
[Federal Register Volume 75, Number 244 (Tuesday, December 21, 2010)]
[Proposed Rules]
[Pages 80174-80218]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-31130]



[[Page 80173]]

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Part III





Commodity Futures Trading Commission





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17 CFR Part 1





Securities and Exchange Commission





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17 CFR Part 240



Further Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,'' 
``Major Swap Participant,'' ``Major Security-Based Swap Participant'' 
and ``Eligible Contract Participant''; Proposed Rule

  Federal Register / Vol. 75 , No. 244 / Tuesday, December 21, 2010 / 
Proposed Rules  

[[Page 80174]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AD06

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-63452; File No. S7-39-10]
RIN 3235-AK65


Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant''

AGENCY: Commodity Futures Trading Commission; Securities and Exchange 
Commission.

ACTION: Joint proposed rule; proposed interpretations.

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SUMMARY: In accordance with Section 712(d)(1) of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-
Frank Act''), the Commodity Futures Trading Commission (``CFTC'') and 
the Securities and Exchange Commission (``SEC'') (collectively, the 
``Commissions''), in consultation with the Board of Governors of the 
Federal Reserve System, are proposing rules and interpretative guidance 
under the Commodity Exchange Act (``CEA''), 7 U.S.C. 1 et seq., and the 
Securities Exchange Act of 1934 (``Exchange Act''), 15 U.S.C. 78a et 
seq., to further define the terms ``swap dealer,'' ``security-based 
swap dealer,'' ``major swap participant,'' ``major security-based swap 
participant,'' and ``eligible contract participant.''

DATES: Submit comments on or before February 22, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:
    CFTC:
     Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: David A. Stawick, Secretary, Commodity Futures 
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., 
Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.
     Federal eRulemaking Portal: Comments also may be submitted 
at http://www.regulations.gov. Follow the instructions for submitting 
comments. ``Definitions'' must be in the subject field of responses 
submitted via e-mail, and clearly indicated on written submissions. All 
comments must be submitted in English, or if not, accompanied by an 
English translation. All comments provided in any electronic form or on 
paper will be published on the CFTC Web site, without review and 
without removal of personally identifying information. All comments are 
subject to the CFTC Privacy Policy.

SEC

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-39-10 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-39-10. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: CFTC: Mark Fajfar, Assistant General 
Counsel, at 202-418-6636, mfajfar@cftc.gov, Julian E. Hammar, Assistant 
General Counsel, at 202-418-5118, jhammar@cftc.gov, or David E. Aron, 
Counsel, at 202-418-6621, daron@cftc.gov, Office of General Counsel, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581; SEC: Joshua Kans, Senior Special 
Counsel, Jeffrey Dinwoodie, Attorney Advisor, or Richard Grant, 
Attorney Advisor, at 202-551-5550, Division of Trading and Markets, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act into 
law.\1\ Title VII of the Dodd-Frank Act \2\ established a comprehensive 
new regulatory framework for swaps and security-based swaps. The 
legislation was enacted, among other reasons, to reduce risk, increase 
transparency, and promote market integrity within the financial system, 
including by: (1) Providing for the registration and comprehensive 
regulation of swap dealers, security-based swap dealers, major swap 
participants and major security-based swap participants; (2) imposing 
clearing and trade execution requirements on swaps and security-based 
swaps, subject to certain exceptions; (3) creating rigorous 
recordkeeping and real-time reporting regimes; and (4) enhancing the 
rulemaking and enforcement authorities of the Commissions with respect 
to, among others, all registered entities and intermediaries subject to 
the Commissions' oversight.
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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may 
be cited as the ``Wall Street Transparency and Accountability Act of 
2010.''
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    More specifically, the Dodd-Frank Act provides that the CFTC will 
regulate ``swaps,'' and the SEC will regulate ``security-based swaps.'' 
The Dodd-Frank Act also adds to the CEA and Exchange Act definitions of 
the terms ``swap dealer,'' ``security-based swap dealer,'' ``major swap 
participant,'' ``major security-based swap participant,'' and 
``eligible contract participant.'' These terms are defined in Sections 
721 and 761 of the Dodd-Frank Act and, with respect to the term 
``eligible contract participant,'' in Section 1a(18) of the CEA,\3\ as 
re-designated and amended by Section 721 of the Dodd-Frank Act.
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    \3\ See 7 U.S.C. 1a(18).
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    Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and 
the SEC, in consultation with the Board of Governors of the Federal 
Reserve System, shall jointly further define the terms ``swap,'' 
``security-based swap,'' ``swap dealer,'' ``security-based swap 
dealer,'' ``major swap participant,'' ``major security-based swap 
participant,'' ``eligible contract participant,'' and ``security-based 
swap agreement.''

[[Page 80175]]

Further, Section 721(c) of the Dodd-Frank Act requires the CFTC to 
adopt a rule to further define the terms ``swap,'' ``swap dealer,'' 
``major swap participant,'' and ``eligible contract participant,'' and 
Section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to 
further define the terms ``security-based swap,'' ``security-based swap 
dealer,'' ``major security-based swap participant,'' and ``eligible 
contract participant,'' with regard to security-based swaps, for the 
purpose of including transactions and entities that have been 
structured to evade Title VII of the Dodd-Frank Act.\4\
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    \4\ The definitions of the terms ``swap,'' ``security-based 
swap,'' and ``security-based swap agreement,'' and regulations 
regarding mixed swaps are the subject of a separate rulemaking by 
the Commissions.
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    In light of the requirements in the Dodd-Frank Act noted above, the 
CFTC and the SEC issued a joint Advance Notice of Proposed Rulemaking 
(``ANPRM'') on August 13, 2010, requesting public comment regarding the 
definitions of ``swap,'' ``security-based swap,'' ``security-based swap 
agreement,'' ``swap dealer,'' ``security-based swap dealer,'' ``major 
swap participant,'' ``major security-based swap participant,'' and 
``eligible contract participant'' in Title VII of the Dodd-Frank 
Act.\5\ The Commissions reviewed more than 80 comments in response to 
the ANPRM. The Commissions also informally solicited comments on the 
definitions on their respective Web sites.\6\ In addition, the staffs 
of the CFTC and the SEC have met with many market participants and 
other interested parties to discuss the definitions.\7\
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    \5\ See Definitions Contained in Title VII of Dodd-Frank Wall 
Street Reform and Consumer Protection Act, Exchange Act Rel. No. 34-
62717, 75 FR 51429 (Aug. 20, 2010). The comment period for the ANPRM 
closed on September 20, 2010.
    \6\ Comments were solicited by the CFTC at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html and the SEC at 
http://www.sec.gov/spotlight/regreformcomments.shtml/.
    \7\ The views expressed in the comments in response to the 
ANPRM, in response to the Commissions' informal solicitation, and at 
such meetings are collectively referred to as the views of 
``commenters.''
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    In this release, the Commissions propose to further define ``swap 
dealer,'' ``security-based swap dealer,'' ``major swap participant,'' 
``major security-based swap participant'' and ``eligible contract 
participant,'' and propose related rules, and also discuss certain 
factors that are relevant to market participants when determining their 
status with respect to the defined terms. In developing these 
proposals, the Commissions have been mindful that the markets for swaps 
and security-based swaps are evolving, and that the rules that we adopt 
will, as intended by the Dodd-Frank Act, significantly affect those 
markets. The rules not only will help determine which entities will be 
subject to comprehensive regulation of their swap and security-based 
swap activities, but may also cause certain entities to modify their 
activities to avoid being subject to the regulations. As a result, we 
are aware of the importance of crafting these rules carefully to 
maximize the benefits of the regulation imposed by the Dodd-Frank Act, 
and to do so in a way that is flexible enough to respond to market 
developments. While we preliminarily believe that these proposals, if 
adopted, would appropriately effect the intent of the Dodd-Frank Act, 
we are very interested in commenters' views as to whether we have 
achieved this purpose, and, if not, how to improve these proposals.\8\
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    \8\ In addition, we recognize that the appropriateness of these 
proposals also should be considered in light of the substantive 
requirements that will be applicable to dealers and major 
participants, including capital, margin and business conduct 
requirements, which are the subject of separate rulemakings. For 
example, whether the definition of a major participant is too broad 
or too narrow may well depend in part on the substantive 
requirements applicable to such entities, and whether those 
substantive requirements are themselves appropriate may in turn 
depend in part on the scope of the major participant definition. We 
therefore encourage comments that take into account the interplay 
between the proposed definitions and these substantive requirements.
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II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''

    The Dodd-Frank Act defines the terms ``swap dealer'' and 
``security-based swap dealer'' in terms of whether a person engages in 
certain types of activities involving swaps or security-based swaps.\9\ 
Persons that meet either of those definitions are subject to statutory 
requirements related to, among other things, registration, margin, 
capital and business conduct.\10\
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    \9\ See Section 721 of the Dodd-Frank Act (defining ``swap 
dealer'' in new Section 1a(49) of the CEA, 7 U.S.C. 1a(49)) and 
Section 761 of the Dodd-Frank Act (defining ``security-based swap 
dealer'' in new Section 3(a)(71) of the Exchange Act, 15 U.S.C. 
78c(a)(71)).
    \10\ The Dodd-Frank Act excludes from the Exchange Act 
definition of ``dealer'' persons who engage in security-based swap 
transactions with eligible contract participants. See Section 
3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by 
Section 761(a)(1) of the Dodd-Frank Act.
    The Dodd-Frank Act does not include comparable amendments for 
persons who act as brokers in swaps and security-based swaps. 
Because security-based swaps are a type of security, persons who act 
as brokers in connection with security-based swaps must, absent an 
exemption, register with the SEC as a broker pursuant to Exchange 
Act section 15(a), and comply with the Exchange Act's requirements 
applicable to brokers.
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    The two definitions in general encompass persons that engage in any 
of the following types of activity:
    (i) Holding oneself out as a dealer in swaps or security-based 
swaps,
    (ii) Making a market in swaps or security-based swaps,
    (iii) Regularly entering into swaps or security-based swaps with 
counterparties as an ordinary course of business for one's own account, 
or
    (iv) Engaging in activity causing oneself to be commonly known in 
the trade as a dealer or market maker in swaps or security-based 
swaps.\11\
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    \11\ See CEA section 1a(49)(A); Exchange Act section 
3(a)(71)(A).
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    The definitions are disjunctive, in that a person that engages in 
any of the enumerated dealing activities is a swap dealer or security-
based swap dealer even if the person does not engage in any of the 
other enumerated activities.
    The definitions, in contrast, do not include a person that enters 
into swaps or security-based swaps ``for such person's own account, 
either individually or in a fiduciary capacity, but not as a part of a 
regular business.'' \12\ The Dodd-Frank Act also instructs the 
Commissions to exempt from designation as a dealer an entity that 
``engages in a de minimis quantity of [swap or security-based swap] 
dealing in connection with transactions with or on behalf of its 
customers.'' \13\ Moreover, the definition of ``swap dealer'' (but not 
the definition of ``security-based swap dealer'') provides that an 
insured depository institution is not to be considered a swap dealer 
``to the extent it offers to enter into a swap with a customer in 
connection with originating a loan with that customer.'' \14\
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    \12\ See CEA section 1a(49)(C); Exchange Act section 
3(a)(71)(C).
    \13\ See CEA section 1a(49)(D); Exchange Act section 
3(a)(71)(D).
    \14\ CEA section 1a(49)(A).
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    The definitions also provide that a person may be designated as a 
dealer for one or more types, classes or categories of swaps, security-
based swaps, or activities without being designated a dealer for other 
types, classes or categories or activities.\15\
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    \15\ See CEA section 1a(49)(B); Exchange Act section 
3(a)(71)(B).
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    The Commissions are proposing rules to further define certain 
aspects of the meaning of ``swap dealer'' and ``security-based swap 
dealer,'' and are providing guidance on how the Commissions propose to 
interpret these terms. This release specifically addresses: (A) The 
types of activities that would cause a person to be a swap dealer or 
security-based swap dealer, including differences in how those two 
definitions should be applied; (B) the statutory provisions requiring 
the Commissions to exempt persons from the dealer

[[Page 80176]]

definitions in connection with de minimis activity; (C) the exception 
from the ``swap dealer'' definition in connection with loans by insured 
depository institutions; (D) the possibility that a person may be 
considered a dealer for some types, classes or categories of swaps, 
security-based swaps, or activities but not others; and (E) certain 
interpretative issues that arise in particular situations. The 
Commissions request comment on all aspects of the proposals, including 
the particular points noted in the discussion below.

A. Swap and Security-Based Swap Dealing Activity

1. Comments Regarding Dealing Activities
    Commenters provided numerous examples of conduct they viewed as 
dealing activities--as well as conduct they did not view as dealing 
activities. For example, many of the commenters stated that dealers 
provide ``bid/ask'' or ``two-way'' prices for swaps on a regular basis, 
or regularly participate in both sides of the swap market. Some 
commenters indicated that dealers perform an intermediary function. 
Other commenters stated that a person holds itself out as a dealer if 
it consistently and systematically markets itself as a swap dealer to 
third parties. Some commenters described market makers in the swap 
markets as persons that stand ready to buy or sell swaps at all times, 
are open to doing swaps business on both sides of a market, or make 
bids to buy and offers to sell swaps or a type of swap at all times. 
Commenters stated that a person should be included in the definition of 
dealer if its sole or dominant line of business is swaps activity. One 
commenter urged the Commissions to adopt a swap association's 
definition of a primary member as the definition of dealer.
    Some commenters stated that the definition of dealer should be read 
narrowly. For example, some commenters suggested that the market maker 
concept should not encompass persons that provide occasional quotes or 
that do not make bids or offers consistently or at all times. Another 
commenter stated that a willingness to buy or sell a swap or security-
based swap at a particular time does not constitute market making 
absent the creating of a two-way market. One commenter suggested that 
solely acting as a market maker should not cause a person to be a 
dealer, since firms may have commercial purposes for offering two-way 
trades. Another commenter stated that an entity that ``holds itself 
out'' as a dealer should qualify as a swap dealer only if it 
``consistently and systematically markets itself as a dealer to third-
parties.'' \16\
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    \16\ See letter from Eric Dennison, Sr. Vice President and 
General Counsel, Stephanie Miller, Assistant General Counsel--
Commodities, and Bill Hellinghausen, Director of Regulatory Affairs, 
EDF Trading, dated September 20, 2010 (distinguishing transactions 
that the commenter enters into as part of energy management 
services).
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    Many commenters called for the exclusion of particular types of 
persons from the definition of swap dealer or security-based swap 
dealer. Several commenters maintained that commercial end-users of 
swaps or security-based swaps that enter into swaps or security-based 
swaps to hedge or mitigate commercial risk should be excluded from the 
definitions. Another commenter stated the definitions should exclude 
persons who use swaps or security-based swaps for bona fide hedging. 
Other commenters indicated that cooperatives that enter into swaps in 
connection with the business of their members should be excluded. 
Commenters also stated that if all of a person's swaps are cleared on 
an exchange or derivatives clearing organization, the person should not 
be deemed to be a dealer. One commenter stated competitive power 
suppliers should be excluded, and another stated that the dealer 
definition should not apply to futures commission merchants that act 
economically like brokers.
    Commenters, particularly those in the securities industry, urged 
the Commissions to interpret the definitions of swap dealer and 
security-based swap dealer consistently with precedent that 
distinguishes between dealers in securities and traders in securities. 
However, one commenter also noted that some concepts from the 
securities and commodities laws may not easily be applied to these 
markets.
2. Application of the Core Tests to ``Swap Dealers'' and ``Security-
Based Swap Dealers''
    The Dodd-Frank Act defines the terms ``swap dealer'' and 
``security-based swap dealer'' in a functional manner, encompassing how 
a person holds itself out in the market, the nature of the conduct 
engaged in by the person, and how the market perceives the person's 
activities. This suggests that the definitions should not be 
interpreted in a constrained or overly technical manner. Rigid 
standards would not provide the necessary flexibility to respond to 
evolution in the ways that dealers enter into swaps and security-based 
swaps. The different types of swap and security-based swap markets are 
diverse, and there does not appear to be a single set of criteria that 
can be determinative in all markets.
    At the same time, we note that there may be certain distinguishing 
characteristics of swap dealers and security-based swap dealers, 
including that:
     Dealers tend to accommodate demand for swaps and security-
based swaps from other parties;
     Dealers are generally available to enter into swaps or 
security-based swaps to facilitate other parties' interest in entering 
into those instruments;
     Dealers tend not to request that other parties propose the 
terms of swaps or security-based swaps; rather, dealers tend to enter 
into those instruments on their own standard terms or on terms they 
arrange in response to other parties' interest; and
     Dealers tend to be able to arrange customized terms for 
swaps or security-based swaps upon request, or to create new types of 
swaps or security-based swaps at the dealer's own initiative.
    We also recognize that the principles relevant to identifying 
dealing activity involving swaps can differ from comparable principles 
associated with security-based swaps. These differences are due, in 
part, to differences in how those instruments are used. For example, 
because security-based swaps may be used to hedge or gain economic 
exposure to underlying securities (while recognizing distinctions 
between securities-based swaps and other types of securities, as 
discussed below), there is a basis to build upon the same principles 
that are presently used to identify dealers for other types of 
securities. Accordingly, we separately address how the core tests would 
apply to swap dealers and to security-based swap dealers.
a. Application to Swap Dealers
    The definition of swap dealer should be informed by the differences 
between swaps, on the one hand, and securities and commodities, on the 
other. Transactions in cash market securities and commodities generally 
involve purchases and sales of tangible or intangible property. Swaps, 
in contrast, are notional contracts requiring the performance of agreed 
terms by each party.\17\ Thus, many of the concepts cited by 
commenters, such as whether a person buys and sells swaps or makes a 
two-sided market in swaps or trades within a bid/offer spread, cannot

[[Page 80177]]

necessarily be applied to all types of swaps to determine if the person 
is a swap dealer. We understand that market participants do use this 
terminology colloquially to describe the process of entering into a 
swap. For example, a person seeking a fixed/floating interest rate swap 
may inquire as to the fixed rates, spread above the floating rate and 
other payments that another person would require in order to enter into 
a swap. But, while these persons may discuss bids, offers, prices and 
so forth, the parties are negotiating the terms of a contract, they are 
not negotiating the price at which they will transfer ownership of 
tangible or intangible property. Accordingly, these concepts are not 
determinative of whether a person is a ``swap dealer.''
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    \17\ As discussed below, however (see note 42, infra), the Dodd-
Frank Act amended the Exchange Act definitions of ``buy,'' 
``purchase,'' ``sale'' and ``sell'' to apply to particular actions 
involving security-based swaps.
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    Instead, persons who are swap dealers may be identified by the 
functional role they fulfill in the swap markets. As noted above, swap 
dealers tend to accommodate demand and to be available to enter into 
swaps to facilitate other parties' interest in swaps (although swap 
dealers may also advance their own investment and liquidity objectives 
by entering into such swaps). In addition, swap dealers can often be 
identified by their relationships with counterparties. Swap dealers 
tend to enter into swaps with more counterparties than do non-dealers, 
and in some markets, non-dealers tend to constitute a large portion of 
swap dealers' counterparties. In contrast, non-dealers tend to enter 
into swaps with swap dealers more often than with other non-
dealers.\18\ The Commissions can most efficiently achieve the purposes 
underlying Title VII of the Dodd-Frank Act--to reduce risk and to 
enhance operational standards and fair dealing in the swap markets--by 
focusing their attention on those persons whose function is to serve as 
the points of connection in those markets. The definition of swap 
dealer, construed functionally in the manner set forth above, will help 
to identify those persons.
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    \18\ Some of the commenters appeared to suggest that significant 
parts of the swap markets operate without the involvement of swap 
dealers. We believe that this analysis is likely incorrect, and that 
the parties that fulfill the function of dealers should be 
identified and are likely to be swap dealers.
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    Clause (A)(iii) of the statutory definition of swap dealer, which 
includes any person that ``regularly enters into swaps with 
counterparties as an ordinary course of business for its own account,'' 
\19\ has been the subject of significant uncertainty among commenters. 
The commenters point out that its literal terms could encompass many 
parties who regularly enter into swaps without engaging in any form of 
swap dealing activity. In this regard, clause (A)(iii) of the 
definition should be read in combination with the express exception in 
subparagraph (C) of the swap dealer definition, which excludes ``a 
person that enters into swaps for such person's own account, either 
individually or in a fiduciary capacity, but not as a part of a regular 
business.'' Thus, the difference between the inclusion in clause 
(A)(iii) and the exclusion in subparagraph (C) is whether or not the 
person enters into swaps as a part of, or as an ordinary course of, a 
``regular business.'' \20\ We believe that persons who enter into swaps 
as a part of a ``regular business'' are those persons whose function is 
to accommodate demand for swaps from other parties and enter into swaps 
in response to interest expressed by other parties. Conversely, persons 
who do not fulfill this function should not be deemed to enter into 
swaps as part of a ``regular business'' and are not likely to be swap 
dealers.
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    \19\ We interpret this reference to a person entering into swaps 
``with counterparties * * * for its own account'' to refer to a 
person entering into a swap as a principal, and not as an agent. A 
person who entered into swaps as an agent for customers (i.e., for 
the customers' accounts) would be required to register as either a 
Futures Commission Merchant, Introducing Broker, Commodity Pool 
Operator or Commodity Trading Advisor, depending on the nature of 
the person's activity.
    \20\ The definition of ``security-based swap dealer'' is 
structured similarly, and should be interpreted similarly.
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    In sum, to determine if a person is a swap dealer, we would 
consider that person's activities in relation to the other parties with 
which it interacts in the swap markets. If the person is available to 
accommodate demand for swaps from other parties, tends to propose 
terms, or tends to engage in the other activities discussed above, then 
the person is likely to be a swap dealer. Persons that rarely engage in 
such activities are less likely to be deemed swap dealers.
    We request comment on this interpretive approach for identifying 
whether a person is a swap dealer.
b. Application to Security-Based Swap Dealers
    The definition of ``security-based swap dealer'' has parallels to 
the definition of ``dealer'' under the Exchange Act.\21\ In addition, 
security-based swaps may be used to hedge risks associated with the 
ownership of certain other types of securities,\22\ and security-based 
swaps may be used to gain economic exposure akin to ownership of 
certain other types of securities.\23\ As a result, the SEC would 
consider the same factors that are relevant to determining whether a 
person is a ``dealer'' under the Exchange Act as also generally 
relevant to the analysis of whether a person is a security-based swap 
dealer.
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    \21\ The Exchange Act in relevant part defines ``dealer'' to 
mean ``any person engaged in the business of buying and selling 
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract 
participants) for such person's own account through a broker or 
otherwise,'' but with an exception for ``a person that buys or sells 
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract 
participants) for such person's own account, either individually or 
in a fiduciary capacity, but not as a part of a regular business.'' 
Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 78c(a)(5)(A) and 
(B), as amended by Section 761(a)(1) of the Dodd-Frank Act.
    \22\ For example, an entity that owns a particular security may 
use a security-based swap to hedge the risks of that security. 
Conversely, an entity may seek to offset exposure involving a 
security-based swap by using another security as a hedge.
    \23\ For example, an entity may enter into a security-based swap 
to gain economic exposure akin to a long or short position in a 
stock or bond, without having to engage in a cash market transaction 
for that instrument.
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    The Exchange Act has been interpreted to distinguish between 
``dealers'' and ``traders.'' In this context, the SEC previously has 
noted that the dealer-trader distinction:

Recognizes that dealers normally have a regular clientele, hold 
themselves out as buying or selling securities at a regular place of 
business, have a regular turnover of inventory (or participate in 
the sale or distribution of new issues, such as by acting as an 
underwriter), and generally provide liquidity services in 
transactions with investors (or, in the case of dealers who are 
market makers, for other professionals).\24\
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    \24\ Securities Exchange Act Release No. 47364 (Feb. 13, 2003) 
(footnotes omitted).

Other non-exclusive factors that are relevant for distinguishing 
between dealers and non-dealers can include the receipt of customer 
property and the furnishing of incidental advice in connection with 
transactions.
    The markets involving security-based swaps are distinguishable in 
certain respects from markets involving cash market securities--
particularly with regard to the concepts of ``inventory'' (which 
generally appears inapplicable in this context) \25\ and ``regular 
place of business.'' For example, the suggestion that dealers are more 
likely to operate at a ``regular place of business'' than traders 
should not be construed in a way that ignores the reality of how the 
security-based swap markets operate (or that

[[Page 80178]]

ignores evolution in dealing practices involving other types of 
securities). Dealers may use a variety of methods to communicate their 
availability to enter into security-based swaps with other market 
participants. The dealer-trader distinction should not be applied to 
the security-based swap markets without taking those distinctions into 
account.\26\ Even in light of those differences, however, we believe 
that the dealer-trader distinction provides an important analytical 
tool to assist in determining whether a person is a ``security-based 
swap dealer.''
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    \25\ In particular, an analysis that considers dealers to differ 
from traders in part because dealers have regular turnover in 
``inventory'' appears not to apply in the context of security-based 
swaps, given that those instruments are created by contract between 
two market counterparties, rather than reflecting financial rights 
issued by third-parties.
    \26\ The definition of ``security-based swap dealer,'' unlike 
the Exchange Act's definition of ``dealer,'' does not specifically 
refer to ``buying'' and ``selling.'' We do not believe that this 
language difference is significant, however, as the Dodd-Frank Act 
amended the Exchange Act definitions of ``buy'' and ``purchase,'' 
and the Exchange Act definitions of ``sale'' and ``sell,'' to 
encompass the execution, termination (prior to its scheduled 
maturity date), assignment, exchange or similar transfer or 
conveyance of, or extinguishing of rights or obligations under, a 
security-based swap. See Dodd-Frank Act sections 761(a)(3), (4) 
(amending Exchange Act sections 3(a)(13), (14)).
---------------------------------------------------------------------------

    Commenters have raised concerns that the ambit of the security-
based swap dealer definition could encompass end-users that use 
security-based swaps for hedging their business risks. Deeming those 
entities to be security-based swap dealers due to their hedging 
activities could discourage their use of hedging transactions or 
subject them to a regulatory framework that was not intended to address 
their businesses and could subject them to unnecessary costs. Under the 
dealer-trader distinction, however, we would expect entities that use 
security-based swaps to hedge their business risks, absent other 
activity, likely would not be dealers.\27\ Also, as discussed below, 
both the ``security-based swap dealer'' definition and the dealer-
trader distinction in part turn on whether a person holds itself out as 
a dealer.
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    \27\ Of course, if a person's other activities satisfy the 
definition of security-based swap dealer, it must comply with the 
applicable requirements with regard to all of its security-based 
swap activities, absent an order to the contrary, as discussed 
below. Also, as discussed below, we would expect end-users to use 
security-based swaps for hedging purposes less commonly than they 
use swaps for hedging purposes.
---------------------------------------------------------------------------

    We request comment on the application of the dealer-trader 
distinction as part of the analysis of whether a person is a security-
based swap dealer.
c. Issues Common to Both Definitions
i. Holding Oneself Out as, and Being Commonly Known in the Trade as, a 
Swap Dealer or Security-Based Swap Dealer
    As noted above, the application of these definitions to persons 
that ``hold themselves out'' as dealers or that are ``commonly known in 
the trade'' as dealers highlights the need for a functional 
interpretation of the dealer definitions. We believe that factors that 
may reasonably indicate that a person is holding itself out as a dealer 
or is commonly known in the trade as a dealer may include (but are not 
limited to) the following:
     Contacting potential counterparties to solicit interest in 
swaps or security-based swaps,
     Developing new types of swaps or security-based swaps 
(which may include financial products that contain swaps or security-
based swaps) and informing potential counterparties of the availability 
of such swaps or security-based swaps and a willingness to enter into 
such swaps or security-based swaps with the potential counterparties,
     Membership in a swap association in a category reserved 
for dealers,
     Providing marketing materials (such as a Web site) that 
describe the types of swaps or security-based swaps that one is willing 
to enter into with other parties, or
     Generally expressing a willingness to offer or provide a 
range of financial products that would include swaps or security-based 
swaps.

Notably, holding oneself out as a security-based swap dealer would 
likely encompass a situation in which a person that is a ``dealer'' in 
another type of security enters into a security-based swap with a 
customer.\28\ Another example of holding oneself out as a security-
based swap dealer would likely be an entity expressing its availability 
to provide liquidity to counterparties that seek to enter into 
security-based swaps, regardless of the ``direction'' of the 
transaction or across a broad spectrum of risks (e.g., credit default 
swaps related to a variety of issuers).
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    \28\ For example, if a person that is a dealer in securities 
that are not security-based swaps enters into a security-based swap 
transaction with one of its cash market customers, the person would 
appear to be engaged in security-based swap dealing activity with 
that customer. In that circumstance, the customer reasonably would 
be expected to view the person as a dealer for purposes of the 
security-based swap, making the applicable business conduct 
requirements particularly important.

    The determination of who is commonly known in the trade as a swap 
dealer or security-based swap dealer may appropriately reflect, among 
other factors, the perspective of persons with substantial experience 
with and knowledge of the swap and security-based swap markets, 
regardless of whether an entity is known as a dealer by persons without 
that experience and knowledge.
ii. Making a Market in Swaps or Security-Based Swaps
    A number of commenters suggested that the market making component 
of the definitions should apply only to persons that quote a two-sided 
market consistently or at all times. Some commenters also suggested 
that a person's willingness to buy or to sell a swap or security-based 
swap at any particular time should not be deemed to be market making 
activity. While continuous two-sided quotations and a willingness to 
stand ready to buy and sell a security are important indicators of 
market making in the equities markets,\29\ these indicia may not be 
appropriate in the context of the swap or security-based swap markets, 
given that parties do not enter into many types of swaps or security-
based swaps on a continuous basis, and that parties may use a variety 
of methods for communicating their willingness to enter into swaps or 
security-based swaps. Any analysis that would impute to the definitions 
a ``continuous'' activity requirement may cause certain persons that 
engage in non-continuous dealing activities not to be regulated as swap 
dealers or security-based swap dealers. We have not identified anything 
in the statutory text or legislative history of the Dodd-Frank Act to 
suggest that Congress intended such a result.
---------------------------------------------------------------------------

    \29\ See Exchange Act Release No. 58875 (Oct. 14, 2008), 73 FR 
61690 (Oct. 17, 2008) (``Although determining whether or not a 
market maker is engaged in bona-fide market making would depend on 
the facts and circumstances of the particular activity, factors that 
indicate a market maker is engaged in bona-fide market making 
activities may include, for example, whether the market maker incurs 
any economic or market risk with respect to the securities (e.g., by 
putting their own capital at risk to provide continuous two-sided 
quotes in markets).'').
---------------------------------------------------------------------------

iii. No Predominance Test
    Although some commenters suggested that a person should be a swap 
dealer or security-based swap dealer only if such activity is the 
person's sole or predominant business, the statutory definition does 
not contain a predominance test or otherwise depend upon the level of 
the person's dealing activity, other than the de minimis exception 
discussed below. A predominance standard would not

[[Page 80179]]

provide a workable test of dealer status because many of the parties 
that are commonly acknowledged as swap or security-based swap dealers 
also engage in other businesses that often outweigh their swap or 
security-based swap dealing business in terms of transaction volume or 
other measures. Based on the plain meaning of the statutory definition, 
so long as a person engages in dealing activity that is not de minimis, 
as discussed below, the person is a swap dealer or security-based swap 
dealer.\30\
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    \30\ As one example, a non-financial company that engages in 
both swap dealing and other commercial activities would fall within 
the definition of swap dealer because of its swap dealing 
activities, notwithstanding that it also engages in other commercial 
activities.
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iv. Application of the Definition to New Types of Swaps and New 
Activities
    The Commissions intend to apply the definitions of swap dealer and 
security-based swap dealer flexibly when the development of innovative 
business models is accompanied by new types of dealer activity. As 
discussed above, the Commissions generally intend to follow a ``facts-
and-circumstances'' approach with respect to identifying dealing 
activities. The dealer definitions must be flexible enough to cover 
appropriate persons as the swap markets evolve.
v. Request for Comment
    The Commissions request comment on these interpretations of holding 
oneself out as a dealer and being commonly known in the trade as a 
dealer, as well as the lack of a predominance test, and the application 
of the definitions to new types of swaps and new activities. Commenters 
particularly are requested to address the relevance, to the dealer 
analysis, of activities such as an entity's membership in a swap 
execution facility (``SEF'') or a security-based SEF, or use of 
facilities that may not be SEFs or security-based SEFs. Are there 
factors that would lead entities to become members of SEFs that would 
not make membership relevant to the dealer analysis? Commenters also 
are requested to generally address how the dealer analysis should 
appropriately apply the requirements applicable to dealers (e.g., 
capital, margin and business conduct requirements) to the entities that 
should be subject to those requirements. In addition, commenters are 
requested to address how the dealer definitions should be applied to 
entities such as, for example, Federal home loan banks subject to 
restrictions limiting their dealing activities to particular types of 
counterparties. Finally, commenters are requested to address whether 
additional guidance is advisable to help identify dealer activity and 
to promote effective enforcement of the requirements applicable to swap 
dealers and security-based swap dealers.
3. Designation of a Person as a Swap Dealer
    The Dodd-Frank Act has amended the CEA and the Exchange Act to 
require a person that meets either of the definitions to register as a 
swap dealer and/or security-based swap dealer,\31\ and the Commissions 
are proposing separate rules regarding this registration requirement. 
In connection with the registration requirement, market participants 
are in a position to assess their activities to determine whether they 
function in the manner described in the definitions. In addition, the 
Commissions have the authority to take enforcement actions in response 
to a dealer's failure to register. In determining whether a person 
meets the applicable definitions, the Commissions may use information 
from other regulators, swap data repositories, registered clearing 
agencies, derivatives clearing organizations and other sources.
---------------------------------------------------------------------------

    \31\ See CEA section 4s(a)-(b); Exchange Act section 15F(a)-(b).
---------------------------------------------------------------------------

4. Application of the Swap Dealer Definition to Agricultural 
Commodities
    Section 723(c)(3)(B) of the Dodd-Frank Act provides that swaps in 
agricultural commodities shall be subject to such terms and conditions 
as the CFTC may prescribe. In a separate rulemaking, the CFTC has 
proposed a definition of the term ``agricultural commodity.'' \32\ 
Acting under the authority in Section 723(c)(3)(B), the CFTC may 
develop particular terms and conditions for the interpretation of the 
swap dealer definition when it is applied to dealing in swaps in 
agricultural commodities. Any such terms and conditions would not be 
applicable to the definition of security-based swap dealer. The CFTC 
requests comment on the application of the swap dealer definition to 
dealers, including potentially agricultural cooperatives, that limit 
their dealing activity primarily to swaps in agricultural commodities. 
The CFTC may consider any comments on this topic for both the 
definition of swap dealer and also for any rulemaking regarding swaps 
in agricultural commodities.
---------------------------------------------------------------------------

    \32\ See 75 FR 65586 (Oct. 26, 2010).
---------------------------------------------------------------------------

B. De Minimis Exemption to the Definitions

    The Dodd-Frank Act requires that the Commissions exempt, from 
designation as a ``swap dealer'' or ``security-based swap dealer,'' a 
person who ``engages in a de minimis quantity of [swap or security-
based swap] dealing in connection with transactions with or on behalf 
of its customers.'' \33\ The statutory definitions do not require that 
the Commissions fix a specific level of swap activity that will be 
considered de minimis, but instead require that the Commissions 
``promulgate regulations to establish factors with respect to the 
making of this determination to exempt.''
---------------------------------------------------------------------------

    \33\ See CEA section 1a(49)(D); Exchange Act section 
3(a)(71)(D).
---------------------------------------------------------------------------

1. Comments Regarding the De Minimis Exemption
    Some commenters asserted that the de minimis exemption should be 
linked to systemic risk concerns, stating that persons engaged in 
dealing activities that do not pose systemic risk should be able to 
take advantage of the exemption. Other commenters suggested that a 
person's dealing activities should be considered de minimis if they do 
not pose undue risks to the person. Commenters also expressed the view 
that the application of the exemption should be based on quantitative 
criteria.
2. Proposed Rule Regarding the De Minimis Exemption
    The Commissions preliminarily believe that the ``de minimis'' 
exemption should be interpreted to address amounts of dealing activity 
that are sufficiently small that they do not warrant registration to 
address concerns implicated by the regulations governing swap dealers 
and security-based swap dealers.\34\ In other words, the exemption 
should apply only when an entity's dealing activity is so minimal that 
applying dealer regulations to the entity would not be warranted.
---------------------------------------------------------------------------

    \34\ The Title VII requirements applicable to swap and security-
based swap dealers include, for example: requirements that dealers 
conform to regulatory standards relating to the confirmation, 
processing, netting, documentation and valuation of swaps and 
security-based swaps (CEA section 4s(i), Exchange Act section 
15F(i)); requirements that dealers disclose, to regulators, 
information concerning terms and conditions of swaps or security-
based swaps, as well as information concerning trading practices, 
financial integrity protections and other trading information (CEA 
section 4s(j)(3), Exchange Act section 15F(j)(3)); conflicts of 
interest provisions (CEA section 4s(j)(5), Exchange Act section 
15F(j)(5)); and chief compliance officer requirements (CEA section 
4s(k), Exchange Act section 15F(k)).
---------------------------------------------------------------------------

    We thus preliminarily do not agree with those commenters that 
argued that

[[Page 80180]]

a de minimis quantity of dealing should be measured in relation to the 
level of the person's other activities (or other swap or security-based 
swap activities). Aside from the fact that the statute does not 
explicitly call for a relative test, such an approach would lead to the 
result that larger and more active companies, which presumably would be 
more able to influence the swap markets, would be more likely to 
qualify for the exemption than smaller and less active companies. Also, 
a relative test not only would require a means of measuring the 
person's dealing activities, but also would require a means of 
measuring the larger scope of activities to which its swap dealing or 
security-based swap dealing activities are to be compared, thus 
introducing unnecessary complexity to the exemption's application.
    Our proposed factors for the de minimis exemption seek to focus the 
availability of the exemption toward entities for which registration 
would not be warranted from a regulatory point of view in light of the 
limited nature of their dealing activities. At the same time, we 
recognize that this focus does not appear to readily translate into 
objective criteria. Thus, while the proposed factors discussed below 
reflect our attempt to delimit the de minimis exemption appropriately, 
we recognize that a range of alternative approaches may be reasonable, 
and we are particularly interested in commenters' suggestions as to the 
appropriate factors.
    The first proposed factor is that the aggregate effective notional 
amount, measured on a gross basis, of swaps or security-based swaps 
that an entity enters into over the prior 12 months in connection with 
its dealing activities \35\ could not exceed $100 million.\36\ We 
understand that in general the notional size of a small swap or 
security-based swap is $5 million or less, and this proposed threshold 
would reflect 20 instruments of that size. Given the customer 
protection issues raised by swaps and security-based swaps--including 
the risks that counterparties may not fully appreciate when entering 
into swaps or security-based swaps--we believe that this notional 
amount reflects a reasonable limit for identifying those entities that 
engage in a de minimis level of dealing activity.\37\ This standard 
would measure an entity's quantity of dealing on a gross basis (without 
consideration of the market risk offsets associated with combining long 
and short positions) to reflect the entity's overall amount of dealing 
activity. Similarly, the proposed notional threshold would not account 
for the amount of collateral held by or provided by the entity, nor 
other risk mitigating factors, in determining whether it engages in a 
de minimis quantity of dealing, given that dealer status focuses on an 
entity's absolute level of activity, and is not directly based on the 
risks that an entity poses or faces.\38\
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    \35\ The de minimis exemption specifically places limits on a 
person's dealing activity involving swaps or security-based swaps. 
Thus, these limits would not apply to swap or security-based swap 
activity that does not itself constitute dealing activity, such as 
activity in which a person hedges or mitigates a commercial risk of 
its business that is unrelated to a dealing business (i.e., as 
discussed above, when the person did not accommodate demand from the 
other party, respond to the other party's interest in swaps or 
security-based swaps, solicit the other party, propose economic 
terms, intermediate between parties, provide liquidity, or engage in 
other dealing activities). See part II.A.2, supra.
    \36\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange 
Act rule 3a71-2(a). To the extent that the stated notional amount of 
a swap or security-based swap is leveraged or enhanced by its 
structure, the calculation shall be based on the effective notional 
amount of the swap or security-based swap rather than on its stated 
notional amount.
    \37\ We preliminarily believe that activity above this amount 
would be sufficient to warrant dealer registration to bring about 
the benefits of such registration.
    \38\ Also, allowing offsets for collateral would result in a de 
minimis standard that could encompass positions of virtually 
unlimited size.
---------------------------------------------------------------------------

    In addition, the aggregate effective notional amount of such swaps 
or security-based swaps, in which the person's counterparty is a 
``special entity'' (as that term is defined in CEA Section 4s(h)(2)(C) 
and Exchange Act Section 15F(h)(2)(C)),\39\ that an entity enters into 
over the prior 12 months could not exceed $25 million.\40\ The Dodd-
Frank Act provided special protections to special entities in 
connection with swaps and security-based swaps, and we preliminarily 
believe that this lower proposed threshold reasonably reflects the 
special protections afforded to those entities.
---------------------------------------------------------------------------

    \39\ The term ``special entity'' encompasses: Federal agencies; 
States, State agencies and political subdivisions (including cities, 
counties and municipalities); ``employee benefit plans'' as defined 
under the Employee Retirement Income Security Act of 1974 
(``ERISA''); ``governmental plans'' as defined under ERISA; and 
endowments.
    \40\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange 
Act rule 3a71-2(b).
---------------------------------------------------------------------------

    In addition, to take advantage of the de minimis exemption, the 
proposed rule would provide that the entity could not have entered into 
swaps or security-based swaps (as applicable) as a dealer with more 
than 15 counterparties, other than security-based swap dealers, over 
the prior 12 months.\41\ The Commissions preliminarily believe that an 
entity that enters into swaps or security-based swaps, in a dealer 
capacity, with a larger number of counterparties should be registered 
to help achieve Title VII's orderly market goals, and thus cannot be 
said to engage in a de minimis quantity of dealing (even if the 
aggregate effective notional amount of the swaps or security-based 
swaps is less than the thresholds noted above).\42\ For purposes of 
determining the number of counterparties, we preliminarily believe that 
counterparties who are members of an affiliated group would generally 
count as one counterparty, given that the purpose of the limit is to 
measure the scope of dealer's interaction with separate 
counterparties.\43\
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    \41\ See proposed CEA rule 1.3(ppp)(4)(iii); proposed Exchange 
Act rule 3a71-2(c). That these tests measure the entity's activities 
over the prior 12 months provides certainty. As of the end of each 
month, the entity will know whether it may qualify for the exemption 
during the following month.
    \42\ Similarly, because all the de minimis factors must be 
satisfied, a person who enters into only a single swap or security-
based swap, as a swap dealer, with a single counterparty could not 
qualify for the de minimis exemption if that swap or security-based 
swap exceeds the effective notional amount threshold.
    \43\ For this purpose, an affiliated group would be defined as 
any group of entities that is under common control and that reports 
information or prepares its financial statements on a consolidated 
basis.
---------------------------------------------------------------------------

    Finally, the proposed rule would provide that, to take advantage of 
the de minimis exemption, the entity could not have entered into more 
than 20 swaps or security-based swaps (as applicable) as a dealer 
during the prior 12 months.\44\ As is the case for the limitation on 
the number of counterparties, the Commissions preliminarily believe 
that an entity that enters into a larger number of swaps or security-
based swaps, in a dealer capacity, would, if registered, help achieve 
Title VII's orderly market goals, and thus cannot be said to engage in 
a de minimis quantity of dealing. For these purposes, we would expect 
that each separate transaction the entity enters into under a swap or 
security-based swap master agreement in general would count as entering 
into a swap or security-based swap, but that an amendment of an 
existing swap or security-based swap in which the counterparty remained 
the same and the underlying item remained substantially the same would 
not count as a new swap or security based swap.\45\
---------------------------------------------------------------------------

    \44\ See proposed CEA rule 1.3(ppp)(4)(iv); proposed Exchange 
Act rule 3a71-2(d).
    \45\ For these purposes only, an amendment to an existing swap 
or security-based swap would not need to be counted as a new swap or 
security-based swap if the underlying item is substantially the same 
as the original item. This may occur, for example, to reflect the 
effect of a corporate action such as a merger. An amendment would be 
counted as a new swap or security-based swap, however, to the extent 
that the change in the underlying item modifies the economic risk 
reflected by the swap or security-based swap.

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[[Page 80181]]

    The proposed rule would not distinguish between different types of 
swaps or security-based swaps into which entities may enter (e.g., rate 
swaps versus other commodity swaps, or credit default swaps versus 
equity swaps). The Commissions preliminarily do not believe that the 
ceiling for distinguishing de minimis dealing activities from other 
dealing activities appropriately turns upon the particular type of swap 
or security-based swap.\46\
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    \46\ The Exchange Act's definition of ``dealer'' does not 
include a de minimis exemption. Thus, an entity that engages in 
dealing activity involving securities (other than security-based 
swaps with eligible contract participants) would be required to 
register as a ``dealer'' under the Exchange Act, and comply with the 
Exchange Act's requirements applicable to dealers, absent some other 
exception or exemption from registration.
---------------------------------------------------------------------------

    The Commissions request comment on the proposed rule regarding the 
de minimis exemption. Commenters particularly are requested to address 
whether certain of the proposed factors should be modified or 
eliminated; for example, should the proposed $100 million limit on 
annual notional swaps or security-based swaps entered into in a dealer 
capacity be raised or lowered to better implement the intended scope of 
the de minimis exemption--i.e., to exclude entities for which dealer 
regulation would not be warranted? Should we adopt different thresholds 
that would appropriately limit the exemption so it encompasses only 
those entities whose dealing activities are such that dealer regulation 
is not warranted? To what extent would certain entities be expected to 
reduce or otherwise adjust their dealing activity to fall within the 
scope of the de minimis exemption? Would there be any adverse 
implications for market participants if this happens? To what extent 
could the proposed factors potentially reduce dealing activity, and in 
doing so reduce the liquidity available in the swap or security-based 
swap market?
    Commenters also are requested to address whether the rule should 
seek to identify only certain types of counterparties with which a 
person could engage in dealing activities under the exemption. We also 
particularly request comment on the proposed $25 million notional 
threshold for dealer transactions with ``special entities,'' including 
whether that proposed threshold should be raised or lowered, and 
whether an entity that enters into dealing transactions with ``special 
entities'' should be able to take advantage of the exemption at all. In 
addition, we request comment on whether the proposed threshold for 
transactions with ``special entities'' would provide a disincentive to 
dealers entering into transactions with such entities.
    Commenters further are requested to address whether the factors may 
appropriately account for the size of the swap or security-based swap 
activities compared to the size of the entity; how an entity's swaps or 
security-based swaps with affiliated counterparties should be treated 
for purposes of the test; and whether the exemption's factors should 
vary depending on the type of swap or security-based swap at issue.
    In addition, commenters are requested to address the significance 
of the fact that the statutory de minimis exemption specifically 
references transactions with or on behalf of a customer. Does that mean 
the exemption was intended to specifically address dealing activity as 
an accommodation to an entity's customers? If so, should the exemption 
be conditioned on the presence of an existing relationship between the 
entity and the counterparty that does not entail swap or security-based 
swap dealing activity, and if so, which types of relationships should 
be treated as creating a ``customer'' relationship?
    Commenters also are requested to address whether the de minimis 
exemption should excuse an entity from having to comply with certain 
regulatory requirements imposed on swap dealers or security-based swap 
dealers, while also mandating compliance with other dealer 
requirements. In addition, commenters are requested to address whether, 
in lieu of the self-executing approach proposed here, the Commissions 
instead should require that entities which seek relief under this de 
minimis exemption must submit exemptive requests to the relevant agency 
for the agency's consideration and action. Commenters further are 
requested to address whether the proposed notional threshold for the de 
minimis exception should be subject to a formula that permits automatic 
periodic adjustments to the threshold, such as to reflect changes in 
market size or in the size of typical contracts.

C. Statutory Exclusion for Swaps in Connection With Originating a Loan

    The ``swap dealer'' definition excludes an insured depository 
institution (``IDI'') ``to the extent it offers to enter into a swap 
with a customer in connection with originating a loan with that 
customer.'' \47\ This exclusion does not appear in the definition of 
``security-based swap dealer.''
---------------------------------------------------------------------------

    \47\ See CEA section 1a(49)(A).
---------------------------------------------------------------------------

1. Comments Regarding the Exclusion for Swaps in Connection With Loans
    Three IDIs commented on this aspect of the definition, stating that 
the exclusion should encompass any swap entered into contemporaneously 
with a loan that is related to any of the borrower's activities that 
affect the ability to repay the loan and can be hedged. Thus, in their 
view, the exclusion should cover exchange rate and physical commodity 
swaps in addition to interest rate swaps. The IDIs also said the 
exclusion should apply to amendments, restructurings and workouts of 
loans, and to lenders that act through a syndicate.
    Another commenter expressed similar views, and also asked for 
clarification whether the exclusion applies to all aspects of the 
definition, or if it applies only to whether a person is commonly known 
in the trade as a swap dealer. The CFTC preliminarily believes the 
exclusion applies to all aspects of the swap dealer definition.
2. Proposed Rule Regarding the Exclusion for Swaps in Connection With 
Loans
    The CFTC preliminarily interprets the word ``offer'' in this 
exclusion to include scenarios where the IDI requires the customer to 
enter into a swap, or the customer asks the IDI to enter into a swap, 
specifically in connection with a loan made by that IDI. Also, the 
proposed rule provides that, in order to prevent evasion, the statutory 
exclusion does not apply where (i) The purpose of the swap is not 
linked to the financial terms of the loan; (ii) the IDI enters into a 
``sham'' loan; or (iii) the purported ``loan'' is actually a synthetic 
loan such as a loan credit default swap or loan total return swap.
    The proposed rule would apply the statutory exclusion only to swaps 
that are connected to the financial terms of the loan, such as, for 
example, its duration, interest rate, currency or principal amount. 
Although commenters urged that this exclusion be extended to other 
aspects of the lending relationship, we preliminarily believe that it 
would not be appropriate that this exclusion from the swap dealer 
definition encompass swaps that are connected to the borrower's other 
business activities, even if the loan agreement requires that the 
borrower enter into such swaps or otherwise refers to them. We 
preliminarily believe that a broader reading of the exclusion could 
encompass all swap activity

[[Page 80182]]

between an IDI and its borrowers, which we do not think is intended.
    The origination of commercial loans is a complex process, and the 
CFTC preliminarily believes that this exclusion should be available to 
all IDIs that are a source of funds to a borrower. For example, all 
IDIs that are part of a loan syndicate providing a loan to a borrower 
could claim this exclusion with respect to swaps entered into with the 
borrower that are connected to the financial terms of the loan. 
Similarly, the proposed exclusion could be claimed with respect to such 
swaps entered into by any IDI that participates in or obtains a 
participation in such loan by means of a transfer or otherwise.\48\ 
Also, an IDI that is a source of funds for the refinancing of a loan 
(whether directly or through a syndicate, participation or otherwise) 
could claim the exclusion if it enters into a swap with the refinancing 
borrower.
---------------------------------------------------------------------------

    \48\ The CFTC preliminarily believes that the proposed exclusion 
could be claimed by any IDI that participates in a loan through any 
means that involves a payment to a lender to take the place of that 
lender, including an ``English style'' participation.
---------------------------------------------------------------------------

    We emphasize that this proposed exclusion, by its statutory terms, 
is available only to IDIs. If an IDI were to transfer its participation 
in a loan to a non-IDI, then the non-IDI would not be able to claim 
this exclusion, regardless of the terms of the loan or the manner of 
the transfer. Similarly, a non-IDI that is part of a loan syndicate 
with IDIs would not be able to claim the exclusion.
    In sum, the proposed exclusion may be claimed by a person that 
meets the following three conditions: (i) The person is an IDI; (ii) 
the person is the source of funds to a borrower in connection with a 
loan (either directly or through syndication, participation, 
refinancing or otherwise); and (iii) the person enters into a swap with 
the borrower that is connected to the financial terms of the loan (so 
long as the loan is not a sham or a synthetic loan).
    The CFTC requests comment on the proposed rule relating to the 
statutory exclusion for swaps in connection with originating a loan, 
and in particular on whether this statutory exclusion should be 
extended beyond swaps that are connected to the financial terms of the 
loan, and if so, why. The CFTC also requests comment on whether this 
exclusion should apply only to swaps that are entered into 
contemporaneously with the IDI's origination of the loan (and if so, 
how ``contemporaneously'' should be defined for this purpose), or 
whether this exclusion should also apply to swaps entered into during 
part or all of the duration of the loan.

D. Designation as a Dealer for Certain Types, Classes, or Categories of 
Swaps, Security-Based Swaps, or Activities

    The statutory definitions include a provision stating that a person 
may be designated as a dealer for one or more types, classes or 
categories of swaps, security-based swaps, or activities without being 
considered a swap dealer or security-based swap dealer for other types, 
classes or categories of swaps, security-based swaps, or activities. 
This provision is permissive and does not require the Commissions to 
designate persons as dealers for only a limited set of types, classes 
or categories of swaps, security-based swaps, or activities.
1. Comments Regarding Limited Designation as a Swap Dealer or Security-
Based Swap Dealer
    One commenter stated that the Commissions should allow a person to 
register as a swap dealer or security-based swap dealer for only a 
limited set of types, classes or categories of swaps or security-based 
swaps. Another commenter expressed the view that a person designated as 
a swap dealer or security-based swap dealer should be designated as 
such for all types of swaps or security-based swaps, respectively.
2. Proposed Rule Regarding Limited Designation as a Swap Dealer or 
Security-Based Swap Dealer
    In general, the Commissions propose that a person that satisfies 
the definition of swap dealer or security-based swap dealer would be a 
dealer for all types, classes or categories of swaps or security-based 
swaps, or activities involving swaps or security-based swaps, in which 
the person engages.\49\ Thus, the person would be subject to all 
regulatory requirements applicable to dealers for all swaps or 
security-based swaps into which it enters. We propose this approach 
because it may be difficult for swap dealers and security-based swap 
dealers to separate their dealing activities from their other 
activities involving swaps or security-based swaps.\50\
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    \49\ See proposed CEA rule 1.3(ppp)(3); proposed Exchange Act 
rule 3a71-1(c).
    \50\ For example, in order to efficiently impose the dealer 
requirements on only the person's dealing activities, it may be 
necessary for the person to have separate books and records and a 
separate compliance regime for its dealing activities.
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    The proposed rule also states, however, that the Commissions may 
provide for a person to be designated as a swap dealer or security-
based swap dealer for only specified categories of swaps, security-
based swaps, or activities, without being classified as a dealer for 
all categories.\51\ This proposed rule would afford persons an 
opportunity to seek, on an appropriate showing, a limited designation 
based on facts and circumstances applicable to their particular 
activities. The Commissions anticipate that a swap dealer could seek a 
limited designation at the same time as, or at a later time subsequent 
to, the person's initial registration as a swap dealer.
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    \51\ CEA section 1a(49)(B); Exchange Act section 3(a)(71)(B). As 
discussed below, the Commissions preliminarily believe that there 
are four major categories of swaps and two major categories of 
security-based swaps. See part IV.A, infra. The designation as a 
swap dealer or security-based swap dealer may, for example, be 
limited in terms of these categories or in terms of particular 
activities of the person.
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    The CFTC understands that there may potentially be non-financial 
entities, such as physical commodity firms, that conduct swap dealing 
activity through a division of the entity, and not a separately-
incorporated subsidiary. In these instances, the entity's swap dealing 
activity would not be a core component of the entity's overall 
business. If this type of entity registered as a swap dealer, the CFTC 
anticipates that certain swap dealer requirements would apply to the 
swap dealing activities of the division, but not necessarily to the 
swap activities of other parts of the entity.
    The Commissions request comment on the proposed rules regarding 
limited designation as a swap dealer or security-based swap dealer. 
Commenters particularly are requested to address the circumstances in 
which such limited purpose designations would be appropriate, the 
factors that the Commissions should consider when addressing such 
requests, and the type of information requestors should provide in 
support of their request. For example, would it be appropriate to grant 
such limited purpose designations only to entities that do not 
otherwise fall within the definition of a financial entity, and whose 
dealing activity is below a defined threshold of the entity's overall 
activity? At what level should the Commissions set such a threshold? 
Which of the requirements applicable to dealers should or should not 
apply to such entity's non-dealing activities in swaps and security-
based swaps?
    In addition, commenters are requested to address whether the 
Commissions should provide for limited purpose designations of swap 
dealers or security-based swap dealers through some other mechanism as 
an alternative to, or in

[[Page 80183]]

addition to, case-by-case evaluations of individual applications. If 
so, what criteria and procedures would be appropriate for making 
limited purpose designations through this type of approach? Also, 
should the limited purpose designation apply on a provisional basis 
starting at the time that the entity makes an application for a limited 
purpose designation?
    Finally, commenters also are asked to address whether such limited 
purpose designations should be conditioned in any way, such as by the 
provision of information of the type that would be required with 
respect to an entity's swaps or security-based swaps involving the 
particular category or activity for which they are not designated as a 
dealer.

E. Certain Interpretative Issues

1. Affiliate Issues
    We preliminarily believe that the word ``person'' in the swap 
dealer and security-based swap dealer definitions should be interpreted 
to mean that the designation applies with respect to a particular legal 
person. That is, for example, we would not view a trading desk or other 
discrete business unit that is not a separately organized legal person 
as a swap dealer; rather, the legal person of which it is a part would 
be the swap dealer. Also, an affiliated group of legal persons under 
common control could include more than one dealer. Within such a group, 
any legal person that engages in swap or security-based swap dealing 
activities would be a swap dealer or security-based swap dealer, as 
applicable.
    In determining whether a particular legal person is a swap dealer 
or security-based swap dealer, we preliminarily believe it would be 
appropriate for the person to consider the economic reality of any 
swaps and security-based swaps it enters into with affiliates (i.e., 
legal persons under common control with the person at issue), including 
whether those swaps and security-based swaps simply represent an 
allocation of risk within a corporate group.\52\ Swaps and security-
based swaps between persons under common control may not involve the 
interaction with unaffiliated persons that we believe is a hallmark of 
the elements of the definitions that refer to holding oneself out as a 
dealer or being commonly known as a dealer. To the extent, however, 
that an entity seeks to use transactions between persons under common 
control to avoid one of the dealer definitions, the Commissions have 
the authority to prohibit practices designed to evade the requirements 
applicable to swap dealers and security-based swap dealers.\53\
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    \52\ Such swaps and security-based swaps should be considered in 
this way only for purposes of determining whether a particular 
person is a swap dealer or security-based swap dealer and does not 
necessarily apply in the context of the Exchange Act's general 
definition of ``dealer.'' The swaps and security-based swaps, 
moreover, would continue to be subject to all laws and requirements 
applicable to such swaps and security-based swaps.
    \53\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3). For 
example, it would not be permissible for an entity that provides 
liquidity on one side of the market to use affiliated entities to 
provide liquidity on the other side in an attempt to avoid having to 
register as a swap or security-based swap dealer.
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    The Commissions invite comment as to how the swap dealer and 
security-based swap dealer definitions should be applied to members of 
an affiliated group. Commenters particularly are invited to address how 
the Commissions should interpret common control for these purposes, and 
whether this interpretation should be limited to wholly-owned 
affiliates.
2. Application to Particular Swap Markets
    The swap markets are diverse and encompass a variety of situations 
in which parties enter into swaps with each other. We believe it is 
helpful to the understanding of the rule to discuss some of these 
situations, particularly those that have been raised by commenters, 
here. The situations discussed below include persons who enter into 
swaps as aggregators, as part of their participation in physical 
markets, or in connection with the generation and transmission of 
electricity. We invite comment as to what aspects of the parties' 
conduct in these situations should, or should not, be considered swap 
dealing activities, and whether the parties involved in these 
situations are swap dealers.
a. Aggregators
    Commenters explained that some persons enter into swaps with other 
parties in order to aggregate the swap positions of the other parties 
into a size that would be more amenable to entering into swaps in the 
larger swap market, or otherwise to make entering into such swaps more 
efficient. For example, certain cooperatives enter into swaps with 
smaller cooperatives, smaller businesses or their members in order to 
establish a position in a commodity that is large enough to be traded 
on a swap or futures market. Similarly, one smaller financial 
institution explained that it enters into swaps with counterparties 
whose swap positions would not be large enough to be of interest to 
larger financial institutions. This institution stated that it enters 
into offsetting swaps with larger financial institutions so that it is 
in a neutral position between the counterparties and the larger 
financial institutions.
    The result of these arrangements is that such persons engage in 
activities that are similar in many respects to those of a swap dealer 
as set out in the definition--the person enters into swaps to 
accommodate demand from other parties, it enters into swaps with a 
relatively large number of non-dealers, and it holds itself out as 
willing to enter into swaps. It may be that the swap dealing activities 
of these aggregators would not exceed the de minimis threshold, and 
therefore they would not be swap dealers. The CFTC, in particular, 
requests comment as to how the de minimis threshold would apply to such 
persons. If their activity would exceed the de minimis threshold set 
forth in the proposed rule, the Commissions request comment on the 
application of the swap dealer definition to their activity.
b. Physical Market Participants
    The markets in physical commodities such as oil, natural gas, 
chemicals and metals are complex and varied. They involve a large 
number of market participants that, over time, have developed highly 
customized transactions and market practices that facilitate 
efficiencies in their market in unique ways. Some of these transactions 
would be encompassed by the statutory definition of ``swap,'' and some 
participants in these markets engage in swap dealing activities that 
are above the proposed de minimis threshold. The Commissions invite 
comment as to any different or additional factors that should be 
considered in applying the swap dealer definition to participants in 
these markets.
c. Electricity Generation and Transmission
    The use of swaps in the generation and transmission of electricity 
is highly complex because electricity cannot be stored and therefore is 
generated, transmitted and used on a continuous, real-time basis. Also, 
the number and variety of participants in the electricity market is 
very large and some electricity services are provided as a public good 
rather than for profit. Nevertheless, some participants engage in swap 
dealing activities as described above that are above the de minimis 
threshold set forth in the proposed rule. The Commissions invite 
comment as to any different or additional factors that should be 
considered in applying the

[[Page 80184]]

swap dealer definition to participants in the generation and 
transmission of electricity. Specifically, the Commissions invite 
comment on whether there are special considerations, including without 
limitation special considerations arising from section 201(f) of the 
Federal Power Act, related to non-profit, public power systems such as 
rural electric cooperatives and entities operating as political 
subdivisions of a State, and the applicability of the exemptive 
authority in section 722(f) of the Dodd-Frank Act to address those 
considerations.

III. Amendments to Definition of Eligible Contract Participant

A. Overview

    The Commodity Futures Modernization Act of 2000 (``CFMA'') \54\ 
generally excluded or exempted transactions between eligible contract 
participants (``ECPs'') from most provisions of the CEA.\55\ Section 
723(a)(1)(A) of the Dodd-Frank Act repeals those exclusions and 
exemptions. ECP status remains important, however, because Section 
723(a)(2) of the Dodd-Frank Act renders it unlawful for a non-ECP to 
enter into a swap other than on, or subject to the rules of, a 
designated contract market (``DCM'').\56\ Section 763(e) of the Dodd-
Frank Act also renders it unlawful for a non-ECP to enter into a 
security-based swap unless such transaction is effected on a national 
securities exchange registered pursuant to Section 6(b) of the Exchange 
Act.\57\ In addition, Section 768(b) of the Dodd-Frank Act makes it 
unlawful for a non-ECP to enter into a security-based swap unless a 
registration statement is in effect. While this means that non-ECPs 
cannot enter into swaps on SEFs or on a bilateral, off-exchange basis, 
it also opens swaps to non-ECPs, so long as the swaps are entered into 
on, or subject to the rules of, a DCM. Similarly, while non-ECPs cannot 
enter into security-based swaps unless the transaction is effected on a 
national securities exchange and the security-based swap has an 
effective registration statement, it also opens security-based swaps to 
non-ECPs.
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    \54\ Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000).
    \55\ See CEA sections 2(d) (Excluded Derivative Transactions), 
2(e) (Excluded Electronic Trading Facilities), 2(g) (Excluded Swap 
Transactions) and 2(h) (Legal Certainty for Certain Transactions in 
Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). The CFMA also 
excluded swap agreements from the definitions of ``security'' in 
Section 3(a)(10) of the Exchange Act and Section 2(a)(1) of the 
Securities Act. See Section 3A of the Exchange Act, 15 U.S.C. 78c-1, 
and Section 2A of the Securities Act, 15 U.S.C. 77b-1 (both of which 
have been modified by the Dodd-Frank Act). The CFMA, however, 
provided that the SEC had antifraud authority over security-based 
swap agreements.
    \56\ Section 723(a)(2) of the Dodd-Frank Act adds new subsection 
(e) to CEA section 2 (7 U.S.C. 2(e)). New CEA section 2(e) provides 
that ``[i]t shall be unlawful for any person, other than an eligible 
contract participant, 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 under section 5.''
    \57\ Section 763(e) of the Dodd-Frank Act adds paragraph (l) to 
Exchange Act section 6. New Exchange section 6(l) provides that 
``[i]t shall be unlawful for any person to effect a transaction in a 
security-based swap with or for a person that is not an eligible 
contract participant, unless such transaction is effected on a 
national securities exchange registered pursuant to subsection 
(b).''
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    Congress also amended \58\ the ECP definition in Section 721(a)(9) 
of the Dodd-Frank Act by: (1) Raising a threshold that governmental 
entities may use to qualify as ECPs, in certain situations, from $25 
million in discretionary investments to $50 million in such 
investments; and (2) replacing the ``total asset'' standard for 
individuals to qualify as ECPs with a discretionary investment 
standard.\59\
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    \58\ The changes to the ECP definition made by the Dodd-Frank 
Act originated in the Administration's ``White Paper'' on financial 
regulatory reform. See Financial Regulatory Reform, A New 
Foundation: Rebuilding Financial Supervision and Regulation, 
available at http://www.financialstability.gov/docs/regs/FinalReprot_web.pdf, at 48-49 (June 17, 2009) (``Current law seeks 
to protect unsophisticated parties from entering into inappropriate 
derivatives transactions by limiting the types of counterparties 
that could participate in those markets. But the limits are not 
sufficiently stringent.'').
    \59\ The monetary component of ECP status for individuals 
remains the same under the amended ECP definition: More than $10 
million (but now in discretionary investments, not in total assets), 
or $5 million if the transactions for which ECP status is necessary 
are for risk management of an asset or liability the individual owns 
or incurs, or is reasonably likely to own or incur.
---------------------------------------------------------------------------

B. Commenters' Views

    The ECP definition elicited comment from nine commenters. The 
comments ranged from requests not to increase the monetary thresholds 
for governmental employee benefit plans in certain instances to 
suggestions to dramatically raise them across the board, and from 
requests not to change the definition in a way that would limit the 
commenter's access to swaps to specific proposals to address such 
otherwise limited access.
    In the Dodd-Frank Act, Congress addressed aspects of the ECP 
definition that it found to be of particular concern regarding 
governmental entities and individuals. Otherwise, though, persons who 
qualified for exclusions or exemptions to enter into bilateral, off-
exchange swaps prior to the Dodd-Frank Act will still qualify to do so 
with respect to non-standardized swaps under the Dodd-Frank Act, with 
the exceptions discussed below. We have not identified any legislative 
history suggesting that Congress intended the Commissions to undertake 
a wholesale revision of the ECP definition. Accordingly, the 
Commissions are limiting the further definition of the term ECP to the 
discrete issues discussed below.

C. New ECP categories

    The CEA definition of ECP generally is comprised of regulated 
persons; \60\ entities defined as ECPs based on a total asset test 
(e.g., a corporation, partnership, proprietorship, organization, trust, 
or other entity with total assets exceeding $10 million) \61\ or an 
alternative monetary test coupled with a non-monetary component (e.g., 
an entity with a net worth in excess of $1 million and engaging in 
business-related hedging; \62\ or certain employee benefit plans, the 
investment decisions of which are made by one of four enumerated types 
of regulated entities \63\); and certain governmental entities and 
individuals that meet defined thresholds.\64\
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    \60\ CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix), 
(x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix), (x)), 
as redesignated by Section 721(a)(9) of the Dodd-Frank Act.
    \61\ CEA section 1a(18)(A)(v)(I) (7 U.S.C. 1a(18)(A)(v)(I)), as 
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
    \62\ CEA section 1a(18)(A)(v)(III) (7 U.S.C. 1a(18)(A)(v)(III)), 
as redesignated by Section 721(a)(9) of the Dodd-Frank Act.
    \63\ CEA section 1a(18)(A)(vi) (7 U.S.C. 1a(18)(A)(vi)), as 
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
    \64\ CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C. 
1a(18)(A)(vii) and (xi), as redesignated by Section 721(a)(9) of the 
Dodd-Frank Act.
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    Persons in the new major swap participant, major security-based 
swap participant, swap dealer and security-based swap dealer categories 
are likely to be among the most active and largest users of swaps and 
security-based swaps. Accordingly, the Commissions propose to further 
define the term ECP to include these new categories, which will permit 
such persons to enter into swaps and security-based swaps on SEFs and 
on a bilateral basis (where otherwise permitted under the Dodd-Frank 
Act and regulations thereunder).
    We seek comment on this proposed expansion of the ECP definition.

D. Relationship Between Retail Foreign Currency and ECP Status in the 
Context of a Commodity Pool

    Prior to the Dodd-Frank Act, clause (A)(iv) of the ECP definition 
provided that a commodity pool was an ECP if the pool and its operator 
met certain requirements (i.e., the commodity pool has $5 million in 
total assets and is operated by a commodity pool operator regulated 
under the CEA or subject to

[[Page 80185]]

foreign regulation), regardless of whether each pool participant was 
itself an ECP.\65\ Section 741(b)(10) of the Dodd-Frank Act amended 
clause (A)(iv) of the ECP definition to provide that a commodity pool 
engaging in retail foreign currency transactions of the type described 
in CEA sections 2(c)(2)(B) or 2(c)(2)(C) ; \66\ (``retail forex'' and 
such pools, ``Retail Forex Pools'') no longer qualifies as an ECP for 
those purposes if any participant in the pool is not independently an 
ECP. The Commissions believe that in some cases commodity pools unable 
to satisfy the conditions of clause (A)(iv) of the ECP definition may 
rely on clause (A)(v) to qualify as ECPs instead for purposes of retail 
forex. Clause (A)(v) of the ECP definition applies to business entities 
irrespective of their form of organization (i.e., corporations, 
partnerships, proprietorships, organizations, trusts and other 
entities), and contains a $1 million net worth test where such an 
entity ``enters into an agreement, contract, or transaction in 
connection with the conduct of the entity's business or to manage the 
risk associated with an asset or liability owned or incurred or 
reasonably likely to be owned or incurred by the entity in the conduct 
of the entity's business.'' \67\
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    \65\ CEA section 1a(12)(A)(iv) (7 U.S.C. 1a(12)(A)(iv)).
    \66\ 7 U.S.C. 2(c)(2)(B) and (C). See generally ``Regulation of 
Off-Exchange Retail Foreign Exchange Transactions and 
Intermediaries,'' 75 FR 55410 (Final Rule; Sept. 10, 2010) 
(discussing the new CFTC retail forex regulatory regime); 
``Regulation of Off-Exchange Retail Foreign Exchange Transactions 
and Intermediaries,'' 75 FR 3282 (Proposed Rule; Jan. 20, 2010) 
(providing historical background on the regulation of retail forex 
transactions).
    \67\ CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), as 
redesignated by Section 721(a)(9) of the Dodd-Frank Act.
---------------------------------------------------------------------------

    The Commissions believe that permitting Retail Forex Pools with one 
or more non-ECP participants to achieve ECP status by relying on clause 
(A)(v) of the ECP definition would frustrate the intent of Congress in 
denying ECP status to Retail Forex Pools under clause (A)(iv). 
Consequently, the Commissions propose to further define the term ECP to 
preclude a Retail Forex Pool with one or more non-ECP participants from 
qualifying as an ECP by relying on clause (A)(v) of the ECP definition 
if such Retail Forex Pool is not an ECP due to the language added to 
clause (A)(iv) of the ECP definition by section 741(b)(10) of the Dodd-
Frank Act (i.e., because the pool contains one or more non-ECP 
participants). Because commodity pools can be structured in various 
ways and can have one or more feeder funds and/or pools, many with 
their own participants, the Commissions propose to preclude a Retail 
Forex Pool from being an ECP pursuant to clause (A)(iv) of the ECP 
definition if there is a non-ECP participant at any investment level 
(e.g., a participant in the pool itself (a direct participant), an 
investor or participant in a fund or pool that invests in the pool in 
question (an indirect participant), an investor or participant in a 
fund or pool that invests in that investor fund or pool (also an 
indirect participant), etc.).
    Similarly, the Commissions believe that some commodity pools unable 
to satisfy the total asset or regulated status components of clause 
(A)(iv) of the ECP definition may rely on clause (A)(v) to qualify as 
ECPs instead. The Commissions are of the view that a commodity pool 
that cannot satisfy the monetary and regulatory status conditions 
prescribed in clause (A)(iv) should not qualify as an ECP in reliance 
on clause (A)(v) of the ECP definition. Therefore, the Commissions 
propose to further define the term ECP to prevent such an entity from 
qualifying as an ECP pursuant to clause (A)(v) of the ECP definition.

E. Request for comment

    The Commissions request comment on all aspects of the proposed 
amendments to the definition of ``eligible contract participant.'' Are 
the proposed interpretations with respect to Retail Forex Pools and 
other commodity pools appropriate? Do entities described in the various 
enumerated ECP categories (other than commodity pools) rely on clause 
(A)(v) to qualify as ECPs? If so, should an entity that would be 
described in one of the clauses of paragraph (A) of the ECP definition, 
but cannot satisfy the conditions prescribed in that clause, be 
prohibited from relying on clause (A)(v) of the ECP definition?
    In addition, should the Commissions further narrow any or all of 
the ECP categories? Why or why not? If so, what additional conditions 
would be appropriate? Should the Commissions define the term 
``discretionary basis,'' as requested by one commenter, either solely 
for purposes of clause (A)(vii) or clause (A)(xi), or for both clauses? 
Alternatively, should the Commissions add any additional categories of 
ECPs, such as the following categories suggested by commenters: 
Commercial real estate developers; energy or agricultural cooperatives 
or their members; or firms using swaps as hedges pursuant to the terms 
of the CFTC's Swap Policy Statement? If so, which ones and why?

IV. Definitions of ``Major Swap Participant'' and ``Major Security-
Based Swap Participant''

    The definitions of ``major swap participant'' and ``major security-
based swap participant'' (also jointly referred to as the ``major 
participant'' definitions) respectively focus on the market impacts and 
risks associated with an entity's swap and security-based swap 
positions. In this respect, the major participant definitions differ 
from the definitions of ``swap dealer'' and ``security-based swap 
dealer,'' which focus on an entity's activities and account for the 
amount or significance of those activities only in the context of the 
de minimis exception.
    Despite those differences in focus, persons that meet the major 
participant definitions in large part must follow the same statutory 
requirements that apply to swap dealers and security-based swap 
dealers.\68\ In this way, the statute applies comprehensive regulation 
to entities whose swap or security-based swap activities do not cause 
them to be dealers, but nonetheless could pose a high degree of risk to 
the U.S. financial system generally.\69\
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    \68\ In particular, under CEA section 4s and Exchange Act 
section 15F, dealers and major participants in swaps or security-
based swaps generally are subject to the same types of margin, 
capital, business conduct and certain other requirements, unless an 
exclusion applies. See CEA section 4s(h)(4), (5); Exchange Act 
section 15F(h)(4), (5).
    \69\ As discussed below, the tests of the major participant 
definitions use terms--particularly ``systemically important,'' 
``significantly impact the financial system'' or ``create 
substantial counterparty exposure''--that denote a focus on entities 
that pose a high degree of risk through their swap and security-
based swap activities. In addition, the link between the major 
participant definition and risk was highlighted during the 
Congressional debate on the statute. See 156 Cong. Rec. S5907 (daily 
ed. July 15, 2010) (dialogue between Senators Hagen and Lincoln, 
discussing how the goal of the major participant definition was to 
``focus on risk factors that contributed to the recent financial 
crisis, such as excessive leverage, under-collateralization of swap 
positions, and a lack of information about the aggregate size of 
positions'').
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    The major participant definitions are similar in their key 
provisions, although one exception, as discussed below, is available 
only in connection with the ``major swap participant'' definition. Both 
major participant definitions encompass persons that satisfy any of 
three alternative tests: \70\
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    \70\ Also, neither major participant definition encompasses an 
entity that meets the respective swap dealer or security-based swap 
dealer definition. See CEA section 1a(33)(A); Exchange Act section 
3(a)(67)(A)(i).
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     The first test encompasses persons that maintain a 
``substantial position'' in any of the ``major'' categories of swaps or 
security-based swaps, as those categories are determined by the CFTC

[[Page 80186]]

or SEC as applicable. This test excludes both ``positions held for 
hedging or mitigating commercial risk,'' and positions maintained by or 
contracts held by any employee benefit plan (as defined in paragraphs 
(3) and (32) of section 3 of ERISA (29 U.S.C. 1002)) for the primary 
purpose of hedging or mitigating risks directly associated with the 
operation of the plan.\71\
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    \71\ See CEA section 1a(33)(A)(i); Exchange Act section 
3(a)(67)(A)(ii)(I).
---------------------------------------------------------------------------

     The second test encompasses persons whose outstanding 
swaps or security-based swaps create ``substantial counterparty 
exposure that could have serious adverse effects on the financial 
stability of the United States banking system or financial markets.'' 
\72\
---------------------------------------------------------------------------

    \72\ See CEA section 1a(33)(A)(ii); Exchange Act section 
3(a)(67)(A)(ii)(II).
---------------------------------------------------------------------------

     The third test encompasses any ``financial entity'' that 
is ``highly leveraged relative to the amount of capital such entity 
holds and that is not subject to capital requirements established by an 
appropriate Federal banking agency'' and that maintains a ``substantial 
position'' in swaps or security-based swaps for any of the ``major'' 
categories of swaps or security-based swaps.\73\
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    \73\ See CEA section 1a(33)(A)(iii); Exchange Act section 
3(a)(67)(A)(ii)(III).
---------------------------------------------------------------------------

    The statute directs the CFTC or the SEC to define ``substantial 
position'' for the respective definition at the threshold that it 
determines to be ``prudent for the effective monitoring, management, 
and oversight of entities that are systemically important or can 
significantly impact the financial system of the United States.'' The 
definitions further provide that when defining ``substantial 
position,'' the CFTC or SEC ``shall consider the person's relative 
position in uncleared as opposed to cleared [swaps or security-based 
swaps] and may take into consideration the value and quality of 
collateral held against counterparty exposures.'' \74\
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    \74\ See CEA Section 1a(33)(B); Exchange Act section 
3(a)(67)(B).
---------------------------------------------------------------------------

    Both major participant definitions provide that a person may be 
designated as a major participant for one or more categories of swaps 
or security-based swaps without being classified as a major participant 
for all classes of swaps or security-based swaps.\75\
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    \75\ See CEA section 1a(33)(C); Exchange Act section 
3(a)(67)(C).
---------------------------------------------------------------------------

    Finally, the definition of ``major swap participant''--but not the 
definition of ``major security-based swap participant''--includes an 
exception for any ``entity whose primary business is providing 
financing, and uses derivatives for the purpose of hedging underlying 
commercial risks related to interest rate and foreign currency 
exposures, 90 percent or more of which arise from financing that 
facilitates the purchase or lease of products, 90 percent or more of 
which are manufactured by the parent company or another subsidiary of 
the parent company.'' \76\
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    \76\ See CEA section 1a(33)(D).
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    Although the two major participant definitions are similar, they 
address instruments that reflect different types of risks and that can 
be used by end-users and other market participants for different 
purposes. Interpretation of the definitions must appropriately account 
for those differences.
    The Commissions are proposing rules to further define the ``major 
swap participant'' and ``major security-based swap participant'' 
definitions, by specifically addressing: (a) The ``major'' categories 
of swaps or securities-based swaps; (b) the meaning of ``substantial 
position''; (c) the meaning of ``hedging or mitigating commercial 
risk''; (d) the meaning of ``substantial counterparty exposure that 
could have serious adverse effects on the financial stability of the 
United States banking system or financial markets''; and (e) the 
meanings of ``financial entity'' and ``highly leveraged.'' We also are 
proposing rules to specify the use of a daily average methodology for 
identifying whether a person meets one of the major participant 
definitions, provide for a reevaluation period for certain entities 
that exceed the relevant daily average by a small amount, and provide 
for a minimum length of time before a person may no longer be deemed a 
major participant.
    We further propose that the CFTC or SEC may limit an entity's 
designation as a major participant to only certain types, classes or 
categories of swaps or security-based swaps. We also address certain 
additional interpretive issues that commenters have raised. Finally, 
while the Commissions also are not proposing any exclusions from the 
major participant definitions, we are soliciting comment as to whether 
certain types of entities should be excluded from the definitions' 
application.\77\
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    \77\ In light of the significant and novel issues raised by the 
major participant definitions, the Commissions recognize the 
importance of monitoring the swap and security-based swap markets 
following adoption of major participant rules. This will help us 
evaluate whether the rules appropriately reflect how market 
participants use these instruments, and will help us consider the 
impact of market evolution and the ways in which market participants 
may change their practices in response to the rules, so we may 
identify potential improvements to the rules or other actions to 
enhance enforcement of major participant regulation.
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A. ``Major'' Categories of Swaps and Securities-Based Swaps

    The first and third tests of the statutory major participant 
definitions encompass entities that have a substantial position in a 
``major'' category of swaps or security-based swaps. The Commissions 
are responsible for designating these ``major'' categories.\78\
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    \78\ See CEA section 1a(33)(A)(i), (iii); Exchange Act section 
3(a)(67)(a)(2)(i), (iii). One commenter suggested that we determine 
these categories by reference to the types of instruments 
specifically listed in the statutory definition of ``swap.'' See 
Northwestern Mutual letter (suggesting that, for regulatory 
consistency, each type of swap listed in the definition and options 
on each of those swaps should be considered to be an individual 
major category). The statutory definition of ``swap'' lists 22 
different types of swaps.
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    The Commissions propose to designate ``major'' categories of swaps 
and security-based swaps in a manner that reflects the risk profiles of 
these various instruments and the different purposes for which end-
users make use of the various instruments. We preliminarily believe 
that it is important not to parse these ``major'' categories so finely 
as to base the ``substantial position'' thresholds on unduly narrow 
risks that would reduce those thresholds' effectiveness as risk 
measures. The ``major'' categories will apply only for purposes of the 
major participant definitions and are not necessarily determinative 
with respect to any other provision of the Dodd-Frank Act or the 
regulations adopted thereunder.
1. Major Categories of Swaps
    We propose to designate four ``major'' categories of swaps for 
purposes of the ``major swap participant'' definition. The four 
categories are rate swaps, credit swaps, equity swaps and other 
commodity swaps.\79\ The first category would encompass any swap which 
is primarily based on one or more reference rates, such as swaps of 
payments determined by fixed and floating interest rates, currency 
exchange rates, inflation rates or other monetary rates. The second 
category would encompass any swap that is primarily based on 
instruments of indebtedness, including but not limited to any swap 
primarily based on one or more indices related to debt instruments, or 
any swap that is an index credit default swap or total return

[[Page 80187]]

swap on one or more indices of debt instruments. The third category 
would encompass any swap that is primarily based on equity securities, 
such as any swap primarily based on one or more indices of equity 
securities, or any total return swap on one or more equity indices. The 
fourth category would encompass any swap not included in any of the 
first three categories. This fourth category would generally include, 
for example and not by way of limitation, any swap for which the 
primary underlying item is a physical commodity or the price or any 
other aspect of a physical commodity.\80\
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    \79\ See proposed CEA rule 1.3(rrr). For the avoidance of doubt, 
the term ``swap'' as it is used in the definitions of the major swap 
categories in rule 1.3(rrr) has the meaning set forth in section 
1a(47) of the CEA and the rules promulgated thereunder.
    \80\ The term ``commodity'' as defined in Section 1a(9) of the 
CEA, 7 U.S.C. 1a(9), and CFTC Rule Sec.  1.3(e), 17 CFR 1.3(e) 
includes interest rates, foreign exchange rates, and equity and debt 
indices as well as physical commodities. Thus, the fourth category 
of swaps is entitled ``other commodity swaps'' because it includes 
any swap not included in the other three categories.
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    The four major categories of swaps are intended to cover all swaps. 
Each swap would be in the category that most closely describes the 
primary item underlying the swap. If a swap is based on more than one 
underlying item of different types, the swap would be in the category 
that describes the underlying item that is likely to have the most 
significant effect on the economic return of the swap. The proposed 
categories are consistent with market statistics that distinguish 
between these general types of swaps, as well as market infrastructures 
that have been established for these types of swaps.
    We request comment on this proposed method of allocating swaps 
among ``major'' categories. Commenters particularly are asked to 
address whether there are any types of swaps that would have unclear 
status under this proposal, as well as whether all swaps instead should 
be placed into a single ``major'' category for purposes of the ``major 
swap participant'' definition, or whether there should be additional 
``major'' categories of swaps. Commenters are also asked to address 
whether the rate swap category should be divided into two separate 
categories--one for swaps based on rates of exchange between different 
currencies, and another for swaps based on interest rates, inflation 
rates and other monetary rates--and if so, in which category cross-
currency rate swaps should be included. Also, should the major swap 
category for other commodity swaps be divided into two separate 
categories--one for swaps based on agricultural commodities, and 
another for swaps based on all other commodities not included in the 
other categories?
2. Major Categories of Security-Based Swaps
    We propose to designate two ``major'' categories of security-based 
swaps for purposes of the ``major security-based swap definition.'' The 
first category would encompass any security-based swap that is based, 
in whole or in part, on one or more instruments of indebtedness 
(including loans), or a credit event relating to one or more issuers or 
securities, including but not limited to any security-based swap that 
is a credit default swap, total return swap on one or more debt 
instruments, debt swap, debt index swap, or credit spread.\81\ The 
second category would encompass any other security-based swaps not 
included in the first category; this category would include, for 
example, equity swaps.\82\
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    \81\ This category does not encompass a security-based swap that 
is based on an instrument of indebtedness solely in connection with 
the swap's financing leg.
    \82\ See proposed Exchange Act rule 3a67-2.
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    The proposed categories reflect the fact that entities that 
transact in security-based swaps for non-speculative purposes would be 
expected to use the respective instruments for different purposes. For 
example, swaps based on instruments of indebtedness, such as credit 
derivatives, can be used to hedge the risks associated with the default 
of a counterparty or debt obligation. Equity swaps can be used, among 
other ways, to hedge the risks associated with equity ownership or gain 
synthetic exposure to equities.\83\ The proposed categories also are 
consistent with market statistics that currently distinguish between 
those general types of security-based swaps, as well as market 
infrastructures, including separate trade warehouses, that have been 
established for credit default swaps and equity swaps.
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    \83\ At the same time, we note that the distinctions between 
these proposed ``major'' categories of ``security-based swaps'' 
arguably are less significant than the distinctions among the 
proposed major categories of ``swaps'' (such as, for example, the 
distinction between other commodity swaps and rate swaps).
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    We request comment on this proposed method of allocating security-
based swaps between two ``major'' categories. In particular, we request 
comment on whether there are any types of security-based swaps that 
would have unclear status under this proposal, as well as whether all 
security-based swaps instead should be placed into a single ``major'' 
category for purposes of the ``major security-based swap participant'' 
definition, or whether there should be additional ``major'' categories 
of security-based swaps.

B. ``Substantial Position''

    As noted above, the Commissions are required to define the term 
``substantial position'' as a threshold that is ``prudent for the 
effective monitoring, management, and oversight of entities that are 
systemically important or can significantly impact the financial system 
of the United States.'' \84\ This raises two fundamental issues: (i) 
What types of measures should be used to identify the risks posed by an 
entity's swap or security-based swap positions; and (ii) for each of 
those measures, how much risk should be required to evidence a 
``substantial position''?
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    \84\ See CEA section 1a(33)(B); Exchange Act section 
3(a)(67)(B).
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1. Commenters' Views
    Commenters have expressed diverse views as to what should 
constitute a substantial position. A number of commenters suggested the 
use of a test based on the current uncollateralized mark-to-market 
exposure posed by an entity's swap or security-based swap positions, 
after taking bilateral netting agreements into account. Two commenters 
suggested specific dollar amounts of uncollateralized exposure to use 
as the substantial position threshold.\85\ Several commenters expressed 
the view that positions subject to central clearing should be entirely 
excluded from the analysis, or at least should be discounted for 
purposes of the analysis.\86\
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    \85\ See letter from Timothy W. Cameron, Esq., Managing 
Director, SIFMA Asset Management Group, dated September 20, 2010 
(``SIFMA AMG letter'') (suggesting a standard of $2.5 billion 
average exposure in any calendar quarter based on the entity's 
entire portfolio of swaps and security-based swaps, other than 
foreign exchange swaps and forwards); letter from Gus Sauter, Chief 
Investment Officer, Vanguard, dated September 20, 2010 (``Vanguard 
letter'') (suggesting that the applicable threshold be $500 million 
in uncollateralized exposure for any single major swap category or 
$1 billion aggregate exposure across all major categories).
    \86\ See letter from Jennifer J. Kalb, Associate General 
Counsel, Metropolitan Life Insurance Company, dated September 20, 
2010 (``MetLife letter'') (suggesting that cleared trades be subject 
to a lesser ``charge'' for purposes of the substantial position 
calculation, or be excluded entirely).
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    Some commenters opposed using the notional amount of swap or 
security-based swap positions to set the threshold, stating that the 
notional amount is not indicative of the risks associated with a 
position. Some commenters similarly opposed using measures of swap or 
security-based swap volume to set the threshold,

[[Page 80188]]

contending that the number of trades does not reflect risk.\87\
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    \87\ But see letter from Christopher A. Klem, Ropes & Gray, 
dated September 2, 2010 (test should account for frequency of 
trading and frequency of trading with non-dealers).
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    A few commenters addressed the possibility that the threshold could 
take into account the potential future risks associated with a 
position, in addition to the risks associated with uncollateralized 
current exposure.\88\ Some commenters suggested that the threshold take 
into account the potential riskiness of the particular type of 
instrument at issue. Some commenters maintained that the threshold 
should take into account the number of counterparties an entity has, 
the size of an entity's positions compared to the size of the market, 
the size of an entity's swap or security-based swap positions compared 
to the entity's ability to absorb losses of that magnitude, or the 
financial strength of an entity's counterparties. Several commenters 
stated that the threshold should be based on an average measure over 
time, so that short-term spikes in measures such as exposure would not 
by themselves cause an entity to meet the major participant 
definitions. Some commenters suggested that the substantial position 
threshold should reflect an amount of ``systemic risk.'' \89\
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    \88\ See letter from Andrew Baker, Chief Executive Officer, 
Alternative Investment Management Association, dated September 24, 
2010 (``AIMA letter'') (discussing possible methods of estimating 
the maximum risk of loss related to positions); letter from Warren 
Davis, Of Counsel, Sutherland Asbill & Brennan LLP on behalf of the 
Federal Home Loan Banks, dated September 20, 2010 (in addressing 
``substantial counterparty exposure'' test, noting the possibility 
of accounting for the potential exposure of a portfolio).
    \89\ See letter from Edward J. Rosen, Cleary Gottlieb Steen & 
Hamilton LLP, dated September 21, 2010 (``Cleary letter'') 
(suggesting that the threshold should be akin to the amount that is 
required for a non-financial entity to be designated as systemically 
important under Title I of the Dodd-Frank Act).
    Section 113 of the Dodd-Frank Act provides that the Financial 
Stability Oversight Council (``FSOC'') may determine that a non-bank 
financial company shall be supervised by the Federal Reserve Board, 
subject to prudential standards, if the FSOC ``determines that 
material financial distress at the U.S. nonbank financial company, 
or the nature, scope, size, scale, concentration, 
interconnectedness, or mix of the activities of the U.S. nonbank 
financial company, could pose a threat to the financial stability of 
the United States.'' In making that determination, the FSOC is to 
consider: Leverage; off-balance sheet exposures; transactions and 
relationships with other significant non-bank financial companies 
and bank holding companies; importance as a source of credit and 
liquidity; extent to which assets are managed rather than owned; the 
nature, scope, size, scale, concentration, interconnectedness and 
mix of activities; presence of a primary financial regulator; assets 
and liabilities; and any other appropriate risk-related factors.
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2. Proposed Substantial Position Thresholds
    The Commissions recognize that it is important for the substantial 
position thresholds to be set using objective numerical criteria. 
Objective criteria should permit regulators, market participants and 
entities that may be subject to the regulations to readily evaluate 
whether swap or security-based swap positions meet the thresholds, and 
should promote the predictable application and enforcement of the 
requirements governing major participants.
    In determining the substantial position thresholds--in light of 
what is ``prudent for the effective monitoring, management, and 
oversight'' of entities that are systemically important or can 
significantly impact the U.S. financial system--the Commissions are 
mindful that tests based on current uncollateralized exposure and tests 
based on potential future exposure both have respective advantages and 
disadvantages. We thus are proposing tests that would account for both 
types of exposure.
    A test that focuses solely on the current uncollateralized exposure 
associated with an entity's swap and security-based swap positions 
should provide a reasonable measure of the theoretical amount of 
potential risk that an entity would pose to its counterparties if the 
entity currently were to default.\90\ Such a test also should be 
relatively clear-cut for market entities to implement, and would be 
based on calculations that we expect that market entities would perform 
as a matter of course.
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    \90\ In practice, however, this measure may underestimate the 
amount of risk that an entity poses to its counterparties, given 
that it may take multiple days to liquidate a defaulting entity's 
swap or security-based swap positions, during which time prices may 
move against the defaulting entity.
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    At the same time, a focus solely on current uncollateralized 
exposure could be overly narrow by failing to identify risky entities 
until some time after they begin to pose the level of risk that should 
subject them to regulation as major participants. Because exposure can 
change significantly over short periods of time, and a swap or 
security-based swap position that may pose large potential exposures 
nonetheless would often have a mark-to-market exposure of zero at 
inception, an entity's positions may already pose significant risk to 
counterparties and to the market even before its uncollateralized mark-
to-market exposure increases up to the applicable threshold. A test 
that focuses solely on current uncollateralized exposure thus would not 
appear to be sufficient to satisfy the systemic importance standard 
required by the statute.
    Tests based on measures of potential future exposure--which would 
address an estimate of how much the value of a swap or security-based 
swap might change against an entity over the remaining life of the 
contract--could address the gap left by a current uncollateralized 
exposure test. Potential future exposure tests, however, would reflect 
only an estimate of that type of risk, and would only be as effective 
as the factors used by the test.
    While we have considered several other types of tests that could be 
used to determine the substantial position threshold, we preliminarily 
do not believe that the advantages of those tests justify their 
disadvantages. For example, while a threshold based on the number of an 
entity's counterparties could help identify highly interconnected 
entities (a factor that some have argued is important for identifying 
an entity's systemic risk), it also has been argued that a large number 
of counterparties could mean that the losses associated with that 
entity's default would be divided and absorbed by many counterparties 
without broader market effects.\91\ While a threshold that is based on 
an entity's financial strength would help account for the possibility 
of an entity's default as well as the effects of such a default, it 
would not address swap-related risks to the market that are not 
directly linked to the entity's default. In other words, an entity that 
has large out-of-the-money swap or security-based swap positions and 
faces a margin call may cause significant price movements in the swaps 
or security-based swaps and in the related reference entities or assets 
if the entity chooses to unwind its positions, even if the entity 
itself does not appear to present a large threat of default. These 
movements may be exacerbated if other entities have similar positions.
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    \91\ See AIMA letter (``An entity that has only a small number 
of counterparties may only affect a small number of entities 
directly, should it fail, but the impact could be significant if the 
position is large and the counterparty is a systemically important 
entity. A diversified exposure to multiple entities could affect 
more entities but is likely to be smaller and thus shares the losses 
in the industry and having less systemic impact.'').
---------------------------------------------------------------------------

    Moreover, although substantial position thresholds based on the 
financial strength of an entity's counterparties would help measure the 
potential that an entity's default would have a broader impact, such 
thresholds could result in disparate results between two entities with 
identical positions,

[[Page 80189]]

and also could encourage concentration of exposure or potential future 
exposure within a few counterparties. While tests that are based on the 
volume of an entity's swaps or security-based swaps may be helpful in 
identifying significant swap or security-based swap activity, such 
tests would not directly be germane to the current or potential future 
exposure posed by an entity's swap and security-based swap positions. 
Finally, while we have considered the feasibility of tests that take 
specific contract features into account (e.g., triggers that require 
the payment of mark-to-market margin if an entity's credit rating is 
lowered), we preliminarily believe that simpler tests of exposure can 
more efficiently identify the risks associated with particular swap or 
security-based swap positions.
    After considering these alternatives, the Commissions are proposing 
two tests to define ``substantial position.'' One test would focus 
exclusively on an entity's current uncollateralized exposure; the other 
would supplement a current uncollateralized exposure measure with an 
additional measure that estimates potential future exposure. A position 
that satisfies either test would be a ``substantial position.''
    The Commissions, however, request comment on whether it would be 
appropriate to use other types of approaches for determining whether an 
entity has a substantial position--as an alternative to, or in addition 
to, the two proposed tests.
a. Proposed Current Exposure Test
    The proposed first substantial position test, which would focus 
solely on current uncollateralized exposure, in general would set the 
substantial position threshold by reference to the sum of the 
uncollateralized current exposure, obtained by marking-to-market using 
industry standard practices, arising from each of the person's 
positions with negative value in each of the applicable ``major'' 
category of swaps or security-based swaps (other than positions 
excluded from consideration, such as positions for the purpose of 
``hedging or mitigating commercial risk'').\92\
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    \92\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act 
rule 3a67-3(b)(1). In other words, the test would measure the 
portion of the exposure that is not offset by the posting of 
collateral. If a position was collateralized only partially, the 
value of the collateral posted would be offset against the total 
exposure, and the test would measure the residual part of the 
exposure. We recognize that there may be operational delays between 
changes in exposure and the resulting exchanges of collateral, and 
in general we would not expect that operational delays associated 
with the daily exchange of collateral would be considered to lead to 
uncollateralized exposure for these purposes.
    As noted above, the statutory definitions require us to consider 
the presence of central clearing in setting the substantial position 
threshold. This test would account for the risk-mitigating effects 
of central clearing in that centrally cleared swaps and security-
based swaps are subject to mark-to-market margining that would 
largely eliminate the uncollateralized exposure associated with a 
position, effectively resulting in cleared positions being excluded 
from the analysis.
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    A person would apply this proposed substantial position test on a 
major category-by-major category basis, examining its positions with 
each counterparty with which the person has swaps or security-based 
swaps in the particular category. For each counterparty, the person 
would determine the dollar value of the aggregate current exposure 
arising from each of its swap or security-based swap positions with 
negative value (subject to the netting provisions described below) in 
that major category by marking-to-market using industry standard 
practices, and deduct from that amount the aggregate value of the 
collateral the person has posted with respect to the swap or security-
based swap positions. The aggregate uncollateralized outward exposure 
would be the sum of those uncollateralized amounts over all 
counterparties with which the person has entered into swaps or 
security-based swaps in the applicable major category.\93\
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    \93\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act 
rule 3a67-3(b)(2).
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    The proposed test would not prescribe any particular methodology 
for measuring current exposure or the value of collateral posted,\94\ 
and instead would provide that the method should be consistent with 
counterparty practices and industry practices generally.\95\
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    \94\ Depending on the particular circumstances of the swap or 
security-based swap, such collateral may be posted to a third-party 
custodian, directly to the counterparty, or in accordance with the 
rules of a derivatives clearing organization or clearing agency.
    \95\ Consistent with industry practices, we would expect that 
entities may value exposure based on measures that take into account 
the amounts that would be payable if the transaction were 
terminated. Also, to the extent the valuation of collateral posted 
in connection with swaps or security-based swaps is subject to other 
rules or regulations, we would expect that the valuation of 
collateral for purposes of the major participant calculations would 
be consistent with those applicable rules.
    At the same time, we recognize that there can be disputes or 
uncertainty as to an entity's exposure in connection with swap and 
security-based swap positions, and as to the valuation of the 
collateral it has posted in connection with those positions. In some 
circumstances this could lead to uncertainty as to whether the 
entity is a major participant. As addressed below, we are requesting 
comment as to the potential significance of these issues, and as to 
whether we should set forth additional guidance or mandate the use 
of specific standards with respect to these valuations.
    Also, it is important to recognize that while we expect that 
other regulatory requirements applicable to the valuation of swap or 
security-based swap positions and collateral would be relevant to 
certain calculations relating to major participant status, our 
proposed rules would not be relevant for other purposes, such as in 
the context of capital and margin requirements.
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    This proposed test would account for the risk mitigating effects of 
netting agreements \96\ by permitting an entity to calculate its 
exposure on a net basis, by applying the terms of master netting 
agreements entered into between the entity and a single 
counterparty.\97\ When calculating the net exposure the entity may take 
into account offsetting positions with that particular counterparty 
involving swaps, security-based swaps and securities financing 
transactions (consisting of securities lending and borrowing, 
securities margin lending and repurchase and reverse repurchase 
agreements) to the extent that is consistent with the offsets provided 
by the master netting agreement.\98\
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    \96\ Section 362(b)(17) of the United States Bankruptcy Code 
generally provides derivatives contracts with a safe harbor from the 
Bankruptcy Code's automatic stay, thus allowing parties to these 
contracts to enforce their contractual rights, including those 
associated with netting and offsets, even after a counterparty has 
filed for bankruptcy.
    In addition, Section 210(c)(8)(A) of the Dodd-Frank Act 
reaffirms the enforceability of netting and offset provisions in 
certain derivatives contracts with insolvent counterparties that 
have been placed under the receivership of the Federal Deposit 
Insurance Corporation (``FDIC''). However, the Dodd-Frank Act also 
places certain limitations on the timing by which netting rights may 
be exercised when the FDIC has been appointed as the receiver of an 
insolvent counterparty. See Dodd-Frank Act section 210(c)(10)(B).
    \97\ To the extent that the two counterparties maintain multiple 
netting agreements (e.g., separate agreements for dollar-denominated 
and euro-denominated instruments), the calculation would account 
only for the netting permitted under the netting agreement that is 
relevant to the swap or security-based swap at issue.
    \98\ See proposed CEA rule 1.3(sss)(2)(iii)(A); proposed 
Exchange Act rule 3a67-3(b)(3)(A). As is the case for the proposed 
rules on valuation, the proposed rules regarding possible offsets of 
various positions are for purposes of determining major participant 
status only. Other rules proposed by the Commissions may address the 
extent to which, if any, persons such as dealers and major 
participants may offset positions for other purposes.
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    The Commissions preliminarily believe that this approach is 
appropriate because it avoids identifying a position's exposure as 
being ``uncollateralized'' when there is no current counterparty risk 
associated with it due to offsets under a netting agreement with the 
counterparty.\99\ In

[[Page 80190]]

calculating current uncollateralized exposure, however, the entity may 
not take into account the market risk offsets associated with holding 
positions with multiple counterparties.\100\ Also, the entity may not 
``double count'' any offset or collateral--once any item of collateral 
or any position with positive value has been applied against current 
exposure, the same item cannot be applied for purposes of this test 
against any other exposure.
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    \99\ If, for example, an entity was $X out of the money in 
connection with a security-based swap, but was $X in the money with 
the same counterparty in connection with a swap, there would be no 
economic need for the entities to exchange collateral in connection 
with those offsetting positions. A test that fails to account for 
this netting of exposure could lead the entities to engage in 
needless offsetting exchanges of collateral.
    \100\ See proposed CEA rule 1.3(sss)(2)(iii)(C); proposed 
Exchange Act rule 3a67-3(b)(2)(iii). While recognizing that 
offsetting positions of that type would reduce the market risk 
facing the entity, the offsets would not be expected to directly 
mitigate the risks that the entity's counterparties would face if 
the entity were to default.
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    The proposal to permit this type of netting, however, raises 
questions as to how an entity's net out-of-the-money exposure with a 
counterparty, and the collateral posted with respect to its positions 
with the counterparty, should be allocated among swap positions, 
security-based swap positions and other positions specified in the 
rule.\101\ In particular, when an entity has not fully collateralized 
its net current exposure to a particular counterparty with which it has 
a netting agreement, there may be questions regarding how to attribute 
the net out-of-the-money positions and associated collateral to its 
swap or security-based swap positions. We preliminarily believe that an 
entity that has net uncollateralized exposure to a counterparty should, 
for purposes of the test, allocate that net uncollateralized exposure 
pro rata in a manner that reflects the exposure associated with each of 
its out-of-the-money swap positions, security-based swap positions and 
non-swap positions.\102\ This allocation would be intended to cause the 
measure of uncollateralized exposure connected with swaps or security-
based swaps for purposes of the test to reasonably reflect the relative 
contribution of those instruments to an entity's total overall 
uncollateralized exposure.
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    \101\ This issue does not arise to the extent that an entity's 
net positions with a counterparty are fully collateralized.
    \102\ In other words, if an entity's out-of-the-money rate swap 
positions have $W exposure, its out-of-the-money other commodity 
swap positions have $X exposure, its out-of-the-money security-based 
swap positions have $Y exposure, and its other out-of-the money 
positions covered by that netting agreement have $Z exposure, 
fractions of the collateral equal to W/(W+X+Y+Z) should be allocated 
to the rate swap positions, X/(W+X+Y+Z) to the other commodity swap 
positions and Y/(W+X+Y+Z) to the security-based swap positions. A 
similar process should be used for allocating net out-of-the-money 
exposure across the categories of swaps and security-based swaps 
that have out-of-the-money exposure when one or more categories are 
in-the-money.
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    For purposes of the definition of ``major swap participant,'' the 
Commissions are proposing to set the current uncollateralized exposure 
threshold at a daily average of $1 billion in the applicable major 
category of swaps, except that the threshold for the rate swap category 
would be a daily average of $3 billion. For purposes of the definition 
of ``major security-based swap participant,'' this threshold would be 
based on a daily average of $1 billion in the applicable major category 
of security-based swaps.\103\ We preliminarily believe that these 
proposed thresholds are appropriate for identifying entities that, 
through their swap and security-based swap activities, have a 
significant potential to pose the systemic importance or risks to the 
U.S. financial system that the major participant definition and 
associated statutory requirements were intended to address, but we also 
recognize that it is possible that the appropriate threshold should be 
higher or lower. In proposing these specific thresholds, we have sought 
to take into account several factors: (i) The ability of the financial 
system to absorb losses of a particular size; \104\ (ii) the 
appropriateness of setting ``prudent'' thresholds that are materially 
below the level that could cause significant losses to the financial 
system as it would not be appropriate for the substantial position test 
to encompass entities only after they pose significant risks to the 
market through their swap or security-based swap activity; \105\ and 
(iii) the need to account for the possibility that multiple market 
participants may fail close in time, rather than focusing narrowly on 
the potential impact of a single participant's default.\106\ Based on 
these factors, we preliminarily believe that the proposed substantial 
position thresholds would reasonably be expected to apply to entities 
that have the potential of satisfying the statutory criteria of 
systemic importance or significant impact to the U.S. financial system. 
As discussed below, however, we welcome comments on the appropriateness 
of the proposed threshold.
---------------------------------------------------------------------------

    \103\ See proposed CEA rule 1.3(sss)(1); proposed Exchange Act 
rule 3a67-3(a)(1).
    \104\ In this regard, the Commissions preliminarily believe that 
the ``Tier 1'' capital of major dealer banks provides relevant 
information about the ability of the financial system to absorb 
losses of a particular size. We note that, among U.S. banks that are 
dealers in credit derivatives, the six largest banks account for the 
vast majority of dealing activities. We understand that the most 
liquid ``Tier 1'' regulatory capital for those six banks ranges from 
$14 billion to $113 billion.
    \105\ In other words, the proposed thresholds are intended to be 
low enough to provide for the appropriately early regulation of an 
entity whose swap or security-based swap positions have a reasonable 
potential of posing significant counterparty risks and risks to the 
market that stress the financial system, while being high enough 
that it would not unduly burden entities that are materially less 
likely to pose these types of risks.
    \106\ For example, the proposed $1 billion threshold for swaps 
and security-based swaps would reflect a potential loss of $3 
billion if three large swap or security-based swap entities were to 
fail close in time. That $3 billion could represent a significant 
impairment of the ability of some major dealers to absorb losses, as 
reflected by their Tier 1 capital.
    We also are mindful of the views expressed by the two commenters 
that suggested particular dollar values for the threshold. See note 
85, supra.
---------------------------------------------------------------------------

    These proposed thresholds would be evaluated by reference to a 
calculation of the mean of an entity's uncollateralized exposure 
measured at the close of each business day, beginning on the first 
business day of each calendar quarter and continuing through the last 
business day of that quarter.\107\ In this regard, the Commissions have 
taken into account commenters' concerns that an entity's exposure 
should not be evaluated based on a single point in time, as short-term 
market fluctuations may not fairly reflect the risks of the entity's 
positions. The use of a daily average approach should help address 
commenters' concerns about the impact of short-term price fluctuations, 
and also help preclude the possibility that an entity may seek to use 
short-term transactions to distort the measure of exposure.
---------------------------------------------------------------------------

    \107\ See proposed CEA rule 1.3(sss)(4); proposed Exchange Act 
rule 3a67-3(d).
---------------------------------------------------------------------------

    The Commissions request comment on the proposed current 
uncollateralized exposure test. Commenters particularly are requested 
to address whether the proposed threshold amounts of current 
uncollateralized exposure are appropriate, and, if not, what 
alternative higher or lower threshold amounts would appropriately 
identify entities that pose the types of risks that the definition was 
intended to address. In this regard, commenters specifically are 
requested to address whether bank Tier 1 capital provides a good 
indicative reference of the ability of major dealers to absorb losses 
of a particular size, or whether alternative reference points for the 
analysis (e.g., the size of the swap market or security-based swap 
market) would also be applied. Commenters are requested to address 
whether uncollateralized mark-to-market exposure is the appropriate way 
to measure current exposure, and if not, what alternative approach is 
more appropriate, and why. Commenters also are requested to address 
whether the

[[Page 80191]]

proposed thresholds reasonably address the need to set the threshold at 
a prudent level so as to avoid the possibility that the substantial 
position test would encompass entities only after they pose significant 
risks to the market, whether the proposed thresholds reasonably address 
the possibility that multiple market entities could fail close in time, 
and whether the proposed thresholds reasonably address the fact that 
swap or security-based swap activities would comprise only part of the 
risks to the market posed by an entity. To what extent would this 
proposed definition of ``substantial position'' have an effect on the 
activities of entities that potentially may be deemed to be major 
participants? What impact could these types of effects have on 
liquidity, on risk-taking or risk-reducing activities, or on other 
aspects of the relevant markets?
    Also, more fundamentally, we request comment on whether the 
substantial position analysis also should encompass a test that does 
not account for the collateral posted in connection with an entity's 
exposure, given that tests that account for the posting of collateral 
would not encompass entities that have very large swap or security-
based swap positions that are fully collateralized (either by the 
posting of bilateral collateral or by virtue of central clearing). In 
that light, should the analysis seek to capture entities that have very 
large positions in light of potential market disruptions such entities 
could cause, regardless of whether the positions are collateralized?
    Commenters further are requested to address whether such thresholds 
should also account for entities that have large in-the-money positions 
that may indicate their potential significance to the market. In this 
regard, commenters also are asked to address whether the thresholds 
should specifically address entities with large in-the-money positions 
that lead them to receive large amounts of collateral posted by their 
counterparties, particularly to the extent that such collateralized in-
the-money positions could later turn and lead the entity to incur 
losses.
    In addition, commenters are requested to address whether and how it 
would be appropriate to adjust the threshold amounts over time, 
including whether these proposed current uncollateralized exposure 
thresholds should periodically be adjusted by formula to reflect 
changes in the ability of the market to absorb losses over time, or 
changes in other criteria over time. Commenters further are requested 
to address whether the test will be practical for potential major 
participants to use. Moreover, commenters are requested to address 
whether the proposed current exposure test should be modified to 
account for the risks associated with the expected time lag between an 
entity's default and the liquidation of its swap or security-based swap 
positions.
    Commenters also are requested to address whether we should set 
forth additional guidance or mandate the use of specific standards with 
respect to the measure of exposure or valuing collateral posted, or 
should specify particular procedures in the event of valuation 
disputes. What particular industry standard documentation and other 
methodologies could be used to measure exposure and value collateral? 
Also, how could regulatory requirements applicable to the valuation of 
collateral be relevant to the valuation of collateral for purposes of 
the major participant definitions?
    Commenters are invited to address whether the rule should provide 
that, in measuring their current uncollateralized exposure, entities 
must value collateral in a way that is at least as conservative as such 
collateral would be valued according to applicable haircuts or other 
adjustments dictated by applicable regulations. Commenters further are 
requested to address whether the test should exclude certain types of 
collateral that cannot readily be valued. Also, commenters are 
requested to address whether the proposed method of evaluation--the 
mean of an entity's uncollateralized exposure measures at the close of 
each business day, beginning on the first business day of each calendar 
quarter and continuing through the last business day of that quarter--
would be unduly burdensome or potentially subject to gaming or evasion.
    Should the proposed approach for measuring uncollateralized current 
exposure be amended or supplemented, such as by establishing 
requirements for how exposure should be measured or collateral should 
be valued in certain circumstances (e.g., requiring the valuation of 
certain types of collateral to be conservative during times of rapid 
price changes in the relevant asset class)? Should current exposure and 
collateral be required to be valued in accordance with US generally 
accepted accounting principles? Would measurement according to such 
principles differ in any respects from measurement under the proposal, 
and, if so, how?
    In addition, commenters are requested to address the proposed 
netting provisions of this test, including: whether the proposed test 
would reasonably permit the measure of uncollateralized exposure to 
account for bilateral netting agreements; whether additional types of 
positions should be included within the netting provisions; whether the 
proposal appropriately takes into account the netting of exposures and 
collateral involving positions in financial instruments other than 
swaps, security-based swaps and securities financing transactions and 
if so, whether any limitations to such offsetting would be necessary or 
appropriate; whether the netting provisions should accommodate 
offsetting positions involving the net equity balance in an entity's 
securities account (e.g., free credit balances, other credit balances, 
and fully paid securities), and if so, whether any limitations to such 
offsetting would be necessary or appropriate; whether the netting 
provisions should accommodate offsets for exposures, or collateral 
connected with the positions that an entity has with the affiliate of a 
counterparty; and whether the proposed method of allocating the 
uncollateralized portion of exposures among the different types of 
financial instruments that are all subject to a single netting 
agreement is appropriate.
    Commenters also are requested to address whether the proposed 
current uncollateralized exposure test would pose significant 
monitoring burdens upon entities that have swap or security-based swap 
positions that are significant enough to potentially meet the current 
uncollateralized exposure threshold. Should we provide guidance as to 
policies and procedures that such an entity should be able to follow to 
demonstrate that it does not meet the applicable thresholds?
b. Proposed Current Exposure Plus Potential Future Exposure test
    The second proposed test would account both for current 
uncollateralized exposure (as discussed above) and for the potential 
future exposure associated with swap or security-based swap positions 
in the applicable ``major'' category of swaps or security-based swaps. 
This additional test would allow the major participant analysis to take 
into account estimates of how the value of an entity's swap or 
security-based swap positions may move against the entity over time.
    The potential future exposure portion of this proposed test would 
be based on an entity's ``aggregate potential outward exposure,'' which 
would reflect the potential exposure of the entity's swap or security-
based swap positions in the applicable ``major'' category of swap or 
security-based swaps, subject to certain adjustments. Bank capital 
standards also

[[Page 80192]]

make use of this type of test,\108\ and this proposal builds upon those 
standards but modifies them to focus on the risk that an entity poses 
to its counterparties (rather than on the risk that counterparties pose 
to an entity). In doing so, this proposal seeks to use a test that can 
be implemented by a range of market participants, and that can be 
expected to lead to reproducible results across market participants 
with identical swap or security-based swap portfolios, rather than 
relying on alternative tests (e.g., value at risk measures or stress 
testing methodologies) that may be costly for market participants to 
implement and that would not be expected to lead to reproducible 
results across participants.
---------------------------------------------------------------------------

    \108\ See 12 CFR part 3, app. C, section 32 (Office of the 
Comptroller of the Currency bank capital standards).
---------------------------------------------------------------------------

    The exposure measures in general would be based on the total 
notional principal amount of those positions, adjusted by certain risk 
factors that reflect the type of swap or security-based swap at issue 
and the duration of the position.\109\ For positions in which the 
stated notional amount is leveraged or enhanced by the particular 
structure, this calculation would be based on the position's effective 
notional amount.\110\
---------------------------------------------------------------------------

    \109\ For example, consistent with the bank standards, the 
multiplier for equity swaps would range from 0.06 for equity swaps 
of one year or less to 0.10 for equity swaps with a maturity of more 
than five years. See proposed Exchange Act rule 3a67-3(c)(2)(i)(A). 
For security-based swaps based on the credit of a reference entity, 
the multiplier would be 0.1.
    The current bank capital standards contain a distinction based 
on whether the credit derivative is on ``investment grade'' or 
``non-investment grade'' reference entities, providing a 0.1 
multiplier for the former and a lower 0.05 multiplier for the 
latter. We preliminarily do not believe that a test that 
distinguishes among reference entities by reference to their credit 
ratings would be appropriate for purposes of these definitions, 
particularly in light of the fact that the Dodd-Frank Act mandates 
the substitution of credit ratings with other standards of 
creditworthiness in U.S. regulations. See Dodd-Frank Act section 
939A.
    The multipliers in part will be a function of the remaining 
maturity of the swap or security-based swap. If the swap or 
security-based swap, however, is structured such that on specified 
dates the outstanding exposure is settled and the terms are reset so 
the market value is zero, the remaining maturity would equal the 
time until the next reset date.
    Although we recognize that these risk multipliers may suggest a 
lower than expected volatility of credit or equity derivatives of 
that duration, this may be offset by the fact that the proposed 
calculations of potential future exposure do not directly account 
for portfolio netting or collateral updates that could mitigate 
future exposure. We preliminarily believe that the use of these 
thresholds (and proposed related calculations) for purposes of 
identifying major participants are consistent with similar bank 
capital standards and are therefore suitable for use as an estimate 
of potential future exposure. We are also cognizant that requiring a 
more complete calculation of potential future exposure may be costly 
and burdensome for participants, especially those who would 
otherwise not meet the thresholds for major swap or security-based 
swap participant and would not have systems in place to perform a 
more complete calculation.
    \110\ See proposed CEA rule 1.3(sss)(3)(ii); proposed Exchange 
Act rule 3a67-3(c)(2)(i)(B). For purposes of this rule, in the case 
of positions that represent the sale of an option on a swap or 
security-based swap (other than the sale of an option permitting the 
person exercising the option to purchase a credit default swap), we 
would view the effective notional amount of the option as being 
equal to the effective notional amount of the underlying swap or 
security-based swap, and we would view the duration used for 
purposes of the formula as being equal to the sum of the duration of 
the option and the duration of the underlying swap or security-based 
swap.
---------------------------------------------------------------------------

    At the same time, the proposed measures would contain adjustments 
for certain types of positions that pose relatively lower potential 
risks.\111\ In addition, the general risk-adjusted notional measures of 
potential future exposure would be reduced to reflect the risk 
mitigation effects of master netting agreements, in a manner consistent 
with bank capital standards.\112\
---------------------------------------------------------------------------

    \111\ The analysis would exclude swap or security-based swap 
positions that constitute the purchase of an option, such that the 
person has no additional payment obligations under the position, as 
well as other positions on which the person has prepaid or otherwise 
satisfied all of its payment obligations. See proposed Exchange Act 
rule 3a67-3(c)(2)(i)(C).
     For similar reasons, the potential outward exposure associated 
with a position by which a person buys credit protection using a 
credit default swap would be capped at the net present value of the 
unpaid premiums. See proposed CEA rule 1.3(sss)(3)(ii)(A)(4); 
proposed Exchange Act rule 3a67-3(c)(2)(i)(D).
    \112\ In particular, for swaps or security-based swaps subject 
to master netting agreements the potential exposure associated with 
the person's swap or security-based swaps with each counterparty 
would equal a weighted average of the potential exposure in the 
applicable ``major'' category of swaps or security-based swaps with 
a particular counterparty as calculated without reference to 
netting, and that amount reduced by the ratio of net current 
replacement cost to gross current replacement cost of all swap and 
security-based swap positions with that counterparty, consistent 
with the following equation: PNet = 0.4 x PGross + 0.6 x NGR x 
PGross.
    Under this formula, PNet is the potential exposure in the 
applicable ``major'' category of swaps or security-based swaps 
adjusted for bilateral netting; PGross is the potential exposure in 
that category without adjustment for bilateral netting; and NGR is 
the ratio of net current replacement cost to gross current 
replacement cost. See proposed CEA rule 1.3(sss)(3)(ii)(B); proposed 
Exchange Act rule 3a67-3(c)(2)(ii).
    The ``NGR'' ratio is intended to serve as a type of proxy for 
the impact of netting on potential future exposure, but does not 
serve as a precise indicator of future changes in net exposure 
relative to gross exposure, as the ratio and potential exposure can 
be influenced by many idiosyncratic properties of individual 
portfolios. See Basle Committee on Banking Supervision, ``The 
Treatment of the Credit Risk Associated with Certain Off-Balance-
Sheet Items'' (July 1994).
---------------------------------------------------------------------------

    The proposed measures of potential future exposure would contain 
further downward adjustments to account for the risk mitigation effects 
of central clearing and mark-to-market margining. In particular, if the 
swap or security-based swap positions are cleared by a registered 
clearing agency or subject to daily mark-to-market margining,\113\ the 
measures of potential future exposure would further be adjusted to 
equal twenty percent of the potential future exposure calculated using 
the methodology described above.\114\ The Commissions preliminarily 
believe that a significant downward adjustment would be appropriate 
because clearing and daily mark-to-market margining would be expected 
to reduce the potential future risks posed by an entity's swap or 
security-based swap positions. Also, it is appropriate to incentivize 
the use of central clearing and daily mark-to-market margining as 
practices for helping to control risks. We are not proposing to 
entirely eliminate such cleared and margined positions from the 
analysis of potential future exposure, however, because clearing may 
not entirely eliminate the risks posed by an entity's potential 
default,\115\ and daily mark-to-market margining would not eliminate 
the risks associated with large intra-day price movements. While the 
proposed amount of the adjustment seeks to balance these

[[Page 80193]]

competing factors, we recognize that alternative higher or lower 
downward adjustments may also be appropriate.
---------------------------------------------------------------------------

    \113\ For these purposes, a swap or security-based swap would be 
considered to be subject to daily mark-to-market margining if, and 
for as long as, the counterparties follow the daily practice of 
exchanging collateral to reflect changes in exposure (after taking 
into account any other positions addressed by a netting agreement 
between the parties). If a person is permitted to maintain an 
uncollateralized ``threshold'' amount under the agreement, that 
amount (regardless of actual exposure) would be considered current 
uncollateralized exposure for purposes of the test. Also, if the 
agreement provides for a minimum transfer amount in excess of $1 
million, the entirety of that amount would be considered current 
uncollateralized exposure. See proposed CEA rule 
1.3(sss)(3)(iii)(B); proposed Exchange Act rule 3a67-3(c)(3)(ii).
    In this way, the measure of potential future exposure would 
reflect for the risk mitigating benefits of daily margining, while 
specifically accounting for industry practices that limit those 
benefits. Of course, to take advantage of this adjustment it is not 
enough to the agreement to provide for daily mark-to-market 
margining--the parties must actually follow that practice.
    \114\ See proposed CEA rule 1.3(sss)(3)(iii)(A); proposed 
Exchange Act rule 3a67-3(c)(3).
    \115\ For example, the central counterparties that clear credit 
default swaps do not necessarily become the counterparties of their 
members' customers (although even absent direct privity those 
central counterparties benefit customers by providing for protection 
of collateral they post as margin, and by providing procedures for 
the portability of the customer's positions in the event of a 
dealer's default). As a result, central clearing may not eliminate 
the counterparty risk that the customer poses to the dealer. Even 
then, however, required mark-to-market margining should help control 
that risk, and central clearing thus would be expected to reduce the 
likelihood that an entity's default would lead to broader market 
impacts.
---------------------------------------------------------------------------

    For purposes of the ``major swap participant'' definition, the 
substantial position threshold would be $2 billion in daily average 
current uncollateralized exposure plus aggregate potential outward 
exposure in the applicable major swap category, except that the 
threshold for the rate swap category would be a daily average of $6 
billion. For purposes of the ``major security-based swap participant'' 
definition, the substantial position threshold would be $2 billion in 
daily average current uncollateralized exposure plus aggregate 
potential outward exposure in any major security-based swap 
category.\116\ These proposed amounts reflect the same factors 
discussed above in the context of the current uncollateralized exposure 
test,\117\ but are raised to reflect the fact that potential future 
exposure is a measure of potential risk over time, and hence is less 
likely to pose a direct, immediate impact on the markets than current 
measures of uncollateralized exposure. We recognize that alternative 
risk thresholds may also be appropriate, and we welcome comment on 
potential alternatives.
---------------------------------------------------------------------------

    \116\ See proposed Exchange Act rule 3a67-3(a)(2).
    \117\ See notes 103 to 106, supra, and accompanying text.
---------------------------------------------------------------------------

    In light of the amount of this threshold and the underlying risk 
adjustments, we preliminarily do not believe that an entity would need 
to calculate its potential future exposure for purposes of the test 
unless the entity has large notional positions. For example, in light 
of the proposed risk adjustment of 0.10 for credit derivatives, an 
entity that does not have any uncollateralized current exposure would 
have to have notional positions of at least $20 billion to potentially 
meet the $2 billion threshold, even before accounting for the discounts 
associated with netting agreements. If those swaps or security-based 
swaps are cleared or subject to mark-to-market margining, the 
additional 20 percent risk adjustment would mean that the entity 
without current uncollateralized exposure would have to have cleared 
notional positions of at least $100 billion to possibly meet that 
threshold.\118\
---------------------------------------------------------------------------

    \118\ Based on these thresholds, we preliminarily believe that 
only relatively few entities would regularly have to perform these 
potential future exposure calculations with regard to their 
security-based swaps. See notes 181 and 182, infra, and accompanying 
text.
---------------------------------------------------------------------------

    The Commissions request comment on this proposed use of a current 
exposure plus potential future exposure test to determine the 
substantial position threshold. Commenters particularly are requested 
to address the appropriateness of using potential exposure risk 
adjustments derived from bank capital rules; and the appropriateness of 
using bank capital methodologies for addressing positions subject to 
netting agreements. Also, should this test be supplemented by a test 
that accounts for the notional amount of an entity's swap or security-
based swap positions without risk-adjustments, to focus on entities 
that have very large swap or security-based swap positions?
    Commenters are requested to address whether the proposed threshold 
amounts for the proposed current exposure plus potential future 
exposure test are appropriate, and if not, what alternative threshold 
amounts would be more appropriate, and why. In addition, commenters are 
requested to address the proposed method of discounting the potential 
future exposure associated with cleared positions or positions subject 
to daily mark-to-market margining to equal 20 percent of what the 
measure of potential future exposure would be otherwise. Would a larger 
or smaller discount be appropriate? Is there data available that may 
assist with reaching the appropriate discount factor? Also, in that 
regard, should both sets of discounts be equal, or should cleared 
positions be subject to more of a discount than uncleared positions 
subject to daily mark-to-market margining? Commenters also are invited 
to address whether the proposed discounts for cleared positions or 
positions that are marked-to-market would make it unnecessary or 
duplicative for this test separately to account for netting agreements. 
Also, if an entity currently has posted excess collateral in connection 
with a position, should the amount of that current 
overcollateralization be deducted from its measure of potential future 
exposure?
    Commenters also are requested to address whether the proposed test 
in connection with purchases of credit protection--which would cap the 
measure of exposure at the net present value of unpaid premiums--would 
raise problems in implementation, and whether we should propose any 
particular discount rate to be used in conducting the calculation (and, 
if so, what discount rate should be appropriate). Also, should the 
measure of potential future exposure in connection with purchases of 
credit protection and options also account for collateral that a 
counterparty has posted in connection with an entity's in-the-money 
positions, given that such collateralized in-the-money positions could 
later turn and cause losses to an entity? In addition, for positions 
that represent the sale of options on swaps or security-based swaps, 
would the effective notional amount of the option for purposes of the 
calculation properly be deemed to be the notional amount of the 
underlying instrument (or should the notional amount of the option vary 
based on the link between the changes in the value of the option and 
changes in the value of the underlying), and would the duration of the 
option properly be deemed to be the sum of the duration of the option 
and the duration of the underlying swap or security-based swap?
    Commenters also are requested to address whether the risk 
adjustment for credit derivatives should reflect the riskiness of the 
underlying reference entity, and, if so, how should that be 
accomplished in a way that does not rely on the use of credit ratings.
    The proposed test of potential future exposure is based in part on 
the application of fixed multipliers to the notional amounts, or 
effective notional amounts, of swaps and security-based swaps. In this 
regard, commenters are invited to discuss whether there are alternative 
tests that would be more effective to determine potential future 
exposure or otherwise to supplement an uncollateralized current 
exposure test, and whether such alternative tests may be more 
effectively developed in the near future, when additional data 
regarding swap and security-based swap positions are likely to be 
available. In particular, commenters are requested to identify any 
tests based on non-proprietary risk models that could be uniformly 
applied by all potential major participants to measure potential future 
exposure. Commenters who propose alternative tests are asked to address 
how the tests would provide consistent results across different types 
of swaps and security-based swaps, including customized instruments, in 
the different major categories. Commenters are also invited to address, 
on the other hand, whether a single test based on uncollateralized 
current exposure (i.e., without any test of potential future exposure) 
would be adequate for identifying entities whose swap or security-based 
swap positions pose a relatively high degree of risk to counterparties 
and to the markets. In addition, commenters are invited to identify any 
tests or thresholds below which a party would be deemed not to be a 
major swap participant, without needing to calculate the exposure tests 
set forth in the proposed rule.

[[Page 80194]]

    Commenters further are requested to address whether and how it 
would be appropriate to adjust the threshold amounts over time, 
including whether these proposed thresholds should periodically be 
adjusted by formula to reflect changes in the ability of the market to 
absorb losses over time, or changes in other criteria over time. In 
addition, commenters are requested to address whether the proposed use 
of a daily average measure for purposes of this test would be 
burdensome for potential major participants to implement, and, if so, 
how often should potential participants have to measure these amounts. 
Commenters also are requested to address whether any such tests should 
seek to reflect the maximum level of exposure associated with a 
position, rather than risk-adjusted estimates of exposure proposed 
here.
    In addition, commenters are requested to address whether this 
proposed test would pose significant monitoring burdens upon entities 
that have swap or security-based swap positions that are significant 
enough to potentially meet the combined current uncollateralized 
exposure and potential future exposure test. Should we provide guidance 
as to policies and procedures that such an entity should be able to 
follow to be able to demonstrate that it does not meet the applicable 
thresholds?

C. ``Hedging or Mitigating Commercial Risk''

    The first test of the major participant definitions excludes 
positions held for ``hedging or mitigating commercial risk'' from the 
substantial position analysis.\119\
---------------------------------------------------------------------------

    \119\ See CEA section 1a(33)(A)(i)(I); Exchange Act section 
3(a)(67)(A)(i)(I).
---------------------------------------------------------------------------

    Commenters took the position that this exclusion from the major 
participant definitions should encompass a variety of uses of swaps and 
security-based swaps to hedge risks faced by non-financial 
entities.\120\ Some commenters also suggested that the exclusion should 
be interpreted to address risks such as ``balance sheet risk,'' the 
``risk of under-diversification,'' and hedges undertaken on a portfolio 
basis. Some commenters favored interpreting this exclusion to permit 
its use by insurers and banks. One commenter emphasized the need to 
avoid taking interpretations that would encourage commercial entities 
not to manage risks that they otherwise would manage.\121\ Commenters 
also took the position that the addition of the word ``mitigating'' was 
intended to expand the exclusion beyond what would have been 
encompassed had only the term ``hedging'' been used.\122\
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    \120\ See, e.g., letter from Coalition for Derivatives End-
Users, dated September 20, 2010 (discussing, inter alia, a 
supplier's use of credit derivatives in connection with a cash 
receivable, and a company's use of equity derivatives in connection 
with a stock repurchase program).
    \121\ See Cleary letter (also urging inclusion of ``all risks'' 
arising in connection with a company's business activities, 
including risks incidental to a company's ordinary course of 
business).
    \122\ See MetLife letter (addition of mitigation ``plainly 
indicates that this exclusion intends an expansive definition of 
hedging and can also encompass non-speculative derivatives positions 
used to manage economic risk, including potentially diversification 
and synthetic asset strategies, such as the conservative 
`replication' strategy permitted under State insurance laws''); 
letter from Joanne R. Medero, Managing Director, BlackRock, dated 
September 20, 2010 (addressing the parallel context of the exclusion 
for ERISA plan positions).
---------------------------------------------------------------------------

1. Proposed Interpretation
    In interpreting the meaning of ``hedging or mitigating commercial 
risk'' for purposes of the first test of the major participant 
definitions, the Commissions first note that virtually identical 
language is found in the Dodd-Frank provisions granting an exception 
from the mandatory clearing requirement to non-financial entities that 
are using swaps or security-based swaps to hedge or mitigate commercial 
risk.\123\ Because Congress used virtually identical language in both 
instances, the Commissions intend to interpret the phrase ``hedging or 
mitigating commercial risk'' with respect to the participant 
definitions in the same manner as the phrase ``hedge or mitigate 
commercial risk'' in the exception from the mandatory clearing 
requirement.\124\ The Commissions also note that although only non-
financial entities that are using swaps or security-based swaps to 
hedge or mitigate commercial risk generally may qualify for the 
clearing exemption, no such statutory restriction applies with respect 
to the exclusion for hedging positions in the first major participant 
test. Accordingly, with respect to the first major participant test, it 
appears that positions established to hedge or mitigate commercial risk 
may qualify for the exclusion, regardless of the nature of the entity--
i.e., whether a financial entity (including a bank) or a non-financial 
entity.\125\
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    \123\ See CEA section 2(h)(7)(A); Exchange Act section 
3C(g)(1)(B) (exception from mandatory clearing requirements when one 
or more counterparties are not ``financial entities'' and are using 
swaps or security-based swaps ``to hedge or mitigate commercial 
risk''). The definition of commercial risk here is for purposes of 
only the major participant definitions and, to the extent the 
interpretation is similar, for purposes of the end-user exception 
from the mandatory clearing requirement. The concept of commercial 
risk may be interpreted differently for other purposes under the CEA 
and the Exchange Act.
    \124\ There is a technical difference in the way those 
provisions use the concept of hedging and mitigating commercial 
risk--in that the major participant definitions specifically refer 
to ``positions held for hedging and mitigating commercial risk'' 
while the end-user exception refers to a counterparty that ``is 
using [swaps or security-based swaps] to hedge or mitigate 
commercial risk.'' That difference is consistent with the different 
language used in the two places (particularly the use of 
``substantial position'' in the major participant definitions) and 
we do not see a reason why the use of the term in the context of the 
major participant definitions should be construed differently than 
its use in the comparable clearing exception.
    \125\ The presence of the third major participant test suggests 
that financial entities generally may not be precluded from taking 
advantage of the hedging exclusion in the first test. The third 
test, which does not account for hedging, specifically applies to 
non-bank financial entities that are highly leveraged and have a 
substantial position in a major category of swaps or security-based 
swaps. That test would be redundant if the hedging exclusion in the 
first major participant test were entirely unavailable to financial 
entities.
    Also, had the statute intended the phrase ``hedge or mitigate 
commercial risk'' to apply only to activities of or positions held 
by non-financial entities, it would not have been necessary to 
include an additional provision in the statute generally restricting 
the availability of the clearing exception to non-financial 
entities.
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    In general, we are premising the proposed exclusion on the 
principle that swaps or security-based swaps necessary to the conduct 
or management of a person's commercial activities should not be 
included in the calculation of a person's substantial position.\126\ In 
this regard, the Commissions preliminarily believe that whether an 
activity is commercial should not be determined solely by the person's 
organizational status as a for-profit company, a non-profit 
organization or a governmental entity. Rather, the determinative factor 
should be whether the underlying activity to which the swap relates is 
commercial in nature.\127\
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    \126\ The scope of the proposed exclusion is based on our 
understanding that when a swap or security-based swap is used to 
hedge an entity's commercial activities, the gains or losses 
associated with the swap or security-based swap itself will be 
offset by losses or gains in the entity's commercial activities, and 
hence the risks posed by the swap or security-based swap to 
counterparties or the industry generally will be mitigated.
    \127\ We do not concur with the suggestion that the use of the 
word ``mitigating'' within the major participant definitions was 
intended to mean something significantly more than hedging. Other 
provisions of the Dodd-Frank Act appear to use the terms ``hedging'' 
and ``mitigating'' interchangeably; for example, certain provisions 
of the Dodd-Frank Act refer to ``risk-mitigating hedging 
activities.'' See Dodd-Frank Act section 619 (adding Section 13 to 
the Bank Holding Company Act of 1956); Dodd-Frank Act section 619 
(adding Section 27B to the Securities Act of 1933). Title VII also 
refers to ``[h]edging and other similar risk mitigating 
activities.'' Dodd-Frank Act section 716(d)(1).

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[[Page 80195]]

a. Proposed Exclusion in the ``Major Swap Participant'' Definition
    As a general matter, the CFTC preliminarily believes that whether a 
position hedges or mitigates commercial risk should be determined by 
the facts and circumstances at the time the swap is entered into, and 
should take into account the person's overall hedging and risk 
mitigation strategies. At the same time, the swap position could not be 
held for a purpose that is in the nature of speculation, investing or 
trading. Although the line between speculation, investing or trading, 
on the one hand, and hedging, on the other, can at times be difficult 
to discern, the statute nonetheless requires such determinations.\128\ 
The CFTC expects that a person's overall hedging and risk management 
strategies will help inform whether or not a particular position is 
properly considered to hedge or mitigate commercial risk. Although the 
definition includes swaps that are recognized as hedges for accounting 
purposes or as bona fide hedging for purposes of an exemption from 
position limits under the CEA, the swaps included within the proposed 
exclusion are not limited to those categories. Rather, the proposal 
covers swaps hedging or mitigating any of a person's business risks, 
regardless of their status under accounting guidelines or the bona fide 
hedging exemption.
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    \128\ We preliminarily believe that swap positions that are held 
for the purpose of speculation or trading are, for example, those 
positions that are held primarily to take an outright view on the 
direction of the market, including positions held for short term 
resale, or to obtain arbitrage profits. Swap positions that hedge 
other positions that themselves are held for the purpose of 
speculation or trading are also speculative or trading positions.
    We preliminarily believe that swap positions that are held for 
the purpose of investing are, for example, those positions that are 
held primarily to obtain an appreciation in value of the swap 
position itself, without regard to using the swap to hedge an 
underlying risk. In contrast, a swap position related to a non-swap 
investment (such as the purchase of an asset that a commercial 
enterprise will use to produce income or otherwise advance its 
commercial interests) may be a hedging position if it otherwise 
qualifies for the definition of hedging or mitigating commercial 
risk.
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    The CFTC invites comment on whether swaps qualifying for the 
hedging or risk mitigation exclusion should be limited to swaps where 
the underlying hedged item is a non-financial commodity. Commenters may 
also address whether swaps subject to this exception should hedge or 
mitigate commercial risk on a single risk or an aggregate risk basis, 
and on a single entity or a consolidated basis. The CFTC also invites 
comment on whether risks such as the foreign exchange, currency, or 
interest rate risk relating to offshore affiliates, should be covered; 
whether industry-specific rules on hedging, or rules that apply only to 
certain categories of commodity or asset classes are appropriate at 
this time; whether swaps facilitating asset optimization or dynamic 
hedging should be included; and whether hedge effectiveness should be 
addressed. Commenters are requested to discuss both the policy and 
legal bases underlying their comments.
b. Proposed Exclusion in the ``Major Security-Based Swap Participant'' 
Definition
    The proposed meaning of ``hedging or mitigating commercial risk'' 
for purposes of the ``major security-based swap participant'' 
definition would require that a security-based swap position be 
economically appropriate to the reduction of risks in the conduct and 
management of a commercial enterprise, where they arise from the 
potential change in the value of assets, liabilities and services 
connected with the ordinary course of business of the enterprise.\129\ 
This standard is intended to exclude from the first major participant 
test security-based swaps that pose limited risk to the market and to 
counterparties because the positions would be substantially related to 
offsetting risks from an entity's commercial operations.\130\ The 
security-based swaps included within the proposed rule would not be 
limited to those recognized as hedges for accounting purposes; rather, 
the proposal has been drafted to cover security-based swaps used in the 
broader range of transactions commonly referred to as economic hedges, 
regardless of their status under accounting guidelines.
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    \129\ See proposed Exchange Act rule 3a67-4(a). The concept of 
``economically appropriate'' already is found in rules under the CEA 
pertaining to the definition of ``bona fide hedging'' for purposes 
of an exemption from position limits. See CEA rule 1.3(z). In the 
context of the definition of ``major security-based swap 
participant,'' we may take into account existing interpretations of 
that term under the CEA, but only to the extent that such 
interpretations would appropriately be applied to the use of 
security-based swaps for hedging.
    The SEC preliminarily plans to interpret the concept of 
``economically appropriate'' based on whether a reasonably prudent 
person would consider the security-based swap to be appropriate for 
managing the identified commercial risk. The SEC also preliminarily 
believes that for a security-based swap to be deemed ``economically 
appropriate'' in this context, it should not introduce any new 
material quantum of risks (i.e., it cannot reflect over-hedging that 
could reasonably have a speculative effect) and it should not 
introduce any basis risk or other new types of risk (other than the 
counterparty risk that is attendant to all security-based swaps) 
more than reasonably necessary to manage the identified risk.
    \130\ These hedging positions would include activities, such as 
the management of receivables, that arise out of the ordinary course 
of an entity's commercial operations, including activities that are 
incidental to those operations.
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    At the same time, the security-based swap position could not be 
held for a purpose that is in the nature of speculation or 
trading.\131\ In addition, the security-based swap position could not 
be held to hedge or mitigate the risk of another security-based swap 
position or swap position unless that other position itself is held for 
the purpose of hedging or mitigating commercial risk as defined by the 
rule or CEA rule 1.3(ttt).\132\
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    \131\ See proposed Exchange Act rule 3a67-4(b)(1). For these 
purposes, we preliminarily believe that security-based swap 
positions that are held for the purpose of speculation or trading 
are those positions that are held intentionally for short-term 
resale and/or with the intent of benefiting from actual or expected 
short-term price movements or to lock in arbitrage profits, as well 
as security-based swap positions that hedge other positions that 
themselves are held for the purpose of speculation or trading. Thus, 
for example, positions that would be part of a ``trading book'' of 
an entity such as a bank would not constitute hedging positions that 
may be excluded for purposes of the first major participant test.
    \132\ See proposed Exchange Act rule 3a67-4(b)(2).
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    We look forward to commenters' views on whether the proposed 
standard strikes an appropriate balance in determining which positions 
may be excluded for purposes of the first major participant test. We 
recognize that there are other reasonable views as to what positions 
may appropriately be considered to be for the purposes of hedging or 
mitigating commercial risk. We also recognize the importance of 
providing as clear guidance as possible as to what is or is not a 
hedging position for these purposes.
    The proposal also would condition the entity's ability to exclude 
these security-based swap positions on the entity engaging in certain 
specified activities related to documenting the underlying risks and 
assessing the effectiveness of the hedge in connection with the 
positions.\133\ These activities are intended to help ensure that 
positions excluded for purposes of the

[[Page 80196]]

first major participant test would not extend to positions that are not 
entered into to reduce or hedge commercial risks, or that at a later 
time no longer substantially serve to reduce or mitigate such 
risks.\134\
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    \133\ See proposed Exchange Act rule 3a67-4(a)(3). The proposal 
particularly would require the person to: Identify and document the 
risks that are being reduced by the security-based swap position; 
establish and document a method of assessing the effectiveness of 
the security-based swap as a hedge; and regularly assess the 
effectiveness of the security-based swap as a hedge.
    We expect that market participants that have security-based swap 
activities significant enough that they may be major participants 
would already engage in risk assessment activities for their hedging 
positions, either formally or informally, and thus we do not believe 
that the proposed requirements would disrupt existing business 
practices. Instead, the proposal is intended to create standards 
that will allow market participants to confirm their compliance with 
the rule by formalizing risk assessment activities that should 
already be part of an effective hedging program.
    \134\ This condition does not mandate that an entity follow a 
particular set of procedures to take advantage of the exclusion. We 
would expect that an entity that already engages in these types of 
risk assessment procedures in connection with its existing business 
activities to be able to rely on those procedures to satisfy the 
condition. These conditions also could be satisfied by the entity's 
use of a third-party to assist with these risk assessment 
activities.
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    We preliminarily believe that this proposed approach would 
facilitate the following types of security-based swap positions:
     Positions established to manage the risk posed by a 
customer's, supplier's or counterparty's potential default in 
connection with: financing provided to a customer in connection with 
the sale of real property or a good, product or service; a customer's 
lease of real property or a good, product or service; a customer's 
agreement to purchase real property or a good, product or service in 
the future; or a supplier's commitment to provide or sell a good, 
product or service in the future; \135\
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    \135\ The references here to customers and counterparties do not 
include swap or security-based swap counterparties.
---------------------------------------------------------------------------

     Positions established to manage the risk posed by a 
financial counterparty (different from the counterparty to the hedging 
position at issue) in connection with a separate transaction (including 
a position involving a credit derivative, equity swap, other security-
based swap, interest rate swap, commodity swap, foreign exchange swap 
or other swap, option, or future that itself is for the purpose of 
hedging or mitigating commercial risk pursuant to the rule or CEA rule 
1.3(ttt));
     Positions established to manage equity or market risk 
associated with certain employee compensation plans, including the risk 
associated with market price variations in connection with stock-based 
compensation plans, such as deferred compensation plans and stock 
appreciation rights;
     Positions established to manage equity market price risks 
connected with certain business combinations, such as a corporate 
merger or consolidation or similar plan or acquisition in which 
securities of a person are exchanged for securities of any other person 
(unless the sole purpose of the transaction is to change an issuer's 
domicile solely within the United States), or a transfer of assets of a 
person to another person in consideration of the issuance of securities 
of such other person or any of its affiliates;
     Positions established by a bank to manage counterparty 
risks in connection with loans the bank has made; and
     Positions to close out or reduce any of those positions.
2. Request for Comments
    We request comment on the proposed definition of ``hedging or 
mitigating commercial risk'' for purposes of both the ``major swap 
participant'' and the ``major security-based swap participant'' 
definitions. Commenters particularly are requested to address whether 
the proposed definitions would adequately limit the types of swaps or 
security-based swaps that are encompassed by the definition, such that 
the definitions do not encompass positions that serve speculative, 
trading or other non-hedging purposes. In this regard, do the proposed 
definitions appropriately exclude from the scope of the definition 
swaps and security-based swaps that would be less likely to pose risks 
to counterparties and the market, by virtue of gains or losses on those 
swaps being offset by losses or gains associated with an entity's 
commercial operations? Commenters further are requested to address 
whether the proposed ``economically appropriate'' standard would 
effectively limit the positions encompassed by the definition. If not, 
what alternative standards (e.g., standards derived from accounting 
principles) would more effectively identify hedging positions and 
distinguish those from positions held for other purposes? In that 
regard, is the concept of ``economically appropriate'' well-understood, 
and, if not, is there another concept that would more effectively 
delimit the nature of the relationship between the swap or security-
based swap position and the risk being hedged or mitigated? Also, in 
the context of the definition of this term for purposes of security-
based swaps, should existing interpretive guidance pertaining to the 
concept of ``economically appropriate'' with respect to the CEA's bona 
fide hedging exemption for position limits be considered, and, if so, 
to what extent? We further request comment on possible alternative 
approaches to the test identifying positions entered into for the 
purpose of hedging or mitigating commercial risk. For example, should 
the test require the entity excluding a position to have a reasonable 
basis to believe, and to actually believe, that the excluded swap would 
be a ``highly effective,'' ``reasonably effective'' or ``economically 
appropriate'' hedge of a specified commercial risk? Should the test be 
generally identical to the proposed test, but with the substitution of 
the phrase ``highly effective'' or ``reasonably effective'' (or another 
standard) for ``economically appropriate''? Should the test be based on 
accounting principles for hedging treatment (i.e., a quantitative test 
requiring the hedge to be within a certain band of effectiveness)?
    Commenters also are requested to address the proposed restrictions 
on positions in the nature of speculation or trading. Is it appropriate 
not to permit any speculative or trading positions from being deemed 
for the purpose of hedging or mitigating commercial risk? What would be 
the impact of such an interpretation on an entity's risk mitigation 
practices? Also, is the dividing line between speculative and trading 
positions on the one hand, and positions eligible to be considered to 
be hedging positions on the other hand, sufficiently clear? Is such a 
line appropriately based on whether the position is intended to be held 
for the short-term versus long-term intent? Would some alternative 
criteria be preferable in terms of setting forth objective standards 
for identifying risk reducing hedging positions and distinguishing them 
from other positions? Also, would additional standards or other 
guidance be appropriate to help ensure that positions used in 
connection with speculative or trading purposes do not fall within the 
definition?
    We further request comment on the proposal that a swap or security-
based swap would not fall within the definition of ``hedging or 
mitigating commercial risk'' if it is held to hedge or mitigate the 
risk of another swap or security-based swap, unless that other position 
itself is held for the purpose of hedging or mitigating commercial 
risk. One consequence of this approach might be that a particular swap 
or security-based swap hedging a particular type of risk would be 
included or excluded based solely on whether that risk arises from 
another swap or security-based swap or from a different type of 
transaction.\136\ Is this the appropriate approach? What would be the 
consequences of this approach for

[[Page 80197]]

different types of entities? How would the proposed approach affect the 
risk management practices of entities that are close to the proposed 
threshold? Is it appropriate to include both positions within the major 
participant calculations? If this general approach in the proposed rule 
were adopted, should there be any exceptions to the approach? What 
alternative approaches might be considered? For example, would it be 
appropriate to exclude a swap or security-based swap that hedges 
another swap or security-based swap from the calculation? What would be 
the advantages and disadvantages of this approach?
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    \136\ For example, under this proposal an entity may exclude 
from the first major participant test a security-based swap used to 
manage the credit risk posed by a customer's default in connection 
with financing that an entity provides to that customer. The entity 
may not exclude an identical security-based swap, however, if that 
security-based swap is used to hedge the credit risk associated with 
a second swap or security-based swap that itself is not for the 
purpose of hedging or mitigating commercial risk.
---------------------------------------------------------------------------

    Moreover, commenters are requested to address whether the 
definition should encompass a quantitative test that would limit the 
total value of swaps and security-based swaps that an entity may 
include under this rule to be no more than the total value of 
underlying risk identified by such entity. If so, what measurement 
should be used for determining an entity's total value of swaps and 
security-based swaps and total value of underlying risk, and what 
methods or procedures should entities be required to follow when 
calculating and comparing the two values?
    In addition, commenters are requested to address whether the 
proposed procedural requirements, in the context of this definition for 
purposes of the ``major security-based swap participant'' analysis, are 
appropriate. In this regard, commenters are requested to discuss 
whether there are any advantages or disadvantages to providing more 
specific procedural requirements; whether the proposed procedural 
requirements will alter business practices to the extent that a 
transition period is necessary before they are implemented; and whether 
specific guidance is required to address how the proposed procedural 
requirements will affect existing positions. In addition, commenters 
are requested to address whether the proposed procedural requirements 
should include a requirement to quantify the underlying risk and the 
effectiveness of the hedge, and whether such quantitative assessments 
would impose significant systems costs or other costs. Also, should an 
assessment of hedging effectiveness be required at all, in light of the 
costs that may be associated with such a requirement?
    More generally, would the proposed standards for identifying 
positions for the purpose of hedging or mitigating commercial risk 
suffice to allow a person holding a security-based swap position to 
identify and document the commercial risks that are being hedged or 
mitigated by that position, and if not, what additional requirements 
are needed? Should additional guidance be provided regarding whether 
components of risks (in assets, liabilities or services) or whether 
risks in portfolios (of assets, liabilities or services) may be 
identified as the commercial risks that are being hedged or mitigated 
by the position, and, if so, which components? Also, should additional 
guidance be provided with respect to the form of documentation or the 
elements of the hedging relationship that should be documented, and, if 
so, which elements? Moreover, if a swap or security-based swap that was 
hedging at inception were no longer to serve a hedging purpose over 
time, should it no longer fall within the definition of hedging or 
mitigating commercial risk?
    In addition, should the rule specify the frequency with which an 
entity should assess the effectiveness of the hedge? Also, should we 
provide additional guidance on the acceptable methods of assessing 
effectiveness? Is a qualitative assessment adequate to assess 
effectiveness or should a quantitative assessment also be required? 
Should the rule establish a level of offset between the position and 
the hedged risk, below which the position would not be considered to be 
effective at reducing risk, and, if so, what is the level of offset (or 
range of levels) below which the position should not be considered to 
be effective? Are there methods for assessing effectiveness that should 
not be permitted for these purposes?
    Commenters also are requested to address whether the proposal also 
should encompass certain activities in which an entity hedges an 
affiliate's risks.
    We further request comment on how the definition should apply to 
hedging activities by financial entities. Commenters particularly are 
invited to address whether financial entities should be able to rely on 
this exclusion, or whether financial entities should face special 
limits in the context of this exclusion. Commenters further are 
requested to address how the proposed provisions excluding positions in 
the nature of speculation or trading from the definition would apply to 
activities by banks, including permissible trading activities by banks, 
and, in particular, whether it is appropriate to exclude positions that 
are part of an entity's ``trading book.''
    Commenters also are requested to address the application of the 
proposal to registered investment companies, including whether 
additional guidance would be appropriate with respect to which uses of 
security-based swaps by registered investment companies would fall 
within the exclusion.

D. ``Substantial Counterparty Exposure''

    The second test of the major participant definitions addresses 
entities whose swaps and security-based swaps ``create substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets.'' \137\ Unlike the first test of the major participant 
definitions, this test does not focus on positions in a ``major'' 
category of swaps or security-based swaps. Also, unlike the first test, 
this test does not explicitly exclude hedging positions or certain 
ERISA plan positions from the analysis.
---------------------------------------------------------------------------

    \137\ See CEA section 1a(33)(A)(ii); Exchange Act section 
3(a)(67)(A)(ii)(II).
---------------------------------------------------------------------------

    Some commenters suggested that the second major participant 
definition test should be interpreted in a manner similar to the first 
test. Many commenters stated that the analysis should also reflect 
netting agreements and the posting of collateral. Some commenters 
stated that the test should exclude hedging positions, and cleared 
positions.
    We preliminarily believe that the second major participant 
definition test's focus on the counterparty risk associated with an 
entity's swap or security-based swap positions is similar enough to the 
``substantial position'' risks embedded in the first test that the 
second test appropriately takes into account the same measures of 
current uncollateralized exposure and potential future exposure that 
are used in our proposal for the first test. For the second test, 
however, the thresholds must focus on the entirety of an entity's swap 
positions or security-based swap positions, rather than on positions in 
any specific ``major'' category. In addition, this second test does not 
explicitly account for positions for hedging commercial risk or ERISA 
positions.
    Accordingly, these proposed calculations of substantial 
counterparty exposure would be performed in largely the same way as the 
calculation of substantial position in the first major participant 
definition tests, except that the amounts would be calculated by 
reference to all of the person's swap or security-based swap positions, 
rather than by reference to a specific ``major'' category of such 
positions.\138\
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    \138\ See proposed CEA rule 1.3(uuu)(2); proposed Exchange Act 
rule 3a67-5(b)(1).
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    For purposes of the ``major swap participant'' definition, the CFTC

[[Page 80198]]

proposes that the second major participant definition test be satisfied 
by a current uncollateralized exposure of $5 billion, or a combined 
current uncollateralized exposure and potential future exposure of $8 
billion, across the entirety of an entity's swap positions.\139\ For 
purposes of the ``major security-based swap participant'' definition, 
the SEC proposes that the second test be satisfied by a current 
uncollateralized exposure of $2 billion, or a combined current 
uncollateralized exposure and potential future exposure of $4 billion, 
across the entirety of an entity's security-based swap positions.\140\ 
We look forward to commenters' views as to whether alternative 
thresholds would be more appropriate to achieve the statutory goals.
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    \139\ See proposed CEA rule 1.3(uuu)(1).
    \140\ See proposed Exchange Act rule 3a67-5(a).
---------------------------------------------------------------------------

    These proposed thresholds in part are based on the same factors 
that underpin the proposed ``substantial position'' thresholds.\141\ 
The proposed thresholds, however, also reflect the fact that this test 
must account for an entity's positions across four major swap 
categories or two major security-based swap categories.\142\ These 
proposed thresholds, moreover, have further been raised to reflect the 
fact that this second test (unlike the first major participant test) 
encompasses certain hedging positions that, in general, we would expect 
to pose fewer risks to counterparties and to the markets as a whole 
than positions that are not for purposes of hedging.
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    \141\ See notes 103 to 106 and 117, supra, and accompanying 
text.
    \142\ Thus, these proposed thresholds in part would account for 
an entity that has large positions in more than one major category 
of swaps or security-based swaps, but that does not meet the 
substantial position threshold for either.
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    We request comment on this proposal. Commenters particularly are 
requested to address whether the proposed use of current 
uncollateralized exposure and potential future exposure tests 
(including the parts of those tests that account for positions that are 
cleared or subject to mark-to-market margining) are appropriate, and 
whether the proposed thresholds are set at an appropriate level. Should 
the thresholds be higher or lower? If so, what alternative threshold 
amounts would be more appropriate, and why? Commenters also are 
requested to address whether the test should exclude commercial risk 
and ERISA hedging positions, on the grounds that those hedging 
positions may not raise the same degree of risk to counterparties as 
other swap or security-based swap positions. Comments are also 
requested on whether the test of substantial counterparty exposure, 
given its focus on the systemic risks arising from the entirety of a 
person's portfolio, should include a measure to take into account the 
person's combined swap positions and security-based swap positions.

E. ``Financial Entity'' and ``Highly Leveraged''

    The third test of the major participant definitions addresses any 
``financial entity,'' other than one subject to capital requirements 
established by an appropriate Federal banking agency,\143\ that is 
``highly leveraged relative to the amount of capital'' the entity 
holds, and that maintains a substantial position in a ``major'' 
category of swaps or security-based swaps. This test does not permit an 
exclusion for positions held for hedging.
---------------------------------------------------------------------------

    \143\ Sections 721 and 761 of the Dodd-Frank Act add a 
definition of the term ``appropriate Federal banking agency'' in 
sections 1a and 3(a) of the CEA and the Exchange Act, respectively, 
7 U.S.C. 1a(2), 15 U.S.C. 78c(a)(72). The Commissions propose to 
refer to those statutory definitions for purposes of the rules.
---------------------------------------------------------------------------

    As discussed below, we are proposing specific definitions of the 
terms ``financial entity'' and ``highly leveraged.'' In addition, we 
request comment on whether we should include additional regulators 
within the proposed interpretation of what is an appropriate Federal 
banking agency.
1. Meaning of ``financial entity''
    While the third major participant definition test does not 
explicitly define ``financial entity,'' Title VII of the Dodd-Frank Act 
defines ``financial entity'' in the context of the end-user exception 
from mandatory clearing (an exception that generally is not available 
to those entities).\144\ Some commenters have pointed out that using 
that definition here would produce circular results.\145\
---------------------------------------------------------------------------

    \144\ See CEA section 2(h)(7)(C)(i); Exchange Act section 
3C(g)(3)(A).
    \145\ See Cleary letter (also addressing status of broker-
dealers and futures commission merchants as part of the analysis).
    The circularity would result because, for purposes of the end-
user clearing exception, ``financial entity'' is defined to include 
swap dealers, security-based swap dealers, major swap participants, 
and major security-based swap participants.
---------------------------------------------------------------------------

    We preliminarily do not believe there is a basis to define 
``financial entity'' for purposes of the major participant definitions 
in a way that materially differs from the definition used in the end-
user exception from mandatory clearing. Using the same basic definition 
also would appear to be consistent with the statute's intent to treat 
non-financial end-users differently than financial entities. 
Accordingly, other than technical changes to avoid circularity, we 
propose to use the same definition in the major participant 
definitions.\146\
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    \146\ See proposed CEA rule 1.3(vvv)(1); proposed Exchange Act 
rule 3a67-6(a). To avoid circularity, the meaning of ``financial 
entity'' for purposes of the ``major swap participant'' definition 
would not encompass any ``swap dealer'' or ``major swap 
participant'' (but would encompass ``security-based swaps dealers'' 
and ``major security-based swap participants''). The meaning of 
``financial entity'' for purposes of the ``major security-based swap 
participant'' definition would not encompass any ``security-based 
swap dealer'' or ``major security-based swap participant (but would 
encompass ``swap dealers'' and ``major swap participants''). For 
both definitions, ``financial entity'' would include any: commodity 
pool (as defined in section 1a(10) of the CEA); private fund (as 
defined in section 202(a) of the Investment Advisers Act of 1940); 
employee benefit plan as defined in paragraphs (3) and (32) of 
section 3 of the Employee Retirement Income Security Act of 1974; 
and person predominantly engaged in activities that are in the 
business of banking or financial in nature (as defined in section 
4(k) of the Bank Holding Company Act of 1956).
---------------------------------------------------------------------------

    Commenters are requested to address our proposed definition of 
``financial entity.''
2. Meaning of ``Highly Leveraged''
    Some commenters have stated that the term ``highly leveraged'' 
should be interpreted by looking at the leverage associated with other 
firms in an entity's line of business, rather than by applying an 
across-the-board measure of leverage.\147\ One commenter suggested that 
higher leverage may be warranted for entities with a smaller capital 
base, and another commenter suggested that we look at analogous banking 
regulations rather than creating a new regime for measuring leverage. 
Some commenters suggested ways of addressing specific items for 
purposes of determining leverage.\148\
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    \147\ See letter from Robert Pickel, Executive Vice Chairman, 
International Swaps and Derivatives Association, Inc., dated 
September 20, 2010 (suggesting that ``leverage ratio limits to which 
banks and other regulated entities are subject would be unsuitably 
low for other enterprises''); letter from Steve Martinie, Assistant 
General Counsel and Assistant Secretary, The Northwestern Mutual 
Life Insurance Company, dated September 20, 2010 (``Northwestern 
Mutual letter'') (suggesting that financial firms require less 
cushion than other entities because financial firms are able to 
match their assets and liabilities more closely).
    \148\ See Northwestern Mutual letter (suggesting that the 
Commissions recognize that liabilities such as bank deposits and 
insurance policy reserves are not leverage); Vanguard letter 
(suggesting that leverage should relate to debt financing and should 
not encompass potential leveraging effects posed by derivatives); 
SIFMA AMG letter (suggesting that the Commissions take into account 
the difference between non-recourse and recourse obligations, the 
difference between notional amounts payable and actual payable 
obligations, and the difference between actual financial obligations 
and leverage embedded in a derivative that affects returns but does 
not result in a payment obligation).
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    The Commissions recognize that traditional balance sheet measures 
of leverage have limitations as tools for

[[Page 80199]]

evaluating an entity's ability to meet its obligations. In part this is 
because such measures of leverage do not directly account for the 
potential risks posed by specific instruments on the balance sheet, or 
financial instruments that are held off of an entity's balance sheet 
(as may be the case with an entity's swap and security-based swap 
positions). At the same time, we preliminarily do not believe that it 
is necessary to use more complex measures of risk-adjusted leverage 
here, particularly given that the third test in the major participant 
definitions already addresses those types of risks by considering 
whether an entity has a substantial position in a major category of 
swaps or security-based swaps. We are also mindful of the costs that 
entities would face if forced to undertake a complex risk-adjusted 
leverage calculation, especially for entities that would not already be 
performing this type of analysis.\149\ Additionally, we preliminarily 
do not believe that it is necessary for the leverage standard to 
account for the degree of leverage associated with different types of 
financial entities.
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    \149\ The Basel Committee on Banking Supervision recently 
proposed one method for calculating risk-adjusted leverage in its 
Consultative Document entitled: ``Strengthening the resilience of 
the banking sector'' (Dec. 2009). This proposal would create a new 
leverage ratio based on a comparison of capital to total exposure. 
Total exposure for these purposes would be measured by, among other 
things, including the notional value of all written credit 
protection, severely limiting the recognition given to netting, and 
calculating the risks associated with off-balance sheet derivatives 
transactions, as measured by the current exposure method for 
calculating future risks outlined in Basel II. The Consultative 
Document drew over 150 comments from the international financial 
community, which included both those in support of, and those that 
questioned the inclusion of a risk-adjusted leverage ratio within 
the Basel framework. The Basel Committee on Banking Supervision 
expects to deliver a full package of reforms by the end of 2010, 
based on the Consultative Document released in December 2009 and 
comments received thereon.
---------------------------------------------------------------------------

    Although the third test of the major participant definitions does 
not define ``highly leveraged,'' we note that Congress addressed the 
issue of leverage in Title I of the Dodd-Frank Act. There, Congress 
provided that the Board of Governors of the Federal Reserve System must 
require a bank holding company with total consolidated assets equal to 
or greater than $50 billion, or a nonbank financial company supervised 
by the Board of Governors, to maintain a debt to equity ratio of no 
more than 15 to 1 if the FSOC determines ``that such company poses a 
grave threat to the financial stability of the United States and that 
the imposition of such requirement is necessary to mitigate the risk 
that such company poses to the financial stability of the United 
States.'' \150\
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    \150\ See Dodd-Frank Act section 165(j)(1).
---------------------------------------------------------------------------

    This requirement in Title I suggests potential alternative 
approaches to the definition of ``highly leveraged'' for purposes of 
the major participant definitions. On the one hand, the 15 to 1 limit 
may represent an upper limit of acceptable leverage, indicating that 
the limit for the major participant definitions should be lower so as 
to create a buffer between entities at that upper limit and entities 
that are not highly leveraged. On the other hand, the Title 1 
requirement, which applies only when the entity in question poses a 
``grave threat'' to financial stability, may indicate that the 15 to 1 
leverage ratio is also the appropriate test of whether an entity poses 
the systemic risk concerns implicated by the major participant 
definitions.
    For these reasons, we propose two possible definitions of the point 
at which an entity would be ``highly leveraged''--either an entity 
would be ``highly leveraged'' if the ratio of its total liabilities to 
equity is in excess of 8 to 1, or an entity would be ``highly 
leveraged'' if the ratio of its total liabilities to equity is in 
excess of 15 to 1. In either case, the determination would be measured 
at the close of business on the last business day of the applicable 
fiscal quarter. To promote consistent application of this leverage 
test, entities that file quarterly reports on Form 10-Q and annual 
reports on Form 10-K with the SEC would determine their total 
liabilities and equity based on the financial statements included with 
such filings.\151\ All other entities would calculate the value of 
total liabilities and equity consistent with the proper application of 
U.S. generally accepted accounting principles.
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    \151\ These entities would include those that submit periodic 
reports on a voluntary basis to the SEC, as well as those that are 
required to file periodic reports with the SEC.
---------------------------------------------------------------------------

    We believe that the 15 to 1 ratio could be consistent with the use 
of that ratio in Title I, which, as noted above, provides that the 15 
to 1 leverage ratio would be applied to a bank holding company or 
nonbank financial company subject to Title I as a maximum only if it is 
determined that the company poses a ``grave threat'' to financial 
stability. Commenters are requested to address whether the proposed 15 
to 1 standard used in Title I suggests that a standard higher than 15 
to 1 should be used here, given that the Title I standard is applicable 
only to large entities that also pose a ``grave threat'' to financial 
stability and thus may suggest that a higher standard is appropriate 
for entities that do not pose the same degree of threat. Alternatively, 
the 8 to 1 ratio could be consistent with the exemption in the third 
test of the major participant definitions for financial institutions 
that are subject to capital requirements set by the Federal banking 
agencies, as it is possible that financial institutions were 
specifically excluded from the third test based on the presumption that 
they generally are highly leveraged, and hence would have been covered 
by the third test if they were not expressly exempted. Based on our 
analysis of financial statements it appears that those institutions 
generally have leverage ratios of approximately 10 to 1, which may 
suggest that the ``highly leveraged'' threshold would have to be lower 
for those institutions to be potentially subject to the third test. 
Such an approach would help to ensure that the third test of the major 
participant definition applies to financial entities that are not 
subject to capital requirements set by the Federal banking agencies, 
but that have leverage ratios similar to institutions that are subject 
to those requirements.
    The Commissions request comment on the proposed alternative 
definitions of ``highly leveraged.'' Commenters particularly are 
requested to specifically address the relative merits of the proposed 
alternative 8 to 1 and 15 to 1 standards, as well as other standards 
that they believe would be appropriate for these purposes.\152\
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    \152\ In this regard, we recognize that under Exchange Act rule 
15c3-1, a broker-dealer may determine its required minimum net 
capital, among other ways, by applying a financial ratio that 
provides that its aggregate indebtedness shall not exceed 1500% of 
its net capital (i.e., a 15 to 1 aggregate indebtedness to net 
capital ratio). Exchange Act Rule 17a-11 further requires that 
broker-dealers that use such method to establish their required 
minimum net capital must provide notice to regulators if their 
aggregate indebtedness exceeds 1200% of their net capital (i.e., a 
12 to 1 aggregate indebtedness to net capital ratio). We recognize 
that these measures, however, reflect a different ratio of total 
liabilities to equity; for example, the calculation of aggregate 
indebtedness in rule 15c3-1 excludes certain liabilities, and the 
calculation of net capital includes certain subordinated debt--
meaning that these measures would respectively be equivalent to 
ratios higher than 15:1 or 12:1 when converted to a balance sheet 
ratio of liabilities to equity such as that used under the proposed 
rule.
---------------------------------------------------------------------------

    Commenters further are requested to address whether a risk-adjusted 
leverage ratio should be used, and, if so, how the ratio should be 
calculated (including whether particular items should be included or 
excluded when making this calculation), and whether a risk-adjusted 
leverage ratio could be developed relying on measures already

[[Page 80200]]

calculated by entities as a matter of course.\153\ Commenters further 
are requested to address whether the leverage ratio should be revised 
to require that the amount of potential future exposure (as outlined in 
the ``substantial position'' discussion above) be combined with total 
liabilities before such number is compared to equity for purposes of 
calculating the ratio, and, if so, whether the proposed ratios would 
still be appropriate; whether the rule should more specifically address 
issues as to how certain types of positions or liabilities should be 
accounted for when calculating leverage; whether the proposed timing of 
the measurement--the close of business on the last business day of the 
applicable fiscal quarter--would be potentially subject to gaming or 
evasion; and whether the rule text should particularly prescribe how 
separate categories of entities calculate leverage.
---------------------------------------------------------------------------

    \153\ For example, would adjustments akin to those discussed 
above in the context of broker-dealer net capital provide a more 
useful measure of leverage for these purposes?
---------------------------------------------------------------------------

F. Implementation Standard, Reevaluation Period and Minimum Duration of 
Status

    While the analysis of whether an entity is a major participant is 
backward looking, an entity that meets the criteria for being a major 
participant is required to register with the CFTC and/or the SEC, and 
comply with the requirements applicable to major participants. We 
recognize that these entities will need time to complete their 
applications for registration and to come into compliance with the 
applicable requirements. We thus propose that an unregistered entity 
that meets the major participant criteria as a result of its swap or 
security-based swap activities in a fiscal quarter would not be deemed 
to be a major participant until the earlier of the date on which it 
submits a complete application for registration pursuant to CEA Section 
4s(b) or Exchange Act Section 15F(b), or two months after the end of 
that quarter.\154\ We preliminarily believe that this would provide 
entities with an appropriate amount of time to apply for registration 
and, with the time between the submission of an application and the 
effectiveness of the registration, to comply with the requirements 
applicable to major participants, without permitting undue delay.
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    \154\ See proposed CEA rule 1.3(qqq)(4)(i); proposed Exchange 
Act rule 3a67-7(a). The Commissions are proposing separate rules 
regarding the registration requirements and processes for major 
participants.
---------------------------------------------------------------------------

    We also propose to provide a reevaluation for entities that meet 
one or more of the applicable major participant thresholds, but only by 
a modest amount.\155\ In particular, an unregistered entity that has 
met these criteria as a result of its swap or security-based swap 
activities in a fiscal quarter, but without exceeding any applicable 
threshold by more than twenty percent, would not immediately be subject 
to the timing requirements discussed above. Instead, that entity would 
become subject to those requirements if the entity exceeded any of the 
applicable daily average thresholds in the next fiscal quarter.\156\ We 
preliminarily believe this type of reevaluation period would avoid 
applying the major participant requirements to entities that meet the 
major participant criteria for only a short time due to unusual 
activity.
---------------------------------------------------------------------------

    \155\ Commenters raised concerns over an entity qualifying as a 
major participant due to an unusual event. See, e.g., letter from 
American Benefits Council and Committee on the Investment of 
Employee Benefit Assets, dated September 20, 2010 (stating that 
quirky volatility may affect the determinations).
    \156\ See proposed CEA rule 1.3(qqq)(4)(ii); proposed Exchange 
Act rules 3a67-7(b).
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    In addition, we propose that any entity that is deemed to be a 
major participant would retain that status until such time that it does 
not exceed any of the applicable thresholds for four consecutive 
quarters after the entity becomes registered.\157\ Commentators raised 
concerns about the possibility of entities moving in and out of the 
status on a rapid basis,\158\ and we believe that this proposal 
appropriately addresses that concern in a way that would help promote 
the predictable application and enforcement of the requirements 
governing major participants.
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    \157\ See proposed CEA rule 1.3(qqq)(5); proposed Exchange Act 
rules 3a67-7(c)(1).
    \158\ See Vanguard letter (suggesting that entities should 
remain in the status after qualification for an extended defined 
period such as one calendar year); AIMA letter (noting that 
recategorization of entities could be disruptive for entities' 
business models and could be administratively burdensome for the 
Commissions).
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    The Commissions request comment on these proposals. Commenters 
particularly are requested to address: Whether two months is an 
adequate amount of time for entities that have met the criteria to 
submit an application for registration; whether there is an adequate 
amount of time to make the necessary internal changes to come into 
compliance with the requirements applicable to major participants 
before being subject to those requirements as a result of a 
registration becoming effective; whether twenty percent is the 
appropriate threshold for applicability of the reevaluation period; 
whether there would be any risks arising from delaying registration as 
a major participant for an entity that exceeds the thresholds, but 
qualifies for the reevaluation period; and whether four consecutive 
quarters of not meeting the criteria for major participant status after 
registration is granted is the appropriate amount of time that a major 
participant should be required to stay in the status.
    In addition, we request comment on the appropriateness of the 
proposed reevaluation period. Commenters particularly are requested to 
address whether it is likely that unusual market conditions could cause 
an entity to exceed the proposed thresholds over the course of a 
quarter (based on a daily average) without generally raising the types 
of risks that the thresholds were intended to identify. Also, should 
the use of the reevaluation period be conditioned on requiring any 
entity relying on the reevaluation period to make a representation, or 
otherwise demonstrate, that it exceeded the threshold due to a one-time 
extraordinary event, and that it will be below the threshold at the 
next time of measurement?

G. Limited Purpose Designations

    In general, a person that meets the definition of major participant 
will be considered to be a major participant with respect to all 
categories of swaps or security-based swaps, as applicable, and with 
regard to all activities involving those instruments.\159\ As discussed 
above, however, the statutory definitions provide that a person may be 
designated as a major participant for one or more categories of swaps 
or security-based swaps without being classified as a major participant 
for all categories.\160\ Thus, as with the definitions of ``swap 
dealer'' and ``security-based swap dealer,'' we propose to provide that 
major participants who engage in significant activity with respect to 
only certain types, classes or categories of swaps or security-based 
swaps may apply for relief with respect to other types of swaps or 
security-based swaps from certain of the requirements that are 
applicable to major participants. The Commissions anticipate that a 
major participant could seek a limited designation at the same time as, 
or at a later time subsequent to, the person's initial registration as 
a major participant. Because of the variety of situations in which 
major participants

[[Page 80201]]

may enter into swaps or security-based swaps, it is difficult to set 
out at this time the conditions, if any, which would allow a person to 
be designated as a major participant with respect to only certain 
types, classes or categories of swaps or security-based swaps.
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    \159\ See proposed CEA rule 1.3(qqq)(2); proposed Exchange Act 
rule 3a67-1(c).
    \160\ CEA section 1a(33)(C); Exchange Act section 3(a)(67)(C).
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    The Commissions request comment on the proposed rules regarding 
limited designation as a major participant. Commenters particularly are 
requested to address the circumstances in which such limited purpose 
designations would be appropriate, and to address the factors that the 
Commissions should consider when addressing such requests, and the type 
of information requestors should provide in support of their request. 
Commenters also are asked to address whether such limited purpose 
designations should be conditioned in any way, such as by the provision 
of information of the type that would be required with respect to an 
entity's swaps or security-based swaps involving the particular 
category or activity for which they are not designated as a major 
participant.

H. Additional Interpretive Issues

    Commenters have raised additional issues related to the major 
participant definitions.
1. Exclusion for ERISA Plan Positions
    As discussed above, the first test of the major participant 
definitions excludes from the analysis ``positions maintained by any 
employee benefit plan (or any contract held by such a plan) as defined 
in paragraphs (3) and (32) of section 3 of ERISA (29 U.S.C. 1002) for 
the primary purpose of hedging or mitigating any risk directly 
associated with the operation of the plan.'' Some commenters suggested 
that the exclusion should encompass activities such as portfolio 
rebalancing and diversification, and gaining exposure to alternative 
asset classes, and that this type of exclusion also should apply to 
certain other types of entities.\161\
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    \161\ See Cleary letter (addressing welfare plans or entities 
holding assets of such plans, such as voluntary employee beneficiary 
associations, employer group trusts or bank-maintained collective 
trusts); see also letter from Jane Hamblen, State of Wisconsin 
Investment Board, dated September 20, 2010.
---------------------------------------------------------------------------

    We preliminarily do not believe that it is necessary to propose a 
rule to further define the scope of this exclusion. In this regard, we 
note that this ERISA plan exclusion, unlike the other exclusion in the 
first major participant test, is not limited to ``commercial'' risk, 
which may be construed to mean that hedging by ERISA plans should be 
broadly excluded.
    While the Commissions are not proposing to make this type of 
exclusion available to additional types of entities, we request comment 
on whether we should do so. If so, what type of entities should receive 
this type of exclusion, and why do the concerns that led to the 
enactment of the major participant requirements in the Dodd-Frank Act 
not apply to such entities?
2. Application of Major Participant Definitions to Managed Accounts
    Some commenters have stated that asset managers and investment 
advisers should not be deemed to be major participants by virtue of the 
swap and security-based swap positions held by the accounts they 
manage. These commenters have emphasized that asset managers and 
investment advisers are separate legal entities from the accounts that 
they administer, the accounts themselves are the counterparties to the 
swaps and security-based swaps, and managers and advisers do not 
maintain capital to support the trades of their clients. One commenter 
also expressed the view that the positions of individual accounts under 
the advisement of a single asset manager should not be aggregated for 
the purpose of the major participant definitions because different 
accounts managed by an asset manager may use the same positions for 
different purposes.\162\
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    \162\ In addition, a colloquy on the Senate floor addressed the 
status of managed accounts for purposes of the major participant 
definitions, particularly focusing on whether the analysis should 
``look at the aggregate positions of funds managed by asset managers 
or at the individual fund level?'' In response, it was stated that, 
``[a]s a general rule, the CFTC and the SEC should look at each 
entity on an individual basis when determining its status as a major 
swap participant.'' See 156 Cong. Rec. S5907 (daily ed. July 15, 
2010) (colloquy between Senators Hagan and Lincoln).
---------------------------------------------------------------------------

    Preliminarily, we do not believe that the major participant 
definitions should be construed to aggregate the accounts managed by 
asset managers or investment advisers to determine if the asset manager 
or investment adviser itself is a major participant. The major 
participant definitions apply to the entities that actually 
``maintain'' substantial positions in swaps and security-based swaps or 
that have swaps or security-based swaps that create substantial 
counterparty exposure. The Commissions have the authority to adopt 
anti-evasion rules to address the possibility that persons who enter 
into swaps and security-based swaps may attempt to allocate the swaps 
and security-based swaps among different accounts (thereby attempting 
to treat such other accounts as the entity that has entered into the 
swaps or security-based swaps) for the purpose of evading the 
regulations applicable to major participants.\163\ In addition, we note 
that since the major participant definitions focus on the entity that 
enters into swaps or security-based swaps, all of the managed positions 
of which a person is the beneficial owner are to be aggregated (along 
with such beneficial owner's other positions) for purposes of 
determining whether such beneficial owner is a major participant.\164\
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    \163\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3).
    \164\ This guidance relates only to the application of the major 
participant definitions to managed accounts. It is not intended to 
apply to the treatment of managed accounts with respect to any other 
rules promulgated by the CFTC or SEC to implement Title VII of the 
Dodd-Frank Act or to any other applicable rules or requirements.
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    The Commissions request comment on the application of the major 
participant definitions to managed accounts. Commenters particularly 
are requested to address: whether additional guidance is necessary to 
address issues relating to the application of the major participant 
definition to managed accounts; whether there are areas of potential 
abuse, and if so, what they may be. Commenters further are requested to 
address whether the Commissions should adopt anti-evasion rules to 
address areas of potential abuse, and if so, how such rules should be 
crafted.
    In addition, commenters are requested to discuss any implementation 
concerns that may arise if the beneficial owner of a managed account 
meets one of the major participant definitions; for example, would the 
beneficial owner face any impediments in terms of identifying whether 
it falls within the major participant definitions? Also, what 
implementation issues would arise with respect to applying the major 
participant definitions to managed accounts and/or their beneficial 
owners if the accounts' advisers or managers are not subject to 
regulation as major participants?
3. Application of Major Participant Definitions to Positions of 
Affiliated Entities
    The issues discussed above with regard to managed accounts also are 
related to the separate issue of whether the major participant tests 
should, in some circumstances, aggregate the swap and security-based 
swap positions of entities that are affiliated. Absent that type of 
aggregation, an entity could seek to evade major participant status by 
allocating swap or security-based swap

[[Page 80202]]

positions among a number of affiliated entities.
    In situations in which a parent is the majority owner of a 
subsidiary entity, we preliminarily believe that the major participant 
tests may appropriately aggregate the subsidiary's swaps or security-
based swaps at the parent for purposes of the substantial position 
analyses.\165\ Attributing those positions to a parent appears 
consistent with the concepts of ``substantial position'' and 
``substantial counterparty exposure,'' given that the parent would 
effectively be the beneficiary of the transaction. In those 
circumstances, however, there still may be questions as to whether the 
requirements applicable to major participants--e.g., capital, margin 
and business conduct--should be placed upon the parent or the 
subsidiary. We recognize that it may be appropriate at times to apply 
such requirements upon the subsidiary to the extent that the subsidiary 
is acting on behalf of the parent.\166\
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    \165\ Arguably, the basis for this type of attribution would be 
even stronger if the parent wholly owns the subsidiary. An 
attribution rule that only addresses 100 percent ownership 
situations, however, may readily be susceptible to gaming if the 
parent were to sell a very small interest in the subsidiary to 
another party.
    \166\ It may also be appropriate to address these issues in 
connection with the rule proposals addressing the substantive 
requirements applicable to major participants.
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    Commenters particularly are invited to discuss when it would be 
appropriate to apply the major participant definitions to entities that 
are the majority owner of subsidiaries that enter into swaps or 
security-based swaps, or whether attribution of a subsidiary's 
security-based swap positions is generally inappropriate. Also, to the 
extent this type of attribution is appropriate, to what extent should 
the subsidiary retain responsibilities for complying with the capital, 
margin, business conduct and other requirements applicable to major 
participants?
    Commenters further are requested to address whether the swaps or 
security-based swaps of corporate subsidiaries in some circumstances 
should be attributed to an entity that itself is not the majority owner 
of the direct counterparty to a swap or security-based swap. Moreover, 
should this type of attribution apply when one entity controls another 
entity, and, if so, how should the concept of control be defined for 
these purposes? In addition, commenters are requested to address 
whether, as an alternative approach, this type of attribution would be 
appropriate specifically when a parent provides guarantees on behalf of 
its subsidiaries, or third parties provide guarantees on behalf of 
unaffiliated entities.
    Commenters further are requested to address any issues that would 
arise with regard to the effective implementation of the requirements 
applicable to major participants in the context of this type of 
attributions.
4. Application of Major Participant Definitions to Inter-Affiliate 
Swaps and Security-Based Swaps
    Several commenters have suggested that swaps and security-based 
swaps between affiliated counterparties should not be considered within 
the analysis of whether an entity's swap or security-based swap 
positions cause it to be a major participant. Such inter-affiliate 
swaps and security-based swaps may be used to achieve various 
operational and internal efficiency objectives.
    The Commissions preliminarily believe that when a person analyzes 
its swap or security-based swap positions under the major participant 
definitions, it would be appropriate for the person to consider the 
economic reality of any swaps or security-based swaps it enters into 
with wholly owned affiliates, including whether the swaps and security-
based swaps simply represent an allocation of risk within a corporate 
group.\167\ Such swaps and security-based swaps among wholly-owned 
affiliates may not pose the exceptional risks to the U.S. financial 
system that are the basis for the major participant definitions. As 
discussed above in the context of managed accounts, however, an entity 
would not be able to evade the requirements applicable to major 
participants by allocating among multiple affiliates swap or security-
based swap positions of which it is the beneficial owner.
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    \167\ Such swaps and security-based swaps should be considered 
in this way only for purposes of determining whether a particular 
person is a major participant. The swaps and security-based swaps 
would continue to be subject to all laws and requirements applicable 
to such swaps and security-based swaps.
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    The Commissions request comment on the treatment of inter-affiliate 
swaps and security-based swaps between wholly-owned affiliates of the 
same corporate parent in connection with the major participant 
definitions. Commenters also are requested to address whether similar 
interpretations should apply to swaps and security-based swaps between 
entities within a consolidated group as determined in accordance with 
U.S. generally accepted accounting principles. Commenters further are 
requested to discuss whether the major participant definition should be 
interpreted to encompass an entity (including an affiliate of the named 
counterparty to the swap or security-based swap) that provides a 
guarantee of the named counterparty's obligations, either in the form 
of a guarantee or through some other form of credit support whereby the 
guarantor agrees to satisfy margin obligations of the named 
counterparty and/or periodic payment obligations of the named 
counterparty.
5. Legacy Portfolios
    Some commenters have stated that certain entities that maintain 
legacy portfolios of credit default swaps that previously had been 
entered into in connection with the activities of monoline insurers and 
``credit derivative product companies'' should not be considered major 
participants. The commenters argued that these entities would be unable 
to comply with the capital and margin requirements applicable to major 
participants, and that regulation as major participants is unnecessary 
given that the entities are not writing any additional swaps or 
security-based swaps.
    We request comment on whether the rules further defining major swap 
participant and major security-based swap participant should exclude 
such entities from the major participant definition if their swap and 
security-based swap positions are limited to those types of legacy 
positions. The exclusion from the definition could be conditional, and 
any such excluded entity would be required to provide the Commissions 
with position information of the type that registered major 
participants would be required to provide. We invite comment on any 
other conditions that might be appropriate to an exclusion of such 
legacy portfolios from the major participant definitions.
6. Potential Exclusions
    Some commenters stated that the major participant definitions 
should not be interpreted to apply to entities such as investment 
companies,\168\ ERISA plans, registered broker-dealers and/or 
registered futures commission

[[Page 80203]]

merchants,\169\ and long-term investors such as sovereign wealth 
funds.\170\
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    \168\ See letter from Karrie McMillan, General Counsel, 
Investment Company Institute, dated September 20, 2010 (registered 
investment companies should be excluded from the major participant 
(and dealer) definitions, or else the terms of the definitions 
should be interpreted to clarify that mutual funds generally will 
not be major participants).
    \169\ See letter from The Swaps & Derivatives Marketing Ass'n, 
dated September 20, 2010 (certain hedged positions of broker-dealers 
and futures commission merchants with customers should not be 
considered as part of the substantial position analysis); Cleary 
letter (registered and well-capitalized broker-dealers and futures 
commission merchants should not fall within the scope of the third 
major participant test).
    \170\ See letter from Lee Ming Chua, General Counsel, Government 
of Singapore Investment Corp., dated September 20, 2010 (stating 
that the major participant definitions were not intended to apply to 
long-term financial investors); see also letter from Richard M. 
Whiting, The Financial Services Roundtable, dated September 20, 2010 
(major participant definitions should exclude firms that solely act 
as investors).
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    These comments, and the rationale behind the comments, raise the 
issue of whether we should exclude, conditionally or unconditionally, 
certain types of entities from the major participant definitions, on 
the grounds that such entities do not present the risks that underpin 
the major participant definitions and/or to avoid duplication of 
existing regulation. While we are not proposing any such exclusions, we 
request comment as to whether we should exclude certain types of 
entities, including those noted above, as well as to entities subject 
to bank capital rules, State-regulated insurers, private and State 
pension plans, and registered derivatives clearing organizations or 
clearing agencies.
    Commenters particularly are requested to address whether such 
exclusions are necessary and appropriate in light of the proposed rules 
that would be applicable to major participants, whether any conditions 
would be appropriate for such exclusions, and whether modifying those 
proposed rules would more effectively address these issues than 
granting specific exclusions from the major participant definitions for 
specific types of entities. Commenters also are particularly requested 
to discuss whether banks should be excluded from the major participant 
definitions because of the regulation to which they already are 
subject. Commenters also are requested to discuss whether registered 
investment companies should be excluded from the major participant 
definitions because of the regulations to which they already are 
subject, and whether registered investment companies would be able to 
comply with capital and margin requirements applicable to major 
participants.
    Commenters also particularly are requested to address whether 
sovereign wealth funds or other entities linked to foreign governments 
should be excluded from the major participant definitions, particularly 
in light of the provisions of the Dodd-Frank Act governing its 
territorial reach, and whether the answer in part should be determined 
based on whether the entity's obligations are backed by the full faith 
and credit of the foreign government.

V. Administrative Law Matters--CEA Revisions (Definitions of ``Swap 
Dealer'' and ``Major Swap Participant,'' and Amendments to Definition 
of ``Eligible Contract Participant'')

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires that agencies consider 
whether the rules they propose will have a significant economic impact 
on a substantial number of small entities and, if so, provide a 
regulatory flexibility analysis respecting the impact.\171\ The rules 
proposed by the CFTC provide definitions that will largely be used in 
future rulemakings and which, by themselves, impose no significant new 
regulatory requirements. Accordingly, the Chairman, on behalf of the 
CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed 
rules will not have a significant economic impact on a substantial 
number of small entities.
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    \171\ 5 U.S.C. 601 et seq.
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B. Paperwork Reduction Act

    The proposed rule will not impose any new recordkeeping or 
information collection requirements, or other collections of 
information that require approval of the Office of Management and 
Budget under the Paperwork Reduction Act.\172\ The CFTC invites public 
comment on the accuracy of its estimate that no additional 
recordkeeping or information collection requirements or changes to 
existing collection requirements would result from the rules proposed 
herein.
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    \172\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Analysis

    Section 15(a) of the CEA \173\ requires the CFTC to consider the 
costs and benefits of its actions before issuing a rulemaking under the 
CEA. By its terms, Section 15(a) does not require the CFTC to quantify 
the costs and benefits of a rule or to determine whether the benefits 
of the rulemaking outweigh its costs; rather, it requires that the CFTC 
``consider'' the costs and benefits of its actions. Section 15(a) 
further specifies that the costs and benefits shall be evaluated in 
light of five broad areas of market and public concern: (1) Protection 
of market participants and the public; (2) efficiency, competitiveness, 
and financial integrity of futures markets; (3) price discovery; (4) 
sound risk management practices; and (5) other public interest 
considerations. The CFTC may in its discretion give greater weight to 
any one of the five enumerated areas and could in its discretion 
determine that, notwithstanding its costs, a particular rule is 
necessary or appropriate to protect the public interest or to 
effectuate any of the provisions or accomplish any of the purposes of 
the CEA.
---------------------------------------------------------------------------

    \173\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

1. Summary of Proposed Requirements
    The proposed regulations would further define the terms ``swap 
dealer,'' ``eligible contract participant,'' ``major swap 
participant,'' and related terms, including ``substantial position'' 
and ``substantial counterparty exposure.'' The proposed regulations 
regarding eligible contract participants are clarifying changes that 
are not expected to have substantive effects on market participants. 
The proposed regulations further defining swap dealer and major swap 
participant are significant because any entity determined to be a swap 
dealer or major swap participant would be subject to registration, 
margin, capital, and business conduct requirements set forth in the 
Dodd-Frank Act, as those requirements are implemented in rules proposed 
or to be proposed by the CFTC. Those requirements will likely lead to 
compliance costs, capital holding costs, and margin posting costs, 
which have been or will be addressed in the CFTC's proposals to 
implement those requirements. On the other hand, those requirements 
will likely lead to benefits in the form of increased market 
transparency, reduced counterparty risk and a lower incidence of 
systemic crises and other market failures. This discussion concerns the 
costs and benefits arising from the proposed definitional tests 
themselves, in terms of the burden on market participants to determine 
how the proposed definitions apply, and the benefits arising from the 
specificity of the proposals.
2. Proposed Regulations Regarding ``Eligible Contract Participant''
    The proposal regarding ``eligible contract participant'' would 
provide that swap dealers and major swap participants would qualify as 
eligible contract participants. The CFTC believes this proposal is in 
line with the expectations of market participants and would impose 
virtually no costs while providing the benefit of greater certainty. 
The proposal would also

[[Page 80204]]

provide that certain commodity pools could not qualify as eligible 
contract participants under certain provisions specified in the 
proposal. The CFTC believes that this proposal clarifies the 
interpretation of this aspect of the eligible contract participant 
definition and would prevent the commodity pools from using a provision 
of the definition that was not intended to apply to the commodity 
pools. Thus, while the proposal would potentially impose some costs on 
the commodity pools that could no longer rely on certain provisions of 
the definition, benefits would arise from preventing the 
misinterpretation of the definition.
3. Proposed Regulations Regarding ``Swap Dealer''
    The proposal regarding ``swap dealer'' would further define the 
term by providing that any person that engages in specified activities 
is a swap dealer. The proposal describes these activities qualitatively 
and in relatively general terms that apply in the same way to all parts 
of the swap markets. With regard to the de minimis exemption from the 
definition, the proposal sets out bright-line quantitative tests to 
determine if a person's swap dealing activity is de minimis. For the 
exclusion of swaps in connection with originating a loan by an insured 
depository institution, the proposal describes the scope of the 
exclusion qualitatively in terms that depend primarily on the terms of 
the swaps that would be eligible for the exclusion and the identity of 
the parties to the swap. Also, the proposal includes a voluntary 
process by which a swap dealer may request that the CFTC limit the swap 
dealer designation to certain aspects of the person's activity.
a. Costs
    The costs to a market participant from the proposed regulations 
further defining ``swap dealer'' would arise primarily from its need to 
review its activities and determine, as a qualitative matter, whether 
its activities are of the type described in the proposal. As its 
activities change from time to time, it would be necessary to repeat 
this review, and ongoing compliance costs may arise if the market 
participant determines that it should adapt its activities so as to not 
be encompassed by the definition. Because the proposed regulations are 
qualitative and on relatively general terms, there may be multiple 
interpretations of the general criteria by market participants. A 
market participant whose activities fall within the realm of those 
described in the proposal may have to incur the costs of a more focused 
review to determine whether or not it is encompassed by the definition.
    The proposal regarding the de minimis exemption, on the other hand, 
would impose lower costs because of the precise, quantitative nature of 
the proposed exemption. A market participant would incur only the cost 
of determining the applicable quantities, such as notional value, 
number of swaps, number of counterparties, and so forth set out in the 
proposal. The CFTC believes that relatively few market participants 
would have to determine whether the de minimis exemption applies to 
their activities, and there would be only a low number of instances 
where application of the quantitative tests would be uncertain. 
Similarly, the CFTC believes that insured depository institutions would 
incur relatively low costs to apply the proposed exclusion of swaps in 
connection with originating loans because the proposed criteria relate 
to matters in which the institution is directly involved.
    Last, the costs of the voluntary process for a request for a 
limited designation as a swap dealer are difficult to predict because 
they would depend on the complexity of the person making the request 
and the particular factors that are relevant to the limited 
designation. The CFTC believes that the person making the request would 
have broad discretion in determining how to do so and thereby could 
control the costs of the request to some extent.
b. Benefits
    The benefits of the proposed regulations further defining ``swap 
dealer'' include that they set out a single set of criteria to be 
applied by all market participants. Thus, the proposed regulations 
create a level playing field that permits all market participants to 
determine, on an equal basis, which activities would potentially lead 
to designation as a swap dealer. The proposed regulations are set out 
in plain language terms that may be understood and applied by all 
market participants without relying on the technical expertise that may 
be required to implement more elaborate tests. The CFTC believes that 
the proposal can be fairly applied by substantially all market 
participants who could potentially be swap dealers.
    Regarding the proposals regarding the de minimis exemption and the 
exclusion of swaps in connection with the origination of loans, 
benefits arise from the relatively specific, quantitative nature of the 
proposals. Since these proposals are expected to be applied by 
relatively few market participants in limited situations, more detailed 
regulations are appropriate. The CFTC believes that these detailed 
criteria will permit market participants to make a relatively quick and 
low-cost determination of whether the exemption or exclusion apply. The 
proposal for requests for a limited swap dealer designation provides 
the benefit of flexibility to allow each market participant making this 
request to determine how to do so.
4. Proposed Regulations Regarding ``Major Swap Participant''
    The proposal regarding ``major swap participant'' would further 
define the term by setting out quantitative thresholds against which a 
market participant would compare its swap activities to determine 
whether it is encompassed by the definition. The proposal would require 
that potential major swap participants analyze their swaps in detail to 
determine, for example, which of their swaps are subject to netting 
agreements or mark-to-market collateralization and the amount of 
collateral posted with respect to the swaps. The proposal includes a 
general, qualitative definition of the swaps that may be excluded from 
the comparison because they are used to ``hedge or mitigate commercial 
risk.'' Like the swap dealer proposal, there is a voluntary process by 
which a major swap participant may request that the CFTC limit the 
major swap participant designation to certain aspects of the person's 
activity.
a. Costs
    The costs to a market participant from the proposed regulations 
further defining ``major swap participant'' would arise primarily from 
its need to analyze its swaps and determine whether it has a 
``substantial position'' or ``substantial counterparty exposure'' as 
defined in the proposal. The proposed rule defines potential future 
exposure by a factor of the dollar notational value of the swap. The 
Commission also considered market-based tests of potential future 
exposure such as margin requirements or other valuations of the 
outstanding position. The Commission decided in favor of a more easily 
implementable test rather than market-based criteria for potential 
future exposure, given that daily variation in market prices is 
captured by the current exposure calculation. The CFTC believes that 
because the proposed quantitative thresholds are high, only very few 
market participants would have to conduct a detailed analysis to 
determine whether they are encompassed by the proposed

[[Page 80205]]

definition. The cost of the detailed analysis would vary for each 
market participant, depending on the particular characteristics of its 
swaps. Similarly, the costs to a market participant of determining 
whether it uses swaps to hedge or mitigate commercial risk would depend 
on how the market participant uses swaps. It is possible that for some 
market participants with complex positions in swaps, the costs of the 
analysis could be relatively high.
    As is the case for the similar proposal regarding swap dealers, the 
costs of the voluntary process for a request for a limited designation 
as a major swap participant are difficult to predict because they would 
depend on the complexity of the particular case. The CFTC believes that 
the person making the request would have broad discretion in 
determining how to do so and thereby could control the costs of the 
request to some extent.
b. Benefits
    The benefits of the proposed regulations further defining ``major 
swap participant'' include that they set out a quantitative, bright-
line test that can be applied at a relatively low cost. Also, the 
definition of ``hedging or mitigating commercial risk'' is stated in 
general terms that may be flexibly applied by potential major swap 
participants. In preparing this proposal, the CFTC considered other 
methods of defining ``major swap participant,'' including multi-factor 
analyses, stress tests and adversary processes. The CFTC believes that 
these other methods would impose significantly higher costs for both 
the market participants that would have to apply them and for the CFTC 
(and, indirectly, the taxpayer), without providing additional benefits. 
The costs would result primarily from the need to retain qualified 
experts who would devote significant time and other resources to a 
detailed analysis of multiple aspects of the potential major swap 
participant's swap positions. The benefits that could justify more 
costly proposals include reductions in arbitrary differences in results 
and greater consistency and predictability. However, other potential 
methods of further defining ``major swap participant'' do not appear 
likely to provide such benefits to an extent that would justify the 
higher costs.
5. Request for Comment
    The CFTC invites public comment on its cost-benefit considerations. 
Commenters are also invited to submit any data or other information 
that they may have quantifying or qualifying the costs and benefits of 
the proposed rules with their comments.

D. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996 (``SBREFA'') \174\ the CFTC must advise the Office of 
Management and Budget as to whether the proposed rules constitute a 
``major'' rule. Under SBREFA, a rule is considered ``major'' where, if 
adopted, it results or is likely to result in: (1) An annual effect on 
the economy of $100 million or more (either in the form of an increase 
or a decrease); (2) a major increase in costs or prices for consumers 
or individual industries; or (3) significant adverse effect on 
competition, investment or innovation. If a rule is ``major,'' its 
effectiveness will generally be delayed for 60 days pending 
Congressional review. We do not believe that any of the proposed rules, 
in their current form, would constitute a major rule.
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    \174\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

    We request comment on the potential impact of the proposed rules on 
the economy on an annual basis, on the costs or prices for consumers or 
individual industries, and on competition, investment or innovation. 
Commenters are requested to provide empirical data and other factual 
support for their views to the extent possible.

VI. Administrative Law Matters--Exchange Act Rules (Definitions of 
``Security-Based Swap Dealer'' and ``Major Security-Based Swap 
Participant'')

A. Paperwork Reduction Act Analysis

    Certain provisions of the proposed rules may impose new 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\175\ The SEC has submitted 
them to the Office of Management and Budget (``OMB'') for review in 
accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. The title of the new 
collection of information is ``Procedural Requirements Associated with 
the Definition of `Hedging or Mitigating Commercial Risk.''' An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless it displays a currently valid OMB 
control number. OMB has not yet assigned a control number to the new 
collection of information.
---------------------------------------------------------------------------

    \175\ 44 U.S.C. 3501 et seq.
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1. Summary of Collection of Information
    Proposed Exchange Act rule 3a67-4 would define the term ``hedging 
or mitigating commercial risk.'' \176\ Security-based swap positions 
that meet this proposed definition would be excluded from the 
``substantial position'' analysis under the first test of the proposed 
definition of major security-based swap participant.
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    \176\ As noted previously, the concept of ``hedging or 
mitigating commercial risk'' also is found in the statutory 
provisions granting an exception to end-users from the mandatory 
clearing requirement in connection with swaps and security-based 
swaps. See CEA section 2(h)(7)(A); Exchange Act section 3C(g)(1)(B) 
(exception from mandatory clearing requirements when one or more 
counterparties are not ``financial entities'' and are using swaps or 
security-based swaps ``to hedge or mitigate commercial risk''). If 
the proposed rule 3a67-4 definition of ``hedging or mitigating 
commercial risk'' is used any future SEC rulemakings, including 
rulemaking with respect to the end-user exception, any necessary 
discussion of administrative law matters relating to the use of 
proposed rule 3a67-4 will be provided at that time.
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    For a security-based swap position to be held for the purpose of 
hedging or mitigating commercial risk under proposed rule 3a67-4, the 
person holding the position must satisfy several conditions, including 
the following:
    (i) The person must identify and document the risks that are being 
reduced by the security-based swap position;
    (ii) The person must establish and document a method of assessing 
the effectiveness of the security-based swaps as a hedge; and
    (iii) The person must regularly assess the effectiveness of the 
security-based swap as a hedge.
2. Proposed Use of Information
    The collections of information in proposed rule 3a67-4 are designed 
to help prevent abuse of the exclusion and to help ensure that the 
exclusion is only available to those entities that are engaged in 
legitimate hedging or risk mitigating activities.
3. Respondents
    The collections of information in proposed rule 3a67-4 would apply 
to those entities seeking to exclude the security-based swap positions 
held for hedging or mitigating commercial risk from the substantial 
position calculation. As discussed below in Section VI.B.4., based on 
the current market, we estimate that approximately 10 entities have 
security-based swap positions of a magnitude that they could 
potentially reach the major security-based swap participant thresholds. 
Accordingly, we estimate that approximately 10 entities would seek to 
avail themselves of the exclusion from

[[Page 80206]]

the substantial position calculation for security-based swap positions 
held for hedging or mitigating commercial risk.
4. Total Annual Reporting and Recordkeeping Burden
    We do not anticipate that the proposed collection of information in 
proposed rule 3a67-4 would cause the estimated 10 entities to incur any 
new costs. We believe that only highly sophisticated market 
participants would potentially meet the proposed thresholds for the 
major security-based swap participant designation and thus have a need 
to take advantage of the exclusion for positions held for hedging or 
mitigating commercial risk (and be required to meet the attendant 
collection requirements). We understand from our staff's discussions 
with industry participants that the entities that have security-based 
swap positions and exposures of this magnitude currently create and 
maintain the documentation proposed to be required in rule 3a67-4, as 
part of their ordinary course business and risk management 
practices.\177\ Thus, we do not believe that any new burdens or costs 
will be imposed on the approximately 10 entities that may seek to use 
the exclusion. We therefore estimate the total annual reporting and 
recordkeeping burden associated with proposed rule 3a67-4 to be 
minimal.
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    \177\ Some entities follow these types of procedures so that 
their hedging transactions will qualify for hedge accounting 
treatment under generally accepted accounting principles, which 
requires procedures similar to those in proposed rule 3a67-4. 
Hedging relationships involving security-based swaps that qualify 
for the hedging or mitigating commercial risk exception in the 
proposed rule are not limited to those recognized as hedges for 
accounting purposes. We believe that all of the estimated 10 
entities that have security-based swap positions of a magnitude that 
they could potentially be deemed to be major security-based swap 
participants already identify and document their risk management 
activities (including their security-based swap positions used to 
hedge or mitigate commercial risks) and assess the effectiveness of 
those activities as a matter of their ordinary business practice--
even if they are not seeking hedge accounting treatment.
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5. Collection of Information is Mandatory
    The collections of information in proposed rule 3a67-4 would be 
mandatory for those entities seeking to exclude positions they hold for 
hedging or mitigating commercial risk from the substantial position 
calculation.
6. Confidentiality
    There is no proposed requirement that the collections of 
information in proposed rule 3a67-4 be provided to the SEC or a third 
party on a regular, ordinary course basis. In a situation where the SEC 
has obtained the information, the SEC would consider requests for 
confidential treatment on a case-by-case basis.
7. Record Retention Period
    Proposed rule 3a67-4 does not contain a specific record retention 
requirement. Nonetheless, we would expect the approximately 10 entities 
that may seek to use the exclusion for positions held for hedging or 
mitigating commercial risk to maintain the records they create in 
connection with the exclusion. Because we understand from our staff's 
discussions with industry participants that the entities that have 
security-based swap positions and exposures of this magnitude currently 
create and maintain the documentation proposed to be required in rule 
3a67-4, as part of their ordinary course business and risk management 
practices, we do not expect any new burdens or costs will be imposed to 
maintain the records.
8. Request for Comments
    The SEC invites comments on these estimates. Pursuant to 44 U.S.C. 
3506(c)(2)(B), the SEC requests comments in order to: (a) Evaluate 
whether the collection of information is necessary for the proper 
performance of our functions, including whether the information will 
have practical utility; (b) evaluate the accuracy of our estimate of 
the burden of the collection of information; (c) determine whether 
there are ways to enhance the quality, utility, and clarity of the 
information to be collected; and (d) evaluate whether there are ways to 
minimize the burden of the collection of information on those who 
respond, including through the use of automated collection techniques 
or other forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. S7-39-10. 
Requests for materials submitted to OMB by the SEC with regard to this 
collection of information should be in writing, with reference to File 
No. S7-39-10, and be submitted to the Securities and Exchange 
Commission, Records Management, Office of Filings and Information 
Services, 100 F Street, NE., Washington, DC 20549-1090. As OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

B. Consideration of Benefits and Costs

1. Introduction
    The Dodd-Frank Act added definitions of ``security-based swap 
dealer'' and ``major security-based swap participant'' to the Exchange 
Act in conjunction with other provisions that require entities meeting 
either of those definitions to register with the SEC and to be subject 
to capital, margin, business conduct and certain other requirements. 
Consistent with the direction of the Dodd-Frank Act, the SEC is 
proposing rules to further define ``major security-based swap 
participant'' along with additional terms used in that definition. The 
SEC also is proposing rules to further define ``security-based swap 
dealer'' and to set forth factors for determining the availability of 
the de minimis exception from that definition. We believe that these 
proposed rules are consistent with the purposes of the Dodd-Frank Act, 
and, as appropriate, set forth objective standards to facilitate market 
participants' compliance with the amendments that the Dodd-Frank Act 
made to the Exchange Act. Market participants, however, may incur costs 
associated with certain of these proposed rules.
    The SEC believes that there would be two categories of potential 
costs. First, there would be costs associated with the regulatory 
requirements that would apply to a ``security-based swap dealer'' or a 
``major security-based swap participant'' (e.g., the registration, 
margin, capital, and business conduct requirements that would be 
imposed on security-based swap dealers and major security-based swap 
participants). While the specific costs and benefits associated with 
these regulatory requirements are being addressed in the SEC's 
proposals to implement those requirements, we recognize that the costs 
and benefits of these proposed definitions are directly linked to the 
costs and benefits of the requirements applicable to dealers and major 
participants. We welcome comment on the costs and benefits of these 
proposed definitions in that broader context.
    Second, there may be costs that entities incur in determining 
whether they qualify as a ``security-based swap dealer'' or a ``major 
security-based swap participant'' under the proposed definitional 
rules. These costs, along

[[Page 80207]]

with the benefits associated with the proposed rules, are discussed 
below.
2. Proposed Exchange Act rule 3a67-1--Definition of ``Major Security-
Based Swap Participant''
    Proposed Exchange Act rule 3a67-1 would largely restate the 
statutory definition of ``major security-based swap participant,'' to 
consolidate the definition and related interpretations for ease of 
reference.
    A person that meets the definition of major security-based swap 
participant generally will be subject to the requirements applicable to 
major security-based swap participants without regard to the purpose 
for which it enters into a security-based swap, and without regard to 
the particular category of security-based swap.\178\ However, the 
statutory definitions provide that a person may be designated as a 
major security-based swap participant for one or more categories of 
security-based swaps or for particular activities without being 
classified as a major security-based swap participant for all 
categories or activities.\179\ Proposed rule 3a67-1 would provide that 
a major security-based swap participant that engages in significant 
activity with respect to only certain types, classes or categories of 
security-based swaps or only in connection with specified activities, 
could obtain relief with respect to other types of security-based swaps 
from certain of the requirements that are applicable to major security-
based swap participants. The rule would have the benefit of 
implementing the statutory provision and providing that major security-
based swap participants may obtain relief from the SEC. A person that 
seeks to be considered to be a major security-based swap participant 
only with respect to one category of security-based swaps, or only with 
respect to certain activities, would be expected to incur costs in 
connection with requesting an order from the SEC. However, any such 
costs would be voluntarily incurred by any person seeking to take 
advantage of that limited designation, and thus we preliminarily do 
believe that those costs would be attributable to the statute and not 
to this rule.
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    \178\ The specific costs associated with these regulatory 
requirements will be addressed in the SEC's proposals to implement 
those requirements.
    \179\ See Exchange Act section 3(a)(67)(C).
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3. Proposed Exchange Act Rule 3a67-2--``Major'' Categories of Security-
Based Swaps
    Proposed Exchange Act rule 3a67-2 would fulfill Congress's mandate 
that the SEC designate ``major'' categories of security-based swaps by 
setting forth two such ``major'' categories--one consisting of credit 
derivatives and the other consisting of equity-swaps and other 
security-based swaps. We believe that these proposed categories would 
have the benefit of being consistent with the different ways in which 
those products are used, as well as market statistics and current 
market infrastructures (particularly the separate trade warehouses for 
credit default swaps and equity swaps). Although, as discussed below, 
this categorization is relevant to the ``substantial position'' tests 
of the ``major security-based swap participant'' definition, we believe 
that the categorization itself would not impose any costs on market 
participants. While the categorization may affect the costs that market 
participants will incur from particular statutory and regulatory 
requirements applicable to major security-based swap participants,\180\ 
those costs are being addressed in our proposals to implement those 
requirements.
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    \180\ For example, distinguishing between categories of 
security-based swaps may cause some entities to incur additional 
costs to calculate their major security-based swap participant 
status with respect to each category. Similarly, categorization may 
affect whether an entity ultimately qualifies as a major security-
based swap participant.
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4. Proposed Exchange Act Rule 3a76-3--Definition of ``Substantial 
Position''
    Proposed Exchange Act rule 3a67-3 would define the term 
``substantial position,'' which is used in the first and third tests of 
the definition of ``major security-based swap participant.'' The Dodd-
Frank Act requires the SEC to define this term. We have proposed two 
tests for identifying the presence of a substantial position--one test 
based on a daily average measure of uncollateralized mark-to-market 
exposure, and one based on a daily average measure of combined 
uncollateralized mark-to-market exposure and potential future exposure. 
Both of these daily measures would be calculated and averaged over a 
calendar quarter.
    We believe that this proposed definition would have the benefit of 
providing objective criteria that reasonably would measure the risks 
associated with security-based swap positions, and reflect the 
counterparty risk and risk to the market factors that are embedded 
within the ``major security-based swap participant'' definition. We 
also believe that the proposed use of objective numerical criteria for 
the substantial position thresholds would promote the predictable 
application and enforcement of the requirements governing major 
security-based swap participants by permitting market participants to 
readily evaluate whether their security-based swap positions meet the 
thresholds.
    The first ``substantial position'' test would encompass entities 
that have a daily average uncollateralized mark-to-market exposure of 
$1 billion in a major category of security-based swaps. The second 
``substantial position'' test would encompass entities that have a 
daily average combined uncollateralized mark-to-market exposure and 
potential future exposure of $2 billion. Potential future exposure 
would be measured, consistent with bank capital rules, largely by 
multiplying notional positions by risk factors. Additional adjustments 
would reflect netting agreements, the presence of central clearing and 
the presence of daily mark-to-market margining practices.
    As previously noted, there will be costs associated with the 
registration, margin, capital, business conduct, and other requirements 
that will be imposed on major security-based swap participants. Those 
costs are being addressed in the SEC's rule proposals to implement 
those requirements. We also believe that there will be costs incurred 
by entities in determining whether they meet the definition of major 
security-based swap participant. These costs are discussed below.
    Based on the current over-the-counter derivatives market, we 
estimate that no more than 10 entities that are not otherwise security-
based swap dealers would have either uncollateralized mark-to-market 
positions \181\ or

[[Page 80208]]

combined uncollateralized current exposure and potential future 
exposure of a magnitude \182\ that may rise close enough to the levels 
of our proposed thresholds to necessitate monitoring to determine 
whether they meet those thresholds. Additionally, we preliminarily 
believe that all of these approximately 10 entities currently maintain 
highly sophisticated financial operations in order to achieve the large 
security-based swap positions necessitating their use of the tests.
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    \181\ We believe that an estimate of an entity's mark-to-market 
exposure associated with its security-based swap positions can be 
derived from the level of an entity's notional positions. We 
recognize that the ratio of exposure to notional amount will vary by 
market participant and by position. We understand that mark-to-
market exposures associated with credit derivative positions on 
average are equal to approximately three percent of an entity's 
level of notional positions in credit derivatives. This estimate is 
based on second quarter 2010 U.S. bank market statistics involving 
credit derivatives, given that banks have credit derivative 
positions with gross positive fair value (which would equate to 
negative fair value for the banks' counterparties) of $403 billion, 
compared to total notional credit derivative positions of $13.9 
trillion. See Office of the Comptroller of the Currency, ``OCC's 
Quarterly Report on Bank Trading and Derivatives Activities'' 
(Second Quarter 2010) at 4 & Table 12. This data suggests that, on 
average, an entity would need to have notional credit derivative 
positions of roughly $33 billion to meet our proposed threshold for 
the first substantial position test, $1 billion in mark-to-market 
exposure.
    We understand, based on our staff's discussions with industry, 
that approximately 39 entities have credit default swap notional 
positions of roughly $33 billion or above. We understand that the 
large majority of those entities are banks or hedge funds (which we 
would expect to fully collateralize their positions with dealers as 
a matter of course). We further understand that banks, securities 
firms, and hedge funds typically collateralize most or all of their 
mark-to-market exposure to U.S. banks as a matter of practice. See 
OCC's Quarterly Report on Bank Trading and Derivatives Activities 
(second quarter 2010) at 6. Therefore, it is not clear if any 
entities would have uncollateralized credit default swap positions 
near the proposed first substantial position threshold of $1 billion 
uncollateralized outward exposure.
    \182\ The proposed risk multiplier of 0.1 for credit derivatives 
would require an entity to have a notional position of $20 billion 
in credit derivatives to reach the proposed $2 billion potential 
future exposure threshold (even before accounting for netting 
adjustments). The proposed additional multiplier of 0.2 for 
security-based swaps cleared by a registered clearing agency or 
subject to daily mark-to-market margining would mean that an entity 
with credit derivative positions that are cleared or subject to 
daily mark-to-market margining would need a notional position in 
credit derivatives of at least $100 billion to potentially reach the 
proposed $2 billion potential future exposure threshold. In this 
example, we are assuming an uncollateralized outward exposure of 
zero.
    We understand, based on our staff's discussions with industry, 
that there are approximately 10 non-dealer entities that have a 
notional position in credit derivatives of over $50 billion.
---------------------------------------------------------------------------

    We expect the costs associated with the proposed substantial 
position tests to be modest for these entities. We understand that the 
entities that have this magnitude of security-based swap positions 
already monitor and collect all of the data necessary for the proposed 
substantial position tests. Preliminarily, we understand that these 
entities already use automated systems to gauge their positions and 
exposures and assist in their risk management. Accordingly, we estimate 
that each of the entities would incur a one-time programming cost,\183\ 
as well as ongoing costs associated with the continuing use and 
monitoring of the testing.\184\ We estimate that the one-time 
programming cost would be approximately $13,444 per entity, and 
$134,440 for all entities.\185\ We estimate that the annual ongoing 
costs would be approximately $7,260 per entity, and $72,600 for all 
entities.\186\
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    \183\ For each of the entities, we estimate that the initial 
programming would require the following levels of work from a 
Compliance Attorney, Compliance Manager, Programmer Analyst, Senior 
Internal Auditor, and Chief Financial Officer. The estimated 
contributions are as follows: approximately 2 hours of work from a 
Compliance Attorney to advise the entity's compliance department on 
the legal requirements associated with the proposed tests; 
approximately 8 hours of work from a Compliance Manager to assist a 
Programmer Analyst in making the necessary changes to the entity's 
existing automated system and to oversee and manage the entire 
programming process; approximately 40 hours of work from a 
Programmer Analyst to make the necessary programming changes to the 
existing automated system and to test the system; approximately 8 
hours of work from a Senior Internal Auditor to perform quality 
assurance to ensure that the automated system is properly performing 
the proposed tests; and approximately 3 hours of work from the 
entity's Chief Financial Officer to monitor the process. We estimate 
that the hourly wage of a Compliance Attorney, Compliance Manager, 
Programmer Analyst, Senior Internal Auditor, and Chief Financial 
Officer would be approximately $291, $294, $190, $195, and $450, 
respectively. The $291/hour figure for a Compliance Attorney, the 
$294/hour figure for a Compliance Manager, the $190/hour figure for 
a Programmer Analyst, and the $195/hour figure for a Senior Internal 
Auditor are from SIFMA's Management & Professional Earnings in the 
Securities Industry 2009, modified by SEC staff to account for an 
1800-hour work-year and multiplied by 5.35 to account for bonuses, 
firm size, employee benefits, and overhead. The $450/hour figure for 
a Chief Financial Officer is from http://www.payscale.com, modified 
by SEC staff to account for an 1800-hour work-year and multiplied by 
5.35 to account for bonuses, firm size, employee benefits, and 
overhead. See http://www.payscale.com (last visited Nov. 1, 2010).
    \184\ We anticipate that each entity would incur ongoing 
monitoring costs to evaluate their test results and to ensure that 
the tests are properly run. We estimate that each entity would have 
a Senior Internal Auditor spend approximately 4 hours each quarter 
(or a total of 16 hours annually) to perform this quality assurance. 
We also estimate that each entity would need a Compliance Attorney, 
a Compliance Manager, and its Chief Financial Officer to each spend 
approximately 1 hour each quarter (or a total of 4 hours annually) 
to monitor the entity's test results and the entity's status under 
the proposed rule.
    \185\ The estimated one-time programming cost of approximately 
$13,444 per entity and $134,440 for all entities was calculated as 
follows: (Compliance Attorney at $291 per hour for 2 hours) + 
(Compliance Manager at $294 per hour for 8 hours) + (Programmer 
Analyst at $190 per hour for 40 hours) + (Senior Internal Auditor at 
$195 per hour for 8 hours) + (Chief Financial Officer at $450 per 
hour for 3 hours) x (10 entities) = $134,440.
    \186\ The estimated ongoing monitoring cost of approximately 
$7,260 per year per entity and $72,600 per year for all entities was 
calculated as follows: (Senior Internal Auditor at $195 per hour for 
16 hours) (Compliance Attorney at $291 per hour for 4 hours) + 
(Compliance Manager at $294 per hour for 4 hours) + (Chief Financial 
Officer at $450 per hour for 4 hours) x (10 entities) = $72,600.
---------------------------------------------------------------------------

5. Proposed Exchange Act Rule 3a67-4--Definition of ``Hedging or 
Mitigating Commercial Risk''
    Proposed Exchange Act rule 3a67-4 would define the term ``hedging 
or mitigating commercial risk.'' Security-based swap positions that 
meet that definition are excluded from the ``substantial position'' 
analysis under the first test of the major participant definition. The 
proposed rule is intended to be objective and promote the predictable 
application and enforcement of the requirements governing major 
security-based swap participants.
    For a security-based swap position to be held for the purpose of 
hedging or mitigating commercial risk under proposed Exchange Act rule 
3a67-4, the person holding the position must satisfy certain 
conditions:
    (i) The person must identify and document the risks that are being 
reduced by the security-based swap position;
    (ii) The person must establish and document a method of assessing 
the effectiveness of the security-based swap as a hedge; and
    (iii) The person must regularly assess the effectiveness of the 
security-based swap as a hedge.
    Proposed rule 3a67-4 would affect whether an entity will meet the 
definition of major security-based swap participant. The specific costs 
associated with these regulatory requirements are being addressed in 
the SEC's proposals to implement those requirements.
    While we expect that there could be some potential costs associated 
with the procedural requirements of proposed rule 3a67-4, as described 
in Section VI.B.4., supra, we expect only highly sophisticated entities 
to hold security-based swap positions of a magnitude that would require 
use of the proposed tests. Thus, we do not anticipate that these 
proposed procedural requirements would cause market participants to 
incur costs that they do not incur already as a matter of their 
ordinary business and risk management practices. Accordingly, we do not 
expect that the proposed definition of ``hedging or mitigating 
commercial risk'' would impose any costs on the potentially affected 
entities beyond those already regularly incurred by these entities as a 
matter of course.
6. Proposed Exchange Act Rule 3a67-5--Definition of ``Substantial 
Counterparty Exposure That Could Have Serious Adverse Effects on The 
Financial Stability of The United States Banking System or Financial 
Markets''
    Proposed Exchange Act rule 3a67-5 would define ``substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets,'' a term that comprises part of the second test of the ``major 
security-based swap participant'' definition. This proposed rule would

[[Page 80209]]

parallel the ``substantial position'' analysis discussed above, but 
would examine an entity's security-based swap positions as a whole 
(rather than focusing on a particular ``major'' category), and would 
not exclude certain hedging positions. Consistent with this broader 
scope, and the proposal that there be two ``major'' categories of 
security-based swaps, the thresholds used in this test would be two 
times the comparable ``substantial position'' thresholds. We believe 
that this approach reasonably would measure the counterparty exposure 
associated with the entirety of an entity's security-based swap 
positions, consistent with the risk factors in the ``major security-
based swap participant'' definition. Additionally, we believe that the 
proposed definition would provide objective criteria and promote the 
predictable application and enforcement of the requirements governing 
major security-based swap participants by permitting market 
participants to readily evaluate whether their security-based swap 
positions meet the proposed thresholds.
    We believe that the same approximately 10 entities would calculate 
their substantial counterparty exposure under this rule as would 
undertake the substantial position calculation under proposed rule 
3a67-3. Given that the threshold for this proposed rule is derived from 
the calculations of substantial position that would be mandated by 
proposed rule 3a67-3, we do not anticipate that it would create any 
costs outside of those already covered in the discussion of the 
estimated costs associated with the proposed definition of substantial 
position.
7. Proposed Exchange Act Rule 3a67-6--Definitions of ``Financial 
Entity'' and ``Highly Leveraged''
    Proposed Exchange Act rule 3a67-6 would define the terms 
``financial entity'' and ``highly leveraged,'' both of which are used 
in the third test of the ``major security-based swap participant'' 
definition. The proposed definition of ``financial entity'' would be 
consistent with the use of that term in the Title VII exception from 
mandatory clearing for end-users of security-based swaps (subject to 
limited technical changes). One of the two alternative proposed 
definitions of ``highly leveraged'' would be consistent with a standard 
used in Title I of the Dodd-Frank Act, while the other alternative is 
based on an understanding of typical leverage ratios for certain 
financial entities. We believe that these proposed alternative 
standards would apply reasonable objective criteria to implement and 
further define the third test. Additionally, we believe that the 
proposed use of these objective definitions and numerical criteria 
would promote the predictable application and enforcement of the 
requirements governing major security-based swap participants by 
permitting market participants to readily evaluate whether they meet 
the threshold for major security-based swap participant status.
    We do not believe that the proposed definition of ``financial 
entity'' would impose any significant costs on market entities, given 
the objective nature of the definition. We also do not believe that the 
proposed definition of ``highly leveraged''--a balance sheet test that 
would be based on the ratio of an entity's liabilities and equity, and 
that, in the case of entities subject to public reporting requirements, 
could be derived from financial statements filed with the SEC--would 
impose any significant costs on entities that have security-based swap 
positions large enough to potentially meet the ``substantial position'' 
requirement that is part of the third test.
8. Proposed Exchange Act Rule 3a67-7--Timing Requirements, Reevaluation 
Period and Termination of Status
    Proposed Exchange Act rule 3a67-7 would set forth methods for 
specifying when an entity that satisfies the tests specified within the 
definition of ``major security-based swap participant'' would be deemed 
to meet that definition. The proposed rule also would address the 
termination of an entity's status as a major security-based swap 
participant. We believe that the proposed rule would set forth 
pragmatic standards for permitting entities that have security-based 
swap positions that require registration to go through the registration 
process, and to terminate their status when appropriate. We believe 
that this proposed rule would impose no direct costs on market 
entities.\187\
---------------------------------------------------------------------------

    \187\ As noted above, we recognize that major security-based 
swap participants will incur costs associated with the registration 
and termination of registration processes. These costs will be 
addressed in the SEC rule's proposals to implement those 
requirements.
---------------------------------------------------------------------------

9. Proposed Exchange Act Rule 3a71-1--Definition of ``Security-Based 
Swap Dealer''
    Proposed Exchange Act rule 3a71-1 largely would restate the 
statutory definition of ``security-based swap dealer,'' to consolidate 
the definition and related interpretations for market participants' 
ease of reference. We are not proposing to further define the four 
specific tests set forth in the ``security-based swap dealer'' 
definition. However, our release contains interpretive language that 
would have the benefit of providing additional legal certainty to 
market participants. While market participants would incur certain 
costs to analyze whether their security-based swap activities cause 
them to be on the ``dealer'' side of the dealer-trader distinction 
(which would require them to register with the SEC and comply with the 
other requirements applicable to security-based swap dealers unless 
they can take advantage of the de minimis exception), these costs would 
be incurred because of the statutory change, rather than due to 
proposed rule 3a71-1. The Dodd-Frank Act determined that persons that 
engage in dealing activities involving security-based swaps should be 
subject to comprehensive regulation, and any such analytic costs arise 
from Congress's determination to amend the Exchange Act.\188\
---------------------------------------------------------------------------

    \188\ Based on our staff's discussions with industry, we 
estimate that approximately 50 entities may be required to register 
as security-based swap dealers following implementation of these 
proposed rules. The specific costs associated with these regulatory 
requirements will be addressed in the SEC's proposals to implement 
those requirements.
---------------------------------------------------------------------------

10. Proposed Exchange Act Rule 3a71-2--de Minimis Exception
    Proposed Exchange Act rule 3a71-2 would set forth factors for 
determining whether a person that otherwise would be a security-based 
swap dealer can take advantage of the de minimis exception. The Dodd-
Frank Act directed the SEC to promulgate these factors.\189\ The 
proposed factors would account for an entity's annual notional 
security-based swap positions in a dealing capacity, its total notional 
security-based swap positions in a dealing capacity when the 
counterparty is a ``special entity,'' \190\ and its total number of 
counterparties and security-based swaps as a dealer. We believe that 
these factors appropriately would focus on dealing activities that do 
not warrant an entity's regulation as a security-based swap dealer. We 
also believe that these objective numerical criteria for the de minimis 
exception would promote the predictable application and enforcement of 
the de minimis exception from security-based swap dealer status.
---------------------------------------------------------------------------

    \189\ See Section 761(a)(6) of the Dodd-Frank Act.
    \190\ See Section 15F(h)(2)(C) of the Exchange Act.
---------------------------------------------------------------------------

    In general, we would expect a person that enters into security-
based swaps in a dealing capacity would, as a matter of course, be 
aware of the notional amount

[[Page 80210]]

of those positions, whether a particular counterparty is a ``special 
entity,'' and the total number of counterparties and security-based 
swaps it has in a dealer capacity. As a result, we believe that there 
would be no new costs incurred by entities in assessing the 
availability of the de minimis exception. Moreover, any costs 
associated with ensuring that a person can take advantage of the de 
minimis exception would be voluntarily incurred by entities that engage 
in dealing activities that seek to take advantage of the exception.
11. Request for Comments
    The SEC requests comment on these estimated benefits and costs. 
Commenters particularly are requested to address: the accuracy of our 
estimate that there would be approximately 10 entities in the market 
(that would not otherwise be security-based swap dealers) that would 
have security-based swap positions of a magnitude that may rise close 
enough to the levels of our proposed thresholds to necessitate 
monitoring to determine whether they meet those thresholds; the 
accuracy of our estimate that there would be approximately 50 entities 
in the market that may be required to register as security-based swap 
dealers following implementation of the proposed rules; the accuracy of 
our estimates of the costs associated with entities performing the 
proposed substantial position tests; whether the entities that have 
security-based swap positions that are significant enough to 
potentially meet one or more of the tests in the ``major security-based 
swap participant'' definition would, as a matter of course, already 
have the data necessary to perform the two proposed substantial 
position tests, and if not, what additional data would they need and 
how much time and expense would gathering that data require; whether 
these same entities would, as a matter of course, already comply with 
the proposed procedural requirements associated with the exclusion for 
positions that are for the purpose of ``hedging or mitigating 
commercial risk;'' and whether entities would change their behavior to 
avoid meeting the proposed definitions of ``security-based swap 
dealer'' or ``major security-based swap participant,'' and if so, what, 
if any, economic costs would be associated with such behavioral 
changes.
    In addition, and more generally, we request comment on the costs 
and benefits of these proposed definitions in the broader context of 
the substantive rules, including capital, margin and business conduct 
rules, applicable to dealers and major participants. Commenters 
particularly are requested to address whether the proposed scope of the 
dealer and major participant definitions are appropriate in light of 
the costs and benefits associated with those substantive rules.

C. Consideration of Burden on Competition, and Promotion of Efficiency, 
Competition, and Capital Formation

    Section 3(f) of the Exchange Act requires the SEC, whenever it 
engages in rulemaking and is required to consider or determine whether 
an action is necessary or appropriate in the public interest, to 
consider whether the action would promote efficiency, competition, and 
capital formation.\191\ In addition, Section 23(a)(2) of the Exchange 
Act \192\ requires the SEC, when adopting rules under the Exchange Act, 
to consider the impact such rules would have on competition. Section 
23(a)(2) of the Exchange Act also prohibits the SEC from adopting any 
rule that would impose a burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \191\ 15 U.S.C. 78c(f).
    \192\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We preliminarily do not believe that the proposed rules would 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Exchange Act. We are 
proposing rules to further define ``major security-based swap 
participant,'' along with several terms used in that definition. We are 
also proposing rules to further define ``security-based swap dealer'' 
and to set forth factors for determining the availability of the de 
minimis exception from that definition. We believe that the proposed 
rules are consistent with the purposes of Title VII of the Dodd-Frank 
Act, and, as appropriate, set forth objective standards to facilitate 
market participants' compliance with the amendments that Title VII of 
the Dodd-Frank Act made to the Exchange Act. These amendments mandate 
that the SEC regulate major security-based swap participants and 
security-based swap dealers, which include some, but not all, entities 
that enter into security-based swaps. Although regulation of certain 
security-based swap market participants may result in competitive 
burdens to these entities when compared to unregulated security-based 
swap market participants, these burdens stem directly from Congress's 
decision to impose regulation on a specified set of security-based swap 
market participants through the Dodd-Frank Act.
    While our decisions on how to further define the terms may have 
some effect on competition (e.g., our determinations regarding the 
proposed definition of substantial position will affect whether 
entities qualify as major security-based swap participants), we 
preliminarily do not believe that our decisions would impose additional 
competitive burdens on entities outside of those that Congress 
previously imposed through its decision in Title VII of the Dodd-Frank 
Act to regulate and differentiate security-based swap market 
participants. Moreover, we believe that defining substantial position 
will help provide market participants with legal certainty regarding 
their need to register as major security-based swap participants and is 
necessary and appropriate to implement the purposes of regulating 
security-based swap dealers and major security-based swap participants.
    We also preliminarily believe that the proposed rules would promote 
efficiency. We believe that the proposed rules would set forth clear 
objective standards to facilitate market participants' compliance with 
the amendments that the Dodd-Frank Act made to the Exchange Act. 
Moreover, we believe that the proposed rules would promote the 
predictable application and enforcement of the Exchange Act. We also 
have considered what effect, if any, our proposed rules would have on 
capital formation. We preliminarily do not believe that our proposed 
rules would have a negative effect on capital formation.
    The SEC requests comment on the effect of the proposed rules on 
efficiency, competition, and capital formation. Commenters are 
particularly requested to address whether entities would change their 
behavior to avoid meeting the proposed definitions of ``security-based 
swap dealer'' or ``major security-based swap participant,'' and if so, 
how. Commenters are also requested to address the effect, if any, that 
the proposed definitions of ``substantial position,'' ``hedging or 
mitigating commercial risk,'' ``substantial counterparty exposure,'' 
``financial entity,'' or ``highly leveraged,'' or the proposed 
categories of security-based swaps would have on business decisions, 
trading behavior, transaction costs, or capital allocation. We also 
request comment on the effect, if any that the proposed de minimis 
exception to the definition of security-based swap dealer would have on 
business decisions, trading behavior, transaction costs, or capital 
allocation, and if so, how. Commenters are particularly

[[Page 80211]]

encouraged to provide quantitative information to support their views.

D. Consideration of Impact on the Economy

    For purposes of SBREFA, the SEC must advise the Office of 
Management and Budget as to whether the proposed rules constitute a 
``major'' rule. Under SBREFA, a rule is considered ``major'' where, if 
adopted, it results or is likely to result in: (1) An annual effect on 
the economy of $100 million or more (either in the form of an increase 
or a decrease); (2) a major increase in costs or prices for consumers 
or individual industries; or (3) significant adverse effect on 
competition, investment or innovation. If a rule is ``major,'' its 
effectiveness will generally be delayed for 60 days pending 
Congressional review. We do not believe that any of the proposed rules, 
in their current form, would constitute a major rule.
    We request comment on the potential impact of the proposed rules on 
the economy on an annual basis, on the costs or prices for consumers or 
individual industries, and on competition, investment or innovation. 
Commenters are requested to provide empirical data and other factual 
support for their views to the extent possible.

E. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \193\ requires Federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities. Section 603(a) \194\ of the Administrative Procedure 
Act,\195\ as amended by the RFA, generally requires the SEC to 
undertake a regulatory flexibility analysis of all proposed rules, or 
proposed rule amendments, to determine the impact of such rulemaking on 
``small entities.'' \196\ Section 605(b) of the RFA provides that this 
requirement shall not apply to any proposed rule or proposed rule 
amendment, which if adopted, would not have a significant economic 
impact on a substantial number of small entities.\197\
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    \193\ 5 U.S.C. 601 et seq.
    \194\ 5 U.S.C. 603(a).
    \195\ 5 U.S.C. 551 et seq.
    \196\ Although Section 601(b) of the RFA defines the term 
``small entity,'' the statute permits the Commissions to formulate 
their own definitions. The SEC has adopted definitions for the term 
small entity for the purposes of SEC rulemaking in accordance with 
the RFA. Those definitions, as relevant to this proposed rulemaking, 
are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange 
Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982) 
(File No. AS-305).
    \197\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    For purposes of SEC rulemaking in connection with the RFA, a small 
entity includes: (i) When used with reference to an ``issuer'' or a 
``person,'' other than an investment company, an ``issuer'' or 
``person'' that, on the last day of its most recent fiscal year, had 
total assets of $5 million or less,\198\ or (ii) a broker-dealer with 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to Rule 17a-5(d) under the 
Exchange Act,\199\ or, if not required to file such statements, a 
broker-dealer with total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last day of the preceding 
fiscal year (or in the time that it has been in business, if shorter); 
and is not affiliated with any person (other than a natural person) 
that is not a small business or small organization.\200\ Under the 
standards adopted by the Small Business Administration, small entities 
in the finance and insurance industry include the following: (i) For 
entities engaged in credit intermediation and related activities, 
entities with $175 million or less in assets; \201\ (ii) for entities 
engaged in non-depository credit intermediation and certain other 
activities, entities with $7 million or less in annual receipts; \202\ 
(iii) for entities engaged in financial investments and related 
activities, entities with $7 million or less in annual receipts; \203\ 
(iv) for insurance carriers and entities engaged in related activities, 
entities with $7 million or less in annual receipts; \204\ and (v) for 
funds, trusts, and other financial vehicles, entities with $7 million 
or less in annual receipts.\205\
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    \198\ See 17 CFR 240.0-10(a).
    \199\ See 17 CFR 240.17a-5(d).
    \200\ See 17 CFR 240.0-10(c).
    \201\ See 13 CFR 121.201 (Subsector 522).
    \202\ See id. at Subsector 522.
    \203\ See id. at Subsector 523.
    \204\ See id. at Subsector 524.
    \205\ See id. at Subsector 525.
---------------------------------------------------------------------------

    Based on feedback from industry participants about the security-
based swap markets, the SEC preliminarily believes that entities that 
would qualify as security-based swap dealers and major security-based 
swap market participants, whether registered broker-dealers or not, 
exceed the thresholds defining ``small entities'' set out above. Thus, 
the SEC believes it is unlikely that the proposed rules would have a 
significant economic impact any small entity.
    For the foregoing reasons, the SEC certifies that the proposed 
rules would not have a significant economic impact on a substantial 
number of small entities for purposes of the RFA.
    The SEC encourages written comments regarding this certification. 
The SEC requests that commenters describe the nature of any impact on 
small entities and provide empirical data to illustrate the extent of 
the impact.

VII. Statutory Basis and Rule Text

List of Subjects

17 CFR Part 1

    Definitions.

17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

Commodity Futures Trading Commission

Text of Proposed Rules

    For the reasons stated in this release, the CFTC is proposing to 
amend 17 CFR part 1 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 
13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 
111-203, 124 Stat. 1376 (2010).

    2. Amend Sec.  1.3 by:
    a. Adding paragraph (m); and
    b. As proposed to be amended at 75 FR 63762, October 18, 2010, and 
75 FR 77576, December 13, 2010, adding (ppp) through (vvv) to read as 
follows:


Sec.  1.3  Definitions

* * * * *
    (m) Eligible contract participant. This term has the meaning set 
forth in Section 1a(18) of the Commodity Exchange Act, except that:
    (1) A major swap participant, as defined in Section 1a(33) of the 
Commodity Exchange Act and Sec.  1.3(qqq), is an eligible contract 
participant;
    (2) A swap dealer, as defined in Section 1a(49) of the Commodity 
Exchange Act and Sec.  1.3(ppp), is an eligible contract participant;
    (3) A major security-based swap participant, as defined in Section 
3(a)(67) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(67)) 
and Sec.  240.3a67-1 of this title, is an eligible contract 
participant;
    (4) A security-based swap dealer, as defined in Section 3(a)(71) of 
the

[[Page 80212]]

Securities and Exchange Act of 1934 (15 U.S.C. 78c(a)(71)) and Sec.  
240.3a71-1 of this title, is an eligible contract participant;
    (5) A commodity pool with one or more direct or indirect 
participants that is not an eligible contract participant is not an 
eligible contract participant for purposes of Sections 2(c)(2)(B)(vi) 
and 2(c)(2)(C)(vii) of the Commodity Exchange Act; and
    (6) A commodity pool that does not have total assets exceeding 
$5,000,000 or that is not operated by a person described in clause 
(A)(iv)(II) of Section 1a(18) of the Commodity Exchange Act is not an 
eligible contract participant pursuant to clause (A)(v) of such 
Section.
* * * * *
    (ppp) Swap Dealer. (1) In general. The term ``swap dealer'' means 
any person who:
    (i) Holds itself out as a dealer in swaps;
    (ii) Makes a market in swaps;
    (iii) Regularly enters into swaps with counterparties as an 
ordinary course of business for its own account; or
    (iv) Engages in any activity causing it to be commonly known in the 
trade as a dealer or market maker in swaps.
    (2) Exception. The term ``swap dealer'' does not include a person 
that enters into swaps for such person's own account, either 
individually or in a fiduciary capacity, but not as a part of regular 
business.
    (3) Scope. A person who is a swap dealer shall be deemed to be a 
swap dealer with respect to each swap it enters into, regardless of the 
category of the swap or the person's activities in connection with the 
swap. However, if a person makes an application to limit its 
designation as a swap dealer to specified categories of swaps or 
specified activities of the person in connection with swaps, the 
Commission shall determine whether the person's designation as a swap 
dealer shall be so limited. A person may make such application to limit 
its designation at the same time as, or at a later time subsequent to, 
the person's initial registration as a swap dealer.
    (4) De minimis exception. A person shall not be deemed to be a swap 
dealer as a result of swap dealing activity involving counterparties 
that meets each of the following conditions:
    (i) The swap positions connected with those activities into which 
the person enters over the course of the immediately preceding 12 
months have an aggregate gross notional amount of no more than $100 
million, and have an aggregate gross notional amount of no more than 
$25 million with regard to swaps in which the counterparty is a 
``special entity'' (as that term is defined in Section 4s(h)(2)(C) of 
the Commodity Exchange Act). For purposes of this paragraph, if the 
stated notional amount of a swap is leveraged or enhanced by the 
structure of the swap, the calculation shall be based on the effective 
notional amount of the swap rather than on the stated notional amount.
    (ii) The person has not entered into swaps in connection with those 
activities with more than 15 counterparties, other than swap dealers, 
over the course of the immediately preceding 12 months. In determining 
the number of counterparties, all counterparties that are members of a 
single group of persons under common control shall be considered to be 
a single counterparty.
    (iii) The person has not entered into more than 20 swaps in 
connection with those activities over the course of the immediately 
preceding 12 months. For purposes of this paragraph, each transaction 
entered into under a master agreement for swaps shall constitute a 
distinct swap, but entering into an amendment of an existing swap in 
which the counterparty to such swap remains the same and the item 
underlying such swap remains substantially the same shall not 
constitute entering into a swap.
    (5) Insured depository institution swaps in connection with 
originating loans to customers. Swaps entered into by an insured 
depository institution with a customer in connection with originating a 
loan with that customer shall not be considered in determining whether 
such person is a swap dealer.
    (i) A swap shall be considered to have been entered into in 
connection with originating a loan only if the rate, asset, liability 
or other notional item underlying such swap is, or is directly related 
to, a financial term of such loan. The financial terms of a loan 
include, without limitation, the loan's duration, rate of interest, the 
currency or currencies in which it is made and its principal amount.
    (ii) An insured depository institution shall be considered to have 
originated a loan with a customer if the insured depository 
institution:
    (A) Directly transfers the loan amount to the customer;
    (B) Is a part of a syndicate of lenders that is the source of the 
loan amount that is transferred to the customer;
    (C) Purchases or receives a participation in the loan; or
    (D) Otherwise is the source of funds that are transferred to the 
customer pursuant to the loan or any refinancing of the loan.
    (iii) The term loan shall not include:
    (A) Any transaction that is a sham, whether or not intended to 
qualify for the exclusion from the definition of the term swap dealer 
in this rule; or
    (B) Any synthetic loan, including without limitation a loan credit 
default swap or loan total return swap.
    (qqq) Major Swap Participant. (1) In general. The term major swap 
participant means any person:
    (i) That is not a swap dealer; and
    (ii)(A) That maintains a substantial position in swaps for any of 
the major swap categories, excluding both positions held for hedging or 
mitigating commercial risk, and positions maintained by any employee 
benefit plan (or any contract held by such a plan) as defined in 
paragraphs (3) and (32) of Section 3 of the Employee Retirement Income 
Security Act of 1974 (29 U.S.C. 1002) for the primary purpose of 
hedging or mitigating any risk directly associated with the operation 
of the plan;
    (B) Whose outstanding swaps create substantial counterparty 
exposure that could have serious adverse effects on the financial 
stability of the United States banking system or financial markets; or
    (C) That is a financial entity that:
    (1) Is highly leveraged relative to the amount of capital such 
entity holds and that is not subject to capital requirements 
established by an appropriate Federal banking agency (as defined in 
Section 1a(2) of the Commodity Exchange Act); and
    (2) Maintains a substantial position in outstanding swaps in any 
major swap category.
    (2) Scope of designation. A person that is a major swap participant 
shall be deemed to be a major swap participant with respect to each 
swap it enters into, regardless of the category of the swap or the 
person's activities in connection with the swap. However, if a person 
makes an application to limit its designation as a major swap 
participant to specified categories of swaps or specified activities of 
the person in connection with swaps, the Commission shall determine 
whether the person's designation as a major swap participant shall be 
so limited. A person may make such application to limit its designation 
at the same time as, or at a later time subsequent to, the person's 
initial registration as a major swap participant.
    (3) Timing requirements. A person that is not registered as a major 
swap participant, but that meets the criteria in this rule to be a 
major swap participant as a result of its swap activities in a

[[Page 80213]]

fiscal quarter, will not be deemed to be a major swap participant until 
the earlier of the date on which it submits a complete application for 
registration as a major swap participant or two months after the end of 
that quarter.
    (4) Reevaluation period. Notwithstanding paragraph (qqq)(3) of this 
section, if a person that is not registered as a major swap participant 
meets the criteria in this rule to be a major swap participant in a 
fiscal quarter, but does not exceed any applicable threshold by more 
than twenty percent in that quarter:
    (i) That person will not immediately be subject to the timing 
requirements specified in paragraph (qqq)(3) of this section; but
    (ii) That person will become subject to the timing requirements 
specified in paragraph (3) at the end of the next fiscal quarter if the 
person exceeds any of the applicable daily average thresholds in that 
next fiscal quarter.
    (5) Termination of status. A person that is deemed to be a major 
swap participant shall continue to be deemed a major swap participant 
until such time that its swap activities do not exceed any of the daily 
average thresholds set forth within this rule for four consecutive 
fiscal quarters after the date on which the person becomes registered 
as a major swap participant.
    (rrr) Category of swaps; major swap category. For purposes of 
Sections 1a(33) and 1a(49) of the Commodity Exchange Act and Sec. Sec.  
1.3(ppp) and 1.3(qqq), the terms major swap category, category of swaps 
and any similar terms mean any of the categories of swaps listed below. 
For the avoidance of doubt, the term swap as it is used in this Sec.  
1.3(rrr) has the meaning set forth in Section 1a(47) of the Commodity 
Exchange Act and the rules thereunder.
    (1) Rate swaps. Any swap which is primarily based on one or more 
reference rates, including but not limited to any swap of payments 
determined by fixed and floating interest rates, currency exchange 
rates, inflation rates or other monetary rates, any foreign exchange 
swap, as defined in Section 1a(25) of the Commodity Exchange Act, and 
any foreign exchange option.
    (2) Credit swaps. Any swap that is primarily based on instruments 
of indebtedness, including but not limited to any swap primarily based 
on one or more broad-based indices related to debt instruments, and any 
swap that is an index credit default swap or total return swap on one 
or more indices of debt instruments.
    (3) Equity swaps. Any swap that is primarily based on equity 
securities, including but not limited to any swap based on one or more 
broad-based indices of equity securities and any total return swap on 
one or more equity indices.
    (4) Other commodity swaps. Any swap that is not included in the 
rate swap, credit swap or equity swap categories.
    (sss) Substantial position. (1) In general. For purposes of Section 
1a(33) of the Commodity Exchange Act and Sec.  1.3(qqq), the term 
substantial position means swap positions, other than positions that 
are excluded from consideration, that equal or exceed any of the 
following thresholds in the specified major category of swaps:
    (i) For rate swaps:
    (A) $3 billion in daily average aggregate uncollateralized outward 
exposure; or
    (B) $6 billion in:
    (1) Daily average aggregate uncollateralized outward exposure plus
    (2) Daily average aggregate potential outward exposure.
    (ii) For credit swaps:
    (A) $1 billion in daily average aggregate uncollateralized outward 
exposure; or
    (B) $2 billion in:
    (1) Daily average aggregate uncollateralized outward exposure plus
    (2) Daily average aggregate potential outward exposure.
    (iii) For equity swaps:
    (A) $1 billion in daily average aggregate uncollateralized outward 
exposure; or
    (B) $2 billion in:
    (1) Daily average aggregate uncollateralized outward exposure plus
    (2) Daily average aggregate potential outward exposure.
    (iv) For other commodity swaps:
    (A) $1 billion in daily average aggregate uncollateralized outward 
exposure; or
    (B) $2 billion in:
    (1) Daily average aggregate uncollateralized outward exposure plus
    (2) Daily average aggregate potential outward exposure.
    (2) Aggregate uncollateralized outward exposure. (i) In general. 
Aggregate uncollateralized outward exposure in general means the sum of 
the current exposure, obtained by marking-to-market using industry 
standard practices, of each of the person's swap positions with 
negative value in a major swap category, less the value of the 
collateral the person has posted in connection with those positions.
    (ii) Calculation of aggregate uncollateralized outward exposure. In 
calculating this amount the person shall, with respect to each of its 
swap counterparties in a given major swap category:
    (A) Determine the dollar value of the aggregate current exposure 
arising from each of its swap positions with negative value (subject to 
the netting provisions described below) in that major category by 
marking-to-market using industry standard practices; and
    (B) Deduct from that dollar amount the aggregate value of the 
collateral the person has posted with respect to the swap positions. 
The aggregate uncollateralized outward exposure shall be the sum of 
those uncollateralized amounts across all of the person's swap 
counterparties in the applicable major category.
    (iii) Relevance of netting agreements. (A) If the person has a 
master netting agreement in effect with a particular counterparty, the 
person may measure the current exposure arising from its swaps in any 
major category on a net basis, applying the terms of the agreement. 
Calculation of net exposure may take into account offsetting positions 
entered into with that particular counterparty involving swaps (in any 
swap category) as well as security-based swaps and securities financing 
transactions (consisting of securities lending and borrowing, 
securities margin lending and repurchase and reverse repurchase 
agreements), to the extent these are consistent with the offsets 
permitted by the master netting agreement.
    (B) Such adjustments may not take into account any offset 
associated with positions that the person has with separate 
counterparties.
    (3) Aggregate potential outward exposure. (i) In general. Aggregate 
potential outward exposure in any major swap category means the sum of:
    (A) The aggregate potential outward exposure for each of the 
person's swap positions in a major swap category that are not subject 
to daily mark-to-market margining and are not cleared by a registered 
clearing agency or derivatives clearing organization, as calculated in 
accordance with paragraph (sss)(3)(ii); and
    (B) The aggregate potential outward exposure for each of the 
person's swap positions in such major swap category that are subject to 
daily mark-to-market margining or are cleared by a registered clearing 
agency or derivatives clearing organization, as calculated in 
accordance with paragraph (sss)(3)(iii) of this section.
    (ii) Calculation of potential outward exposure for swaps that are 
not subject to daily mark-to-market margining and are not cleared by a 
registered clearing

[[Page 80214]]

agency or derivatives clearing organization. (A) In general. (1) For 
positions in swaps that are not subject to daily mark-to-market 
margining and are not cleared by a registered clearing agency or a 
derivatives clearing organization, potential outward exposure equals 
the total notional principal amount of those positions, adjusted by the 
following multipliers on a position-by-position basis reflecting the 
type of swap. For any swap that does not appropriately fall within any 
of the specified categories, the ``other commodities'' conversion 
factors are to be used. If a swap is structured such that on specified 
dates any outstanding exposure is settled and the terms are reset so 
that the market value of the swap is zero, the remaining maturity 
equals the time until the next reset date.

                          Table to Sec.   1.3 (sss)--Conversion Factor Matrix for Swaps
----------------------------------------------------------------------------------------------------------------
                                                     Foreign exchange     Precious metals
      Residual maturity          Interest rate        rate and gold        (except gold)      Other commodities
----------------------------------------------------------------------------------------------------------------
One year or less............                0.00                 0.01                  0.07                 0.10
Over one to five years......                0.005                0.05                  0.07                 0.12
Over five years.............                0.015                0.075                 0.08                 0.15
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
       Residual maturity               Credit               Equity
------------------------------------------------------------------------
One year or less..............                 0.10                 0.06
Over one to five years........                 0.10                 0.08
Over five years...............                 0.10                 0.10
------------------------------------------------------------------------

     (2) Use of effective notional amounts. If the stated notional 
amount on a position is leveraged or enhanced by the structure of the 
position, the calculation in paragraph (sss)(3)(ii)(A)(1) of this 
section shall be based on the effective notional amount of the position 
rather than on the stated notional amount.
    (3) Exclusion of certain positions. The calculation in paragraph 
(sss)(3)(ii)(A)(1) of this section shall exclude:
    (i) Positions that constitute the purchase of an option, such that 
the person has no additional payment obligations under the position; 
and
    (ii) Other positions for which the person has prepaid or otherwise 
satisfied all of its payment obligations.
    (4) Adjustment for certain positions. Notwithstanding paragraph 
(sss)(3)(ii)(A)(1) of this section, the potential outward exposure 
associated with a position by which a person buys credit protection 
using a credit default swap or index credit default swap is capped at 
the net present value of the unpaid premiums.
    (B) Adjustment for netting agreements. Notwithstanding paragraph 
(sss)(3)(ii)(A) of this section, for positions subject to master 
netting agreements the potential outward exposure associated with the 
person's swaps with each counterparty equals a weighted average of the 
potential outward exposure for the person's swaps with that 
counterparty as calculated under paragraph (sss)(3)(ii)(A), and that 
amount reduced by the ratio of net current exposure to gross current 
exposure, consistent with the following equation as calculated on a 
counterparty-by-counterparty basis:

    PNet = 0.4 * PGross + 0.6 * NGR * PGross


    Note to paragraph (sss)(3)(ii)(B): PNet is the potential outward 
exposure, adjusted for bilateral netting, of the person's swaps with 
a particular counterparty; PGross is that potential outward exposure 
without adjustment for bilateral netting; and NGR is the ratio of 
net current exposure to gross current exposure.

    (iii) Calculation of potential outward exposure for swaps that are 
subject to daily mark-to-market margining or are cleared by a 
registered clearing agency or derivatives clearing organization. For 
positions in swaps that are subject to daily mark-to-market margining 
or cleared by a registered clearing agency or derivatives clearing 
organization:
    (A) Potential outward exposure equals the potential exposure that 
would be attributed to such positions using the procedures in paragraph 
(sss)(3)(ii) of this section multiplied by 0.2.
    (B) For purposes of this calculation, a swap shall be considered to 
be subject to daily mark-to-market margining if, and for so long as, 
the counterparties follow the daily practice of exchanging collateral 
to reflect changes in the current exposure arising from the swap (after 
taking into account any other financial positions addressed by a 
netting agreement between the counterparties. If the person is 
permitted by agreement to maintain a threshold for which it is not 
required to post collateral, the total amount of that threshold 
(regardless of the actual exposure at any time) shall be added to the 
person's aggregate uncollateralized outward exposure for purposes of 
paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section, 
as applicable. If the minimum transfer amount under the agreement is in 
excess of $1 million, the entirety of the minimum transfer amount shall 
be added to the person's aggregate uncollateralized outward exposure 
for purposes of paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B), 
as applicable.
    (4) Calculation of daily average. Measures of daily average 
aggregate uncollateralized outward exposure and daily average aggregate 
potential outward exposure shall equal the arithmetic mean of the 
applicable measure of exposure at the close of each business day, 
beginning the first business day of each calendar quarter and 
continuing through the last business day of that quarter.
    (ttt) Hedging or mitigating commercial risk. For purposes of 
Section 1a(33) of the Commodity Exchange Act and Sec.  1.3(qqq), a swap 
position shall be deemed to be held for the purpose of hedging or 
mitigating commercial risk when:
    (1) Such position:
    (i) Is economically appropriate to the reduction of risks in the 
conduct and management of a commercial enterprise, where the risks 
arise from:
    (A) The potential change in the value of assets that a person owns, 
produces, manufactures, processes, or merchandises or reasonably 
anticipates owning, producing, manufacturing, processing, or 
merchandising in the ordinary course of business of the enterprise;
    (B) The potential change in the value of liabilities that a person 
has incurred or reasonably anticipates incurring in the ordinary course 
of business of the enterprise; or
    (C) The potential change in the value of services that a person 
provides, purchases, or reasonably anticipates

[[Page 80215]]

providing or purchasing in the ordinary course of business of the 
enterprise;
    (D) The potential change in the value of assets, services, inputs, 
products, or commodities that a person owns, produces, manufactures, 
processes, merchandises, leases, or sells, or reasonably anticipates 
owning, producing, manufacturing, processing, merchandising, leasing, 
or selling in the ordinary course of business of the enterprise;
    (E) Any potential change in value related to any of the foregoing 
arising from foreign exchange rate movements associated with such 
assets, liabilities, services, inputs, products, or commodities; or
    (F) Any fluctuation in interest, currency, or foreign exchange rate 
exposures arising from a person's current or anticipated assets or 
liabilities; or
    (ii) Qualifies as bona fide hedging for purposes of an exemption 
from position limits under the Commodity Exchange Act; or
    (iii) Qualifies for hedging treatment under Financial Accounting 
Standards Board Accounting Standards Codification Topic 815, 
Derivatives and Hedging (formerly known as Statement No. 133); and
    (2) Such position is:
    (i) Not held for a purpose that is in the nature of speculation, 
investing or trading;
    (ii) Not held to hedge or mitigate the risk of another swap or 
securities-based swap position, unless that other position itself is 
held for the purpose of hedging or mitigating commercial risk as 
defined by this rule or Sec.  240.3a67-4 of this title.
    (uuu) Substantial counterparty exposure. (1) In general. For 
purposes of Section 1a(33) of the Act and Sec.  1.3(qqq), the phrase 
substantial counterparty exposure that could have serious adverse 
effects on the financial stability of the United States banking system 
or financial markets means a swap position that satisfies either of the 
following thresholds:
    (i) $5 billion in daily average aggregate uncollateralized outward 
exposure; or
    (ii) $8 billion in:
    (A) Daily average aggregate uncollateralized outward exposure plus
    (B) Daily average aggregate potential outward exposure.
    (2) Calculation methodology. For these purposes, the terms ``daily 
average aggregate uncollateralized outward exposure'' and ``daily 
average aggregate potential outward exposure'' have the same meaning as 
in Sec.  1.3(sss), except that these amounts shall be calculated by 
reference to all of the person's swap positions, rather than by 
reference to a specific major swap category.
    (vvv) Financial entity; highly leveraged. (1) For purposes of 
Section 1a(33) of the Commodity Exchange Act and Sec.  1.3(qqq), the 
term ``financial entity'' means:
    (i) A security-based swap dealer;
    (ii) A major security-based swap participant;
    (iii) A commodity pool as defined in Section 1a(10) of the 
Commodity Exchange Act;
    (iv) A private fund as defined in Section 202(a) of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-2(a));
    (v) An employee benefit plan as defined in paragraphs (3) and (32) 
of Section 3 of the Employee Retirement Income Security Act of 1974 (29 
U.S.C. 1002); and
    (vi) A person predominantly engaged in activities that are in the 
business of banking or financial in nature, as defined in Section 4(k) 
of the Bank Holding Company Act of 1956.
    (2) For purposes of Section 1a(33) of the Commodity Exchange Act 
and Sec.  1.3(qqq), the term ``highly leveraged'' means the existence 
of a ratio of an entity's total liabilities to equity in excess of [8 
to 1 or 15 to 1] as measured at the close of business on the last 
business day of the applicable fiscal quarter. For this purpose, 
liabilities and equity should each be determined in accordance with 
U.S. generally accepted accounting principles.

Securities and Exchange Commission

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and 
particularly, Sections 3 and 23 thereof, and Sections 712 and 761(b) of 
the Dodd-Frank Act, the SEC is proposing to adopt Rules 3a67-1, 3a67-2, 
3a67-3, 3a67-4, 3a67-5, 3a67-6, 3a67-7, 3a71-1, and 3a71-2 under the 
Exchange Act.

Text of Proposed Rules

    For the reasons stated in the preamble, the SEC is proposing to 
amend Title 17, Chapter II of the Code of the Federal Regulations as 
follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 is amended by adding the 
following citation in numerical order:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78p, 78q, 78s, 
78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 
80b-4, 80b-11, and 7201 et seq., 18 U.S.C. 1350; and 12 U.S.C. 
5221(e)(3), unless otherwise noted.
* * * * *
    Sections 3a67-1 through 3a67-7 and sections 3a71-1 and 3a71-2 
are also issued under Pub. L. 111-203, Sec. Sec.  712, 761(b), 124 
Stat. 1841 (2010).
* * * * *
    2. Add Sec. Sec.  240.3a67-1 through 240.3a67-7 and Sec. Sec.  
240.3a71-1, 240.3a71-2 to read as follows:
* * * * *
Sec.
240.3a67 1--Definition of ``Major Security-based Swap Participant.''
240.3a67 2--Categories of Security-based Swaps.
240.3a67 3--Definition of ``Substantial Position.''
240.3a67 4--Definition of ``Hedging or Mitigating Commercial Risk.''
240.3a67 5--Definition of ``Substantial Counterparty Exposure.''
240.3a67 6--Definitions of ``Financial Entity'' and ``Highly 
Leveraged.''
240.3a67 7--Timing Requirements, Reevaluation Period, and 
Termination of Status.
240.3a71 1--Definition of ``Security-based Swap Dealer.
240.3a71 2--De minimis Exception.
* * * * *


Sec.  240.3a67-1  Definition of ``Major Security-based Swap 
Participant.''

    (a) General. Major security-based swap participant means any 
person:
    (1) That is not a security-based swap dealer; and
    (2)(i) That maintains a substantial position in security-based 
swaps for any of the major security-based swap categories, excluding 
both positions held for hedging or mitigating commercial risk, and 
positions maintained by any employee benefit plan (or any contract held 
by such a plan) as defined in paragraphs (3) and (32) of section 3 of 
the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002) 
for the primary purpose of hedging or mitigating any risk directly 
associated with the operation of the plan;
    (ii) Whose outstanding security-based swaps create substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets; or
    (iii) That is a financial entity that:
    (A) Is highly leveraged relative to the amount of capital such 
entity holds and that is not subject to capital requirements 
established by an appropriate Federal banking agency (as defined in 15 
U.S.C. 78c(a)(72)); and
    (B) Maintains a substantial position in outstanding security-based 
swaps in any major security-based swap category.

[[Page 80216]]

    (b) Scope of designation. A person that is a major security-based 
swap participant in general shall be deemed to be a major security-
based swap participant with respect to each security-based swap it 
enters into, regardless of the category of the security-based swap or 
the person's activities in connection with the security-based swap, 
unless the Commission limits the person's designation as a major 
security-based swap participant to specified categories of security-
based swaps or specified activities of the person in connection with 
security-based swaps.


Sec.  240.3a67-2  Categories of Security-based Swaps.

    For purposes of sections 3(a)(67) and 3(a)(71) of the Act, 15 
U.S.C. 78c(a)(67) and 78c(a)(71), and the rules thereunder, the terms 
major security-based swap category, category of security-based swaps 
and any similar terms mean either of the following categories of 
security-based swaps:
    (a) Security-based credit derivatives. Any security-based swap that 
is based, in whole or in part, on one or more instruments of 
indebtedness (including loans), or on a credit event relating to one or 
more issuers or securities, including but not limited to any security-
based swap that is a credit default swap, total return swap on one or 
more debt instruments, debt swap, debt index swap, or credit spread.
    (b) Other security-based swaps. Any security-based swap not 
described in paragraph (a) of this section.


Sec.  240.3a67-3  Definition of ``Substantial Position.''

    (a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C. 
78c(a)(67), and Sec.  240.3a67-1 of this chapter, the term substantial 
position means security-based swap positions, other than positions that 
are excluded from consideration, that equal or exceed either of the 
following thresholds in any major category of security-based swaps:
    (1) $1 billion in daily average aggregate uncollateralized outward 
exposure; or
    (2) $2 billion in:
    (i) Daily average aggregate uncollateralized outward exposure; plus
    (ii) Daily average aggregate potential outward exposure.
    (b) Aggregate uncollateralized outward exposure. (1) General. 
Aggregate uncollateralized outward exposure in general means the sum of 
the current exposure, obtained by marking-to-market using industry 
standard practices, of each of the person's security-based swap 
positions with negative value in a major security-based swap category, 
less the value of the collateral the person has posted in connection 
with those positions.
    (2) Calculation of aggregate uncollateralized outward exposure. In 
calculating this amount the person shall, with respect to each of its 
security-based swap counterparties in a given major security-based swap 
category:
    (i) Determine the dollar value of the aggregate current exposure 
arising from each of its security-based swap positions with negative 
value (subject to the netting provisions described below) in that major 
category by marking-to-market using industry standard practices; and
    (ii) Deduct from that dollar amount the aggregate value of the 
collateral the person has posted with respect to the security-based 
swap positions. The aggregate uncollateralized outward exposure shall 
be the sum of those uncollateralized amounts across all of the person's 
security-based swap counterparties in the applicable major category.
    (3) Relevance of netting agreements. (i) If a person has a master 
netting agreement with a counterparty, the person may measure the 
current exposure arising from its security-based swaps in any major 
category on a net basis, applying the terms of the agreement. 
Calculation of net exposure may take into account offsetting positions 
entered into with that particular counterparty involving security-based 
swaps (in any swap category) as well as swaps and securities financing 
transactions (consisting of securities lending and borrowing, 
securities margin lending and repurchase and reverse repurchase 
agreements), to the extent these are consistent with the offsets 
permitted by the master netting agreement.
    (ii) Such adjustments may not take into account any offset 
associated with positions that the person has with separate 
counterparties.
    (c) Aggregate potential outward exposure. (1) General. Aggregate 
potential outward exposure means the sum of:
    (i) The aggregate potential outward exposure for each of the 
person's security-based swap positions in a major security-based swap 
category that are not cleared by a registered clearing agency or 
subject to daily mark-to-market margining, as calculated in accordance 
with paragraph (c)(2) of this section; and
    (ii) The aggregate potential outward exposure for each of the 
person's security-based swap positions in a major security-based swap 
category that are cleared by a registered clearing agency or subject to 
daily mark-to-market margining, as calculated in accordance with 
paragraph (c)(3) of this section.
    (2) Calculation of potential outward exposure for security-based 
swaps that are not cleared by a registered clearing agency or subject 
to daily mark-to-market margining.
    (i) General. (A)(1) For positions in security-based swaps that are 
not cleared by a registered clearing agency or subject to daily mark-
to-market margining, potential outward exposure equals the total 
notional principal amount of those positions, multiplied by the 
following factors on a position-by-position basis reflecting the type 
of security-based swap. For any security-based swap that is not of the 
``credit'' or ``equity'' type, the ``other'' conversion factors are to 
be used:

----------------------------------------------------------------------------------------------------------------
                Residual maturity                         Credit               Equity               Other
----------------------------------------------------------------------------------------------------------------
One year or less.................................                 0.10                 0.06                 0.10
Over one to five years...........................                 0.10                 0.08                 0.12
Over five years..................................                 0.10                 0.10                 0.15
----------------------------------------------------------------------------------------------------------------

    (2) If a security-based swap is structured such that on specified 
dates any outstanding exposure is settled and the terms are reset so 
that the market value of the security-based swap is zero, the remaining 
maturity equals the time until the next reset date.
    (B) Use of effective notional amounts. If the stated notional 
amount on a position is leveraged or enhanced by the structure of the 
position, the calculation in paragraph (c)(2)(i)(A) of this section 
shall be based on the effective notional amount of the position rather 
than on the stated notional amount.

[[Page 80217]]

    (C) Exclusion of certain positions. The calculation in paragraph 
(c)(2)(i)(A) of this section shall exclude:
    (1) Positions that constitute the purchase of an option, such that 
the person has no additional payment obligations under the position; 
and
    (2) Other positions for which the person has prepaid or otherwise 
satisfied all of its payment obligations.
    (D) Adjustment for certain positions. Notwithstanding paragraph 
(c)(2)(i)(A) of this section, the potential outward exposure associated 
with a position by which a person buys credit protection using a credit 
default swap is capped at the net present value of the unpaid premiums.
    (ii) Adjustment for netting agreements. Notwithstanding paragraph 
(c)(2)(i) of this section, for positions subject to master netting 
agreements the potential outward exposure associated with the person's 
security-based swaps with each counterparty equals a weighted average 
of the potential outward exposure for the person's security-based swaps 
with that counterparty as calculated under paragraph (c)(2)(i) of this 
section, and that amount reduced by the ratio of net current exposure 
to gross current exposure, consistent with the following equation as 
calculated on a counterparty-by-counterparty basis:

    PNet = 0.4 x PGross + 0.6 x NGR x PGross


    Note to paragraph (c)(2)(ii). Where: PNet is the potential 
outward exposure, adjusted for bilateral netting, of the person's 
security-based swaps with a particular counterparty; PGross is that 
potential outward exposure without adjustment for bilateral netting; 
and NGR is the ratio of net current exposure to gross current 
exposure.

    (3) Calculation of potential outward exposure for security-based 
swaps that are cleared by a registered clearing agency or subject to 
daily mark-to-market margining. For positions in security-based swaps 
that are cleared by a registered clearing agency or subject to daily 
mark-to-market margining:
    (i) Potential outward exposure equals the potential outward 
exposure that would be attributed to such positions using the 
procedures in paragraph (c)(2) of this section, multiplied by 0.2.
    (ii) For purposes of this calculation, a security-based swap shall 
be considered to be subject to daily mark-to-market margining if, and 
for as long as, the counterparties follow the daily practice of 
exchanging collateral to reflect changes in the current exposure 
arising from the security-based swap (after taking into account any 
other financial positions addressed by a netting agreement between the 
counterparties). If the person is permitted by agreement to maintain a 
threshold for which it is not required to post collateral, the total 
amount of that threshold (regardless of the actual exposure at any 
time) shall be added to the person's aggregate uncollateralized outward 
exposure for purposes of paragraph (a)(2) of this section. If the 
minimum transfer amount under the agreement is in excess of $1 million, 
the entirety of the minimum transfer amount shall be added to the 
person's aggregate uncollateralized outward exposure for purposes of 
paragraph (a)(2) of this section.
    (d) Calculation of daily average. Measures of daily average 
aggregate uncollateralized outward exposure and daily average aggregate 
potential outward exposure shall equal the arithmetic mean of the 
applicable measure of exposure at the close of each business day, 
beginning the first business day of each calendar quarter and 
continuing through the last business day of that quarter.


Sec.  240.3a67-4  Definition of ``Hedging or Mitigating Commercial 
Risk.''

    For purposes of section 3(a)(67) of the Act, 15 U.S.C. 78c(a)(67), 
and Sec.  240.3a67-1 of this chapter, a security-based swap position 
shall be deemed to be held for the purpose of hedging or mitigating 
commercial risk when:
    (a) Such position is economically appropriate to the reduction of 
risks that are associated with the present conduct and management of a 
commercial enterprise, or are reasonably expected to arise in the 
future conduct and management of the commercial enterprise, where such 
risks arise from:
    (1) The potential change in the value of assets that a person owns, 
produces, manufactures, processes, or merchandises or reasonably 
anticipates owning, producing, manufacturing, processing, or 
merchandising in the ordinary course of business of the enterprise;
    (2) The potential change in the value of liabilities that a person 
has incurred or reasonably anticipates incurring in the ordinary course 
of business of the enterprise; or
    (3) The potential change in the value of services that a person 
provides, purchases, or reasonably anticipates providing or purchasing 
in the ordinary course of business of the enterprise;
    (b) Such position is:
    (1) Not held for a purpose that is in the nature of speculation or 
trading; and
    (2) Not held to hedge or mitigate the risk of another security-
based swap position or swap position, unless that other position itself 
is held for the purpose of hedging or mitigating commercial risk as 
defined by this section or 17 CFR 1.3(ttt); and
    (c) The person holding the position satisfies the following 
additional conditions:
    (1) The person identifies and documents the risks that are being 
reduced by the security-based swap position;
    (2) The person establishes and documents a method of assessing the 
effectiveness of the security-based swap as a hedge; and
    (3) The person regularly assesses the effectiveness of the 
security-based swap as a hedge.


Sec.  240.3a67-5  Definition of ``Substantial Counterparty Exposure.''

    (a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C. 
78c(a)(67), and Sec.  240.3a67-1 of this chapter, the term substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets means a security-based swap position that satisfies either of 
the following thresholds:
    (1) $2 billion in daily average aggregate uncollateralized outward 
exposure; or
    (2) $4 billion in:
    (i) Daily average aggregate uncollateralized outward exposure; plus
    (ii) Daily average aggregate potential outward exposure.
    (b) Calculation. For these purposes, daily average aggregate 
uncollateralized outward exposure and daily average aggregate potential 
outward exposure shall be calculated the same way as is prescribed in 
Sec.  240.3a67-3 of this chapter, except that these amounts shall be 
calculated by reference to all of the person's security-based swap 
positions, rather than by reference to a specific major security-based 
swap category.


Sec.  240.3a67-6  Definitions of ``Financial Entity'' and ``Highly 
Leveraged.''

    (a) For purposes of section 3(a)(67) of the Act, 15 U.S.C. 
78c(a)(67), and Sec.  240.3a67-1 of this chapter, the term financial 
entity means:
    (1) A swap dealer;
    (2) A major swap participant;
    (3) A commodity pool as defined in section 1a(10) of the Commodity 
Exchange Act (7 U.S.C. 1a(10));
    (4) A private fund as defined in section 202(a) of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-2(a));
    (5) An employee benefit plan as defined in paragraphs (3) and (32) 
of section 3 of the Employee Retirement Income Security Act of 1974 (29 
U.S.C. 1002); and

[[Page 80218]]

    (6) A person predominantly engaged in activities that are in the 
business of banking or financial in nature, as defined in section 4(k) 
of the Bank Holding Company Act of 1956 (12 U.S.C. 1843k).
    (b) For purposes of section 3(a)(67) of the Act, 15 U.S.C. 
78c(a)(67), and Sec.  240.3a67-1 of this chapter, the term highly 
leveraged means the existence of a ratio of an entity's total 
liabilities to equity in excess of [8 to 1 or 15 to 1] as measured at 
the close of business on the last business day of the applicable fiscal 
quarter. For this purpose, liabilities and equity should each be 
determined in accordance with U.S. generally accepted accounting 
principles.


Sec.  240.3a67-7  Timing Requirements, Reevaluation Period, and 
Termination of Status.

    (a) Timing requirements. A person that is not registered as a major 
security-based swap participant, but that meets the criteria in Sec.  
240.3a67-1 of this chapter to be a major security-based swap 
participant as a result of its security-based swap activities in a 
fiscal quarter, will not be deemed to be a major security-based swap 
participant until the earlier of the date on which it submits a 
complete application for registration pursuant to 15 U.S.C. 78o-8 or 
two months after the end of that quarter.
    (b) Reevaluation period. Notwithstanding paragraph (a) of this 
section, if a person that is not registered as a major security-based 
swap participant meets the criteria in Sec.  240.3a67-1 of this chapter 
to be a major security-based swap participant in a fiscal quarter, but 
does not exceed any applicable threshold by more than twenty percent in 
that quarter:
    (1) That person will not immediately be subject to the timing 
requirements specified in paragraph (a) of this section; but
    (2) That person will become subject to the timing requirements 
specified in paragraph (a) of this section at the end of the next 
fiscal quarter if the person exceeds any of the applicable daily 
average thresholds in that next fiscal quarter.
    (c) Termination of status. A person that is deemed to be a major 
security-based swap participant shall continue to be deemed a major 
security-based swap participant until such time that its security-based 
swap activities do not exceed any of the daily average thresholds set 
forth within Sec.  240.3a67-1 of this chapter for four consecutive 
fiscal quarters after the date on which the person becomes registered 
as a major security-based swap participant.


Sec.  240.3a71-1  Definition of ``Security-based Swap Dealer.''

    (a) General. The term security-based swap dealer in general means 
any person who:
    (1) Holds itself out as a dealer in security-based swaps;
    (2) Makes a market in security-based swaps;
    (3) Regularly enters into security-based swaps with counterparties 
as an ordinary course of business for its own account; or
    (4) Engages in any activity causing it to be commonly known in the 
trade as a dealer or market maker in security-based swaps.
    (b) Exception. The term security-based swap dealer does not include 
a person that enters into security-based swaps for such person's own 
account, either individually or in a fiduciary capacity, but not as a 
part of regular business.
    (c) Scope of designation. A person that is a security-based swap 
dealer in general shall be deemed to be a security-based swap dealer 
with respect to each security-based swap it enters into, regardless of 
the category of the security-based swap or the person's activities in 
connection with the security-based swap, unless the Commission limits 
the person's designation as a major security-based swap participant to 
specified categories of security-based swaps or specified activities of 
the person in connection with security-based swaps.


Sec.  240.3a71-2  De minimis Exception.

    For purposes of section 3(a)(71) of the Act, 15 U.S.C. 78c(a)(71), 
and Sec.  240.3a71-1 of this chapter, a person shall not be deemed to 
be a security-based swap dealer as a result of security-based swap 
dealing activity involving counterparties that meets each of the 
following conditions:
    (a) Notional amount of outstanding security-based swap positions. 
The security-based swap positions connected with those activities into 
which the person enters over the course of the immediately preceding 12 
months have an aggregate gross notional amount of no more than $100 
million and have an aggregate gross notional amount of no more than $25 
million with regard to security-based swaps in which the counterparty 
is a ``special entity'' (as that term is defined in 15 U.S.C. 78o-8). 
For purposes of this paragraph (a), if the stated notional amount of a 
security-based swap is leveraged or enhanced by the structure of the 
security-based swap, the calculation shall be based on the effective 
notional amount of the security-based swap rather than on the stated 
notional amount.
    (b) No more than 15 counterparties. The person does not enter into 
security-based swaps in connection with those activities with more than 
15 counterparties, other than security-based swap dealers, over the 
course of the immediately preceding 12 months. In determining the 
number of counterparties, all counterparties that are members of a 
single affiliated group shall be considered to be a single 
counterparty.
    (c) No more than 20 security-based swaps. The person has not 
entered into more than 20 security-based swaps in connection with those 
activities over the course of the immediately preceding 12 months. For 
purposes of this paragraph, each transaction entered into under a 
master agreement for security-based swaps shall constitute a distinct 
security-based swap, but entering into an amendment of an existing 
security-based swap in which the counterparty to such swap remains the 
same and the notional item underlying such security-based swap remains 
substantially the same shall not constitute entering into a security-
based swap.

    Dated: December 1, 2010.

    By the Commodity Futures Trading Commission.
David A. Stawick,
Secretary.
    Dated: December 7, 2010.

    By the Securities and Exchange Commission.
Elizabeth M. Murphy,
Secretary.

Additional Statement by the Commodity Futures Trading Commission 
Regarding the Joint Proposed Rule Entitled ``Further Definition of 
`Swap Dealer,' `Security-Based Swap Dealer,' `Major Swap Participant,' 
`Major Security-Based Swap Participant,' and `Eligible Contract 
Participant.'''

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

[FR Doc. 2010-31130 Filed 12-20-10; 8:45 am]
BILLING CODE 6351-01-P; 8011-01-P


