U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5000

www.cftc.gov

Office of the

General Counsel

CFTC Letter No. 12-64

No-Action

December 21, 2012

Office of the General Counsel

Re: Time Limited No-Action Relief: Compo Equity Total Return Swaps

Ladies and Gentlemen:

This letter responds to a request submitted by Davis Polk & Wardell LLP, on behalf of 

certain clients, addressed to the Division of Market Oversight of the Commodity Futures Trading 

Commission (“CFTC”), which has been referred to this Office.1 The Davis Polk Letter requests

relief from certain obligations under Title VII of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (“Dodd-Frank Act”) and related CFTC regulations applicable to a 

specific derivative product known as a compo equity total return swap. The Office of General 

Counsel (“OGC”) has determined to issue time-limited no-action relief through June 30, 2013, as 

described herein.

Background

In August 2010, the CFTC and the Securities and Exchange Commission (“SEC” and, 

together with the CFTC, the “Commissions”) jointly issued an advance notice of proposed 

rulemaking and request for public comment regarding “Definitions Contained in Title VII of 

Dodd-Frank Wall Street Reform and Consumer Protection Act.”

2

 The Commissions considered 

comments received in response to the Definitions ANPRM when developing their joint proposed 

rules and proposed interpretations regarding “Further Definition of ‘Swap,’ ‘Security-Based 

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

Recordkeeping.”

3

 When discussing total return swaps in the Products NPRM, the Commissions

stated,

 

1

See Letter from James T. Rothwell and Daniel N. Budofsky, Davis Polk & Wardwell LLP, to Richard Shilts, 

Director, Division of Market Oversight of the Commission, Dec. 5, 2012, available on the CFTC’s website at 

http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59004&SearchText= (“Davis Polk Letter”). 

The Davis Polk Letter was submitted on behalf of Barclays Bank PLC; Citibank NA; Credit Suisse; Deutsche 

Bank AG; Goldman, Sachs & Co.; JPMorgan Chase Bank, N.A.; Morgan Stanley; and UBS AG.

2

75 FR 51429, Aug. 20, 2010 (“Definitions ANPRM”).

3

76 FR 29818, May 23, 2011 (“Products NPRM”).
CFTC Letter No. 12- 

No-Action

December 21, 2012

Page 2

The Commissions believe that when . . . interest rate payments act merely as a 

financing component in a [total return swap], or in any other security-based swap, 

the inclusion of such interest rate terms would not cause the security-based swap 

to be characterized as a mixed swap. . . . However, the Commissions note that 

where such payments incorporate additional elements that create additional 

interest rate or currency exposures that are unrelated to the financing of the 

security-based swap, or otherwise shift or limit risks that are related to the 

financing of the security-based swap, those additional elements may cause the 

security-based swap to be a mixed swap.4

In a request for public comment in the Products NPRM, the Commissions asked, 

78. Do market participants embed foreign currency swaps into a foreign 

currency payment component of a [total return swap]? If so, how frequently and 

for what purpose?5

The Securities Industry and Financial Markets Association (“SIFMA”) submitted a comment 

letter stating, among other things, its belief that “terms of a total return swap (“TRS”) that create 

interest rate or currency exposures incidental to the swap should not cause a transaction that 

otherwise would be deemed to be [a security-based swap] to be characterized as a mixed swap . . 

. .

6

 The SIFMA Letter cited a quanto equity swap as an example “where a TRS can provide for 

some interest rate or currency exposure that is incidental to the primary purpose of the TRS.”

7

 

Subsequently, CFTC staff participated in a telephone conference with SIFMA and others during 

which SIFMA's comment regarding total return equity swaps, including quanto and compo 

equity swaps, was discussed.8

In August 2012, the Commissions jointly published final rules and interpretations under 

the Commodity Exchange Act (“CEA”) and the Securities Exchange Act of 1934 (“Exchange 

Act”) to, among other things, further define the terms “swap,” “security-based swap,” and 

“security-based swap agreement,” and to address “mixed swaps.”

9

 In the Product Definitions 

Adopting Release, in response to the SIFMA comments, the Commissions interpreted quanto 

 

4

Id. at 29842 (footnote omitted).

5

Id. at 29843.

6 Letter from Kenneth E. Bentsen, Jr., Executive Vice President, Public Policy and Advocacy, SIFMA, Jul. 22, 2011 

(“SIFMA Letter”), available on the CFTC’s website at 

http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47928&SearchText, at 2.

7

Id. at 7.

8

See Call with SIFMA regarding equity TRS, Ex Parte No: 459, Nov. 30, 2011, available on the CFTC’s website at 

http://comments.cftc.gov/PublicComments/ViewExParte.aspx?id=459&SearchText.

9

See Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement;” Mixed Swaps; 

Security-Based Swap Agreement Recordkeeping,” 77 FR 48208, Aug. 13, 2012 (“Product Definitions Adopting 

Release”).
CFTC Letter No. 12- 

No-Action

December 21, 2012

Page 3

equity swaps to be security-based swaps where certain conditions are satisfied.10 “[F]or 

illustrative purposes,”11 the Commissions also interpreted compo equity swaps, “a similar but 

contrasting product,”12 to be mixed swaps because the Commissions determined that “the 

currency exposure obtained via a compo equity swap is not incidental to the equity exposure for 

purposes of determining mixed swap status.”

13

Requests for Relief

After the effective date of the regulations and interpretations contained in the Product 

Definitions Adopting Release, several financial institutions (“Dealers”) informed staff of the 

Commissions that they had believed that all foreign equity total return swaps on single securities 

or narrow-based indices would be security-based swaps, subject solely to the jurisdiction of the 

SEC; they further advised that the market was surprised by the Commissions’ interpretation 

treating compo equity swaps as mixed swaps. The Davis Polk Letter represents that “[t]he 

classification of compo equity total return swaps as mixed swaps will have very significant shortterm consequences for both sell-side and buy-side market participants.”14

 It states: “The Dealers 

estimate that ‘compo’ swaps on non-U.S. dollar denominated stocks represent 15-20% of the 

total market for equity total return swaps transacted with U.S. persons. By contrast, ‘quanto’ 

swaps represent significantly less than 1% of the market.”15

The Dealers represent that the Commissions’ interpretation regarding compo equity 

swaps, which they represent they did not expect, has complicated their plans to reorganize their 

businesses to comply with the new registration, recordkeeping, reporting, and business conduct 

requirements under the Dodd-Frank Act. The Dealers assert that their clients also were caught 

unawares by the Commissions’ interpretation and had not anticipated that they might have to 

register with the CFTC, and comply with the CFTC’s regulations regarding swaps, as a result of 

entering into compo equity swaps. The Davis Polk Letter further represents that: i) “[b]uilding 

the necessary infrastructure . . . on the timetable required for compliance with the CFTC’s rules 

would be extremely difficult;” and ii) “without additional time to prepare for such registration 

and such treatment [of compo equity swaps as mixed swaps, certain] entities will be precluded 

from conducting their businesses as planned, resulting in a significant disruption of the market 

for foreign equity total return swaps.”16 The CFTC also has received comments describing the 

 

10 Id. at 48265. Descriptions of the quanto equity swap and compo equity swap products can be found in the 

materials cited in footnotes 654 and 658, respectively, of the Product Definitions Adopting Release.

11 Id. at 48265.

12 Id.

13 Id. at 48265-6.

14 Davis Polk Letter at 3.

15 Id.

16 Id. at 3, 4.
CFTC Letter No. 12- 

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December 21, 2012

Page 4

details of the compo equity total return swap product and arguing that it should be treated the 

same way as a quanto equity swap.17 

Time-Limited No-Action Relief

Based on the Dealers’ representations regarding the difficulty of complying with the 

CFTC’s compliance timetables with respect to compo equity total return swaps, OGC has 

determined that time-limited no-action relief is appropriate. Accordingly, before July 1, 2013, 

OGC will not recommend that the CFTC commence enforcement action against any person in 

connection with any failure of such person to comply with any provision of the Dodd-Frank Act 

or the rules promulgated thereunder (other than those relating to the Commission’s anti-fraud 

and anti-manipulation authority) to the extent such failure arises solely because such person 

treats a compo equity total return swap solely as a security-based swap and not as a mixed swap. 

As a condition to reliance upon this no-action position, market participants shall act 

reasonably and in good faith in progressing to full compliance with all CEA requirements and 

CFTC regulations applicable to mixed swaps with respect to compo equity total return swaps by 

July 1, 2013.

18

 Despite the no-action position taken herein expiring on a certain future date, 

affected persons are required to come into full compliance with the CEA and the CFTC’s 

regulations with respect to compo equity total return swaps as soon as the technical and 

operational issues preventing timely compliance have been resolved, even if such resolution 

occurs prior to such future expiration date. During the pendency of the no-action period, and 

prior to reporting compo equity total return swap transaction data records to a swap data 

repository, affected persons must retain records with respect to all transactions covered by this 

no-action position and make such records available to the Commission for inspection and 

production immediately upon request to the extent provided in and in accordance with applicable 

law, rule, or regulation. 

This letter, and the positions taken herein, represent the views of OGC only, and do not 

necessarily represent the position or view of the CFTC or of any other office or division of the 

CFTC. The relief issued by this letter applies only to compo equity total return swaps. The 

relief issued by this letter does not excuse affected persons from compliance with any other 

applicable requirements contained in the CEA or in the CFTC’s regulations issued thereunder. 

Further, this letter, and the relief contained herein, is based upon the representations and 

information provided to OGC. Any different or changed material facts or circumstances might 

render this letter void. As with all no-action letters, OGC retains the authority to condition 

 

17 See, e.g., letter from Ilene Froom, Jones Day, Dec. 4, 2012, available on the CFTC’s website at 

http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58970&SearchText=.

18 This includes the reporting of historical and transition swaps, entered into prior to July 1, 2013, pursuant to part 46 

of the Commission’s regulations. As of July 1, 2013, compo equity swap activities from October 12, 2012 through 

June 30, 2013 count in determining whether de minimis or other thresholds have been exceeded for swap dealer, 

major swap participant, commodity pool operator or other registration purposes.
CFTC Letter No. 12- 

No-Action

December 21, 2012

Page 5

further, modify, suspend, terminate, or otherwise restrict the terms of the no-action relief 

provided herein, in its discretion.

Should you have any questions, please do not hesitate to contact Terry Arbit, Deputy 

General Counsel (tarbit@cftc.gov; 202-418-5357); Lee Ann Duffy, Assistant General Counsel

(lduffy@cftc.gov; 202-418-6763); or David Aron, Counsel (daron@cftc.gov; 202-418-6621).

Very truly yours,

Dan M. Berkovitz

General Counsel

cc: Regina Thoele, Compliance 

National Futures Association, Chicago