 78c(a)(68)(A)(ii)(I), as 

incorporated in section 1a(42) of the 

Commodity Exchange Act, the term 

narrow-based security index means an 

index in which: 

(i)(A) The index is composed of nine 

or fewer securities or securities that are 

issued by nine or fewer non-affiliated 

issuers, provided that a security shall 

not be deemed a component of the 

index for purposes of this section 

unless: 

(1) A credit event with respect to the 

issuer of such security or a credit event 

with respect to such security would 

result in a payment by the credit 

protection seller to the credit protection 

buyer under the credit default swap 

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based on the related notional amount 

allocated to such security; or 

(2) The fact of such credit event or the 

calculation in accordance with 

paragraph (aaaa)(1)(i)(A)(1) of this 

section of the amount owed with respect 

to such credit event is taken into 

account in determining whether to make 

any future payments under the credit 

default swap with respect to any future 

credit events; 

(B) The effective notional amount 

allocated to the securities of any issuer 

included in the index comprises more 

than 30 percent of the index’s 

weighting; 

(C) The effective notional amount 

allocated to the securities of any five 

non-affiliated issuers included in the 

index comprises more than 60 percent 

of the index’s weighting; or 

(D) Except as provided in paragraph 

(aaaa)(2) of this section, for each 

security included in the index, none of 

the criteria in paragraphs 

(aaaa)(1)(i)(D)(1) through (8) is satisfied: 

(1) The issuer of the security included 

in the index is required to file reports 

pursuant to section 13 or section 15(d) 

of the Securities Exchange Act of 1934 

(15 U.S.C. 78m or 78o(d)); 

(2) The issuer of the security included 

in the index is eligible to rely on the 

exemption provided in rule 12g3–2(b) 

under the Securities Exchange Act of 

1934 (17 CFR 240.12g3–2(b)); 

(3) The issuer of the security included 

in the index has a worldwide market 

value of its outstanding common equity 

held by non-affiliates of $700 million or 

more; 

(4) The issuer of the security included 

in the index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(77))) has outstanding notes, 

bonds, debentures, loans or evidences of 

indebtedness (other than revolving 

credit facilities) having a total remaining 

principal amount of at least $1 billion; 

(5) The security included in the index 

is an exempted security as defined in 

section 3(a)(12) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(12)) (other than any municipal 

security as defined in section 3(a)(29) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(29))); 

(6) The issuer of the security included 

in the index is a government of a foreign 

country or a political subdivision of a 

foreign country; 

(7) If the security included in the 

index is an asset-backed security as 

defined in section 3(a)(77) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)), the security was 

issued in a transaction registered under 

the Securities Act of 1933 (15 U.S.C. 77a 

et seq.) and has publicly available 

distribution reports; and 

(8) For a credit default swap entered 

into solely between eligible contract 

participants as defined in section 1a(18) 

of the Commodity Exchange Act: 

(i) The issuer of the security included 

in the index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(77))) makes available to the 

public or otherwise makes available to 

such eligible contract participant 

information about such issuer pursuant 

to rule 144A(d)(4) of the Securities Act 

of 1933 (17 CFR 230.144A(d)(4)); 

(ii) Financial information about the 

issuer of the security included in the 

index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(77))) is otherwise publicly 

available; or 

(iii) In the case of an asset-backed 

security as defined in section 3(a)(77) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)), information of the 

type and level included in public 

distribution reports for similar assetbacked securities is publicly available 

about both the issuing entity and such 

asset-backed security; and 

(ii)(A) The index is not composed 

solely of exempted securities as defined 

in section 3(a)(12) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(29))), as in effect on the 

date of enactment of the Futures 

Trading Act of 1982; and 

(B) Without taking into account any 

portion of the index composed of 

exempted securities as defined in 

section 3(a)(12) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(29))), the remaining 

portion of the index would be within 

the term ‘‘narrow-based security index’’ 

under paragraph (aaaa)(1)(i) of this 

section. 

(2) Paragraph (aaaa)(1)(i)(D) of this 

section will not apply with respect to 

securities of an issuer included in the 

index if: 

(i) The effective notional amounts 

allocated to all securities of such issuer 

included in the index comprise less 

than five percent of the index’s 

weighting; and 

(ii) The securities that satisfy 

paragraph (aaaa)(1)(i)(D) of this section 

comprise at least 80 percent of the 

index’s weighting. 

(3) For purposes of this paragraph 

(aaaa): 

(i) An issuer of securities included in 

the index is affiliated with another 

issuer of securities included in the 

index (for purposes of paragraph 

(aaaa)(3)(iv) of this section) or another 

entity (for purposes of paragraph 

(aaaa)(3)(v) of this section) if it controls, 

is controlled by, or is under common 

control with, that other issuer or other 

entity, as applicable; provided that each 

issuer of securities included in the 

index that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(77)) will not be considered 

affiliated with any other issuer of 

securities included in the index or any 

other entity that is an issuing entity of 

an asset-backed security. 

(ii) Control for purposes of this 

section means ownership of more than 

50 percent of the equity of an issuer of 

securities included in the index (for 

purposes of paragraph (aaaa)(3)(iv) of 

this section) or another entity (for 

purposes of paragraph (aaaa)(3)(v) of 

this section), or the ability to direct the 

voting of more than 50 percent of the 

voting equity an issuer of securities 

included in the index (for purposes of 

paragraph (aaaa)(3)(iv) of this section) or 

another entity (for purposes of 

paragraph (aaaa)(3)(v) of this section). 

(iii) In identifying an issuer of 

securities included in the index for 

purposes of this section, the term issuer 

includes: 

(A) An issuer of securities; and 

(B) An issuer of securities that is an 

issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(77)). 

(iv) For purposes of calculating the 

thresholds in paragraphs (zzz)(1)(i)(A) 

through (1)(i)(C) of this section, the term 

issuer of the security included in the 

index includes a single issuer of 

securities included in the index or a 

group of affiliated issuers of securities 

included in the index as determined in 

accordance with paragraph (aaaa)(3)(i) 

of this section (with each issuer of 

securities included in the index that is 

an issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Securities Exchange Act of 1934 (15 

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48354 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

U.S.C. 78c(a)(77)) being considered a 

separate issuer of securities included in 

the index). 

(v) For purposes of determining 

whether one of the criterion in either 

paragraphs (aaaa)(1)(i)(D)(1) through 

(aaaa)(1)(i)(D)(4) of this section or 

paragraphs (aaaa)(1)(iv)(D)(8)(i) and 

(aaaa)(1)(iv)(D)(8)(ii) of this section is 

met, the term issuer of the security 

included in the index includes a single 

issuer of securities included in the 

index or a group of affiliated entities as 

determined in accordance with 

paragraph (aaaa)(3)(i) of this section 

(with each issuing entity of an assetbacked security as defined in section 

3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) 

being considered a separate entity). 

(bbbb) Futures contracts on certain 

foreign sovereign debt. The term 

security-based swap as used in section 

3(a)(68) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(68)), as 

incorporated in section 1a(42) of the 

Commodity Exchange Act, does not 

include an agreement, contract, or 

transaction that is based on or 

references a qualifying foreign futures 

contract (as defined in rule 3a12–8 

under the Securities Exchange Act of 

1934 (17 CFR 240.3a12–8)) on the debt 

securities of any one or more of the 

foreign governments enumerated in rule 

3a12–8 under the Securities Exchange 

Act of 1934 (17 CFR 240.3a12–8), 

provided that such agreement, contract, 

or transaction satisfies the following 

conditions: 

(1) The futures contract that the 

agreement, contract, or transaction 

references or upon which the 

agreement, contract, or transaction is 

based is a qualifying foreign futures 

contract that satisfies the conditions of 

rule 3a12–8 under the Securities 

Exchange Act of 1934 (17 CFR 

240.3a12–8) applicable to qualifying 

foreign futures contracts; 

(2) The agreement, contract, or 

transaction is traded on or through a 

board of trade (as defined in the 

Commodity Exchange Act); 

(3) The debt securities upon which 

the qualifying foreign futures contract is 

based or referenced and any security 

used to determine the cash settlement 

amount pursuant to paragraph (bbbb)(4) 

of this section were not registered under 

the Securities Act of 1933 (15 U.S.C. 77 

et seq.) or the subject of any American 

depositary receipt registered under the 

Securities Act of 1933; 

(4) The agreement, contract, or 

transaction may only be cash settled; 

and 

(5) The agreement, contract or 

transaction is not entered into by the 

issuer of the debt securities upon which 

the qualifying foreign futures contract is 

based or referenced (including any 

security used to determine the cash 

payment due on settlement of such 

agreement, contract or transaction), an 

affiliate (as defined in the Securities Act 

of 1933 (15 U.S.C. 77 et seq.) and the 

rules and regulations thereunder) of the 

issuer, or an underwriter of such 

issuer’s debt securities. 

■ 3. Add §§ 1.6 through 1.9 to read as 

follows: 

Sec. 

1.6 Anti-evasion. 

1.7 Books and records requirements for 

security-based swap agreements. 

1.8 Requests for interpretation of swaps, 

security-based swaps, and mixed swaps. 

1.9 Regulation of mixed swaps. 

* * * * * 

§ 1.6 Anti-evasion. 

(a) It shall be unlawful to conduct 

activities outside the United States, 

including entering into agreements, 

contracts, and transactions and 

structuring entities, to willfully evade or 

attempt to evade any provision of the 

Commodity Exchange Act as enacted by 

Subtitle A of the Wall Street 

Transparency and Accountability Act of 

2010 or the rules, regulations, and 

orders of the Commission promulgated 

thereunder (Subtitle A). 

(b) The form, label, and written 

documentation of an agreement, 

contract, or transaction, or an entity, 

shall not be dispositive in determining 

whether the agreement, contract, or 

transaction, or entity, has been entered 

into or structured to willfully evade as 

provided in paragraph (a) of this 

section. 

(c) An activity conducted outside the 

United States to evade as provided in 

paragraph (a) of this section shall be 

subject to the provisions of Subtitle A. 

(d) Notwithstanding the foregoing, no 

agreement, contract, or transaction 

structured as a security (including a 

security-based swap) under the 

securities laws (as defined in section 

3(a)(47) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(47))) shall be 

deemed a swap pursuant to this section. 

§ 1.7 Books and records requirements for 

security-based swap agreements. 

(a) A person registered as a swap data 

repository under section 21 of the 

Commodity Exchange Act and the rules 

and regulations thereunder: 

(1) Shall not be required to keep and 

maintain additional books and records 

regarding security-based swap 

agreements other than the books and 

records regarding swaps required to be 

kept and maintained pursuant to section 

21 of the Commodity Exchange Act and 

the rules and regulations thereunder; 

and 

(2) Shall not be required to collect and 

maintain additional data regarding 

security-based swap agreements other 

than the data regarding swaps required 

to be collected and maintained by such 

persons pursuant to section 21 of the 

Commodity Exchange Act and the rules 

and regulations thereunder. 

(b) A person shall not be required to 

keep and maintain additional books and 

records, including daily trading records, 

regarding security-based swap 

agreements other than the books and 

records regarding swaps required to be 

kept and maintained by such persons 

pursuant to section 4s of the Commodity 

Exchange Act and the rules and 

regulations thereunder if such person is 

registered as: 

(1) A swap dealer under section 

4s(a)(1) of the Commodity Exchange Act 

and the rules and regulations 

thereunder; 

(2) A major swap participant under 

section 4s(a)(2) of the Commodity 

Exchange Act and the rules and 

regulations thereunder; 

(3) A security-based swap dealer 

under section 15F(a)(1) of the Securities 

Exchange Act of 1934 (15 U.S.C. 78o10(a)(1)) and the rules and regulations 

thereunder; or 

(4) a major security-based swap 

participant under section 15F(a)(2) of 

the Securities Exchange Act of 1934 (15 

U.S.C. 78o-10(a)(2)) and the rules and 

regulations thereunder. 

(c) The term security-based swap 

agreement has the meaning set forth in 

section 1a(47)(A)(v) of the Commodity 

Exchange Act. 

§ 1.8 Requests for interpretation of swaps, 

security-based swaps, and mixed swaps. 

(a) In general. Any person may submit 

a request to the Commission and the 

Securities and Exchange Commission to 

provide a joint interpretation of whether 

a particular agreement, contract, or 

transaction (or class thereof) is: 

(1) A swap, as that term is defined in 

section 1a(47) of the Commodity 

Exchange Act and the rules and 

regulations promulgated thereunder; 

(2) A security-based swap, as that 

term is defined in section 1a(42) of the 

Commodity Exchange Act and the rules 

and regulations promulgated 

thereunder; or 

(3) A mixed swap, as that term is 

defined in section 1a(47)(D) of the 

Commodity Exchange Act and the rules 

and regulations promulgated 

thereunder. 

(b) Request process. In making a 

request pursuant to paragraph (a) of this 

section, the requesting person must 

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provide the Commission and the 

Securities and Exchange Commission 

with the following: 

(1) All material information regarding 

the terms of the agreement, contract, or 

transaction (or class thereof); 

(2) A statement of the economic 

characteristics and purpose of the 

agreement, contract, or transaction (or 

class thereof); 

(3) The requesting person’s 

determination as to whether the 

agreement, contract, or transaction (or 

class thereof) should be characterized as 

a swap, a security-based swap, or both, 

(i.e., a mixed swap), including the basis 

for such determination; and 

(4) Such other information as may be 

requested by the Commission or the 

Securities and Exchange Commission. 

(c) Request withdrawal. A person may 

withdraw a request made pursuant to 

paragraph (a) of this section at any time 

prior to the issuance of a joint 

interpretation or joint proposed rule by 

the Commission and the Securities and 

Exchange Commission in response to 

the request; provided, however, that 

notwithstanding such withdrawal, the 

Commission and the Securities and 

Exchange Commission may provide a 

joint interpretation of whether the 

agreement, contract, or transaction (or 

class thereof) is a swap, a security-based 

swap, or both (i.e., a mixed swap). 

(d) Request by the Commission or the 

Securities and Exchange Commission. 

In the absence of a request for a joint 

interpretation under paragraph (a) of 

this section: 

(1) If the Commission or the Securities 

and Exchange Commission receives a 

proposal to list, trade, or clear an 

agreement, contract, or transaction (or 

class thereof) that raises questions as to 

the appropriate characterization of such 

agreement, contract, or transaction (or 

class thereof) as a swap, a security-based 

swap, or both (i.e., a mixed swap), the 

Commission or the Securities and 

Exchange Commission, as applicable, 

promptly shall notify the other of the 

agreement, contract, or transaction (or 

class thereof); and 

(2) The Commission or the Securities 

and Exchange Commission, or their 

Chairmen jointly, may submit a request 

for a joint interpretation as described in 

paragraph (a) of this section; such 

submission shall be made pursuant to 

paragraph (b) of this section, and may be 

withdrawn pursuant to paragraph (c) of 

this section. 

(e) Timeframe for joint interpretation. 

(1) If the Commission and the Securities 

and Exchange Commission determine to 

issue a joint interpretation as described 

in paragraph (a) of this section, such 

joint interpretation shall be issued 

within 120 days after receipt of a 

complete submission requesting a joint 

interpretation under paragraph (a) or (d) 

of this section. 

(2) The Commission and the 

Securities and Exchange Commission 

shall consult with the Board of 

Governors of the Federal Reserve 

System prior to issuing any joint 

interpretation as described in paragraph 

(a) of this section. 

(3) If the Commission and the 

Securities and Exchange Commission 

seek public comment with respect to a 

joint interpretation regarding an 

agreement, contract, or transaction (or 

class thereof), the 120-day period 

described in paragraph (e)(1) of this 

section shall be stayed during the 

pendency of the comment period, but 

shall recommence with the business day 

after the public comment period ends. 

(4) Nothing in this section shall 

require the Commission and the 

Securities and Exchange Commission to 

issue any joint interpretation. 

(5) If the Commission and the 

Securities and Exchange Commission do 

not issue a joint interpretation within 

the time period described in paragraph 

(e)(1) or (e)(3) of this section, each of the 

Commission and the Securities and 

Exchange Commission shall publicly 

provide the reasons for not issuing such 

a joint interpretation within the 

applicable timeframes. 

(f) Joint proposed rule. (1) Rather than 

issue a joint interpretation pursuant to 

paragraph (a) of this section, the 

Commission and the Securities and 

Exchange Commission may issue a joint 

proposed rule, in consultation with the 

Board of Governors of the Federal 

Reserve System, to further define one or 

more of the terms swap, security-based 

swap, or mixed swap. 

(2) A joint proposed rule described in 

paragraph (f)(1) of this section shall be 

issued within the timeframe for issuing 

a joint interpretation set forth in 

paragraph (e) of this section. 

§ 1.9 Regulation of mixed swaps. 

(a) In general. The term mixed swap 

has the meaning set forth in section 

1a(47)(D) of the Commodity Exchange 

Act. 

(b) Regulation of bilateral uncleared 

mixed swaps entered into by duallyregistered dealers or major participants. 

A mixed swap that is neither executed 

on nor subject to the rules of a 

designated contract market, national 

securities exchange, swap execution 

facility, security-based swap execution 

facility, or foreign board of trade; that 

will not be submitted to a derivatives 

clearing organization or registered or 

exempt clearing agency to be cleared; 

and where at least one party is 

registered with the Commission as a 

swap dealer or major swap participant 

and also with the Securities and 

Exchange Commission as a securitybased swap dealer or major securitybased swap participant, shall be subject 

to: 

(1) The following provisions of the 

Commodity Exchange Act, and the rules 

and regulations promulgated 

thereunder: 

(i) Examinations and information 

sharing: sections 4s(f) and 8 of the 

Commodity Exchange Act; 

(ii) Enforcement: sections 2(a)(1)(B), 

4(b), 4b, 4c, 4s(h)(1)(A), 4s(h)(4)(A), 6(c), 

6(d), 6c, 6d, 9, 13(a), 13(b), and 23 of the 

Commodity Exchange Act; 

(iii) Reporting to a swap data 

repository: section 4r of the Commodity 

Exchange Act; 

(iv) Real-time reporting: section 

2(a)(13) of the Commodity Exchange 

Act; 

(v) Capital: section 4s(e) of the 

Commodity Exchange Act; and 

(vi) Position Limits: section 4a of the 

Commodity Exchange Act; and 

(2) The provisions of the Federal 

securities laws, as defined in section 

3(a)(47) of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c(a)(47)), and the 

rules and regulations promulgated 

thereunder. 

(c) Process for determining regulatory 

treatment for other mixed swaps—(1) In 

general. Any person who desires or 

intends to list, trade, or clear a mixed 

swap (or class thereof) that is not subject 

to paragraph (b) of this section may 

request the Commission and the 

Securities and Exchange Commission to 

issue a joint order permitting the 

requesting person (and any other person 

or persons that subsequently lists, 

trades, or clears that mixed swap) to 

comply, as to parallel provisions only, 

with specified parallel provisions of 

either the Commodity Exchange Act or 

the Securities Exchange Act of 1934 (15 

U.S.C. 78a et seq.), and the rules and 

regulations thereunder (collectively, 

specified parallel provisions), instead of 

being required to comply with parallel 

provisions of both the Commodity 

Exchange Act and the Securities 

Exchange Act of 1934. For purposes of 

this paragraph (c), parallel provisions 

means comparable provisions of the 

Commodity Exchange Act and the 

Securities Exchange Act of 1934 that 

were added or amended by the Wall 

Street Transparency and Accountability 

Act of 2010 with respect to swaps and 

security-based swaps, and the rules and 

regulations thereunder. 

(2) Request Process. A person 

submitting a request pursuant to 

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48356 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

paragraph (c)(1) of this section must 

provide the Commission and the 

Securities and Exchange Commission 

with the following: 

(i) All material information regarding 

the terms of the specified, or specified 

class of, mixed swap; 

(ii) The economic characteristics and 

purpose of the specified, or specified 

class of, mixed swap; 

(iii) The specified parallel provisions, 

and the reasons the person believes 

such specified parallel provisions 

would be appropriate for the mixed 

swap (or class thereof); and 

(iv) An analysis of: 

(A) The nature and purposes of the 

parallel provisions that are the subject 

of the request; 

(B) The comparability of such parallel 

provisions; 

(C) The extent of any conflicts or 

differences between such parallel 

provisions; and 

(D) Such other information as may be 

requested by the Commission or the 

Securities and Exchange Commission. 

(3) Request withdrawal. A person may 

withdraw a request made pursuant to 

paragraph (c)(1) of this section at any 

time prior to the issuance of a joint 

order under paragraph (c)(4) of this 

section by the Commission and the 

Securities and Exchange Commission in 

response to the request. 

(4) Issuance of orders. In response to 

a request under paragraph (c)(1) of this 

section, the Commission and the 

Securities and Exchange Commission, 

as necessary to carry out the purposes 

of the Wall Street Transparency and 

Accountability Act of 2010, may issue a 

joint order, after notice and opportunity 

for comment, permitting the requesting 

person (and any other person or persons 

that subsequently lists, trades, or clears 

that mixed swap) to comply, as to 

parallel provisions only, with the 

specified parallel provisions (or another 

subset of the parallel provisions that are 

the subject of the request, as the 

Commissions determine is appropriate), 

instead of being required to comply 

with parallel provisions of both the 

Commodity Exchange Act and the 

Securities Exchange Act of 1934. In 

determining the contents of such joint 

order, the Commission and the 

Securities and Exchange Commission 

may consider, among other things: 

(i) The nature and purposes of the 

parallel provisions that are the subject 

of the request; 

(ii) The comparability of such parallel 

provisions; and 

(iii) The extent of any conflicts or 

differences between such parallel 

provisions. 

(5) Timeframe. (i) If the Commission 

and the Securities and Exchange 

Commission determine to issue a joint 

order as described in paragraph (c)(4) of 

this section, such joint order shall be 

issued within 120 days after receipt of 

a complete request for a joint order 

under paragraph (c)(1) of this section, 

which time period shall be stayed 

during the pendency of the public 

comment period provided for in 

paragraph (c)(4) of this section and shall 

recommence with the business day after 

the public comment period ends. 

(ii) Nothing in this section shall 

require the Commission and the 

Securities and Exchange Commission to 

issue any joint order. 

(iii) If the Commission and the 

Securities and Exchange Commission do 

not issue a joint order within the time 

period described in paragraph (c)(5)(i) of 

this section, each of the Commission 

and the Securities and Exchange 

Commission shall publicly provide the 

reasons for not issuing such a joint order 

within that timeframe. 

Securities and Exchange Commission 

Pursuant to the Securities Act, 15 

U.S.C. 77a et seq., and particularly, 

sections 19 and 28 thereof, and the 

Exchange Act, 15 U.S.C. 78a et seq., and 

particularly, sections 3 and 23 thereof, 

and sections 712(a)(8), 712(d), 721(a), 

761(a) of the Dodd-Frank Act, the SEC 

is adopting rule 194 under the 

Securities Act and rules 3a68–1a 

through 3a68–5 and 3a69–1 through 

3a69–3 under the Exchange Act. 

Text of Final Rules 

For the reasons stated in the 

preamble, the SEC is amending Title 17, 

Chapter II of the Code of the Federal 

Regulations as follows: 

PART 230—GENERAL RULES AND 

REGULATIONS, SECURITIES ACT OF 

1933 

■ 1. The authority citation for Part 230 

continues to read, in part, as follows: 

Authority: 15 U.S.C. 77b, 77b note, 77c, 

77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 

78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o–7 note, 

78t, 78w, 78ll(d), 78mm, 80a–8, 80a–24, 80a– 

28, 80a–29, 80a–30, 80a–37, and Pub. L. 111– 

203, § 712, 124 Stat. 1376 (2010) unless 

otherwise noted. 

* * * * * 

■ 2. Section 230.194 is added to read as 

follows: 

§ 230.194 Definitions of the terms ‘‘swap’’ 

and ‘‘security-based swap’’ as used in the 

Act. 

(a) The term swap as used in section 

2(a)(17) of the Act (15 U.S.C. 77b(a)(17)) 

has the same meaning as provided in 

section 3(a)(69) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(69)) and 17 CFR 240.3a69–1 

through 240.3a69–3. 

(b) The term security-based swap as 

used in section 2(a)(17) of the Act (15 

U.S.C. 77b(a)(17)) has the same meaning 

as provided in section 3(a)(68) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(68)) and 17 CFR 240.3a68– 

1a through 240.3a68–5. 

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

■ 3. The general authority citation for 

Part 240 is revised to read as follows: 

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

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

77kkk, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 

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

78n–1, 78o, 78o–4, 78o–8, 78p, 78q, 78s, 

78u–5, 78w, 78x, 78dd(b), 78dd(c), 78ll, 

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

3, 80b–4, 80b–11, 7201 et seq., and 8302; 18 

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

L. 111–203, Sec. 712, 124 Stat. 1376 (2010), 

unless otherwise noted. 

* * * * * 

■ 4. Add an undesignated center 

heading and §§ 240.3a68–1a through 

240.3a68–5 and §§ 240.3a69–1 through 

240.3a69–3 to read as follows: 

Further Definition of Swap, Security-Based 

Swap, and Security-Based Swap Agreement; 

Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping 

240.3a68–1a Meaning of ‘‘issuers of 

securities in a narrow-based security 

index’’ as used in section 

3(a)(68)(A)(ii)(III) of the Act. 

240.3a68–1b Meaning of ‘‘narrow-based 

security index’’ as used in section 

3(a)(68)(A)(ii)(I) of the Act. 

240.3a68–2 Requests for interpretation of 

swaps, security-based swaps, and mixed 

swaps. 

240.3a68–3 Meaning of ‘‘narrow-based 

security index’’ as used in the definition 

of ‘‘security-based swap.’’ 

240.3a68–4 Regulation of mixed swaps. 

240.3a68–5 Regulation of certain futures 

contracts on foreign sovereign debt. 

240.3a69–1 Safe Harbor Definition of 

‘‘security-based swap’’ and ‘‘swap’’ as 

used in sections 3(a)(68) and 3(a)(69) of 

the Act—insurance. 

240.3a69–2 Definition of ‘‘swap’’ as used in 

section 3(a)(69) of the Act—additional 

products. 

240.3a69–3 Books and records requirements 

for security-based swap agreements. 

* * * * * 

§ 240.3a68–1a Meaning of ‘‘issuers of 

securities in a narrow-based security 

index’’ as used in section 3(a)(68)(A)(ii)(III) 

of the Act. 

(a) Notwithstanding § 240.3a68–3(a), 

and solely for purposes of determining 

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whether a credit default swap is a 

security-based swap under section 

3(a)(68)(A)(ii)(III) of the Act (15 U.S.C. 

78c(a)(68)(A)(ii)(III)), the term issuers of 

securities in a narrow-based security 

index as used in section 

3(a)(68)(A)(ii)(III) of the Act means 

issuers of securities included in an 

index (including an index referencing 

loan borrowers or loans of such 

borrowers) in which: 

(1)(i) There are nine or fewer nonaffiliated issuers of securities that are 

reference entities included in the index, 

provided that an issuer of securities 

shall not be deemed a reference entity 

included in the index for purposes of 

this section unless: 

(A) A credit event with respect to 

such reference entity would result in a 

payment by the credit protection seller 

to the credit protection buyer under the 

credit default swap based on the related 

notional amount allocated to such 

reference entity; or 

(B) The fact of such credit event or the 

calculation in accordance with 

paragraph (a)(1)(i)(A) of this section of 

the amount owed with respect to such 

credit event is taken into account in 

determining whether to make any future 

payments under the credit default swap 

with respect to any future credit events; 

(ii) The effective notional amount 

allocated to any reference entity 

included in the index comprises more 

than 30 percent of the index’s 

weighting; 

(iii) The effective notional amount 

allocated to any five non-affiliated 

reference entities included in the index 

comprises more than 60 percent of the 

index’s weighting; or 

(iv) Except as provided in paragraph 

(b) of this section, for each reference 

entity included in the index, none of the 

criteria in paragraphs (a)(1)(iv)(A) 

through (a)(1)(iv)(H) of this section is 

satisfied: 

(A) The reference entity included in 

the index is required to file reports 

pursuant to section 13 or section 15(d) 

of the Act (15 U.S.C. 78m or 78o(d)); 

(B) The reference entity included in 

the index is eligible to rely on the 

exemption provided in § 240.12g3–2(b); 

(C) The reference entity included in 

the index has a worldwide market value 

of its outstanding common equity held 

by non-affiliates of $700 million or 

more; 

(D) The reference entity included in 

the index (other than a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the Act (15 

U.S.C. 78c(a)(77))) has outstanding 

notes, bonds, debentures, loans, or 

evidences of indebtedness (other than 

revolving credit facilities) having a total 

remaining principal amount of at least 

$1 billion; 

(E) The reference entity included in 

the index is the issuer of an exempted 

security as defined in section 3(a)(12) of 

the Act (15 U.S.C. 78c(a)(12)) (other 

than any municipal security as defined 

in section 3(a)(29) of the Act (15 U.S.C. 

78c(a)(29))); 

(F) The reference entity included in 

the index is a government of a foreign 

country or a political subdivision of a 

foreign country; 

(G) If the reference entity included in 

the index is an issuing entity of an assetbacked security as defined in section 

3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), 

such asset-backed security was issued in 

a transaction registered under the 

Securities Act of 1933 (15 U.S.C. 77a et 

seq.) and has publicly available 

distribution reports; and 

(H) For a credit default swap entered 

into solely between eligible contract 

participants as defined in section 

3(a)(65) of the Act (15 U.S.C. 78c(a)(65)): 

(1) The reference entity included in 

the index (other than a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the Act (15 

U.S.C. 78c(a)(77))) makes available to 

the public or otherwise makes available 

to such eligible contract participant 

information about the reference entity 

included in the index pursuant to 

§ 230.144A(d)(4)) of this chapter; 

(2) Financial information about the 

reference entity included in the index 

(other than a reference entity included 

in the index that is an issuing entity of 

an asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77))) is otherwise publicly 

available; or 

(3) In the case of a reference entity 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the Act (15 

U.S.C. 78c(a)(77)), information of the 

type and level included in publicly 

available distribution reports for similar 

asset-backed securities is publicly 

available about both the reference entity 

included in the index and such assetbacked security; and 

(2)(i) The index is not composed 

solely of reference entities that are 

issuers of exempted securities as 

defined in section 3(a)(12) of the Act (15 

U.S.C. 78c(a)(12)), as in effect on the 

date of enactment of the Futures 

Trading Act of 1982 (other than any 

municipal security as defined in section 

3(a)(29) of the Act (15 U.S.C. 

78c(a)(29))), as in effect on the date of 

enactment of the Futures Trading Act of 

1982); and 

(ii) Without taking into account any 

portion of the index composed of 

reference entities that are issuers of 

exempted securities as defined in 

section 3(a)(12) of the Act (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the Act 

(15 U.S.C. 78c(a)(29))), the remaining 

portion of the index would be within 

the term ‘‘issuer of securities in a 

narrow-based security index’’ under 

paragraph (a)(1) of this section. 

(b) Paragraph (a)(1)(iv) of this section 

will not apply with respect to a 

reference entity included in the index if: 

(1) The effective notional amounts 

allocated to such reference entity 

comprise less than five percent of the 

index’s weighting; and 

(2) The effective notional amounts 

allocated to reference entities included 

in the index that satisfy paragraph 

(a)(1)(iv) of this section comprise at least 

80 percent of the index’s weighting. 

(c) For purposes of this section: 

(1) A reference entity included in the 

index is affiliated with another 

reference entity included in the index 

(for purposes of paragraph (c)(4) of this 

section) or another entity (for purposes 

of paragraph (c)(5) of this section) if it 

controls, is controlled by, or is under 

common control with, that other 

reference entity included in the index or 

other entity, as applicable; provided that 

each reference entity included in the 

index that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77)) will not be considered 

affiliated with any other reference entity 

included in the index or any other 

entity that is an issuing entity of an 

asset-backed security. 

(2) Control for purposes of this section 

means ownership of more than 50 

percent of the equity of a reference 

entity included in the index (for 

purposes of paragraph (c)(4) of this 

section) or another entity (for purposes 

of paragraph (c)(5) of this section), or 

the ability to direct the voting of more 

than 50 percent of the voting equity of 

a reference entity included in the index 

(for purposes of paragraph (c)(4) of this 

section) or another entity (for purposes 

of paragraph (c)(5) of this section). 

(3) In identifying a reference entity 

included in the index for purposes of 

this section, the term reference entity 

includes: 

(i) An issuer of securities; 

(ii) An issuer of securities that is an 

issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Act (15 U.S.C. 78c(a)(77)); and 

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48358 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

(iii) An issuer of securities that is a 

borrower with respect to any loan 

identified in an index of borrowers or 

loans. 

(4) For purposes of calculating the 

thresholds in paragraphs (a)(1)(i) 

through (a)(1)(iii) of this section, the 

term reference entity included in the 

index includes a single reference entity 

included in the index or a group of 

affiliated reference entities included in 

the index as determined in accordance 

with paragraph (c)(1) of this section 

(with each reference entity included in 

the index that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77)) being considered a separate 

reference entity included in the index). 

(5) For purposes of determining 

whether one of the criterion in either 

paragraphs (a)(1)(iv)(A) through 

(a)(1)(iv)(D) of this section or paragraphs 

(a)(1)(iv)(H)(1) and (a)(1)(iv)(H)(2) of this 

section is met, the term reference entity 

included in the index includes a single 

reference entity included in the index or 

a group of affiliated entities as 

determined in accordance with 

paragraph (c)(1) of this section (with 

each issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Act (15 U.S.C. 78c(a)(77)) being 

considered a separate entity). 

§ 240.3a68–1b Meaning of ‘‘narrow-based 

security index’’ as used in section 

3(a)(68)(A)(ii)(I) of the Act. 

(a) Notwithstanding § 240.3a68–3(a), 

and solely for purposes of determining 

whether a credit default swap is a 

security-based swap under section 

3(a)(68)(A)(ii)(I) of the Act (15 U.S.C. 

78c(a)(68)(A)(ii)(I)), the term narrowbased security index as used in section 

3(a)(68)(A)(ii)(I) of the Act means an 

index in which: 

(1)(i) The index is composed of nine 

or fewer securities or securities that are 

issued by nine or fewer non-affiliated 

issuers, provided that a security shall 

not be deemed a component of the 

index for purposes of this section 

unless: 

(A) A credit event with respect to the 

issuer of such security or a credit event 

with respect to such security would 

result in a payment by the credit 

protection seller to the credit protection 

buyer under the credit default swap 

based on the related notional amount 

allocated to such security; or 

(B) The fact of such credit event or the 

calculation in accordance with 

paragraph (a)(1)(i)(A) of this section of 

the amount owed with respect to such 

credit event is taken into account in 

determining whether to make any future 

payments under the credit default swap 

with respect to any future credit events; 

(ii) The effective notional amount 

allocated to the securities of any issuer 

included in the index comprises more 

than 30 percent of the index’s 

weighting; 

(iii) The effective notional amount 

allocated to the securities of any five 

non-affiliated issuers included in the 

index comprises more than 60 percent 

of the index’s weighting; or 

(iv) Except as provided in paragraph 

(b) of this section, for each security 

included in the index none of the 

criteria in paragraphs (a)(1)(iv)(A) 

through (a)(1)(iv)(H) of this section is 

satisfied: 

(A) The issuer of the security 

included in the index is required to file 

reports pursuant to section 13 or section 

15(d) of the Act (15 U.S.C. 78m or 

78o(d)); 

(B) The issuer of the security included 

in the index is eligible to rely on the 

exemption provided in § 240.12g3–2(b); 

(C) The issuer of the security included 

in the index has a worldwide market 

value of its outstanding common equity 

held by non-affiliates of $700 million or 

more; 

(D) The issuer of the security included 

in the index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77))) has outstanding notes, 

bonds, debentures, loans, or evidences 

of indebtedness (other than revolving 

credit facilities) having a total remaining 

principal amount of at least $1 billion; 

(E) The security included in the index 

is an exempted security as defined in 

section 3(a)(12) of the Act (15 U.S.C. 

78c(a)(12)) (other than any municipal 

security as defined in section 3(a)(29) of 

the Act (15 U.S.C. 78c(a)(29))); 

(F) The issuer of the security included 

in the index is a government of a foreign 

country or a political subdivision of a 

foreign country; 

(G) If the security included in the 

index is an asset-backed security as 

defined in section 3(a)(77) of the Act (15 

U.S.C. 78c(a)(77)), the security was 

issued in a transaction registered under 

the Securities Act of 1933 (15 U.S.C. 77a 

et seq.) and has publicly available 

distribution reports; and 

(H) For a credit default swap entered 

into solely between eligible contract 

participants as defined in section 

3(a)(65) of the Act (15 U.S.C. 78c(a)(65)): 

(1) The issuer of the security included 

in the index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77))) makes available to the 

public or otherwise makes available to 

such eligible contract participant 

information about such issuer pursuant 

to § 230.144A(d)(4)) of this chapter; 

(2) Financial information about the 

issuer of the security included in the 

index (other than an issuer of the 

security that is an issuing entity of an 

asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77))) is otherwise publicly 

available; or 

(3) In the case of an asset-backed 

security as defined in section 3(a)(77) of 

the Act (15 U.S.C. 78c(a)(77)), 

information of the type and level 

included in public distribution reports 

for similar asset-backed securities is 

publicly available about both the issuing 

entity and such asset-backed security; 

and 

(2)(i) The index is not composed 

solely of exempted securities as defined 

in section 3(a)(12) of the Act (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the Act 

(15 U.S.C. 78c(a)(29))), as in effect on 

the date of enactment of the Futures 

Trading Act of 1982); and 

(ii) Without taking into account any 

portion of the index composed of 

exempted securities as defined in 

section 3(a)(12) of the Act (15 U.S.C. 

78c(a)(12)), as in effect on the date of 

enactment of the Futures Trading Act of 

1982 (other than any municipal security 

as defined in section 3(a)(29) of the Act 

(15 U.S.C. 78c(a)(29))), the remaining 

portion of the index would be within 

the term ‘‘narrow-based security index’’ 

under paragraph (a)(1) of this section. 

(b) Paragraph (a)(1)(iv) of this section 

will not apply with respect to securities 

of an issuer included in the index if: 

(1) The effective notional amounts 

allocated to all securities of such issuer 

included in the index comprise less 

than five percent of the index’s 

weighting; and 

(2) The securities that satisfy 

paragraph (a)(1)(iv) of this section 

comprise at least 80 percent of the 

index’s weighting. 

(c) For purposes of this section: 

(1) An issuer of securities included in 

the index is affiliated with another 

issuer of securities included in the 

index (for purposes of paragraph (c)(4) 

of this section) or another entity (for 

purposes of paragraph (c)(5) of this 

section) if it controls, is controlled by, 

or is under common control with, that 

other issuer or other entity, as 

applicable; provided that each issuer of 

securities included in the index that is 

an issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48359 

the Act (15 U.S.C. 78c(a)(77)) will not be 

considered affiliated with any other 

issuer of securities included in the 

index or any other entity that is an 

issuing entity of an asset-backed 

security. 

(2) Control for purposes of this section 

means ownership of more than 50 

percent of the equity of an issuer of 

securities included in the index (for 

purposes of paragraph (c)(4) of this 

section) or another entity (for purposes 

of paragraph (c)(5) of this section), or 

the ability to direct the voting of more 

than 50 percent of the voting equity an 

issuer of securities included in the 

index (for purposes of paragraph (c)(4) 

of this section) or another entity (for 

purposes of paragraph (c)(5) of this 

section). 

(3) In identifying an issuer of 

securities included in the index for 

purposes of this section, the term issuer 

includes: 

(i) An issuer of securities; and 

(ii) An issuer of securities that is an 

issuing entity of an asset-backed 

security as defined in section 3(a)(77) of 

the Act (15 U.S.C. 78c(a)(77)). 

(4) For purposes of calculating the 

thresholds in paragraphs (a)(1)(i) 

through (a)(1)(iii) of this section, the 

term issuer of the security included in 

the index includes a single issuer of 

securities included in the index or a 

group of affiliated issuers of securities 

included in the index as determined in 

accordance with paragraph (c)(1) of this 

section (with each issuer of securities 

included in the index that is an issuing 

entity of an asset-backed security as 

defined in section 3(a)(77) of the Act (15 

U.S.C. 78c(a)(77)) being considered a 

separate issuer of securities included in 

the index). 

(5) For purposes of determining 

whether one of the criterion in either 

paragraphs (a)(1)(iv)(A) through 

(a)(1))(iv)(D) of this section or 

paragraphs (a)(1)(iv)(H)(1) and 

(a)(1)(iv)(H)(2) of this section is met, the 

term issuer of the security included in 

the index includes a single issuer of 

securities included in the index or a 

group affiliated entities as determined 

in accordance with paragraph (c)(1) of 

this section (with each issuing entity of 

an asset-backed security as defined in 

section 3(a)(77) of the Act (15 U.S.C. 

78c(a)(77)) being considered a separate 

entity). 

§ 240.3a68–2 Requests for interpretation 

of swaps, security-based swaps, and mixed 

swaps. 

(a) In general. Any person may submit 

a request to the Commission and the 

Commodity Futures Trading 

Commission to provide a joint 

interpretation of whether a particular 

agreement, contract, or transaction (or 

class thereof) is: 

(1) A swap, as that term is defined in 

section 3(a)(69) of the Act (15 U.S.C. 

78c(a)(69)) and the rules and regulations 

promulgated thereunder; 

(2) A security-based swap, as that 

term is defined in section 3(a)(68) of the 

Act (15 U.S.C. 78c(a)(68)) and the rules 

and regulations promulgated 

thereunder; or 

(3) A mixed swap, as that term is 

defined in section 3(a)(68)(D) of the Act 

and the rules and regulations 

promulgated thereunder. 

(b) Request process. In making a 

request pursuant to paragraph (a) of this 

section, the requesting person must 

provide the Commission and the 

Commodity Futures Trading 

Commission with the following: 

(1) All material information regarding 

the terms of the agreement, contract, or 

transaction (or class thereof); 

(2) A statement of the economic 

characteristics and purpose of the 

agreement, contract, or transaction (or 

class thereof); 

(3) The requesting person’s 

determination as to whether the 

agreement, contract, or transaction (or 

class thereof) should be characterized as 

a swap, a security-based swap, or both 

(i.e., a mixed swap), including the basis 

for such determination; and 

(4) Such other information as may be 

requested by the Commission or the 

Commodity Futures Trading 

Commission. 

(c) Request withdrawal. A person may 

withdraw a request made pursuant to 

paragraph (a) of this section at any time 

prior to the issuance of a joint 

interpretation or joint proposed rule by 

the Commission and the Commodity 

Futures Trading Commission in 

response to the request; provided, 

however, that notwithstanding such 

withdrawal, the Commission and the 

Commodity Futures Trading 

Commission may provide a joint 

interpretation of whether the agreement, 

contract, or transaction (or class thereof) 

is a swap, a security-based swap, or both 

(i.e., a mixed swap). 

(d) Request by the Commission or the 

Commodity Futures Trading 

Commission. In the absence of a request 

for a joint interpretation under 

paragraph (a) of this section: 

(1) If the Commission or the 

Commodity Futures Trading 

Commission receives a proposal to list, 

trade, or clear an agreement, contract, or 

transaction (or class thereof) that raises 

questions as to the appropriate 

characterization of such agreement, 

contract, or transaction (or class thereof) 

as a swap, a security-based swap, or 

both (i.e., a mixed swap), the 

Commission or the Commodity Futures 

Trading Commission, as applicable, 

promptly shall notify the other of the 

agreement, contract, or transaction (or 

class thereof); and 

(2) The Commission or the 

Commodity Futures Trading 

Commission, or their Chairmen jointly, 

may submit a request for a joint 

interpretation as described in paragraph 

(a) of this section; such submission shall 

be made pursuant to paragraph (b) of 

this section, and may be withdrawn 

pursuant to paragraph (c) of this section. 

(e) Timeframe for joint interpretation. 

(1) If the Commission and the 

Commodity Futures Trading 

Commission determine to issue a joint 

interpretation as described in paragraph 

(a) of this section, such joint 

interpretation shall be issued within 120 

days after receipt of a complete 

submission requesting a joint 

interpretation under paragraph (a) or (d) 

of this section. 

(2) The Commission and the 

Commodity Futures Trading 

Commission shall consult with the 

Board of Governors of the Federal 

Reserve System prior to issuing any 

joint interpretation as described in 

paragraph (a) of this section. 

(3) If the Commission and the 

Commodity Futures Trading 

Commission seek public comment with 

respect to a joint interpretation 

regarding an agreement, contract, or 

transaction (or class thereof), the 120- 

day period described in paragraph (e)(1) 

of this section shall be stayed during the 

pendency of the comment period, but 

shall recommence with the business day 

after the public comment period ends. 

(4) Nothing in this section shall 

require the Commission and the 

Commodity Futures Trading 

Commission to issue any joint 

interpretation. 

(5) If the Commission and the 

Commodity Futures Trading 

Commission do not issue a joint 

interpretation within the time period 

described in paragraph (e)(1) or (e)(3) of 

this section, each of the Commission 

and the Commodity Futures Trading 

Commission shall publicly provide the 

reasons for not issuing such a joint 

interpretation within the applicable 

timeframes. 

(f) Joint proposed rule. (1) Rather than 

issue a joint interpretation pursuant to 

paragraph (a) of this section, the 

Commission and the Commodity 

Futures Trading Commission may issue 

a joint proposed rule, in consultation 

with the Board of Governors of the 

Federal Reserve System, to further 

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define one or more of the terms swap, 

security-based swap, or mixed swap. 

(2) A joint proposed rule described in 

paragraph (f)(1) of this section shall be 

issued within the timeframe for issuing 

a joint interpretation set forth in 

paragraph (e) of this section. 

§ 240.3a68–3 Meaning of ‘‘narrow-based 

security index’’ as used in the definition of 

‘‘security-based swap.’’ 

(a) In general. Except as otherwise 

provided in § 240.3a68–1a and 

§ 240.3a68–1b, for purposes of section 

3(a)(68) of the Act (15 U.S.C. 78c(a)(68)), 

the term narrow-based security index 

has the meaning set forth in section 

3(a)(55) of the Act (15 U.S.C. 78c(a)(55)), 

and the rules, regulations, and orders of 

the Commission thereunder. 

(b) Tolerance period for swaps traded 

on designated contract markets, swap 

execution facilities and foreign boards 

of trade. Notwithstanding paragraph (a) 

of this section, solely for purposes of 

swaps traded on or subject to the rules 

of a designated contract market, swap 

execution facility, or foreign board of 

trade pursuant to the Commodity 

Exchange Act (7 U.S.C. 1 et seq.), a 

security index underlying such swaps 

shall not be considered a narrow-based 

security index if: 

(1)(i) A swap on the index is traded 

on or subject to the rules of a designated 

contract market, swap execution facility, 

or foreign board of trade pursuant to the 

Commodity Exchange Act (7 U.S.C. 1 et 

seq.) for at least 30 days as a swap on 

an index that was not a narrow-based 

security index; or 

(ii) Such index was not a narrowbased security index during every 

trading day of the six full calendar 

months preceding a date no earlier than 

30 days prior to the commencement of 

trading of a swap on such index on a 

market described in paragraph (b)(1)(i) 

of this section; and 

(2) The index has been a narrowbased security index for no more than 

45 business days over three consecutive 

calendar months. 

(c) Tolerance period for securitybased swaps traded on national 

securities exchanges or security-based 

swap execution facilities. 

Notwithstanding paragraph (a) of this 

section, solely for purposes of securitybased swaps traded on a national 

securities exchange or security-based 

swap execution facility, a security index 

underlying such security-based swaps 

shall be considered a narrow-based 

security index if: 

(1)(i) A security-based swap on the 

index is traded on a national securities 

exchange or security-based swap 

execution facility for at least 30 days as 

a security-based swap on a narrowbased security index; or 

(ii) Such index was a narrow-based 

security index during every trading day 

of the six full calendar months 

preceding a date no earlier than 30 days 

prior to the commencement of trading of 

a security-based swap on such index on 

a market described in paragraph (c)(1)(i) 

of this section; and 

(2) The index has been a security 

index that is not a narrow-based 

security index for no more than 45 

business days over three consecutive 

calendar months. 

(d) Grace period. (1) Solely with 

respect to a swap that is traded on or 

subject to the rules of a designated 

contract market, swap execution facility 

or foreign board of trade pursuant to the 

Commodity Exchange Act (7 U.S.C. 1 et 

seq.), an index that becomes a narrowbased security index under paragraph 

(b) of this section solely because it was 

a narrow-based security index for more 

than 45 business days over three 

consecutive calendar months shall not 

be a narrow-based security index for the 

following three calendar months. 

(2) Solely with respect to a securitybased swap that is traded on a national 

securities exchange or security-based 

swap execution facility, an index that 

becomes a security index that is not a 

narrow-based security index under 

paragraph (c) of this section solely 

because it was not a narrow-based 

security index for more than 45 business 

days over three consecutive calendar 

months shall be a narrow-based security 

index for the following three calendar 

months. 

§ 240.3a68–4 Regulation of mixed swaps. 

(a) In general. The term mixed swap 

has the meaning set forth in section 

3(a)(68)(D) of the Act (15 U.S.C. 

78c(a)(68)(D)). 

(b) Regulation of bilateral uncleared 

mixed swaps entered into by duallyregistered dealers or major participants. 

A mixed swap: 

(1) That is neither executed on nor 

subject to the rules of a designated 

contract market, national securities 

exchange, swap execution facility, 

security-based swap execution facility, 

or foreign board of trade; 

(2) That will not be submitted to a 

derivatives clearing organization or 

registered or exempt clearing agency to 

be cleared; and 

(3) Where at least one party is 

registered with the Commission as a 

security-based swap dealer or major 

security-based swap participant and 

also with the Commodity Futures 

Trading Commission as a swap dealer or 

major swap participant, shall be subject 

to: 

(i) The following provisions of the 

Commodity Exchange Act (7 U.S.C. 1 et 

seq.), and the rules and regulations 

promulgated thereunder, set forth in the 

rules and regulations of the Commodity 

Futures Trading Commission: 

(A) Examinations and information 

sharing: 7 U.S.C. 6s(f) and 12; 

(B) Enforcement: 7 U.S.C. 2(a)(1)(B), 

6(b), 6b, 6c, 6s(h)(1)(A), 6s(h)(4)(A), 9, 

13b, 13a–1, 13a–2, 13, 13c(a), 13c(b), 15 

and 26; 

(C) Reporting to a swap data 

repository: 7 U.S.C. 6r; 

(D) Real-time reporting: 7 U.S.C. 

2(a)(13); 

(E) Capital: 7 U.S.C. 6s(e); and 

(F) Position Limits: 7 U.S.C. 6a; and 

(ii) The provisions of the Federal 

securities laws, as defined in section 

3(a)(47) of the Act (15 U.S.C. 78c(a)(47)), 

and the rules and regulations 

promulgated thereunder. 

(c) Process for determining regulatory 

treatment for other mixed swaps—(1) In 

general. Any person who desires or 

intends to list, trade, or clear a mixed 

swap (or class thereof) that is not subject 

to paragraph (b) of this section may 

request the Commission and the 

Commodity Futures Trading 

Commission to issue a joint order 

permitting the requesting person (and 

any other person or persons that 

subsequently lists, trades, or clears that 

mixed swap) to comply, as to parallel 

provisions only, with specified parallel 

provisions of either the Act (15 U.S.C. 

78a et seq.) or the Commodity Exchange 

Act (7 U.S.C. 1 et seq.), and the rules 

and regulations thereunder (collectively, 

specified parallel provisions), instead of 

being required to comply with parallel 

provisions of both the Act and the 

Commodity Exchange Act. For purposes 

of this paragraph (c), parallel provisions 

means comparable provisions of the Act 

and the Commodity Exchange Act that 

were added or amended by the Wall 

Street Transparency and Accountability 

Act of 2010 with respect to securitybased swaps and swaps, and the rules 

and regulations thereunder. 

(2) Request process. A person 

submitting a request pursuant to 

paragraph (c)(1) of this section must 

provide the Commission and the 

Commodity Futures Trading 

Commission with the following: 

(i) All material information regarding 

the terms of the specified, or specified 

class of, mixed swap; 

(ii) The economic characteristics and 

purpose of the specified, or specified 

class of, mixed swap; 

(iii) The specified parallel provisions, 

and the reasons the person believes 

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such specified parallel provisions 

would be appropriate for the mixed 

swap (or class thereof); and 

(iv) An analysis of: 

(A) The nature and purposes of the 

parallel provisions that are the subject 

of the request; 

(B) The comparability of such parallel 

provisions; 

(C) The extent of any conflicts or 

differences between such parallel 

provisions; and 

(D) Such other information as may be 

requested by the Commission or the 

Commodity Futures Trading 

Commission. 

(3) Request withdrawal. A person may 

withdraw a request made pursuant to 

paragraph (c)(1) of this section at any 

time prior to the issuance of a joint 

order under paragraph (c)(4) of this 

section by the Commission and the 

Commodity Futures Trading 

Commission in response to the request. 

(4) Issuance of orders. In response to 

a request under paragraph (c)(1) of this 

section, the Commission and the 

Commodity Futures Trading 

Commission, as necessary to carry out 

the purposes of the Wall Street 

Transparency and Accountability Act of 

2010, may issue a joint order, after 

notice and opportunity for comment, 

permitting the requesting person (and 

any other person or persons that 

subsequently lists, trades, or clears that 

mixed swap) to comply, as to parallel 

provisions only, with the specified 

parallel provisions (or another subset of 

the parallel provisions that are the 

subject of the request, as the 

Commissions determine is appropriate), 

instead of being required to comply 

with parallel provisions of both the Act 

(15 U.S.C. 78a et seq.) and the 

Commodity Exchange Act (7 U.S.C. 1 et 

seq.). In determining the contents of 

such joint order, the Commission and 

the Commodity Futures Trading 

Commission may consider, among other 

things: 

(i) The nature and purposes of the 

parallel provisions that are the subject 

of the request; 

(ii) The comparability of such parallel 

provisions; and 

(iii) The extent of any conflicts or 

differences between such parallel 

provisions. 

(5) Timeframe. (i) If the Commission 

and the Commodity Futures Trading 

Commission determine to issue a joint 

order as described in paragraph (c)(4) of 

this section, such joint order shall be 

issued within 120 days after receipt of 

a complete request for a joint order 

under paragraph (c)(1) of this section, 

which time period shall be stayed 

during the pendency of the public 

comment period provided for in 

paragraph (c)(4) of this section and shall 

recommence with the business day after 

the public comment period ends. 

(ii) Nothing in this section shall 

require the Commission and the 

Commodity Futures Trading 

Commission to issue any joint order. 

(iii) If the Commission and the 

Commodity Futures Trading 

Commission do not issue a joint order 

within the time period described in 

paragraph (c)(5)(i) of this section, each 

of the Commission and the Commodity 

Futures Trading Commission shall 

publicly provide the reasons for not 

issuing such a joint order within that 

timeframe. 

§ 240.3a68–5 Regulation of certain futures 

contracts on foreign sovereign debt. 

The term security-based swap as used 

in section 3(a)(68) of the Act (15 U.S.C. 

78c(a)(68)) does not include an 

agreement, contract, or transaction that 

is based on or references a qualifying 

foreign futures contract (as defined in 

§ 240.3a12–8 on the debt securities of 

any one or more of the foreign 

governments enumerated in § 240.3a12– 

8, provided that such agreement, 

contract, or transaction satisfies the 

following conditions: 

(a) The futures contract that the 

agreement, contract, or transaction 

references or upon which the 

agreement, contract, or transaction is 

based is a qualifying foreign futures 

contract that satisfies the conditions of 

§ 240.3a12–8 applicable to qualifying 

foreign futures contracts; 

(b) The agreement, contract, or 

transaction is traded on or through a 

board of trade (as defined in 7 U.S.C. 2); 

(c) The debt securities upon which 

the qualifying foreign futures contract is 

based or referenced and any security 

used to determine the cash settlement 

amount pursuant to paragraph (d) of this 

section were not registered under the 

Securities Act of 1933 (15 U.S.C. 77 et 

seq.) or the subject of any American 

depositary receipt registered under the 

Securities Act of 1933; 

(d) The agreement, contract, or 

transaction may only be cash settled; 

and 

(e) The agreement, contract or 

transaction is not entered into by the 

issuer of the debt securities upon which 

the qualifying foreign futures contract is 

based or referenced (including any 

security used to determine the cash 

payment due on settlement of such 

agreement, contract or transaction), an 

affiliate (as defined in the Securities Act 

of 1933 (15 U.S.C. 77 et seq.) and the 

rules and regulations thereunder) of the 

issuer, or an underwriter of such 

issuer’s debt securities. 

§ 240.3a69–1 Safe Harbor Definition of 

‘‘security-based swap’’ and ‘‘swap’’ as used 

in sections 3(a)(68) and 3(a)(69) of the Act— 

insurance. 

(a) This paragraph is a non-exclusive 

safe harbor. The terms security-based 

swap as used in section 3(a)(68) of the 

Act (15 U.S.C. 78c(a)(68)) and swap as 

used in section 3(a)(69) of the Act (15 

U.S.C. 78c(a)(69)) do not include an 

agreement, contract, or transaction that: 

(1) By its terms or by law, as a 

condition of performance on the 

agreement, contract, or transaction: 

(i) Requires the beneficiary of the 

agreement, contract, or transaction to 

have an insurable interest that is the 

subject of the agreement, contract, or 

transaction and thereby carry the risk of 

loss with respect to that interest 

continuously throughout the duration of 

the agreement, contract, or transaction; 

(ii) Requires that loss to occur and to 

be proved, and that any payment or 

indemnification therefor be limited to 

the value of the insurable interest; 

(iii) Is not traded, separately from the 

insured interest, on an organized market 

or over the counter; and 

(iv) With respect to financial guaranty 

insurance only, in the event of payment 

default or insolvency of the obligor, any 

acceleration of payments under the 

policy is at the sole discretion of the 

insurer; and 

(2) Is provided: 

(i)(A) By a person that is subject to 

supervision by the insurance 

commissioner (or similar official or 

agency) of any State, as defined in 

section 3(a)(16) of the Act (15 U.S.C. 

78c(a)(16)), or by the United States or an 

agency or instrumentality thereof; and 

(B) Such agreement, contract, or 

transaction is regulated as insurance 

under applicable State law or the laws 

of the United States; 

(ii)(A) Directly or indirectly by the 

United States, any State or any of their 

respective agencies or instrumentalities; 

or 

(B) Pursuant to a statutorily 

authorized program thereof; or 

(iii) In the case of reinsurance only by 

a person to another person that satisfies 

the conditions set forth in paragraph 

(a)(2) of this section, provided that: 

(A) Such person is not prohibited by 

applicable State law or the laws of the 

United States from offering such 

agreement, contract, or transaction to 

such person that satisfies the conditions 

set forth in paragraph (a)(2) of this 

section; 

(B) The agreement, contract, or 

transaction to be reinsured satisfies the 

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conditions set forth in paragraph (a)(1) 

or (3) of this section; and 

(C) Except as otherwise permitted 

under applicable State law, the total 

amount reimbursable by all reinsurers 

for such agreement, contract, or 

transaction may not exceed the claims 

or losses paid by the person writing the 

risk being ceded or transferred by such 

person; or 

(iv) In the case of non-admitted 

insurance by a person who: 

(A) Is located outside of the United 

States and listed on the Quarterly 

Listing of Alien Insurers as maintained 

by the International Insurers 

Department of the National Association 

of Insurance Commissioners; or 

(B) Meets the eligibility criteria for 

non-admitted insurers under applicable 

State law; or 

(3) Is provided in accordance with the 

conditions set forth in paragraph (a)(2) 

of this section and is one of the 

following types of products: 

(i) Surety bond; 

(ii) Fidelity bond; 

(iii) Life insurance; 

(iv) Health insurance; 

(v) Long term care insurance; 

(vi) Title insurance; 

(vii) Property and casualty insurance; 

(viii) Annuity; 

(ix) Disability insurance; 

(x) Insurance against default on 

individual residential mortgages; and 

(xi) Reinsurance of any of the 

foregoing products identified in 

paragraphs (i) through (x) of this 

section. 

(b) The terms security-based swap as 

used in section 3(a)(68) of the Act (15 

U.S.C. 78c(a)(68)) and swap as used in 

section 3(a)(69) of the Act (15 U.S.C. 

78c(a)(69)) do not include an agreement, 

contract, or transaction that was entered 

into on or before the effective date of 

this section and that, at such time that 

it was entered into, was provided in 

accordance with the conditions set forth 

in paragraph (a)(2) of this section. 

§ 240.3a69–2 Definition of ‘‘swap’’ as used 

in section 3(a)(69) of the Act—additional 

products. 

(a) In general. The term swap has the 

meaning set forth in section 3(a)(69) of 

the Act (15 U.S.C. 78c(a)(69)). 

(b) Inclusion of particular products. 

(1) The term swap includes, without 

limiting the meaning set forth in section 

3(a)(69) of the Act (15 U.S.C. 78c(a)(69)), 

the following agreements, contracts, and 

transactions: 

(i) A cross-currency swap; 

(ii) A currency option, foreign 

currency option, foreign exchange 

option and foreign exchange rate option; 

(iii) A foreign exchange forward; 

(iv) A foreign exchange swap; 

(v) A forward rate agreement; and 

(vi) A non-deliverable forward 

involving foreign exchange. 

(2) The term swap does not include an 

agreement, contract, or transaction 

described in paragraph (b)(1) of this 

section that is otherwise excluded by 

section 1a(47)(B) of the Commodity 

Exchange Act (7 U.S.C. 1a(47)(B)). 

(c) Foreign exchange forwards and 

foreign exchange swaps. 

Notwithstanding paragraph (b)(2) of this 

section: 

(1) A foreign exchange forward or a 

foreign exchange swap shall not be 

considered a swap if the Secretary of the 

Treasury makes a determination 

described in section 1a(47)(E)(i) of the 

Commodity Exchange Act (7 U.S.C. 

1a(47)(E)(i)). 

(2) Notwithstanding paragraph (c)(1) 

of this section: 

(i) The reporting requirements set 

forth in section 4r of the Commodity 

Exchange Act (7 U.S.C. 6r) and 

regulations promulgated thereunder 

shall apply to a foreign exchange 

forward or foreign exchange swap; and 

(ii) The business conduct standards 

set forth in section 4s(h) of the 

Commodity Exchange Act (7 U.S.C. 6s) 

and regulations promulgated thereunder 

shall apply to a swap dealer or major 

swap participant that is a party to a 

foreign exchange forward or foreign 

exchange swap. 

(3) For purposes of section 1a(47)(E) 

of the Commodity Exchange Act (7 

U.S.C. 1a(47)(E)) and this section, the 

term foreign exchange forward has the 

meaning set forth in section 1a(24) of 

the Commodity Exchange Act (7 U.S.C. 

1a(24)). 

(4) For purposes of section 1a(47)(E) 

of the Commodity Exchange Act (7 

U.S.C. 1a(47)(E)) and this section, the 

term foreign exchange swap has the 

meaning set forth in section 1a(25) of 

the Commodity Exchange Act (7 U.S.C. 

1a(25)). 

(5) For purposes of sections 1a(24) 

and 1a(25) of the Commodity Exchange 

Act (7 U.S.C. 1a(24) and (25)) and this 

section, the following transactions are 

not foreign exchange forwards or foreign 

exchange swaps: 

(i) A currency swap or a crosscurrency swap; 

(ii) A currency option, foreign 

currency option, foreign exchange 

option, or foreign exchange rate option; 

and 

(iii) A non-deliverable forward 

involving foreign exchange. 

§ 240.3a69–3 Books and records 

requirements for security-based swap 

agreements. 

(a) A person registered as a swap data 

repository under section 21 of the 

Commodity Exchange Act (7 U.S.C. 24a) 

and the rules and regulations 

thereunder: 

(1) Shall not be required to keep and 

maintain additional books and records 

regarding security-based swap 

agreements other than the books and 

records regarding swaps required to be 

kept and maintained pursuant to section 

21 of the Commodity Exchange Act (7 

U.S.C. 24a) and the rules and 

regulations thereunder; and 

(2) Shall not be required to collect and 

maintain additional data regarding 

security-based swap agreements other 

than the data regarding swaps required 

to be collected and maintained by such 

persons pursuant to section 21 of the 

Commodity Exchange Act (7 U.S.C. 24a) 

and the rules and regulations 

thereunder. 

(b) A person shall not be required to 

keep and maintain additional books and 

records, including daily trading records, 

regarding security-based swap 

agreements other than the books and 

records regarding swaps required to be 

kept and maintained by such persons 

pursuant to section 4s of the Commodity 

Exchange Act (7 U.S.C. 6s) and the rules 

and regulations thereunder if such 

person is registered as: 

(1) A swap dealer under section 

4s(a)(1) of the Commodity Exchange Act 

(7 U.S.C. 6s(a)(1)) and the rules and 

regulations thereunder; 

(2) A major swap participant under 

section 4s(a)(2) of the Commodity 

Exchange Act (7 U.S.C. 6s(a)(2)) and the 

rules and regulations thereunder; 

(3) A security-based swap dealer 

under section 15F(a)(1) of the Act (15 

U.S.C. 78o–10(a)(1)) and the rules and 

regulations thereunder; or 

(4) A major security-based swap 

participant under section 15F(a)(2) of 

the Act (15 U.S.C. 78o–10(a)(2)) and the 

rules and regulations thereunder. 

(c) The term security-based swap 

agreement has the meaning set forth in 

section 3(a)(78) of the Act (15 U.S.C. 

78c(a)(78)). 

PART 241—INTERPRETATIVE 

RELEASES RELATING TO THE 

SECURITIES EXCHANGE ACT OF 1934 

AND GENERAL RULES AND 

REGULATIONS THEREUNDER 

■ 5. Part 241 is amended by adding 

Release No. 34–67453 and the release 

date of July 18, 2012, to the list of 

interpretative releases. 

Dated: July 18, 2012. 

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1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

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

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

LawRegulation/OTCDERIVATIVES/index.htm. 

2See 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 25, available at http:// 

www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPOFCIC.pdf (‘‘concluding that ‘‘enactment of * * * 

[the Commodity Futures Modernization Act of 2000 

(‘‘CFMA’’)] to ban the regulation by both the 

Federal and State governments of over-the-counter 

(OTC) derivatives was a key turning point in the 

march toward the financial crisis.’’). 

3See Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap 

Agreement’’; Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping, 76 FR 29818, 29829, 

May 23, 2011. 

4Further Definition of ‘‘Swap,’’ ‘‘Security-Based 

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

Mixed Swaps; Security-Based Swap Agreement 

Recordkeeping, 77 FR ___, ___ (‘‘Adopting 

Release’’); Statutory Interpretation Concerning 

Forward Transactions, 55 FR 39188, Sept. 25, 1990 

Continued 

By the Commodity Futures Trading 

Commission. 

David A. Stawick, 

Secretary. 

By the Securities and Exchange 

Commission. 

Dated: July 18, 2012. 

Elizabeth M. Murphy, 

Secretary. 

Product Definitions Contained in Title 

VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act— 

CFTC Voting Summary and Statements 

of CFTC Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

CFTC Voting Summary 

On this matter, Chairman Gensler and 

Commissioners Sommers, O’Malia and 

Wetjen voted in the affirmative; 

Commissioner Chilton voted in the negative. 

Statement of CFTC Chairman Gary Gensler 

I support the final rulemaking to 

implement the Dodd-Frank Wall Street 

Reform and Consumer Protection Act (DoddFrank Act) requirement to further define 

‘‘swap’’ and other products that come under 

swaps market reform. The Commodity 

Futures Trading Commission (CFTC) worked 

closely with the Securities and Exchange 

Commission (SEC), in consultation with the 

Federal Reserve, on the final rules and 

interpretations to further define ‘‘swaps,’’ 

‘‘security-based swaps,’’ ‘‘mixed swaps’’ and 

‘‘security-based swap agreements.’’ 

The statutory definition as laid out by 

Congress of swap is very detailed. These final 

rules and interpretations are consistent with 

that detailed definition and Congressional 

intent. For example, interest rate swaps, 

currency swaps, commodity swaps, 

including energy, metals and agricultural 

swaps, and broad-based index swaps, such as 

index credit default swaps, are all swaps. 

Consistent with Congress’s definition of 

swaps, the rule also defines options as swaps. 

In preparing this final rulemaking, staff 

worked to address the more than 140 

comments that were submitted by the public 

in response to the product further definition 

proposal. Many of the commenters asked the 

Commissions to specifically provide 

guidance on what is not a swap or securitybased swap. 

For example, under the Commodity 

Exchange Act, the CFTC does not regulate 

forward contracts. Over the decades, there 

have been a series of orders, interpretations 

and cases that market participants have come 

to rely upon regarding the exception from 

futures regulation for forwards and forwards 

with embedded options. Consistent with that 

history, the Dodd-Frank Act excluded from 

the definition of a swap ‘‘any sale of a 

nonfinancial commodity or security for 

deferred shipment or delivery, so long as the 

transaction is intended to be physically 

settled.’’ The Commission is interpreting that 

exclusion in a manner that is consistent with 

Commission precedent and, in response to 

commenters, is providing increased clarity 

on the forward exclusion from futures 

regulation. The final release provides 

guidance regarding forwards with embedded 

volumetric options, like those used within 

the electricity markets, and is requesting 

comment on this interpretation. 

Further, consistent with the Dodd-Frank 

Act, insurance products will not be regulated 

as swaps. Similarly, this final rulemaking 

clarifies that certain consumer and 

commercial arrangements that historically 

have not been considered swaps, such as 

consumer mortgage rate locks, contracts to 

lock in the price of home heating oil and 

contracts relating to inventory or equipment, 

also will not be regulated as swaps. 

The rule provides clarity on the dividing 

line between ‘‘swaps’’ and ‘‘security-based 

swaps’’ or both, i.e. mixed swaps. The rule 

also provides a process for requesting joint 

interpretations in circumstances where there 

are questions. These dividing lines and the 

process will benefit market participants, as 

they will provide greater clarity as to what 

regulatory requirements apply when they 

transact in the derivatives markets. 

Lastly, the final release includes specific 

provisions that guard against transactions 

that are willfully structured to evade DoddFrank Act swaps market reforms. 

I’d like to express my appreciation for their 

dedication to completing this rule to 

Chairman Mary Schapiro and her fellow 

Commissioners at the SEC, as well as the 

staff, including Robert Cook, Brian Bussey, 

Amy Starr, Donna Chambers, Christie March, 

Andy Schoeffler, Wenchi Hu, John Guidroz 

and Sarah Otte. 

I’d also like to thank the CFTC’s 

hardworking staff: Julian Hammar, Lee Ann 

Duffy, David Aron, Terry Arbit, Eric Juzenas 

and Stephen Kane. 

Dissent of CFTC Commissioner Chilton on 

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

Agreement;’’ Mixed Swaps; Security-Based 

Swap Agreement Recordkeeping 

I respectfully dissent from this joint final 

rule and interpretive guidance because I have 

reservations about certain aspects of the 

Commodity Futures Trading Commission’s 

(‘‘Commission’’) interpretive guidance on 

forward contracts. Apart from this specific 

area, I agree with the joint release and would 

support its adoption. 

I am dissenting from the interpretive 

guidance for two chief reasons. First, I 

believe that the Commission should make 

stronger efforts to ensure market participants 

claim the forward contract exclusion only 

under appropriate circumstances, consistent 

with its interpretive guidance. The 

Commission should apply a rebuttable 

presumption that contracts do not have as 

their predominant feature actual delivery in 

instances where market participants often do 

not follow the delivery settlement term in a 

contract. The Commission should set forth 

the conditions for a safe harbor, consistent 

with its interpretation of the forward contract 

exclusion, for market participants that often 

do not terminate ‘‘forward’’ contracts through 

physical delivery that includes some 

affirmative statement to the Commission 

explaining the circumstances leading to nondelivery. This safe harbor, in my view, would 

encourage market participants to submit 

information that would vastly improve the 

ability of the Commission to ensure that 

market participants claiming the forward 

contract exclusion are doing so 

appropriately, consistent with the law and 

Commission and staff interpretation of the 

law. 

Second, the Commission has failed to 

provide adequate legal certainty to market 

participants engaging in contracts with 

embedded volumetric commodity options, 

particularly those that can terminate without 

physical delivery. Contracts with embedded 

commodity options that can negate the 

physical delivery term have optionality that 

targets the delivery term of the contract and 

therefore cannot be seen as having as a 

predominant feature actual delivery, a 

necessary element in any forward contract 

under applicable Commission precedent. The 

Commission has failed to perform an analysis 

of these types of contracts in an excess of 

caution that may invite confusion, at best, 

and evasion, at worst. 

The Dodd-Frank Wall Street Reform and 

Consumer Protection Act (‘‘Dodd-Frank 

Act’’) 1 imposes new safeguards on hitherto 

unregulated markets. These safeguards 

increase the integrity of the markets by, e.g., 

improving market transparency and thereby 

deterring abuses of the sorts seen in recent 

decades. These safeguards inevitably increase 

compliance costs, particularly in the initial 

phase of implementation. As I can predict 

with absolute certainty, bad actors (a` la 

Amaranth) will be drawn to dark markets in 

search of spoils. Less ill-intentioned or 

‘‘grey’’ actors may follow them in search of 

lower compliance costs. The Commission 

should not cede swaths of jurisdiction 

because such markets have not hitherto given 

rise to concerns.2

The Commission proposed 3 and is now 

adopting an approach to the forward contract 

exclusion that draws on ‘‘the principles 

underlying’’ the Brent Interpretation.4 I agree 

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48364 Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 

(‘‘Brent Interpretation’’). I note that the Commission 

did not endorse the outcome of the Brent 

Interpretation. 

5 I recognize (and perhaps the Commission has 

quietly recognized as well) the merit in the dissent 

of former Commissioner Fowler West to the Brent 

Interpretation and am heartened to find elements of 

his analytical approach in this release. 

Commissioner West, among other things, 

emphasized the importance of the underlying 

purpose of a transaction in a forward contract 

analysis. Id., Dissent of Commissioner Fowler West, 

available at http://www.cftc.gov/ucm/groups/ 

public/@aboutcftc/documents/file/ 

fwestdissent092090.pdf (because, among other 

things, 15-day Brent contracts are entered into for 

the purpose of hedging or speculation rather than 

for the purpose of transferring ownership in crude 

oil they do not sufficiently resemble forward 

contracts to be excluded from the CEA) citing CFTC 

v. Co. Petro Marketing Group, Inc., 680 F.2d 573, 

580 (9th Cir. 1982). Commissioner West’s dissent 

presaged the Brent market aberrations of the 1990s 

and early 2000s that some tied to squeezes of the 

Brent delivery complex through a hoarding of 

‘‘forwards’’ that made leveraged cash-settled 

contract positions designed to benefit from such 

aberrations very profitable. While I endorse the 

Commission’s approach to affirming the principles 

contained in the Brent Interpretation, I believe 

future interpretive guidance should apply the 

lessons of the past two-plus decades of market and 

regulatory history and apply the Brent 

Interpretation principles in that light. In this 

dissent, however, I do not need to go so far as to 

reinterpret the principles underlying the Brent 

Interpretation: even based on a conservative review 

of our precedent I feel we did not provide the 

market adequate clarity. 

6See Adopting Release. 7See Adopting Release. 

8CEA section 4c(b), 7 U.S.C. 6c(b). 

9CEA section 4c(b) has been in the Act in 

substantially the same form since it was added by 

the Commodity Futures Trading Commission Act of 

1974. See Public Law 93–463, October 23, 1974. 

10See CEA section 1a(47)(A)(iii), 7 U.S.C. 

1a(47)(A)(iii). 

11See CEA section 1a(47)(A)(i), 7 U.S.C. 

1a(47)(A)(i). Note that the swap definition excludes 

options on futures (which must be traded on a DCM 

pursuant to part 33 of the Commission’s 

regulations) (see CEA section 1a(47)(B)(i), 7 U.S.C. 

1a(47)(B)(i)), but it includes options on physical 

commodities (whether or not traded on a DCM) (see 

CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i)). 

12The Commission’s regulations define a 

commodity option transaction or commodity option 

as ‘‘any transaction or agreement in interstate 

commerce which is or is held out to be of the 

character of, or is commonly known to the trade as, 

an ‘option,’ ‘privilege,’ ‘indemnity,’ ‘bid,’ ‘offer,’ 

‘call,’ ‘put,’ ‘advance guaranty’ or ‘decline 

guaranty’.’’ 17 CFR 1.3(hh). 

13See CEA section 1a(47)(B)(ii), 7 U.S.C. 

1a(47)(B)(ii) (excluding from the definition of 

‘‘swap’’ contracts involving ‘‘any sale of a 

nonfinancial commodity or security for deferred 

shipment or delivery, so long as the transaction is 

intended to be physically settled.’’). See also CEA 

section 8(d), 7 U.S.C. 12(d), which directs the CFTC 

to investigate the marketing conditions of 

commodities and commodity products and 

byproducts, including supply and demand for these 

commodities, cost to the consumer, and handling 

and transportation charges; CEA sections 6(c), 6(d) 

and 9(a)(2), 7 U.S.C. 9, 13b, and 13(a)(2), which 

proscribe any manipulation or attempt to 

manipulate the price of any commodity in interstate 

commerce; and CEA section 6(c) as amended by 

section 753 of the Dodd-Frank Act, which contains 

prohibitions regarding manipulation and false 

reporting with respect to any commodity in 

generally with this approach (I voted in the 

affirmative on releasing the proposal). In 

addition, the Commission recognizes that the 

underlying purpose of a transaction is a 

critical factor in determining whether a given 

transaction is more appropriately classified 

as a forward or swap (or commodity option).5

I commend this clarification and hope it is 

applied or further clarified in a way that 

affirms the principles underlying the Brent 

Interpretation without endorsing the outcome 

of the Brent Interpretation. 

1. Safe Harbor for ‘‘Forwards’’ That Often 

Do Not Terminate With Actual Delivery 

I believe that the Commission should make 

stronger efforts to ensure market participants 

claim the forward contract exclusion only 

under appropriate circumstances. I am 

concerned that the forward contract 

exclusion may be abused if not intentionally 

evaded by the lack of safeguards to ensure its 

appropriate application.6 This concern is 

exacerbated by the fact that actors claiming 

the forward contract exclusion are not subject 

to any reporting requirements, nor have we 

even provided for a safe harbor that 

encourages such reporting. In light of the 

transparency the CEA now provides for 

futures, options, and swaps markets, the 

regulatory differential between these 

regulated markets and unregulated markets, 

like forward markets, is going to encourage 

regulatory arbitrage. Despite substantial 

progress in improving the Commission’s 

visibility into regulated markets, the 

Commission has failed to set forth 

interpretive guidance that ensures that, at the 

minimum, it can see and understand the 

transactions that market participants claim as 

being subject to the forward contract 

exclusion. I believe the Commission should 

be more active when it comes to ensuring 

that the forward contract exclusion is 

properly applied, particularly in instances 

where an ostensible ‘‘forward’’ closely 

resembles, in form, purpose, or economic 

substance regulated products. 

The Commission has endorsed the purpose 

of a transaction as a factor in determining a 

contract’s eligibility for the forward contract 

exclusion.7 The Brent Interpretation or the 

Commission’s re-interpretation of it 

notwithstanding, I believe that when few 

‘‘forward’’ contracts for a given market 

participant result in delivery, then there is 

sufficient ground for the Commission to have 

doubt about the appropriateness of the 

forward contract exclusion claim. Moreover, 

under such circumstances the Commission 

should have doubt about the underlying 

purpose of the claimed ‘‘forwards.’’ 

Therefore, the Commission should apply a 

rebuttable presumption that the market 

participant may not be engaging in 

transactions that have as their predominant 

feature actual delivery. 

At the same time, the Commission should 

specify the means by which this presumption 

may be rebutted. I believe that the 

Commission provide for a safe harbor for 

market participants that regularly engage in 

transactions they believe to qualify for the 

forward contract exclusion that, nonetheless, 

often do not terminate with delivery (e.g., in 

less than 20% of instances as measured by 

number of ‘‘forward’’ contracts or by 

potential total quantity under all ‘‘forward’’ 

contracts). This non-delivery could be of the 

result of, for example, exercised embedded 

volumetric optionality or through book-outs. 

Market participants claiming this safe harbor 

should include a brief, periodic statement 

that explains the reason why their forward 

transactions, in general terms or with more 

specificity as is necessary for the 

Commission to determine whether the 

presumption that the market participant is 

inappropriately claiming the forward 

contract exclusion is rebutted. 

I request comment on my proposed safe 

harbor concept. I encourage the Commission 

to adopt some version of this safe harbor in 

order to allay the very real concerns I and, 

indeed, many market participants and many 

in the public have expressed to me that 

unregulated forwards markets could become 

a refuge for those that thrive in opacity. Our 

regulations implementing the Dodd-Frank 

Act will vastly improve transparency in 

regulated futures, options, and swaps 

markets. Unfortunately, our interpretive 

guidance today does little to ensure even any 

visibility for regulators in how players in the 

physical commodity markets, so critical to 

the Commission’s mission, are claiming the 

forward contract exclusion: the unwatched 

back door out of the transparency-related 

requirements of the CEA. 

2. Legal Certainty for Certain Commodity 

Options 

Section 4c(b) of the CEA provides: 

No person shall offer to enter into, enter 

into or confirm the execution of, any 

transaction involving any commodity 

regulated under this chapter which is of the 

character of, or is commonly known to the 

trade as, an ‘‘option’’, ‘‘privilege’’’, 

‘‘indemnity’’, ‘‘bid’’, ‘‘offer’’, ‘‘put’’, ‘‘call’’, 

‘‘advance guaranty’’, or ‘‘decline guaranty’’, 

contrary to any rule, regulation, or order of 

the Commission prohibiting any such 

transaction or allowing any such transaction 

under such terms and conditions as the 

Commission shall prescribe. Any such order, 

rule, or regulation may be made only after 

notice and opportunity for hearing, and the 

Commission may set different terms and 

conditions for different markets.8

Through this decades-old provision, 

Congress gave the Commission jurisdiction 

and plenary rulemaking authority over 

physical commodity option transactions.9

The Dodd-Frank Act not only preserved this 

plenary authority over commodity options, 

but also reaffirmed the reach of the CEA over 

commodity options. Section 721 of the DoddFrank Act added section 1a(47) to the CEA, 

defining ‘‘swap’’ to include not only ‘‘any 

agreement, contract, or transaction 

commonly known as,’’ among other things, 

‘‘a commodity swap,’’ 10 but also ‘‘[an] option 

of any kind that is for the purchase or sale, 

or based on the value, of 1 or more * * * 

commodities * * *,’’11 i.e. commodity 

options.12 While commodity options are 

subject to the Commission’s plenary 

jurisdiction, the Commission has limited 

jurisdiction over forward contracts.13

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Federal Register / Vol. 77, No. 156 / Monday, August 13, 2012 / Rules and Regulations 48365 

interstate commerce, including prohibiting any 

person to (i) ‘‘use or employ, or attempt to use or 

employ * * * any manipulative or deceptive 

device or contrivance’’ (section 6(c)(1)); (ii) ‘‘to 

make any false or misleading statement of material 

fact’’ to the CFTC or ‘‘omit to state in any such 

statement any material fact that is necessary to 

make any statement of material fact made not 

misleading in any material respect’’ (section 

6(c)(2)); and (iii) ‘‘manipulate or attempt to 

manipulate the price of any swap, or of any 

commodity in interstate commerce * * *’’ (section 

6(c)(3)). See also Rule 180.1(a) under the CEA, 17 

CFR 180.1(a) (broadly prohibiting in connection 

with a commodity in interstate commerce 

manipulation, false or misleading statements or 

omissions of material fact to the Commission, fraud 

or deceptive practices or courses of business, and 

false reporting). 

14See Adopting Release. 

15See In re Wright, CFTC Docket No. 97–02, 2010 

WL 4388247 (Oct. 25, 2010) (emphasis added). See 

also Characteristics Distinguishing Cash and 

Forward Contracts and ‘‘Trade’’ Options, 50 FR 

39656 (Sept. 30, 1985) (finding that hedge-to-arrive 

contracts with pricing optionality could be 

categorized as forwards so long as it created a 

binding delivery obligation that could only be 

annulled in the event of a crop failure, in which 

case liquidated damages may apply). 

16 In re Wright, CFTC Docket No. 97–02, 2010 WL 

4388247 (Oct. 25, 2010). 

17See Adopting Release. 

18See, e.g., 50 FR 39656, 39660. 

19These forward contract and commodity option 

hybrid contracts can, as I understand it, generally 

be severed into two separate forward and 

commodity option contracts. Some commenters 

suggested that many ‘‘peaking’’ contracts involve 

volumetric optionality that cannot be severed, but 

Continued 

In the Brent Interpretation, the 

Commission found certain Brent oil contracts 

to be eligible for the forward contract 

exclusion, notwithstanding the fact that such 

transactions ‘‘may ultimately result in 

performance through the payment of cash as 

an alternative to actual physical transfer or 

delivery of the commodity.’’ The 

Commission found that when delivery 

obligations under a forward were terminated 

pursuant to a separate and individually 

negotiated ‘‘book-out’’ agreement, the parties 

escaped the physical delivery obligation 

traditionally required to claim the forward 

contract exclusion. The Commission also 

emphasized two features (among others) of 

the Brent oil contracts at issue: (1) The 

absence of a contractual right to offset (or to 

terminate without delivery) the transaction 

‘‘by the terms of the contracts as initially 

entered into’’ and (2) the counterparties had 

to incur ‘‘substantial economic risks of a 

commercial nature’’ relating to actual 

delivery in order to claim the exclusion. 

Underlying the Brent Interpretation, other 

CFTC precedent, and the Commission’s 

approach to the interpretive guidance on the 

forward contract exclusion is the essential 

feature of forward contracts: actual delivery 

(and not potential delivery).14

The Commission has failed to provide 

adequate legal certainty to market 

participants engaging in contracts with 

embedded volumetric commodity options, 

particularly those that can terminate without 

physical delivery. Contracts that are 

composed of a forward delivery obligation 

component combined with an embedded 

commodity option that can render delivery 

optional (‘‘zero-delivery’’ embedded 

volumetric options) are not forwards because 

the predominant feature of the contract 

cannot be actual delivery under these 

circumstances (more literally, the 

predominant feature is potential delivery 

which is an essential characteristic of 

commodity options). Such contracts include 

a contractual right to offset through the 

exercise of the volumetric option that can 

extinguish the delivery obligation. Because 

such contracts have a commodity option 

component that mitigates the risk incurred 

from an underlying forward delivery 

obligation, these contracts may fail to meet 

the incurring ‘‘economic risks of a 

commercial nature’’ element. Moreover, the 

purpose of the delivery optionality in these 

types of contracts shares a common purpose 

with commodity options: To provide market 

participants a means to hedge commodity 

quantity risk of a commercial nature. The 

Commission should therefore clarify, in any 

future interpretive guidance, that zerodelivery embedded volumetric options are 

generally commodity options because the 

delivery obligation is not obligatory. 

The confluence of these features, as 

analyzed under a conservative reading of the 

Brent Interpretation, leads me to conclude 

that contracts with embedded zero-delivery 

option components cannot be said to have 

actual delivery as their essential feature. 

Other relevant Commission precedent is 

consistent with this analysis. Most recently, 

in In re Wright, a forward contract containing 

pricing optionality was found to be a forward 

contract because the optionality: 

(i) May be used to adjust the forward 

contract price, but do not undermine the 

overall nature of the contract as a forward 

contract; (ii) do not target the delivery term, 

so that the predominant feature of the 

contract is actual delivery; and (iii) cannot be 

severed and marketed separately from the 

overall forward contract in which they are 

embedded.15

In re Wright is distinguishable because it 

involves pricing optionality, not volumetric 

optionality–the latter a feature the 

Commission has not hitherto opined on in 

the context of the forward contract exclusion. 

As the emphasized section of the block quote 

immediately above discusses, the 

interpretation there turned on the fact that 

the optionality in the In re Wright options did 

‘‘not target the delivery term.’’ Optionality 

that can result in zero delivery ‘‘targets the 

delivery term,’’ in direct contrast to the In re 

Wright options. I commend the Commission 

for not overextending (to put it charitably) In 

re Wright to cover zero-delivery volumetric 

optionality, as argued by some commenters. 

Nonetheless, the Commission did not clarify 

that a contract that provides for optionality 

that can render delivery optional cannot 

therefore have as its predominant feature 

actual delivery because the optionality 

‘‘targets the delivery term.’’16

Instead of, in my opinion, a proper 

application of the statute and precedent, the 

Commission has adopted a seven-element 

interpretation that applies to contracts with 

embedded volumetric optionality. This 

interpretative approach would potentially 

allow contracts with zero-delivery option 

components to nonetheless claim the forward 

contract exclusion when: 

1. The embedded optionality does not 

undermine the overall nature of the 

agreement, contract, or transaction as a 

forward contract; 

2. The predominant feature of the 

agreement, contract, or transaction is actual 

delivery; 

3. The embedded optionality cannot be 

severed and marketed separately from the 

overall agreement, contract, or transaction in 

which it is embedded; 

4. The seller of a nonfinancial commodity 

underlying the agreement, contract, or 

transaction with embedded volumetric 

optionality intends, at the time it enters into 

the agreement, contract, or transaction, to 

deliver the underlying nonfinancial 

commodity if the optionality is exercised; 

5. The buyer of a nonfinancial commodity 

underlying the agreement, contract or 

transaction with embedded volumetric 

optionality intends, at the time it enters into 

the agreement, contract, or transaction, to 

take delivery of the underlying nonfinancial 

commodity if it exercises the embedded 

volumetric optionality; 

6. Both parties are commercial parties; and 

7. The exercise or non-exercise of the 

embedded volumetric optionality is based 

primarily on physical factors, or regulatory 

requirements, that are outside the control of 

the parties and are influencing demand for, 

or supply of, the nonfinancial commodity. 

The first two elements, in particular, 

invoke the Brent Interpretation and related 

precedent.17 The seventh and most 

problematic element seems to imply that 

supply and demand, i.e., economic factors, 

could be a primary factor in the exercise or 

non-exercise of an embedded volumetric 

option. I fear how broadly this element could 

be interpreted by those predisposed to 

interpret the CEA in an opportunistic light. 

When can supply and demand factors not be 

correlated with physical factors? Does this 

mean that if delivery renders such a contract 

unprofitable for a party to such a contract 

that they can elect not to deliver? If that is 

the case, then the contract is a commodity 

option.18

I would amend the seventh element by 

making it clear the exercise or non-exercise 

for physical factors that influence demand 

and supply can negate the delivery obligation 

only in exceptional circumstances. If delivery 

renders a contract merely unprofitable and 

the contract permits a party to elect not to 

deliver, such a contract is not a forward and 

is a commodity option. 

In addition, I would require, consistent 

with the third, ‘‘severability,’’ element, that 

in order to claim the forward contract 

exclusion where the contract at issue 

contains a zero-delivery embedded 

volumetric option, the parties must sever the 

forward contract component, which has as its 

purpose the delivery of commodities, from 

the remaining commodity option component, 

which has as its purpose the management of 

the commodity quantity risk associated with 

operating a commercial enterprise.19 The 

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I have yet to be convinced that the same party that 

is the ‘‘seller’’ under these contracts cannot simply 

become the appropriate counterparty when such 

contracts are severed into a forward contract 

component and a commodity option component 

that can offset or book-out the buyer’s obligation to 

take delivery. 

20Commodity Options, 77 FR 25320, Apr. 27, 

2012, codified at 17 CFR 32.3. 

21As of July 10, 2012, the Commission has 

received 12 comments on the interim final rule 

setting forth the trade option exemption. 

22The Commission’s inclusion of the underlying 

purpose of a transaction as a factor in determining 

its classification as a forward, commodity option, or 

other form of swap. The Commission will, under 

the interpretive guidance, consider the ‘‘purpose of 

the claimed forward’’ and whether its purpose is to 

sell physical commodities, hedge risk, or speculate. 

See Adopting Release. 

23See Adopting Release, fn 337 (‘‘When a forward 

contract includes an embedded option that is 

severable from the forward contract, the forward 

can remain subject to the forward contract 

exclusion, if the parties document the severance of 

the embedded option component and the resulting 

transactions, i.e. a forward and an option. Such an 

option would be subject to the CFTC’s regulations 

applicable to commodity options.’’). 

24 Id. (‘‘Do the agreements, contracts, and 

transactions listed in question no. 6 above have 

embedded optionality in the first instance? Based 

on descriptions by commenters, it appears that they 

may have a binding obligation for delivery, but have 

no set amount specified for delivery. Instead, 

delivery (including the possibility of nominal or 

zero delivery) is determined by the terms and 

conditions contained within the agreement, 

contract, or transaction (including, for example, the 

satisfaction of a condition precedent to delivery, 

such as a commodity price or temperature reaching 

a level specified in the agreement, contract, or 

transaction). That is, the variation in delivery is not 

driven by the exercise of embedded optionality by 

the parties. Do the agreements, contracts, and 

transactions listed in question no. 6 exhibit these 

kinds of characteristics? If so, should the CFTC 

consider them in some manner other than its 

forward interpretation? Why or why not?’’). 

commodity option component of these 

transactions could be eligible for a trade 

option exemption 20 that exempts (and 

importantly, does not exclude) them from 

many CEA requirements.21

Moreover, while the Adopting Release’s 

guidance is the first of its kind and therefore 

an incremental step toward more legal 

certainty, it doesn’t directly address 

embedded zero-delivery volumetric 

optionality specifically or any of the 

conceivable specific variations of such 

contracts. I believe this to be a flaw; a flaw 

that did not exist in a previous version of this 

document. 

The Commission should affirm in any 

relevant future interpretive guidance the 

formal features in the Brent Interpretation’s 

forward contract exclusion, e.g., that the 

delivery obligation cannot be offset based on 

terms contained in the contract, that any 

delivery obligation be appropriately bookedout (in a separate transaction), or that the 

contract involve incurring ‘‘substantial 

economic risks of a commercial nature.’’ 22 In 

the absence of the Commission’s courage to 

provide for more legal certainty on these 

kinds of transactions, I stress the application 

of the third, severability, element in the 

Commission’s seven-element interpretation 

and note that as long as a market participant 

can decompose a pre-Dodd-Frank Act 

transaction into components, such action 

would not be in violation of the CEA if the 

resulting agreements, contracts, or 

transactions (1) neatly fall into forward, 

commodity option, or other swap contract 

buckets and (2) are dealt with as such.23

I look forward to receiving and reviewing 

comments on the Commission’s 

interpretation, in particular those submitted 

in response to Question Seven.24 I also 

welcome comments on this statement too, of 

course, particularly as it relates to zerodelivery embedded volumetric options. I am 

particularly interested in understanding 

under what circumstances such embedded 

option contracts and other contracts can be 

structured to evade Dodd-Frank Act 

requirements in a way that creates plausible 

deniability for one or both counterparties that 

they did not ‘‘willfully’’ intend to structure 

a transaction in a manner intended to evade. 

Should the Commission, instead of my 

proposed approach, follow a rebuttable 

presumption approach with respect to zerodelivery embedded option contracts whereby 

the presumption can be rebutted by a 

certification of facts that indicate a true 

commercial purpose for the transaction? 

[FR Doc. 2012–18003 Filed 8–10–12; 8:45 am] 

BILLING CODE 8011–01– 6351–01–P 

mstockstill on DSK4VPTVN1PROD with RULES2