```

[Federal Register Volume 78, Number 163 (Thursday, August 22, 2013)]
[Rules and Regulations]
[Pages 52285-52308]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-19945]

[[Page 52285]]

Vol. 78

Thursday,

No. 163

August 22, 2013

Part III

Commodity Futures Trading Commission

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17 CFR Parts 4 and 50

Clearing Exemption for Certain Swaps Entered Into by Cooperatives; 
Harmonization of Compliance Obligations for Registered Investment 
Companies Required To Register as Commodity Pool Operators; Final Rules

Federal Register / Vol. 78, No. 163 / Thursday, August 22, 2013 / 
Rules and Regulations

[[Page 52286]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD47

Clearing Exemption for Certain Swaps Entered Into by Cooperatives

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') is adopting final regulations pursuant to its authority 
under section 4(c) of the Commodity Exchange Act (``CEA'') allowing 
cooperatives meeting certain conditions to elect not to submit for 
clearing certain swaps that such cooperatives would otherwise be 
required to submit for clearing in accordance with section 2(h)(1) of 
the CEA.

DATES: Effective September 23, 2013.

FOR FURTHER INFORMATION CONTACT: Brian O'Keefe, Deputy Director, 202-
418-5658, bokeefe@cftc.gov, Division of Clearing and Risk, or Erik F. 
Remmler, Deputy Director, 202-418-7630, eremmler@cftc.gov, Division of 
Swap Dealer and Intermediary Oversight, Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, 
DC 20581.

I. Background

    The CEA, as amended by Title VII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (the ``Dodd-Frank Act''),\1\ 
establishes a comprehensive new regulatory framework for swaps. The CEA 
requires a swap: (1) To be submitted for clearing through a derivatives 
clearing organization (``DCO'') if the Commission has determined that 
the swap is required to be cleared, unless an exception or exemption to 
the clearing requirement applies; (2) to be reported to a swap data 
repository (``SDR'') or the Commission; and (3) if such swap is subject 
to a clearing requirement, to be executed on a designated contract 
market (``DCM'') or swap execution facility (``SEF''), unless no DCM or 
SEF has made the swap available to trade.
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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010).
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    Section 2(h)(1)(A) of the CEA establishes a clearing requirement 
for swaps, providing that ``[i]t shall be unlawful for any person to 
engage in a swap unless that person submits such swap for clearing to a 
[DCO] that is registered under [the CEA] or a [DCO] that is exempt from 
registration under [the CEA] if the swap is required to be cleared.'' 
\2\ However, section 2(h)(7)(A) of the CEA provides that the clearing 
requirement of section 2(h)(1)(A) shall not apply to a swap if one of 
the counterparties to the swap: ``(i) is not a financial entity; (ii) 
is using swaps to hedge or mitigate commercial risk; and (iii) notifies 
the Commission, in a manner set forth by the Commission, how it 
generally meets its financial obligations associated with entering into 
non-cleared swaps'' (referred to hereinafter as the ``end-user 
exception'').\3\ The Commission has adopted Sec.  39.6 (now recodified 
as Sec.  50.50 \4\) to implement certain provisions of section 2(h)(7). 
Accordingly, any swap that is required to be cleared by the Commission 
pursuant to section 2(h)(2) of the CEA must be submitted to a DCO for 
clearing by the counterparties unless the conditions of Sec.  50.50 are 
satisfied or another exemption adopted by the Commission applies.
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    \2\ See section 2(h)(1)(A) of the CEA, 7 U.S.C. 2(h)(1)(A).
    \3\ See section 2(h)(7)(A) of the CEA, 7 U.S.C. 2(h)(7)(A).
    \4\ 77 FR 74284 (Dec. 13, 2012). The Commission re-codified the 
end-user exception regulations as Sec.  50.50 so that market 
participants are able to locate all rules related to the clearing 
requirement in one part of the Code of Federal Regulations. Because 
of this re-codification, all citations thereto in this final release 
will be to the sections as renumbered.
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    Congress adopted the end-user exception in section 2(h)(7) of the 
CEA to permit certain non-financial entities to continue using non-
cleared swaps to hedge or mitigate risks associated with their 
underlying businesses, such as manufacturing, energy exploration, 
farming, transportation, or other commercial activities. Additionally, 
in section 2(h)(7)(C)(ii) of the CEA, the Commission was directed to 
``consider whether to exempt [from the definition of `financial 
entity'] small banks, savings associations, farm credit system 
institutions, and credit unions, including:
    (I) Depository institutions with total assets of $10,000,000,000 or 
less;
    (II) farm credit system institutions with total assets of 
$10,000,000,000 or less; or
    (III) credit unions with total assets of $10,000,000,000 or less.''
    In Sec.  50.50(d), the Commission identifies which financial 
entities are small financial institutions and establishes an exemption 
from the definition of ``financial entity'' for these small financial 
institutions pursuant to section 2(h)(7)(C)(ii) (the ``small financial 
institution exemption''). The small financial institution exemption 
largely adopts the language of section 2(h)(7)(C)(ii) in providing for 
an exemption from the definition of ``financial entity'' for the types 
of section 2(h)(7)(C)(ii) institutions having total assets of $10 
billion or less.
    On December 23, 2010, the Commission published for public comment a 
notice of proposed rulemaking (``end-user exception NPRM'') to 
implement the end-user exception.\5\ Several parties that commented on 
the end-user exception NPRM recommended that the Commission extend 
relief from clearing to cooperatives.\6\ These commenters primarily 
reasoned \7\ that the member ownership nature of cooperatives and the 
fact that cooperatives act in the interests of members that are non-
financial entities or cooperatives whose members are non-financial 
entities, justified allowing the cooperatives to also elect the end-
user exception. In effect, they proposed that because a cooperative 
acts in the interests of its members when facing the larger financial 
markets, the end-user exception that would be available to a 
cooperative's members should also be available to the cooperative. 
Accordingly, commenters asserted, if the members themselves could elect 
the end-user exception, then the Commission should permit the 
cooperatives to do so as well.\8\
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    \5\ See 75 FR 80747 (Dec. 23, 2010).
    \6\ See, e.g., comments received on the end-user exception NPRM 
from: Agricultural Leaders of Michigan (ALM), The Farm Credit 
Council (FCC), Allegheny Electric Cooperative, Inc. (AEC), Garkane 
Energy Cooperative, Inc. (GEC), National Council of Farmer 
Cooperatives, Dairy Farmers of America, and National Rural Utilities 
Cooperative Finance Corporation (CFC). Comments received on the end-
user exception NPRM can be found on the Commission's Web site at 
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=937.
    \7\ Other reasons given for providing an exemption from clearing 
to cooperatives, including risk considerations, are discussed below.
    \8\ In addition to the comments received on the end-user 
exception NPRM, the Commission notes that several Senators and 
members of the House of Representatives have expressed similar 
support in committee hearings for ensuring that the implementation 
of the Dodd-Frank Act does not change the way financial cooperatives 
operate in relation to their members. See, e.g., Oversight Hearing: 
Implementation of Title VII of the Wall St. Reform and Consumer 
Prot. Act Before the S. Comm. on Agric., 112th Cong. 18 (2011) 
(statement of Sen. Debbie Stabenow, Chairwoman, S. Comm. on Agric.) 
(``I just want to make sure that . . . you're saying or that you're 
going to guarantee that the relationship between farmers and co-ops 
will be preserved and that farmers will continue to have affordable 
access to risk management tools.''); One Year Later--The Wall St. 
Reform and Consumer Prot. Act: Hearing Before the S. Comm. on 
Agric., 112th Cong. 14 (statement of Sen. Amy Klobuchar, Member, S. 
Comm. on Agric.) (``I hope there is a way to uniquely define farmer 
co-ops so they can continue to do the kinds of things that they 
do.''); Derivatives Reform: the View from Main St.: Hearing Before 
the H. Comm. on Agric., 112th Cong. 12 (2011) (statement of Rep. 
Timothy Johnson, Member, H. Comm. on Agric.) (``I'm also concerned, 
real concerned, representing an area, as a lot of us do, where rural 
electric cooperatives, agricultural cooperatives, and all that are 
an essential part of our being, critical, positive entities that 
really do a whole lot for the infrastructure of this country. . . . 
And I'm very concerned that we're treating, in many ways, and you 
are, those cooperatives in a way almost identical to Goldman Sachs, 
and I think that's--frankly, I think that fall[s] of its own 
weight.''); The Commodity Futures Trading Comm'n 2012 Agenda: 
Hearing Before the H. Comm. on Agric., 112th Cong. 13 (2012) 
(statement of Rep. Rick Crawford, Member, H. Comm. on Agric.) 
(``[Agricultural cooperatives provide] swaps to their members and 
then enter into [another swap to offset that risk]. This is critical 
to their ability to continue [to provide] hedging tools to member[s] 
of their coops. . . . '').

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[[Page 52287]]

    However, section 2(h)(7) of the CEA does not differentiate 
cooperatives from other types of entities and therefore, cooperatives 
that are ``financial entities,'' as defined in section 2(h)(7)(i) of 
the CEA, are unable to elect the end-user exception unless they qualify 
for the small financial institution exemption. Some commenters 
recommended including cooperatives that are ``financial entities'' with 
total assets in excess of $10 billion in the small financial 
institution exemption.\9\ However, as explained in greater detail in 
the final release for Sec.  50.50, section 2(h)(7)(C)(ii) of the CEA 
focused on asset size and not on the structure of the financial entity. 
Accordingly, only cooperatives that are financial entities with total 
assets of $10 billion or less can qualify as small financial 
institutions under the small financial institution exemption.
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    \9\ See, e.g., comments received on the end-user exception NPRM 
from: FCC, CFC, AEC, ALM, and GEC.
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    Notwithstanding the foregoing, the Commission recognized that the 
member-owner structure of cooperatives and the merits of effectively 
allowing cooperatives to also use the end-user exception when acting in 
the interests of their members, warranted consideration. Accordingly, 
the Commission is using the authority provided in section 4(c) of the 
CEA to finalize Sec.  50.51 (proposed as Sec.  39.6(f) \10\), to permit 
cooperatives that meet certain qualifications to elect not to clear 
certain swaps that are otherwise required to be cleared pursuant to 
section 2(h)(1)(A) of the CEA (hereinafter referred to as the 
``cooperative exemption''). Under section 4(c) of the CEA, the 
Commission can subject such exemptive relief to appropriate terms and 
conditions.\11\
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    \10\ For ease of reference, the Commission is re-codifying 
proposed Sec.  39.6(f) as Sec.  50.51 so that market participants 
are able to locate all rules related to the clearing requirement in 
one part of the Code of Federal Regulations.
    \11\ 7 U.S.C. 6(c)(1).
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    On July 17, 2012, the Commission published for public comment a 
notice of proposed rulemaking (``NPRM'') proposing the cooperative 
exemption as Sec.  39.6(f) (now Sec.  50.51).\12\ The Commission 
explained that cooperatives have a unique legal structure that 
differentiates them from other legal business structures in terms of 
how they are operated and who benefits from their activities. In a 
cooperative, the members of the cooperative are the principal customers 
of the cooperative and are also the owners of the cooperative. 
Accordingly, the cooperatives exist to serve their member-owners and do 
not act for their own profit.\13\ The member-owners of the cooperative 
collectively have full control over the governance of the cooperative. 
In a real sense, a cooperative is not separable from its member-owners. 
The cooperative exists to act in the mutual interests of its member-
owners in the marketplace.
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    \12\ 77 FR 41940 (July 17, 2012).
    \13\ For example, the CFC was formed as a nonprofit corporation 
under the District of Columbia Cooperative Association Act of 1940 
to arrange financing for its members and their patrons and for the 
``primary and mutual benefit of the patrons of the Association and 
their patrons, as ultimate consumers.'' CFC Articles of 
Incorporation and Bylaws, Art. I, (last amended Mar. 1, 2005), 
available at https://www.nrucfc.coop/content/dam/cfc_assets/public_tier/publicDocs/governance/CFCbylaws_3_11.pdf.
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    As described in greater detail below in section II, some 
cooperatives provide financial services to their members including 
lending and providing swaps, and the cooperatives sometimes hedge or 
mitigate risks associated with those lending activities with other 
financial entities such as swap dealers (``SDs''). The memberships of 
some of these cooperatives consist of entities that can each elect the 
end-user exception when entering into a swap. However, the end-user 
exception is unavailable to some of those cooperatives because they 
fall within the definition of ``financial entity'' and have assets in 
excess of $10 billion. Accordingly, if the cooperative members continue 
to enter into loans and swaps with their cooperative, they would not 
receive the full benefits of the end-user exception because the 
cooperative would have to clear its swaps even though it is entering 
into the swaps to offset the risks associated with financial activities 
with its members or to hedge risks associated with wholesale borrowing 
activities, the proceeds of which are used to fund member loans. In 
effect, absent an exception from the clearing requirement for a 
cooperative that is providing certain swap services to its members, the 
cooperative structure would be unable--solely because the cooperative 
is large and has substantial assets--to achieve the intended benefits 
for its members who can elect the end-user exception. In light of the 
foregoing, the Commission is exercising its authority under section 
4(c) of the CEA to establish the cooperative exemption.
    The Commission received approximately 25 comment letters and 
Commission staff participated in approximately two ex parte meetings 
concerning the cooperative exemption NPRM.\14\ The Commission 
considered these comments in formulating the final regulations, as 
discussed below.
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    \14\ All comments received in response to the cooperative 
exemption NPRM can be viewed on the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1237.
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II. Financial Entity Cooperatives

    In the NPRM, the Commission described the structure of cooperatives 
that provide financial services to their members to provide context for 
the underlying rationale for the proposed cooperative exemption. The 
description provided in the NPRM is summarized below to facilitate an 
understanding of the comments received and the Commission's responses 
thereto.
    Cooperatives that are ``financial entities,'' as defined in section 
2(h)(7)(C)(i) of the CEA, generally serve as collective asset and 
liability managers for their members. In this role, the cooperatives, 
in effect, face the financial markets as intermediaries for their 
members. These cooperatives sometimes enter into swaps with members and 
with non-member counterparties, typically SDs or other financial 
entities, to hedge the risks associated with the swaps or loans they 
execute with their members, or to hedge risks associated with their 
wholesale borrowing activities, the proceeds of which are used to fund 
member loans. If these financial entity cooperatives have total assets 
in excess of $10 billion, then the cooperatives do not qualify for the 
small financial institution exemption and thus cannot elect the end-
user exception.
    Some cooperatives with more than $10 billion in total assets have 
members that are non-financial entities, small financial institutions, 
or other cooperatives whose members consist of such entities.\15\ For 
example, there are four Farm Credit System (``FCS'') banks chartered 
under Federal law, each of which has total assets in excess of $10 
billion.\16\ The FCS banks are

[[Page 52288]]

cooperatives primarily owned by their cooperative associations.\17\ The 
FCS banks are regulated and prudentially supervised by the Farm Credit 
Administration (``FCA''), an independent agency of the Federal 
government.\18\ The Farm Credit Act authorizes the banks ``to make 
loans and commitments to eligible cooperative associations.'' \19\ The 
FCS association members are, in turn, cooperatives authorized to make 
loans to farmers and ranchers, rural residents, and persons furnishing 
farm-related services.\20\ In effect, FCS bank cooperatives primarily 
make loans to FCS association cooperatives, which lend to farmers and 
ranchers, rural residents, and persons furnishing farm-related 
services, and these borrowers are member-owners of the FCS 
associations, which are member-owners of the FCS banks. In addition to 
the example of the FCS banks, other cooperatives formed under federal 
and state laws also have a similar entity structure in that they are 
owned and governed by their members and they exist to serve those 
members.
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    \15\ See, e.g., comments received on the end-user exception NPRM 
from FCC, CFC, AEC, ALM, and GEC.
    \16\ See FCA, 2011 Annual Report on the Farm Credit System, at 
11, available at http://www.fca.gov/Download/AnnualReports/2011AnnualReport.pdf.
    \17\ See 12 U.S.C. 2124(c) (providing that ``[v]oting stock may 
be issued or transferred to and held only by . . . cooperative 
associations eligible to borrow from the banks.'').
    \18\ See id. at 2241.
    \19\ Id. at 2128(a).
    \20\ See id. at 2075.
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    The cooperative exemption, in effect, provides the end-user 
exception created in section 2(h)(7) of the CEA to financial entity 
cooperatives when acting in the interests of their members and in 
connection with loans to members. The exemption benefits the members 
that qualify for the end-user exception (or members that are 
cooperatives whose own members qualify for the end-user exception) 
because they own and control the cooperatives, which exist for the 
mutual benefit of its members. As described in greater detail 
below,\21\ in the laws that establish financial cooperatives as legal 
entities distinct from other business structures, Congress and state 
legislatures made a policy determination to facilitate the formation of 
cooperatives in order to provide the cooperative members with the 
unique benefits of accessing markets on a cooperative basis. In this 
way, financial cooperatives were created to serve as an alternative 
source of capital for their members. Some of the laws establishing 
cooperatives acknowledge that cooperatives will compete with other 
market participants and may have certain benefits or advantages that 
are acceptable for promoting the benefits that members achieve through 
their cooperatives.\22\ Because the cooperatives are established to 
serve their members and the net earnings they generate through their 
activities are returned to those members, the benefits of the 
cooperative exemption ultimately inure to the members of the 
cooperative. In the context of required clearing and the end-user 
exception, the cooperative exemption furthers the purpose for which 
financial cooperatives were established, i.e., to act for the mutual 
benefit of their members.
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    \21\ See section IV.
    \22\ Id.
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III. Comments on the Proposed Cooperative Exemption Rule

A. Introduction

    In proposing an exemption for certain swaps entered into by certain 
cooperatives that are financial entities, the Commission acknowledged 
in the NPRM that central clearing of swaps is a primary focus of Title 
VII of the Dodd-Frank Act. Central clearing mitigates financial system 
risks that could result from swaps and any exemption from central 
clearing should be narrowly drawn to minimize the impact on the risk 
mitigation benefits of clearing and should also be in line with the 
end-user exception requirements of section 2(h)(7) of the CEA. 
Accordingly, the Commission sought to narrowly tailor the cooperative 
exemption by limiting the types of entities that could elect the 
cooperative exemption and the types of swaps for which the exemption 
could be elected.
    The Commission received a number of comment letters both supporting 
and opposing the proposed cooperative exemption. Fourteen rural 
electric cooperatives (``Rural Electric Cooperatives'') \23\ and their 
trade association, the National Rural Electric Cooperative Association 
(``NRECA'') submitted substantially similar comment letters supporting 
the rulemaking. The FCC, the National Rural Utilities Cooperative 
Finance Corporation (``CFC''),\24\ the Credit Union National 
Association (``CUNA''), the American Farm Bureau Federation (``AFBF''), 
Chris Barnard (``Mr. Barnard''), and the National Council of Farmer 
Cooperatives (``NCFC'') similarly supported the proposed cooperative 
exemption. Eleven of the twelve Federal Home Loan Banks (``FHL Banks'') 
submitted a comment letter supporting the concept of a cooperative 
exemption generally, but requested certain changes to the rule as 
described below.
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    \23\ See Allegheny Electric Cooperative, Inc., Coast Electric 
Power Association, Choptank Electric Cooperative, Claiborne Electric 
Cooperative, Inc., Deaf Smith Electric Cooperative Inc., Dixie 
Electric Cooperative, First Electric Cooperative Inc., Garkane 
Energy, Hoosier Energy Rural Electric Cooperative, Inc., Mountain 
View Electric Association, Inc., Pioneer Rural Electric Cooperative, 
Inc., Sullivan County Rural Electric Cooperative, Inc., Sumter 
Electric Cooperative, Inc., and Sunflower Electric Power 
Corporation.
    \24\ The comment letter from the CFC incorporates, as an 
attachment, the signatures of approximately 500 individuals 
associated with nonprofit rural electric cooperatives supporting the 
cooperative exemption.
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    The American Bankers Association (``ABA''), Lake City Bank, and the 
Independent Community Bankers of America (``ICBA'') submitted comments 
opposing the cooperative exemption on several grounds. All three 
opposed the rule on the grounds that it provides cooperatives with 
advantages at the expense of certain banks. The ABA and ICBA generally 
objected to the rule because they believe the reasoning behind the 
proposed rule was faulty and that the rule making did not comply with 
the requirements of section 4(c) of the CEA and the Administrative 
Procedure Act (``APA''). They also commented on the efficacy of the 
cost-benefit analysis in the NPRM.
    The following discussion first addresses comments on each paragraph 
of the proposed rule followed by a discussion of the comments 
addressing compliance of the proposed rule with the legal parameters 
applicable to the rulemaking under section 4(c) of the CEA.

B. Regulation 39.6(f)(1) (now Sec.  50.51(a)): Definition of Exempt 
Cooperative

    The end-user exception is generally available to entities, 
including cooperatives, that are not ``financial entities,'' as defined 
in section 2(h)(7)(C)(i) of the CEA, and entities that would be 
financial entities, including cooperatives, but for the fact that they 
meet the requirements of the small financial institution exemption in 
Sec.  50.50(d). The proposed cooperative exemption would add an 
exemption from required clearing for cooperatives that do not fall into 
these two categories if they meet the definition of ``exempt 
cooperative.'' Proposed Sec.  39.6(f)(1) (now Sec.  50.51(a)) defines 
``exempt cooperative'' to mean a cooperative that is a ``financial 
entity'' solely as defined in section 2(h)(7)(C)(i)(VIII) of the CEA 
for which each member of the cooperative is either (1) a non-financial 
entity, (2) a financial institution to which the small financial 
institution exemption applies, or (3) itself a cooperative each of 
whose members fall into either of the first two categories.
    The Commission received a number of comment letters in support of 
the Commission's rationale provided in the

[[Page 52289]]

NPRM for the proposed definition of exempt cooperative. The Rural 
Electric Cooperatives and NRECA agreed with the Commission's proposed 
definition of ``exempt cooperative'' and the Commission's reasons for 
establishing the exemption. The Rural Electric Cooperatives commented 
that the exempt cooperative definition is appropriate because members 
of exempt cooperatives would be eligible for the end-user exception if 
entering into swaps on their own. In their view, effectively extending 
the end-user exception available to the members of an exempt 
cooperative to the exempt cooperative itself is appropriate because the 
members act in the financial markets through the cooperatives that they 
own.
    The FCC, the CFC, CUNA, Mr. Barnard, and the NCFC similarly 
supported the Commission's definition of exempt cooperative. Like the 
Rural Electric Cooperatives, the FCC suggested that the ``unique 
structure of cooperatives and their relationship to their member-
owners'' warrants the cooperative exemption. The CFC and Mr. Barnard 
supported the ``pass-through concept'' embodied in the cooperative 
exemption. The FHL Banks commented that the unique ownership structure 
of cooperatives and the fact that cooperatives act on behalf of 
``members that are non-financial institutions or small financial 
institutions'' justify the Commission issuing the cooperative 
exemption.
    The ABA and the ICBA submitted comments opposing the definition of 
exempt cooperative because they believe there is no policy 
justification for the exemption and that the Commission's reasons for 
the exemption are not analytically appropriate. They commented that 
cooperatives do not play a unique role and are not themselves unique. 
The ABA suggested the Commission ignored the ``fact that banks perform 
the same functions for customers that cooperatives perform for their 
members.'' Similarly, the ICBA commented that the Commission has not 
described how exempt cooperatives differ from commercial banks. 
According to ICBA, ``community banks play the same role on behalf of 
their customers'' that cooperatives play when facing the larger 
financial markets on behalf of their members. Both the ABA and the ICBA 
also noted that banks enter into swaps to hedge risks. The ABA noted 
that almost one-third of all the loans made by the FCS did not involve 
individual farmers or ranchers.
    According to the ICBA, smaller ``community'' banks should be given 
the ``same exemption as any financial cooperative of the same or larger 
size.'' The ICBA and the ABA requested that ``smaller'' banks, with 
assets above the $10 billion threshold in the end-user exception, be 
exempted from mandatory clearing along with cooperatives.
    In response, the Commission does not disagree with these comments 
to the extent that banks often provide the same services to their 
customers that exempt cooperatives provide to their members. However, 
the nature of the services provided by cooperatives to their members is 
not the rationale for the cooperative exemption. The Commission's 
rationale is based in large part on the relationship between a 
cooperative and its members, which is different from the relationship 
between banks and their customers. The cooperative exemption in effect 
provides the end-user exception created in section 2(h)(7) of the CEA 
to entities whose members themselves qualify for the end-user 
exception, but would otherwise not be able to realize the full effects 
of the exception when those members act in the financial markets 
through their member-owned exempt cooperatives that do not qualify for 
the small financial institution exemption. The rule benefits the 
members who qualify for the end-user exception through the cooperatives 
that they own and control and exist for their mutual benefit. Because 
the cooperatives are established to serve their members and the net 
earnings they generate through their activities are returned to those 
members, the benefits of the cooperative exemption ultimately inure to 
the members of the cooperative.
    The Commission notes that the definition of ``exempt cooperative'' 
is narrowly tailored so that only a cooperative for which each of its 
members individually, or if it has members that are cooperatives, each 
of the members of those cooperatives individually, would qualify for 
the end-user exception would qualify for the cooperative exemption. 
Furthermore, Sec.  39.6(f)(2) (now Sec.  50.51(b)) provides that the 
exemption is only available for swaps executed in connection with 
originating member loans and swaps that hedge or mitigate risk related 
to loans to members or arising from certain swaps with members. As 
such, under the final rule, an exempt cooperative shall not elect the 
exemption for swaps related to non-member activity of the cooperative.
    Exempt cooperatives are distinct from banks not because of the 
services they offer, but because they exist to serve their members' 
interests and act as intermediaries for their members in the 
marketplace. The member-owners generally are the customers of the 
cooperatives and the Commission drafted the proposed rule to be 
available only to the extent the cooperative exemption is used in 
connection with member-related activities. Cooperatives are owned by 
their members and as such, their governing bodies generally consist of 
members. Their net earnings are returned to their members either 
through rebates or distributions, often referred to as ``patronage,'' 
or are retained by the cooperatives as capital to be used to provide 
services to members. For example, the FCC noted in its comments that 
FCS cooperatives were established by federal law to operate for the 
benefit of farmer-owners.\25\ The FCC further noted that by law, each 
cooperative association in the FCS has a board of directors comprised 
of voting members of the association, and as required by law, at least 
one ``outside'' director.\26\ Furthermore, voting stock may only be 
held by farmers, ranchers, producers of aquatic products, and 
cooperative associations eligible to borrow from FCS institutions.\27\ 
Each owner of association voting stock is entitled to one vote in the 
affairs of the association, regardless of the amount of the stock 
held.\28\ FCS additionally commented that each year FCS cooperatives 
pay patronage to their members, both in cash and allocated equity.\29\ 
Furthermore, unlike for-profit entities that generally pay out 
dividends based on the amount of stock purchased by each investor, as 
discussed in greater detail below, cooperatives generally pay out or 
allocate earnings to the member-owners based on the amount of business

[[Page 52290]]

undertaken by each member with the cooperative.\30\
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    \25\ The FCC cited Section 1.1(a) of the Farm Credit Act (12 
U.S.C. 2001) (``farmer-owned cooperative Farm Credit System'') and 
Section 1.1(b) thereof (``It is the objective of this chapter to 
continue to encourage farmer- and rancher-borrowers participation in 
the management, control, and ownership of a permanent system of 
credit for agriculture which will be responsive to the credit needs 
of all types of agricultural producers having a basis for credit, 
and to modernize and improve the authorizations and means for 
furnishing such credit and credit for housing in rural areas made 
available through the institutions constituting the Farm Credit 
System as herein provided.'').
    \26\ 12 U.S.C. 2072.
    \27\ 12 U.S.C. 2154a(c)(1)(D)(i).
    \28\ 12 CFR 611.350.
    \29\ For example, in 2011, FCS institutions distributed about 
$903 million in cash patronage and $243 million in stock patronage 
to the approximately 489,000 system shareholders. Farm Credit 
Admin., 2011 Annual Report on the Farm Credit System, 18 (2011); 
Press Release, Fed. Farm Credit Banks Funding Corp., Farm Credit 
System Reports Net Income of $3.940 Billion for 2011, 5 (Feb. 17, 
2012), available at https://www.farmcreditfunding.com/farmcredit/serve/public/pressre/finin/report.pdf?assetId=198426.
    \30\ See 18 a.m. Jur. 2d Cooperative Associations Sec.  19 
(2012) (``Ordinarily, the profits of a cooperative association are 
distributed to its members in the form of patronage refunds or 
dividends in amounts determined by the use made of the association 
facilities by the patrons, and statutes frequently so provide.'').
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    On the other hand, banks generally are for-profit, publicly or 
privately held corporations whose investor-owners are not required to 
be the users of the bank's services, and often are not. The governing 
bodies of banks, like other for-profit entities, are typically elected 
by the shareholders whose voting power is determined by the amount of 
common stock each investor owns. A board of directors of a corporation 
has a legal duty to the corporation and the shareholders and, 
accordingly, must consider shareholder value in its actions.\31\ As 
such, unlike the member-focused purposes of exempt cooperatives, a 
primary purpose of banks is to generate value for their owners, who 
generally are not their customers. The mission of a cooperative is to 
act in the interests of its members, while the goal of a for-profit 
business, whatever its size, is to benefit the owners of that business, 
which are not necessarily its customers. Unlike a cooperative, which is 
an extension of its members as a business matter, a bank is not an 
extension of its customers. Accordingly, the Commission believes the 
rationale for extending the end-user exception to cooperatives does not 
apply to banks in the same way.
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    \31\ See, e.g., 18B Am. Jur. 2d Corporations 1460 (2012).
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    The ICBA further questioned whether ``members'' are any different 
from ``customers,'' because, in the case of the FCS, borrowers can be 
considered owners or members even if they do not put their own capital 
into the organization. For example, according to the ICBA, an FCS 
borrower can become a member by paying an additional $1,000 on a loan 
or one percent of the loan value, whichever is less.
    The FCC commented that the Farm Credit Act and related regulations 
prescribe minimum stock purchase requirements for FCS borrowers and 
also require that FCS institutions meet minimum capital standards well 
in excess of the amount of purchased stock, citing 12 U.S.C. 2151. The 
FCC noted that as of December 31, 2011, combined FCS association 
capital was over $24 billion dollars, or 19% of outstanding loans. 
Furthermore, the FCS noted that ``[v]irtually all that capital is the 
result of income earned and retained.''
    The Commission believes that the comments of the ICBA and FCC on 
this issue further demonstrate the uniqueness of the member-owner 
relationship between exempt cooperatives and their members and how the 
cooperatives are, in effect, extensions of their members acting in the 
interests of their members in a way that is not the case for the 
relationship between other types of financial institutions and their 
customers. The earnings retained by FCS cooperatives would otherwise be 
paid out to members pro rata based on the amount of borrowing from the 
cooperatives. As such, a cooperative member has a vested, pro rata 
interest in its cooperative based on the amount of business the member 
does with the cooperative. While a for-profit entity such as a bank 
also may retain capital, the capital, if paid out to the owners, would 
be paid to the equity investors, not the customers of the entity and 
not based on the amount of business the customers do with the entity.
    The ICBA and the ABA further commented that some of the entities 
that the cooperatives are ``standing in the marketplace on behalf of'' 
are sophisticated entities and are capable of entering into the swap 
marketplace on their own and do not need a cooperative to face the 
market. The ICBA also commented that all of the component entities of 
cooperatives would have ``no trouble arranging financing from private 
sector sources.''
    The Commission did not assert in the NPRM that the members of 
cooperatives could only access financial markets through the 
cooperatives or that sole access through cooperatives was a reason for 
the proposed rule. Rather, the Commission recognized that certain 
entities for which the end-user exception is available have 
traditionally accessed the markets through financial cooperatives that 
they own and which exist for their benefit. For example, this 
relationship is well established and is codified into the federal law 
that created the FCS.\32\ If the cooperative exemption were not adopted 
by the Commission, these entities would not be able to both continue to 
use their cooperatives and receive the full benefit of the end-user 
exception created in the Dodd-Frank Act.
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    \32\ ``It is declared to be the policy of the Congress . . . 
that the farmer-owned cooperative [FCS] be designed to accomplish 
the objective of improving the income and well-being of American 
farmers and ranchers by furnishing sound, adequate, and constructive 
credit and closely related services to them, their cooperatives, and 
to selected farm-related businesses necessary for efficient farm 
operations.'' 12 U.S.C. 2001(a).
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    The ICBA questioned the Commission's statement in the preamble to 
the proposed cooperative exemption that ``cooperatives exist to serve 
their member-owners and do not act for their own profit.'' The ICBA 
commented that the FCS, credit unions and other cooperatives ``pay 
their executives millions of dollars each year.''
    The ICBA, Lake City Bank, and ABA also noted that the FCS and 
credit unions and other cooperatives that would be able to use the 
cooperative exemption already enjoy a number of significant advantages, 
such as low-cost funding, tax exemptions, and, in some cases, 
government sponsored enterprise (``GSE'') status. They expressed 
concern that providing credit unions, FCS cooperatives, and other 
cooperatives with an exemption from mandatory clearing would 
``exacerbate their competitive advantage over banks.'' Furthermore, the 
ICBA stated that ``FCS lenders have in recent years positioned 
themselves to act almost identically to banks through deposit taking 
arrangements, credit card offerings, check writing capabilities and 
outright illegitimate activities granted by their permissive 
regulator.''
    The Commission is not responsible for the creation, administration, 
or implementation of those legal characteristics of cooperatives 
referred to in the comments as being ``competitive advantages.'' These 
characteristics, by and large, flow from policies enacted by Congress 
or state legislatures. Further, the Commission is not the regulator 
responsible for the laws and regulations referred to by commenters that 
govern cooperatives. The Commission has determined without regard to 
such other asserted benefits for cooperatives, to offer an elective 
clearing exemption to entities qualifying as exempt cooperatives to 
extend the full benefits of the end-user exception established in the 
Dodd-Frank Act to entities that would qualify for that exception, but 
which choose to act through their cooperatives in the financial 
marketplace.\33\
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    \33\ For a discussion of the related ``fair competition'' 
provision in section 4(c), see section IV herein.
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    Comments regarding the compensation of executives are outside the 
scope of this rulemaking. The rationale for the cooperative exemption 
is based on the member-owner structure of cooperatives, not on how much 
executives are paid or whether that pay is fair. The Commission defers 
to the regulators who enforce those regulations

[[Page 52291]]

for issues related to executive compensation.
    With respect to swaps, the ICBA noted that cooperatives and 
community banks both enter into swaps to hedge the interest rate risk 
of loans to their customers or members. The ICBA suggested that swaps 
hedging the underlying risks of loans to customers pose the same lower 
risk to the financial system that the FCC claims regarding swaps 
hedging the risks of loans to its cooperative members.
    The Commission notes that it is not relying on the assertion by the 
FCC that swaps related to hedging loans to cooperative members may be 
less risky than other types of swaps that financial entities may 
undertake as a primary reason for distinguishing exempt cooperatives 
from other types of lending entities.\34\ As explained in the NPRM, the 
potential lower risk of such swaps is, however, one of the reasons why 
the Commission is restricting the cooperative exemption to swaps 
related to member loans.
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    \34\ The Commission believes, however, that because exempt 
cooperatives serve their members and are controlled by their 
members, it can be expected that cooperatives will focus their swap 
activity on member loan-related activities.
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    The National Association of Federal Credit Unions requested that 
the Commission specify that the cooperative exemption applies to ``all 
credit unions.'' The Commission clarifies that the exemption applies to 
all cooperatives, including credit unions that meet the definition of 
``exempt cooperative'' in the final rule. The Commission does not have 
enough information to determine whether ``all credit unions'' are 
eligible for the exemption. Whether any particular credit union meets 
the definition of an exempt cooperative will depend on the relevant 
facts and circumstances for that credit union.
    The FHL Banks stated that they would not qualify as exempt 
cooperatives because each FHL Bank has one or more members that are 
financial institutions that do not qualify for the small financial 
institution exemption. The FHL Banks commented that the cooperative 
exemption, as proposed, would ``unfairly and arbitrarily'' penalize 
members of a cooperative that would qualify as small financial 
institutions under the end-user exception if the cooperative also has 
one or more large financial institutions as members. The FHL Banks 
stated that this would result in the inconsistent treatment of two 
similarly situated entities. The FHL Banks also point to the joint 
final rule on the definition of the term ``swap dealer,'' where the 
Securities and Exchange Commission along with the Commission excluded 
all swaps between a cooperative and its members from the analysis of 
whether that cooperative is an SD. This regulatory treatment, according 
to the FHL Banks, would be ``consistent'' with the Commission allowing 
the FHL Banks to elect the cooperative exemption in certain 
circumstances.
    The FHL Banks requested that the Commission remove the limitation 
that bars a cooperative from being an ``exempt cooperative'' if it has 
one or more members that are financial entities that are not themselves 
cooperatives with members that qualify for the end-user exception. 
Instead, the FHL Banks suggested that the Commission allow cooperatives 
to enter into swaps that hedge or mitigate commercial risk related to 
loans to ``qualified members'' or arising from swaps entered into with 
``qualified members'' that are eligible for the end-user exception. The 
FHL Banks proposed the term ``qualified member'' to mean a member of an 
exempt cooperative that is (1) not a financial entity, (2) a financial 
entity that is exempt from the definition of financial entity under the 
small financial institution exemption in Sec.  50.50(d), or (3) a 
cooperative, each member of which is not a financial entity or is 
exempt from mandatory clearing because it qualifies for the small 
financial institution exemption. The FHL Banks commented that their 
proposed approach is consistent with the Dodd-Frank Act's objective of 
mandating that swaps entered into in connection with or for large 
financial institutions be cleared, without penalizing small financial 
institutions. According to the FHL Banks, their proposed revisions to 
the cooperative exemption would allow FHL Banks to qualify as an 
``exempt cooperative,'' in appropriate situations. The FHL Banks also 
stated that this revised cooperative exemption would apply to less than 
10% of the outstanding notional amount of the FHL Banks' swaps. The 
ICBA, like the FHL Banks, suggested that the Commission revise the 
definition of exempt cooperative to not exclude the FHL Banks ``to the 
extent that they engage in swaps for the benefit of their members who 
individually qualify as small financial institutions.''
    In response to the FHL Banks' and the ICBA's comments regarding 
cooperatives that are ineligible for the cooperative exemption because 
they have one or more financial entity members, the Commission declines 
to extend the exemption beyond the parameters as proposed. The 
Commission disagrees with the FHL Banks' assertion that the cooperative 
exemption is arbitrary or unfair to financial institutions that qualify 
for the small financial institution exemption. Under Sec.  
39.6(f)(1)(iii)(A) (now Sec.  50.51(a)(3)(i)) of the proposed rule, 
small financial institutions that meet the definition thereof in Sec.  
50.50(d) can be members of exempt cooperatives. These members can 
include banks, savings associations, FCS institutions, or credit 
unions, so long as each of them qualifies as a small financial 
institution under Sec.  50.50(d) (i.e. the institution has total assets 
of $10 billion or less). They would be treated in the same way as all 
other entities that may qualify for the end-user exception, and 
therefore can be members of exempt cooperatives as defined.
    Furthermore, as the Commission acknowledged above and in the NPRM, 
it is concerned that exemptions from the clearing requirement could 
detract from the systemic risk reducing benefits of clearing. This is 
particularly a concern if the exemption could be elected for swaps that 
relate to risks of entities that Congress clearly intended to be 
subject to the clearing requirement--financial entities as defined in 
section 2(h)(7)(C) of the CEA that are not expressly exempted from that 
definition. As such, the Commission narrowed the cooperative exemption 
to apply solely to a cooperative whose members (or if it has members 
that are cooperatives, the members of those cooperatives) could 
themselves elect the end-user exception.
    The importance of a narrow cooperative exemption is apparent when 
considering the possible effect of broadening the exemption in the 
manner requested by the FHL Banks and ICBA. A fundamental 
characteristic of cooperatives is that they distribute or allocate the 
patronage earnings of the cooperative, i.e., the excess of a 
cooperative's revenues over its costs arising from transactions done 
with or for its members,\35\ to each member based on the amount of 
patronage by the member, i.e., proportionally based on the amount of 
business each member does with the cooperative.\36\ Accordingly, even 
if a cooperative with financial entity members only elected

[[Page 52292]]

the cooperative exemption for swaps related to loans to members that 
qualify for the end-user exception, a portion of the financial benefits 
from those swaps in the form of higher net income may shift from the 
qualifying small members to the larger members as part of the full 
member pro rata patronage distribution or allocation. Furthermore, the 
risks of such swaps because they are non-cleared could also negatively 
impact the large financial institution members to the extent that the 
net income of the cooperative is negatively impacted.
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    \35\ See FASB ASC 905-10-05.
    \36\ The distribution or allocation of patronage earnings to the 
members based on the amount of business they do with the cooperative 
is a guiding principle of cooperatives and is a necessary element 
for a cooperative to claim a deduction for taxation purposes under 
federal law. See Donald A. Frederick, Income Tax Treatment of 
Cooperatives: Background, Cooperative Information Report 44, Part 1, 
2005 Ed. (April 2005) at 50, citing, Puget Sound Plywood, Inc. v. 
Commissioner, 44 T.C. 305, 308 (1965).
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    As an example, consider the relative amounts of lending by the FHL 
Banks to those of their largest members that do not qualify for the 
end-user exception as compared to the FHL Banks' lending to their other 
members. The 12 FHL Banks had 7,774 members as of the end of 2011.\37\ 
Each of the 12 FHL Banks reported the amount of lending business they 
did with their five largest members in the 2011 Combined Financial 
Report for the FHL Banks. In 2011, $222.6 billion of the $403.3 billion 
lent by the FHL Banks to their members was lent to the largest five 
members of each of the 12 FHL Banks.\38\ Of those 60 large members, 
approximately 49 had total assets in excess of $10 billion.\39\ The 
amount loaned to those 49 members was about $212.7 billion, or 53% of 
the dollar amount lent by the FHL Banks. Furthermore, those 49 members 
do not include all members of the FHL Banks with assets greater than 
$10 billion. Accordingly, the Commission estimates the percentage of 
lending by the FHL Banks to members that cannot qualify for the end-
user exception was higher than 53% of total lending in 2011.\40\ If the 
FHL Banks were able to use the cooperative exemption, under the 
cooperative structure in which patronage benefits are allocated pro 
rata based on the amount of business each member does with the 
cooperative, a significant portion of the benefits and risks from the 
election of the exemption could spread to the large financial entity 
members. This would also be the case even if the exemption were only 
available to swaps related to small financial institutions because the 
distribution of patronage to the members is based to a large degree on 
the amount of borrowing by each member.
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    \37\ FHL Banks, Combined Financial Report for the Year Ended 
December 31, 2011 (issued March 29, 2012) at 43, available at http://www.fhlb-of.com/ofweb_userWeb/resources/11yrend.pdf.
    \38\ Id. at 44-45. The Commission arrived at the $222.6 billion 
amount by adding together the loan values of the 60 individual 
members listed in the Combined Financial Report of the FHL Banks.
    \39\ The Commission estimated this number by reviewing 
publically available information related to the assets of each of 
the 60 members, such as members' annual 10-K financial reports filed 
with the SEC (available on the SEC's Web site and posted on the 
members' Web sites), other annual financial reports and information, 
such as press releases posted on members' Web sites, and reports 
published by the Federal Reserve and Federal Deposit Insurance 
Corporation. As an example, the Commission reviewed the Federal 
Reserve's Statistical Release for Large Banks, which provided 
information regarding the total assets held by 27 of the 60 members. 
See Federal Reserve, Statistical Release for Large Banks, available 
at http://www.federalreserve.gov/releases/lbr/current/default.htm.
    \40\ The FHL Banks Combined Financial Report for the Year Ended 
December 31, 2011, does not break down lending amount for every 
member. The 49 members used in the Commission's calculations do not 
include all members of the FHL Banks with assets greater than $10 
billion. Accordingly, while the total percentage of lending to 
financial entities with total assets greater than $10 billion cannot 
be calculated based on the information available in the financial 
report, it is likely significantly higher than the 53% calculated 
for the 49 members with over $10 billion in total assets for which 
lending information is available.
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    Similarly, the Commission is concerned that allowing cooperatives 
with members that do not qualify for the end-user exception to elect 
the cooperative exemption could open up avenues for abuse of the 
exemption and evasion of clearing. For example, larger financial 
entities could form cooperatives capitalized by the large financial 
entities, but which also include small affiliates or trading partners 
of the larger financial entities that would qualify as small financial 
institutions. They could then use these cooperatives to shift their 
borrowing and swap needs between the large and small entities to be 
able to take advantage of the cooperative exception in ways that 
benefit the larger institutions. The Commission considers these risks 
of abuse of the exemption and evasion of the clearing requirement 
warrant limiting the definition of exempt cooperative as written. The 
Commission notes that small financial institutions can elect the end-
user exception themselves.
    The ICBA noted that the Dodd-Frank Act's requirement that the 
Commission consider exempting small financial institutions is not 
necessarily limited to institutions with less than $10 billion in total 
assets. The ICBA commented that there are 36 ``community banks'' \41\ 
with assets over $10 billion, and within the category of ``community 
banks,'' the asset sizes of those banks range from $10.5 billion to $50 
billion. The ICBA suggested that the asset size test in the end-user 
exception be increased up to $50 billion or that community banks be 
given a ``ride along'' provision so that community banks that do not 
qualify for the end-user exception could elect the same exemption as 
cooperatives.
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    \41\ The ICBA did not specifically define the term ``community 
banks'' other than by reference to the $50 billion maximum asset 
level.
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    With these comments, the ICBA is effectively asking the Commission 
to reopen and revise the end-user exception rule as applied to 
financial institutions generally. The Commission set forth the reasons 
for the $10 billion total asset limit for small financial institutions 
in the end-user exception rulemaking and believes that those reasons 
remain appropriate. This rulemaking addresses the specific issue of 
whether an exemption from clearing should be granted to certain 
cooperatives--including the issue of whether there are relevant 
differences between the covered cooperatives and private banks--and is 
not intended as a vehicle for reopening the end-user exception 
regulations.

C. Regulation 39.6(f)(2) (now Sec.  50.51(b)): Swaps to Which the 
Cooperative Exemption Applies

    Proposed Sec.  39.6(f)(2) (now 50.51(b)) limits application of the 
cooperative exemption to swaps entered into with members of the exempt 
cooperative in connection with originating loans \42\ for members or 
swaps entered into by exempt cooperatives that hedge or mitigate risks 
related to loans to members or arising from member loan-related swaps. 
This provision assures that the cooperative exemption is used only for 
swaps related to member lending activities. Since the definition of an 
exempt cooperative requires that all members be entities who can elect 
the end-user exception or cooperatives all of whose members can, this 
condition assures that the exemption will benefit entities who could 
themselves elect the end-user exception and can be used for swaps that 
hedge or mitigate risk in connection with member loans and swaps as 
would be required by section 2(h)(7)(A)(ii) of the CEA.
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    \42\ The phrase ``in connection with originating a loan'' is 
similarly used in the definition of swap dealer in Sec.  1.3(ggg) of 
the Commission's Regulations. See 77 FR 30596, 30744 (May 23, 2012). 
That meaning is incorporated in the final rule.
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    The primary rationale for the cooperative exemption is based on the 
unique relationship between cooperatives and their member-owners. 
Expanding this exemption to include swaps related to non-member 
activities would extend the exemption beyond its intended purpose. 
Furthermore, allowing cooperatives to enter into non-cleared swaps with 
non-member borrowers, or swaps that serve purposes other than hedging 
member loans or

[[Page 52293]]

swaps, would give the cooperatives, which are large financial entities, 
an exception from regulatory requirements that would not be provided to 
other market participants engaging in such similar business with 
respect to non-members that is not justified by their cooperative 
structure or the provisions of the Dodd-Frank Act.
    The CFC commented that it agrees with the types of swaps eligible 
for the cooperative exemption described by the Commission in the 
preamble of the NPRM. The CFC stated that the use of the phrase 
``related to'' in the rule text is consistent with the ``pass-through 
concept'' that underlies the cooperative exemption. The FCC suggested 
that the Commission provide additional clarity on the ``related to'' 
standard. The FCC commented that the ``related to'' standard should be 
broad enough to cover swaps that hedge or mitigate risk related to 
``interest rate, liquidity, and balance sheet risks'' associated with a 
cooperative's lending business. The FCC pointed to the statement in the 
preamble to the proposed rule that explained that the ``related to'' 
test involves hedging or mitigating risks ``associated with'' member 
loans. The FCC supported this interpretation. The FCC requested that 
the Commission clarify that certain types of transactions would be 
covered by the cooperative exemption. Specifically, the FCC suggested 
that the following swaps should be covered by the cooperative 
exemption: (1) Swaps managing interest rate, liquidity, and balance 
sheet risk, (2) swaps qualifying as GAAP hedges of bonds and floating 
rate notes, and (3) swaps hedging FCS banks' liquidity reserves that 
are required by the FCA.
    The AFBF also requested that the Commission clarify that swaps 
mitigating or hedging balance sheet, interest rate, and liquidity risks 
associated with their cooperative lending business are eligible for the 
cooperative exemption.
    The Commission's rationale for the cooperative exemption is based 
on the unique relationship between a cooperative and its members. The 
primary purpose for the cooperative exemption is to, in effect, provide 
the full benefits of the end-user exception created in section 2(h)(7) 
of the CEA to entities that qualify for the end-user exception, but 
otherwise do not receive the full benefits of the exception if they use 
their cooperatives as their intermediary in the markets as they have 
traditionally done. Thus, the Commission will interpret this exemption 
to ensure that the exemption is only used for swaps that are undertaken 
to directly further the interests of the members who are themselves 
eligible for the end-user exception. Accordingly, the Commission 
declines to expand the types of transactions eligible for the exemption 
beyond those swaps that are entered into in connection with originating 
a loan or loans for a member, or swaps that hedge or mitigate 
commercial risk related to loans with members, or hedge or mitigate the 
commercial risk associated with a swap between an exempt cooperative 
and its members in connection with originating loans to members.
    With respect to the comments of the AFBF and the FCC regarding 
swaps that hedge balance sheet, interest rate, and liquidity risks 
associated with their cooperative lending business, the Commission 
reiterates that only those swaps relating to member loans are eligible 
for the exemption, not swaps related to a cooperative's entire lending 
business to the extent that lending business includes loans to non-
members. Accordingly, the exemption may be used for swaps that hedge 
balance sheet, interest rate, and liquidity risks, but only limited to 
the extent those risks are related to loans made by the cooperative to 
its members. The Commission is concerned that without this limitation, 
cooperatives could use this exemption for risks related to non-member-
based activities, which would be inconsistent with the general 
rationale for the exemption and could result in a competitive benefit 
to eligible cooperatives that is also inconsistent with the 
Commission's rationale for the exemption.
    As the text of Sec.  39.6(f)(2)(i) (now Sec.  50.51(b)(1)) 
provides, the phrase ``swap is entered into with a member of the exempt 
cooperative in connection with originating a loan or loans for the 
member'' should be read consistent with 17 CFR 1.3(ggg)(5). Among other 
things, 17 CFR 1.3(ggg)(5) provides that an acceptable swap includes a 
swap with members for which the rate, asset, liability or other 
notional item underlying such swap is, or is directly related to, a 
financial term of such loan, which includes, without limitation, the 
loan's duration, rate of interest, the currency or currencies in which 
it is made and its principal amount; or the swap is required, as a 
condition of the loan under the exempt cooperative's loan underwriting 
criteria, to be in place in order to hedge price risks incidental to 
the borrower's business and arising from potential changes in the price 
of a commodity (other than an excluded commodity).
    Section 39.6(f)(2)(ii) (now Sec.  50.51(b)(2)) also includes in the 
cooperative exemption swaps that hedge or mitigate risk related to 
loans to members or arising from a swap or swaps with members entered 
into pursuant to Sec.  39.6(f)(2)(i) (now Sec.  50.51(b)(1)). This 
provision includes swaps that the exempt cooperatives may enter into 
with non-members to hedge or mitigate the risks incurred by the 
cooperatives related to their member lending activities. Such swaps can 
include swaps entered into with non-member parties (e.g., SDs) to hedge 
or mitigate risks such as interest rate risk related to funding loans 
to fund member loans, or liquidity or balance sheet risks, so long as 
those liquidity and balance sheet risks arise from activities related 
to member loans.
    As discussed above in this section, the risks must be related to 
member loans only. For example, the Commission understands that 
cooperatives sometimes issue bonds or enter into wholesale funding 
transactions to fund member and non-member loans. The cooperative 
exemption would permit an exemption for swaps, such as interest rate 
swaps or interest rate caps, used to hedge those funding transactions, 
but only to the extent that the interest rate swaps or interest rate 
caps relate to member-associated loans. Only swaps hedging or 
mitigating risk arising from the portion of the bonds or wholesale 
funding proceeds that is related to, or is expected to be related to, 
direct loans to members are eligible for the exemption. Practically 
speaking, this means that for a cooperative borrowing on a wholesale 
basis for both member and non-member-associated loans, the aggregate 
notional amount of any non-cleared swaps hedging the wholesale funding 
loans must not exceed the aggregate principal value of the wholesale 
funding loans less the aggregate principal amount lent or expected to 
be lent to non-members. Cooperatives would need to adjust that 
aggregate notional amount by termination or other means as soon as 
practicable if that aggregate amount is exceeded during the life of any 
such swaps.
    As another example, eligible cooperatives may want to hedge 
interest rate risk associated with a portfolio of loans to multiple 
borrowers with one or more swaps. If the loan portfolio being hedged 
consists solely of loans to members, then the cooperative exemption 
would be available for those hedging swaps if the requirements of Sec.  
39.6(f) (now Sec.  50.51) are met. However, if the cooperative has non-
member loans in the loan portfolio being hedged, then the swap may be 
hedging risk that is not related to

[[Page 52294]]

member loans and, if so, the exemption would not be available for that 
swap. In order to be able to elect the exemption for swaps that hedge a 
portfolio of member loans and non-member loans, the aggregate notional 
amount of any such swaps must not exceed the aggregate principal amount 
of the member loans in the portfolio. Cooperatives would need to adjust 
that notional amount by termination or other means, such as clearing 
certain swaps, as soon as practicable if that amount is exceeded during 
the life of any such swap. The same limitation applies to balance sheet 
risks. The exemption may be elected for swaps hedging balance sheet 
risks only to the extent they arise from member loan related activity. 
For example, balance sheet risks could be hedged with swaps for which 
the cooperative exemption may be available to the extent that the 
aggregate notional amount of such swaps does not exceed the aggregate 
principal amount of member loans.
    With respect to FCC's comments relating to ``liquidity reserves'' 
required by the FCA, the Commission believes the same general approach 
described above should apply. That is, swaps hedging risks related to 
liquidity reserves may be eligible for the exemption only to the extent 
that such reserves being hedged are related to member loans. For 
example, if a cooperative makes loans to both members and non-members 
and hedges risks related to liquidity reserves for the combined loan 
portfolio, the cooperative would be permitted to elect the exemption 
for the hedging swaps to the extent that the aggregate notional amount 
of the swaps does not exceed an amount equal to the total liquidity 
reserves multiplied by the proportion of the member loans principal 
amount to the total principal amount of member loans and non-member 
loans in the cooperative's combined loan portfolio.
    The CFC commented that the Commission should modify the language of 
section 39.6(f)(2)(ii) (now Sec.  50.51(b)(2)), which is a cross-
reference to the definition of hedging or mitigating commercial risk 
for the purposes of the end-user exception, to replace the term 
``commercial enterprise'' with the term ``exempt cooperative.''
    The requested change is not necessary. As explained in the final 
release for the end-user exception,\43\ the use of the term 
``commercial enterprise'' is intended to refer to the underlying 
activity to which the risk being hedged or mitigated relates in the 
context of the entity's normal business activities, not simply the type 
of entity claiming the exemption. For example, in the context of the 
cooperative exemption, it would include the risks undertaken by a 
cooperative in the normal course of business of providing loans to 
members.
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    \43\ 77 FR 42572 (July 19, 2012).
---------------------------------------------------------------------------

D. Regulation 39.6(f)(3) (now Sec.  50.51(c)): Reporting

    The Commission believes it is appropriate to impose certain 
reporting requirements on any entities that may be exempted from the 
clearing requirement by this regulation. The reporting requirements in 
the final rule are effectively identical to the reporting requirements 
for the end-user exception. For purposes of regulatory consistency, 
Sec.  39.6(f)(3) (now Sec.  50.51(c)) incorporates the provisions of 
Sec.  50.50(b) with only those changes needed to apply the reporting 
provisions in the specific context of the cooperative exemption. 
Regulation 50.50(b) requires one of the counterparties (the ``reporting 
counterparty'') to provide, or cause to be provided, to a registered 
SDR, or if no registered SDR is available, to the Commission, 
information about how the counterparty electing the exception generally 
expects to meet its financial obligations associated with non-cleared 
swaps. In addition, Sec.  50.50(b) requires reporting of certain 
information that the Commission will use to monitor compliance with, 
and prevent abuse of, the exception. The reporting counterparty would 
be required to provide the information at the time the electing 
counterparty elects the cooperative exemption.
    The CUNA requested that the Commission minimize the compliance 
burdens on cooperatives that elect to use the cooperative exemption, 
including the notification requirement. The ICBA requested that the 
Commission modify the reporting requirement when the cooperative 
exemption is elected. The ICBA commented that the aggregate reporting 
requirements of Sec.  50.50(b) do not allow the Commission to ``monitor 
actual risks or swaps usage.'' The ICBA stated that it was concerned 
that FCS members actively seek to lend to a number of entities that are 
not owners of the FCS. Because of this, the Commission, according to 
the ICBA, would not have a way of verifying that the swaps for which an 
FCS bank elected this exemption are actually eligible for the 
cooperative exemption. Neither the ICBA nor the CUNA proposed any 
specific changes to the rule text in connection with their comments.
    The Commission has determined not to change the reporting 
requirements proposed in Sec.  39.6(f)(3) (now Sec.  50.51(c)) and to 
keep them consistent with the reporting requirements of the end-user 
exception. The Commission discussed at length in the final release of 
the end-user exception how the reporting requirements for entities 
electing the clearing requirement exception are simplified through a 
check-the-box approach and can be reported along with the other 
reporting required for all swaps under the Commission's part 45 
regulations.\44\ The Commission believes that the reporting 
requirements will provide the Commission with sufficient information, 
along with the other information to be reported for all swaps and 
information publicly reported by cooperatives, to detect evasion of 
required clearing or abuse of the exemption. For example, every swap 
executed by a cooperative, as is the case with all swaps, must be 
reported to an SDR or to the Commission and the parties to that swap 
will be identified. Accordingly, the Commission will be able to review 
and analyze the economic and other details of all swaps entered into by 
each cooperative. As such, the Commission is able to monitor actual 
swap usage by cooperatives. The swap reporting requirements are not 
intended to monitor the risk levels of individual cooperatives. 
Monitoring the accumulated risk undertaken by financial cooperatives is 
generally the purview of their supervisory regulators.
---------------------------------------------------------------------------

    \44\ 77 FR at 42565-70.
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    Based on a review of publicly available information and discussions 
with the regulators of financial cooperatives, the Commission believes 
that a large majority of lending by these cooperatives is to their 
members. As such, at present there do not appear to be substantial 
incentives for cooperatives to abuse the exemption with respect to 
swaps that are not member related. Notwithstanding the foregoing, the 
limitations on using the exemption for non-member related activities is 
clearly established in the final rule and the Commission is confident 
that the tools available to the Commission for addressing abuse or 
evasion of the cooperative exemption are sufficient without changing 
the reporting requirements as proposed.

E. Other Comments on the Proposed Rule

    The ABA and the ICBA commented that the FCS, as a GSE, presents a 
significant risk for the U.S. taxpayer. The ICBA stated that the FCS 
was ``bailed out'' by the government during the farm credit crisis in 
the 1980s. The ABA and the ICBA noted that the FCS,

[[Page 52295]]

if viewed as a single financial institution because of the mutual 
support provisions for the FCS institutions, has assets worth more than 
$230 billion. According to the ICBA, the FCS may be systemically 
important under the Dodd-Frank Act because it has assets in excess of 
$50 billion. The ICBA also suggested that the Commission should not 
provide any exemptions for any institution with over $50 billion in 
assets because institutions over $50 billion are considered to be 
potentially systemically important under the Dodd-Frank Act.
    In contrast, the FCC commented that the FCS banks have strong 
protections in place for counterparty default, including, for example, 
collateral posting agreements, which are overseen by the FCA. According 
to the FCC, these protections have been effective throughout the recent 
financial crisis. Accordingly, the FCC suggested that the FCS poses no 
systemic risk to the U.S. financial system.
    The fact that Congress designated the FCS as a GSE does not by 
itself imply the existence of a sufficiently higher level of risk to 
justify rejecting the limited exemption from clearing provided to 
cooperatives. The Commission notes that the FCS is supervised by the 
FCA, an independent Federal agency charged with overseeing the safety 
and soundness of the FCS.\45\ The Commission acknowledged in the NPRM 
that the proposed exemption would be available to cooperatives with 
total assets in excess of $50 billion. However, the Commission believes 
that the exemption, as narrowly drafted, is appropriate given the 
benefits conferred by it to the entities Congress designated for the 
end-user exception who are members of exempt cooperatives. Regarding 
the possible designation of the FCS as systemically important, the 
Commission notes that Congress excluded the possibility of the FCS from 
being designated as systemically important by the Financial Stability 
Oversight Council.\46\
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    \45\ See 12 U.S.C. 2241 (establishing the FCA); 12 U.S.C. 2252 
(enumerating the powers of the FCA including the power to ensure the 
safety and soundness of FCS institutions).
    \46\ The Financial Stability Oversight Council does not have the 
authority to determine that the FCS be supervised by the Board of 
Governors of the Federal Reserve System as a ``nonbank financial 
company'' pursuant to section 113 of the Dodd-Frank Act. The 
definition of ``nonbank financial company'' includes a ``U.S. 
nonbank financial company'' and a ``U.S. nonbank financial company'' 
specifically excludes a ``Farm Credit System institution chartered 
and subject to the provisions of the Farm Credit Act of 1971.'' 12 
U.S.C. 5311(a)(4); section 102(a)(4)(B) of the Dodd-Frank Act.
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    The CFC requested that the Commission, when coordinating with the 
other prudential regulators working to finalize the margin rules for 
non-cleared swaps, ensure that the final margin requirements for non-
cleared swaps are consistent with the final cooperative exemption. In 
effect, the CFC requested that the final margin rules for non-cleared 
swaps not require margin for swaps eligible for the cooperative 
exemption.
    The Commission intends to continue to work with the other 
prudential regulators to ensure that the cooperative exemption, along 
with other clearing exceptions or exemptions, are taken into 
consideration when finalizing the margin rules for non-cleared swaps.
    The ICBA suggested that the Commission should review the exemption 
``every three years to see if the exemption is warranted on an ongoing 
basis'' because cooperatives will have had time to ``adjust to the 
evolving swaps markets and clearing systems.''
    The Commission declines to include an explicit sunset or study 
provision in the final rule. As the Commission's swap regulations are 
new and the market is evolving in response, the Commission anticipates 
evaluating its swap-related regulations on an as-needed basis and will 
modify them as appropriate.
    The ABA requested that the Commission extend the comment period for 
this rule because of the ``impending regulatory deadlines, complexity, 
and economic consequences'' of the cooperative exemption.
    The Commission declines to extend the comment period because the 
public was given an opportunity to, and did, participate in the 
rulemaking process.

IV. Section 4(c) of the Commodity Exchange Act

    Section 4(c)(1) of the CEA states that ``[i]n order to promote 
responsible economic or financial innovation and fair competition'' the 
CFTC may exempt any agreement, contract, or transaction subject to 
section 4(a) from the requirements of that section or any other section 
of the CEA. Section 4(c) authorizes the Commission to grant exemptive 
relief to foster the development or continuance of market practices 
that contribute to market innovation and competition.\47\ Congress, in 
adding section 4(c) to the CEA, intended that the Commission, ``in 
considering fair competition, will implement this provision in a fair 
and even-handed manner.'' \48\ At the same time, Congress expected 
that, in doing so, the Commission ``will apply consistent standards 
based on the underlying facts and circumstances of the transaction and 
markets being considered, and may make distinctions between exchanges 
and other markets taking into account the particular facts and 
circumstances involved, consistent with the public interest and the 
purposes of the Act, where such distinctions are not arbitrary and 
capricious.'' \49\ While this language refers specifically to 
distinctions between exchanges and other markets, it implies that 
Congress more generally expected the Commission, in applying section 
4(c)(1), to draw distinctions among different market participants where 
circumstances justify it.\50\ As discussed in detail elsewhere herein, 
cooperatives are unique in their organizational form, in the way that 
they act in the interests of their members, and in the well-established 
public policies that support the ability of cooperative members to make 
use of their cooperatives for purposes of accessing markets. These 
unique characteristics justify an exemption specifically tailored to 
enable non-financial entity end users that are members of cooperatives 
to realize the full benefits of the end-user exception when they access 
markets through their cooperatives.
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    \47\ See Conference Report, H.R. Report 102-978 at 8 (Oct. 2, 
1992) (``The goal of providing the Commission with broad exemptive 
powers . . . is to give the Commission a means of providing 
certainty and stability to existing and emerging markets so that 
financial innovation and market development can proceed in an 
effective and competitive manner.'').
    \48\ Id. at 78.
    \49\ Id.
    \50\ Cf., CEA section 4(c)(2)(A), 7 U.S.C. 6(c)(2)(A) (expressly 
requiring a determination that an exemption from CEA section 4(a), 7 
U.S.C. 6, under CEA section 4(c)(1), 7 U.S.C. 6(c)(1), be consistent 
with the public interest and the purposes of the CEA, one of which 
is ``to promote . . . fair competition . . . among . . . market 
participants'').
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    The end-user exception provided in section 2(h)(7) of the CEA is 
not available to an entity that is a ``financial entity,'' as defined 
in section 2(h)(7)(C)(i), unless the entity is exempt from the 
definition because it is a small financial institution based on total 
assets, as provided in section 2(h)(7)(C)(ii) of the CEA and Sec.  
50.50(d), or it meets one of the narrowly drawn exemptions provided in 
section 2(h)(7) or the Commission regulations. Section 2(h)(7)(C)(ii) 
does not provide special consideration for cooperatives that meet the 
definition of ``financial entity'' and, therefore, the asset size limit 
applies to them.
    As described in the NPRM and above, cooperatives whose member-
owners consist exclusively of persons or entities

[[Page 52296]]

that could elect the end-user exception provide important financial 
services to their members. These cooperatives are, in many respects, an 
extension of their member-owners and are not separable from their 
members in any real sense because their mission is to act in the 
interests of the members. However, some of those cooperatives meet the 
definition of ``financial entity'' and have total assets in excess of 
$10 billion, and therefore the end-user exception is unavailable to 
them. By extension, the full benefits of the end-user exemption would 
be unavailable to their members accessing financial services through 
their cooperatives. Accordingly, absent this exemption, cooperative 
members would lose the ability to use their cooperative for financial 
services and at the same time, realize the full benefits of end-user 
exception. Without the cooperative exemption, when a cooperative 
engages in financial activity that could benefit from the end-user 
exception and that activity is in the interest of the cooperative's 
members, the members would not realize the full benefits of the end-
user exception because the cooperative cannot elect the exception. 
Although the members of a cooperative may seek out financial services 
from other market participants, some of which may be able to elect the 
end-user exception, such members would not be able to realize the same 
benefits as if they had acted through the cooperative. As previously 
explained, such other market participants were not established solely 
to serve the interests of its customers, and thus do not provide the 
same benefits to its customers as the cooperative structure provides to 
its members, even for similar services. Absent this exception, the 
members of the cooperative would no longer be able to fully realize the 
benefits for which the cooperatives were established of being the 
members' intermediary in the financial markets acting in the mutual 
interests of the members. In light of this, the Commission determined 
to exercise its authority under section 4(c) of the CEA to propose 
Sec.  39.6(f) (now Sec.  50.51) and establish the cooperative 
exemption.
    As noted above, section 4(c) of the CEA authorizes the Commission 
to provide exemptions to classes of persons ``to promote responsible 
economic or financial innovation and fair competition.'' Many of the 
comments focused on this provision. For example, the ICBA commented 
that the cooperative exemption does not promote financial innovation. 
According to the ICBA, the Commission's estimate that the cooperative 
exemption would affect 500 or less swaps a year shows that there is no 
financial innovation by the exempt cooperatives. The ICBA also 
commented that the Commission has not shown financial innovation 
because the proposal excludes the FHL Banks, which, according to the 
ICBA would potentially provide just as much, ``if not more,'' financial 
innovation than an exemption for the FCS and credit unions. In essence, 
the ICBA stated that the cooperative exemption does not promote 
financial innovation because it is narrowly tailored and affects only a 
small number of swaps and institutions. In contrast, the FCC commented 
that ``[t]o provide tailored financing products for farmers and farm-
related businesses, FCS institutions rely on the safe use of 
derivatives to manage interest rate, liquidity, and balance sheet risk, 
primarily in the form of interest rate swaps.''
    As discussed above in this section IV, Congress contemplated that 
section 4(c) of the CEA would provide the Commission with the ``means 
of providing certainty and stability to existing and emerging markets 
so that financial innovation and market development can proceed in an 
effective and competitive manner.'' \51\ Financial cooperatives have 
existed for over 100 years and were given separate legal status by 
Congress as far back as 1916.\52\ Without these cooperatives, members 
have less choice in where they can borrow capital and hedge risks 
related to those borrowing activities. Swaps are a fairly recent 
innovation in the financial markets that has become an integral part of 
borrowing and lending. The cooperative form has enabled members to 
manage their borrowing activities and to use swaps to hedge risks in 
connection therewith at a lower cost. By pooling member capital in 
financial cooperatives, members are in effect aggregating their 
resources to allow them not only to gain a lower cost of funding, but 
also to be able to hire experienced executives who, as employees of the 
cooperative, are charged with managing the financial activities of the 
cooperative and advising the board of directors of the cooperative for 
the benefit of the member-owners, who often have specific, shared 
purposes that are the mission focus of the cooperative.\53\ Further, 
because the cooperative members elect the board members of the 
cooperative on a democratic, one member, one vote, basis,\54\ and often 
most, if not all, board members are cooperative members,\55\ the 
membership, through the governing board, has a unique opportunity to 
better understand the benefits and risks of swaps used in connection 
with their financial activities and as a group control the thoughtful 
application thereof in a responsible manner and for their mutual 
benefit. The mutual benefit of pooling resources and acting 
cooperatively is one of the principal policy reasons for the 
establishment of cooperative structures.\56\ These are benefits that 
the cooperative member-owners would not have as customers of other 
financial institutions that they do not own or control and that are not 
established with the mission of providing financing and financial 
services to a particular type of customer and for their benefit.
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    \51\ See Conference Report, H.R. Report 102-978 at 8 (October 2, 
1992).
    \52\ See The Federal Farm Loan Act, Public Law 64-158, 39 Stat. 
360 (1916) (repealed 1923) (a predecessor to the Farm Credit Act).
    \53\ See, e.g., the mission statement of the Farm Credit Bank of 
Texas: ``Other lenders may lend to agriculture and rural America 
only when it is profitable to do so, but at Farm Credit, financing 
rural America is all we do. When Congress created the Farm Credit 
System in 1916, it gave the System a mission to be a competitive, 
reliable source of funds for eligible borrowers in agriculture and 
rural America. Because we specialize in these areas, we have 
expertise that is unparalleled among other lenders.'' http://www.farmcreditbank.com/farm-credit-advantage.aspx; See also CoBank 
2011 Annual Report, 31 (``We are a mission-based lender with 
authority to make loans and provide related financial services to 
eligible borrowers in the agribusiness and rural utility industries, 
and to certain related entities, as defined by the Farm Credit Act. 
. . . We are cooperatively owned by our U.S. customers.'').
    \54\ To receive treatment as cooperatives under the Internal 
Revenue Code, an entity must be ``operating on a cooperative 
basis.'' 26 U.S.C. 1381(a). The United States Tax Court has held 
that one of the guiding principles for determining whether an entity 
is operating on a cooperative basis is if it is democratically 
controlled by the members. Puget Sound Plywood, Inc. v. 
Commissioner, 44 T.C. 305, 308 (1965).
    \55\ See, e.g., 12 U.S.C. 2072, 92 (requiring boards for 
production credit associations and federal land bank associations be 
selected from its voting members); 12 CFR 701 app. A (bylaws for 
national credit unions requiring board members be members of the 
credit union); Kan. Stat. Ann. Sec.  17-1510 (West) (requiring board 
members to be selected from the membership); Va. Code Ann. Sec.  
13.1-324 (West) (requiring the board, except for the public 
director, consist of members).
    \56\ See, e.g., the initial statement of Congress in the Farm 
Credit System Act, which authorizes the Farm Credit System that the 
FCS cooperatives are a part of: ``It is the objective of this 
chapter to continue to encourage farmer- and rancher-borrowers 
participation in the management, control, and ownership of a 
permanent system of credit for agriculture which will be responsive 
to the credit needs of all types of agricultural producers having a 
basis for credit, and to modernize and improve the authorizations 
and means for furnishing such credit and credit for housing in rural 
areas made available through the institutions constituting the Farm 
Credit System as herein provided.'' 12 U.S.C. 2001.
---------------------------------------------------------------------------

    In addition, section 4(c) of the CEA does not specify that the 
financial

[[Page 52297]]

innovation realized must be of a certain size. Innovation often begins 
on a small scale before becoming widely accepted and implemented, if 
successful. Regarding whether the FHL Banks should be included because 
the exemption would also provide innovation through the FHL Banks, as 
described in detail above in section III.B of this final release, the 
Commission determined to carefully narrow the cooperatives that can 
elect the exemption to those whose members consist exclusively of 
entities that (or other cooperatives whose members) do qualify for the 
end-user exception on their own, given the clear Congressional intent 
in section 2(h)(7) of the CEA to exclude financial entities (the 
definition of which excludes small financial institutions) from the 
end-user exception to the clearing requirement. Given that FHL Banks 
are not made up exclusively of non-financial entities or small 
financial institutions, the cooperative exemption would not be 
available to them.
    The ABA and ICBA also commented that the cooperative exemption does 
not qualify under section 4(c) and is discriminatory because it would 
give cooperatives a competitive advantage over banks and therefore it 
does not promote ``fair competition.'' They also commented that 
cooperatives compete with banks for the same business opportunities, 
and as GSEs and tax-exempt entities, cooperatives can offer more 
competitive pricing than traditional banks. Lake City Bank commented 
that it has difficulty competing with the FCS and credit unions for 
business due to the GSE status of the FCS, the large amount of assets 
the FCS maintains, and the favorable tax status afforded to the FCS and 
credit unions.
    In contrast, the FCC commented that the cooperative exemption 
preserves a ``level field for FCS institutions and commercial banks'' 
that qualify for the end-user exception because FCS associations that 
otherwise would qualify as small financial institutions and compete 
with qualifying banks hedge risk at the level of the FCS bank 
cooperatives in which they are members. In effect, the FCC asserts that 
the FCS associations would be unable to use the end-user exception 
because the cooperative structure of the FCS system means that the 
associations act through the FCS bank cooperatives (all of which have 
total assets over $10 billion) for their hedging activities and not 
directly.
    As discussed previously, the essential function of cooperatives is 
to enable their members to access markets through a commonly-owned 
intermediary. The memberships of the cooperatives that would qualify 
for the cooperative exemption consist of entities that can elect the 
end-user exception if acting on their own or other cooperatives the 
members of which can elect the end-user exception. However, these 
cooperatives meet the definition of ``financial entity'' and are too 
large to qualify for the small financial institution exemption, which, 
in turn, renders the end-user exception unavailable to the 
cooperatives. Accordingly, if the cooperative members wish to access 
the markets through their financial cooperative, which has been 
established for that same purpose, they would not receive the full 
benefits of the end-user exception because the cooperative would have 
to clear its swaps even though it is acting in the interests of its 
members in the markets. On the other hand, the members could enter into 
loans and swaps with other financial entities that can elect the end-
user exception. In effect, the cooperative structure, which is intended 
to give the members the benefit of size by allowing them to pool their 
resources and act together for their mutual benefit, instead would 
frustrate their ability to realize the full benefits of the end-user 
exception when acting through their cooperatives. As such, the 
cooperative exemption seeks to preserve the benefits available to the 
members of cooperatives as intended under the cooperative legal 
structure.
    The Commission's recognition that the cooperatives provide a means 
for its members to access the financial markets in a variety of ways is 
consistent with the intent of Congress and state legislatures in the 
laws establishing cooperative legal structures. As described below, 
some of these laws acknowledge that cooperatives may have certain 
benefits or advantages that other entities do not have, but that any 
such advantages are acceptable for promoting the benefits of 
cooperatives because ultimately the benefits inure to the members of 
the cooperatives. The cooperative exemption is being adopted by the 
Commission in the context of the foregoing policy determinations.\57\
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    \57\ As an example of these legislative policy determinations, 
the Federal Credit Union Act states:
    The Congress finds the following:
    (1) The American credit union movement began as a cooperative 
effort to serve the productive and provident credit needs of 
individuals of modest means.
    (2) Credit unions continue to fulfill this public purpose, and 
current members and membership groups should not face divestiture 
from the financial services institution of their choice as a result 
of recent court action.
    (3) To promote thrift and credit extension, a meaningful 
affinity and bond among members, manifested by a commonality of 
routine interaction, shared and related work experiences, interests, 
or activities, or the maintenance of an otherwise well understood 
sense of cohesion or identity is essential to the fulfillment of the 
public mission of credit unions.
    (4) Credit unions, unlike many other participants in the 
financial services market, are exempt from Federal and most State 
taxes because they are member-owned, democratically operated, not-
for-profit organizations generally managed by volunteer boards of 
directors and because they have the specified mission of meeting the 
credit and savings needs of consumers, especially persons of modest 
means.
    (5) Improved credit union safety and soundness provisions will 
enhance the public benefit that citizens receive from these 
cooperative financial services institutions.
    12 U.S.C. 1751. State cooperative laws also acknowledge the 
different status cooperatives are being provided within the 
competitive landscape. See N.Y. Coop. Corp. Law, which states that: 
``[a] cooperative corporation shall be classed as a non-profit 
corporation, since its primary object is not to make profits for 
itself as such, or to pay dividends on invested capital, but to 
provide service and means whereby its members may have the economic 
advantage of cooperative action, including a reasonable and fair 
return for their product and service.'' N.Y. Coop. Corp. Law 3 
(McKinney) (emphasis added); see also Ky. Rev. Stat. Ann. Sec.  
272.1001(2) (West 2012).
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    Importantly, the Commission notes that the swaps that are the 
subject of the exemption are limited to those swaps related to member 
loans. Accordingly, the exemption applies only to the swaps related to 
lending services that financial cooperatives have been established to 
provide, and traditionally do provide, to their owner-members.\58\
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    \58\ For example, with respect to the FCS, the Farm Credit Act 
of 1971 provides, ``It is declared to be the policy of the Congress, 
recognizing that a prosperous, productive agriculture is essential 
to a free nation and recognizing the growing need for credit in 
rural areas, that the farmer-owned cooperative Farm Credit System be 
designed to accomplish the objective of improving the income and 
well-being of American farmers and ranchers by furnishing sound, 
adequate, and constructive credit and closely related services to 
them, their cooperatives, and to selected farm-related businesses 
necessary for efficient farm operations.'' 12 U.S.C. 2001.
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    The ABA and ICBA also cited to ``preferred tax and funding 
advantages as [GSEs]'' for FCS banks and the tax-exempt status that 
qualifying cooperatives have under Subchapter T of the Federal Internal 
Revenue Code (``Tax Code'') as existing advantages cooperatives have 
over banks. On the other hand, financial cooperatives, such as the FCS 
and credit unions, are subject to other legal restrictions and 
regulated by their own regulators, who may impose restrictions that put 
them at a competitive disadvantage when compared to banks. For example, 
federal statutes and regulations applicable to FCS cooperatives 
restrict lending services to particular classes of borrowers, prohibit 
them from taking deposits (which limits their funding sources as 
compared to banks), and

[[Page 52298]]

limit other services that they can provide to members. Similarly, the 
Tax Code, U.S. Tax Court rulings, and other guidance from the Internal 
Revenue Service impose limits on the business structure of cooperatives 
that seek cooperative tax treatment under the Tax Code that may impact 
their competitiveness. Also, cooperatives generally cannot raise equity 
capital from independent, non-customer investors. While the 
Commission's role is not to determine the relative overall competitive 
advantages or disadvantages that cooperatives or other financial 
institutions may have, the Commission believes that any limited 
advantage the cooperative exemption may provide to exempt cooperatives 
is likely to be small when viewed in the context of the complete 
competitive landscape in which financial cooperatives and banks 
operate.
    Given that Sec.  39.6(f) (now Sec.  50.51) and its attendant terms 
and conditions would (1) promote economic and financial innovation for 
the benefit of the members of exempt cooperatives, (2) foster the 
ability of cooperative members to access the financial markets through 
their cooperatives and (3) further Congressional intent by providing a 
limited exemption from clearing that effectively extends the end-user 
exception to cooperatives that have end users for members, the 
Commission concludes that the adoption of Sec.  39.6(f) (now Sec.  
50.51) and its attendant terms and conditions would promote responsible 
economic and financial innovation and fair competition in accordance 
with section 4(c) of the CEA.
    The Commission also concludes that the cooperative exemption will 
be limited to entities that fall within the term ``appropriate 
person,'' as required by section 4(c)(2)(B)(i) of the CEA.\59\ Section 
2(e) of the CEA renders it ``unlawful for any person, other than an 
[eligible contract participant (``ECP'')], to enter into a swap unless 
the swap is entered into on, or subject to the rules of, a board of 
trade designated as a contract market.'' \60\ Since the cooperative 
exemption can only be elected for swaps that are executed bilaterally 
and not on a board of trade or contract market, both the exempt 
cooperatives and their respective counterparties to such swaps must be 
ECPs. Given that the criteria for the ECP definition covering business 
organizations generally is more restrictive than the comparable 
criteria for the appropriate person definition in section 4(c)(3),\61\ 
the Commission finds that the class of persons relying on Sec.  
50.51(a) will be limited to appropriate persons for purposes of CEA 
section 4(c)(2)(B)(i).\62\
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    \59\ 7 U.S.C. 6(c)(2)(B)(i).
    \60\ 7 U.S.C. 2(e).
    \61\ Compare CEA section 4(c)(3)(F) identifying the applicable 
type of appropriate person (a ``corporation, partnership, 
proprietorship, organization, trust, or other business entity with a 
net worth exceeding $1,000,000 or total assets exceeding $5,000,000 
. . .'' and section 1a(18)(A)(v) that identifies a comparable type 
of ECP (a ``corporation, partnership, proprietorship, organization, 
trust, or other entity'' with a net worth exceeding $1,000,000 (and 
that enters into an agreement, contract or transaction for certain 
risk management purposes) or total assets exceeding $10,000,000).
    \62\ Although Sec.  39.6(f) (now Sec.  50.51) is an exemption 
from the clearing requirement of section 2(h)(1)(A) of the CEA and 
section 2(e) of the CEA sets forth a standard for entering into a 
swap, section 4(c)(2)(B)(i) requires that any agreement, contract or 
transaction that is the subject of a CEA section 4(c)(1) exemption 
be ``entered into'' solely between appropriate persons. Therefore, 
focusing on section 2(e), which is an execution standard rather than 
a clearing standard, is appropriate, particularly given that if it 
is unlawful to enter into a swap in the first instance, the clearing 
requirement is moot.
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    Furthermore, the Commission concludes that the cooperative 
exemption will not have a material adverse effect on the ability of the 
Commission or any contract market or derivatives transaction execution 
facility to discharge their respective regulatory duties under the CEA 
as provided in section 4(c)(2)(B)(ii) of the CEA. The cooperative 
exemption effectively extends the end-user exception established in 
section 2(h)(7) of the CEA to cooperatives acting for non-financial 
entities. Section 39.6(f)(3) (now Sec.  50.51(c)) has the same 
reporting requirement that the end-user exception has with the only 
difference being that the reporting party must report that the 
cooperative exemption has been elected for the swap being reported 
instead of the end-user exception. In this way, the Commission will be 
able to track the swaps for which the cooperative exemption is being 
elected and who is electing the exemption thereby allowing the 
Commission to oversee the use of the cooperative exemption in the same 
manner as the end-user exception. Regarding contract markets and 
derivatives transaction execution facilities, the cooperative exemption 
does not modify their regulatory duties under the CEA. Accordingly, 
those entities will not have any increase or reduction in their 
regulatory duties with regard to the exempted swaps.

V. Administrative Procedure Act Related Comments

    The ABA and the ICBA submitted a number of comments asserting that 
the rule is discriminatory or violates the arbitrary and capricious 
standard in the APA.\63\ The ABA commented that the Commission did not 
provide a reasonable explanation for why cooperatives with over $10 
billion in total assets were given an exemption while banks with total 
assets over $10 billion were not. According to the ABA, the Commission 
did not take into account the Congressional intent not to exempt banks 
and cooperatives with total assets above $10 billion from mandatory 
clearing.
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    \63\ See 5 U.S.C. 706(2)(A).
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    The Commission disagrees with the commenters' assertion that the 
Commission did not provide a reasonable explanation for the rule or 
that it does not fulfill Congressional intent. As discussed throughout 
the NPRM and as reiterated in this final release in response to 
specific comments, the cooperative exemption fulfills Congressional 
intent as expressed in section 2(h)(7) of the CEA by providing the full 
benefits of the end-user exception to the end-user members of 
cooperatives who act in the markets through their cooperatives. The 
limitation on the definition of ``exempt cooperative'' to those 
cooperatives whose members consist exclusively of entities and persons 
who may elect the end-user exception and other cooperatives whose 
members meet that requirement makes that readily apparent and is 
explained in detail in the NPRM.\64\ Furthermore, the Commission 
considered both this element of Congressional intent and Congress' 
clear mandate that the Commission require that certain swaps entered 
into by financial institutions be cleared by carefully and purposefully 
limiting the types of swaps for which the cooperative exemption is 
available.\65\ The Commission's reasoning behind the cooperative 
exemption based on the unique member-owner structure of cooperatives 
and the nature of cooperatives as entities whose primary purpose is to 
act in the interests of their member-owners in the financial 
marketplace is thoroughly discussed throughout the NPRM and reiterated 
in this final release. Commenters' assertions that the cooperative 
exemption rule is inconsistent with Congressional intent or is 
arbitrary and capricious are therefore without merit.
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    \64\ 77 FR 41942 and 41943, and section III.B above.
    \65\ 77 FR 41942 and 41943, and section III.C above.

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[[Page 52299]]

VI. Consideration of Costs and Benefits

A. Background

    In the wake of the financial crisis of 2008, Congress adopted the 
Dodd-Frank Act, which, among other things, requires the Commission to 
determine whether a particular swap, or group, category, type or class 
of swaps, shall be required to be cleared.\66\ Specifically, section 
723(a)(3) of the Dodd-Frank Act amended section 2(h)(1)(A) of the CEA 
to make it ``unlawful for any person to engage in a swap unless that 
person submits such swap for clearing to a [DCO] that is registered 
under the CEA or a [DCO] that is exempt from registration under [the 
CEA] if the swap is required to be cleared.'' This clearing requirement 
is designed to reduce counterparty risk associated with swaps and, in 
turn, mitigate the potential systemic impact of such risk and reduce 
the likelihood for swaps to cause or exacerbate instability in the 
financial system.\67\
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    \66\ See section 2(h)(2) of the CEA, 7 U.S.C. 2(h)(2).
    \67\ When a bilateral swap is moved into clearing, the DCO 
becomes the counterparty to each of the original participants in the 
swap. This standardizes counterparty risk for the original swap 
participants in that they each bear the same risk attributable to 
facing the DCO as counterparty. In addition, DCOs exist for the 
primary purpose of managing credit exposure from the swaps being 
cleared and therefore DCOs are effective at mitigating counterparty 
risk through the use of risk management frameworks. These frameworks 
model risk and collect defined levels of initial and variation 
margin from the counterparties that are adjusted for changing market 
conditions and use guarantee funds and other risk management tools 
for the purpose of assuring that, in the event of a member default, 
all other counterparties remain whole. DCOs have demonstrated 
resilience in the face of past market stress. Most recently, they 
remained financially sound and effectively settled positions in the 
midst of turbulent events in 2007-2008 that threatened the financial 
health and stability of many other types of entities and the 
financial system as a whole. These, and other benefits of clearing, 
are explained more fully at: 77 FR 74284.
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    Notwithstanding the benefits of clearing, section 2(h)(7) of the 
CEA provides the end-user exception if one of the swap counterparties: 
``(i) is not a financial entity; (ii) is using swaps to hedge or 
mitigate commercial risk; and (iii) notifies the Commission, in a 
manner set forth by the Commission, how it generally meets its 
financial obligations associated with entering into non-cleared 
swaps.'' Section 2(h)(7)(C)(ii) of the CEA directs the Commission to 
consider making the end-user exception available to small banks, 
savings associations, credit unions, and farm credit institutions, 
including those institutions with total assets of $10 billion or less, 
through an exemption from the definition of ``financial entity.'' \68\ 
In Sec.  39.6(d) (now Sec.  50.50(d)), the Commission established the 
small financial institution exemption from the definition of 
``financial entity'' for these institutions. The small financial 
institution exemption largely adopted the language of section 
2(h)(7)(C)(ii) providing for an exemption for the institutions 
identified in section 2(h)(7)(C)(ii) that have total assets of $10 
billion or less.
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    \68\ See section 2(h)(7)(C)(ii) of the CEA.
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    On December 23, 2010, the Commission published for public comment 
an NPRM for Sec.  39.6 (now Sec.  50.50) proposing the end-user 
exception.\69\ As discussed in section I hereof, several parties that 
commented on the end-user exception NPRM recommended that the 
Commission provide extend the end-user exception to cooperatives. These 
commenters reasoned \70\ that the member ownership structure of 
cooperatives and the fact that they act in the interests of members 
that are non-financial entities justified an extension of the end-user 
exception to the cooperatives. In effect, the commenters posited that 
because a cooperative effectively acts as an intermediary for its 
members when facing the larger financial markets with its interests 
being effectively the same as its members' interests, the end-user 
exception that would be available to a cooperative's members should 
also be available to the cooperative. If the members themselves could 
elect the end-user exception, then, according to the commenters, the 
Commission should permit the cooperatives to do so as well.
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    \69\ See 75 FR 80747.
    \70\ Other reasons given for providing an exemption from 
clearing for cooperatives are discussed above in this final rule.
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    The Commission is adopting the cooperative exemption herein as 
described in this release. Through Sec.  39.6(f) (now Sec.  50.51), the 
Commission uses the authority provided in section 4(c) of the CEA to 
permit ``exempt cooperatives,'' as defined in Sec.  39.6(f)(1) (now 
Sec.  50.51(a)) to elect not to clear certain swaps that are otherwise 
required to be cleared pursuant to section 2(h)(1)(A) of the CEA. In 
effect, the cooperative exemption makes available to exempt 
cooperatives the end-user exception that is available to their members, 
as described in greater detail above.\71\ It is the costs and benefits 
of this exemption that the Commission considered in the discussion that 
follows.
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    \71\ Exempt cooperatives can be financial entities that do not 
qualify for the small financial institution exemption because their 
assets exceed $10 billion. As provided in Sec.  39.6(f)(2) (now 
Sec.  50.51(b)) of the rule, an exempt cooperative would not be 
required to clear swaps with members in connection with originating 
member loans, or swaps used by the exempt cooperative to hedge or 
mitigate commercial risk arising in connection with such swaps with 
members or loans to members.
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B. Statutory Requirement To Consider the Costs and Benefits of the 
Commission's Action: CEA Section 15(a)

    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders. Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
the following five broad areas of market and public concern: (1) 
Protection of market participants and the public; (2) efficiency, 
competitiveness and financial integrity of futures markets; (3) price 
discovery; (4) sound risk management practices; and (5) other public 
interest considerations. Accordingly, the Commission considers the 
costs and benefits resulting from its own discretionary determinations 
with respect to the section 15(a) factors.
    Absent this rulemaking, all cooperatives that are financial 
entities as defined in section 2(h)(7)(C)(i) of the CEA and which are 
not otherwise exempt from that definition would be subject to the 
clearing requirement under section 2(h)(7)(A)(i) of the CEA. Thus, the 
scenario against which this rulemaking's costs and benefits are 
considered is cooperatives within the definition of financial entity in 
Section 2(h)(7)(C)(i) with assets exceeding $10 billion, which remain 
subject to the clearing requirement of section 2(h)(1)(A) of the CEA. 
Additionally, the Commission considers the rulemaking's costs and 
benefits relative to alternatives considered by the Commission.
    As discussed in more detail below, the Commission is able to 
estimate certain reporting costs. The dollar estimates are offered as 
ranges with upper and lower bounds, which is necessary to accommodate 
the uncertainty that surrounds them. The discussion below considers the 
rule's costs and benefits as well as alternatives to the rule. The 
discussion concludes with a consideration of the rule's costs and 
benefits in light of the five factors specified in section 15(a) of the 
CEA.

C. Costs and Benefits of the Final Rule

1. Costs and Benefits to Electing Cooperatives and Their Members
    Providing an exemption from required clearing to cooperatives that 
meet the criteria described in the final rule will benefit them and 
their members in that they will not have to bear the costs of

[[Page 52300]]

clearing that they would otherwise incur. Without the cooperative 
exemption rule, cooperatives meeting the criteria of the exemption 
would have to clear swaps pursuant to section 2(h)(1)(A) of the CEA 
when they are either: (1) Entering into a swap with a member that is 
subject to required clearing, or (2) transacting with another financial 
entity to hedge or mitigate risk related to loans with members or swaps 
with members related to such loans. Required clearing would introduce 
additional costs for cooperatives, including fees associated with 
clearing as well as costs associated with margin and capital 
requirements.
    Regarding fees, DCOs typically charge Futures Commission Merchants 
(``FCMs'') an initial transaction fee for each of the FCM customers' 
swaps that are cleared, as well as an annual maintenance fee for each 
of their customers' open positions.\72\ As a result, cooperatives 
eligible for the exemption will bear lower costs related to swaps and 
would likely pass along these costs savings to their members either by 
providing swaps at more attractive rates or through larger patronage 
distributions or allocations.\73\
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    \72\ For example, not including customer-specific and volume 
discounts, the transaction fees for interest rate swaps at CME range 
from $1 to $24 per million notional amount and the maintenance fees 
are $2 per year per million notional amount for open positions. LCH 
transaction fees for interest rate swaps range from $1 to $20 per 
million notional amount, and the maintenance fee ranges from $5 to 
$20 per swap per month, depending on the number of outstanding swap 
positions that an entity has with the DCO. See LCH pricing for 
clearing services related to OTC interest rate swaps at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.
    \73\ The CUNA stated that the exemption ``would help minimize 
the additional costs and fees associated with mandatory clearing.''
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    The ABA questioned whether the exemption would have benefits that 
accrue to members of exempt cooperatives. The ABA stated that in the 
absence of the proposed exemption, cooperative members can still exempt 
their swaps from clearing. Therefore, the ABA believes that ``the 
proposed clearing exemption would solely benefit cooperatives larger 
than $10 billion.''
    The Commission, however, anticipates that benefits will accrue to 
members of exempt cooperatives. Generally, as discussed in section IV, 
the mission of the cooperatives is to provide loans and other financial 
services to particular types of borrowers and the cooperatives operate 
for the mutual benefit of their respective members. As such, in keeping 
with its mission and purpose, a cooperative is likely to elect the 
exemption only if the election thereof benefits its members. As 
discussed further in this section VI, the exemption is likely to lower 
operational costs for exempt cooperatives and to reduce their margin 
requirements. As a consequence, exempt cooperatives will be able to 
provide lower-cost funding to their members, to retain more member 
allocable capital, or to pay out higher patronage distributions to 
their members. Ultimately, the members, as owners of the cooperatives, 
will benefit.
    Regarding margin requirements, by allowing cooperatives to exempt 
certain swaps from clearing, the final rule may reduce the amount of 
margin that exempt cooperatives and their counterparties are required 
to post for swaps used to hedge or mitigate risk associated with loans 
to eligible members and for swaps related to those loans.\74\ Reduced 
margin requirements will reduce the amount of capital that exempt 
cooperatives must allocate to margin, which will increase the amount of 
capital that exempt cooperatives may distribute or allocate to members. 
On the other hand, to the extent that the exemption results in exempt 
cooperatives and their counterparties holding less margin against 
exempt swap positions, each will be exposed to greater counterparty 
risk.
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    \74\ The Commission notes that regulations addressing margin and 
capital requirements for non-cleared swaps have not yet been 
finalized. Accordingly, the Commission cannot determine, quantify, 
or estimate what margin, if any, may be required for the swaps 
exempted from clearing under the cooperative exemption.
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    The final rule may also affect the capital that cooperatives that 
are financial entities are required to hold with respect to their swap 
positions pursuant to prudential regulatory capital requirements. As 
stated above, when compared to a situation in which the cooperative 
exemption is not available, the cooperative exemption will reduce the 
number of swaps that exempt cooperatives are required to clear. The 
Commission anticipates that reducing the number of swaps that such 
cooperatives clear may impact the amount of capital that exempt 
cooperatives are required to hold. This creates both benefits and 
costs. If reduced clearing lowers the amount of capital that exempt 
cooperatives must hold, that would increase the cooperative's lending 
capacity, enabling them to lend more to their members without retaining 
or raising additional capital. As for costs, this allows exempt 
cooperatives to become more highly leveraged, which increases the 
counterparty risk that they pose to their members and other market 
participants with whom they transact. On the other hand, if reduced 
clearing increases the amount of capital that exempt cooperatives must 
hold, that would have the opposite effect.
    Cooperatives that elect the exemption will be required to report, 
or to cause to be reported, additional information to an SDR or to the 
Commission, which will create incremental costs for the reporting 
party. The final rule requires that exempt cooperatives adhere to the 
reporting requirements of Sec.  50.50(b). For each swap where the 
exemption is elected, either the exempt cooperative or its counterparty 
(likely if the counterparty is an SD or MSP) must report: (1) That the 
election of the exemption is being made; (2) which party is the 
electing counterparty; and (3) certain information specific to the 
electing counterparty unless that information has already been provided 
by the electing counterparty through an annual filing.\75\ In addition, 
for entities that are registered with the SEC, the reporting party will 
also be required to report with respect to the electing counterparty: 
(1) The SEC filer's central index key number; and (2) that an 
appropriate committee of the board of directors has approved the 
decision for that entity to enter into swaps that are exempt from the 
requirements of sections 2(h)(1) and 2(h)(8) of the Act.
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    \75\ The third set of information comprises data that is likely 
to remain relatively constant and therefore, does not require swap-
by-swap reporting and can be reported less frequently.
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    For each exempted swap, to comply with the swap-by-swap reporting 
requirements in Sec. Sec.  50.50(b)(1)(i) and (ii), the reporting 
counterparty will be required to check one box indicating the exemption 
is being elected and complete one field identifying the electing 
counterparty. The Commission expects that this information will be 
entered into the appropriate reporting system concurrently with 
additional information that is required by the CEA and part 45 of the 
Commission's regulations. Furthermore, the Commission estimates that 
there will be approximately 500 swaps per year that are exempted from 
clearing pursuant to this rule.\76\ Therefore, each reporting

[[Page 52301]]

counterparty is likely to spend 15 seconds to 2 minutes per transaction 
in incremental time entering the swap-by-swap information into the 
reporting system, or in the aggregate, 1.5 hours to 17 hours per year 
for all 500 estimated swaps. A financial analyst's average salary is 
$208/hour, which corresponds to approximately $1-$7 per transaction or 
in aggregate, $300-$3,500 per year for all 500 estimated swaps.\77\ 
While the above information must be reported on a swap-by-swap basis, 
some information may be reported annually. Regulation Sec.  
50.50(b)(1)(iii) allows for certain counterparty specific information 
identified therein to be reported either swap-by-swap by the reporting 
counterparty or annually by the electing counterparty. When exempt 
cooperatives enter into exempt swaps with members, the cooperative is 
likely to be the reporting counterparty. Furthermore, assuming the 
cooperative is the reporting counterparty, the time burden for the 
first swap entered into by an exempt cooperative in collecting and 
reporting the information required by Sec.  50.50(b)(1)(iii) will be 
approximately the same as the time burden for collecting and reporting 
the information for the annual filing. Given the cost equivalence for 
annual reporting to reporting a single swap if the exempt cooperative 
is both the electing and reporting counterparty, the Commission assumes 
that all ten exempt cooperatives will make an annual filing of the 
information required for Sec.  50.50(b)(1)(iii). The Commission 
estimates that it will take an average of 30 minutes to 90 minutes to 
complete and submit the annual filing. The average hourly wage for a 
compliance attorney is $300, which means that the annual per 
cooperative cost for the filing is likely to be between $150 and $450. 
If all ten exempt cooperatives were to undertake an annual filing, the 
aggregate cost would be $1,500 to $4,500.\78\
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    \76\ A review of information provided for five cooperatives that 
likely would be exempt cooperatives showed a range of swap usage 
from none to as many as approximately 200 swaps a year with most 
entering into less than 50 swaps a year. Using the high end of 
reported swaps for the five cooperatives for which information was 
available, an estimate of 50 swaps per year was calculated. The 
Commission believes this estimate is high because some of the 
reported swaps may not meet the requirements of the final rule and, 
based on discussions with other regulators, several cooperatives for 
which detailed information was not available to the Commission 
likely undertake little, if any, swap activity. However, for 
purposes of the cost calculations, the Commission assumes that each 
of the 10 potential exempt cooperatives will enter into 50 swaps 
each year. Accordingly, it is estimated that exempt cooperatives may 
elect the cooperative exemption for 500 swaps each year.
    \77\ Wage estimates are taken from the SIFMA ``Report on 
Management and Professional Earnings in the Securities Industry 
2011.'' Hourly wages are calculated assuming 1,800 hours per year 
and a multiplier of 5.35 to account for overhead and bonuses. In 
light of the challenges of developing precise estimates, the results 
of calculations have been rounded.
    \78\ The average wage for a compliance attorney is $300.95 
[($112,505 per year)/(2,000 hours per year) * 5.35 = $300.95]. For 
the purposes of the Cost Benefit Considerations section, the 
Commission has used wage estimates that are taken from the SIFMA 
``Report on Management and Professional Earnings in the Securities 
Industry 2011'' because industry participants are likely to be more 
familiar with them. Hourly costs are calculated assuming 2,000 hours 
per year and a multiplier of 5.35 to account for overhead and 
bonuses. All totals calculated on the basis of cost estimates are 
rounded to two significant digits.
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    Furthermore, when an exempt cooperative is not functioning as the 
reporting counterparty (i.e., when transacting with a SD or MSP), it 
may, at certain times, need to communicate information to its reporting 
counterparties in order to facilitate reporting. That information may 
include, among other things, whether the electing counterparty has 
filed an annual report pursuant to Sec.  50.50(b) and information to 
facilitate any due diligence that the reporting counterparty may 
conduct. These costs will likely vary substantially depending on the 
number of different reporting counterparties with whom an electing 
counterparty conducts transactions, how frequently the electing 
counterparty enters into swaps, whether the electing counterparty 
undertakes an annual filing, and the due diligence that the reporting 
counterparty chooses to conduct. The Commission estimates that non-
reporting electing counterparties will incur between 5 minutes and 10 
hours of annual burden hours, or in the aggregate, between 
approximately 1 hour and 100 hours. The hourly wage for a compliance 
attorney is $300, which means that the annual aggregate cost for 
communicating information to the reporting counterparty is likely to be 
between $300 and $30,000. Given the unknowns associated with this cost 
estimate noted above, the Commission does not believe this wide range 
can be narrowed without further information.\79\
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    \79\ As noted above, the average wage for a compliance attorney 
is $300.95 per hour [($112,505 per year)/(2,000 hours per year) * 
5.35 = $300.95].
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    The ABA and the ICBA suggested that the Commission's assumption 
that each potentially exempt cooperative engages in 50 swaps a year 
does not take into account the fact that the number of swaps entered 
into by the exempt cooperatives may change or increase over time. The 
ABA also commented that the Commission underestimated the number of 
cooperatives eligible and assumes that the number of cooperatives would 
not increase by either reorganization or growth.
    The Commission contacted the FCA and National Credit Union 
Administration for further assistance in assessing whether the 
estimates used in the NPRM are reasonable. These regulators discussed 
generally the observed level of swap activity of the cooperatives they 
regulate. Based on these discussions, the Commission concluded that the 
estimates in the NPRM are reasonable and appropriate for this 
rulemaking. The Commission recognizes that the number of entities 
eligible for the exemption and the number of swaps per eligible 
cooperative is likely to change in the future and that the benefits of 
this exemption for exempt cooperatives could encourage the number or 
size of exempt cooperatives and of swaps used by those cooperatives to 
grow. However, the Commission notes that the extent to which such 
growth is realized also depends on several additional factors that the 
Commission does not have adequate information to evaluate, including: 
(1) Subsequent changes to laws or regulations affecting one or more 
types of cooperatives; (2) increases or decreases in the size of the 
industries served by those cooperatives; and (3) the frequency with 
which exempt cooperatives make loans or experience other changes that 
require rebalancing of their hedging strategies. Because the Commission 
does not have sufficient information to estimate the direction or 
magnitude of the effect that these forces will have on the number of 
exempt cooperatives and exempt swaps per cooperative, it is not 
possible to evaluate how future changes in either are likely to affect 
the costs or benefits related to the exemption.
2. Costs and Benefits for Counterparties to Electing Cooperatives
    The benefits of the exemption for counterparties to electing exempt 
cooperatives differ depending on whether they are members of the 
cooperatives. For entities that are members of the electing 
cooperative, they will likely benefit from the reduced operational 
costs the exempt cooperative achieves through reduced clearing fees 
associated with the cooperative's swaps with the market. The benefit 
may be passed on in the form of better terms on swaps between members 
and the cooperative and through the cooperative's patronage 
distributions to members. For entities that are not members of the 
cooperative (i.e. market makers entering into swaps with the 
cooperative), the benefits are different. Market makers entering into 
swaps with cooperatives that are subject to the exemption do not 
participate in the pro rata patronage distributions, but may benefit 
from reduced clearing costs associated with non-cleared swaps.
    Reduced clearing of swaps by exempt cooperatives will increase 
counterparty risk for both exempt cooperatives and their 
counterparties. Cooperatives will be more exposed to the credit risk of 
their counterparties, and conversely, the cooperatives' counterparties 
will be more exposed to the credit risk of the exempt cooperatives. 
This could be

[[Page 52302]]

problematic for an exempt cooperative if one of the dealers with which 
the cooperative has large non-cleared positions defaults, or if groups 
of members whose financial strength may be highly correlated and whose 
aggregate non-cleared positions with the cooperative are large, 
encounter financial challenges. In this way, the credit risk of one of 
the cooperative's counterparties could adversely impact the other 
counterparties of that cooperative.
    Conversely, if an exempt cooperative becomes insolvent and its 
positions with a SD or MSP are substantial, it is possible that its 
non-cleared positions could be large enough to exacerbate instability 
at the SD or MSP or could create greater risk exposure for the members 
with which the cooperative entered into swaps.
    The FCC stated that because FCS institutions have collateral 
agreements in place, ``clearing offers very little additional 
protection to FCS institutions.'' The Commission acknowledges that 
counterparty risk can be mitigated through collateral arrangements, but 
also notes that the extent to which counterparty risk is reduced 
through collateral agreements depends on the amount of collateral 
required from each party to the swap, the liquidity of that collateral 
in stressed market conditions, the frequency with which the amount of 
collateral is adjusted to account for variations in the value of the 
swap or the collateral, and the ability of the non-defaulting party to 
claim the collateral quickly in the event that their counterparty 
defaults.\80\ The Commission does not have adequate information to 
determine how effectively collateral arrangements may mitigate 
counterparty risk born by exempt cooperatives and their counterparties 
in the absence of central clearing.
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    \80\ The 2012 ISDA Margin Survey indicates that 71% of all OTC 
derivatives transactions were subject to collateral agreements 
during 2011, but notes that the degree of collateralization may vary 
significantly depending on the type of derivative and counterparties 
entering into a transaction.
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3. Costs and Benefits for Other Market Participants
    The ABA commented that the Commission did not consider competitive 
harm to banks when analyzing the costs and benefits of the cooperative 
exemption. The ABA and ICBA commented that cooperatives compete with 
banks for the same business opportunities and provide similar services. 
They further stated that the exemption would provide cooperatives with 
a competitive advantage because they ``would have more liquidity 
available for lending than comparable banks would and be able to 
provide lower cost funding.'' Further, the ABA stated that ``the 
competitive impact of the proposed exemption would grow as more 
cooperatives increase their swaps portfolios to take advantage of the 
pricing and other economic benefits it affords.''
    The Commission recognizes that the cooperative exemption may 
provide clearing cost savings related benefits to eligible cooperatives 
with assets in excess of $10 billion.\81\ However, in assessing the 
competitive costs and benefits of the cooperative exemption the 
Commission believes the policy considerations for establishing 
cooperatives also need to be taken into account. As described section 
IV, Congress and the states have established the cooperative legal 
structure distinct from other corporate forms to facilitate the 
economic advantage of cooperative action for the mutual benefit of a 
cooperative's members. The cooperative exemption provides the members 
with the benefits of the end-user exception, both directly and 
indirectly through their cooperatives, without having to switch from 
doing business with their existing cooperatives to doing business with 
small financial institutions or other entities that can elect to exempt 
their swaps from clearing, but which are not organized for the specific 
purpose of benefitting those members. The cooperative exemption 
furthers these benefits by recognizing that the cooperatives were 
established to act on behalf of their members in the marketplace and 
providing an exemption from clearing to eligible cooperatives. In 
effect, the cooperative exemption ensures that the existing members of 
exempt cooperatives can achieve the full benefits of both cooperative 
action and of the end-user exception.
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    \81\ The Commission notes, however, that most small banks are 
also eligible for the end-user exception, which can be elected for a 
wider range of swaps than the cooperative exemption. Section 
50.50(d) of the Commission's regulations provides that banks, FCS 
institutions, and credit unions that have total assets of $10 
billion or less are eligible for the end-user exception with certain 
exceptions--primarily that they not be SDs or MSPs.
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4. Costs and Benefits to the Public
    The public generally has an interest in mandatory clearing because 
of its potential to reduce counterparty risk among large, 
interconnected institutions, and to facilitate rapid resolution of 
outstanding positions held by such institutions in the event of their 
default. By narrowly crafting the proposed cooperative exemption to 
incorporate qualifying criteria limiting both the types of institutions 
and the types of swaps that are eligible, the Commission has sought to 
conserve this public interest.
    The ABA and the ICBA commented that the four FCS banks and FCS 
lending associations are jointly and severally liable for one another, 
and that ``the aggregated asset size of these institutions is $230 
billion and growing rapidly.'' The ICBA also stated that the financial 
cooperatives affected by the exemption will grow larger over time and 
may present a systemic risk in the future. The ABA stated that because 
the FCS is a GSE, it is a potential liability to U.S. taxpayers. The 
CUNA, on the other hand, asserted that the exemption would not have 
significant impact on the overall swap market because of the small 
number of entities eligible for the exemption. Similarly, the FCC 
stated that because of collateral agreements that FCS institutions have 
in place that ``the FCS poses no systemic risk to the U.S. financial 
system.''
    The Commission acknowledges that the magnitude of risk and 
potential costs to the public created by an exemption from clearing 
depends on several factors including: The number and size of the exempt 
cooperatives electing the exemption; the size, number, and type of 
exempt swaps held by each institution; the risks inherent in their 
outstanding swaps; the concentration of swaps with individual 
counterparties; the financial strength of counterparties to exempt 
swaps; and the presence of collateral agreements related to the exempt 
swaps.\82\ The Commission has limited data with which to evaluate these 
factors. Commenters provided limited data, noting the size of the four 
farm credit banks \83\ and the number and size of certain credit unions 
with more than $10 billion in assets.\84\ However, commenters did not 
provide, and the Commission does not have, detailed data regarding the 
size of exempt cooperatives' non-cleared swaps, information regarding 
the concentration

[[Page 52303]]

of non-cleared positions with particular counterparties, or information 
regarding the financial strength of those counterparties. In addition, 
while commenters noted the potential for collateral agreements to 
mitigate counterparty risk in the absence of clearing, they did not 
provide data or additional information regarding the agreements that 
they anticipate will be used. Each of these factors could have a 
significant bearing on how much risk is created for the public by 
exempting eligible counterparties from the clearing requirement.
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    \82\ As noted above, the ability of collateral agreements to 
mitigate counterparty risk and risk to the public depends on the 
details of those agreements with regard to the amount and quality of 
collateral required, the frequency with which it is adjusted to 
reflect changing valuations, and the speed with which the non-
defaulting party can claim the collateral in the event that their 
counterparty defaults.
    \83\ ABA stated that the four Farm Credit banks have 
approximately $15 billion, $29 billion, $76 billion, and $90 billion 
in assets.
    \84\ ABA stated that there are four credit unions with more than 
$10 billion in assets and are likely to be several more within the 
next year. They also stated that one credit union has nearly $50 
billion in assets and another has more than $25 billion.
---------------------------------------------------------------------------

    Notwithstanding the limited data available, the Commission 
considered the potential risks that could arise from cooperatives 
entering into non-cleared swaps and the Commission believes it has 
mitigated these risks with the conditions imposed in the rule that 
limit the number of entities and types of swaps eligible for the 
cooperative exemption. These conditions are described in sections I, II 
and II above.
    In addition, the Commission notes that cooperatives that may 
qualify as exempt cooperatives are supervised by other regulators that 
have access to more detailed information regarding the swaps executed 
by the cooperatives and that are likely to have additional information 
regarding the risk factors discussed above. These regulators can 
monitor the use of swaps by these cooperatives and the risk factors 
related to that swap activity. Using this information, these regulators 
can assess the risks related to the non-cleared swaps in the context of 
the overall regulatory framework applicable to the cooperatives and the 
changing financial condition of the cooperatives and in that context 
address the potential systemic risk with the cooperatives using their 
regulatory authority.
    Finally, while it is important to consider the potential risks 
noted above, it is also important to assess the benefits provided by 
the cooperative exemption. The Commission believes ensuring that the 
members of exempt cooperatives can continue to use their cooperatives 
in the manner intended and also realize the full benefits of the end-
user exception through their cooperatives is appropriate given the 
unique nature of cooperatives and the statutory and policy 
considerations discussed above in section III.

D. Costs and Benefits Compared to Alternatives

    There were several alternatives proposed by commenters that the 
Commission considered including: Providing a ``ride along'' exemption 
for community banks larger than $10 billion; and including cooperatives 
with members that are financial entities, either with or without 
additional restrictions on the eligibility of swaps conducted by such 
cooperatives.
    The Commission considered a ``ride-along'' provision, proposed by 
the ICBA, which would provide a clearing exemption for community banks 
that exceed the $10 billion total assets threshold. Providing a ``ride-
along'' provision could mitigate the potential competitive effects of 
the exception, as alleged by the ICBA, but would also increase the 
potential risk to the public by increasing the number of large 
financial entities eligible for an exemption from clearing.
    Moreover, expanding the exemption in this way could also make it 
possible for SDs, MSPs, and other large financial institutions to avoid 
clearing by using exempt community banks as an intermediary for their 
swap transactions. Finally, allowing non-cooperatives to use the 
exemption would not reflect the unique structure of cooperatives that 
is the basis for the exemption and result in an expansion of the small 
financial institution exemption beyond the parameters detailed in the 
final release for the Commissions regulations implementing the end-user 
exception.\85\ For these reasons, the Commission has determined not to 
include the suggested ``ride-along'' provision.
---------------------------------------------------------------------------

    \85\ 77 FR 42559 (Jul. 19, 2012).
---------------------------------------------------------------------------

    The ICBA also stated that the cooperative exemption does not 
include the FHL Banks, and that thousands of small banks that are 
members of the FHL Bank system will be disadvantaged by the cooperative 
exemption because the FHL Banks will not be able to provide the same or 
similar low cost financing to community banks as FCS lenders do for 
their cooperative associations. The ICBA and the FHL Banks commented 
that the FHL Banks should be included as exempt cooperatives either 
generally, or to the extent they provide services to their members that 
qualify for the small financial institution exemption from the 
definition of financial entity.
    In the NPRM, the Commission considered including cooperatives 
consisting of members that could not elect the end-user exception, as 
suggested by the FHL Banks. Such an exemption would assist in ensuring 
that a greater number of cooperatives are able to elect not to clear 
swaps. However, as described in greater detail in section III, if the 
cooperatives elected the exemption when transacting with or for the 
benefit of members that are not eligible for the end-user exception 
(i.e. financial institutions with total assets greater than $10 
billion) it could significantly increase the number of swaps that are 
exempt from the clearing requirement and result in exemptions for 
entities that Congress has not provided any indication should be exempt 
from the clearing requirement.\86\ If the cooperative exemption were 
expanded in this way, it would reduce the benefits derived from 
required clearing. By contrast, with the limiting conditions included 
in the cooperative exemption rule, the Commission is ensuring that the 
exemption is only available to cooperatives whose members can elect the 
end-user exception or are themselves cooperatives whose members can 
elect the end-user exception.\87\
---------------------------------------------------------------------------

    \86\ Note, for example, that while the FHL Banks have thousands 
of members that qualify for the small financial institution 
exemption and who therefor can elect the end-user exception, over 
one hundred members of the FHL Banks would not qualify because they 
are financial entities with total assets in excess of $10 billion. 
These members include some of the largest financial entities in the 
United States. In addition, as described above in section III, 
financial entities with assets in excess of $10 billion have 
borrowed more than half the amount lent by the FHL banks to members.
    \87\ The Commission notes that banks and other entities that 
qualify for the small financial institution exemption from the 
financial entity definition are not excluded under the regulation 
from being members of exempt cooperatives.
---------------------------------------------------------------------------

    The FHL Banks suggested that this problem could be addressed by 
limiting the exemption to swaps that hedge risks associated with loans 
to eligible members. However, allowing new or existing cooperatives 
with financial entity members to elect not to clear swaps related to 
activities with members that are eligible for the end-user exception 
would dilute the benefits that qualifying members achieve through the 
exemption thereby undermining the purpose for the exemption. For 
example, as described above in section III, if the FHL Banks elect the 
cooperative exemption only for swaps related to members who qualify as 
small financial institutions, the decision not to clear those swaps 
could create clearing cost savings for the FHL Banks. Those savings 
would increase the capital that the FHL Banks distribute or allocate to 
their members as part of the full member pro rata patronage 
distribution. If larger members hold a large ownership stake in the 
cooperative, those members would also receive a proportionately large 
share of the distributions, including a proportionately large share of 
the savings that result from the cooperative

[[Page 52304]]

exemption.\88\ In other words, members that are eligible for the end-
user exception would not receive the full benefits of the exemption 
that is extended to the cooperative. By contrast, with the limiting 
conditions included in the cooperative exemption rule, the Commission 
is ensuring that the exemption is only available to cooperatives whose 
members could all elect the end-user exception or are themselves 
cooperatives whose members could elect the end-user exception, and thus 
the additional pro-rata patronage distributions that an exempt 
cooperative makes because of the cooperative exemption will only go to 
such entities.
---------------------------------------------------------------------------

    \88\ See section II above for a full discussion of the relative 
benefits available to different sized members of the FHL Banks.
---------------------------------------------------------------------------

    The FCC requested clarification with respect to the Commission's 
view on what swaps are ``related to'' a cooperative's loans to its 
members, and advocated a broad interpretation. They also stated that 
``clarification of these items will serve to increase the likelihood 
that the System's farmer and rancher member borrowers will be able to 
benefit from this proposed exemption from clearing.'' The broader 
interpretation requested by the FCC could increase the number of swaps 
that are eligible for the exemption by including swaps that serve non-
member related purposes, which would further reduce clearing-related 
costs for eligible cooperatives, but would also increase the 
counterparty risk that eligible cooperatives and their counterparties 
bear due to decreased clearing. In the Commission's view, this broader 
exemption is not justified given the rationale behind the cooperative 
exemption. As stated above, the term ``related to'' is intended to 
include swaps that the exempt cooperatives may enter into with non-
members to hedge or mitigate the risks incurred by the cooperatives 
related to their member lending activities. For example, where 
cooperatives obtain wholesale funding, only the portion of funding that 
is not used to make non-member loans may be hedged with exempt 
swaps.\89\ By limiting the eligibility of exempt cooperatives' swaps in 
this way, the Commission reduces the counterparty risk that exempt 
cooperatives and their counterparties could experience due to decreased 
clearing.
---------------------------------------------------------------------------

    \89\ See section III.C above.
---------------------------------------------------------------------------

E. Section 15(a) Factors

1. Protection of Market Participants and the Public
    As described above, if exempt cooperatives elect to exempt certain 
swaps from required clearing, these cooperatives may not need to pay 
DCO and FCM clearing fees for clearing those swaps. In addition, the 
exemption may reduce the amount of capital that exempt cooperatives 
must allocate to margin accounts with their FCM. This, in turn, 
provides benefits to the members of exempt cooperatives, that may 
otherwise absorb such costs as they are passed on by the cooperatives 
to their members in the form of fees, less desirable spreads on swaps 
or loans conducted with the cooperative, or lower member allocated 
capital or patronage distributions.
    The exemption will create certain reporting costs for eligible 
entities. However, as described in the rulemaking for the end-user 
exception where the specific reporting requirements were addressed, the 
reporting required uses a simple check-the-box approach and elective 
annual reporting of certain information that should minimize per swap 
reporting costs, particularly for cooperatives that enter into multiple 
swaps.
    The exemption is narrowly tailored to exempt only a relatively 
small number of institutions and to include only swaps that are 
associated with positions established in connection with originating 
loans made to customers, or that hedge or mitigate risk arising in 
connection with such member loans or swaps. These limitations will tend 
to mitigate the risk to the public that could result from the 
exemption.
    In addition, this exemption is likely to increase counterparty risk 
for counterparties to exempted swaps as well as for the exempted 
cooperatives. However, as described above, exempted cooperatives and 
their counterparties may use collateral agreements with exempted swaps 
to mitigate counterparty risk.
2. Efficiency, Competitiveness, and Financial Integrity of Swap Markets
    While the cooperative exemption would take swaps out of clearing, 
it mitigates the impact on the financial integrity of the swap markets 
by limiting the types of entities and swaps that are eligible. As 
discussed above, the exemption is designed to include only cooperatives 
that are made up entirely of entities that could elect the end-user 
exception, and only swaps associated with loans between the cooperative 
and such members.
    The exemption may have competitive effects by allowing the members 
of exempt cooperatives to achieve additional benefits from the actions 
of their cooperatives. The Commission believes such benefits are 
consistent with the intended public interests served by the 
establishment of cooperative structures as a separate legal form by 
Congress and the states. The Commission addresses these issues in 
section IV and VI.C.3. Commenters did not provide, and the Commission 
does not have, information that is sufficient to quantify the 
competitive effects that will result from the exemption.
3. Price Discovery
    Clearing, in general, encourages better price discovery because it 
eliminates the importance of counterparty creditworthiness in pricing 
swaps cleared through a given DCO. That is, by making the counterparty 
creditworthiness of all swaps of a certain type essentially the same, 
prices should reflect factors related to the terms of the swap, rather 
than the idiosyncratic risk posed by the entities trading it.\90\ To 
the extent that the cooperative exemption reduces the number of swaps 
subject to required clearing, it will lessen the beneficial effects of 
required clearing for price discovery. However, the Commission 
anticipates that the number of swaps eligible for this exemption, 
currently estimated at approximately 500 a year, will be a de minimis 
fraction of all those that are otherwise required to be cleared. 
Therefore, the Commission believes that there will not be a material 
impact on price discovery.
---------------------------------------------------------------------------

    \90\ See Chen, K., et al. ``An Analysis of CDS Transactions: 
Implications for Public Reporting,'' September 2011, Federal Reserve 
Bank of New York Staff Reports, at 14.
---------------------------------------------------------------------------

4. Sound Risk Management Practices
    To the extent that a swap is removed from clearing, all other 
things being constant, it is a detriment to a sound risk management 
regime. To the extent that exempt cooperatives enter into non-cleared 
swaps on the basis of this rule, it likely increases the exposure of 
exempt cooperatives and their counterparties to counterparty credit 
risk. For the public, it increases the risk that financial distress at 
one or more cooperatives could spread to other financial institutions 
with which those cooperatives have concentrated positions. However, as 
discussed above, this additional risk may be reduced by the presence of 
bilateral margin agreements, which the Commission

[[Page 52305]]

believes are often used in the absence of clearing.
5. Other Public Interest Considerations
    The Commission believes that the cooperative exemption serves the 
public interest by furthering the public benefits cited by Congress and 
state legislatures in legislation authorizing cooperative business 
forms as discussed in section IV above. The cooperative structure 
allows the members to pool their resources, achieve economies of scale, 
and realize the benefits of acting in markets through larger entities. 
However, absent the cooperative exemption, the exempt cooperatives 
would be unable to elect the end-user exception because the amount of 
their assets precludes them from qualifying as small financial 
institutions. In effect, the cooperative structure, which is intended 
to provide advantages to its member-owners by creating a large entity 
whose mission is to serve their interests, instead prevents the members 
from receiving the full benefits of the end-user exception when using 
their large cooperatives. The cooperative exemption therefor is in the 
public interest because it resolves a conflict between the small 
financial institution language of section 2(h)(7) of the CEA and the 
general policy behind establishing cooperatives of creating large 
financial institutions with the mission of serving the mutual interests 
of their member-owners.

VII. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities \91\ and, if 
so, provide a regulatory flexibility analysis respecting the 
impact.\92\ Regulation Sec.  39.6(f) (now Sec.  50.51) would affect 
cooperatives, their members, and potentially the counterparties with 
whom they trade. These entities could be SDs, MSPs, and eligible 
contract participants (``ECPs'').\93\ Regulation Sec.  39.6(f) (now 
Sec.  50.51) would additionally affect SDRs. As noted in the NPRM, the 
Commission has previously determined that SDs, MSPs, and SDRs are not 
small entities for purposes of the RFA.\94\
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    \91\ The Small Business Administration identifies (by North 
American Industry Classification System codes) a small business size 
standard of $7 million or less in annual receipts for Subsector 
523--Securities, Commodity Contracts, and Other Financial 
Investments and Related Activities. 13 CFR parts 1, 121.201.
    \92\ 5 U.S.C. 601 et seq.
    \93\ It is possible that a cooperative or members thereof may 
not be ECPs. However, pursuant to Section 2(e) of the CEA, if a 
counterparty to a swap is not an ECP, then such swap must be entered 
into on, or subject to the rules of, a board of trade designated as 
a contract market under Section 5 of the CEA. All such swaps must be 
cleared by the board of trade. See section 5(d)(11) of the CEA, 7 
U.S.C. 7(d)(11). In effect all swaps entered into by a cooperative 
or a member that is not an ECP will need to be executed on a board 
of trade and therefore will be cleared.
    \94\ See 77 FR 30596, 30701 (May 23, 2012); see also 75 FR 
80898, 80926 (Dec. 23, 2010).
---------------------------------------------------------------------------

    It is possible that some members of cooperatives may be small 
entities under the RFA. For these members to be impacted by the 
cooperative exemption compliance requirements they would have to be 
entering into swaps with the exempt cooperative and the exemption would 
need to be elected. In order for two counterparties to a swap to enter 
into a swap bilaterally, both parties must be ECPs.\95\ Based on the 
definition of ECP in the Commodity Futures Modernization Act of 2000, 
and the legislative history underlying that definition, the Commission 
has previously determined that ECPs should not be small entities for 
purposes of the RFA.\96\ The Commission has been made aware in other 
contexts that some ECPs, specifically those that do not fall within a 
category of ECP that is subject to a dollar threshold, may be small 
entities. If there are cooperative members that are both ECPs as 
defined in the CEA and small entities for purposes of the RFA, the 
exemption is nevertheless most likely to provide an economic benefit to 
the cooperative member. Furthermore, if elected, the cooperative 
exemption would impose the same or similar costs of compliance on 
members that the previously adopted end-user exception from the 
clearing requirement imposes. The end-user exception provides 
effectively the same type of relief from clearing. Accordingly, the 
cooperative exemption does not create any materially new or different 
compliance costs than similar regulations that were previously adopted. 
Finally, the cooperative exemption is elective. If a member that is a 
small entity wanted to clear its swap, the cooperative exemption does 
not require them to enter into swaps with their cooperatives and they 
could execute swaps with other parties that would agree to clearing. 
Accordingly, the cooperative exemption would not cause any new 
significant economic impact on these members.
---------------------------------------------------------------------------

    \95\ 7 U.S.C. 2(e).
    \96\ See 66 FR 20740, 20743 (Apr. 25, 2001).
---------------------------------------------------------------------------

    The Chairman, on behalf of the Commission, certified in the NPRM, 
pursuant to 5 U.S.C. 605(b), that Sec.  39.6(f) (now Sec.  50.51(a)) 
will not have a significant impact on a substantial number of small 
entities. The Commission requested comment on this decision in the 
NPRM.
    The ICBA commented that the proposal impacts a substantial number 
of small community banks because they are members of the FHL banks and 
the FHL banks are not exempt cooperatives. According to the ICBA, the 
small bank members of the FHL bank system would be disadvantaged 
because the FHL banks will not be able to provide the same or similar 
low cost financing to community banks as FCS lenders will for their 
cooperatives.
    The Commission also received two comments regarding the impact of 
Regulation Sec.  39.6(f) (now Sec.  50.51(a)) on the competition 
between banks that are small entities and cooperatives that elect the 
cooperative exemption. According to the ABA, the Commission's analysis 
of the economic impact on small entities did not consider that economic 
impact on the ``hundreds of end-user banks that are competing with 
cooperatives for the same business opportunities.'' Similarly, the ICBA 
commented that the ``competitive advantages afforded to large credit 
unions and large FCS funding banks . . . would allow these institutions 
advantages in competing directly against small community banks even if 
they have a small financial institution exemption.'' The ICBA then 
referenced CoBank as an example of an FCS funding bank with a wide 
geographic footprint over two dozen states that could grow larger.
    The ABA and the ICBA asserted that the Commission is obliged under 
the RFA to consider the impact of the regulation on small banks, 
including small banks that are members of the FHL bank system. 
Specifically, commenters asserted that the Commission should consider 
the competitive benefit the cooperative exemption might give to exempt 
cooperatives as compared to small banks that might be small entities 
for purposes of the RFA both on their own and because small banks are 
members of the FHL bank system.\97\ The Commission has applied the RFA 
to entities that are cooperatives who may elect the cooperative 
exemption and their members. Small community banks that are not members 
of exempt cooperatives are not subject to the cooperative exemption. 
The Commission also notes that, as discussed above, to the extent a 
small

[[Page 52306]]

community bank is or becomes a member of an exempt cooperative and 
enters into a swap bilaterally with an exempt cooperative for which the 
cooperative exemption is elected, that member would have to be an ECP, 
in order to enter into the swap bilaterally, and also an entity that 
could elect the end-user exception. Accordingly, the Commission 
continues to believe that the cooperative exemption will not have a 
significant economic impact on small entities.
---------------------------------------------------------------------------

    \97\ The FHL banks would not qualify for the cooperative 
exemption because they have large financial entity members. See 
section IV above.
---------------------------------------------------------------------------

    Therefore, the Chairman, on behalf of the Commission, hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the final regulation would 
not have a significant economic impact on a substantial number of small 
entities.

B. Paperwork Reduction Act

    Regulation Sec.  39.6(f)(3) (now Sec.  50.51(c)) requires a 
cooperative to conform with certain reporting conditions if it elects 
the cooperative exemption. These new requirements constitute a 
collection of information within the meaning of the Paperwork Reduction 
Act of 1995 (``PRA'').\98\ Under the PRA, an agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it has been approved by the Office of Management and 
Budget (``OMB'') and displays a currently valid control number.\99\ 
This rulemaking contains new collections of information for which the 
Commission must seek a valid control number. The Commission therefore 
requested that OMB assign a control number and OMB assigned control 
number 3038-0102 for this new collection of information. The Commission 
has also submitted the proposed rulemaking, this final rule release, 
and supporting documentation to OMB for review in accordance with 44 
U.S.C. 3507(d) and 5 CFR 1320.11. The title for these new collections 
of information is ``Rule 39.6(f) Cooperative Clearing Exemption 
Notification.'' Responses to these information collections will be 
mandatory if the cooperative exemption is elected.
---------------------------------------------------------------------------

    \98\ 44 U.S.C. 3501 et seq.
    \99\ Id.
---------------------------------------------------------------------------

    With respect to all of the Commission's collections, the Commission 
will protect proprietary information according to the Freedom of 
Information Act and 17 CFR part 145, ``Commission Records and 
Information.'' In addition, section 8(a)(1) of the Act strictly 
prohibits the Commission, unless specifically authorized by the Act, 
from making public ``data and information that would separately 
disclose the business transactions or market positions of any person 
and trade secrets or names of customers.'' The Commission also is 
required to protect certain information contained in a government 
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information To Be Provided by Reporting Parties
    For each swap where the exemption is elected, either the 
cooperative, or its counterparty if the counterparty is an SD or MSP, 
must report: (1) That the election of the exemption is being made; (2) 
which party is the electing counterparty; and (3) certain information 
specific to the electing counterparty unless that information has 
already been provided by the electing counterparty through an annual 
filing. As noted in the NPRM, the third set of information comprises 
data that is likely to remain relatively constant for many, but not 
all, electing counterparties and therefore, does not require swap-by-
swap reporting and can be reported less frequently. In addition, for 
entities registered with the SEC, the reporting party will also be 
required to report: (1) The SEC filer's central index key number; and 
(2) that an appropriate committee of the board of directors has 
approved the decision for that entity to enter into swaps that are 
exempt from the requirements of section 2(h)(1)(A) of the CEA.
    Exempt cooperatives entering into swaps with members and electing 
the exemption will likely be responsible to report this information. 
When cooperatives enter into swaps with SDs or MSPs, the SDs or MSPs 
will be responsible for reporting the information, but cooperatives 
would bear some costs related to the personnel hours committed to 
reporting the required information.
    As discussed in the NPRM, for purposes of estimating the cost of 
reporting in connection with the cooperative exemption, the Commission 
estimated that each of the ten exempt cooperatives would enter into 50 
swaps per year on average. Accordingly, the Commission estimated that 
exempt cooperatives would elect the cooperative exemption for 500 swaps 
each year. The reporting cost estimates are discussed separately below 
according to each requirement.
    The Commission invited public comment on any aspect of the 
reporting burdens discussed in the NPRM. The Commission received two 
comments on the Commission's approach to calculating the estimated cost 
burdens. The ABA questioned whether the Commission had underestimated 
its estimations of the number of cooperatives eligible for the 
exemption, and the number of swaps each eligible cooperative engages in 
per year. The ABA also commented that the figures used are static and 
as such do not allow for potential future growth in the number of 
potential exempt cooperatives and number of swaps in which they may 
transact. The ICBA similarly commented on the static nature 
Commission's approach, and noted that the approach does not account for 
future growth when the use of swaps in the OTC market has grown 
significantly in recent years. Furthermore, the ICBA noted that the 
CFTC looked at information from five of the ten estimated cooperatives 
that may be eligible for the cooperative exemption, but did not 
indicate which of the five cooperatives it considered or what the 
reason was for not reviewing information from the other five 
cooperatives.
    In response to the comments received, the Commission notes that the 
commenters provided no data or other information to support their 
assertions that the number of cooperatives and the number of swaps that 
may be eligible for the cooperative exemption may be low or inaccurate. 
The summary information regarding swap activities of five prospective 
exempt cooperatives was provided to the Commission on a voluntary basis 
through the FCC and CFC. Based on discussions with these entities, the 
Commission believes that these five cooperatives were more active than 
the other potential exempt cooperatives in using swaps and therefore 
this sampling of information was appropriate for estimating the number 
of swaps executed by the ten potential exempt cooperatives identified 
by the Commission. Subsequent to receipt of the comments on the NPRM, 
the Commission contacted the regulators for FCS cooperatives and 
federal credit unions and these regulators expressed a view that the 
Commission's estimates were not inappropriate.
    In response to the comments that the estimates represent only a 
current snap shot of activity, the Commission recognizes that the 
number of entities eligible for the exemption and the number of swaps 
per eligible cooperative is likely to change in the future and that the 
benefits of this exemption for exempt cooperatives could encourage more 
exempt cooperatives to use swaps and could increase the number of swaps 
used by those cooperatives. However, the Commission notes that whether 
such growth is realized also depends on

[[Page 52307]]

additional factors that the Commission does not have adequate 
information to evaluate such as: (1) Subsequent changes to laws or 
regulations affecting one or more types of cooperatives and the extent 
to which they may use swaps; (2) increases or decreases in the total 
amount of borrowing undertaken by the members of those cooperatives; 
and (3) the frequency with which exempt cooperatives make the types of 
loans or experience other business changes that might increase or 
decrease the use of swaps. It is not possible to evaluate how future 
changes in these factors are likely to affect the number of swaps for 
which the cooperative exemption may be elected. Accordingly, the 
Commission believes using a static estimate is reasonable.
a. Regulation Sec.  39.6(f)(3) (now Sec.  50.51(c)): Reporting 
Requirements
    Regulation Sec.  39.6(f)(3) (now Sec.  50.51(c)) requires exempt 
cooperatives that are reporting counterparties to comply with the 
reporting requirements of Sec.  50.50(b), which require delivering 
specific information to a registered SDR or, if no SDR is available, 
the Commission. An exempt cooperative that is the reporting 
counterparty would have to report the information required in Sec.  
50.50(b)(1)(i) and (ii) for each swap for which it elects the 
cooperative exemption.
    As discussed in the NPRM, the Commission anticipates that to comply 
with Sec.  50.50(b)(1)(i) and (ii), each reporting counterparty would 
be required to check one box in the SDR or Commission reporting data 
fields indicating that the exempt cooperative is electing not to clear 
the swap. The Commission estimated that the cost of complying with this 
requirement for each reporting counterparty to be between less than $1 
and $7 for each transaction, or approximately $300 to $3,500 per year 
for all transactions.
    The Commission did not receive any comments concerning the cost to 
exempt cooperatives from complying with Sec.  50.50(b)(1)(i) and (ii).
b. Regulation Sec.  50.50(b)(1)(iii): Annual Reporting Option
    Regulation 50.50(b)(1)(iii) allows for certain counterparty 
specific information identified therein to be reported either swap-by-
swap by the reporting counterparty or annually by the electing 
counterparty. As discussed in the NPRM, the Commission anticipates that 
the exempt cooperatives will make annual filings of the information 
required. The Commission estimated the annual per cooperative cost for 
the filing to be between $200 and $590, or $2,000 to $5,900 as the 
aggregate cost for all exempt cooperatives.
    The Commission did not receive any comments concerning the cost to 
exempt cooperatives for electing the annual reporting option under 
Sec.  50.50(b)(1)(iii).
c. Updating Reporting Procedures
    As discussed in the NPRM, the Commission anticipates that 
cooperatives electing the exemption that are reporting counterparties 
may need to modify their reporting systems to accommodate the 
additional data fields required by the rule. The Commission estimated 
that the modifications to comply with Sec.  39.6(f)(3) (now Sec.  
50.51(c)) would likely cost each reporting counterparty between $340 
and $3,400, with the aggregate one-time cost for all potential exempt 
cooperatives to be $3,400 to $34,100.
    The Commission did not receive any comments concerning the cost to 
exempt cooperatives in updating their reporting systems to comply with 
Sec.  39.6(f)(3) (now Sec.  50.51(c)).
d. Burden on Non-Reporting Cooperatives
    As discussed in the NPRM, when an exempt cooperative is not 
functioning as the reporting counterparty (i.e., when transacting with 
an SD or MSP), the Commission anticipated that it may, at certain 
times, need to communicate information to its reporting counterparties 
in order to facilitate reporting. This information might include 
whether the exempt cooperative has filed an annual report pursuant to 
Sec.  50.50(b), and information to facilitate any due diligence that 
the reporting counterparty may conduct. The Commission estimated that a 
non-reporting exempt cooperative would incur an annual aggregate cost 
for communicating information to the reporting counterparty between 
$400 and $39,000.\100\
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    \100\ The Commission noted the wide range in this estimation, 
but explained the range could not be narrowed given the unknowns 
associated with the cost estimate.
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    The Commission did not receive any comments concerning the cost a 
non-reporting exempt cooperative will incur in communicating 
information to the reporting counterparty.

List of Subjects in 17 CFR Part 50

    Business and industry, Clearing, Cooperatives, Reporting 
requirements, Swaps.

    Accordingly, the CFTC amends 17 CFR part 50 as follows:

PART 50--CLEARING REQUIREMENT AND RELATED RULES

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

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

0
2. Add Sec.  50.51 to read as follows:

Sec.  50.51  Exemption for Cooperatives.

    Exemption for cooperatives. Exempt cooperatives may elect not to 
clear certain swaps identified in paragraph (b) of this section that 
are otherwise subject to the clearing requirement of section 2(h)(1)(A) 
of the Act if the following requirements are satisfied.
    (a) For the purposes of this paragraph, an exempt cooperative means 
a cooperative:
    (1) Formed and existing pursuant to Federal or state law as a 
cooperative;
    (2) That is a ``financial entity,'' as defined in section 
2(h)(7)(C)(i) of the Act, solely because of section 2(h)(7)(C)(i)(VIII) 
of the Act; and
    (3) Each member of which is not a ``financial entity,'' as defined 
in section 2(h)(7)(C)(i) of the Act, or if any member is a financial 
entity solely because of section 2(h)(7)(C)(i)(VIII) of the Act, such 
member is:
    (i) Exempt from the definition of ``financial entity'' pursuant to 
Sec.  50.50(d); or
    (ii) A cooperative formed under Federal or state law as a 
cooperative and each member thereof is either not a ``financial 
entity,'' as defined in section 2(h)(7)(C)(i) of the Act, or is exempt 
from the definition of ``financial entity'' pursuant to Sec.  50.50(d).
    (b) An exempt cooperative may elect not to clear a swap that is 
subject to the clearing requirement of section 2(h)(1)(A) of the Act if 
the swap:
    (1) Is entered into with a member of the exempt cooperative in 
connection with originating a loan or loans for the member, which means 
the requirements of Sec.  1.3(ggg)(5)(i), (ii), and (iii) are 
satisfied; provided that, for this purpose, the term ``insured 
depository institution'' as used in those sections is replaced with the 
term ``exempt cooperative'' and the word ``customer'' is replaced with 
the word ``member;'' or
    (2) Hedges or mitigates commercial risk, in accordance with Sec.  
50.50(c), related to loans to members or arising from a swap or swaps 
that meet the requirements of paragraph (b)(1) of this section.
    (c) An exempt cooperative that elects the exemption provided in 
this section shall comply with the requirements of Sec.  50.50(b). For 
this purpose, the exempt cooperative shall be the ``electing

[[Page 52308]]

counterparty,'' as such term is used in Sec.  50.50(b), and for 
purposes of Sec.  50.50(b)(1)(iii)(A), the reporting counterparty, as 
determined pursuant to Sec.  45.8, shall report that an exemption is 
being elected in accordance with this section.

    Issued in Washington, DC, on August 13, 2013, by the Commission.
Melissa D. Jurgens,
Secretary of the Commission.

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

Appendix to Clearing Exemption for Certain Swaps Entered Into by 
Cooperatives--Commission Voting Summary

Appendix 1--Commission Voting Summary

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

[FR Doc. 2013-19945 Filed 8-21-13; 8:45 am]
BILLING CODE 6351-01-P
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