78030 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1See Final Rules for a New Regulatory

Framework for Clearing Organizations, p.12.

1 65 FR 39033 (June 22, 2000).

2Recognizing the importance of the OTC

derivatives markets, the chairmen of the Senate and

House Agriculture Committees requested that the

PWG conduct a study of OTC derivatives markets.

After studying the existing regulatory framework of

OTC derivatives, recent innovations, and the

potential for future developments, the PWG on

November 9, 1999, reported to Congress its

recommendations. See Over-the-Counter

Derivatives Markets and the Commodity Exchange

Act, Report of the President’s Working Group on

Financial Markets (PWG Report). The PWG Report

focused on promoting innovation, competition,

efficiency, and transparency in OTC derivatives

markets and in reducing systemic risk.

3See Our Estimates of Global Size Market (visited

Oct. 10, 2000), http://www.swapsmonitor.com.

4 In addition to these 31, a significant number of

letters commenting on aspects of the regulatory

framework in companion notices were also

submitted to the Commission. In this and three

companion Notices of Final Rulemaking which are

being published in this edition of the Federal

Register, comment letters (CLs) are referenced by

file number, letter number and page. Comments

filed in response to the notice of proposed

exchanges are choosing to contract with new

or existing clearing organizations for this

aspect of traditional exchange activity. From

what the Commission heard at the public

hearing on the proposed framework, this

trend is expected to continue and accelerate.

Accordingly, this proposal represents a first

step toward providing clearing organizations

with the flexibility they will need to adapt

to this new environment.

Nevertheless, I am sympathetic to the

concerns of domestic clearing organizations

regarding competition, jurisdiction and

scope. Specifically, the final rule’s treatment

of securities clearinghouses, banks, bank

affiliates, and foreign clearinghouses with

regard to the requirements of Part 39 would

appear to subject futures clearinghouses to a

significant competitive disadvantage. The

Commission’s final rules justify this

approach with little more than the

observation that it is consistent with the

‘‘unanimous recommendations of the

President’s Working Group.’’ 1 Much more

needs to be done so that one segment of the

industry is not disproportionately affected

and unfairly hamstrung by these regulations.

Therefore, while I support the final rules to

the extent they represent the Commission’s

willingness to meet the evolving marketplace

with innovative approaches, I do so with the

caveat that Part 39 will clearly need the

Commission’s full attention in order to

ensure that the Commission is not picking

winners and losers. At a minimum, since

these reforms follow so closely the

recommendations of the President’s Working

Group, I hope that the members of the PWG

will respond swiftly to today’s action by

making parallel changes to their own

regulatory schemes implementing the PWG’s

recommendations.

Date: November 20, 2000.

Thomas J. Erickson,

Commissioner.

[FR Doc. 00–30269 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 35

RIN 3038–AB58

Exemption for Bilateral Transactions

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rules.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is adopting final rules to clarify

the operation of the current swaps

exemption. In addition, in a companion

notice of final rulemaking published in

this edition of the Federal Register, the

Commission is adopting rules that

provide for the clearing of transactions

under the revised exemption. The

Commission, in other companion

releases, also is adopting a new

regulatory framework to apply to

multilateral transaction execution

facilities and to market intermediaries.

This new framework establishes a

number of new market categories,

including a category of exempt

multilateral transaction execution

facility. Nothing in these releases,

however, affects the continued vitality

of the Commission’s exemption for

swaps transactions in effect before

December 13, 2000, or any of its other

existing exemptions, policy statements

or interpretations.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT: Paul

M. Architzel, Chief Counsel, or Nancy E.

Yanofsky, Assistant Chief Counsel,

Division of Economic Analysis,

Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st Street, NW., Washington, DC

20581. Telephone: (202) 418–5260. Email: PArchitzel@cftc.gov or

NYanofsky@cftc.gov.

SUPPLEMENTARY INFORMATION:

I. The Proposed Rules

On June 22, 2000, the Commission

published proposed amendments to its

part 35 swaps exemption to expand and

to clarify its operation, including the

availability of clearing for these

transactions.1 These amendments were

proposed in order to provide greater

legal certainty to the over-the-counter

(OTC) markets and to reduce systemic

risk. The President’s Working Group on

Financial Markets (PWG) 2 and the

chairmen of the Commission’s

Congressional oversight committees

encouraged the Commission in this

undertaking.

The Commission proposed the

amendments to part 35 in light of the

changes that have occurred in the OTC

markets since the Commission adopted

its Swaps Policy Statement in 1989, and

its subsequent part 35 swaps exemption

in 1993. In the intervening years, the

OTC derivatives markets have

experienced dramatic and sustained

growth. During this period, OTC

financial derivatives have developed

into global markets having outstanding

contracts with a total notional value of

over $90 trillion.3 OTC derivatives have

transformed finance, increasing the

range of financial products available for

managing risk.

The Commission proposed making

several changes to part 35. First, the

Commission proposed deleting specific

reference to ‘‘swaps’’ within the

exemption itself. Instead, the rule would

refer to a ‘‘contract, agreement or

transaction’’ that meets the requisite

exemptive conditions. Moreover, as

suggested by the PWG Report, the

Commission proposed to delete the

requirement that exempt transactions

not be fungible or standardized and to

make clear that insofar as such exempt

transactions may be cleared,

creditworthiness of the counterparty is

not a condition of the exemption. PWG

Report at 17. In addition, the

Commission proposed, through an

exemption from the private right of

action provision of section 22 of the Act,

that transactions entered into in reliance

on the part 35 swaps exemption would

not be subject to a claim for rescission

solely due to a violation of the

exemption’s requirements. See id. at 18.

In proposing the rules, the

Commission affirmed the continuing

vitality of the exemptive relief that it

had previously granted to transactions

in the OTC market, including the part

35 exemption, the Policy Statement

Concerning Swap Transactions (54 FR

30694 (July 21, 1989)) (Swaps Policy

Statement), the Statutory Interpretation

Concerning Forward Transactions (55

FR 39188 (Sept. 25, 1990)) (Energy

Interpretation), and the Exemption for

Certain Contracts Involving Energy

Products (58 FR 21286 (April 20, 1993))

(Energy Exemption). Moreover, in

recognition of its continuing vitality and

to assist the public in locating it, the

Commission proposed publishing the

Swaps Policy Statement as Appendix A

to part 35.

II. Comments Received

The Commission received 31

comment letters on the proposed

rulemaking.4 The commenters included

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78031

rulemaking on multilateral transaction execution

facilities, parts 36–38, are contained in file No. 21,

on the notice of proposed rulemaking on

intermediaries in file No. 22, on the notice of

proposed rulemaking on clearing organizations in

file No. 23 and on the notice of proposed

rulemaking on the part 35 exemption in file No. 24.

These letters are available through the

Commission’s internet web site, http://

www.cftc.gov.

5The associations that filed comment letters are

the Managed Funds Association, the International

Swaps and Derivatives Association, Inc., the

National Grain and Feed Association, the Futures

Industry Association, the Commodity Floor Brokers

& Traders Association, the Silver Users Association,

the Weather Risk Management Association, the

Association for Investment Management and

Research, Advocacy Advisory Committee,

Derivatives Subcommittee, and the Securities

Industry Association, OTC Derivatives Products

Committee.

6The futures exchanges that filed comment letters

are the Chicago Board of Trade, the New York

Mercantile Exchange and the Chicago Mercantile

Exchange.

7The brokerage firms that filed comment letters

are Merrill Lynch & Co. Inc. and J.P. Morgan

Securities Inc.

8The coalition of commercial and investment

banks (the Coalition) consists of the following

financial institutions: The Chase Manhattan Bank,

Citigroup Inc., Credit Suisse First Boston Inc.,

Goldman Sachs & Co., Merrill Lynch & Co., Inc. and

Morgan Stanley Dean Witter & Co.

9The law firms that filed comment letters are

Covington & Burling, McDermott, Will & Emery, on

behalf of Virginia Electric & Power Company,

Vinson and Elkins, and Gardner, Carter and

Douglas.

10The representatives of the energy services

community that filed comment letters are Williams

Energy Marketing and Trading Company, the

California Power Exchange, Oxy Energy Services,

Inc. and Petrocosm Corporation.

11The agricultural firm that filed a comment

letter is Cargill.

12The others filing comment letters are the

National Futures Association, the Financial Markets

Lawyers Group, the Federal Reserve Bank of

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

Regulatory Studies Program of the Mercatus Center,

Reuters Group PLC, and The EBS Partnership.

13 J.P. Morgan Securities Inc. (J.P. Morgan) raises

jurisdictional issues similar to those raised by

Mercatus, while specifically focusing on the

Commission’s proposed rules concerning exempt

multilateral transaction execution facilities and

recognized clearing organizations. CL 24–19 at 2–

5. The Commission is responding to those

comments more thoroughly in its companion

releases on those matters.

14Commission rule 35.1(a) provides that the

provisions of the exemption apply to any

transaction ‘‘which may be subject to the Act’’

(emphasis added). The final rules amend this scope

provision to incorporate a technical amendment

which substitutes the phrase ‘‘any contract,

agreement or transaction’’ for ‘‘any swap

agreement.’’ This change merely conforms the

formal statement of scope in rule 35.1(a) to the

substantive provisions of the rule.

15When it adopted section 4(c) in 1992, the

Conferees of the Congress stated:

The Conferees do not intend that the exercise of

exemptive authority by the Commission [under

section 4(c)] would require any determination

Continued

nine trade associations,5 three future

exchanges,6 two brokerage firms,7 a

coalition of commercial and investment

banks,8 four law firms,9 four

representatives of the energy services

community,10 an agricultural firm 11 and

others.12

The majority of commenters strongly

supported the Commission’s proposed

amendments and expressed the view

that the amendments, among other

things, would increase legal certainty

for the OTC market. Two commenters

took the opposite view, expressing

jurisdictional concerns. The

commenters also raised a number of

technical issues concerning the

operation of the exemption, the

definition of ‘‘eligible participant’’ and

other matters. The comments are

addressed in the final rules section

below.

III. The Final Rules

A. The Exemption

Except for certain technical changes,

the Commission is adopting the

proposed rules expanding and clarifying

the operation of the swaps exemption as

final rules. As noted above, the majority

of commenters strongly supported the

amendments, expressing the view that

they will increase legal certainty for the

OTC market and reduce systemic risk.

See, e.g., CL 24–6; CL 24–8; CL 24–25;

CL 24–29; CL 24–30; CL 24–31; CL 24–

34; CL 24–36. The International Swaps

and Derivatives Association (ISDA)

views the proposed amendments as

necessary to ensuring that new and

evolving risk management tools will

enjoy legal certainty comparable to that

which has been available to transactions

covered by the Commission’s swaps

exemption since 1993. CL 24–8 at 2. See

also CL 24–6 at 3; CL 24–29 at 3–4.

ISDA specifically commented that: The

proposed expansion of the exemption to

cover all bilateral agreements would

‘‘enable market participants to focus on

legal and economic substance rather

than labels’’ (CL 24–8 at 3); that the

elimination of the requirement that

exempt transactions not be standardized

or fungible would ‘‘eliminate a potential

source of uncertainty with respect to the

scope of the exemption’’ (id.); that the

authorization of clearing would

‘‘eliminate the ‘Hobson’s Choice’ that

now exists between legal certainty and

the use of clearing to reduce systemic

risk’’ (id.); and that the nonrepudiation

provisions would deal directly with the

‘‘main source of legal risk under the

CEA’’ (id. at 5). As ISDA noted, the

substantial growth of the OTC swaps

market since the Commission first

promulgated part 35 in 1993:

did not occur in a vacuum. It was fostered

by this Commission in an earlier regulatory

initiative commencing with the release of the

Swaps Policy Statement in 1989 and

continuing with the promulgation of the

Swaps Exemption * * * and the Hybrids

Exemption * * * These latter actions were of

course entirely consistent with the intent of

Congress, as reflected in the enactment of the

Futures Trading Practices Act of 1992. * * *

The pivotal role that OTC derivatives

transaction [sic] now play in our economy is

an outgrowth of these earlier policies of the

Commission and the continuing expressions

of support for those policies by Congress.

ISDA believes that the proposed regulatory

initiative now under consideration can and

should be viewed as a vital and positive step

in carrying out the Commission’s longstanding policy with respect to OTC

derivatives.

ISDA believes that * * * the proposed

regulatory initiative is an important change

for the better. We applaud the sensitivity of

both the Commission and its professional

staff to the need to avoid structuring the

proposals in ways that could result in legal

uncertainty, and we believe that the

proposals will not have this effect. We

likewise applaud the decision of the

Commission to propose specific actions

intended to increase, within the parameters

of the CEA, legal certainty and we believe the

proposals will have this effect. * * *

(CL 24–8 at 2; emphasis in original).

One commenter, however, the

Regulatory Studies Program of the

Mercatus Center (Mercatus), expressed

the view that, by expanding the category

of products to which the exemption

applies, the Commission may exacerbate

rather than reduce legal uncertainty. CL

24–21 at 4–5. Mercatus is concerned

about the ‘‘implications’’ of the broad

definitions used, commenting that, if

adopted as proposed, the Commission

could attempt to exercise its antifraud

authority over contracts, agreements and

transactions as to which it has no

jurisdiction. Id. Mercatus suggests that

the Commission instead limit the scope

of part 35 to instruments over which the

Act vests the Commission with

jurisdiction, such as ‘‘contracts of sale of

a commodity for future delivery.’’ Id. at

9.13

These amendments, however, do not

expand the Commission’s jurisdiction.

To the contrary, the substance of part

35’s scope provision remains unchanged

from the current part 35 exemption.14

Furthermore, the Commission’s

antifraud authority in rule 35.3, as

proposed and as being adopted herein,

is limited to ‘‘transactions and persons

otherwise subject to those [antifraud]

provisions’’ (emphasis added). Thus, the

antifraud provisions will continue to

apply only to those transactions already

covered by them. The Commission’s

approach is consistent with how

Congress intended the Commission to

exercise its exemptive authority.15

78032 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

beforehand that the agreement, instrument, or

transaction for which an exemption is sought is

subject to the Act. Rather, this provision provides

flexibility for the Commission to provide legal

certainty to novel instruments where the

determination as to jurisdiction is not

straightforward.

H.R. Rep. No. 978, 102d Cong., 2d Sess. 82–83

(1992). The Commission did not make a

determination in 1993 that the transactions that it

was exempting under part 35 were or were not

subject to its jurisdiction. The Commission

similarly declined to make any such determination

in proposing the current amendments to part 35 and

will not make any such determination now.

16See note 8, supra.

17For rules pertaining to clearing, see part 39

which the Commission is adopting in a companion

release in this edition of the Federal Register.

18The Commission has made a technical change

to the nonrepudiation provision in rule 35.3(b) to

make clear that the reasonable belief is to exist at

the time the transaction is entered into. In addition,

the Commission has reorganized the

nonrepudiation provisions of section 35.3.

19That definition generally uses the list of

‘‘appropriate persons’’ set forth in section 4(c)(3)(A)

through (J) of the Act, and utilizes the authority

granted by section 4(c)(3)(K) to determine other

persons to be appropriate persons (specifically,

natural persons with total assets exceeding at least

$10 million). The Commission placed certain

financial and other limitations on various categories

of appropriate persons, consistent with Congress’

intent that the Commission may limit the terms of

an exemption to some, but not all, of the listed

categories of appropriate persons. See H.R. Rep. No.

978, 102nd Cong., 2d Sess. 79 (1992).

Moreover, the contract

nonrepudiation provision that the

Commission is adopting today further

removes any potential legal uncertainty.

As one commenter, McDermott, Will &

Emery, on behalf of Virginia Electric &

Power Company, noted, this provision

‘‘would prevent economically

disappointed counterparties from

bringing a private cause of action

seeking to void the contract on the

theory that it is illegal.’’ CL 24–25 at 2.

This provision, as ISDA commented,

will reduce legal uncertainty because

‘‘[it] deal[s] directly with the main

source of legal risk under the CEA.’’ CL

24–8 at 5.

The expansion of the exemption to

cover all bilateral ‘‘contracts,

agreements and transactions’’ was

endorsed by most other commenters. As

one commenter, Reuters Group PLC,

noted, this amendment should permit a

‘‘substantially broader range of

transactions to enjoy a new level of legal

certainty.’’ CL 24–30 at 2. In this regard,

the Commission believes that certain

pending matters may now be considered

within the context of the new regulatory

framework.

Two commenters, a coalition of

commercial and investment banks (the

Coalition)16 and the OTC Derivatives

Products Committee of the Securities

Industry Association (SIA),

recommended two changes regarding

the operation of the exemption. CL 24–

31; CL 24–36. First, they suggested that

the Commission delete the requirement

of the exemption that, in cases where a

transaction is not submitted for

clearing,17 the creditworthiness of the

counterparty be a material consideration

in entering into the transaction. These

commenters believe that retention of the

creditworthiness requirement for noncleared transactions will create

uncertainty and confusion as to what

types of non-cleared transactions are

permissible. The Commission agrees

and has deleted the creditworthiness

requirement from part 35.

The Coalition and SIA also

recommended that rule 35.2(d) be

amended to authorize explicitly the

netting of deliveries or delivery

obligations in connection with

transactions pursuant to part 35.

Currently, part 35 permits bilateral

arrangements for the netting of payment

obligations. It also permits multilateral

arrangements for the netting of

payments ‘‘provided that the underlying

gross obligations among the parties are

not extinguished until all netted

obligations are fully performed.’’ 58 FR

at 5591. SIA commented that many

categories of OTC derivatives require or

permit settlement by delivery, that it

can see no policy reason for excluding

netting of such deliveries while

permitting netting of payments, and that

permitting such netting would be

consistent with the goal of reducing

systemic risk for OTC derivatives. CL

24–36 at 10. In light of these comments,

the Commission is clarifying that the

types of netting agreements that are

permissible under part 35 include

arrangements for the netting of delivery

obligations or deliveries, respectively.

As is currently the case for multilateral

netting of payments, multilateral netting

of deliveries would be permitted

provided that the underlying gross

obligations among the parties are not

extinguished until all netted obligations

are fully performed.

ISDA, the Coalition and SIA suggested

that the Commission clarify that the

determination whether a party is an

eligible participant is to be determined

by whether there was a reasonable belief

at the time the transaction was entered

into that a party was an eligible

participant. CL 24–8 at 3; CL 24–31 at

8; CL 24–36 at 8. The language of the

exemption currently tracks the language

of the statute, which provides that the

Commission shall not grant an

exemption under section 4(c) of the Act

unless the Commission determines that

the exempted transaction ‘‘will be

entered into solely between appropriate

persons.’’ 7 U.S.C. 6(c)(2)(B)(i).

However, as the Commission noted

when it adopted the swaps exemption

in 1993 (58 FR at 5589; footnotes

omitted):

As the Act specifies that the swap

agreement may only be ‘‘entered into’’ by

appropriate persons, this determination is to

be made at the inception of the transaction.

Further, it is sufficient that the parties have

a reasonable basis to believe that the other

party is an eligible swap participant at such

time.

Furthermore, the Commission notes that

the nonrepudiation provision

specifically exempts a party from a

rescission action based solely on the

failure of the agreement to comply with

the terms of the exemption when that

party entered into the agreement with

an eligible participant or with a

counterparty ‘‘reasonably believed by

such party at the time the transaction

was entered into’’ to be an eligible

counterparty.18

As part of its proposed amendments

to part 35, the Commission proposed to

publish its Swaps Policy Statement as

Appendix A to part 35 and to include

its Swaps Policy Statement and its

Statutory Interpretation Concerning

Certain Hybrid Instruments (55 FR

13582 (April 11, 1990)) (Hybrid

Interpretation) within the

nonrepudiation provision. The

commenters generally supported these

proposals, but recommended that the

Commission update the Swaps Policy

Statement, provide additional relief

regarding the Treasury Amendment (7

U.S.C. 2(ii)) and revise and update the

Hybrid Interpretation. CL 24–31 at 14–

16; CL 24–36 at 3–7. As the Commission

has noted, nothing in these rules affects

the continuing vitality of the

Commission’s existing exemptions,

policy statements or interpretations. The

Commission is persuaded, however, that

these commenters have raised important

issues which, although outside the

scope of this rulemaking, should be

addressed expeditiously. The

Commission plans to address these

issues through a separate rulemaking or

other appropriate action.

B. Eligible Participants

A number of commenters suggested

changes to the definition of ‘‘eligible

participant’’ in rule 35.1. The

Commission proposed applying the

definition of eligible participant set

forth in the 1993 swaps exemption19 to

the revised and amended bilateral

transaction exemption in part 35. Two

commenters, the Managed Funds

Association (MFA) and the Futures

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78033

20Many commenters also suggested modifications

to the Commission’s proposed definition of

‘‘multilateral transaction execution facility’’ in part

36. These comments are addressed in a companion

release being issued by the Commission today

adopting final rules governing multilateral

transaction execution facilities. In this regard, the

Commission notes that the use of the term

‘‘bilateral’’ in the title of part 35 does not import

any independent requirements regarding the

exemption. Taken together, however, part 35

governing bilateral transactions and parts 36

through 38 governing multilateral transactions

execution facilities are intended to be seamless in

the sense that transactions that do not fall within

the definition of multilateral transaction execution

facility in part 36 will be considered to be bilateral.

21 In light of this general agency authorization by

eligible participants on behalf of other eligible

participants, the Commission is deleting the

language in paragraphs 35.1(b)(2)(i), (ix) and (x)

which specifically authorizes certain entities such

as banks and futures commission merchants that are

eligible participants to act in an agency capacity on

behalf of other eligible participants. See 7 U.S.C.

6(c)(3)(A), (I) and (J). This specific authorization is

now unnecessary. 22 In a companion release being issued in this

edition of the Federal Register, however, the

Commission has modified the access standards for

CTAs to provide that CTAs with at least $25 million

under management may trade on a recognized

derivatives transaction facility through any

registered futures commission merchant. Moreover,

in response to the comments of the futures

exchanges, in the same companion release being

issued today, the Commission has modified the

eligibility standards for recognized derivatives

transaction facilities to include certain registered

floor brokers and floor traders. The Commission,

however, is retaining the existing eligibility

standards for floor brokers and floor traders when

entering into bilateral transactions under part 35

(and when trading on exempt multilateral

transaction execution facilities). 23Furthermore, with regard to the comments

suggesting that some of the financial thresholds in

the definition are too restrictive, the Commission

notes that the part 35 definition of eligible

participant has worked well over the years and that

the amounts in real terms are less restrictive than

when the exemption was first adopted.

24Rule 32.13 includes its own exemption which

imposes a different financial threshold than part 35.

Under rule 32.13(g), an option is exempt from

various regulatory requirements if, among other

things, each party to the option has a net worth of

not less than $10 million. The Commission has

reserved the application of rule 32.13 in part 35, see

rule 35.3(a), and it is that reservation to which

NGFA and Cargill object.

25H.R. Rep. No. 978, 102d Cong., 2d Sess. 82–83

(1992).

Industry Association (FIA), suggested

that the Commission create a new

category of eligible participant that

would include certain large commodity

trading advisors. CL 24–4 at 4; CL 24–

12 at 11. Specifically, MFA and FIA

suggested that commodity trading

advisors (CTAs) with at least $25

million in assets under management be

permitted to trade in all exempt markets

on behalf of their customers, without

regard to the individual customers’

financial qualifications. FIA also

suggested that registered investment

advisers (IAs) with at least $25 million

in assets under management be

included in this category of eligible

participant.

Several other commenters suggested

additional modifications to the

definition of eligible participant. ISDA,

the Coalition, The EBS Partnership and

SIA recommended that the definition of

eligible participant be expanded to

include several additional categories of

financial institutions and to include

agency transactions by eligible

participants on behalf of other eligible

participants. CL 24–8; CL 24–31; CL 24–

34; CL 24–36. Certain commenters,

including the California Power

Exchange, the National Grain and Feed

Association (NGFA) and the Weather

Risk Management Association,

suggested that the financial thresholds

for corporations and other entities were

too restrictive. CL 24–5; CL 24–10; CL

24–28. Other commenters, including the

FIA, the Coalition and SIA, commented

that the financial threshold for natural

persons who enter into exempt

transactions for risk management

purposes should be reduced from a total

asset test of $10 million to a total asset

test of $5 million. CL 24–12; CL 24–31;

CL 24–36. Finally, the National Futures

Association suggested that the

Commission impose a $5 million asset

test on investment companies to

conform the standard for those

collective investment vehicles to that

which applies to commodity pools. CL

24–4.20

After careful consideration of these

comments, the Commission is

modifying the definition of eligible

participant to permit agency

transactions by eligible participants on

behalf of other eligible participants,21 to

include foreign banks and their U.S.

branches and agencies and the regulated

subsidiaries and affiliates of insurance

companies within that definition and to

include a $5 million asset test for

investment companies (as is required for

investment companies under the current

part 36). The Commission will consider

MFA’s and NFA’s suggestion that a new

category of eligible participant be added

for registered CTAs and IAs with at least

$25 million in assets under management

in conjunction with its subsequent

review of relief for CPOs and CTAs.22

In response to the comments

regarding expanding the categories of

eligible financial institutions and

reducing the financial thresholds for

corporations and other entities, the

Commission notes that the current

definition of eligible participant

contains a general corporate category,

which itself contains alternative means

of qualifying, and that this general

corporate category enables many

different types and sizes of entities

(including financial institutions) to

qualify as eligible participants under

part 35. As the Coalition acknowledges

(CL 24–31 at 6), many financial

institutions that are not specifically

encompassed by the definition of

eligible participant fall within this

general corporate category. The

Commission believes that this general

corporate category is an appropriate

standard to determine corporate

eligibility.23

C. Agricultural Trade Options

Finally, the NGFA and Cargill opined

that the bilateral transaction exemption

should be available for all transactions

in the agricultural commodities

enumerated in section 1a(3) of the Act,

including agricultural trade options. CL

24–10 at 3; CL 24–15 at 1–2. The

Commission is retaining in part 35 its

reservation of rule 32.13 which governs

trading in certain agricultural trade

options at this time.24 The Commission

has not yet had sufficient experience

with rule 32.13, which the Commission

recently reconsidered and adopted (64

FR 68011 (December 6, 1999)), to

determine whether the $10 million net

worth level should be modified.

Furthermore, at the time the

Commission adopted that exemptive

level it noted the lack of industry

consensus on the issue. Id. at 68015.

The Commission has no reason to

believe that a greater level of consensus

has been reached since that time.

The Commission reiterates that these

amendments to the part 35 exemption

are designed to enhance legal certainty.

In adopting these amendments to part

35, the Commission is not making any

determination that the exempted

transactions are or are not subject to its

jurisdiction. When it adopted section

4(c) in 1992, the Conferees of the

Congress stated:

The Conferees do not intend that the

exercise of exemptive authority by the

Commission [under section 4(c)] would

require any determination beforehand that

the agreement, instrument, or transaction for

which an exemption is sought is subject to

the Act. Rather, this provision provides

flexibility for the Commission to provide

legal certainty to novel instruments where

the determination as to jurisdiction is not

straightforward.25

Moreover, these changes in no way

call into question any transaction

undertaken under part 35 before the

adoption of these amendments. In

recognition of its continuing vitality and

to assist the public in locating it, the

Commission as proposed is

incorporating its 1989 Swaps Policy

78034 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

26The Swaps Policy Statement originally was

published at 54 FR 30694 (July 21, 1989). In this

republication, the Commission has corrected certain

typographical errors that appeared in the original

publication.

27See 7 U.S.C. 6(c).

28 ‘‘Small organization,’’ as used in the RFA,

means ‘‘any not-for-profit enterprise which is

independently owned and operated and is not

dominant in its field * * *.’’ 5 U.S.C. 601(4). The

RFA does not incorporate the size standards of the

Small Business Administration for small

organizations. Agencies are expressly authorized to

establish their own definition of small organization.

Id.

29 47 FR 18618–20 (Apr. 20, 1982).

Statement as Appendix A to part 35.26

Finally, the Commission again affirms

the continuing applicability of its

Energy Interpretation and its Energy

Exemption which are not being changed

or altered in any way by these part 35

amendments.

III. Section 4(c) Findings

These rule amendments are being

promulgated under section 4(c) of the

Act, which grants the Commission

broad exemptive authority. Section 4(c)

of the Act provides that, in order to

promote responsible economic or

financial innovation and fair

competition, the Commission may by

rule, regulation or order exempt any

class of agreements, contracts or

transactions, either unconditionally or

on stated terms or conditions from any

of the requirements of any provision of

the Act. For any exemption granted

pursuant to section 4(c), the

Commission must find that the

exemption would be consistent with the

public interest. For any exemption

granted pursuant to section 4(c) from

the requirements of section 4(a), the

Commission must further find that the

section 4(a) requirements should not be

applied to the agreement, contract or

transaction to be exempted, that the

exemption would be consistent with the

public interest and the purposes of the

Act, that the agreement, contract or

transaction to be exempted would be

entered into solely between appropriate

persons and that the exemption would

not have a material adverse effect on the

ability of the Commission or any

contract market to discharge its

regulatory or self-regulatory duties

under the Act.27

No one commented directly on the

Commission’s section 4(c) findings. Two

U.S. futures exchanges, the Chicago

Board of Trade and the Chicago

Mercantile Exchange, however,

cautioned the Commission to ensure

that traditional exchange markets would

not be put at an unfair competitive

disadvantage within this new regulatory

regime contemplated by this and the

Commission’s companion Federal

Register releases. CL 24–7 at 12–13; CL

24–17 at 13–14. In this regard, the

Commission believes that the regulatory

lines that it has drawn are necessary and

appropriate to protect the public

interests embodied in the Act. Under

the framework as a whole, the degree of

regulation will turn on whether the

market is multilateral, whether the

market participants are eligible and

whether or not the commodity is

susceptible to manipulation. The

Commission believes that these are

appropriate factors on which to base

regulatory differences and that, within

the framework, the exchanges will be

able to fairly compete with the OTC

market.

The proposed exemption for bilateral

transactions is available only to

appropriate persons. Moreover, these

amendments to part 35 will promote

financial innovation and fair

competition and reduce systemic risk.

The Commission further finds that these

proposed amendments would have no

adverse effect on any of the regulatory

or self-regulatory responsibilities

imposed by the Act. Finally, the

Commission finds that these

amendments are consistent with the

public interest.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA),

5 U.S.C. 601 et seq., requires that

agencies, in promulgating rules,

consider the impact of these rules on

small entities. A small entity is defined

to include, inter alia, a ‘‘small business’’

and a ‘‘small organization.’’ 5 U.S.C.

601(6).28 The Commission previously

has formulated its own standards of

what constitutes a small business with

respect to the types of entities regulated

by it. The Commission has determined

that contract markets, futures

commission merchants, registered

commodity pool operators, and large

traders should not be considered small

entities for purposes of the RFA.29

The Commission believes that it is

unlikely that firms defined as small

businesses under Section 3 of the Small

Business Act could offer or be offered

transactions subject to the part 35

exemption and thus be affected by the

rules exempting such transactions. See

58 FR 5587, 5593 (January 22, 1993).

Further, the amendments to part 35 that

the Commission is adopting today

remove the requirement that the exempt

transactions not be fungible or

standardized as to their material

economic terms and makes the

expanded relief available to a broader

category of transactions.

Accordingly, the Chairman, on behalf

of the Commission, certifies pursuant to

section 3(a) of the RFA, 5 U.S.C. 605(b),

that the amendments to part 35 will not

have a significant economic impact on

a substantial number of small entities.

In this regard, the Commission notes

that it did not receive any comments

regarding the RFA implications of the

amendments to part 35.

B. Paperwork Reduction Act

The Paperwork Reduction Act (PRA)

of 1995 (44 U.S.C. 3507(d)) imposes

certain requirements on federal agencies

(including the Commission) in

connection with their conducting or

sponsoring any collection of

information as defined by the PRA. As

the Commission noted in proposing

these amendments, it has determined

that the PRA does not apply to these

amendments because they do not

contain information collection

requirements which require the

approval of the Office of Management

and Budget. No comments were

received concerning the Commission’s

determination in this regard.

List of Subjects in 17 CFR Part 35

Commodity futures, Commodity

Futures Trading Commission.

In consideration of the foregoing, and

pursuant to the authority contained in

the Commodity Exchange Act and, in

particular, sections 2, 4, 4c, and 8a

thereof, 7 U.S.C. 2, 6, 6c, and 12a, the

Commission hereby revises part 35 of

title 17 of the Code of Federal

Regulations to read as follows:

PART 35—EXEMPTION OF BILATERAL

AGREEMENTS

Sec.

35.1 Scope and definitions.

35.2 Exemption.

35.3 Enforceability.

Appendix A to Part 35—Policy

Statement Concerning Swap

Transactions

Authority: 7 U.S.C. 2, 6, 6c, and 12a.

§ 35.1 Scope and definitions.

(a) Scope. The provisions of this part

shall apply to any contract, agreement

or transaction which may be subject to

the Act, and which has been entered

into on or after October 23, 1974.

(b) Definition. As used in this part,

‘‘eligible participant’’ means, and shall

be limited to, the following persons or

classes of persons, either trading for

their own account or through another

eligible participant:

(1) A bank or trust company or a

foreign bank or a branch or agency of a

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78035

foreign bank (as defined in section 1(b)

of the International Bank Act of 1978

(12 U.S.C. 3101(b));

(2) A savings association or credit

union;

(3) An insurance company that is

regulated by a State or that is regulated

by a foreign government and is subject

to comparable regulation (including a

regulated subsidiary or affiliate of such

an insurance company);

(4) An investment company subject to

regulation under the Investment

Company Act of 1940 (15 U.S.C. 80a–1

et seq.) or a foreign person performing

a similar role or function subject as such

to foreign regulation, provided that such

investment company or foreign person

is not formed solely for the specific

purpose of constituting an eligible

participant and has total assets

exceeding $5,000,000;

(5) A commodity pool formed and

operated by a person subject to

regulation under the Act or a foreign

person performing a similar role or

function subject as such to foreign

regulation, provided that such

commodity pool or foreign person is not

formed solely for the specific purpose of

constituting an eligible participant and

has total assets exceeding $5,000,000;

(6) A corporation, partnership,

proprietorship, organization, trust, or

other entity not formed solely for the

specific purpose of constituting an

eligible participant:

(i) Which has total assets exceeding

$10,000,000, or

(ii) The obligations of which under

the contract, agreement or transaction

are guaranteed or otherwise supported

by a letter of credit or keepwell,

support, or other agreement by any such

entity referenced in paragraph (b)(6) of

this section or by an entity referred to

in paragraph (b)(1), (2), (3), (4), (5), (6)

or (8) of this section; or

(iii) Which has a net worth of

$1,000,000 and enters into the

agreement in connection with the

conduct of its business; or which has a

net worth of $1,000,000 and enters into

the agreement to manage the risk of an

asset or liability owned or incurred in

the conduct of its business or reasonably

likely to be owned or incurred in the

conduct of its business;

(7) An employee benefit plan subject

to the Employee Retirement Income

Security Act of 1974 or a foreign person

performing a similar role or function

subject as such to foreign regulation

with total assets exceeding $5,000,000,

or whose investment decisions are made

by a bank, trust company, insurance

company, investment adviser subject to

regulation under the Investment

Advisers Act of 1940 (15 U.S.C. 80a–1

et seq.), or a commodity trading advisor

subject to regulation under the Act;

(8) Any governmental entity

(including the United States, any state,

or any foreign government) or political

subdivision thereof, or any

multinational or supranational entity or

any instrumentality, agency, or

department of any of the foregoing;

(9) A broker-dealer subject to

regulation under the Securities

Exchange Act of 1934 (15 U.S.C. 78a et

seq.) or a foreign person performing a

similar role or function subject as such

to foreign regulation: Provided, however,

that if such broker-dealer is a natural

person or proprietorship, the brokerdealer must also meet the requirements

of either paragraph (b)(6) or (11) of this

section;

(10) A futures commission merchant,

floor broker, or floor trader subject to

regulation under the Act or a foreign

person performing a similar role or

function subject as such to foreign

regulation: Provided, however, that if

such futures commission merchant,

floor broker, or floor trader is a natural

person or proprietorship, the futures

commission merchant, floor broker, or

floor trader must also meet the

requirements of paragraph (b)(6) or

(b)(11) of this section; or

(11) Any natural person with total

assets exceeding at least $10,000,000.

§ 35.2 Exemption.

A contract, agreement or transaction

is exempt from all provisions of the Act

and any person or class of persons

offering, entering into, rendering advice,

or rendering other services with respect

to such contract, agreement or

transaction, is exempt for such activity

from all provisions of the Act (except in

each case the provisions enumerated in

§ 35.3(a)) provided the following terms

and conditions are met:

(a) The contract, agreement or

transaction is entered into solely

between eligible participants either

trading for their own account or through

another eligible participant;

(b) The contract, agreement or

transaction is not entered into and

traded on or through a multilateral

transaction execution facility as defined

in § 36.1 of this chapter; and

(c) The contract, agreement or

transaction, if cleared, is submitted for

clearance or settlement to a

clearinghouse that is authorized under

§ 39.2 of this chapter.

(d) The provisions of paragraphs (b)

and (c) of this section shall not be

deemed to preclude:

(1) Arrangements or facilities between

parties to such contracts, agreements or

transactions that provide for netting of

payment or delivery obligations

resulting from such contracts,

agreements or transactions;

(2) Arrangements or facilities among

parties to such contracts, agreements or

transactions that provide for netting of

payments or deliveries resulting from

such contracts, agreements or

transactions; or

(3) The use of an electronic or nonelectronic market or similar facility used

solely as a means of communicating

bids or offers by market participants or

the use of such a market or facility by

a single counterparty to offer to enter

into or to enter into bilateral

transactions with multiple

counterparties.

(e) Any person may apply to the

Commission for exemption from any of

the provisions of the Act (except section

2(a)(1)(B)) for other arrangements or

facilities, on such terms and conditions

as the Commission deems appropriate,

including but not limited thereto, the

applicability of other regulatory

regimes.

§ 35.3 Enforceability.

(a) Notwithstanding the exemption in

§ 35.2, sections 2(a)(1)(B), 4b, and 4o of

the Act, § 32.9 of this chapter as adopted

under section 4c(b) of the Act, § 32.13

of this chapter, and sections 6(c) and

9(a)(2) of the Act to the extent that they

prohibit manipulation of the market

price of any commodity in interstate

commerce or for future delivery on or

subject to the rules of any contract

market, continue to apply to

transactions and persons otherwise

subject to those provisions.

(b) A party to a contract, agreement or

transaction that is with a counterparty

that is an eligible participant (or

counterparty reasonably believed by

such party at the time the contract,

agreement or transaction was entered

into to be an eligible participant) shall

be exempt from any claim, counterclaim

or affirmative defense by such

counterparty under section 22(a)(1) of

the Act or any other provision of the

Act:

(1) That such contract, agreement or

transaction is void, voidable or

unenforceable, or

(2) To rescind, or recover any

payment made in respect of, such

contract, agreement or transaction,

based solely on the failure of such party

or such contract, agreement or

transaction to comply with the terms or

conditions of the exemption under this

part.

(c) A party to a contract, agreement or

transaction that is entered into pursuant

to the Statement of Policy Concerning

Swap Transactions in appendix A to

78036 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1 7 U.S.C. 6(a), 6c(b), 6c(c). Section 4(a) of the

CEA provides, inter alia, that it is unlawful to enter

into a commodity futures contract that is not made

‘‘on or subject to the rules of a board of trade which

has been designated by the Commission as a

‘contract market’ for such commodity.’’ 7 U.S.C.

6(a). This prohibition does not apply to futures

contracts made on or subject to the rules of a foreign

board of trade, exchange or market. 7 U.S.C. 6(a).

The exchange trading requirement reflects

Congress’s view that such an environment would

control speculation and promote hedging. H.R. Rep.

No. 44, 67th Cong., 1st Sess. 2 (1921). See also 7

U.S.C. 5 (Congressional findings concerning

necessity for regulation of futures and commodity

option transactions). Pursuant to sections 4c(b) and

4c(d), 7 U.S.C. 6c(b) and 6c(d), of the CEA, the

Commission has authority to permit transactions in

commodity options which do not take place on

contract markets. Currently, only two narrow

categories of such option transactions exist: trade

options (in which the offeree is a ‘‘commercial

user’’ of the underlying commodity) and dealer

options (in which the grantor fulfills the criteria of

section 4c(d)(1) of the CEA). See also 54 FR 1128

(January 11, 1989) (Proposed Rules Concerning

Regulation of Hybrid Instruments). Final Rules

Concerning Regulation of Hybrid Instruments.

2 52 FR 47022 (December 11, 1987) (Advance

Notice of Proposed Rulemaking); 54 FR 1139

(January 11, 1989) (Statutory Interpretation

Concerning Certain Hybrid Instruments); 54 FR

1128 (January 11, 1989) (Proposed Rules

Concerning Regulation of Hybrid Instruments). See

also 50 FR 42963 (October 23, 1985) (Statutory

Interpretation and Request for Comments

Concerning Trading in Foreign Currencies for

Future Delivery).

3The Commission staff’s Task Force on OffExchange Instruments has addressed a number of

proposed offerings of hybrid instruments in a series

of published ‘‘no-action’’ letters. See, e.g., CFTC

Advisory No. 39–88, June 23, 1988 [Interpretative

Letter No. 88–10, June 20, 1988, 2 Comm. Fut. L.

Rep. (CCH) ¶ 24,262] (notes indexed to dollar/Yen

exchange rate); CFTC Advisory No. 45–88, July 19,

1988 [Interpretative Letter No. 88–11, July 13, 1988,

2 Comm. Fut. L. Rep. (CCH) ¶ 24,284] (notes

indexed to dollar/Yen exchange rate); CFTC

Advisory No. 48–88, July 26, 1988 [Interpretative

Letter No. 88–12, July 22, 1988, 2 Comm. Fut. L.

Rep. (CCH) ¶ 24,285] (notes indexed to dollar/

foreign currency exchange rate); CFTC Advisory No.

58–88, August 30, 1988 [Interpretative Letter No.

88–16, August 26, 1988, 2 Comm. Fut. L. Rep.

(CCH) ¶ 24,312] (federally-chartered corporation

issuing notes indexed to nationally disseminated

measure of inflation published by a U.S.

government agency); CFTC Advisory No. 63–88,

September 21, 1988 [Interpretative Letter No. 88–

17, September 6, 1988, 2 Comm. Fut. L. Rep. (CCH)

¶ 24,320] (fixed-rate debentures with additional

payments indexed to the price of natural gas over

an established base price); CFTC Advisory No. 66–

88, September 23, 1988, 2 Comm. Fut. L. Rep.

(CCH) ¶ 24,321 (certificates of deposit with interest

payable at maturity indexed in part to the spot price

of gold). See also CFTC Advisory No. 18–19, March

17, 1989 (letter dated November 23, 1988,

concerning proposed sale of hay for delayed

delivery).

4CFTC v. Co Petro Marketing Group, Inc., 680

F.2d 573, 581 (9th Cir. 1982).

5CFTC v. Trinity Metals Exchange, No. 85–1482–

CV–W–3 (W.D. Mo. January 21, 1986] [citing CFTC

v. National Coal Exchange, Inc. [1980–1982

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,424

at 26,046 (W.D. Tenn. 1982)].

6See generally, 52 FR 47022, 47023 (December

11, 1987) (citing In the Matter of First National

Monetary Corp., [1984–1986 Transfer Binder]

Comm. Fut. L. Rep. (CCH) ¶ 22,698 (CFTC 1985));

Letter to the Honorable Patrick Leahy and the

Honorable Richard Lugar, Committee on

Agriculture, Nutrition and Forestry, United States

Senate, from Wendy L. Gramm, Chairman,

Commodity Futures Trading Commission, dated

May 16, 1989 (Attachment at 7–8). The Commission

has explained that this does not mean that ‘‘all

commodity futures contracts must have all of these

elements * * *’’ In re Stovall, [1977–1980 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,941 (CFTC

1979). To hold otherwise would permit ready

evasion of the CEA.

7E.g., Advance Notice, 52 FR 47023; Letter to the

Honorable Patrick Leahy and the Honorable Richard

Lugar, Committee on Agriculture, Nutrition and

Forestry, United States Senate, from Wendy L.

Gramm, Chairman, Commodity Futures Trading

Commission, dated May 16, 1989 (Attachment at 8);

OGC Statutory and Regulatory Interpretation

(Regulation of Leverage Transactions and Other OffExchange Future Delivery-Type Instruments), 50 FR

11656, 11657, n.2 (March 25, 1985); CFTC v. Co

Petro Marketing Group, Inc., 680 F.2d 573 (9th Cir.

1982).

this part 35 or the Statutory

Interpretation Concerning Certain

Hybrid Instruments, as the same may be

revised by the Commission from time to

time, shall be exempt from any claim

under section 22(a)(1) of the Act or any

other provision of the Act:

(1) That such contract, agreement or

transaction is void, voidable or

unenforceable, or

(2) To rescind, or recover any

payment made in respect of, such

contract, agreement or transaction,

based solely on the failure of such party,

or such contract, agreement or

transaction, to comply with the

Statement of Policy Concerning Swap

Transactions in appendix A to this part

35 or the Statutory Interpretation

Concerning Certain Hybrid Instruments,

as the same may be revised by the

Commission from time to time,

respectively, or with any provision of

the Act or other Commission rule or

exemption, excluding, in the case of this

paragraph, any claim for manipulation

or fraud arising under a provision of the

Act or Commission rules applicable by

its terms to a contract, agreement or

transaction that is not otherwise subject

to regulation under the Act.

Appendix A to Part 35—Policy

Statement Concerning Swap

Transactions

(a) Background.

(1) Section 2(a)(1)(A) of the Commodity

Exchange Act (CEA or Act) grants the

Commission exclusive jurisdiction over

‘‘accounts, agreements (including any

transaction which is of the character of * * *

an ‘option’ * * *), and transactions

involving contracts of sale of a commodity

for future delivery traded or executed on a

contract market * * * or any other board of

trade, exchange, or market. * * *’’ 7 U.S.C.

2. The CEA and Commission regulations

require that transactions in commodity

futures contracts and commodity option

contracts, with narrowly defined exceptions,

occur on or subject to the rules of contract

markets designated by the CFTC.1 In several

recent releases 2 and in response to requests

for case-by-case review of various proposed

offerings,3 the Commission has addressed the

applicability of the Act and Commission

regulations to various forms of commodityrelated instruments offered and sold other

than on designated contract markets. An

overview of off-exchange transactions and

issues was commenced by issuance in

December 1987 of an Advance Notice of

Proposed Rulemaking (Advance Notice). The

Advance Notice requested comment

concerning, among other things, a proposed

no-action position concerning certain

commercial transactions, which, as

described, would have extended to certain

categories of swap transactions.

(2) Based upon careful review of the

comments received in response to the

Advance Notice, indicating generally a need

for greater clarity in this area, representations

from market users, and consultations with

other federal regulators concerning the issues

raised by swap transactions, the Commission

is issuing this policy statement to clarify its

view of the regulatory status of certain swap

transactions. This statement reflects the

Commission’s view that at this time most

swap transactions, although possessing

elements of futures or options contracts, are

not appropriately regulated as such under the

Act and regulations. This policy statement is

intended to recognize a non-exclusive safe

harbor for transactions satisfying the

requirements set forth in this Appendix.

(b) Safe harbor standards. (1) In

determining whether a transaction

constitutes a futures contract, the

Commission and the courts have assessed the

transaction ‘‘as a whole with a critical eye

toward its underlying purpose.’’ 4 Such an

assessment entails a review of the ‘‘overall

effect’’ of the transaction as well as a

determination as to ‘‘what the parties

intended.’’ 5 Although there is no definitive

list of the elements of futures contracts, the

CFTC and the courts recognize certain

elements as common to such contracts.6

Futures contracts are contracts for the

purchase or sale of a commodity for delivery

in the future at a price that is established

when the contract is initiated, with both

parties to the transaction obligated to fulfill

the contract at the specified price. In

addition, futures contracts are undertaken

principally to assume or shift price risk

without transferring the underlying

commodity. As a result, futures contracts

providing for delivery may be satisfied either

by delivery or offset.

(2) In addition to these necessary elements,

the CFTC and the courts also recognize

certain additional elements common to

exchange-traded futures contracts, including

standardized commodity units, margin

requirements related to price movements,

clearing organizations which guarantee

counterparty performance, open and

competitive trading in centralized markets,

and public price dissemination.7 These

additional elements facilitate the trading of

futures contracts on exchanges and

historically have developed in conjunction

with the growth of organized contract

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78037

8 In addition, the Commission and the courts have

consistently recognized that ‘‘the requirement that

a futures contract be executed on a designated

contract market is what makes the contract legal,

not what makes it a futures contract.’’ In the Matter

of First National Monetary Corp., [1984–1986

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,698

at 30,975 (CFTC 1985); In re Stovall, [1977–1980

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,941

at 23,776 (CFTC 1979). See, also, Interpretative

Statement, ‘‘The Regulation of Leverage

Transactions and Other Off-Exchange Future

Delivery Type Investments-Statutory

Interpretation,’’ 50 FR 11656 (March 25, 1985). 9See generally, Bank for International

Settlements, Recent Innovations in International

Banking at 37–60 (April 1986); S.K. Henderson,

‘‘Swap Credit Risk: A Multi-Perspective Analysis,’’

44 Business Lawyer 365 (1989). Interest rate swaps

have been described as having three primary forms:

coupon swaps (fixed rate to floating rate swaps);

basis swaps (swap of one floating rate for another

floating rate); and cross-currency interest rate swaps

(swaps of fixed rate payments in one currency to

floating rate payments in another currency).

Currency swap transactions involve agreements

between two parties providing for exchanges of

amounts in different currencies which are

calculated on the basis of a pre-established interest

rate, a specified exchange rate, and a specified

notional amount. Commodity swaps generally

include swap transactions similar in structure to

interest rate swaps, except that payments are

calculated by reference to the price of a specified

commodity, such as oil. 10The average notional amount for swaps has

been estimated at $24 million. Letter from the New

York Clearing House to CFTC, dated April 6, 1989,

commenting on Proposed Rule and Statutory

Interpretation Concerning Certain Hybrid and

Related Instruments. 11E.g., Letter to CFTC from the International

Swap Dealers Association, Inc., dated April 8, 1988,

concerning Advance Notice; letter to CFTC from

Morgan Guaranty Trust Company of New York,

dated April 11, 1988, concerning Advance Notice.

12Section 2(a)(1)(A) of the CEA provides that the

term ‘‘future delivery’’ does not include sales of any

cash commodity for deferred shipment or delivery.

7 U.S.C. 2. Sales of cash commodities for deferred

delivery, or forward contracts, generally have been

recognized to be commercial, merchandising

transactions in physical commodities entered into

by commercial counterparties who have the

capacity to make or take delivery of the underlying

commodity but in which delivery ‘‘may be deferred

for purposes of convenience or necessity.’’ 52 FR

47027; In re Stovall, [1977–1980 Transfer Binder]

Comm. Fut. L. Rep. (CCH) ¶ 20,941 at 23,777–78

(CFTC 1979). The forward contract exclusion may

apply to certain types of swap transactions.

13The Treasury Amendment provides that

‘‘[n]othing in this Act shall be deemed to govern or

in any way be applicable to transactions in foreign

currency, security warrants, security rights, resales

of installment loan contracts, repurchase options,

government securities, or mortgages and mortgage

purchase commitments, unless such transactions

involve the sale thereof for future delivery

conducted on a board of trade.’’ 7 U.S.C. 2. See

generally, 50 FR 42963 (October 23, 1985) (CFTC

Statutory Interpretation). See also, Commodity

Futures Trading Commission v. American Board of

Trade, 473 F. Supp. 117 (S.D.N.Y. 1979), aff’d, 803

F.2d 1242 (2d Cir. 1986). The Treasury Amendment

may apply to some types of transactions also

characterized as swaps.

14The trade option exemption, which is set forth

in Rule 32.4(a), 17 CFR 32.4(a) (1988), authorizes

commodity option transactions, other than those on

commodities specified in rule 32.2(a), that are not

executed on a designated contract market and that

are:

Offered by a person which has a reasonable basis

to believe that the option is offered to a producer,

processor, or commercial user of, or a merchant

handling the commodity which is the subject of the

commodity option transaction, or the products or

byproducts thereof, and that such producer,

processor, commercial user or merchant is offered

or enters into the commodity option transaction

solely for purposes related to its business as such.

It should be noted that under Rule 32.4(a), only the

offeree of the trade option need qualify as a

‘‘commercial user’’ or ‘‘merchant.’’ Rule 32.4(a) is

silent concerning which party to a trade option may

be the option buyer of a put or call or ‘‘long,’’ and

which party may be the option seller of a put or

call or ‘‘short.’’ As a result, provided that the

qualifying commercial offeree is entering the trade

option transaction solely for non-speculative

purposes demonstrably related to its commercial

business in the commodity which is the subject of

the option transaction, the requirements of Rule

32.4(a) are met.

15The forward contract exclusion facilitates

commodity transactions within the commercial

merchandising chain. The trade option exemption

similarly may be viewed as facilitating principal-toprincipal transactions in which the offeree is a

commercial party with respect to the underlying

commodity. The Treasury Amendment reflects

Congressional intent to avoid duplicative regulation

of foreign currency transactions and other

transactions in the interbank market supervised by

bank regulatory agencies.

16As noted previously, certain categories of swap

transactions may be subject to the forward contract

exclusion, the Treasury Amendment and the trade

option exemption. The safe harbor criteria set forth

in this Appendix apply equally to options on

swaps.

17Formation of swaps pursuant to a master

agreement between two counterparties that

establishes some or all contract terms for one or

more individual swap transactions between those

counterparties is not precluded by this requirement,

provided that material terms of the master

agreement and transaction specifications are

individually tailored by the parties.

markets. The presence or absence of these

additional elements, however, is not

dispositive of whether a transaction is a

futures contract.8

(3) In general, a swap may be characterized

as an agreement between two parties to

exchange a series of cash flows measured by

different interest rates, exchange rates, or

prices with payments calculated by reference

to a principal base (notional amount).9

Commenters have described the swap market

as one in which the customary large

transaction size effectively limits the market

to institutional participants rather than the

retail public.10 Market participants also have

noted that swaps typically involve long-term

contracts, with maturities ranging up to

twelve years.11 In addition to these

characteristics, many comparisons between

swaps and futures contracts have stressed the

tailored, non-standardized nature of swap

terms; the necessity for particularized credit

determinations in connection with each swap

transaction (or series of transactions between

the same counterparties); the lack of public

participation in the swap markets; and the

predominantly institutional and commercial

nature of swap participants. Other

commenters have stressed that, despite these

distinctions in the manner of trading of

swaps and exchange products, the economic

reality of swaps nevertheless resembles that

of futures contracts.

(4) The Commission recognizes that swaps

generally have characteristics, such as

individually-tailored terms, predominantly

commercial and institutional participants,

and expectation of being held to maturity,

rather than offset during the term of the

agreement, that may warrant distinguishing

them from futures contracts. The criteria set

forth in this Appendix identify certain swaps

for which regulation under the CEA and

Commission regulations is unnecessary.

These safe harbor standards are consistent

with policies reflected in the CEA’s

jurisdictional exclusion for forward

contracts,12 the Treasury Amendment,13 and

the trade option exemption,14 and are

otherwise consistent with section 2(a)(1)(A)

of the CEA. Although these jurisdictional and

exemptive or exclusionary provisions are not

sufficiently broad to provide clear exemptive

boundaries for many swaps, they reflect

policies relevant to the safe harbor policy set

forth in this Appendix and may encompass

certain swap transactions.15

(5) Consequently, the Commission has

determined that a greater degree of clarity

may be achieved through safe harbor

guidelines establishing specific criteria for

swap transactions to which the Commission’s

regulatory framework will not be applied.

Swaps satisfying the requirements set forth in

this Appendix will not be subject to

regulation as futures or commodity option

transactions under the Act and regulations.

This policy statement addresses only swaps

settled in cash, with foreign currencies

considered to be cash.16

(i) Individually-tailored terms. (A)

Individual tailoring of the terms of swap

agreements is frequently cited as

indispensable to the operation of the swap

market. Commenters have indicated that

swap agreements are based upon

individualized credit determinations and are

tailored to reflect the particular business

objectives of the counterparties. Tailoring

occurs through private negotiations between

the parties and may involve not only

financial terms but issues such as

representations, covenants, events of default,

term to maturity, and any requirement for the

posting of collateral or other credit

enhancement. Such tailoring and

counterparty credit assessment distinguish

swap transactions from exchange

transactions, where the contract terms are

standardized and the counterparty is

unknown. In addition, the tailoring of swap

terms means that, unlike exchange contracts,

which are fungible, swap agreements are not

fully standardized.

(B) To qualify for safe harbor treatment,

swaps must be negotiated by the parties as

to their material terms, based upon

individualized credit determinations, and

documented by the parties in an agreement

or series of agreements that is not fully

standardized.17 This requirement is intended

to exclude from safe harbor treatment

instruments which are fungible and therefore

may be readily transferred and traded.

(ii) Absence of exchange-style offset. (A)

Exchange-traded futures contracts generally

78038 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

18 In the context of exchange-traded futures, offset

refers to the liquidation of a futures position

through the acquisition of an opposite position.

Availability of such offset, resulting in the

liquidation of the position, typically is established

by exchange rules governing exchange members’

relationships with the clearing house. See, e.g.,

Chicago Mercantile Exchange Rule 808 (‘‘a clearing

member long or short any commodity to the

Clearing House as a result of substitution may

liquidate the position by acquiring an opposite

position for its principal’’); Board of Trade Clearing

Corporation Regulation 705.00 (‘‘Where a member

buys and sells the same commodity for the same

delivery, and such contracts are cleared through the

Clearing House, the purchases and sales shall be

offset to the extent of their equality, and the

member shall be deemed a buyer from the Clearing

House to the extent that his purchases exceed his

sales, or a seller to the Clearing House to the extent

that his sales exceed his purchases’’); New York

Futures Exchange Rule 3–4 (‘‘As between the

Clearing Corporation and the original parties to

futures contracts and option contracts, such

contracts shall be binding upon the original parties

until liquidated by offset, delivery, exercise or

expiration, as the case may be’’). Of course, the

ability to offset in any given case depends upon the

availability of a counterparty to enter into an

offsetting transaction at an acceptable price.

19However, the ability to liquidate contractual

positions through offset is established by clearing

organization rules to which all clearing members

consent.

20Swap parties may agree in advance upon a

termination formula or price for the swap.

21Several commenters urged the Commission to

adopt a safe harbor for swaps that would be

conditioned upon, among other things, the absence

of a credit support mechanism. See Letter to CFTC

from Sullivan & Cromwell, dated April 8, 1988,

concerning Advance Notice, at 41–42; Letter to

CFTC from Manufacturers Hanover, dated April 11,

1988, concerning Advance Notice, at 4. The safe

harbor standard is based upon individualized credit

determinations at the outset and during the

pendency of the contract.

22Letter dated April 8, 1988, to CFTC from

International Swap Dealers Associations, Inc.

concerning Advance Notice.

23Swap transactions entered into with respect to

exchange rate, interest rate, or other price exposure

arising from a participant’s line of business or the

financing of its business would be consistent with

this standard.

may be terminated by offset,18 that is,

liquidated through establishment of an equal

and opposite position. For exchange-traded

futures contracts, the universal counterparty

to each cleared position is the clearing

organization. Prior consent of the clearing

organization, as counterparty, is unnecessary

to offset.19

(B) In contrast, swap transactions have

been described as transactions which create

performance obligations terminable only

with counterparty consent and which

generally are expected to be maintained to

maturity. A swap counterparty who seeks to

eliminate the economic effect of a swap

agreement may enter into a reverse swap

agreement, that is, a second swap with the

same maturity and payment requirements,

with the same or a new counterparty, but in

which the party seeking to eliminate its

economic exposure assumes the reverse

position (in this case the obligations of each

party to both transactions continue to

maturity). A swap counterparty who seeks to

terminate, absent default, its obligations

under a swap agreement may: Undertake a

swap sale in which, based upon consent of

the counterparty, it assigns its rights and

obligations under the swap to a third party

or negotiate an early termination of the

transaction, or swap ‘‘closeout,’’ in which it

negotiates a lump-sum payment with its

counterparty to terminate the swap.20 In the

latter two cases, termination of the

obligations created by a swap is dependent

upon consent of the counterparty.

(C) To qualify for safe harbor treatment, the

swap must create obligations that are

terminable, absent default, only with the

consent of the counterparty. If consent to

termination is given at the outset of the

agreement and a termination formula or price

fixed, the consent provision must be

privately negotiated. This requirement is

intended to confine safe harbor treatment to

instruments that are not readily used as

trading vehicles, that are entered into with

the expectation of performance, and that are

terminated as well as entered into based

upon private negotiation.

(iii) Absence of clearing organization or

margin system. (A) As noted in paragraph

(b)(5)(ii) of this Appendix, the necessity for

individualized credit determinations has

been described as a hallmark of swap

transactions. A number of commenters have

stressed both the dependence of the current

swap market on such determinations and the

absence of a multilateral ‘‘credit support’’

mechanism, such as a clearing organization,

for swaps. In accordance with the concept of

swaps as dependent upon private negotiation

and individualized credit determinations as

to the capacity of certain parties to perform,

this safe harbor is applicable only to swap

transactions that are not supported by the

credit of a clearing organization and that are

not primarily or routinely supported by a

marked-to-market margin and variation

settlement system designed to eliminate

individualized credit risk.21 The ability to

impose individualized credit enhancement

requirements to secure either changes in the

credit risk of a counterparty or increases in

the credit exposure between two

counterparties consistent with the criteria in

paragraph (b)(5)(ii) would not be affected.

(B) [Reserved]

(iv) The Transaction is Undertaken in

Conjunction With a Line of Business.

(A) The absence of public participation in

the swaps market has frequently been cited

as a factor supporting different regulatory

treatment of swaps and futures contracts.

Swap market participants are predominantly

institutional and commercial entities such as

corporations, commercial and investment

banks, thrift institutions, insurance

companies, governments, and governmentsponsored or chartered entities.22

(B) The safe harbor set forth in this

Appendix is limited to swap transactions

undertaken in conjunction with the parties’

line of business.23 This restriction is

intended to preclude public participation in

qualifying swap transactions and to limit

qualifying transactions to those based upon

individualized credit determinations. This

restriction does not preclude dealer

transactions in swaps undertaken in

conjunction with a line of business,

including financial intermediation services.

(v) Prohibition Against Marketing to the

Public. Swap transactions eligible for safe

harbor treatment may not be marketed to the

public. This restriction reflects the

institutional and commercial nature of the

existing swap market and the Commission’s

intention to restrict qualifying swap

transactions to those undertaken as an

adjunct of the participant’s line of business.

(c) Conclusion. This policy statement is

intended to clarify the regulatory treatment of

certain transactions in order to facilitate

legitimate market transactions in a field

distinguished by innovation and rapid

growth. Consequently, the Commission

proposes to continue to review on a case-bycase basis transactions that do not meet the

criteria set out in this Appendix and that are

not otherwise excluded from Commission

regulation.

Issued in Washington, DC, this 21st day of

November, 2000, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 00–30270 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P