2012-18383

Federal Register, Volume 77 Issue 146 (Monday, July 30, 2012)[Federal Register Volume 77, Number 146 (Monday, July 30, 2012)]

[Rules and Regulations]

[Pages 44441-44456]

From the Federal Register Online via the Government Printing Office [www.gpo.gov]

[FR Doc No: 2012-18383]

=======================================================================

-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD60

Swap Transaction Compliance and Implementation Schedule: Clearing

Requirement Under Section 2(h) of the CEA

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

is adopting regulations to establish a schedule to phase in compliance

with the clearing requirement under new section 2(h)(1)(A) of the

Commodity Exchange Act (CEA or Act), enacted under Title VII of the

Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank

Act). The schedule will provide additional time for compliance with

this requirement. This additional time is intended to facilitate the

transition to the new regulatory regime established by the Dodd-Frank

Act in an orderly manner that does not unduly disrupt markets and

transactions.

DATES: The rules will become effective September 28, 2012.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director,

202-418-5684, [email protected]; Brian O'Keefe, Associate Director,

202-418-5658. [email protected]; or Peter Kals, Attorney-Advisor, 202-

418-5466, [email protected], Division of Clearing and Risk, Commodity

Futures Trading Commission, Three Lafayette Centre, 1155 21st Street

NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

II. Comments on the Notices of Proposed Rulemaking

A. Comment Period

B. Harmonization

C. Cross-Border and Affiliate Transactions

D. Comprehensive Implementation Schedule

E. Prerequisite Rules

F. Definitions

1. Active Fund

2. Third-Party Subaccount

3. Category 1 and Category 2 Entities

G. Compliance Schedule for the Clearing Requirement

4. Application to All Swap Types

5. Timing of Implementation Schedules

III. Cost-Benefit Considerations

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide,

under new section 2(h)(1)(A) of the CEA, that it shall be unlawful for

any person to engage in a swap unless that person submits such swap for

clearing to a derivatives clearing organization (DCO) that is

registered under the CEA or a DCO that is exempt from registration

under the CEA if the swap is required to be cleared (the Clearing

Requirement).\1\ Section 2(h)(2) charges the Commission with the

responsibility for determining whether a swap is required to be cleared

(a Clearing Requirement determination), through one of two avenues: (1)

Pursuant to a Commission-initiated review; or (2) pursuant to a

submission from a DCO of each swap, or any group, category, type, or

class of swaps that the DCO ``plans to accept for clearing.'' \2\ The

Commission is proposing its first Clearing Requirement determination

concurrently with its adoption of this compliance schedule rule. The

finalization of that proposal will trigger the compliance schedule

provided for under this adopting release.

---------------------------------------------------------------------------

\1\ Section 2(h)(7) of the CEA provides an exception to the

Clearing Requirement when one of the counterparties to a swap (i) is

not a financial entity, (ii) is using the swap to hedge or mitigate

commercial risk, and (iii) notifies the Commission how it generally

meets its financial obligations associated with entering into a non-

cleared swap.

\2\ Under section 2(h)(2)(B)(ii), the Commission must consider

swaps listed for clearing by a DCO as of the date of enactment of

the Dodd-Frank Act.

---------------------------------------------------------------------------

On September 20, 2011, the Commission published proposed Sec.

39.5(e) \3\ to phase in compliance of the Clearing Requirement upon the

Commission's issuance of a Clearing Requirement determination pursuant

to Sec. 39.5(b) or (c).\4\ That notice of proposed rulemaking (NPRM)

also included an implementation schedule for the requirement pursuant

to amended section 2(h)(8)(A), which requires a swap subject to the

Clearing

[[Page 44442]]

Requirement to be executed on a designated contract market (DCM) or

swap execution facility (SEF), unless no SEF or DCM makes the swap

available to trade (the Trade Execution Requirement). The Commission is

hereby adopting proposed Sec. 39.5(e), as newly designated Sec.

50.25, to establish a schedule for compliance only for the Clearing

Requirement. A separate rulemaking will promulgate the final

implementation schedule for the Trade Execution Requirement.\5\

---------------------------------------------------------------------------

\3\ Commission regulations referred to herein are found at 17

CFR Ch. 1.

\4\ See 76 FR 58186 (Sept. 20, 2011).

\5\ The Commission will address the proposed compliance

schedules for trading documentation and margining under section 4s

of the CEA, 76 FR 58176 (Sept. 20, 2011), at the same time that it

finalizes the underlying documentation and margin rules.

---------------------------------------------------------------------------

The compliance schedule for the Clearing Requirement is based on

the type of market participants entering into a swap subject to the

Clearing Requirement. The compliance schedule balances several goals.

First, the Commission believes that some market participants, such as

certain managed accounts, referred to under Sec. 50.25 as ``Third-

Party Subaccounts,'' may require additional time to bring their swaps

into compliance with the Clearing Requirement. Pursuant to Sec.

39.5(e) (finalized as Sec. 50.25), these market participants would be

afforded additional time to clear their swaps so that they will be able

to document new client clearing arrangements, connect to market

infrastructure such as DCOs, and prepare themselves and their customers

for the new regulatory requirements.

Another goal of the compliance schedule is to have adequate

representation of market participants involved at the outset of

implementing a new regime for requiring certain swaps to be cleared.

The Commission believes that having a cross-section of market

participants involved at the outset of formulating and designing the

rules and infrastructure under which the Clearing Requirement is

implemented will best meet the needs of all market participants.

The compliance schedule set forth in Sec. 50.25 defines three

categories of market participants: Category 1 Entities,\6\ Category 2

Entities,\7\ and all other market participants. As described in Sec.

50.25(b), a swap between two Category 1 Entities must comply with the

Clearing Requirement no later than 90 days after the publication of the

Clearing Requirement determination in the Federal Register.\8\ A swap

between a Category 2 Entity and a Category 1 Entity or another Category

2 Entity must comply within 180 days, and all other swaps must be

submitted for clearing no later than 270 days after the Clearing

Requirement determination is published in the Federal Register. To

clarify, the swap is subject to the latest compliance date for one of

the counterparties. In other words, if a Category 1 Entity enters into

a swap with a Category 2 Entity, both parties have 180 days to submit

the swap for clearing. However, the counterparty entitled to the later

compliance date may elect to clear the swap earlier, and in that event,

its counterparty is required to oblige.

---------------------------------------------------------------------------

\6\ A Category 1 Entity is defined under Sec. 50.25(a) to

include a swap dealer; security-based swap dealer; major swap

participant; major security-based swap participant; or active fund

(also defined by Sec. 50.25(a)).

\7\ A Category 2 Entity is defined under Sec. 50.25(a) to

include a commodity pool; a private fund as defined in section

202(a) of the Investment Advisers Act of 1940 other than an active

fund; or a person predominantly engaged in activities that are in

the business of banking, or in activities that are financial in

nature as defined in section 4(k) of the Bank Holding Company Act of

1956, provided that, in each case, the entity is not a Third-Party

Subaccount. As proposed, this category contained employee benefit

plans under the Employee Retirement Income and Security Act of 1974,

but under the final rule, these plans will not be included in

Category 2. See below for further discussion.

\8\ As proposed, the rule required compliance within 90, 180, or

270 days after the effective date set by the Commission for a

Clearing Requirement determination. In order to clarify precisely

when the compliance period will commence, the Commission has

modified the rule to indicate that the compliance periods begin as

of the date of publication of final Clearing Requirement

determination rules in the Federal Register. From this point, market

participants have either 90, 180, or 270 days to come into

compliance.

---------------------------------------------------------------------------

II. Comments on the Notices of Proposed Rulemaking

The Commission received 26 comments during the six-week public

comment period following publication of the NPRM. The Commission

considered each of these comments in formulating the final regulation,

Sec. 39.5(e) (finalized as Sec. 50.25).

A. Comment Period

The Commission published the NPRM in the Federal Register on

September 20, 2011, and the public comment period closed on November 4,

2011.

Financial Services Roundtable (FSR) comments that the public should

be able to comment on an implementation schedule for each swap subject

to the Clearing Requirement because the characteristics of one

particular swap may necessitate a very different schedule from another.

Pursuant to Sec. 39.5(b)(5) in the case of swap submissions and

Sec. 39.5(c)(2) in the case of Commission-initiated reviews, the

public will have an opportunity to comment on each of the Commission's

proposed Clearing Requirement determinations, and to comment on whether

the Commission should employ the compliance schedule for that

determination. In this manner, the public will have an opportunity to

comment on whether use of the compliance schedule is appropriate for a

given Clearing Requirement determination covering particular swaps.

B. Harmonization

The NPRM reflects consultation with the staff of the Securities and

Exchange Commission (SEC), prudential regulators, and international

regulatory authorities. With respect to the latter, the Commission is

mindful of the benefits of harmonizing its regulatory framework with

that of its counterparts in foreign countries. The Commission therefore

has monitored global advisory, legislative, and regulatory proposals,

and has consulted with foreign regulators in developing the final

regulations.

Vanguard, the Federal Home Loan Banks (FHLBs), and the Investment

Company Institute (ICI) each recommend that the Commission coordinate

the compliance schedule for the Clearing Requirement, as well as

implementation schedules concerning other Dodd-Frank Act requirements,

with the SEC, the prudential regulators, and international regulators

to avoid market disruption and avoid regulatory arbitrage. The American

Council of Life Insurers (ACLI) urges the Commission to coordinate with

the SEC and international regulators to achieve reductions in

compliance costs. A joint letter by the Futures Industry Association,

the International Swaps and Derivatives Association, and the Securities

Industry and Financial Markets Association (FIA/ISDA/SIFMA) urges the

Commission to coordinate implementation schedules with those introduced

by the SEC, the National Futures Association, self-regulatory

organizations, and market infrastructure providers.

In addition to the regulators referenced above, the Commission has

consulted with other U.S. financial regulators including: (1) The Board

of Governors of the Federal Reserve System; (2) the Office of the

Comptroller of the Currency; and (3) the Federal Deposit Insurance

Corporation. Staff from each of these agencies has had the opportunity

to provide oral and/or written comments to this adopting release, as

well as to the proposal.

[[Page 44443]]

C. Cross-Border and Affiliate Transactions

The NPRM did not differentiate between domestic and foreign swap

dealers (SDs), major swap participants (MSPs) or their counterparties,

and did not address affiliate transactions.

MarkitSERV and the Alternative Investment Management Association

(AIMA) each comment that the NPRM, as well as other proposals setting

forth implementation schedules for complying with Dodd-Frank Act

requirements, should clarify the status of cross-border transactions.

Better Markets states that trading relationships between an SD or MSP

and its affiliate or an international counterparty should not be

treated any differently than any other trading relationship. FIA/ISDA/

SIFMA comments that the Commission should publish guidance concerning

the extraterritorial application of Title VII prior to the commencement

of any implementation schedule.

The Commission separately has issued guidance on the cross-border

application of Title VII, including the Clearing Requirement.\9\ With

regard to inter-affiliate transactions, the Commission will be

considering this issue in an upcoming proposal.

---------------------------------------------------------------------------

\9\ See Cross-Border Application of Certain Swaps Provisions of

the Commodity Exchange Act, 77 FR 41213 (July 12, 2012).

---------------------------------------------------------------------------

D. Comprehensive Implementation Schedule

This adopting release pertains exclusively to the implementation of

the Clearing Requirement.

The Coalition for Derivatives End-Users (CDE), a joint letter by

the Edison Electric Institute, the National Rural Electric Cooperative

Association, and the Electric Power Supply Association (Joint

Associations); ICI; and MarkitSERV each argue that the Commission

should create an implementation plan addressing all of its final Dodd-

Frank rules and that the Clearing Requirement compliance schedule

should be part of that comprehensive schedule. CDE comments further

that a comprehensive schedule is important to end-users, particularly

in the areas of recordkeeping and reporting. The Joint Associations

also comment that a comprehensive schedule should detail compliance

dates, both specific and market-wide, for each registered entity and

that the Commission should request further comment on this subject as

more final rules are published.

Vanguard comments that in implementing Title VII, the Commission

should focus first on systemic risk issues and then issues relating to

transparency and trade practices. Implementation schedules should be

organized by type of participant and asset class. The schedules should

also allow for voluntary compliance.

ACLI argues that the Commission has not provided sufficient

guidance concerning new rules and effective dates in order for market

participants to conduct a prudent review of resource planning. ACLI

maintains that complying with only some rules creates a risk that

documents will have to be renegotiated when other rules are phased in.

In this adopting release, the Commission is focused on providing

additional time to market participants that may require more time to

comply with one of the key elements of the Dodd-Frank Act--the Clearing

Requirement. The compliance schedule that is the subject of this

adopting release was proposed at the same time as three other

compliance schedules--schedules for the Trade Execution Requirement and

two important requirements under section 4s of the CEA, documentation

and margin for uncleared swaps. Each of these proposed compliance

schedules responded to particular concerns from market participants,

especially those that are not required to register with the Commission.

The Commission also has published compliance dates for phasing in

implementation in nearly all of its final rules.\10\ In addition, the

Commission has twice published on its Web site general schedules

regarding the sequence and timing for its own consideration of final

rules.\11\

---------------------------------------------------------------------------

\10\ See, e.g., Swap Data Recordkeeping and Reporting

Requirements, 77 FR 2136, 2195-2196 (Jan. 13, 2012); Business

Conduct Standards for Swap Dealers and Major Swap Participants with

Counterparties, 77 FR 9734, 9803 (Feb. 17, 2012); and Derivatives

Clearing Organization General Provisions and Core Principles, 76 FR

69334, 69408 (Nov. 8, 2011).

\11\ See http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.

---------------------------------------------------------------------------

In response to ACLI, as discussed further below, the Commission has

finalized all the documentation requirements necessary for compliance

with the Clearing Requirement.\12\ With regard to Vanguard's comment,

the Commission intends to implement the Clearing Requirement based on

specific classes of swaps, beginning with those asset classes that are

currently being cleared. The Commission believes that implementation of

the Clearing Requirement will serve to reduce systemic risk by

mitigating counterparty credit risk through the use of the marking-to-

market, margining, and risk mutualization provided by central

counterparties. The adoption of this compliance schedule is an

important step toward implementing that requirement. In addition, the

compliance schedule expressly allows for voluntary clearing prior to

the required compliance date, and market participants currently are

free to clear all swaps offered for clearing by DCOs on a voluntary

basis.

---------------------------------------------------------------------------

\12\ See Customer Clearing Documentation, Timing of Acceptance

for Clearing, and Clearing Member Risk Management, 77 FR 21278

(April 9, 2012).

---------------------------------------------------------------------------

E. Prerequisite Rules

The preamble to the NPRM stated that prior to requiring compliance

with any Clearing Requirement determination, the Commission must

publish the following final rules: Definitions of swap, SD, and MSP;

End-User Exception to Mandatory Clearing of Swaps; and Protection of

Cleared Swaps Customer Collateral.

The FHLBs comment that the rule text of an implementation rule

should state that the compliance schedule will not take effect until

the Commission has published applicable final rules. The FHLBs believe

that it is insufficient for the preamble to make this point.

The Joint Associations state that they cannot comment on the

adequacy of either the compliance schedule for the Clearing Requirement

or other implementation schedules until various final rules have been

published, including the definitions of swap, SD, and MSP. The Joint

Associations want to see how many of their comments to these rules have

been adopted because this will affect how long it will take their

members to comply with Title VII requirements. ICI comments that

parties cannot prepare for centralized clearing until the Commission

publishes the final rule concerning the definition of swap.

Citadel, FHLBs, and FIA/ISDA/SIFMA each recommend that the

Commission publish final rules related to clearing, such as customer

clearing documentation, timing of acceptance for clearing, and clearing

member risk management, prior to phasing in the Clearing Requirement.

FHLBs state that the prior publication of the Customer Clearing

Documentation, Timing of Acceptance for Clearing, and Clearing Member

Risk Management rules is important so that market participants can

fully appreciate risks and not have to renegotiate documentation.

The Committee on Investment of Employee Benefit Assets (CIEBA)

recommends that the Commission not impose the Clearing Requirement

until full physical segregation is available for margin of cleared

swaps. CIEBA also

[[Page 44444]]

comments that if the Commission publishes final segregation rules for

cleared swaps customer collateral at the same time that it phases in

the Clearing Requirement, then market participants' limited resources

would be overwhelmed. ICI comments that parties cannot prepare for

centralized clearing until the Commission publishes the final rule

concerning the Protection of Cleared Swaps Customer Collateral. ICI

also argues that the documentation requirements under section 4s(i) of

the CEA must be finalized before market participants are required to

comply with mandatory clearing.

CME recommends that the Commission finalize the DCO Conflicts of

Interest rules prior to requiring compliance with the Clearing

Requirement.

The American Bankers Association (ABA) believes that end-user banks

not be required to comply with the Clearing Requirement until 180 days

after the Commission determines whether end-user banks will be exempt

from the Clearing Requirement.

AIMA believes the Commission should publish final rules concerning

the Margin Requirement, as well as customer collateral protection

rules, prior to phasing in the Clearing Requirement.

The Commission has finalized all four of the rules identified in

the NPRM that it needed to be completed prior to requiring compliance

with the Clearing Requirement (namely, the End-User Exception to

Mandatory Clearing of Swaps; \13\ Protection of Cleared Swaps Customer

Collateral; \14\ the Further Definition of ``Swap Dealer,'' ``Security-

Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

Swap Participant'' and ``Eligible Contract Participant''; \15\ and the

Further Definition of ``Swap,'' ``Security-Based Swap,'' and

``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap

Agreement Recordkeeping).\16\ In addition, the Commission has finalized

rules related to Customer Clearing Documentation, Timing of Acceptance

for Clearing, and Clearing Member Risk Management.\17\ Finalizing these

rules addresses the FHLBs' concerns about having to revise

documentation more than once and provides certainty as to swap

processing requirements and expectations regarding risk management for

clearing members. On the other hand, in response to CME's comment, the

Commission does not believe it is necessary for final DCO Conflicts of

Interest rules to be in effect before requiring compliance with the

Clearing Requirement because these rules do not relate directly to the

clearing process, customer connectivity, clearinghouse risk management,

or other matters that would affect the implementation of the Clearing

Requirement.

---------------------------------------------------------------------------

\13\ End-User Exception to the Clearing Requirement for Swaps,

adopted by the Commission on July 10, 2012, available at

www.cftc.gov.

\14\ Protection of Cleared Swaps Customer Contracts and

Collateral; Conforming Amendments to the Commodity Broker Bankruptcy

Provisions, 77 FR 6336 (Feb. 7, 2012).

\15\ Further Definition of ``Swap Dealer,'' ``Security-Based

Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

Swap Participant'' and ``Eligible Contract Participant,'' 77 FR

30596 (May 23, 2012).

\16\ Further Definition of ``Swap,'' ``Security-Based Swap,''

and ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based

Swap Agreement Recordkeeping, Section VII, adopted by the Commission

on July 10, 2012, available at www.cftc.gov.

\17\ Customer Clearing Documentation, Timing of Acceptance for

Clearing, and Clearing Member Risk Management, 77 FR 21278, (April.

9, 2012).

---------------------------------------------------------------------------

In response to the FHLBs' request that the implementation rule text

include a provision that the rule is not effective until the

definitions of SD, MSP, and swap are finalized, the Commission

reiterates that all of the pre-requisite rules for the Clearing

Requirement have been adopted. With regard to CIEBA's comment about

full physical segregation, the Commission published its final rule

concerning Protection of Cleared Swaps Customer Collateral on February

7, 2012.\18\ In that rulemaking, the Commission indicated that it may

address issues related to collateral held in third-party safekeeping

accounts at some point in the future. However, given that a fully

operational segregation regime is required to be in place by November

8, 2012, the Commission does not believe that it is necessary for this

additional matter to be resolved prior to requiring compliance with the

Clearing Requirement.

---------------------------------------------------------------------------

\18\ 77 FR 6336 (Feb. 7, 2012).

---------------------------------------------------------------------------

In response to ICI's comment, the Commission clarifies that

finalization of the swap trading relationship documentation

requirements for SDs and MSPs under section 4s(i) of the CEA is not

required for compliance with the Clearing Requirement because the

documentation that is the subject of those rules relates primarily to

bilaterally-executed, uncleared swap transactions, and none of the

provisions in proposed Sec. 23.504 pertain directly to the Clearing

Requirement. Similarly, in response to AIMA's comment, final margin

rules for uncleared swaps are not required to be finalized prior to

requiring compliance with the Clearing Requirement as these are

related, but distinct, provisions under the Dodd-Frank Act.

F. Definitions

Under Sec. 39.5(e)(1), the Commission proposed definitions of the

terms ``Category 1 Entity,'' ``Category 2 Entity,'' ``Active Fund,''

and ``Third-Party Subaccount.'' The definitions set forth in proposed

Sec. 39.5(e) (now Sec. 50.25) would apply specifically to provisions

contained in part 39 (now part 50) and only those other rules that

explicitly cross-reference these definitions. The Commission is

adopting the definitions as proposed, with the exceptions discussed

below.

1. Active Fund

As proposed under Sec. 39.5(e)(1), ``any private fund as defined

in section 202(a) of the Investment Advisers Act of 1940, that is not a

third-party subaccount and that executes 20 or more swaps per month''

would be defined as an ``Active Fund'' and subject to the shortest

implementation schedule for compliance with the Clearing Requirement.

Numerous commenters, such as Better Markets, Chris Barnard, and

AIMA, agree with the Commission that using a market participant's

average monthly trading volume would be an appropriate proxy for

determining an entity's ability to comply with the Clearing Requirement

and would be better than a proxy based on notional volume or open

interest. AIMA agrees with the NPRM's proposal that Active Funds be

subject to the 90-day deadline.

Other commenters express concerns about solely relying on monthly

volumes as a proxy, especially without further defining the types of

swaps that would be included in the calculation. ACLI states that the

frequency of trading is not an appropriate indicator of a market

participant's experience or resources. The Association of Institutional

Investors (AII) states that the definition should specify the type of

swaps that count towards the threshold. CDE recommends a minimum

average monthly notional threshold to avoid capturing smaller end-

users. CDE also states that hedges and inter-affiliate swaps should be

excluded from this monthly average threshold. Managed Funds Association

(MFA) similarly requests clarification regarding those swaps that would

be included in the monthly swap calculation. Specifically, MFA requests

clarification as to whether novations, amendments, or partial tear-ups

would be included.

Commenters also focus on the average monthly threshold of 20 swaps

per

[[Page 44445]]

month for the preceding 12 months. FIA/ISDA/SIFMA proposes that the

threshold be an average of 200 trades per month. Vanguard proposes a

similar threshold. Both AII and MFA think the proposed threshold was

overly inclusive. MFA also highlights its belief that the proposed

definition would be difficult to administer, while unnecessarily

creating another tier of market participants for the purposes of the

implementation schedules.

In response to these comments, the Commission is increasing the

average monthly threshold to 200 swap trades per month for the

preceding 12 months. The Commission believes that monthly trading

volume is a suitable proxy for determining the appropriate

implementation schedule for a swap counterparty. By increasing the

threshold to 200, as recommended by FIA/ISDA/SIFMA, as well as

Vanguard, the risk of capturing smaller, less experienced swap

counterparties should be substantially diminished. The market

participants engaging in this level of swap activity should be able to

access the resources necessary to meet the 90-day implementation

schedule. In light of the number of transactions currently being

cleared on a voluntary basis by funds, the Commission does not believe

that an increase in the threshold of monthly swap trades will

negatively impact the goal of broad market participation in the

implementation of the Clearing Requirement. The Commission believes

this increase in the average monthly threshold also addresses CDE's

concerns about smaller market participants using swaps only to hedge

risk.

Further, by maintaining the concept of Active Fund, the Commission

believes that it will continue to ensure adequate representation across

the spectrum of market participants during the first phase of the

implementation of the Clearing Requirement. As a result of this

participation, processes and infrastructure will be established to

serve all segments of the market, not just SDs and MSPs, which are

included in the initial phase of the compliance schedule for the

Clearing Requirement.

In response to AII and MFA, the Commission clarifies that the

average monthly threshold of swaps applies to new swaps that the entity

enters into, and it does not apply to novations, amendments, or partial

tear-ups. In addition, the Commission clarifies that the 200 swap

threshold includes any swap, as defined under the CEA and Sec. 1.3,

and not just those swaps that would be subject to the relevant Clearing

Requirement determination and attendant compliance schedule.

2. Third-Party Subaccount

Under Sec. 39.5(e) (finalized herein as Sec. 50.25), Third-Party

Subaccounts are excluded from the definitions of Category 1 Entity and

Category 2 Entity, with the effect that such subaccounts will have 270

days, the longest period, in which to comply with the Clearing

Requirement. The NPRM defined Third-Party Subaccounts as ``a managed

account that requires the specific approval by the beneficial owner of

the account to execute documentation necessary for executing,

confirming, margining, or clearing swaps.'' The purpose of excluding

Third-Party Subaccounts from the defined categories was to ensure that

investment managers, who may be faced with bringing numerous accounts

into compliance, would have adequate time to do so.

Commenters question whether the definition was broad enough to

provide sufficient time for Third-Party Subaccounts to comply with the

Clearing Requirement. ICI noted that Third-Party Subaccounts, whether

subject to the specific execution authority of the beneficiary or not,

require managers to work closely with clients when entering into

trading agreements on the customer's behalf. As such, ICI feels that no

distinction should be made based on specific execution authority or

lack thereof. ICI comments that all Third-Party Accounts should be

uniformly classified and be given 270 days to comply. AII similarly

states that the definition is too narrow given the administrative work

required to manage an account, regardless of the execution authority.

Further, AII states that execution authority is not an industry

standard. The term, as proposed, therefore divides the universe of

managed accounts inappropriately. FIA/ISDA/SIFMA recommends that all

accounts managed by third parties, regardless of the execution

authority, should be given the most time to comply with the Clearing

Requirement.

Based on the comments received, the Commission is revising the

definition of Third-Party Subaccount to mean ``an account that is

managed by an investment manager that (1) is independent of and

unaffiliated with the account's beneficial owner or sponsor, and (2) is

responsible for the documentation necessary for the account's

beneficial owner to clear swaps.'' In modifying this definition, the

Commission is taking into account the point made by AII, FIA/ISDA/

SIFMA, and ICI that all investment managers will need additional time

to comply with a Clearing Requirement regardless of whether they have

explicit execution authority. However, the definition retains the nexus

between the investment manager and the documentation needed for

clearing swaps. In other words, if the investment manager has no

responsibility for documenting the clearing arrangements, then that

account would be required to clear its swaps subject to required

clearing within 180 days. For those accounts under the revised

definition, however, the Commission believes that the 270-day deadline

is more appropriate. Given the general notice investment managers have

had about the Dodd-Frank Act's Clearing Requirement since the enactment

of the statute in July, 2010, managers should have been able to

consider and plan the infrastructure and resources that are necessary

for all of their accounts, including Third-Party Subaccounts, to comply

with the Clearing Requirement. Thus, the 180- and 270-day deadlines

should provide adequate time to accommodate all managed accounts.

3. Category 1 and Category 2 Entities

The compliance schedule is organized according to the type of

market participant. To the extent that the Commission determines that a

compliance schedule is warranted in connection with a Clearing

Requirement determination (i.e. to comply with the Clearing

Requirement) a market participant defined as a Category 1 Entity will

have 90 days to comply, a Category 2 Entity will have 180 days, and all

others will have 270 days. According to the proposed definitions, a

Category 1 Entity includes an SD, a security-based swap dealer, an MSP,

a major security-based swap participant, or an Active Fund. A Category

2 Entity includes a commodity pool, a private fund, as defined by the

Investment Advisers Act of 1940, an ERISA plan, or a person

predominantly engaged in banking or other financial activities, as

defined by section 4(k) of the Bank Holding Company Act. A Category 2

Entity would not include an Active Fund or a Third-Party Subaccount.

Encana Marketing (USA) Inc. (Encana) and the Joint Associations

comment that non-financial end users should be expressly included in

the category with the longest timeframe. CDE argues that financial end-

users should be treated identically to non-financial end-users because

they do not pose systemic risk, and, therefore, should be given the

most time to comply with the Clearing Requirement, and not included in

Category 2. ICI seeks clarification that a market participant can

determine whether it is an MSP for purposes of the compliance schedule

for the Clearing

[[Page 44446]]

Requirement at the same time that it is required to review its status

as an MSP under other Commission and SEC rules.

CIEBA states that in-house ERISA funds should be in the group with

the longest compliance time, and not Category 2 Entities. CIEBA notes

that such funds do not pose systemic risk, and they typically rely upon

third-party managers for some portion of their fund management.

Splitting in-house and external accounts (i.e. those accounts meeting

definition of Third-Party Subaccount and permitted 270 days) of the

same ERISA plan will impact risk management given different

implementation schedules. CIEBA also states that this distinction will

cause pension funds to bear the costs of compliance because they will

need to comply prior to their third-party managers, who would be better

positioned to provide insight and service in this regard.

The Commission believes that the definitions of Category 1 Entity

should be finalized as proposed, but that the definition of Category 2

Entity should be modified by removing the reference to ERISA plans. In

response to Encana and the Joint Associations, non-financial end users

are adequately addressed in Sec. 39.5(e)(2)(iii) (now Sec.

50.25(b)(3))--unless the swap transactions are eligible to claim the

exception from the Clearing Requirement under section 2(h)(7) of the

CEA, the parties are given 270 days to comply with the Clearing

Requirement. With respect to issues raised by CDE regarding those

financial entities included in Category 2, based on numerous meetings

with participants in the swap market, the Commission believes that

financial entities are capable of complying with the Clearing

Requirement 90 days sooner than non-financial entities. Accordingly,

the compliance schedule has correctly situated Category 2 Entities

based upon their ability to meet the requirements of the underlying

regulations. Moreover, the distinction between financial and non-

financial entities has a statutory basis in section 2(h)(7) of the CEA.

The Commission recognizes the concerns raised by CIEBA regarding

splitting in-house and external accounts (i.e., those accounts meeting

the definition of Third-Party Subaccount and permitted 270 days) of the

same ERISA plan. In response to these concerns, the Commission is

removing the reference to employee benefit plans as defined in

paragraphs (3) and (32) of section 3 of the Employee Retirement Income

and Security Act of 1974. As a result, these ERISA plans will be

afforded the longest compliance period (270 days).

With regard to ICI's comment, a potential MSP can review its

obligation to register as an MSP at the same time it is reviewing where

it fits under the Clearing Requirement compliance schedule. In many

instances, MSPs will have to review their registration obligations

ahead of complying with the Clearing Requirement. However, if an entity

discovers that it has crossed the threshold established under the MSP

rules and is required to register during the 90-day period for Category

1 Entities, the Commission would consider allowing that entity to

petition for additional time to come into compliance with the Clearing

Requirement.\19\

---------------------------------------------------------------------------

\19\ Similarly, the Commission would consider allowing entities

to petition for additional time to comply to the extent that they

discover that they have exceeded the de minimis threshold under the

swap dealer definition and are required to register during the 90-

day period for Category 1.

---------------------------------------------------------------------------

G. Compliance Schedule for the Clearing Requirement

As mentioned above, Sec. 39.5(e)(2) provides that when the

Commission determines that an implementation schedule is appropriate in

connection with a given Clearing Requirement determination, market

participants within the definition of Category 1 will have 90 days to

comply, those within the definition of Category 2 will have 180 days,

and all others 270 days to implement the Clearing Requirement.

4. Application to All Swap Types

The Clearing Requirement compliance schedule is based upon the

nature of a given swap market participant, considering the

participant's risk profile, compliance burden, resources, and

expertise. The schedule does not contemplate different implementation

timeframes based upon the characteristics of particular swaps.

AIMA states that it does not believe further implementation

schedules are necessary based on the nature of the swap itself. Better

Markets, Citadel, and MFA comment that the compliance schedule should

apply, however, to all swaps within a ``group'' or ``class,'' as

defined by the Commission's Clearing Requirement determination.

Commenters such as CDE state that the Commission should publish an

implementation schedule specific to the characteristics of a particular

type of swap. CDE comments that because it is unlikely that end-users,

and other entities relied upon by end-users, will be able to meet the

requirements necessary to comply with clearing determinations for all

swap products at the same time, the Commission should phase in

implementation deadlines by swap type, according to the amount of

systemic risk posed by a particular swap.

MarkitSERV asserts that all Dodd-Frank Act requirements should be

phased-in by asset class, taking into account that different asset

classes have various levels of product standardization,

electronification, volumes, and types of counterparties. FIA/ISDA/SIFMA

also states that there should be a separate compliance schedule for

each asset class. FIA/ISDA/SIFMA also states that the Commission should

require credit default swaps and interest rate swaps to be cleared

first because those products are already being cleared. Commodity and

equity swaps, according to FIA/ISDA/SIFMA, should be required to be

cleared later because the marketplace is currently clearing fewer of

those products.

AIMA, CDE, ICI, and MarkitSERV state that the compliance schedule

should require the Commission to phase in each Clearing Requirement

determination as set forth in Sec. 39.5(e). FHLB and ICI comment that

the Commission should have the flexibility to extend clearing

implementation dates, but not shorten them. Citadel counters that the

compliance schedule should only be triggered when a determination is

issued for a new category of swaps.

This rule affords the Commission discretion to determine whether to

apply the compliance schedule in connection with a particular Clearing

Requirement determination. The Commission agrees that while the

schedule may be necessary in connection with some Clearing Requirement

determinations, especially those covering new classes of swaps, there

also may be determinations that are sufficiently similar to prior ones

that no compliance schedule is necessary. As such, the Commission will

determine whether or not to apply the Sec. 39.5(e) (now Sec. 50.25)

compliance schedule as part of its analysis in connection with each

Clearing Requirement determination.

Further, it remains the Commission's intention that those swaps

currently being cleared will be subject to the first Clearing

Requirement determinations. As a result, market participants initially

will comply with the Clearing Requirement using established platforms

and technology. This should limit a market participant's burden in

transitioning to clearing, as the use of existing infrastructure will

mean less time and expense necessary to develop independent programs,

technology, or platforms to clear such transactions.

[[Page 44447]]

5. Timing of Implementation Schedules

Citadel and Better Markets comment that they agree with the

proposed compliance schedule because market participants have had

notice of the movement towards clearing for one to three years, and the

clearing infrastructure already exists with regard to interest rate and

credit default swap products. Citadel and Tradeweb believe the proposed

schedule correctly staggers compliance according to category of market

participant. Citadel does not support extending the 270-day timeframe

because 270 days would grant sufficient time to market participants

without providing so much time as to engender a material, competitive

advantage or regulatory arbitrage. AIMA believes the proposed schedule

grants sufficient time to each category of market participant so that

they will be able to comply with the Clearing Requirement. Similarly,

the Joint Associations and The Westpac Group (Westpac) generally agree

with phasing in implementation with the Clearing Requirement according

to category of participant.

CIEBA states that because SDs, MSPs, and Active Funds will be the

first focus for all third party vendors, ERISA plans will be competing

for these resources only after the first implementation deadline has

passed, leaving only 90 days for a crowded market place to comply. With

limited resources, such a tight timeframe may lead to inadequate

agreements and/or increased risk exposure. Further, inadequate

agreements caused by lack of resources and rushed documentation will

create even further cost disparity for clearing between U.S. pension

plans and European ones that will not be required to clear swaps. As

such, CIEBA recommends that Category 2 Entities have more than 180 days

to comply. Likewise, FIA/ISDA/SIFMA note that the compliance schedule

should be lengthened and that buy-side entities, which may currently be

categorized as Category 1 Entities, should not be required to commence

clearing until the second quarter of 2013 at the earliest.

CDE argues that SDs and MSPs should comply before establishing

other end-user deadlines. CDE believes that if Category 1 Entities

cannot comply, then that will compound problems for Category 2 and 3

Entities. If an implementation schedule must be set, the CDE recommends

one year for end-users, in light of their limited internal resources

and the competition for external resources.

ACLI comments that complex issues will surface as market

participants try to combine the agency framework presently existing in

the futures markets (i.e., customer-futures commission merchant) with

the principal-to-principal framework that has existed in the over-the-

counter swaps market. In addition to executing the necessary

agreements, insurers will want to ensure they enter into agreements

with parties that serve them best. The combination of these factors

means that timeframes are too short and may result in smaller firms

accepting unfavorable agreements with fewer counterparties, possibly

concentrating risk. ACLI also highlights that insurers face an

additional burden in ensuring that compliance with the Clearing

Requirement is consistent with their state regulatory obligations.

Vanguard argues that additional time will be required to enter into

the new agreements necessitated by the move to a cleared derivatives

market. Vanguard highlights the large volume of such agreements and the

lack of market standards. ICI also finds the compliance schedule to be

too short in light of the needs to build and test new systems, adapt to

new regulatory requirements, and educate customers about these changes.

Mastercard Worldwide urges the Commission to give non-bank firms at

least 270 days to comply with the Clearing Requirement in respect of

their foreign currency hedging activities, even if the firm is covered

by section 4(k) of the Bank Holding Company Act. Westpac comments that

Category 1 Entities should have at least 180 days to comply with the

Clearing Requirement, noting that not all SDs, particularly smaller

ones, are currently DCO members. Regional Banks also request that small

SDs have at least 180 days to comply with the Clearing Requirement in

light of their relative lack of resources and experience, as compared

to larger SDs.

ACLI and FSR believe that the compliance schedule for the

respective entity categories should run consecutively rather than

concurrently. For example, the 180 days given to Category 2 Entities to

comply with the Clearing Requirement should begin only after the

expiration of the 90 days given to Category 1 Entities.

FSR does not believe there are sufficient resources, either

internally, at market participants, or externally, at third party

vendors, for the compliance schedule to run concurrently. If the

schedule were to run concurrently, then resources would be allocated

sequentially to the detriment of entities in the later implementation

groups. ACLI, Joint Associations, and the Coalition of Physical Energy

Companies (COPE) each express concern that the proposed compliance

schedule does not provide sufficient time for the software companies

and other vendors, upon which many smaller market participants rely, to

develop, test, and debug the software and other technology that will be

needed to ensure compliance with the Clearing Requirement. The Joint

Associations and COPE each suggests the Commission take affirmative

steps to solicit feedback from these software makers, particularly from

vendors that provide ``position and trade capture software,'' in order

to determine the amount of time market participants will need to

implement software necessary to comply with the Clearing Requirement.

The Commission is finalizing the compliance schedule for the

Clearing Requirement as proposed, except for the changes described

above for ERISA plans and Third-Party Subaccounts. The Commission

believes that the 90-, 180-, and 270-day implementation periods will

give market participants sufficient time to comply with the Clearing

Requirement. The Commission agrees with commenters such as Citadel and

Better Markets that the move to required clearing has been proceeding

for two years under the Dodd-Frank Act. This period should have allowed

parties to contemplate and design implementation plans and to identify

the resources needed to execute those plans. With the Commission's

decision to focus on those swaps that are currently cleared when

considering its initial Clearing Requirement determinations, market

participants will be working with clearing offerings that are seasoned

and established, justifying the timeframes provided for in the

compliance schedule. For these reasons, the Commission also declines to

change the concurrent nature of the compliance schedule.

Given the final rules for the definitions of swap dealers, and the

threshold used in terms of annual notional volume of swaps for such

swap dealers, the Commission does not believe it necessary to further

distinguish between larger swap dealers and smaller ones for purposes

of the implementation periods related to Clearing Requirements.\20\

Similarly, the Commission does not believe it practicable to make

distinctions between entities covered by section 4(k) of the Bank

Holding Company Act for the purpose of establishing a 180-day

[[Page 44448]]

implementation period as compared to a 270-day period.

---------------------------------------------------------------------------

\20\ Further Definition of ``Swap Dealer,'' ``Security-Based

Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

Swap Participant'' and ``Eligible Contract Participant,'' 77 FR

30596 (May 23, 2012).

---------------------------------------------------------------------------

In response to CDE, the Commission also notes that certain swaps

would not be subject to the Clearing Requirement under section 2(h)(7)

of the CEA when one of the counterparties to a swap (i) is not a

financial entity, (ii) is using the swap to hedge or mitigate

commercial risk, and (iii) notifies the Commission how it generally

meets its financial obligations associated with entering into a non-

cleared swap. If a market participant can claim an exemption, the

Clearing Requirement will not be applicable. In all other cases, the

implementation schedule for a Clearing Requirement would provide for up

to 180 or 270 days for such market participants.

In response to concerns that state regulatory obligations for

insurance companies might create obstacles to compliance with

implementation schedules as suggested by ACLI, the Commission observes

that those insurers would have a minimum of six months to work with

their state regulators to address the matter. If no solution could be

found within that time period, an affected insurer would be able to

petition the Commission for specific relief.

The Commission also has taken affirmative steps to ensure that

external providers of services to derivative market participants, such

as derivatives software providers, have been included in the dialogue

concerning implementation scheduling. At the May 2011 Implementation

Roundtable, these vendors voiced their opinions with respect to how an

implementation schedule could provide sufficient time for market

participants relying on ``off-the-shelf'' derivatives tracking software

to deploy such software such that they could comply with the Clearing

Requirement. The Commission will continue to develop its understanding

of technology issues and will solicit comment on this issue in

forthcoming proposed Clearing Requirement determinations.

III. Cost-Benefit Considerations

A. Pre-Dodd-Frank Context

Prior to the enactment of the Dodd-Frank Act,\21\ swaps were not

subject to required clearing. However, the limited market data that is

available suggests that over-the-counter (OTC) swap markets have been

migrating into clearing over the last few years in response to natural

market incentives as well as in anticipation of the Dodd-Frank Act's

clearing requirement. LCH.Clearnet data, for example, shows that the

outstanding volume of interest rate swaps cleared by LCH has grown

steadily since at least November 2007, as has the monthly registration

of new trade sides. Together, those facts indicate increased demand for

LCH clearing services related to interest rate swaps, a portion of

which preceded the Dodd-Frank Act.\22\ Data available through CME and

TriOptima indicate similar patterns of growing demand for interest rate

swap clearing services, though their publicly available data does not

provide a picture of demand prior to the passage of the Dodd-Frank Act

in July 2010.\23\ The trend toward increased clearing of swaps is

likely to continue as the Commission begins determining that certain

swaps are required to be cleared (Clearing Requirement determination).

In fact, the Tabb Group estimates that 60-80% of the swaps market

measured by notional amount will be cleared within five years of the

time that the Dodd-Frank Act is implemented.\24\

---------------------------------------------------------------------------

\21\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

Pub. L. No. 111-203, 124 Stat. 1376 (2010).

\22\ See http://www.lchclearnet.com/swaps/volumes/.

\23\ See http://www.cmegroup.com/trading/interest-rates/cleared-otc/index.html#data and http://www.trioptima.com/repository/historical-reports.html.

\24\ See Tabb Group, ``Technology and Financial Reform: Data,

Derivatives and Decision Making.''

---------------------------------------------------------------------------

B. Dodd-Frank Act Section 723(a)(3)

In the wake of the financial crisis of 2008, Congress determined,

among other things, that swaps shall be cleared upon Commission

determination. Specifically, section 723(a)(3) of the Dodd-Frank Act

amended section 2(h)(1)(A) of the CEA to make it ``unlawful for any

person to engage in a swap unless that person submits such swap for

clearing to a derivatives clearing organization that is registered

under this Act or a derivatives clearing organization that is exempt

from registration under this Act if the swap is required to be

cleared.'' \25\ The statutory swap clearing requirement is designed to

standardize and reduce counterparty risk associated with swaps, and, in

turn, mitigate the potential systemic impact of such risks and reduce

the likelihood for swaps to cause or exacerbate instability in the

financial system.\26\ It reflects a fundamental premise of the Dodd-

Frank Act: The use of properly functioning central clearing can reduce

systemic risk.

---------------------------------------------------------------------------

\25\ Section 2(h)(2) of the CEA charges the Commission with

responsibility for determining whether a swap is required to be

cleared (a Clearing Requirement determination).

\26\ When a bilateral swap is moved into clearing, the

clearinghouse becomes the counterparty to each of the original

participants in the swap. This standardizes counterparty risk for

the original swap participants in that they each bear the same risk

attributable to facing the clearinghouse as counterparty. In

addition, clearing mitigates counterparty risk to the extent that

the clearinghouse is a more creditworthy counterparty relative to

those that each participant in the trade might have otherwise faced.

This is because a clearinghouse benefits from netting with

counterparties and may compel counterparties to post additional

initial margin as collateral or force them to reduce their

outstanding positions when markets move against them. Clearinghouses

have demonstrated resilience in the face of past market stress. Most

recently, they remained financially sound and effectively settled

positions in the midst of turbulent events in 2007-2008 that

threatened the financial health and stability of many other types of

entities.

---------------------------------------------------------------------------

C. Final Rule

The rule contained in this adopting release addresses one aspect of

required swap clearing under section 2(h) of the CEA: Implementation

scheduling following a Commission determination that a class of swaps

is required to be cleared. In other words, is immediate clearing

required or is implementation subject to some delay. On September 20,

2011, the Commission published a NPRM.\27\ The Commission proposed a

phased-in compliance schedule for swaps subject to Clearing Requirement

determinations that distinguishes among Category 1 Entities, Category 2

Entities, and all other entities (referred to for purposes of this

section III as ``Category 3 Entities''); those entities, respectively,

would have 90 days, 180 days, and 270 days, from the date of the

Clearing Requirement determination to comply with the Clearing

Requirement.\28\ The NPRM also requested comment with respect to the

costs and benefits of the proposed schedule, including, specifically,

data, assumptions, calculations, or other information to quantify its

costs and benefits, as well as alternatives to it. The Commission

received 26 comment letters in response, none of which provided

quantitative analysis regarding the costs or benefits of the proposed

compliance schedule.\29\

---------------------------------------------------------------------------

\27\ See 76 FR 58186.

\28\ The schedule contained in the NPRM, like the one contained

in this adopting release, can be used at the option of the

Commission when issuing Clearing Requirement determinations.

\29\ ACLI provides an estimate for one member's information

technology and legal costs to comply with all Title VII

requirements. The estimate does not include any calculations and

does not separate out any costs they believe are directly

attributable to this rule.

---------------------------------------------------------------------------

These comments touch upon a variety of issues, and include a number

that supported the Commission's approach as proposed. Others note

certain areas of concern about costs or benefits under

[[Page 44449]]

the rule as proposed, and either expressly propose alternatives or

raise issues that have caused the Commission to consider alternatives

to it. Among other things, commenters responded to the phased approach,

the entities included in Category 1, Category 2, and Category 3, the

amount of time that the schedule provides for entities in each

category, and the optionality of the schedule.

In the absence of this rule, market participants would be required

to comply with the Clearing Requirement immediately upon issuance of a

Clearing Requirement determination by the Commission. Pursuant to the

rule, however, when the Commission deems it appropriate, market

participants will be provided additional time as prescribed in the

rule's schedule to comply with Clearing Requirement determinations.

Category 1 entities, which include, among others, SDs, MSPs, and Active

Funds,\30\ will have 90 days from the date that a Clearing Requirement

determination is published in the Federal Register to comply. Category

2 Entities, which include commodity pools; private funds as defined by

the Investment Advisers Act of 1940, other than Active Funds; and

banks; but not Third-Party Subaccounts, will have 180 days to comply

with a new Clearing Requirement determination. Category 3 Entities are

those with Third-Party Subaccounts, as well as any other entity not

eligible to claim an exception under section 2(h)(7) of the CEA,

including ERISA plans, and they will have 270 days to comply with a

Clearing Requirement determination once it is published in the Federal

Register.

---------------------------------------------------------------------------

\30\ An ``Active Fund'' is any private fund as defined in

section 202(a) of the Investment Advisers Act of 1940, that is not a

third-party subaccount and that executes 200 or more swaps per

month. The Commission does not intend to use the designation for any

purpose beyond this rule.

---------------------------------------------------------------------------

The discussion that follows considers the costs and benefits of,

and alternatives to, the rule in this adopting release.

D. Statutory Mandate To Consider the Costs and Benefits of the

Commission's Action: CEA Section 15(a)

Section 15(a) of the CEA \31\ requires the Commission to consider

the costs and benefits of its actions before promulgating a regulation

under the CEA or issuing certain orders. Section 15(a) further

specifies that the costs and benefits shall be evaluated in light of

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 Commission considers the costs and benefits

resulting from its discretionary determinations with respect to the

section 15(a) factors.

---------------------------------------------------------------------------

\31\ 7 U.S.C. 19(a).

---------------------------------------------------------------------------

In this rulemaking the Commission is not imposing clearing

requirements, but is exercising its discretion to stagger required

clearing implementation according to a particular schedule and subject

to the conditions specified in these rules. For purposes of this

analysis, the Commission considers the costs and benefits attributable

to its choices in this rulemaking--e.g., to stagger the implementation

of clearing requirements and to do so in the manner prescribed--against

those that would arise absent this Commission action--i.e., if

implementation of the Dodd-Frank Act's Clearing Requirement for those

swaps that the Commission separately determines to be subject to

clearing was not staggered according to the rule's schedule.

For reasons discussed in more detail below, the cost and benefits

associated with requiring clearing immediately upon the Clearing

Requirement determination for a swap class, or after some longer versus

shorter period of delay, are not susceptible to meaningful

quantification. As described above, these are not the costs and

benefits of implementing Clearing Requirement determinations, but

rather the costs and benefits of implementing them more slowly than

would be required in the absence of this rule. The Commission is not

aware of any analog to either an immediate or delayed requirement to

establish the capability to clear that would produce data that the

Commission could use to estimate the difference in costs and benefits

between the two. Moreover, any data that might be gleaned from the

experiences of an individual market participant establishing a

relationship with a futures commission merchant (FCM) during normal

market conditions would not reflect the influence of a number of

effects that are likely to result from the simultaneous implementation

of many market participants in a series of three waves. This

coordinated movement creates both costs and benefits that cannot be

quantified using data drawn from current market conditions.

Notwithstanding these limitations, the Commission identifies and

considers the costs and benefits of this rule in qualitative terms.

E. Costs and Benefits of This Rule

Determining whether to implement required clearing immediately upon

Commission determination or after some period of delay necessarily

involves cost and benefit tradeoffs. On the one hand, delaying required

clearing implementation also delays the benefits of clearing of certain

swaps, including reduced counterparty risk and increased stability in

the financial system. These benefits are substantial, and any delay in

their realization represents a cost to the market and the public. On

the other hand, requiring implementation immediately or within a very

compressed timeframe creates certain costs for industry participants.

Reducing these costs--enumerated below--by extending the implementation

schedule represents a benefit.

First, to meet pressing timelines, some firms will need to contract

additional staff or hire vendors to handle some necessary tasks or

projects. Additional staff hired or vendors contracted in order to meet

more pressing timelines represent an additional cost for market

participants. Moreover, a tightly compressed timeframe raises the

likelihood that more firms will be competing to procure services at the

same time; this could put firms that conduct fewer swaps at a

competitive disadvantage in obtaining those services, making it more

difficult for them to meet required timelines.\32\ In addition, it

could enable service providers to command a pricing premium when

compared to times of ``normal'' or lesser competition for similar

services. That premium represents an additional cost when compared to a

longer implementation timeline.

---------------------------------------------------------------------------

\32\ See letter from CIEBA.

---------------------------------------------------------------------------

Second, if entities are not able to comply with Clearing

Requirement determinations by the required date, they may avoid

transacting swaps that are required to be cleared until such a time as

they are able to comply. In this event, liquidity that otherwise would

result from those foregone swaps would be reduced, making the swaps

more expensive for market participants taking the other side. Moreover,

firms compelled to withdraw from the market pending implementation of

required clearing measures will either leave certain positions un-

hedged--potentially increasing the firm's own default risk, and

therefore the risk to their counterparties and the public.

Alternatively, firms compelled to withdraw from the market for a period

of time could attempt to approximate

[[Page 44450]]

their foregone swap hedges using other, likely more expensive,

instruments. And to the extent the withdrawing entities are market

makers, they will forsake the revenue potential that otherwise would

exist for the period of their market absence.

Third, firms may have to implement technological solutions, sign

contracts, and establish new operational procedures before industry

standards have emerged that address new problems effectively. To the

extent that this occurs, it is likely to create costs. Firms may have

to incur additional costs later to modify their technology platforms

and operational procedures further, and to renegotiate contracts--

direct costs that a more protracted implementation schedule would have

avoided.\33\ Moreover, costs created by the adoption of standards that

fail to address certain problems, or attributable to undesired

competitive dynamics resulting from such standards, may be

longstanding.

---------------------------------------------------------------------------

\33\ See e.g., ACLI letter.

---------------------------------------------------------------------------

Given the factors identified above, this rulemaking aims to strike

the optimal cost-balance tradeoff amidst the competing concerns.

Shorter timelines will tend to push greater numbers of swaps into

clearing more quickly, reducing the counterparty and systemic exposures

in ways that were intended by the Dodd-Frank Act--a benefit. But,

shorter timelines also increase the costs as discussed above. Longer

timelines have the opposite effect, decreasing the costs described

above, but increasing the amount of time during which counterparty and

systemic exposures that would otherwise be mitigated by required

clearing persist.

In theory, the optimal tradeoff between the two is the point at

which the marginal cost of an additional one-day delay in

implementation equals the marginal benefits of the same incremental

delay. But it is not possible, at this stage, to determine the marginal

costs or benefits of each day of delay. To estimate such values

reliably requires data that does not yet exist--i.e., data gleaned in

the midst of the transition process. Therefore, neither the Commission

nor commenters are able to assert conclusively that any particular

schedule is more or less advantageous relative to all others that the

Commission might have considered. Thus, in the face of these practical

limitations, the Commission has relied on qualitative considerations,

informed by commenters, to guide the necessary tradeoff determinations.

The Commission, informed by its consideration of comments and

alternatives, discussed in the sections above and below, believes that

the approach contained in this adopting release is reasonable and

appropriate in light of the tradeoffs described above. The schedule

established here gives the Commission the opportunity to provide

additional time to entities in ways that generally align with: (1)

Their resources and expertise, and therefore their ability to comply

more quickly; and (2) their level of activity in the swap markets, and

therefore the possible impact of their swap activities on the stability

of the financial system. Entities with the most expertise in, and

systems capable to transact, swaps also are likely to be those whose

swaps represent a significant portion of all transactions in the swap

markets. They are more likely to be able to comply quickly, and the

benefits of requiring them to do so are greater than would be the case

for less active entities. On the other hand, entities with less system

capability and in-house swap expertise may need more time to comply

with Clearing Requirement determinations, but it is also likely that

their activities represent a smaller proportion of the overall market,

and therefore are less likely to create or exacerbate shocks to the

financial system.\34\ The Commission believes that Category 1

encompasses entities likely possessing more advanced systems and

expertise, and whose swap activities constitute a significant portion

of overall swap market transactions, while Categories 2 and 3 encompass

those likely to have relatively less developed infrastructure and whose

swap activities constitute a less significant proportion of the market.

---------------------------------------------------------------------------

\34\ OCC data demonstrates that among insured U.S. commercial

banks, ``the five banks with the most derivatives activity hold 96

percent of all derivatives, while the largest 25 banks account for

nearly 100% of all contracts.'' The report is limited to insured

U.S. commercial banks, and also includes derivatives that are not

swaps. However, swap contracts are included among the derivatives in

the report, constituting approximately 63 percent of the total

notional value of all derivatives. These statistics suggest that a

relatively small number of banks hold the majority of swap positions

that could create or contribute to distress in the financial system.

Data is insufficient, however, to generalize the conclusions to non-

banking institutions. See ``OCC's Quarterly Report on Bank Trading

and Derivatives Activities: Fourth Quarter 2011'' at 11. http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf.

---------------------------------------------------------------------------

The Commission notes that clearing of certain swaps, and in

particular interest rate and credit default swaps, has been occurring

for some time; by implication, this indicates that the requisite

technology, contractual terms, and operational standards among

clearinghouses, clearing members, and some clients exist.\35\ The

Commission also notes that it is likely that the degree to which firms

have already implemented such technology, contracts, and operational

patterns varies considerably, particularly among potential customers of

FCMs, and that the legal, technological, and operational changes that

are necessary for less frequent swap market participants may be more

substantial. However, given the availability of FCMs (through which

market participants may clear swaps) as well as the technology and

contractual standards necessary to clear swaps, the Commission believes

that a number of firms can reduce the costs associated with meeting

compliance timelines by forming necessary FCM relationships and

contracts, and implementing the necessary technology, before the

Commission begins issuing Clearing Requirement determinations.\36\

Nonetheless, the Commission considered these concerns, among other

issues, when determining to grant Category 2 and Category 3 Entities an

extended 180 and 270 days, respectively, rather than requiring them to

comply at the same time as Category 1 Entities.

---------------------------------------------------------------------------

\35\ For example, CME and ICE both began clearing credit default

swaps (CDS) in 2009. As of March 2012, ICE had cleared more than $11

trillion notional in CDS, and had 26 clearing members in CDS. CME

began clearing interest rate swaps in 2010 and currently has open

interest of $210 billion notional and 15 clearing members in

interest rate swaps. Moreover, by March of 2010, 26 of the largest

market makers were clearing interest rate derivatives. At that time,

ISDA asserted that ``In excess of 90% of new dealer-to-dealer volume

in Eligible Trades of Interest Rate Derivative products, and total

dealer-to-dealer volume in Eligible Trades of Credit Derivative

products is now cleared through CCPs.'' See http://www.newyorkfed.org/newsevents/news/markets/2010/100301_letter.pdf.

\36\ The Commission understands approximately 2.5 months is

sufficient for some market participants to enter into a clearing

arrangement with an FCM for purposes of clearing swaps. See External

Meeting with Blackrock, 4/2/2012. http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/dfmeeting_040212_1463.

---------------------------------------------------------------------------

Moreover, use of the schedule contained in this release is at the

Commission's discretion; in situations where the Commission determines

that the benefits of delayed implementation do not justify the

additional costs of such a delay, the Commission may require immediate

compliance with Clearing Requirement determinations. Therefore, in

situations where the Commission determines that a swap must be cleared,

and further believes that clearing the swap will not necessitate

significant changes to market participants' technology, legal

arrangements, or operational patterns, the Commission is likely to

determine that immediate compliance is

[[Page 44451]]

warranted. In these cases, the benefits of required clearing will be

realized immediately.

The discretionary nature of the schedule contained in the adopting

release, however, may create some uncertainty for market participants,

and consequently may create some costs as market participants take

steps to protect themselves from the impact of such uncertainty. For

example, if a market participant believes that the Commission may issue

a determination that a particular swap must be cleared, but is not

certain whether clearing will be required immediately or according to

the schedule contained in this release, that entity may begin

developing the capacity to clear such a swap prior to a determination

by the Commission in order to reduce the risk that it would be forced

to stop trading the swap while it comes into compliance. If that

participant's belief that the Commission will require the swap to be

cleared is incorrect, the participant will have unnecessarily borne the

cost of preparing for such a possibility. The Commission considered

this cost, but believes that the notice and comment approach that the

Commission will use when issuing Clearing Requirement determinations

mitigates it. Each proposed Clearing Requirement determination will be

published in the Federal Register and will be available for public

comment for a period of at least 30 days; the Commission anticipates

clarifying in each proposed Clearing Requirement determination whether

compliance will be required immediately upon the final determination or

according to the schedule contained in this rule. This approach will

provide market participants with notice regarding the expected timeline

for compliance, which will mitigate costs associated with uncertainty

about compliance timelines.

F. Consideration of Comments and the Costs and Benefits of Alternatives

Commenters propose or otherwise highlight points that suggest

alternatives with respect to various aspects of the NPRM.\37\ These

aspects, as categorized for discussion below, are: (1) Phased approach;

(2) entity categorization; (3) schedule increments; and (4) schedule

discretion.

---------------------------------------------------------------------------

\37\ Other commenters raise issues beyond the scope of this

rule--i.e., implementation timing of required clearing--that,

consequently, are beyond, and not appropriate for Commission

consideration in, this rulemaking. Specifically, some commenters

request that the Commission establish a comprehensive schedule for

implementation of all rules and requirements pursuant to the Dodd-

Frank Act. (See Barnard, MFA.) Others request a comprehensive

schedule of clearing requirement determinations (See, e.g., CDEU),

an issue already addressed by the Dodd-Frank Act and the rule

regarding the Process for Review of Swaps for Mandatory Clearing.

See section 2(h)(2)(B)(ii) of the CEA; 76 FR 44473.

---------------------------------------------------------------------------

Phased Approach

A number of commenters express support generally for additional

time to comply with Clearing Requirement determinations and for a

phased approach that distinguishes between various types of

entities.\38\ Commenters note that the additional clarity provided by

the schedule will encourage industry participants to commit resources

to overcoming structural and economic barriers that prevent widespread

clearing.\39\ Some commenters, however, maintain that the phased

approach used to implement clearing requirement determinations should

not be applied to exchange trade requirements.\40\ The AIMA believes

that effective required clearing will enable execution of swaps on SEFs

and DCMs and that linking the trading and clearing compliance schedules

could delay the transition into central clearing. In response to these

comments, the Commission has decided to limit the scope of this rule to

Clearing Requirement determinations, to retain the phased approach to

required clearing, and to address implementation of trade execution in

a separate rule.

---------------------------------------------------------------------------

\38\ See letters from Encana, Vanguard, ICI, FSR, MFA, FIA/ISDA/

SIFMA, AII, MarkitSERV, and AIMA.

\39\ See MFA letter.

\40\ See letters from AIMA and MFA.

---------------------------------------------------------------------------

Some commenters note that a phased approach could complicate

implementation for large investor advisor firms that may have multiple

funds in separate categories. Specifically, AII expresses concern that

it may be difficult for institutional advisers to execute block trades

for multiple clients during the implementation period because they will

have to consider whether each client must comply with the Clearing

Requirement. Nevertheless, AII recommends retaining the phased approach

with at least 18 months for entities to comply. The Commission

recognizes that such complexities exist and could introduce certain

costs for large investor adviser firms. However, it is not clear that

delaying the implementation period would alleviate this concern,

although prolonging the implementation period likely would exacerbate

the issue by extending the time during which such concerns are

relevant. Moreover, the Commission notes that the benefits of required

clearing are substantial and that further delays create costs borne by

market participants and the public. In these circumstances, the

Commission considers the latter consideration most compelling and,

accordingly, has determined not to delay implementation beyond what is

set forth in the schedule in the adopting release.

Finally, relative to the alternative of immediate implementation

following a Commission Clearing Requirement determination--the result

in the absence of this rule--the Commission believes that the phased

approach reflected in this adopting release is superior. The immediate

implementation alternative would not mitigate the costs, enumerated

above, to market participants and the public. In contrast, while

delaying implementation also entails a different set of costs, also

discussed above, the Commission has carefully tailored the rule's

phased approach to contain and dampen them.

Entity Categorization

Commenters generally agree that some buy-side representation in

Category 1 is valuable in order to ensure that buy-side interests are

represented as technological and legal standards begin to form,\41\

though commenters express varied views about whether Active Funds

should play that role, and what entities should be included in that

group. Some commenters state their belief that transaction volume is an

appropriate proxy for a firm's level of expertise in conducting swaps

and, therefore, is a useful criterion for identifying the buy-side

entities that are best equipped to make the transition as part of

Category 1.\42\ Some express concern, however, that as defined in the

NPRM, the term ``Active Fund'' could be over-inclusive and recommend

raising the threshold number of swaps or excluding swaps that are

hedges or have a notional value below $10 million.\43\

---------------------------------------------------------------------------

\41\ See AIMA letter.

\42\ See letters from Barnard and AIMA.

\43\ See letters from AII and CDEU.

---------------------------------------------------------------------------

The Commission's intent in selecting Active Funds to participate in

Category 1 is to identify those market participants that are larger and

have significant experience in the swap markets. To ensure that the

rule effectively selects for these entities, and in response to

commenters, the Commission has raised the threshold number of swaps

from a trailing average of 20 swaps per month over the previous twelve

months, to a trailing average of 200 swaps per month over the previous

twelve months. The Commission, however, believes that

[[Page 44452]]

further criteria restricting the swaps that are included against that

count would create incremental administrative and operational costs

that do not justify the resulting benefit, and therefore has not placed

further restrictions on the types of swaps that count against the

threshold. However, per commenters' request for clarification, the

Commission is clarifying that the average monthly threshold of swaps

applies to new swaps that the entity enters into, and it does not apply

to novations, amendments, or partial tear-ups.

ACLI maintains that there is diversity among buy-side participants

in their use of swaps, and expresses concern that Active Funds may not

be able to effectively represent diverse buy-side interests, and those

of insurance companies in particular. ACLI, however, does not describe

or quantify specific costs that it believes would result from this

circumstance.\44\ The Commission acknowledges that buy-side market

participants are diverse and may have specific needs reflecting

concerns or interests unique to individual industries or even

individual entities. However, the Commission also notes that the fact

of certain differences among firms does not exclude the possibility of

remaining similarities. Further, it believes that realizing the

benefits provided by some buy-side representation in Category 1 is

preferable to a scenario in which these benefits are foregone by

removing Active Funds from Category 1 for required clearing

implementation. Moreover, in the absence of any input as to how

dissimilarities may specifically impact the compliance implementation

process, the apparent solution to ACLI's concern would be to include

insurance companies in Category 1 to assure representation of their

interests earlier in the implementation process. While any Category 2

Entity or any other entity may elect to comply sooner than the schedule

requires (and are encouraged by the Commission to do so), the

Commission finds no basis to believe that the benefits of requiring all

insurance companies to participate in Category 1 warrant the additional

costs that such an approach would create for them.

---------------------------------------------------------------------------

\44\ See ACLI letter.

---------------------------------------------------------------------------

MFA expresses concern that questions related to the term ``Active

Fund'' could create an additional burden for fund operations and

Commission staff, and proposed that all private funds be placed in

Category 2 in order to eliminate this burden.\45\ MFA, however, does

not specify what these questions are, nor the cost to funds associated

with addressing them. In the absence of more specific information about

the nature of the potential questions and their associated costs, the

Commission has insufficient basis to conclude that costs to clarify

Active Fund issues--either for fund operators or itself--are likely to

be significant. Accordingly, it believes that the benefits of early-

stage, buy-side representation warrant retention of the Category 1

Active-Fund component.

---------------------------------------------------------------------------

\45\ See MFA letter.

---------------------------------------------------------------------------

Some commenters express concern about the definition of the term

Third-Party Subaccounts. They maintain that the Third-Party Subaccount

category should include any managed accounts, regardless of the level

of authority granted in the advisory agreement to enter into trading

agreements, on grounds that the operational and contractual challenges

for moving swaps related to these accounts into clearing will be much

the same regardless of whether the accounts' investment management

agreements have ``specific approval'' requirements.\46\ Similarly, some

commenters advocate in favor of including all ERISA plans in Category 3

given their expectations that (1) Category 2 entities will bear more

``start-up'' costs related to required clearing than those in Category

3, and (2) putting some ERISA plans in Category 2 and others in

Category 3 will make overlays more difficult and costly.\47\

Conversely, AIMA specifically states that making all funds Category 3

Entities is not a suitable approach because it would eliminate buy-side

representation during the early stages of implementation, and,

consequently, urges the Commission not to adopt this approach.\48\

---------------------------------------------------------------------------

\46\ See e.g., letters from ICI and AII.

\47\ See CIEBA letter.

\48\ See AIMA letter.

---------------------------------------------------------------------------

Furthermore, AIMA and FSR asserted that some Third-Party

Subaccounts may be ``private funds'' as defined in the Investment

Advisers Act of 1940 that would otherwise qualify as Active Funds; AIMA

expresses concern that allowing such funds 270 days to comply with

clearing requirements could provide them a competitive advantage

relative to other Active Funds that are not Third-Party Subaccounts for

the period of time between the compliance dates for Categories 1 and 3.

To level this playing field, AIMA proposes placing all Active Funds in

Category 1, regardless of whether the funds also meet the criteria for

a Third-Party Subaccount. In support of this proposition, AIMA opines

that large institutional managers of large numbers of Third-Party

Subaccounts are likely to have sufficient resources to make the

transition within the 90 days required of Category 1 Entities.

The Commission recognizes that some managed funds that do not

require third party sign-off for clearing agreements, nevertheless, may

choose to involve their clients in negotiation of relevant documents,

and that some costs may result from placing some managed funds and

ERISA plans in Category 2 and others in Category 3. After considering

the alternatives posed by commenters, the Commission has modified the

definition of Third-Party Subaccount to include managed accounts for

which the investment manager is responsible for clearing documentation,

regardless of whether the investment manager has explicit execution

authority. In addition, the Commission has determined not to include

ERISA plans in Category 2. The Commission has made these changes

despite the fact that commenters do not attempt to quantify the costs

associated with these provisions, nor do they recognize that such costs

must be considered against the costs of further delaying required

clearing implementation by a number of managed funds and ERISA plans. A

fundamental premise of the Dodd-Frank Act is that central clearing

minimizes risk to counterparties and the financial system as a whole;

therefore, further delaying implementation of one or more groups of

market participants creates costs associated with prolonged exposure of

the financial system to a greater number of un-cleared swaps.

Nonetheless, the Commission believes it appropriate to permit certain

market participants an additional 90 days to come into compliance with

the clearing requirement based on the comments received.

Schedule Increments

Some commenters express the opinion that 90, 180, and 270 days is

sufficient for Category 1, 2, and 3 Entities, respectively, to comply

with Clearing Requirement determinations.\49\ Several other commenters,

however, expressed concern that the additional time provided in this

rule may not be sufficient for some entities to comply.\50\ In that

vein, commenters state that the

[[Page 44453]]

schedules may not be sufficient for contract negotiations to be

completed,\51\ that pressing timelines could undermine the ability of

some entities to negotiate effectively,\52\ and that rapid compliance

may lead to the creation of industry standards that are not fair or

prudent.\53\ Some commenters also express concern that entities in

Categories 2 and 3 may not be able to find vendors able to provide

sufficient support to meet the deadlines effectively.\54\

---------------------------------------------------------------------------

\49\ See e.g., letters from Better Markets and MFA. MFA

qualifies its support, stating that certain additional rules should

be adopted prior to the schedule becoming effective, and also

requests changes to the entities included in each category, but

still generally supports the 90-, 180-, and 270-day implementation

schedule.

\50\ See e.g., letters from AII, CIEBA, ICI, FIA/ISDA/SIFMA, and

FSR.

\51\ See e.g., ACLI letter.

\52\ See letters from ACLI, AII, and CIEBA.

\53\ See letters from ACLI and ICI.

\54\ See letters from ACLI, CDEU, CIEBA, COPE, and EEI. COPE and

EEI specifically requested that the Commission determine whether

``off the shelf'' software is available to meet the needs of

entities that do not yet have necessary technology. Further

conversation clarified that both were concerned about technologies

that extend beyond those directly related to Clearing Requirements

established by the Act.

---------------------------------------------------------------------------

It is impossible to quantify the costs and benefits of one

particular schedule phase-in increment relative to another--e.g., 90

days to comply versus 110--and the permutations of such an exercise

would be endless, even if possible. Similarly, as discussed above,

whether the schedule included in this adopting release mitigates costs

to a greater degree than other increments the Commission might have

adopted as an alternative to immediate implementation of required

clearing (the result in the absence of this rule) is also a question

that cannot be resolved with precision. In light of these limitations,

however, the Commission has drawn upon its historical experience

monitoring clearing, as well as its consideration of the qualitative

feedback offered by market participants, in determining to incorporate

the 90-, 180-, and 270-day benchmark features within the schedule

adopted in this release. In so doing, the Commission believes that it

has selected a reasonable schedule that is appropriate and well-suited

to mitigate compliance pressures for market participants, and fairly

accommodate the various competing interests involved.

As is stated above, the Commission recognizes that extending the

compliance schedule for one or more entities will reduce compliance

costs for market participants in a number of different ways, but will

also increase the amount of time during which market participants and

the public do not benefit from the protections provided by mandatory

clearing.

Scheduling Discretion

Some commenters support the Commission's retention of discretion to

override the schedule in this release to require immediate clearing

when it believes that the benefits do not justify the associated

costs.\55\ These commenters note that over time market participants

will gain experience to enable swifter compliance with later Clearing

Requirement determinations, and maintain that, over time, the

compliance schedules will not be warranted for Clearing Requirement

determinations for new types, groups, or categories of swaps within an

asset class that are already subject to a prior Clearing

Requirement.\56\ Other commenters, however, support application of the

schedule to all Clearing Requirement determinations in order to reduce

uncertainty and facilitate orderly transitions to compliance.\57\

---------------------------------------------------------------------------

\55\ See letters from Barnard and MFA.

\56\ See letters from Barnard and MFA.

\57\ See letters from FHLB and ICI.

---------------------------------------------------------------------------

As discussed below, the Commission believes that the challenges of

compliance are likely to vary depending on whether previous Clearing

Requirement determinations have been made for other swaps in the same

class, how long previous Clearing Requirement determinations for swaps

in that class have been in place, the similarities between the swaps

addressed by a determination and swaps subject to previous

determinations, and a number of other factors. Therefore, the

Commission believes that the tradeoff between the costs and benefits of

more rapid compliance will vary as well. Where Clearing Requirement

determinations pertain to swaps that have important points of

similarity with swaps already required to be cleared, it is likely that

the costs associated with more rapid compliance will be significantly

less, and therefore the balance will shift in favor of a shorter

compliance deadline than would be allowed under the schedule contained

in this rule. Also, by including the applicable compliance schedule

within its public notifications of a proposed Clearing Requirement

determination, the Commission will mitigate uncertainty costs that

could result.

G. Consideration of Section 15(a) Factors

(1) Protection of Market Participants and the Public

Category 1 includes, among others, SDs as well as MSPs and Active

Funds. If SDs were not able to comply immediately with a Clearing

Requirement determination, and were not given additional time to

comply, they could choose to withdraw from the market as they work

toward compliance. Such withdrawal would create lost opportunities for

them as they fail to capture business that they would have otherwise

conducted during that period. If MSPs or Active Funds choose to

withdraw from the market while they work to come into compliance, it

could become more costly for them to either effectively create or hedge

certain exposures, which could also prompt them to leave certain risks

un-hedged that they would otherwise mitigate through the use of swaps.

By giving Category 1 Entities an additional 90 days to comply with

Clearing Requirement determinations, the schedule contained in this

adopting release reduces the likelihood of these entities withdrawing

from the swap markets while they work toward compliance; this, in turn,

reduces the probability that these Category 1 Entities will bear the

potential costs of un-hedged risk exposure.

Moreover, the Commission believes that SDs are an important source

of liquidity for swap market participants. If SDs withdraw from the

market while they work toward compliance, it could negatively impact

swap liquidity, increasing costs for market participants forced to

hedge certain risks through less efficient means (or not at all) for a

period of time. The costs of not hedging certain risks would be borne

not only by the firms that choose such an approach, but by the public

in the form of increased counterparty risk throughout the financial

system. Again, by providing additional time for SDs to comply with

Clearing Requirement determinations, the schedule in the adopting

release facilitates an orderly transition and reduces the likelihood

that the costs associated with SDs withdrawing from the market for a

period of time would materialize. The Commission considered this

benefit in light of the cost associated with delayed compliance among

Category 1 Entities and believes that an appropriate balance has been

struck.

The Commission also anticipates that the staggered compliance

schedule contained in this rule will, to some extent, enable Category 2

and 3 Entities to adopt technological, legal, and operational standards

developed by Category 1 Entities. To the extent that this occurs, it

will reduce the number of entities that are working in parallel to

develop solutions to the same problems by allowing Category 2 and 3

Entities some time to wait for Category 1 Entities and vendors to

develop viable solutions to technological, legal, and operational

challenges. Some of those solutions are likely to be proprietary, while

others

[[Page 44454]]

will likely relate to non-proprietary standards that must be shared in

order to be effective. Both types of advances can reduce costs for

Category 2 and 3 Entities. In the case of non-proprietary standards,

Category 2 and 3 entities will benefit from the opportunity to adopt

them without having to invest in their development. In the case of

proprietary solutions, some of them are likely to be owned by vendors

marketing them to multiple market participants, thereby spreading the

development costs among their clients. Each of these consequences is

likely to reduce overall development costs for the industry, and

development costs for Category 2 and 3 Entities, in particular.\58\

---------------------------------------------------------------------------

\58\ As indicated in the NPRM, to the extent that Category 1

Entities bear a larger portion of the industry wide ``start-up'' or

development costs, the Commission believes this is appropriate since

they are likely to be among the most active participants in these

markets.

---------------------------------------------------------------------------

In weighing the tradeoff between shorter versus longer compliance

timelines, the Commission believes Category 2 Entities are likely to be

less well-resourced and less active in these markets. Therefore the

dynamic between more or less rapid compliance tips in favor of

providing additional time for these entities. As stated above, by

providing 180 days, it becomes more likely that Category 2 Entities

will be able to draw from lessons learned and standards established by

Category 1 Entities. It also increases the likelihood that where

Category 2 Entities will depend on vendors for help developing and

implementing necessary technology, legal agreements, and operational

patterns, they will not have to compete as directly with Category 1

Entities for those resources.

The Commission believes that entities with Third-Party Subaccounts

have an additional challenge of transitioning hundreds (or in some

cases, thousands) of subaccounts into compliance with Clearing

Requirement determinations, which may require formalizing new

agreements with each of their customers, and educating their customers

about how the Clearing Requirement will impact costs and operations. In

the Commission's view, this additional challenge justifies additional

time for compliance beyond what is allowed for Category 2 Entities.\59\

---------------------------------------------------------------------------

\59\ As stated in the NPRM, Category 2 and 3 Entities that want

to come into compliance sooner than the 180- and 270-day deadlines

are allowed, and encouraged, to do so.

---------------------------------------------------------------------------

As described above, the Commission recognizes that delaying

implementation creates some additional costs in the form of delayed

protections that central clearing of swaps would otherwise provide--

standardized and reduced counterparty risk for swaps that are required

to be cleared, and associated reductions in the overall level of

systemic risk. However, the Commission believes that this approach

appropriately balances the tradeoff by requiring firms that are likely

to be the most active in these markets to comply first and allowing

additional time for those whose positions are less likely to pose

significant risk to the financial system as a whole.

(2) Efficiency, Competitiveness, and Financial Integrity of Futures

Markets

As suggested above, Category 1 Entities are likely to establish

technological, legal, and operational standards that will influence or

be adopted by Category 2 and 3 Entities. This will (1) serve to reduce

development costs that Category 2 and 3 Entities otherwise would face,

(2) focus responsibility for shaping new platforms and standards on

those firms that possess greater cleared swap experience, and (3)

support the likelihood that new platforms and standards will reflect

current best practices. Each of these elements promotes the efficiency

and integrity of the markets. Moreover, by reducing the number of

entities necessarily working in parallel to develop such standards, and

allowing Category 2 and 3 Entities to learn from and build on the

solutions developed by Category 1 Entities, the phased schedule

contained in this adopting release holds the potential to foster

compatibility and interoperability, which reduces the cost and

complexity of interconnectedness.

The phased schedule as adopted also will promote an implementation

plan in which similar entities (i.e., those that usually compete with

one another) generally have the same compliance timelines, thereby

protecting competition during the transition period. One commenter

states, ``A phased approach to compliance will allow the Commission to

balance its goal of obtaining adequate representation at each stage of

the regulatory roll-out with the goal of avoiding anti-competitive

concerns.'' \60\

---------------------------------------------------------------------------

\60\ See ICI letter.

---------------------------------------------------------------------------

That said, however, the Commission also has to balance the goal of

maintaining a level playing field with other priorities. In particular,

the Commission deems it important to ensure representation of both buy

and sell side firms in the earliest stages of compliance. Moreover, the

Commission believes that, in certain circumstances, variance in

compliance burden among competitors warrants placing them in different

implementation categories. Some competitive consequences may result

from the need to balance these various priorities. The Commission

believes, however, that it has built sufficient flexibility into the

phased schedule to mitigate such consequences; specifically, the

schedule preserves entities' ability to respond to competitive

incentives to move into clearing voluntarily prior to the date required

by the compliance schedule. The Commission believes that providing

flexibility to allow expression of competitive market incentives is

preferable to the alternative of imposing a more compressed compliance

schedule for purposes of maintaining a level playing field. As

discussed above, a shorter schedule could also increase the likelihood

that industry standards established during the implementation period

could create and perpetuate undesirable competitive dynamics. In sum,

the Commission anticipates that any temporary impacts on competitive

dynamics created by the phased implementation approach it is adopting

are likely to be less costly than an approach that increases the

likelihood of sustained competitive disparities, and therefore has

chosen not to shorten the compliance schedule as a remedy to address

the risk of competitive advantages that may be conferred on market

participants that have later compliance dates.

As discussed above, for the 90-, 180-, and 270-day periods that

Clearing Requirements are delayed, the markets are exposed to the risks

that the Clearing Requirements would mitigate. However, the Commission

has considered this cost for the limited delay durations prescribed in

light of the benefits--reduced implementation costs, greater degrees of

compatibility and interoperability, and lessened risk of market

disturbances from the withdrawal of entities that are not able to

comply immediately--and considers the tradeoff reflected in the rules

warranted.

(3) Price Discovery

Neither the Commission nor commenters have identified consequences

for price discovery that are expected to result from this rule.

(4) Sound Risk Management Practices

An orderly transition for swaps subject to a Clearing Requirement

determination promotes sounder risk management practices, particularly

during the transition period. As mentioned above, in the absence of the

[[Page 44455]]

schedule provided in this rule, some entities might exit swap markets

while taking steps to come into compliance. This result could reduce

liquidity, particularly if the withdrawing entities are SDs. Reduced

liquidity likely would increase the cost of using swaps to manage risk

by increasing spreads, and make it more difficult for entities to enter

and exit positions in a timely manner. It could also prompt some

entities to maintain exposures that they would otherwise use swaps to

mitigate, which would elevate the risk profile of those entities and

the level of risk that their counterparties bear as a consequence. By

providing a timetable for orderly transition, this rule encourages

continued participation in the swap markets and use of swaps for risk

mitigation purposes during the transition.

Clearing Requirement delay does prolong existing costs associated

with not having counterparty credit risk monitored and managed

effectively by a DCO. More prompt implementation of Clearing

Requirements would have the benefit of preventing losses from

accumulating over time through the settlement of variation margin

between a DCO's clearing members each day. The settlement of variation

margin each day (and in some cases, multiple times per day) reduces the

size of exposures a clearinghouse faces should one of its

counterparties default, and the mechanisms that a clearinghouse has to

ensure its own solvency reduce the probability that it would default on

obligations to clearing members. Moreover, more prompt implementation

also promotes the use of initial margin as a performance bond against

potential future losses such that if a party fails to meet its

obligation to pay variation margin, resulting in a default, the DCO may

use the defaulting party's initial margin to cover most or all of any

loss based on the need to replace the open position. The Commission

believes, however, that (1) it has tailored the rule to limit the

degree, and thereby these costs attributable to, clearing

implementation delay and (2) the benefits afforded by the schedule's

operation when the Commission elects to use it warrant the costs of the

tailored implementation delay.

(5) Other Public Interest Considerations

The schedule allows market participants to comply with the

requirements of the Dodd-Frank Act and provides a sound basis for

achieving the overarching Dodd-Frank Act goals of reducing counterparty

risk and promoting stability of the financial system.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) requires that agencies

consider whether the rules they propose will have a significant

economic impact on a substantial number of small entities and, if so,

provide a regulatory flexibility analysis respecting the impact.\61\ As

stated in the NPRM, the subject of this rulemaking provides a

compliance schedule for a new statutory requirement, section 2(h)(1)(A)

of the CEA, and does not itself impose significant new regulatory

requirements.\62\ Accordingly, the Chairman, on behalf of the

Commission, certified pursuant to 5 U.S.C. 605(b) that the proposed

rule would not have a significant economic impact on a substantial

number of small entities. The Commission then invited public comment on

this determination.

---------------------------------------------------------------------------

\61\ 5 U.S.C. 601 et seq.

\62\ 76 FR 58192-58193 (Sept. 20, 2011).

---------------------------------------------------------------------------

FSR comments that the NPRM failed to evaluate the impact of the

proposed compliance schedule for the Clearing Requirement on a

substantial number of small entities. FSR argued that small entities

may have to bear a more significant burden than larger entities in

establishing clearing arrangements with FCMs because larger entities

will be able to enter into such arrangements first.

In response, the Commission points out that the compliance schedule

for the Clearing Requirement will affect only eligible contract

participants (ECPs). Pursuant to section 2(e) of the CEA, only ECPs may

enter into swaps, unless the swap is listed on a DCM. The Clearing

Requirement will affect only ECPs because all persons that are not ECPs

are required to execute their swaps on a DCM, and all contracts

executed on a DCM must be cleared by a DCO, as required by statute and

regulation; not by operation of any Clearing Requirement.

The Commission has previously determined that ECPs are not small

entities for purposes of the RFA.\63\ However, in their comment letter,

the Joint Associations assert that certain members of the National

Rural Electric Cooperative Association (NRECA) may both be ECPs under

the CEA and small businesses under the RFA. These members of NRECA, as

the Commission understands, have been determined to be small entities

by the Small Business Administration (SBA) because they are ``primarily

engaged in the generation, transmission, and/or distribution of

electric energy for sale and [their] total electric output for the

preceding fiscal year did not exceed 4 million megawatt hours.'' \64\

Although the Joint Associations do not provide details on whether or

how the NRECA members that have been determined to be small entities

use the types of swaps that will be subject to the Clearing

Requirement, the Joint Associations do state that NRECA members

``engage in swaps to hedge commercial risk.'' \65\ Because the NRECA

members that have been determined to be small entities would be using

swaps to hedge commercial risk, the Commission expects that they would

be able to use the end-user exception from the Clearing Requirement and

therefore would not be affected to any significant extent by the

Clearing Requirement.

---------------------------------------------------------------------------

\63\ See 66 FR 20740, 20743 (Apr. 25, 2001).

\64\ Small Business Administration, Table of Small Business Size

Standards, Nov. 5, 2010.

\65\ See Joint Associations' comment letter, at 2. The letter

also suggests that NRECA members are not financial entities. See

id., at note 5, and at 5 (the associations' members ``are not

financial companies'').

---------------------------------------------------------------------------

Thus, because nearly all of the ECPs that may be subject to the

Clearing Requirement are not small entities, and because the few ECPs

that have been determined by the SBA to be small entities are unlikely

to be subject to the Clearing Requirement, the Chairman, on behalf of

the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the

rule herein creating the compliance schedule for the Clearing

Requirement will not have a significant economic impact on a

substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act (PRA) \66\ imposes certain requirements

on federal agencies (including the Commission) in connection with

conducting or sponsoring any collection of information as defined by

the PRA. As stated in the NPRM, this rulemaking will not require a new

collection of information from any persons or entities.\67\

---------------------------------------------------------------------------

\66\ 44 U.S.C. 3507(d).

\67\ 76 FR 58186, 58193 (Sept. 20, 2011).

---------------------------------------------------------------------------

V. List of Subjects

List of Subjects in 17 CFR Part 50

Business and industry, Clearing, Swaps.

In consideration of the foregoing, and pursuant to the authority in

the Commodity Exchange Act, as amended, and in particular section 2(h)

of the Act, the Commission hereby adopts an amendment to Chapter I of

Title 17 of the Code of Federal Regulation by adding a new part 50 as

follows:

[[Page 44456]]

PART 50--CLEARING REQUIREMENT

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

1376.

Sec. 50.25 Clearing requirement compliance schedule.

(a) Definitions. For the purposes of this paragraph:

Active Fund means any private fund as defined in section 202(a) of

the Investment Advisers Act of 1940, that is not a third-party

subaccount and that executes 200 or more swaps per month based on a

monthly average over the 12 months preceding the Commission issuing a

clearing requirement determination under section 2(h)(2) of the Act.

Category 1 Entity means a swap dealer, a security-based swap

dealer; a major swap participant; a major security-based swap

participant; or an active fund.

Category 2 Entity means a commodity pool; a private fund as defined

in section 202(a) of the Investment Advisers Act of 1940 other than an

active fund; or a person predominantly engaged in activities that are

in the business of banking, or in activities that are financial in

nature as defined in section 4(k) of the Bank Holding Company Act of

1956, provided that, in each case, the entity is not a third-party

subaccount.

Third-party Subaccount means an account that is managed by an

investment manager that is independent of and unaffiliated with the

account's beneficial owner or sponsor, and is responsible for the

documentation necessary for the account's beneficial owner to clear

swaps.

(b) Upon issuing a clearing requirement determination under section

2(h)(2) of the Act, the Commission may determine, based on the group,

category, type, or class of swaps subject to such determination, that

the following schedule for compliance with the requirements of section

2(h)(1)(A) of the Act shall apply:

(1) A swap between a Category 1 Entity and another Category 1

Entity, or any other entity that desires to clear the transaction, must

comply with the requirements of section 2(h)(1)(A) of the Act no later

than ninety (90) days from the date of publication of such clearing

requirement determination in the Federal Register.

(2) A swap between a Category 2 Entity and a Category 1 Entity,

another Category 2 Entity, or any other entity that desires to clear

the transaction, must comply with the requirements of section

2(h)(1)(A) of the Act no later than one hundred and eighty (180) days

from the date of publication of such clearing requirement determination

in the Federal Register.

(3) All other swaps for which neither of the parties to the swap is

eligible to claim the exception from the clearing requirement set forth

in section 2(h)(7) of the Act and Sec. 39.6, must comply with the

requirements of section 2(h)(1)(A) of the Act no later than two hundred

and seventy (270) days from the date of publication of such clearing

requirement determination in the Federal Register.

(c) Nothing in this rule shall be construed to prohibit any person

from voluntarily complying with the requirements of section 2(h)(1)(A)

of the Act sooner than the implementation schedule provided under

paragraph (b).

Issued in Washington, DC, on July 24, 2012, by the Commission.

Sauntia Warfield,

Assistant Secretary of the Commission.

Appendices to Swap Transaction Compliance and Implementation

Schedule: Clearing Requirement under Section 2(h) of the CEA--

Commission Voting Summary and Statements of Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 1--Statement of Chairman Gary Gensler

I support the final rule to establish a schedule to phase in

compliance with the clearing requirement provisions in the Dodd-

Frank Wall Street Reform and Consumer Protection Act.

The rule gives market participants an adequate amount of time to

comply and helps facilitate an orderly transition to the new

clearing requirements for the swaps market. The rule provides

greater clarity to market participants regarding the timeframe for

bringing their swaps into compliance with the clearing requirement.

[FR Doc. 2012-18383 Filed 7-27-12; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: July 30, 2012